Cohu, Inc. (COHU) Q1 2013 Earnings Report, Transcript and Summary

Greetings, and welcome to the Cohu Inc. First Quarter 2013 Conference Call and Webcast. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, John Donahue, Chairman and CEO for Cohu. Thank you, Mr. Donahue. You may begin.

Hello, Doug. That's actually James Donahue. Good afternoon, everyone, and thank you for joining us on today's conference call that will cover Cohu's results for the first quarter ended March 30, 2013. Our Chief Financial Officer, Jeff Jones, is with me today. I hope you have a copy of our earnings release and have had an opportunity to review it. But if you need a copy, you can obtain one from our website, cohu.com, or by contacting Cohu Investor Relations at (858) 848-8106. I'll provide an overview and comments on our results for the first quarter. Jeff will take us through the financials. And then, we'll discuss the current business environment and take your questions. But before we go on, Jeff has information concerning forward-looking statements, estimates and other matters that we'll discuss during today's call.

The company's discussion this afternoon will include forward-looking statements reflecting management's current expectations concerning certain aspects of the company'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. Forward-looking statements include our comments regarding the company's expectations regarding industry conditions, future operations, financial results and any comments we make about the company's future in response to your questions. Our comments speak only as of today, March -- excuse me, May 1, 2013, and the company assumes no obligation to update these comments. Certain matters discussed on this conference call, including statements concerning Cohu's new products, expectations of business conditions, orders, sales and operating results are forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those projected or forecasted. Such risks and uncertainties include, but are not limited to, risks associated with acquisitions, inventory, goodwill or other intangible asset write-downs; our ability to convert new products under development into production on a timely basis, support product development and meet customer delivery and acceptance requirements for next-generation equipment; our reliance on third-party contract manufacturers; failure to obtain customer acceptance resulting in the inability to recognize revenue and accounts receivable collection problems; customer orders may be canceled or delayed; the concentration of our revenue from a limited number of customers; intense competition in the semiconductor test handler industry; our reliance on patents and intellectual property; compliance with U.S. export regulations; and the cyclical and unpredictable nature of capital expenditures by semiconductor manufacturers. These and other risks and uncertainties are discussed more fully in Cohu's filings with the Securities and Exchange Commission, including the most recently filed Form 10-K and Form 10-Q. Cohu assumes no obligation to update the information in this release. Further, our comments and responses to any questions will not make reference to any specific customers, as we are precluded from disclosing such information by our nondisclosure agreements.

Thank you, Jeff. First quarter sales were $56 million compared to $50.7 million in the fourth quarter of 2012. The non-GAAP loss was $0.32 per share compared to a loss of $0.07 per share in the fourth quarter. Non-GAAP results were negatively impacted by a number of unusual items, including the onetime effect of $2 million of deferred profit at Ismeca in changing revenue recognition from IFRS to GAAP, and also a revenue shortfall at BMS due to delays in orders from certain government entities. The impact of these items was $0.15 per share. On a GAAP basis, restructuring charges in our semiconductor equipment group and a required purchase accounting inventory step-up and the related cost-of-sale impact at Ismeca accounted for an additional loss of $0.05 per share. The restructuring that I mentioned reduced annual spending by approximately $4.1 million. Sales of semiconductor equipment were on plan. And as the quarter progressed, we saw encouraging signs of improving business conditions. Semiconductor sales are increasing in some market segments, and this has led to higher equipment utilization on customer test floors that reached 80% in March, and that's the first time in 2 years. Orders were $60.3 million compared to $42.1 million in the fourth quarter. Semiconductor equipment orders were $52.5 million compared to $33.7 million in the fourth quarter. Q1 orders include $17.7 million for Ismeca. Backlog was $63.4 million at the end of the quarter. Following the acquisition of Ismeca, we will begin to report the dollar value of semiconductor equipment orders in 2 categories: First, systems that consists of all handlers; and, second, tooling and services that includes spares, consumables, conversion kits, upgrades and services. For Q1, systems represented 43%, and tooling and services accounted for 57% of total orders. This was an active quarter not only with…

Okay. Thanks, Jim. Semiconductor equipment-related revenues for Q1 were approximately 85% international and 15% domestic. International sales were distributed 77% Asia-Pacific, 12% the America and 11% other. We recorded approximately $1.4 million of stock-based compensation expense and $1.7 million of purchased intangible amortization expense in Q1. And the comments I make today include the impact of these items. Gross margin was 27.8% in Q1 and lower than our projection as a result of a revenue shortfall at BMS that impacted our overall gross margin by approximately 200 basis points. Additionally, in connection with the purchase of -- with the purchase accounting for the Ismeca acquisition, we recorded an inventory step-up and related cost of sales increase of $800,000, impacting gross margin by approximately 140 basis points in Q1. We expect gross margin in Q2 to increase to approximately 34% as a result of improved product mix and the elimination of the negative impact on our Q1 gross margin from the initial deferral of revenue recognition under U.S. GAAP at Ismeca. Operating expense in Q1 was $28.5 million and higher than our projection as a result of material and labor cost related to new product development and approximately $500,000 of restructuring costs incurred in connection with our transition of manufacturing to Asia. In Q2, we expect lower R&D cost, as certain new products are nearing completion. And as a result, we expect operating expense in Q2 to be approximately $26 million. In Q1, income tax provision was a benefit of $800,000. We expect our 2013 effective tax rate will be approximately 10%. Q1 loss per share on a GAAP basis was $0.49. Non-GAAP loss per share, which excludes the after-tax impact of share-based compensation, amortization of intangibles, step-up of inventory valuation, restructuring costs and acquisition costs incurred in connection with the acquisition of Ismeca was $0.32 for the quarter. So now moving to the balance sheet. Cash and investments were $48.7 million at March. Cash used in operations in Q1 was approximately $6 million. Net accounts receivables were $56.5 million at March, increasing $19.5 million from December, primarily as a result of the Ismeca acquisition. DSO at March was increased to 86 from 65 at December, primarily due to a longer collection cycle at Ismeca as a result of high levels of product customization leading to extended customer buy-offs and past-due receivables in our semi equipment and microwave communications segments, which we expect to collect in Q2. Inventory was $73.3 million at March, increasing $11 million from December, primarily as a result of the Ismeca acquisition. Additions to property, plant and equipment for Q1 were approximately $200,000. And depreciation was approximately $1.4 million. Deferred profit at March was $5.6 million compared to $2.1 million at December. The related deferred revenue at the end of Q1 was $6.7 million compared to $3.6 million at December and consists primarily of revenue deferrals on shipments of test handlers and mobile microwave communication equipment.

Okay. Thank you, Jeff. I'll comment now briefly on our other businesses. Sales improved sequentially at the Electronics Division, and order input increased throughout the quarter. Following several quarters of reduced activity due to tight state budgets, key orders were received for multiple traffic incident management applications. And in March, we announced the 8800 HD. That's an IP-based 1080-pixel high-def long-range surveillance camera and positioner. We're the first to market with an HD long-range camera, and we believe this is a significant new product for military, court, airport, border patrol and maritime applications. Increased security concerns are driving expanded requirements for products like the 8800HD. As noted earlier, revenue at BMS declined sequentially and was below plan because several large orders that were expected to book and ship during the quarter were delayed as a result of the budget impasse in Washington. This also had a waterfall effect on local law enforcement projects that rely on federal funding. But with a continuing resolution signed at the end of March, our customers expect to begin placing orders again this quarter. For some time, we've discussed our plans to increase gross margin by transitioning volume manufacturing of our pick-and-place handlers to Asia. Clearly, last year, we put these plans on hold pending the potential acquisition of Ismeca, that has a manufacturing facility in Malaysia, supported by a local cost-effective supply chain. Before building new manufacturing infrastructure in Asia, we needed to determine if we could leverage Ismeca's existing operations. So this became a key focus of our due diligence during the second half of last year. We concluded that, should we complete the acquisition, and of course we did, Ismeca's operations could be expanded and that this was a more cost-effective approach than building new manufacturing capability from the ground up. So…

[Operator Instructions] Our first question comes from the line of Jairam Nathan from Sidoti & Company. Jairam Nathan - Sidoti & Company, LLC: I just wanted to kind of -- can you tell us what share of your revenue comes from -- came from OSATs this quarter or your -- or orders that have came from OSATs?

So I don't have that specific information at hand, Jairam, but I think it's something like 20% to 25% OSAT, and the rest IDM would be sort of the typical distribution for us. Jairam Nathan - Sidoti & Company, LLC: Okay. And now coming to your -- the shift in manufacturing to Malaysia. What's the timeline? It looks like you took some actions. Part of the shift has already happened, or it's going to happen this current quarter? And what's the timeline for going ahead? And what kind of gross margin targets are you internally thinking off?

So as I indicated, we couldn't do much -- or really anything with Ismeca, of course, until we had completed the acquisition. So we've begun that, restarted that work in earnest, and we'll be progressing on that throughout the year. We expect to begin seeing incremental improvements in the second half and to fully realize the benefits sometime next year. Our target is the first half of 2014. Jairam Nathan - Sidoti & Company, LLC: And how should we think about, in the gross margins, once that -- once the whole transition is done?

Well, again, Jairam, as Jim indicated, our target is 40%. And so that depends on this -- completion of this transition, but also a return to a normalized sort of business environment or sales level, which is roughly about $80 million per quarter. Jairam Nathan - Sidoti & Company, LLC: Okay, okay. And our next question was on the CCTV business. Let me just wrap up with this. How should we think about growth rates there in the long run and even going forward this year?

Over the last year, the new leadership at the Electronics Division has done a good job resizing the company so that it's operating profitably, have what are relatively low levels of revenue. And I'm not projecting any dramatic increase in revenue for that business over the next year, but it will be a solid, though modest, contributor to our profitable operations.

[Operator Instructions] Our next question comes from the line of Tony Grillo from Needham & Company.

One quick question about gross margins. You mentioned the onetime effect that kept gross margin down this quarter. Looking forward, it goes up a lot, projecting it all the way up to 34%, is there -- could you be a little more specific as far as where you see that margin improvement coming from outside of just the shipments coming from new lower-cost products?

The improvement is driven primarily out of our semi equipment group. And again, there is an impact -- or a benefit from eliminating that onetime effect that we incurred in Q1, but just an overall increase in business activity and as a result of new products that we will be shipping and beginning to recognizing -- begin to recognize revenue from. In Q2, all of that together is the main driver of the increase in gross margin to approximately 34% in Q2.

Yes, and just to supplement that, Tony, so I really think there's 3 factors. So Jeff -- and Jeff mentioned the accounting change at Ismeca that's required and also the benefit of new products. But also, there was that revenue shortfall with BMS, the delayed government orders that had a pretty significant, unexpected impact in Q1. And we think that, that's back on track and won't be an issue in the second quarter and beyond.

Okay. And just looking back, I have the revenue shortfall accounting for about 200 basis points and the inventory step-up being about 140. Is there one more thing? Was it the accounting change that was the other effect to gross margin that you mentioned?

Yes, yes. And that's...

And how many basis points was that?

That's about 200 basis points as well, a $2 million impact.

There are no other questions in queue. I'd like to hand the call back over to management for closing comments.

Thank you for joining our call today, and we look forward to speaking to you next when we report our Q2 results. Thank you, and good day.