Cohu Q3 2023 Earnings Call Transcript

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November 2, 2023

There are 7 speakers on the call.

Operator

Welcome to Cohu's Third Quarter 2023 Financial Results Conference Call. At this time, all participants are in a listen only mode. After the speakers' presentation, there will be a question and answer session. You will then hear an automated message advising your hand is raised. Please be advised that today's conference is being recorded.

Operator

I would now like to hand the conference over to your host today, Jeff Jones, Chief Financial Officer.

Speaker 1

Good afternoon, and welcome to our conference call to discuss Cohu's Q3 2023 results and Q4 2023 outlook. I'm joined today by our President and CEO, Luis Muller. If you need a copy of our earnings release, you may access it from our website at cohu.com or Contacting Cohu Investor Relations. There's also a slide presentation in conjunction with today's call that may be accessed on Cohu's website In the Investor Relations section, replays of this call will be available via the same page after the call concludes. Now to the Safe Harbor.

Speaker 1

During today's call, we will make forward looking statements reflecting management's current expectations concerning Cohu's future business. These statements are based on current information that we have assessed, but which by its nature is subject to rapid and even abrupt changes. We encourage you to review the forward looking statements section of the slide presentation and the earnings release as well as Cohu's filings with the SEC, including the most recently filed Form 10 ks and Form 10 Q. Our comments speak only as of today, November 2, 2023 and Cohu assumes no obligation to update these statements for developments occurring after this call. Finally, during this call, we will discuss certain non GAAP financial measures.

Speaker 1

Please refer to our earnings release and slide presentation for reconciliations to the most comparable GAAP measures. Now I'd like to turn the call over to Luis Mueller, Cohu's President and CEO. Luis?

Speaker 2

Good afternoon. 3rd quarter gross margin and profitability were again strong driven by higher than forecasted margin on testers And Cohu's resilient recurring business. Q3 non GAAP gross margin of 47.1 That was 51% of Q3 total revenue. On October 2, we announced the acquisition of equip test engineering, which we refer to as EQT, with the goal to expand our test interface products and recurring revenue That continues to deliver resilient profitability through industry cycles. EQT's trailing 12 months revenue was approximately $20,000,000 Selling primarily semiconductor test contactors to Tier 1 IDM and OSAT customers.

Speaker 2

The rationale for the acquisition is to broaden our product portfolio in mid- to high power test contactors, Better serving our automotive and industrial semiconductor customers. EQT also enhances our complex machining capability And manufacturing expertise expands engineering capacity and customer presence in Southeast Asia. This acquired business will contribute 3 months revenue to our 4th quarter guidance and it is forecasted to be accretive to Q4 adjusted EBITDA. In support of plans to grow Cohu's Interface business, we're constructing a new 92,000 Square Foot facility in the Philippines that is Approximately 85% complete and targeted to be operational in the first half of twenty twenty four. As we have been communicating, it remains our strategy to expand recurring revenue, which was $322,000,000 over the last 12 months With a 3 year compound growth rate of 6% through Q3.

Speaker 2

The service portion of this revenue has delivered a year to date renewal rate of 92% in 2023 with customers increasingly relying on Cohu personnel to support the large active installed base Of over 24,600 systems across 108 customers. In the 3rd quarter, We landed 3 new applications for test contactors at Cohu's Tier 1 customers with an estimated potential We also received orders from 2 new customers for DI Core to monitor equipment performance In a first order for AI inspection, that is a new module in our software suite that provides artificial intelligence services to increase vision yield. We continue to make progress with DI Core, adding new capabilities and expanding the software as a growth service model for the company. This is still at the beginning of a long journey to grow software services, but one we view as a very attractive business Switching over to Cohu's Systems business, it contributed 49% of 3rd quarter revenue, decreasing 2 points quarter over quarter in reflecting weak demand across all markets. Estimated test cell utilization Remained flat quarter over quarter at 73%, with Automotive and Industrial down 1 point sequentially.

Speaker 2

Utilization in the Consumer segment was 2 points up and Mobility increased by 1 point. All small changes, but more indicative of the inventory digestion coming to an end, particularly in the smartphone market. The Computing segment showed a 2 point sequential utilization decline, following what has been a small increase in demand to test AI related GPUs in prior quarters. At the macroeconomic level, with the ongoing Russia Ukraine conflict and now the Hamas Israel conflict. And while the economy adapts to a higher interest rate environment and continuing trade restrictions with China, It is not surprising that customers are taking a more cautious approach on capital spending.

Speaker 2

It is too soon to forecast market dynamics And revenue for 2024, but perhaps safer to remain cautious on near term revenue projections and assume this market downturn will last longer than we originally expected and into the first half of next year. We're modeling incremental growth in the second half of twenty twenty four in line with our customers' recent forecasts. We remain optimistic on the long term prospects for the technology industry and in particular semiconductor test markets. And as usual, the longer it takes for a recovery inflection, the steeper the upcycle ramp will be. However, In the near term, we will continue to look for ways to lower quarterly expenses while focusing on customer design wins and qualification on new products To deliver organic growth when market conditions improve, we will continue executing our strategy to grow recurring business, Broaden the use of Diamond X into automotive and industrial customers, add to our inspection and metrology portfolio and increased subscriptions to our Emergent Software business.

Speaker 2

Let me now turn it over to Jeff to provide further details on 3rd quarter results And Q4 guidance.

Speaker 1

Jeff? Thanks, Luis. Before I walk through the Q3 results and Q4 guidance, please note that are included in the accompanying earnings release and investor presentation, which are located on the Investor page of our website. Now turning to the Q3 financial results. Cohu delivered strong profitability on revenue of $150,800,000 which is slightly higher than our guidance.

Speaker 1

During the Q3, 2 customers in the automotive market each accounted for more than 10% of sales. Q3 gross margin was strong at 47.1%, about 110 basis points higher than guidance, driven by Cohu's resilient recurring business and differentiated products. Operating expenses for Q3 were approximately $1,000,000 lower than guidance At $49,000,000 3rd quarter non GAAP operating income was 14.7 percent of revenue And adjusted EBITDA was 16.5%. The non GAAP effective tax rate for Q3 was approximately 28% and higher than guidance due to the projected concentration of annual pretax income in higher tax rate jurisdictions and capitalized R and D. Non GAAP EPS for the 2nd quarter was $0.35 In summary, Q3 gross margin and adjusted EBITDA were strong, exceeding the midterm financial targets at this level of revenue.

Speaker 1

Moving to the balance sheet. Cash flow from operations in Q3 was 29,000,000 And cash and investments grew to $388,000,000 at the end of Q3. Debt repayment in the 3rd quarter totaled $1,000,000 And we ended Q3 with net cash of $7.20 per share. Cohu shares repurchased in Q3 totaled $4,700,000 And CapEx in Q3 was $4,000,000 with approximately $3,000,000 related to construction of the new Philippines facility To support long term growth prospects in our Interface business, total CapEx for 2023 including the new building is The share repurchase program and investment opportunities like EQT to expand our served markets and technology portfolio in line with our growth strategy. The acquisition of EQT occurred in early Q4 and utilized approximately $48,000,000 of cash.

Speaker 1

Now moving to our Q4 outlook. We're guiding Q4 revenue to be in the range of 136,000,000 Plus or minus $6,000,000 reflecting continued weakness across end markets and low test cell utilization at customers' production facilities. Q4 gross margin is forecasted to be approximately 46%, better than the financial target model at this level of revenue. Gross margin for full year 2023 is forecasted to be approximately 47% and in line with 2022 results Despite approximately 20% lower year over year revenue, the strong gross margin performance is due in large part to Cohu's differentiated products And our stable high margin recurring business, which adds resilience to profitability and provides consistent cash flow Through industry cycles, operating expenses for Q4 are projected to increase $1,000,000 quarter over quarter to approximately $50,000,000 Due to the addition of EQT, the balance of Cohu's expenses are flat quarter over quarter. We continue to exercise tight control over operating expenses and look for opportunities to lower spending going into next year Without sacrificing critical new product investments and maintaining profitability while navigating through the trough of this cycle, We're projecting Q4 interest expense to be approximately $1,000,000 and offset by interest income of approximately $2,000,000 We expect Q4 adjusted EBITDA to be approximately 12%.

Speaker 1

The Q4 forecasted non GAAP tax rate is approximately 26%. The diluted share count for Q4 is expected to be approximately 48,100,000 shares. That concludes our prepared remarks. And now we'll open the call to questions.

Operator

Our first question comes from the line of Charles Hsieh with Needham and Company. Charles, your line is now open.

Speaker 3

Hello, can you hear me?

Operator

Yes, we can hear you now.

Speaker 3

Hey, good afternoon, Luis and Jeff. Thanks. I just want to start with the first question Then on the Q4 guide, I thought about a quarter ago, you were expecting maybe flattish environment in Q4, but it seems like it's weakened a little bit. Can you kind of walk us through what the puts and takes In terms of the Q4 and if any early indication about Q1 next year, that would be great. Thanks.

Speaker 2

Hi, Charles. This is Luis. Yes, we in Q4, in terms of puts and takes, we actually saw continued Caution buying from our automotive and industrial customers sorry, in the Q3 going into Q4. At the same time, we see some of these customers starting to push out some of the deliveries and some of the orders Into 2024, as I said in my prepared remarks, auto and industrial came down utilization came down about a point In the quarter, and I wouldn't be surprised if that doesn't decline another point or a couple of points in the Q4. At the same time, we saw a little bit of an opposite trend on the mobility side, where utilization has improved a point Quarter over quarter, in fact, mobility was the only segment across the board that in absolute dollar terms, We saw an increase in orders on the Q3.

Speaker 2

Nevertheless, as you know, Cohu's business is much more indexed George, automotive and industrial analog semiconductor customers. So what we're seeing here is what you're seeing from our customers' announcement as you had a few of the Large analog semiconductor customers guiding next quarter down, we're seeing the same behavior. And quite honestly, at this time, we're not going to be calling out specificity to Q1 next year. I think we're going to go Quarter on quarter here. As we see this thing evolve and looking for the another improvement or

Speaker 3

Thanks. Maybe a follow-up question. I think you made a commentary you made a comment on test I saw utilization versus your projected revenue levels. Obviously, utilization seems to be flattening out, I mean, overall, from Q3 to Q4, but the revenue is down a bit, right, given some of the And usually would indicate what kind of revenue level or such correlation doesn't exist? Thanks.

Speaker 2

We tend to see capacity additions when utilizations are above 80% atorabove80%. And below that, they tend to be more technology driven or customers winning a new device application, a new Socket to their end customers. So again, capacity adds on the capital equipment side, 80% and above, otherwise more technology driven. On the recurring side, it typically goes point for point, Utilization drops a point, you could see recurring drop a point. So recurring is a lot more stable as we see utilization Fluctuating just a couple of points up and down.

Speaker 2

But as you pointed out, at the end of Q3 utilization was flat over quarter over quarter from the end of Q2.

Speaker 3

Thanks, Luis.

Operator

Our next question comes from the line of Brian Chin with Stifel.

Speaker 4

Hi, Brian Chin at Stifel. Maybe to start off with maybe financial model, I think your guidance suggests gross and operating margins maybe 400 to 600 basis points higher this down cycle. I guess, firstly, does this feel like trough revenue? And secondly, can you discuss the key changes in the model trough to trough that Allow the company to better protect profitability in challenging market conditions?

Speaker 1

Yes. It Certainly does feel like a trough, but as Louis said, we don't have a lot of clarity on the first half of next year. So we're just kind of playing that Week by week here. As you referenced, Brian, we just go back to 2021 With much higher revenue, but gross margins were in the 40% range. And so over that time, we've done We've made a lot of improvements in reducing costs, primarily in the handler products as well as the contactor products.

Speaker 1

We've had some price increases to cover some of the inflationary costs that we've incurred. But Again, we've done a lot to reduce product costs, improve manufacturing efficiencies, productivity, things of that nature. So now as I stated in my remarks, revenue down approximately 20% year over year And we're holding a 47% gross margin, which was essentially the same as last year. So Margin has been very resilient. As you know, recurring revenue carries a higher gross margin.

Speaker 1

And as Luis stated, that's less susceptible To the volatility of the cycle, and so that's obviously helpful as that becomes a higher percentage of our total revenue. And that's why it's really a key part of our strategy as well to grow the recurring revenue.

Speaker 4

Very great. Thanks for the color. And then maybe for Luis for a follow-up. Is the 4Q revenue decline sort of equal parts Auto and Industrial. And in the past, you've talked about the composition of your auto revenue as being kind of equally distributed across EV, ADAS and traditional auto.

Speaker 4

Based on the incremental softness you're seeing, can you distinguish which of those buckets are more impacted or resilient? And does that give you any optimism regarding either duration or magnitude slowdown in those markets?

Speaker 2

Yes. So the let me start from the back here. The distribution The distribution across ADAS and EV and everything else auto is, It still stays about the same. I think we're about a third currently about a third on each one of those segments. As far as the drop quarter over quarter, we saw really a 6 points drop on the revenue associated with automotive and a 4 point drop on Revenue associated with industrial markets.

Speaker 2

So in reality, you look at this proportionally looking at the revenue size, it's More auto related than actually industrial related quarter over quarter, Q2 to Q3. As far as I think the other question is confidence on a go forward basis. Generally speaking, We see many of our auto and industrial customers, they tend to be the same customers by the way, investing significant CapEx In facility constructions this year and we have been told the plan is and continues to be To tool up those facilities because across the board, the forecast for semiconductor growth in the automotive market For a 16% CAGR through 2026, if I'm not mistaken, And industrial is 9%. So the forecast continues to be that both automotive and industrial are the highest growing Semiconductor segments, to bat on, but the expectation is facility constructions coming online, Tooling up of those facilities start at some point next year. The question really the $100,000,000 questions here is, Do we start seeing those orders in Q2 or do we start seeing them already at the late part of Q1?

Speaker 2

That's still an open question. Okay, great.

Speaker 4

Thank

Operator

you. Our next question comes from the line of Krish Sankar With TD Cowen.

Speaker 5

Hi, this is Bob Mertens on My first one is just in terms of the tests utilization. I know you gave some color on the individual Market segments and how those progressed through the quarter, but just sort of looking ahead into the December quarter, just trying to think of how you would expect Each end market to progress, is it sort of across the board with the utilization probably dipping down? Or is there any segment that

Speaker 2

So we don't typically forecast utilization, Bob, But I'll give you my sort of qualitative perspective here. We've seen the Something I haven't mentioned in the prepared remarks, we've seen OSAT utilization picking up 3 points quarter over quarter from Q2 to Q3 and IDMs down 1 point. And I think that correlates well with also by market with automotive and industrial down a point and mobility up 1 and consumer up 2 points. I would venture to say that based on current order forecast that the mobility and consumer market will continue to trend up by the end of Q4 and that automotive and industrial may continue to trend down by the end of Q4. How does that going to shape out from the 73% approximately 73% utilization we are today?

Speaker 2

I don't know. I think there are 2 competing forces here. 1 is the automotive industrial market pausing for a quarter or 2, And the other one is the mobility and the consumer is starting to pick up some momentum as we start to see inventory levels flush out in those 2 segments.

Speaker 5

Got it. That's helpful. And then just quickly on the acquisition, in terms of the revenue profile, I just want to make sure I heard you right. Did you say that was the business is more geared towards the Industrial and automotive markets in terms of that $20,000,000 trailing 12 month revenue profile?

Speaker 2

That is correct. EQT had a trailing 12 months revenue of approximately $20,000,000 it's all recurring and it was more tailored towards the automotive and industrial They were doing a good job serving a few Tier 1 IDM customers and OSATs in Southeast Asia. And for us, it really adds to our portfolio, particularly in the mid to high power test contactor segment. So think about more in terms of EV and power management in the vehicle or in and out on our industrial application.

Speaker 5

Okay, great. Thank you.

Operator

Our next question comes from the line of Christian Schwab with Craig Hallum Capital.

Speaker 5

Hey, great. Thanks for taking my question. Most of them have been answered. I just have one. Last quarter, we talked about $30,000,000 worth of handler orders that were going to be pushed out, that you thought were going to be accepted.

Speaker 5

Obviously, from your guidance, that's not happening. So can you give us an update of what's What do you think is going on there, please?

Speaker 2

Well, we do have, we had about 100 systems that We're sitting waiting on testers to be integrated. That number has come down substantially now. So what we see today is really a weaker demand of the automotive and industrial market going into the Q4. That's And I'm kind of restating what I said before, but that's pretty much the status.

Speaker 5

Okay. So that We've kind of satisfied all of that, it appears. Okay. So as we begin

Speaker 2

Christian, just to clarify, it's never 0, right? But that number has come back to a normalized level We typically see on a quarter over quarter as we wait on testers and I'm assuming in some cases testers are waiting on handlers as well.

Speaker 5

Okay. Okay. That was my only question. Thank you.

Speaker 2

Welcome.

Operator

Our next question comes from the line of Craig Ellis with B. Riley Securities.

Speaker 6

Yes. Thanks for taking the question. Luis and Jeff, I wanted to follow-up on some of the inquiry just about The demand environment, but do it in a different way and maybe in a way that sheds some light on the business a little bit longer term, even though I think Visibility is slow, so it's hard to draw the arc of what next year's revenues would look like. So what I wanted to Tremendous are going for you across your different businesses. Are they pointing to things that Leave you confident that there's increased share of wallet, SAM expansion and success for some of your Newer, more emerging product drivers or in this environment, are you finding that some of those avenues are closing down?

Speaker 6

Just help us understand what the Customer engagement activity looks like please.

Speaker 2

Yes. Craig, the funny thing is When markets are down is when the customer engagements usually go up and the demand on engineering goes up. We have had an email exchange just before this call about a customer that had done an acquisition into space that they were not participating in. And now talking about qualification of one of our product lines to satisfy This new set of products that they're bringing to market, that's one example. We have a few engagements on the Diamond X Tester platform For particularly the analog PMIC space, but as I commented not too long ago actually, It's very interesting to go through these qualifications and hear the great performance and how much faster your test time is relative to the Current incumbent and how wonderful it is, but it's a little sad to hear, let's get back and when we have incremental Capacity needs will start buying the tester.

Speaker 2

Well, that happens to be not now, not this quarter. So we do have Quite a few engagements on the Diamond X analog PMIC side. As you can imagine, less Fewer engagements on the handler side just simply because of our very dominant market share in the handler space. We are already serving all the large customers. We have quite a bit of activity on the contactor side.

Speaker 2

They tend to be a longer list of smaller wins versus the typical capital equipment where you really Count the engagements on one hand and they could mean $10,000,000 $15,000,000 $20,000,000 So To sum up, a lot of activity engineering is extremely busy and that's usually the case in a down market environment. And that's why, as Jeff pointed out, we will continue to look for ways to lower OpEx on the downturn, but we also don't want to Cut back from those critical new product developments and customer engagements that those are very important to be In the right place at the right time when the market turns up and the demand picks up again.

Speaker 6

That's really helpful, Luis. The Next question I wanted to get into is related to the EQT deal. So you might have mentioned it, Jeff, but Given that this is a $20,000,000 trailing 1 year revenue company, is it fair to think that you've baked in about $5,000,000 And to guidance and the more longer term question is, can you just walk us through some of the integration steps with this business and How long would it be before you could look for another tuck in like this to further bolster recurring?

Speaker 1

Well, I think we're ready to go. We were looking for the next opportunity right now. So we're ready. If there was another opportunity out there, I think we could capitalize on that pretty quickly. With respect to the revenue outlook, They're not immune to the downturn either.

Speaker 1

So it's not a full run rate or $5,000,000 that you mentioned. It's a number that's Lower than that. And then, sorry, I think I'm missing one of your questions there.

Speaker 6

I was just talking about some of the steps on integration of EQT as well

Speaker 2

as Jeff.

Speaker 3

What's involved there?

Speaker 1

The approach on EQT is to really sort of maintain their operations sort of as is for the foreseeable future, and we think we have opportunities more on the front end. We also think we have some opportunities perhaps to Move some of our qualifications, new products into their manufacturing operation and gain some efficiencies through their operating technology. So As opposed to the typical, we're going to gain X $1,000,000 of cost synergies, We're thinking more on the sort of operations, technology, as well as something on the revenue front.

Speaker 2

Yes. I was just going to add on the revenue front. They do have a few products that are interesting to our customer base. So We're starting the dialogue to get qualifications going on some of the EQT product lines.

Speaker 6

And how long would that call process take?

Speaker 2

Realistically speaking, Craig, I would give it 3 quarters. I think a quarter 2 is when somebody is on an mode and on a ramp mode and they want to get something done quickly. I think right now customers are taking their time Until they're pressed for time. So I'm going to say 3 quarters.

Speaker 6

Sure. Okay. And then last one is just a little cleanup item. Jeff, the deck usually has on the slide that shows the recurring and systems mix and some of the other stats, the Gross margin for the 2 different businesses, I didn't see that this time. Can you just hit us with recurring and systems gross margin?

Speaker 1

Sure. Yes, no problem. Recurring gross margin in the quarter was 55% and systems was 39%.

Speaker 6

All right. And that systems number, I think, is down a little bit from the prior quarter. What was that?

Speaker 1

It's down 200 basis points. Yes, just a matter of mix.

Speaker 2

Lower, lower. Factor utilization as well, right? I mean, we got Although we are largely outsourced comp manufacturing, we still have factories in Malaysia, Philippines and Japan. And so with less lower systems revenue, there's less absorption of overhead on the system side. Yes.

Speaker 2

Makes sense. Thanks, guys.

Speaker 1

Thank you.

Operator

That concludes today's question and answer session. I'd like to turn the call back to Jeff Jones for closing remarks.

Speaker 1

I'd just like to say thank you to everybody for joining

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