Good day, ladies and gentlemen, and welcome to the Cohu, Inc. Second Quarter 2018 Financial Results Conference Call. [Operator Instructions]. As a reminder, this conference call may be recorded. I would now like to introduce your host for today's conference, Mr. Jeff Jones, Vice President, Finance and Chief Financial Officer. Sir, you may begin.

Good afternoon, and welcome to our discussion of Cohu's most recent financial results. I'm joined today by our President and CEO, Luis Müller. Following our opening remarks, we'll provide details of our performance for our second quarter 2018 as well as our outlook for the third quarter 2018. If you need a copy of our earnings release, you may obtain one from our website, cohu.com, or by contacting Cohu investor relations. Before we begin, you should all be aware that during the course of this conference call, we will make forward-looking statements reflecting management's current expectations concerning the company's future business. These statements are based on current information that we have assessed, which by its nature is subject to rapid and even abrupt changes. Forward-looking statements include our comments regarding strength in automotive and industrial semiconductor markets, new products and customers, sales progress on Kita pins and cHybrid and cDragon contactors, the Xcerra acquisition, synergies, last 12 months' pro formas, EPS accretion, integration plans and timing, acquisition debt repayment, future results including Q3 guidance, effective tax rate, 2018 sales growth and midterm model targets and any other comments we make about the company's future and in response to your questions. We encourage you to review the Forward-Looking Statements section of the earnings release as well as Cohu's filings with the Securities and Exchange Commission, including the most recently filed Form 10-K, Form 10-Q and registration statement on Form S-4. Our comments speak only as of today, August 2, 2018, and Cohu assumes no obligation to update these statements as a result of developments occurring after this call. 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. Finally, during the call today,…

All right. Thanks, Luis. Cohu's Q2 results exceeded our expectations as we generated non-GAAP operating and adjusted EBITDA margins of 21.3% and 22.7%, respectively, on sales of $99.8 million. Cohu generated $15.2 million of cash from operations during the second quarter, and our cash balance increased $11.1 million to approximately $50.9 million -- $150.9 million at the end of the quarter, primarily reflecting strong cash collections and working capital management. Our contactor business represented 10.4% of sales for the quarter. For Q2, the GAAP to non-GAAP adjustments include approximately $1.9 million of stock-based compensation expense, $1 million of purchased intangible amortization expense, $100,000 of restructuring costs, $3.8 million of acquisition costs related to Xcerra and a $577,000 adjustment to the earnout valuation from the Kita acquisition. My comments that follow, including the Q3 guidance, are all based on Cohu's non-GAAP results, which exclude the impact of these items. As I mentioned, sales for the quarter were $99.8 million. One customer in the computing market represented 11% of second quarter sales. No other customer exceeded 10% of sales in Q2. Q2 gross margin was 42.4% and above our guidance, primarily due to lower manufacturing overhead costs and favorable product mix. Operating expenses for the second quarter were $21 million and below our guidance of $24.5 million due to a $3 million foreign currency gain and $400,000 of new product development materials that were delayed to Q3. The non-GAAP effective tax rate was approximately 13% for Q2 and 16% for the first half of 2018. And as I mentioned previously, our tax rate continues to benefit from profit generated outside the U.S. in countries with lower statutory income tax rates and in certain countries where Cohu has income tax holidays. Furthermore, U.S. profits do not currently incur a tax provision because of…

[Operator Instructions]. And our first question comes from Craig Ellis from B. Riley FBR.

To start, I'd like to just do a few quick clarifications on the financial guidance, Jeff. One, on gross margin, down a little more than 100 basis points quarter-on-quarter from trailing 2Q trends. What's at play in that decrease? And with the operating expense guidance, I take it -- the increase sequentially is the absence of that currency exchange benefit. But are there any other gives and takes that are in the mix there?

I'll start with the last part of that. On the operating expense, you're absolutely right, it's the assumption of not having that $3 million currency gain occur in Q3. So the spending was -- in Q2 was right about on forecast, the $24.5 million. Aside from some materials for development that was delayed to Q3, we're anticipating a similar spending rate in Q3. So yes, that's how we get to the $24.5 million. With respect to the gross margin, you're right, 41% in Q3, driven by the lower sales from almost $100 million to $98 million. As well as in Q3, we had very strong recurring sales, which carry a higher gross margin. And we're modeling more of a standard mix, if you will, for Q3.

Got it. And I'll use that last comment to pivot a little bit because I think the order activity was a little bit stronger, and maybe that's a longer-term dynamic. But Luis, it seems like the recurring part of the business and the contactor part of the business is showing some nice signs of further inflection. As you look at the business, can you just comment on some of the broader trends that you're seeing with contactors and pins, et cetera? Luis Müller: Yes, you're right. I mean, we've talked about a strong booking quarter, right? I mentioned during the prepared remarks, book-to-bill at parity. So both systems and recurring orders were actually strong in the quarter. But recurring is growing faster. It's growing at an annual rate of actually 23% over the last 12 months and much stronger than the systems business. The plan -- our plan continues to be -- to grow the contactor business, in particular, at a 20% rate year-over-year. Now obviously, with the Xcerra acquisition, we need to reassess this number because just based on having a much larger group, combining the 2 businesses, we'll have a contactor sales of approximately $125 million a year. Still, the opportunity in our combined handler fleet is for approximately $300 million of annual contactor sales, which means we still have a long runway for growth from the $125 million combined. But we'll have to recast that projection for annual growth rate from the larger base once we complete the acquisition.

Okay. We'll look forward to that. Then the follow-up question for you is tying together two things. One, I think you mentioned that there was weakness in smartphone APU application that was impacting the guidance. And then I thought I heard you say that you thought there was potential for 8% growth in the business this year. If that's so, what impact is the APU headwind that you're seeing having on the overall growth rate of the business? Is it worth 100 basis points, 200 basis points? How would you handicap that? Luis Müller: Yes, you're correct. Just to start backwards, you're correct, we are modeling right now an 8% growth in sales in 2018 year-over-year. About -- speaking for last year numbers, about 7% of our sales last year was associated with testing -- equipment for testing APUs, application processors. I'm not going to be able to handicap right now how much that would be this year, but it's certainly down year-on-year. It's not a large percentage of our revenues, but it is down with the slower growth in smartphone units year-over-year and, in fact, I think, even down units of smartphones quarter-over-quarter. On the other hand, automotive and industrial semiconductor markets are growing. IoT applications are increasing. We're seeing some new applications in LiDAR and some early work towards 5G standards as well.

And our next question comes from David Duley from Steelhead.

So just to clarify as far as the September quarter goes, the only segment that you saw any weakness in is the mobility space, and the other segments are kind of growing on a year-over-year basis? Luis Müller: Yes, that's correct. We're seeing weakness in the mobility, and more specifically, isolated to application processor -- or equipment associated with application processor tests.

Okay. And as far as I know, it's difficult, but when you think about having some weakness in the current quarter, do you -- would that spill over into the December quarter? Do you have any idea about what the December quarter might look like at this point? Luis Müller: Well, in essence, yes. We provided here on the remarks, talking about an 8% growth year-over-year. So you can take the Q1, Q2 actual, Q3 guidance and the 8% growth from last year and squeeze out sort of how we're thinking about Q4 at this point, which is slightly higher than the third quarter here and seasonally still a strong quarter for fourth quarter.

Okay. And with the -- so some of the bookings -- like since the bookings were at parity this quarter, some of the orders that you got are for longer lead time items and spread out into the December and March quarters? Luis Müller: Yes, that's right. That's right, Dave. Yes. So we've got actually a chunk of the backlog at the end of Q2 that doesn't ship until Q4 and even there's smaller amounts that don't ship until 2019.

Okay. And final question from me is, can you just help us understand the size of the opportunity for you guys in the inspection market? I think you have a couple different products now. And maybe help us frame it for how big do you think that market is and what are your kind of inspection-related revenues at this point. Luis Müller: Okay. So the way we look at it is the market for semiconductor inspection in total is about $500 million. The package inspection segment, specifically, is in the order of $150 million, and that's where we have products and we continue to expand our technology. We're still a small supplier in that space. Last year, sales were about $34 million for pure inspection equipment. Now this infrared vision module that we introduced here applies to that segment of the market, that $150 million segment of the market. I would say that I expect inspection to increase, and particularly, infrared imaging to become sort of the new norm in the coming years for wafer-level package and bare dies; and even possibly, in certain cases, seeing a 100% inspection of these devices, particularly as these tools become faster and per device cost of inspection comes down. And this was really important for some of the big brand-name consumer electronic products, like high-end cell phone manufacturers and suppliers to those manufacturers that don't want to see failures coming to market.

And our next question comes from Patrick Ho from Stifel.

This is Brian on for Patrick. Kind of curious, first question for you, Luis, given the various pushes and pulls on the market, how does that impact your outlook for the overall test handler market in 2018 in terms of year-on-year growth? And also Cohu specific, are you still on track to gain roughly, I think, it's 2 to 3 points of market share in the handler market this year? Luis Müller: Yes. I'm still expecting that the handler market will grow about mid-single digit this year and that we're going to gain, like I said, 2 to 3 points share. But as I mentioned a quarter ago when we announced the successful capturing of 2 major customers, one in Korean, one in Europe, those market share gain points are going to develop through the year and have more of a volume into 2019. So for this year alone, I'm expecting a couple of points growth faster than market in handlers. The contactor market, I think, is growing a little bit faster than the handlers, and we're also targeting about 1 point share gain in contactors this year.

Okay, got it. Okay, very helpful. Doubling back on, I think, one of the questions in the Q&A, I think you mentioned some deliveries and backlog even going in the early part of 2019. That does seem like longer than typical order visibility. The suspects based on your commentary sound like they're sort of auto, industrial, maybe things like turret and gravity-feed handlers. I'm just curious, are lead times stretching out there? Is that sort of the reason you're shipping out sort of the early '19 time frame?

No. No, it's actually more in the computing and mobility spaces. So it's not -- automotive, industrial still sort of holding to the normal lead times and delivery dates. But we've got a couple of orders. Actually, it's approaching about 1/3 of the backlog at the end of the quarter that most of that ships in Q4, like I said, some of it in the first part of 2019. But it's not automotive, industrial related.

Okay. That's helpful. Over the longer term, I think you talked about potential doubling of the cost synergy over an extended time frame and you talked about some of those margin targets being gross margin 48%, EBITDA of 22-ish. What revenue level are you paying that against in terms of those margin targets?

That's a modest sort of annual low single-digit growth rate from where we are today on a combined basis. So that's in the -- as I mentioned, combining today for last 12 months would be about $846 million. So adding a low single-digit growth rate to that probably takes us into the $850 million to $900 million range.

Okay, very helpful. Maybe one last question here. One thing that -- when you look at the product portfolio, even the IP maybe of Xcerra, is there anything there that is maybe a good segue into servicing the broader memory market, which is that SAM, TAM that Cohu historically haven't really addressed? Luis Müller: Yes. We have discussed this in the past that we will continue to look for a discontinuity in the memory market. But we don't have the intention to go in head-to-head with well-established incumbent suppliers in that space. If and when that discontinuity materializes, we'll look for, if there's an opportunity to leverage our technology and provide product -- differentiated products. We will continue to update you on that if and when that develops.

Our next question comes from Steve Marascia from Capitol Securities Management.

Actually, one of my questions is about handler market share growth was just answered. My other question was given all the tariff talk, have any of your customers discussed whether there was going to be any change to their future order patterns or potential -- their production levels? Or is that more a function of they're going to wait and see what happens to their orders coming through on their front side? Luis Müller: Yes. The simple answer is no, we haven't seen any impact from our customers yet related to the tariffs. And now with that said, I think we'll continue to monitor the situation and whether an increase in tariffs would cause any change in behavior on semiconductor spending over time, but nothing at this moment.

And our next question comes from Edwin Mok from Needham & Company.

So my question is on high bandwidth memory. I heard from a few suppliers stating that there is some pickup in demand on that area. Have you guys seen that? And you stand to benefit on that in any way? Luis Müller: Sorry, Edwin, which area were you referring to?

I was referring to high-bandwidth memory, HBM for DRAM. Luis Müller: Yes, no. I think the way to look at this is the same as I answered before to Brian Chin is we'll continue to monitor an opportunity to -- an inflection point in the way products in memory are tested in which we can leverage our product portfolio or technology. But we really have nothing to report and talk about as of Q2 results.

I see. And then can you give us an update on PANTHER, where you stand on that right now? And I know that there -- at some point, you were discussing with multiple customers, one being a mobile and one being an auto customer. Just to kind of see where you stand on that. Luis Müller: Yes. The product is still a small part of our total business and not much has changed, actually. And in that, we're still working to fulfill the customer requirements in our F&PMIC and the automotive device test customer that you just mentioned. So not much of a change quarter-on-quarter on that product line.

And then last question, I guess, for you, Jeff. Just kind of talk a little bit about margin. On the guidance, I understand the guiding for lower gross margin in the third quarter. Is there a way to kind of think about the margin run rate? Should we go back to just your target model? Or you mentioned 4Q, you're going back up a little bit on top line. Should we expect a slight margin expansion? Just give us some color on that.

Yes. No, you're absolutely right. Actually, Q2 margin was higher than our financial model. If you recall, at $100 million in quarterly sales, we're modeling 42%. So we came in at 42.4%. It's a little bit higher than the model, again, driven by favorable product mix. We also had small reduction in some manufacturing overhead that benefited Q2. So for Q3, we're basically back to that model. And at $92 million in quarterly sales, 41% is basically in line with that model.

And I am showing no further questions from our phone lines. I would now like to turn the conference back over to Jeff Jones for any closing remarks.

Well, thank you for joining us today. We look forward to speaking with you at upcoming investor conferences we plan to attend such as the D.A. Davidson and Jefferies conferences later this month and the Dougherty conference in early September or when we report our third quarter 2018 results. Thank you, and have a good day.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a wonderful day.