Cohu Inc Q3 FY2021 Earnings Call

Good day and thank you for standing by. Welcome to the Cohu Incorporated Third Quarter 2021 Financial Results Conference Call. At this time, all participant lines are online and in listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference may be recorded. I'd now like to hand the conference over to Jeff Jones, CFO.

Thank you and good afternoon and welcome to our conference call to discuss Cohu's third quarter 2021 results and fourth quarter 2021 outlook. I'm joined today by our President and CEO, Luis Müller. If you need a copy of our earnings release, you may access it from our website at cohu.com or by 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. 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-K and Form 10-Q. Our comments speak only as of today, October 28, 2021, 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. 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 Müller, Cohu's President and CEO. Luis?

Thank you, Jeff. Good afternoon everyone and thanks for joining us. Third quarter revenue was approximately $225 million, and that was up 49% year-over-year on strong demand for test and inspection systems. Earnings per share were in line with expectations at $0.70 and adjusted EBITDA of 21.8% was up over 850 basis points year-over-year, underscoring the significant growth in both revenue and profitability. Cohu remains on track for a record year with revenue forecast up approximately 40% in 2021. We continue the deployment of our DI-Core data analytics software, with follow-on orders from key automotive customers from design wins in the second quarter, as well as expansion to several new automotive segment customers in the third quarter. As a reminder, Cohu's data intelligence for DI-Core is a suite of software solutions that provide real-time equipment monitoring and process control to improve overall equipment efficiency (OEE) and productivity. Customers can monitor critical equipment parameters such as yield, OEE, throughput, and other equipment states to ensure optimal test cell performance. DI-Core software also interfaces with customers' manufacturing execution systems for remote equipment control, recipe, and lot management. As the need for data analytics grows, we plan to continue expanding DI-Core offerings to help improve quality and yield and to continue to increase the value-add differentiation of our systems. We're essentially enabling our customers to upgrade the large installed base of Cohu equipment to improve efficiency and productivity. We estimate the market for DI-Core Analytics to be around $170 million with high customer interest, particularly in the automotive semiconductor segments, to increase and optimize productivity. The DI-Core is a software solution and thus a 90% plus gross margin product expansion for Cohu. Now on the test-cell business, we are encouraged by the growth of our DiamondX universal platform into power management, display driver, and RF applications. Cohu offers today a unique solution for testing and inspecting high-performance RF devices, deployed in satellites and ground-based transceivers. Our test-cell delivers advanced microwave RF measurement performance with integrated solutions for the device under test ensuring accurate signal integrity and temperature control. The global small satellite market is projected to grow at 20% CAGR through 2025 and Cohu is at the forefront of supporting well-known customers in their endeavors to deploy low-orbit satellites to create a global broadband communication network. With estimated test cell utilization of 87% at the end of September, we're encouraged by the momentum and customers' forecast for test, inspection, and metrology equipment and interface products entering 2022. Mobility customers are forecasting and starting to drive demand for another wave of equipment for high-frequency RF testing, enhancing capabilities for 5G, Sub-6 gigahertz, Wi-Fi 7, and even millimeter wave applications in the first half of 2022. There's a global shortage of power management devices that is limiting electronics manufacturing, and Cohu is positioned to help customers address this growing demand and also support the expansion of high-performance computing applications. Our vision systems, particularly the new neon platform, continues to capture new customers and expand applicability beyond our original expectations, driving Cohu's inspection and metrology revenue to a projected $70 million in 2021. The automotive market seems to have passed the initial recovery cycle post-pandemic in 2020, and now is reaching a new normal demand level that is largely supporting growth in battery management systems for electric vehicles and ADAS processors and sensors. Cohu is well-positioned in automotive with a broad portfolio of thermal handlers and interface contactors to address a variety of test requirements, from automotive processors to high power management ICs. We have also made significant progress in operations, increasing sourcing and productivity at our Philippine manufacturing facility, yielding a significant 410 basis points gross margin improvement from Q2 to Q3 in our contractor business. As the contractor business grows and gains momentum in 2022, this is expected to be a significant contributor to our margin expansion toward the midterm target of 48%. Additionally, we completed the implementation of price increases to our handler product lines that largely offset gross margin erosion seen in the second and third quarters. Consequently, regarding fourth quarter margins being up to 44%, despite continuous trends in mix favoring handlers, we expect the mix to shift in the first half of 2022 to less handlers and more testers with concurrent growth of our contactor business in line with our mid-term targets. Switching topics, the supply chain continues to be extremely tight with material shortages and logistic issues dominating the headlines. Cohu has taken steps to get ahead on inventory and ensure we can continue supporting customers' capacity expansion plans and the introduction of new device technologies. Our business model is working; Cohu is delivering solid profitability and projecting a strong baseline EPS and cash flow during the typical seasonally low fourth quarter. Equipment lead times remained largely unchanged from a quarter ago with handlers averaging 18 weeks and testers about nine weeks, contactors and spares about six weeks. Looking ahead, we are encouraged by our design wins and product traction in key growing segments, and we're equally optimistic about our gross margin improvements and order forecasts in the fourth quarter. With so much investment going into wafer fab equipment, we’re enthused about the mid-term growth for semiconductor testing and the need for greater inspection and metrology in support of new advanced packaging technologies. Let me turn it over to Jeff to share third quarter results, provide specifics about our fourth quarter guidance, and describe our Board's authorization for a share repurchase program. Jeff?

Thanks, Luis. Before I walk through the Q3 results and Q4 guidance, please note that my comments that follow will refer to non-GAAP figures. Information about the non-GAAP financial measures, including the GAAP to non-GAAP reconciliations and other disclosures are included in the accompanying earnings release investor presentation, which are located on the investor page of our website. Now turning to the financial results, Cohu again delivered strong revenue and profitability in the quarter. Q3 revenue was $225.1 million, an increase of 49% compared to Q3 of 2020. During the third quarter, two automotive segment customers each accounted for more than 10% of sales. In the third quarter, Cohu’s gross margin was 42.3% and in line with our guidance. Operating expenses were $49.5 million and lower than guidance due to some one-time credits and tight management of expenses. Third quarter non-GAAP operating income was 20.2% of revenue and adjusted EBITDA was 21.8%. Return on invested capital in the third quarter was 51%, well above our target ROIC of 30% or higher. Cohu’s non-GAAP effective tax rate for Q3 was approximately 19%, higher than guidance primarily due to lower income generated in the US combined with higher income generated in Germany, which is subject to statutory tax rates higher than the US. Non-GAAP EPS for the second quarter was $0.70, bringing our nine month year-to-date non-GAAP EPS to $2.48, more than double full year 2020 results and illustrating the earnings leverage in the business model. Now, moving to the balance sheet, the Q3 balance sheet reflects a net cash position with increased resources for accelerated debt reduction, investment, and opportunities to expand our served markets and technology portfolio in line with our growth strategy, and a newly authorized $70 million stock repurchase program to return capital to investors, offset dilution from our equity plans, and express confidence in Cohu’s future growth prospects and cash generation. The ending cash balance for the third quarter was $365 million, which is net of debt repayment totaling $101 million during the quarter. The balance sheet reflects net cash of $245 million, as total debt at the end of Q3 was reduced to approximately $120 million. The term loan Be outstanding balance at the end of Q3 was approximately $103 million. Cash flow generation was solid again in Q3 with free cash flow at approximately 14% of revenue. Now moving to our Q4 outlook. Entering the typical seasonally low Q4, Cohu’s business model is projecting to deliver strong profitability on revenue between $182 million and $195 million. Some customers have pushed new test capacity into 2022 due to a shortage of wafers and lead frames impacting their semiconductor production. We expect first quarter sales to be incrementally stronger based on current order momentum, and assuming our customers successfully work through their supply chain shortages. Q4 gross margin is forecasted to be approximately 44%. And as predicted, we're seeing a moderation of automotive test handlers, improving product mix, and solid cost reductions in the manufacturing of contactors. Recurring revenue for Q4 is projected to be approximately 41% of total sales and approaching the 45% mid-term target. Q4 operating expenses are projected to be approximately $51 million. And we're projecting Q4 interest expense to be approximately $900,000. We anticipate Q4 debt repayment to be in the $1 million to $7 million range based on cash forecasts including after anticipating potential share repurchases in Q4. We expect Q4 adjusted EBITDA at the midpoint of guidance to be approximately 19% and the Q4 non-GAAP tax rates approximately 14% at the midpoint of guidance. The diluted share count for Q4 is expected to be approximately 49.5 million shares. That concludes our prepared remarks, and now we'll open the call to questions.

Our first question comes from Brian Chin with Stifel.

Hi, there. Good afternoon. Nice results in a tough operating environment and thanks for letting us ask a few questions. Maybe first just a quick one. Jeff or Luis, how much of the forecast declines, is seasonality versus supply constraint, which you kind of reflected in that push to Q1 for some customers?

Yes, we know for sure it's not, you know, somewhat difficult to understand the full impact, but we know for sure about $4 million that has been delayed out of Q4 into 2022.

Got it. And I think you said incremental, based on your backlog visibility. Yes, an incremental sequential growth into Q1, can you put any sort of parameters around what you're seeing relative to backlog thus far in terms of demand to increase?

Well, I mean, I can't speak to that incremental comment. First, Brian, it's, you know, when we look at Q1, right, we are currently seeing current order momentum that is increasing. So let's say that assuming that continues, and customers successfully work through the supply chain constraints, you know, Q1 could be a 5% to 10% increase over Q4.

That's helpful. And I guess maybe, perhaps even more importantly, in terms of the next and sort of the progress we're making on the gross margin front, in terms of initiatives as well as sort of a more normalized next to some degree, right? Maybe first, can you give us a sense of what mainly drove this driving the 170 basis points of sequential improvement in Q4 and then also kind of moving into first half, you alluded to tester demand potentially coming back, handler business sort of normalizing lower, further improvement on the contactors, there's some price increases on the handlers, a couple piece if I'm missing, but maybe think about how much of the gap you can, you know, if revenue is, you know, Q1, this, I'm going to throw a number out, if it's 200 million in Q1, relative to what the target model was just with, I think something like a 46 or somewhere in that territory, on the gross margin, how much – how much can you start to narrow that, close that gap in first half?

Okay. All right. There's a lot there, Brian. So let me do my best. And you can remind me of some areas that maybe I don't touch on. In terms of the expansion of gross margin into Q4, a couple of main areas here. One is the insourcing of more contactor manufacturing in the Philippines. We saw some great success in Q3 in increasing the gross margin. So we see that continuing, and we continue to add more insourcing into the Philippines, which is going to increase our utilization and productivity, lowering costs. We're going to continue to see higher contactor gross margins, again, targeting about 45% second half of the year for contactor gross margin. The other piece of it is, as I mentioned in my comments, the moderation of the automotive handler revenue. And so there's an overall more favorable mix of products. Now, we're not where we need to be in the target model, but we're getting closer to it. And we're seeing a favorable impact from price increase on handlers, not 100% effective yet, as we work through backlog and long-term contracts with customers, but it has been effective to at least offset cost increases. So as we look into 2022, as you mentioned, we do see a mix that has higher tester revenue, continuing growth of contractor revenue and the gross margin there. So we're modeling internally that 2022 is going to be from a gross margin perspective would be in the mid-40% range. I would say if you're looking specifically at Q1 projection, there would be maybe about a 50 basis point or so improvement over Q4 on gross margin.

Great, that's really helpful. I'll hop back in the queue for other folks.

All right, thanks. Thanks, Brian.

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

Hey, guys, thanks for taking the question. And nice to see the gross margins moving back up again. I wanted to start just by asking a clarification question on revenue. I think three months ago, one of the messages was that there was $14 million of handler sales that pushed from 3Q to 4Q. So as we look at the fourth quarter guidance and what's embedded, did those revenues actually shut down and is the $14 million included in the guidance that we're seeing today?

Yes, just a correction on that Craig. That $14 million was caused by suppliers that were under control movement orders. We knew that we wouldn't catch that up in Q3 and that would filter through in Q4 as well but thought we'd be caught up sometime at the beginning of next year. So it was not a takeout of Q2 and put into Q3.

Yeah, I thought it was out of Q3 and into future quarters yet.

Yeah, right.

Do I have the periods run there, Jeff or?

No, no, no. That's correct. I mixed up the quarters.

Yeah. But your point is, you didn't expect to recapture at all in both quarter and would be recaptured for Q1.

Yeah.

Okay, got it. Got it. Okay. So that's helpful. Secondly, given everything that we've seen happening in the automotive supply chain, centered around COVID issues with Asia manufacturing disruptions, Malaysia, etcetera, what impact did that have on the third quarter for the company? And to what extent is that also impacting guidance excluding the $4 million that you mentioned earlier? That may or may not be related to that in revenue?

Let me address that, Craig. The automotive customers have faced supply chain shortages, which are reflected in the numbers Jeff mentioned, specifically the $4 million that has been pushed to next year due to these disruptions. They are the main cause of this issue. To answer your question, that's about it. I believe that's a significant factor.

Yeah. And then I wanted to go back to gross margin. So it was great to see the increase in recurring gross margin in the quarter. And it sounds like Jeff, that since that's based on utilization increases and yields in the Philippines, that's a structural gain. And so the question is, from that 52% level, is there further upside you can achieve on that as volumes rise through the year as your mix normalizes this in its? So to what extent can gross margins in recurring rise from where they are today?

Yeah, I would talk first about the contractor gross margin. As you know, all of the contractor revenue is considered recurring. And we're going to exit 2021 where it's about a 40% gross margin and contactors, expecting that to be about 45% in the second half of next year. So that'll have an impact on the overall recurring margin. But I think it's important to look at that element first. And then of course, on a higher base of revenue, it'll increase that overall gross margin, but not to the same extent that the contactor gross margin will grow.

Got it. Okay. And then lastly, just looking at the backlog and some of the color, you're providing very helpful, Jeff, to get the color on the first quarter. But beyond the first quarter, any sense for what the contour of the year would look like? Are you getting the sense from your customers that if we've reached this more normalized level in automotive, for example, that we could be back to an environment where we see more normal seasonality, or are there other things that might give us a different profile that you're starting to hear? Whether it be from your test customers, your handler customers, etcetera?

It's a bit early for us to comment on the remainder of the year. We're currently finalizing our plans for next year. We have more visibility for the first half of the year as we are already engaging with customers regarding their production needs. We're noticing an increased interest in RF front end IC tests and an uptick in demand for our tester business. Additionally, we're seeing growth in context, as we're improving both revenue and gross margins quarter-on-quarter. On the handler side, the automotive segment has eased following a recovery from the constrained environment of 2020. We are currently experiencing stronger demand from automotive customers developing Battery Management Systems, ADAS processes, and sensors, among other devices. Regarding seasonality, we expect to see a return to seasonal patterns in the second half of this year, including the typical seasonal dip in the fourth quarter. However, the company is in a stronger position now, even with this expected decline. Next year, we anticipate a return to normal seasonality, with growth in the second and third quarters, followed by a slowdown in the fourth quarter. We still need to finalize our plans before we can provide more details, but the first half looks promising as the mix is shifting as we've discussed.

Real helpful color, Luis. I'll jump back into the queue, guys. Thank you.

Our next question comes from Tom Diffely with D.A. Davidson.

Yes. Good afternoon. Thanks for the question. I was hoping to get a little bit from you on your view of the 5G of the RF tester market. In terms of whether or not you think that the build-out over the next couple of quarters will be similar to what we saw a year ago. And then maybe beyond that, where do you think we are in this multi-year build-out of 5G?

Hi, Tom. Yes, I think you will. Actually, we saw a demand ramp for testing to support approximately, if I'm not mistaken, it was about 250 million 5G phones at the end of 2020. And then that ramp, though, happened quite late in the year, probably because of pandemic concerns in the first half of 2020. And then we're looking at 2022 as another 250 million phones that are 5G enabled. So we expect that build-up to be very strong again. More importantly, I would say we have had some design wins in the last year and a half that we expect to generate incremental dollars for us next year. So yes, we're looking very optimistically for a strong RF front-end IC ramp.

Okay, great. And then switching gears a bit here, when you look at different regions throughout Asia, where you're exposed and maybe specifically the Philippines. What has been the impact of COVID? Over there recently? And have you seen any labor shortages or labor impact?

No, we haven't. Our Philippine factory is running at full capacity. We haven't had any bumps since, I think it was the first half or even the middle of last year when things were complicated in the Philippines. We don't have many suppliers in the Philippines. It’s actually a fairly narrow supply chain for us, so not a supply chain problem. Our factory, like I said, is fully operational. And our customers in the Philippines are taking products. So right now, totally transparent, no issues over the Philippines.

Okay, that's great. And then finally, on the DI-Core, I think last quarter, you said it was a fairly small market for you today. What do you think it becomes a meaningful piece of your business?

Yeah, it's a very difficult to answer question, Tom. We're essentially crawling into it, looking at lots of small numbers here, we're looking at close to a $1 million of revenue this year. Probably double that maybe a little bit more than double that into next year. So it will continue to be a small revenue profile for the next couple of years for sure. Nevertheless, it is, as I said on prepared remarks, it is softer. So it's essentially a 90% plus gross margin product sale. Revenue will increase is not only as we succeed in demonstrating to customers but succeeding in developing and delivering new capabilities. We intend to move to a subscription model on the new capabilities next year. It will obviously augment the differentiation of our products and increase our recurrent revenue stream. But I think from a top-line perspective, it would still be kind of single-digit low to mid single-digit for the next two to three years.

Okay, great. Well, thank you for your time today.

Thanks.

Our next question comes from David Duley with Steelhead Securities.

Good afternoon. And thanks for taking my questions. Just a couple of housekeeping questions, I guess, could you help us understand what you think the size of the contactor market is in 2021? And then what you think the growth rate of the overall market is? And then along that same topic, maybe tell us what your market share goals are currently for the next couple of years.

So the obviously the market forecast information for 2021 is not out there yet. But we're going to venture to say it's around $800 to $850 million for the contractor market that we can address. The market is growing, I mean, overall trend line looks like about a 7% CAGR from the last projections that I have seen in the contractor space. We've been looking at this, as I said, in prior quarters more as an attachment rate story. What is the attachment rate in contactors? Unfortunately, as we discussed in the past, the attachment rate has been calculated on a quarter to quarter basis, which tends to have quite a bit of volatility from the equipment sales. So we took a look back and doing more of a weighted average, it approximates to 29% attachment rate today. And our goal over the midterm is to grow that to 50%. That's our aspirational goal.

Okay. You mentioned that there were some price increases for certain handler products. What is the status of recognizing that benefit? It typically takes some time because you must work through the current backlog before you can recognize the price increases. Could you help us understand how much of that has already been captured and how much is still to be captured?

Hey, Dave, yeah, you're absolutely right. It rolls in really based on how much backlog is left and as new orders come in for customers. So as I said, it's been effective; it was effective in Q3, essentially to offset costs. We're going to see a small, additional improvement in Q4, call it 25 to 50 basis points. And then as we enter into Q1 of next year, more customers are subject to it, so about 100 basis points from that point on.

Could you help us understand more about the gross margin progression next year from the Q4 level you've guided to? If the revenue environment is normal seasonally, what would you expect the gross margin trajectory to be for the middle to the end of the year? Can we reach 46% or 47% by year-end, or what are your thoughts?

Yeah, Dave, I mean, I would kind of phrase it as mid-40s. And that to me means that 46% is achievable. Our midterm target is 48%, right? And that's over a three-year time horizon. 47% I think might be a bit aggressive. But I think based on what we see out of the contactor business, reducing costs there, growing revenue and expectations for testers, and I think I'm comfortable with 45%, 46% being achievable in those seasonally strong quarters.

All right. Thank you.

Thanks, Dave.

Our next question comes from Krish Sankar with Cowen.

Hi, this is Bob Mertens on behalf of Krish. Thanks for taking my questions. First, because you provide some clarity on the breakout of the automotive business, is there any way to bifurcate between ED and ADAS or sort of how the margins are overall, within the business line? And then I have a follow up.

Yeah, let me think about the first part of the question. I’ll let's Jeff address the second on the gross margin. So it's not an exact science. But we tally we're measuring about 30% of our automotive handler demand to be in the third quarter, which should be associated with a combination of battery management and ADAS. Battery management being the predominant driver. ADAS is a small portion, but in aggregate, about 30%, so close to one-third of our handlers.

So, Robert, regarding the margin, I won’t go into too much detail about the specific units. However, I want to mention that we shared in the presentation today that the systems gross margin for the quarter was 37% and the recurring margin was 52%. Additionally, I would like to note that the overall margin for handlers was approximately 40%.

Great. Thank you. That's helpful. And then just a last one before I hand it over. Just in terms of your pricing, do you typically have it under contract and sort of a step-wise function, or how should we think about the recent price increases and going forward, if costs continue to rise?

Well, we have gone to our handler customers and issued an essentially a price increase. Now, it's not applicable to some customers because there are long-term contracts and pricing is set for that period of time. Other customers have already ordered and so we had a backlog of handlers. But once we get through the backlog and new orders are placed, it's not 100% across the handler orders, but it's a majority of them that new orders will be placed with that price increase. And so that's why we see the offsetting impact against the increasing costs incremental with each quarter. And as I said, as we get into Q1, we're closer to the full effect of it, perhaps 100 basis points impact in the quarter.

Great. Thanks. That's all from me.

Our next question comes from Christian Schwab with Craig-Hallum.

Hey, guys. So, most of my questions have been asked, but just a quick one. We have a lot of different fabs, in particular, legacy nodes adding capacity where you historically have been very strong. As we kind of think about the multiyear layout of wafer starts ramping more materially in all these new fabs, when would you expect that to impact your results since it sounds like in next year, you kind of expect to return to normal seasonality? Is any of that capable of offsetting typical seasonality on a go-forward basis, or am I thinking about that wrong?

Hi, Christian. It's really going to happen over time. If you look at trailing edge nodes, Texas Instruments is leading the way in ramping up capacity, particularly for automotive and industrial applications, and this is publicly known. They have new assembly test sites coming online at the beginning of 2022. However, many others are lagging and have capacity additions that will start affecting 2023, even towards the end of that year. There's not a single moment when this will occur; it will unfold over time. As for whether this will change the trend of seasonality, I honestly don't think so. Seasonality will primarily be driven by end market demand and consumer demand rather than capacity additions. The capacity increases reflect confidence in the growing end market demand and the expansion of semiconductors. For instance, I spoke with an executive recently about the semiconductor content in vehicles, comparing what they used to supply when they joined the company to what they supply today. The increase in semiconductor content in cars is significant. There is a strong belief that this trend will continue in the upcoming years. Therefore, while the trend is positive, seasonality will likely be driven by end market demand, and I don't believe capacity will significantly influence that. But that's just my opinion.

Great. No other questions. Thanks, guys.

Thank you.

Our next question comes from Charles Shi with Needham & Company.

Hi, Luis and Jeff. I'm asking questions on behalf of Quinn Bolton here. So first off, I want to start with your tester, the trend line of tester revenue growth. It looks to me the third quarter you may have a little bit of moderation in terms of the tester revenue. And is that kind of like normal seasonality there? Do you expect the second half tester revenue kind of lower than the first half, given how strong the first half was?

Yes, I think that's right. That latter statement is correct. Customers took a lot of equipment Q4 of 2020 through Q2 of this year. I think as we discussed on our Q2 call that those customers essentially taking a pause. And so we're seeing softer tester business in the second half of this year. Thing, as Luis indicated, conversations with customers are indicating that we're looking at a next phase of a ramp here for RF testing coming in the first half of next year.

Got it. Got it. This maybe pushing you a little bit harder understanding the tester revenue trajectory going forward, is that first half you expect tester demand to be strong? May I ask the stronger relative to second half 2021 or stronger than first half 2021?

I would say definitely relative to the second half of 2021. Yes. And we'll get into more details when we get there as it compares to the first half of 2021.

Yeah. Obviously, I know, we’re probably still a little bit early to really pinpoint what the first half 2022 numbers are like. Maybe a little bit on gross margin, you sort of mentioned mid-40s gross margin for next year, maybe something like 46%, maybe in reach 47%. How much of that from what you see today can be driven by a little bit of favorable product mix, maybe you've got a little bit more testing next year, a little bit more contractor, which you are steadily improving gross margin from first half this year to the fourth quarter. Just want to understand the product mix side of the puts and takes in terms of the gross margin improvement into next year. Thank you.

Yes, Charles, absolutely. The variety of products is important for increasing the gross margin. We are confident that we will continue to grow the contractor revenue and also enhance the gross margin, which is a crucial aspect of our strategy for not just increasing revenue but also for gross margin and profitability. Another strategic focus is the growth of the tester business, which has very good margins. Our strategy is to boost tester revenue, and as we do that while maintaining our handler position and revenue, we expect to improve the product mix from a gross margin perspective. When I mentioned earlier the strong quarters for 2022, we were referring to a gross margin of around 45% to 46%. While we haven't finalized our annual plan for 2022 yet, I believe that based on current insights and my confidence in the model regarding the growth in testers and contactors, I would anticipate that these strong quarters in 2022 will have a gross margin in the mid-40s range. A margin of 47% might be a stretch, but I am more comfortable with a range of 45% to 46% for those strong quarters.

Got it. Maybe for my last question, Luis, this is for you. You always provide great insights on the industry. I noticed you mentioned that power management ICs are among the top components in shortage within the semiconductor sector. It seems that investments in new capacities for power management ICs will remain strong next year. Can you give us an overview of how your products relate to this segment of the market? What factors are influencing the demand for testers, handlers, or contactors? Thank you. That's all from me.

Okay. Yeah, Charles, let me start from the end. We obviously do have contactor product lines for small power management IC applications and are going all the way up to high voltage, high current application. So the whole gamut of PMIC devices. And again by that I mean, small PMICs that go into mobile phones to very large power devices. I wouldn't call them PMICs; I will call them power discrete, actually, they may go on industrial applications, trains, you name it—that’s sort on the contactor side. Handlers, very much the same. We have small PMIC applications running in our current handlers and we have very large power management devices running on gravity feed handlers also for non-good dye power management applications. And looking here at also march that from silicon carbide. When it comes to the tester business, I would say we're much more narrow focus on small PMIC devices, small power, small applications, more mobile in nature, not so much the high voltage, high current, not silicon carbide, for example, not MOSFETs. But more so the small PMIC solutions on the tester side. Hopefully that covers it from all three product lines for you.

Yeah, thank you.

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

Yeah, just two follow-ups. First, just a lot of conversation today about the pricing action that's been taken on the handler side of the systems portfolio. And it's nice to see that. But the question is, strategically, have you thought about pricing action in other parts of the portfolio? And since you're doing it in handlers, why wouldn't you try and execute it elsewhere as well?

Well, Craig, this is Luis. What we've done is pass on cost increases to our customers. We're not looking to overcharge customers unless we truly have a differentiated product; pricing will reflect the product's value. This year, we've experienced cost increases for components used in our handler products, including off-the-shelf components, motors, sensors, control boards, and some additional labor for subassemblies at our contract manufacturers. We consolidated these cost increases and, once we had a clear understanding of their value, we discussed it with our customers. We recognize that we're not alone in this approach; our competitors are doing something similar in related areas of the semiconductor space. However, we're only raising prices when justified by differentiation, and we’re not seeking higher prices unless we see corresponding cost increases.

Okay. And is that the point there then, Luis, that you just haven't seen that much of a bomb cost increase with testers or the broader market dynamics different in testers that would not allow you to make such a move even if you had a similar such cost increase?

Yes, that is correct. We have not seen that level of cost increase on the tester side.

Okay. And then lastly, because you mentioned and included in the press release the $70 million share repurchase program. I just wanted to give you an opportunity to talk about how you might go after that, whether it's in the fourth quarter or in coming quarters and how you plan to execute on that repurchase.

Craig, we're going to start with opportunistic buying here, as early as next week. Soon thereafter, we'll put a 10b5-1 plan in place with different pricing parameters and let the purchasing happen, you know, essentially automatically, if you will. So that's sort of the mechanics of it. It's probably why we put it in place. We truly believe the company is undervalued and wanted to take some action on that. Very confident in cash flows moving forward. Also would like to say that this doesn't mean that we won't be doing acquisitions. We've sized it so that we believe we can continue, obviously pay down debt, make investments, do acquisitions, and we believe with cash generation, we project that we can also return some capital to shareholders and send a message to the market about how confident we are in the company.

Got it. Jeff, Luis, thank you very much.

Thanks, Craig.

I’m showing no further questions in the queue at this time. I’d like to turn the call back to Jeff Jones for closing remarks.

Thank you. Before we sign-off, I just like to say that we'll be attending the following conferences: Stifel Virtual Conference on November 11; The Craig-Hallum Virtual Conference on November 16; CEO Summit which will be held in person on December 8 in San Francisco, and the D.A. Davidson Virtual Conference on December 15. If you'd like to attend any or all of these events, please reach out to your respective banking and/or conference contacts to arrange a meeting with Cohu. I look forward to speaking with you soon. Thank you for joining today's meeting. Have a good day.

This concludes today's conference call. Thank you for participating. You may now disconnect.