Cohu, Inc. (COHU) Q4 2013 Earnings Report, Transcript and Summary

Greetings, and welcome to the Cohu Fourth Quarter and Full Year 2013 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. James A. Donahue, Chairman and Chief Executive Officer for Cohu. Thank you, Mr. Donahue, you may begin.

Thank you, and thank you, everyone for joining us today. And joining me today is our Chief Financial Officer, Jeff Jones. If you need a copy of our press release, you can obtain one from our website, cohu.com, or by contacting Cohu Investor Relations at (858) 848-8106. Jeff will provide an overview and comments on Cohu's results for the fourth quarter of 2013, comments on orders and take us through the financial statements. I will discuss key activities, provide an update on progress 1 year after the acquisition of Ismeca and comment on the business environment and outlook. And then we'll take your questions. So I'll turn it over to Jeff.

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, February 12, 2014, and the company assumes no obligation to update these comments. Certain matters discussed on this conference call, including statements regarding the growth in the ATE industry, expectations of business and market conditions, orders, sales, revenues 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 and 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 on accounts receivable collection problems; customer orders may be canceled or delayed; the concentration of our revenues 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…

Okay. Thanks, Jeff. We noted improved conditions during Q4 in the industrial semiconductor market. This is a well-established market, but it's expected to accelerate with improved GDP and expanded applications, leading to a CAGR of close to 9% compared to 6.5% of the overall semiconductor industry. Within the industrial segment, it's likely that energy-related applications will have the strongest growth, following efforts to increase efficiency across the value chain from generation through transmission and distribution and on to consumption. All that requires sophisticated electronics. Other sectors that should exhibit growth are health care, where connected devices will become increasingly ubiquitous as health services shift from clinical settings to the home environment. And also commercial and residential buildings, as these structures become more connected to digital devices, often referred to as the Internet-of-things, for applications such as security and building automation. Cohu has a strong position in this segment, supplying solutions to long-time industrial semiconductor companies like STMicroelectronics, Linear Technologies, Infineon, Analog Devices and others, that will continue to be major players in this market. We have a broad portfolio of systems from Rasco gravity-feed and strip handlers to Delta pick-and-place, to Ismeca turrets and, more recently, augmented with our new line of high-power contactors. We offer complete contactor and handler solutions for power management customers. These products have enabled testing of large semiconductor devices that optimize current and voltage control for many applications from solar and wind mill generation to smart meters that are used by delivery services for homes and businesses. We also offer state-of-the-art systems for testing and inspecting smaller packaged ICs that are used in a variety of industrial and consumer products. Our SO1000 gravity handler is a well-established solution, and the new Jupiter high-parallelism gravity-feed handler strengthens our competitive differentiation in this growing industrial segment. These systems deliver more than just handling capability for large semiconductor packages. They are uniquely able to control temperature at increasingly higher current and voltage, safely testing some of the most powerful semiconductors. Our precision Kelvin contactor solutions ensure testing results are highly accurate regardless of power, which at times can be an excess of multiple kilowatts. With the advent of power wafer level packages, our NX32 turret handler, test and performs vision inspection in a single process, thus optimizing handling of delicate semiconductors and increasing final test efficiency. Our latest turret platform, the NY20, addresses requirements for small power management device test and also inspection, with high speed and reliability. The industrial semiconductor segment, like the automotive market, is another example of a mature market where new applications are serving as a catalyst for accelerated growth, and where Cohu, with its broad product line and differentiated technologies, has a unique opportunity to benefit. And now Jeff will provide details on Cohu's financial results.

In Q4, we recorded approximately $1.5 million of stock-based compensation expense, $2.1 million of purchased intangible amortization expense and $900,000 of restructuring cost related to our manufacturing transition and severance. The following comments are based on our non-GAAP results, which exclude the impact of these items. Gross margin was 32.1% and was negatively impacted by product mix and higher-than-forecasted cost to manufacture the initial units of our new thermal subsystems. In Q1, the manufacturing cost of the thermal subsystems are forecasted to be in line with our ongoing cost targets. Gross margin in Q1 is expected to be approximately 35%. Operating expense was $22.8 million in Q4 and lower than the forecast due to adjustments to accrued employee compensation and benefits, which totaled approximately $800,000 in the quarter. Operating expense in Q1 is expected to be approximately $23.5 million, excluding approximately $1 million of restructuring costs related to severance and our manufacturing transition. There was a minor Q4 GAAP income tax provision as tax expense on earnings in Asia was offset by a tax credit on losses in other foreign locations. We expect that our 2014 effective tax rate will be approximately 15%. The Q4 non-GAAP loss per share, which excludes the after-tax impact of share-based compensation, amortization of intangibles, manufacturing transition and employee severance costs was $0.10. And moving to the balance sheet. Cash investments were $52.9 million at December, unchanged from September. Cash provided by operations in Q4 was approximately $3.8 million. Net accounts receivable increased approximately $2.6 million to $60.8 million at December, as a result of higher sequential shipments from our semiconductor equipment group. DSO at December was 85, down from 93 at September, primarily due to the collection of past due receivables within our semi-equipment segment. Inventory was $59 million at December, decreasing $1.4 million from September. Adjusting for the inventory acquired with Ismeca on December 31, 2012, our net balance declined approximately $13 million in 2013 and approximately $35 million since September 2011, as a result of strict inventory management. Additions to property plant equipment in Q4 were approximately $1.4 million and depreciation for the fourth quarter was approximately $1.3 million. Deferred profit at December was $6.1 million compared to $5.5 million at September. The related deferred revenue at the end of Q4 was $7.4 million compared to $7.2 million at September, and consists primarily of revenue deferrals on shipments of test handlers.

Okay. Thank you, Jeff. It's been just over a year since we acquired Ismeca and I'd like to provide an update on the status of that acquisition and the progress we made. With this acquisition, we extended our customer base for test handling solutions to include discrete semis, wafer level packages and LEDs. We now field the broadest range of products in the test handler industry. This breadth of handling technologies enables us to address every major market segment from consumer mobility, automotive, industrial, computing, MEMs and LED. Ismeca products and vision technology expanded our SAM to include an additional process step in back-end IC manufacturing, solutions for package and die inspections. Key enabling technology such as thermal, vision and high performance contactors differentiate our products and provide customers with solutions that improve yield and optimize ASPs. One of the first actions we took following the acquisition was to integrate the global sales and service organization. Cohu's customer support team is one of our strongest assets, with customer contacts and applications expertise to deliver solutions in every major region of the world. With Ismeca, we significantly expanded our support capability in China, the fastest-growing semiconductor market. At the same time, our new turret business benefited from our long-established customer support organization and relationships in the Philippines and the Americas. We provide our customers with direct support regardless of location, and this is a competitive advantage. Capitalizing on sales synergies was one of the key strategic objectives of the acquisition, following the successes we realized with the 2008 acquisition of Rasco. In 2013, we captured key cross-selling opportunities, including selling turret handlers into one of Cohu's major analog semiconductor customers, penetrating back-end package inspection at several consumer mobile accounts, increasing our market share at OSAT and planting the seeds for many…

[Operator Instructions] Our first question comes from the line of Vernon Essi from Needham & Company. Vernon P. Essi - Needham & Company, LLC, Research Division: I just wanted to sort of -- and I apologize I logged on a little bit late on the call here. But, Jeff, could you go over sort of the timeline, or Jim as well, of the actual manufacturing transition almost on a -- as granular a basis as you can and give us the understanding about the sort of this manufacturing transition charges that we're seeing on the P&L side, and when this is expected to be cleared up? And really, kind of what I'm trying to understand is when will we get sort of a clean quarter of where you're basically commencing the -- I know you're already shipping your pick-and-place out of Malaysia, but when you'll sort of have a full quarter without these charges and then when the actual transition will be complete? Just update us on sort of a timeline there.

Well, maybe I'll take the second half of the question and Jeff can address the first half. We will complete the first pick-and-place handler in this temporary facility in Malacca in the first quarter, so we expect that product to ship in the second quarter and some additional handlers to ship in the second quarter. That will ramp-up as the year progresses and the production will begin to -- pick-and-place handler production will begin to transition from primarily U.S.-based to Malaysia-based towards the back end of 2014, more in the fourth quarter than the third quarter.

With respect to the restructuring costs, Vern, I expect, as I noted in my comments, that Q1 will be about $1 million for the cost of transitioning that manufacturing to Malaysia, plus the severance that we will incur worldwide as a result of the restructuring. The transition, the initial phase of the transition, will last through Q2, so I expect to have cost -- restructuring costs in Q2 not at the extent of Q1, but we will have them in Q2 as well. So the first phase then will be done. The transition will be complete mid-2014. Then, we will look to start the gravity-feed transition. So I would expect that each quarter we're going to have some level of restructuring, but certainly, we're in the heavy -- heaviest part of the restructuring cost, Vern, and so that will trend lower Q2 through Q4, significantly lower. Vernon P. Essi - Needham & Company, LLC, Research Division: Okay. So let me try to, I guess, characterize this, Jeff, not to totally get too granular here, but you've had just under $1 million of transition cost in the third quarter of last year and the fourth quarter of last year. You're anticipating sort of a similar level in the first quarter and then we'll start to wind down from there until you commence the gravity migration, and then we would expect it probably to be up at these levels again?

No, no. Vernon P. Essi - Needham & Company, LLC, Research Division: Okay. It would be less. So the gravity would be a lower watermark?

Exactly. Vernon P. Essi - Needham & Company, LLC, Research Division: Okay. Okay. That's very helpful. I'm sorry I missed it earlier. And then just -- in your prepared comments you talked a little bit about integrating the contactors side of the technology front and trying to lever your existing sales channels. Can you dive into that a little bit more, are you looking to build sort of a material business around that or is this just sort of a synergistic internal restructuring of how you're going to sell the product? Can you just elaborate on this.

Well, it's actually both, Vern. Now with 3 handler companies, each of which produces, designs and develops its own contactor solutions at varying degrees, as well as using third-party contactors. There were obvious opportunities to consolidate technologies, look at best practices and solutions, and just make that as efficient and effective from a cost standpoint, as well as from capitalizing on the best technology. So we're doing that. Secondly, we do like the contactor business and see it as a real opportunity for growth. It's somewhat like a consumable, it's certainly less cyclical and it's more stable than the systems business, so we'd like to grow that business. We think we have good opportunities to do so.

[Operator Instructions] Our next question comes from the line of Jairam Nathan from Sidoti & Company. Jairam Nathan - Sidoti & Company, LLC: I was trying to get some -- if you could give us some magnitude on the thermal systems operator? And as this part of the business gets more and more meaningful, can you give us some idea of where -- what is the kind of the industry, kind of potential growth and the potential market size? And you also talked about gross margin impact, when do you expect to get back to normalized -- will it -- has it -- does it have a lower gross margin profile than the corporate average?

Let me talk a little bit about the market opportunity and then Jeff can address the margin and cost question. This is an unfolding story and developing opportunity because of the growth of the mobile processing market. Historically, this thermal requirement was primarily focused on microprocessors. And we, for many years, were the pretty much exclusive supplier of thermal-enabled test handling solutions for microprocessor testing for all of certainly the major suppliers. As the PC market has softened and as the mobile market has grown quite dramatically, there's a need for elements of the same thermal technology, not to the same extent required for high-end processors, micro -- high-end PC or server processors, but there's still a requirement and definitely a yield and ASP benefit to using this thermal technology to precisely control test -- to precisely control temperature during test that optimizes ASP. So we're working on opportunities as they develop. We, for the last 18 months or so, have had an excellent one here, the one we referred to. These thermal subsystems are used in, typically, in custom systems that batch tests and, in some cases, perform functional tests, as well as burn-in. So it's not a conventional handler, it's a custom automated system typically built by an integrator into whom we provide the thermal subsystem. So what's the market opportunity? I frankly don't know at this time. It's a developing -- it's a developing story. But the good news for us is that we have unique proprietary thermal technology that gives us the capability to address this in a very compelling way. Jairam Nathan - Sidoti & Company, LLC: Okay. And as far as the gross margins, I know today they are below corporate average and that's impacting your gross margin for the quarter. But is that -- will it always remain that way or...?

Jairam, we've worked through the issues that we experienced last quarter, so we're back on track with the cost and the gross margin is at an acceptable corporate profile level. Jairam Nathan - Sidoti & Company, LLC: Okay. And just to follow-up on the earlier personal contactors, like if I look -- like do you -- what percentage of handlers that you sell do you sell with your own contactors? And where do you see and expect to see increase in that proportion? In separate, how many -- can you talk about growth there? Is that what you're talking about?

The percentage of handlers that we sell of -- handlers that we sell with our contactors, varies depending on the technology. For example, with gravity, it's a very high percentage. It's quite high double digits, likewise with turret handlers. Pick-and-place handlers are -- can utilize third-party solutions. So you find maybe half, slightly less than half of the pick-and-place handlers that we ship with our own contactors installed. The balance are from the third-party suppliers.

[Operator Instructions] Gentlemen, there are no other questions in the queue at this time. I'd like to hand it back over to management for closing comments.

Thank you for joining us on this call today, and we look forward to speaking to you next time when we report our first quarter 2014 results. Thank you, and good day.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.