Good day and thank you for standing by. Welcome to the Cohu Inc. Third Quarter 2022 Financial Results Conference Call. At this time, all participants are in listen-only mode. After the speaker’s presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Jeff Jones, Chief Financial Officer. Please go ahead.

Good afternoon, and welcome to our conference call to discuss Cohu's third quarter 2022 results and fourth quarter 2022 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 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 27, 2022, 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 Muller, Cohu's President and CEO.

Hi, everyone. Good afternoon, and thanks for joining us. Cohu reported another great quarter with revenue of $206.7 million and non-GAAP EPS at $0.74, exceeding the midpoint of guidance. Non-GAAP gross margin of 47.5% continues to progress towards our three-year target financial model and benefited from strong recurring business and sale of differentiated products in the quarter. Free cash flow was approximately 16.7% of revenue in the third quarter delivering strong cash generation in line with the model. Estimated test cell utilization came down 2 points quarter-over-quarter to about 82%, reflecting known ongoing softness in mobility and consumer end markets, but also moderating conditions in the automotive and the industrial markets. Cohu's significant recurring business has produced a three-year compound annual growth rate of 6.5% and represented approximately 42% of third quarter revenue at 54% non-GAAP gross margin. In the last four quarters, recurring was $336 million or 41% of sales, delivering a profitable and resilient revenue stream through industry cycles. Our recurring revenue is primarily made up of test contactors and device application kits that are mainly IC design-driven and benefit from the introduction of new semiconductor products by our customers. The balance of approximately 43% of our recurring over the last 12 months comes from service revenue across 280 customers manufacturing facilities in 31 countries. Our service business unit manages a large volume of transactions through a cloud-based automated order management system, handling over 1 million parts shipments per year and provides on-site and remote assisted support to Cohu's 23,700 equipment installed base. This is not part of our customers' capital budget, but a necessary operating investment to ensure continued semiconductor production. As such, we have many customers engaged in support contracts with an annual renewal rate of more than 87% in the first half of 2022. Moving on to our DI-Core data analytics software initiative. We added another customer in the third quarter. This one is a leading European supplier of optoelectronics semiconductor. We expect DI-Core to help fuel continued growth of Cohu's recurring business in the coming years, delivering greater equipment output and uptime for the installed base. Data analytics could represent a $15 million to $25 million profitable revenue stream for Cohu in a few years, and we remain committed to broadening the penetration of the DI-Core software offering expanding functionality with predictive maintenance, contactor analytics and more. Switching over to Cohu's systems business, it added 58% of third quarter revenue at 43% non-GAAP gross margin. System revenue distribution in the quarter was well balanced across end markets, notably stronger in the automotive and industrial segments. Automotive ADAS and EV applications continue to be the primary driver with many customers adopting Cohu's T-Core technology for a temperature test. During the quarter, we have design wins testing high-end processors using server farms, capturing new orders and system acceptance with large U.S. headquartered customers. Cohu's use of differentiated thermal technology was a determining factor in securing these new businesses as we continue to demonstrate the greater test yield advantage of our T-Core technology. We're also winning new business in the inspection of non-good die silicon carbide power devices. This is the growing opportunity across many customers, integrating Cohu's automation equipment with our proprietary high-power contactors. We have systems shipping to a major U.S. silicon carbide manufacturer in the fourth quarter, and we expect to soon have customer acceptance with a strong volume forecast over the next two years. Also in the third quarter, Cohu introduced a new integrated test, automation, and inspection solution for high signal-to-noise ratio MEMS devices, essentially precision sensors. We anticipate this product gaining market traction with applications across automotive, mobility, and industrial robotics. As stated earlier, gross margin is steadily expanding with the transition of contactor manufacturing to our Philippines operation, ongoing progress to mitigate component shortages and lower costs, and development of differentiated products for test and inspection of silicon carbide, MEMS, ADAS, and other advanced semiconductors. Cohu's prospects remain strong and aligned to secular growth applications. In the third quarter, we repurchased about 638,000 shares at an average price of $27.74 reaffirming our belief in Cohu's growth initiatives. We're executing well against our strategic plans, are positioned to remain profitable during periods of market uncertainty, and we continue to make very good progress revamping our product portfolio with differentiated test and inspection solutions. Let me now turn it over to Jeff to share details on third quarter results and provide our fourth quarter guidance.

Thanks, Luis. Before I walk through the Q3 results and Q4 guidance, please note that my comments that follow, I'll 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 and 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 $206.7 million and slightly higher than the midpoint of our guidance range. During the third quarter, one customer in the automotive market accounted for more than 10% of sales. Gross margin in Q3 was 47.5%, about 100 basis points higher than guidance driven by Cohu's recurring business and differentiated products. Headwinds from cost increases for IC components used on our tester products impacted our gross margin by approximately 130 basis points. We expect these challenges to persist at a reduced level into mid-2023 as we increase sourcing directly with semiconductor manufacturers and component availability improves. Operating expenses for Q3 were lower than guidance at $52.6 million, due mainly to lower labor costs from hiring delays and higher utilization of vacation. Third quarter non-GAAP operating income was 22.1% of revenue, and adjusted EBITDA was strong at 24.5%. The non-GAAP effective tax rate for Q3 was 23% and higher than guidance due to a shift of projected annual pretax income from lower tax rate jurisdictions to higher tax rate jurisdictions such as Germany. Non-GAAP EPS for the third quarter was $0.74. In summary, Q3 profitability was strong as gross margin and adjusted EBITDA continue to expand toward the midterm financial target. Moving to the balance sheet. Q3 cash flow from operations was strong at $39.5 million. And net of share repurchases totaling $17.7 million, debt repayment of $11.7 million, capital additions of about $5 million and other changes in working capital, cash and investments ended the quarter at $369 million. Overall, Cohu's balance sheet maintains a strong position to support debt reduction, the share repurchase program, and investment opportunities to expand our served markets and technology portfolio in line with our growth strategy. Now moving to our Q4 outlook. We're guiding Q4 revenue to be between $180 million and $198 million. Our assessment of the new China export rules is they will have little to no impact on our Q4 revenue. Q4 gross margin is forecasted to be approximately 47% better than the financial target model, but down 50 basis points quarter-over-quarter due to lower sales volume and mix. The IC cost component headwinds in the tester business I mentioned earlier will persist, and we're projecting the Q4 impact to be approximately 50 basis points. With a three-year compound annual growth rate of 6.5%, Cohu's high-margin recurring business provides consistent cash flow through industry cycles. Operating expenses for Q4 projected to be approximately $52.5 million, essentially flat quarter-over-quarter. We're projecting Q4 interest expense to be approximately $1 million and offset by interest income of approximately $1 million. We expect Q4 adjusted EBITDA at the midpoint of guidance to be approximately 21%. The Q4 forecast non-GAAP tax rate is approximately 22% at the midpoint of guidance. Full year 2022 non-GAAP tax rate is projected to be approximately 21%. The diluted share count for Q4 is expected to be approximately 48 million shares. That concludes our prepared remarks. Now, we'll open the call to questions.

Our first question comes from Atif Malik from Citi.

A nice job on the gross margins. Luis, I have a question on your comments on moderation in auto industrial demand. Is this something that you have been seeing throughout this year? Or is it incremental? And then I have a follow-up.

Atif, no, no, that's something that we talked about and expected to see happening, and it is. Just to remind, we think automotive will remain a growing market and frankly, a substantial portion of Cohu's revenue next year. We see some customers stepping on the brakes for a quarter, but also part of the normal year-end seasonality. As you know, typically, Q4 and Q1, things do slow down in the industry. At the same time, we do have a few other customers, particularly in the power market, silicon carbide in electrification that are continuing the theme, adding capacity and have some strong forecasts for next year. That's not just automotive; to be honest with you, a mix of that is a bit industrial. So, electrification is a major thing. We also have a few other customers that are driving hard on ADAS for automotive at this time. So despite the moderation, like I said in the remarks here, it's part of the normal seasonality at the end of the year in automotive. And we do think automotive will continue to be an interesting growth market and probably even slightly up next year.

Great. And Jeff, on the gross margins, nice job on the gross margins. If I look at your recurring business growth in the last few years, you talked about kind of 6%, 7% growth. How should we view that growth into next year with utilization potentially coming down? And then if you can talk about any steps that you have to take to move any manufacturing or any supply chain out of China because of restrictions; I understand you don't have any direct impact from restrictions.

Yes. Maybe I'll just address the first one. We don't really have any supply chain to speak of either in China. So we've been on a path to move out of China, and we've essentially completed that. So no issues there to speak of, Atif. Recurring revenue, as you know, the reason why you like it and promote it so much, it's more stable. It's a stable revenue stream. And we typically look at it and it's performed over the years versus systems to react to a downturn, perhaps 1/3 of what we might see from the systems business. So not expecting big changes ultimately either way, up or down for next year, just a pretty consistent revenue stream.

Thank you. One moment for our next. Our next question comes from the line of Michael Mani from B. Riley Securities.

This is Michael Mani on for Craig Ellis. Thanks for letting us ask a couple of questions. My first question is just on seasonality. So I know Q1 is typically a weaker period for the business. Given the kind of contracts we're seeing in mobility testers but also in auto and industrial, how should we think about sequential growth into the first half of next year?

Michael, this is Luis. So you're correct. We typically see seasonally low fourth and first quarters of the year. We are expecting sort of the same this year around Q1. Hard to predict right now; I'm going to peg it at somewhere between 3% to 5% down sequentially from Q4, which is generally in line, I think, with what we've been saying. Generally speaking, a softer half of the year, like we talked about earlier as well a quarter ago, mostly because of the way the markets are in consumer and mobility, also PCs. And then we're forecasting more of a pickup in the second half of the year. We do have already some orders on the books for Q2 and Q3 delivery related to mobility market processes for testing. We do have some strong forecasts now for the server market ramping in the second half of the year, much stronger than the first half. As I said in the prior call, we do think industrial and automotive will also be strong next year, probably also stronger in the second half as that continues to grow. And as we put on the slide deck and in the remarks, we do run a pretty strong recurring business, which in the last 12 months is about $336 million, and it's been growing over the years, and we think that that's going to continue as more systems that we have shipped over the last 12 to 18 months start coming out of warranty. So hope that paints a general picture for Q1 and the expectation for next year.

Very helpful. For my follow-up on gross margins, as we look out into the first half of next year, you mentioned something that's giving margins a boost is product differentiation. So as you have these new products coming online, ramping up in the first half of next year and as headwinds season, as we get the benefit of more in-house manufacturing, where do you think margins could trend relative to the 47% target levels we've seen this quarter or for the next quarter, rather?

Yes, Michael, it's Jeff. So margin will trend with revenue as well, but it's less susceptible to changes in mix. And that's because we've done a good job of expanding gross margins in our handler business. They've delivered in the 43% to 46% gross margin range. Contactor gross margin, we talk about all the time, expanding into the mid-40% range. And so with that improvement there, it really reduces the volatility we have when we have a mix shift. And then on with respect to volume, as you probably know, we're sort of manufacturing light on systems, if you will; we outsource quite a bit. We do final assembly and test in-house. And so we really have a limited infrastructure in-house infrastructure and fixed cost. Most of it or a high percentage of it is variable. So we're feeling pretty good about the gross margin resiliency. As Luis said, if the first half of next year is lower as we've talked about in prior calls, I'm still expecting to be in that 46% gross margin range. And then probably for the full year, something similar to where we are today, looking at about a 46.5% gross margin for the full year.

Our next question comes from Robert Mertens from Cowen.

This is Robert Mertens on for Chris Sankar. First, could you just take me through some of the cost controls in place through the end of the year and into next year, and along with that, maybe just some of the progress on in-sourcing the contactor business?

Overall cost control is not just gross margin but operating expenses as well. Okay. Yes. Well, I think you probably are aware of the gross margin story. I just touched on that. We've made a lot of progress over the last 12 months with respect to reducing product costs. Also with respect to pulling in work that we would have outsourced to suppliers in the U.S. and Europe into the Philippines for contactors, and that has done two things. It's increased utilization there. We've improved in the manufacturing efficiencies. And so it's driven costs down overall, expanded gross margin for contactors. We also increased handler prices in the second half of last year, so we had the full effect here in the last couple of quarters. So with respect to operating expense, then, in the quarter, we mentioned hiring delays. What we typically do should we roll into a soft period? We would freeze hiring. We would eliminate temporary personnel. We would encourage utilization of vacation. We would reduce travel; sort of the normal leverage that we have when we run into a soft spot. And so we're forecasting OpEx to be about $52.5 million, which is flat over last quarter. If I look back over time, over some soft periods, we've been down to $50 million a quarter. So I have no doubt we could get back down to those levels if necessary.

Rob, just going to add a little bit more on the contactor in-house manufacturing. I think you asked that, too. We did about 65% of in-house manufacturing in our Philippines operation in Q3, and we're targeting to be just shy of 80%, about 78%, 79% in Q4, which is right in line with what we've been saying all along to get to about 80% by the end of the year.

Thank you. One moment for your question. Your next question comes from the line of Tyler Burmeister from Craig-Hallum. Your line is now open.

Could you hear me? This is actually Christian Schwab. Can you hear me?

Christian, yes, we can.

Okay. Great. Sorry about that. As you know, Ty works with me. So we just mentioned I have a few quick questions. When you are looking at your test utilization for the calendar year 2023, and as we enter the softer period, do you expect that utilization rate to change significantly from where it currently is, or considering some of the growth areas, are you not anticipating a material difference?

Christian, this is Luis. Yes, like I said, utilization is about 82% at the end of Q3. It is weaker at OSATs and stronger at IDMs. Now what do you expect going forward? Yes, seasonally slow period in the fourth and the first quarter. I would venture to say this utilization could drop another couple of hundred basis points to about 80%. Hard to say, to be honest with you, but that's just a guess here that it will hover at about 80% a quarter from now.

Okay. So that being the case, you don't think there doesn't appear to be significant overcapacity of your testing products out there. Is that fair to say?

I believe that's a reasonable observation, especially regarding testing. Our most significant exposure lies in analog integrated circuits and the end markets, particularly in automotive and industrial sectors. I think those areas are performing quite well. Analog integrated circuits have a wide range of end-market users, so we aren't tied to any specific customer or niche manufacturing for high-end processors. It's a broad semiconductor market that we cater to. Therefore, I don't anticipate any major issues in the testing area, which has been growing in line with end market demand. However, I would advise caution not to overly relate our situation to wafer fabrication equipment spending, as that operates under a different set of dynamics.

Right. Right. And then lastly, can you give us some greater color on the new win in the server CPU area? Is it an expansion with an existing customer? Is this a new customer calling it out? Is this something that over time could be a substantial annual run rate business for you?

Yes. Realistically, it's an existing customer. We've been doing business for years, and it's challenging to acquire many new customers in this space. However, there is an existing customer with whom we've conducted some business, though not substantial, over the last decade. Now, we see an opportunity to expand by introducing qualified new products, which are closely linked to our T-Core thermal technology. This technology is one of our core intellectual properties and stands out in the marketplace. It enables faster test times, reduces power and thermal issues, and increases yields. Looking at our computing business, it has been showing quarter-to-quarter growth. Revenue from computing systems rose by 50% in Q3 compared to Q2 and 80% compared to Q3 of last year. It's been a positive trend. There are also a few new customers, albeit at smaller revenue levels. These companies are designing their own server chips and outsourcing manufacturing since they don't have operations of their own. However, the majority of the revenue growth is coming from an existing customer with whom we've been increasing our business over the past few quarters.

Thank you. One moment for our next question. Your next question comes from the line of Hans Chung from DADCO.

This is Linda on behalf of Hans. Thank you for letting us ask questions. So I guess my first question, given all that is going on in the macro environment, heading into 2023, I would love to hear how you're thinking about 2023 semi-unit growth? And maybe how we should tolerate that with system business?

Linda, this is Luis. I previously shared some insights that might be relevant. Typically, we experience slower activity in the fourth and first quarters of the year, so it’s not unexpected that we anticipate a soft start for Q1. I would suggest that the first half of the year might continue this trend. However, we maintain strong and consistent expectations in the automotive and industrial sectors, forecasting continued growth in the market, possibly a few hundred basis points for the total addressable market next year. We already have confirmed orders for mobility in the second and third quarters, along with a significant server ramp forecast for the latter half of next year. We are also developing device test programs for specific mobility applications that have deadlines aligned with anticipated incremental business beginning in Q2. Additionally, recurring revenue has represented about 41% to 42% of our business over the last year, totaling $336 million and expected to grow as our recent shipments come out of warranty periods. Considering all these factors, while it may be slightly premature to project for the market next year—perhaps almost a quarter too early—I would estimate that the test and inspection market might realistically see a mid-single-digit decline next year due to a slower beginning to the year.

That's very helpful. Thank you. And so onto supply bottlenecks, A lot of companies are seeing improvements in that and if I missed this in your remarks, but I was wondering, in your view, impact our supply chain issues having on your company, especially in the third quarter, and maybe to what extent do you think softening demand might help mitigate the supply chain issues?

Yes, I can comment on the supply chain. And Jeff, maybe you can add what we expect for headwinds on that on the P&L. But you're right, it has been improving. Frankly, we have now two quarters of actions around it as well and working to go direct with certain suppliers and source material. So it is a situation that is improving. There were still headwinds in the third quarter. We expect it to remain, although that's a much smaller headwind in the fourth quarter, and maybe Jeff can put some numbers on that. But the plan here is we should be able to eliminate that by the middle of 2023. That's the plan. When we look at our customers, there's also a supply chain challenge there with that limits when we can ship products, and it generally has to do with the availability of wafers. Our automotive customers are starting to get more wafers and some of them have new fabs, as you're aware, TI with our Fab 2 and the Lehi acquisition and some of the silicon carbide companies having new fabs launching now in the first half of next year. Others are talking about the expansion of fabs in Italy with some capacity coming online in the second half of the year. So I think, in general, by the middle of next year, we expect supply chain issues for us and hopefully here true as well for our customers on the wafer side to abate so that we can get this behind us.

So with respect to the Q3 impact, it relates to a higher cost for ICs that we use on our tester products. And so just having to pay just because due to availability or lack thereof, we've had to pay a higher than standard cost for those ICs. We had an impact in Q3 of 130 basis points, and thankfully, the availability is loosening and we're working directly with semiconductor companies many of which are our customers. We see a much reduced impact in Q4. So it's a 50 basis points forecasted impact in Q4. Now this will dribble into Q1 and Q2 of next year as well, but that likely less than 50 basis points for each quarter.

And lastly, could you also give us some color on the lead times for your different products, testers, handlers and contractors?

Sure, Linda. Let's say, handlers are running approximately 20 to 22 weeks lead time, testers approximately 14 weeks, contactors about 10 weeks. And like I said, those are on average, right? I mean there are products that we can ship faster and some configurations will take a little longer. But that's about where it stands.

Thank you. One moment for our next question. Your next question comes from the line of David Duley from Steelhead Securities.

Louis, you mentioned something about a silicon carbide opportunity in Q4. I'm sorry, if you could just elaborate a little bit more on which product that is? And what sort of opportunity that might be over time, that would be great.

Yes, David. Well, obviously, I can't tell you the customer, but we do have a multi-unit order already from that customer. It's essentially for test automation, inspection, and metrology and contactor interface products. So it cuts across quite broadly. Being silicon carbide, obviously, very high voltage application, we'll be shipping the products in the fourth quarter. Maybe, maybe not, we got acceptances in the fourth quarter as well. And there's a pretty decent forecast for the next two years from that particular customer. They are ramping capital expenditures; I think that's public knowledge. And we hope to be enjoying a significant portion of that CapEx from that customer. They have spent quite a bit on the front-end side recently. I think they're essentially back-end test and yield bottleneck at the moment, so we're hoping to help resolve that.

Excellent. I don't remember you mentioning silicon carbide in previous conference calls. Is this the first major opportunity in that segment of the power market? Could you elaborate on whether there are more customers coming or how we should view this overall opportunity?

Yes. They're not the only ones, actually, David. We have had some business in the space predominantly with two large European customers, one in Italy, one in Germany, but now we're talking about this other one that I elaborated on before, which is essentially a new customer in the U.S., and we have some business already in Europe in this space. So it's not new. It's been migrating from sort of older MOSFET technology into silicon carbide over time, and it's starting to pick up momentum. It's still a relatively small number relative to over $207 million revenue in the third quarter. But it is a key part of our forecast for ramping over the next few years.

Thank you. I would now like to turn the conference back over to Jeff Jones, Chief Financial Officer, for closing remarks.

Thank you. And before we sign off, I'd like to mention the investor conferences we'll be attending over the next few months, including the Stifel Midwest Growth Conference in Chicago on November 10 and the Needham Virtual Growth Conference on January 12, 2023. If you'd like to attend either of these events, please reach out to your respective banking and conference contacts to arrange a meeting with Cohu. We look forward to speaking with you soon. Have a good day.

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