Cohu Inc Q1 FY2024 Earnings Call

Good day, and thank you for standing by. Welcome to Cohu's First Quarter 2024 Financial Results Conference Call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to Jeff Jones, Chief Financial Officer. Please go ahead.

Good afternoon, and welcome to our conference call to discuss Cohu's first quarter 2024 results and second quarter 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, May 2, 2024, 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. Luis?

Good afternoon. First quarter results were in line or better than guidance with non-GAAP gross margin of 46% and EPS of $0.01 as we navigate through the eye of the storm in this semiconductor cycle. We estimated test cell utilization at the end of first quarter, up 1 point to 72%. We expect business conditions to remain more or less at this level for another quarter or two before we start seeing improvement. Test cell utilization at IDMs was down 1 point to 74% with computing, industrial and automotive demand down sequentially. OSAT utilization improved slightly to 70%, although still well below the trigger threshold for capacity buys at approximately 80%. There are a couple of bright spots in the quarter, a leading U.S. fabless semiconductor manufacturer has selected our Sense+ system with MicroSense for testing their next-generation, high-fidelity microphones. This MicroSense microphone tester is Cohu's latest product in our MEMS solution portfolio. And when combined with the Sense+ automation platform, delivers state-of-the-art testing of up to 96 devices in parallel. According to industry analysts, the MEMS microphone sensor market is projected to grow 14.5% annually over the next 7 years, reaching an estimated revenue of $6.2 billion. We estimate a buy rate of approximately 1% for integrated test in vision inspection systems, making this an attractive market opportunity over the midterm. In the optoelectronics market we saw increased demand for our testers, handlers and interface products for automotive LED production from a European customer. A leading automotive ADAS customer has selected Cohu's high-performance RF contactors for testing automotive radar sensors. Finally, we completed the qualification of Diamondx for final test of display driver ICs at a large customer in Korea, opening the door for the next stage of revenue growth in this important market that we started developing a few years ago. This has been a fundamental strategy for our tester business to add a market segment in which Cohu can differentiate and diversify revenue. As the industry moves through its cycle, it remains critical to Cohu's strategy to leverage our profitable recurring business, which provides for a more stable revenue stream of mostly consumable products. Recurring revenue was approximately 66% of revenue in the first quarter, serving an installed base of about 24,700 systems worldwide. Cohu's recurring business delivered revenue of $304 million over the last 12 months with a 3-year compound growth rate of 2.7%. Finally, we published our 2023 sustainability report with improvements in many areas. Renewable source energy usage increased to 32%. We completed construction of a new modern facility in the Philippines with a rainwater harvesting system and are investing in solar energy installations at our factories in Malaysia and the Philippines. Cohu has also recently committed to engage with the science-based targets initiative, or SBTI with the goal to develop near-term science-based emissions reduction targets. As the industry grows through this cycle, we remain focused on managing cash flow while continuing to execute critical new product developments and customer design win initiatives to enable growth when customers resume capacity buys. Let me now turn it over to Jeff to provide further details on first quarter results and second quarter 2024 guidance. Jeff?

Thanks, Luis. Before I walk through the Q1 results and Q2 guidance, please note that my comments that follow all 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 Q1 financial results. Cohu delivered revenue and profitability above the midpoint of our guidance. Q1 revenue was $107.6 million. Recurring revenue, which is largely consumable-driven and more stable than systems revenue represented 66% of total revenue in Q1. During the first quarter, one customer in the automotive market accounted for more than 10% of sales. Q1 gross margin was 46%, about 100 basis points higher than guidance driven by better-than-forecasted margins on Cohu's resilient recurring business. Operating expenses for Q1 were lower than guidance at $50.2 million driven by lower labor and labor-related costs. First quarter non-GAAP operating income was approximately breakeven and adjusted EBITDA was 2.6%. Interest income, net of interest expense, loss on extinguishment of debt and a foreign currency loss of approximately $0.5 million was $1.6 million. Q1 pretax income consists of foreign profits combined with a loss in the U.S. The Q1 tax provision reflects tax on foreign profits, but no tax benefit from the U.S. loss, due to our valuation allowance against deferred tax assets. Additionally, the non-GAAP tax provision in Q1 of $300,000 is net of a one-time $2.7 million credit for the reversal of reserves for uncertain tax positions in foreign jurisdictions. Non-GAAP EPS for the first quarter was $0.01. Moving to the balance sheet. Cash and investments decreased by $64 million during Q1 to $271 million due to variable comp and payroll taxes totaling approximately $20 million plus $29 million used to pay off the remaining term loan B balance and approximately $11 million to repurchase 334,000 shares of Cohu common stock. CapEx in Q1 was $3.3 million with approximately $2 million related to our factories in the Philippines and Malaysia, supporting operations for our interface and automation businesses. Overall, Cohu continues to maintain a strong balance sheet to support investment opportunities to expand our served markets and technology portfolio in line with our growth strategy and return capital to shareholders through our share repurchase program. Now moving to our Q2 outlook. We're guiding Q2 revenue to be in the range of $105 million, plus or minus $6 million, reflecting continued weakness across end markets and low test cell utilization at customers' production facilities. Q2 gross margin is forecasted to be approximately 45%, better than the financial target model at this level of revenue due in large part to Cohu's differentiated products and our stable high-margin recurring business, which adds resilience to profitability and provides consistent cash flow through industry cycles. We expect gross margin to increase again when our revenue recovers with a broader semiconductor device market recovery and with better absorption of our factories infrastructure costs. Operating expenses for Q2 are projected to decrease about $1.5 million quarter-over-quarter to approximately $48.5 million due primarily to a reduction in force and optimizations as we completed certain product developments. As I noted during our last earnings call, we have taken action to reduce operating expenses without sacrificing critical new product investments while navigating through the trough of this cycle. As a result, we're now modeling operating expenses to average approximately $48 million per quarter in the second half of this year. We're projecting Q2 interest income net of interest expense and foreign currency impacts to be approximately $2 million at current interest rates. We expect Q2 adjusted EBITDA to be approximately 2%. The Q2 non-GAAP tax provision is expected to be approximately $1.6 million because of tax on foreign profits without benefit from the U.S. loss. Additionally, the $2.7 million credit recorded in Q1 is not expected to repeat in Q2. Until the markets recover, we expect a similar tax provision profile as we navigate through this cycle. The basic share count for Q2 is expected to be approximately 47 million shares. That concludes our prepared remarks, and now we'll open the call to questions.

Our first question comes from the line of Brian Chin with Stifel.

Thanks for letting us ask a few questions. Maybe to start with, I'd say that the recurring revenue was even maybe a little bit more, even down less than I might have anticipated sequentially, given that I think a lot of industrial automotive semi-related companies that seem to have curtailed production quite a bit. But again, your revenue Q-on-Q actually did not decline by that much. Do you feel that now that maybe some of your customers' utilization rates are starting to stabilize? Do you think that revenue has also stabilized in sort of Q1, Q2, what's sort of the trend you're seeing? And even if you don't have full visibility on the system business, do you have more confidence that the recurring revenue will improve in the second half?

Brian, this is Luis. Yes. The way we see it right now with stabilizing utilization and recurring seems to be stable as well. And obviously, the expectation and what we've seen in the past is when utilization starts to increase, so does recurring, both from a usage of the equipment and therefore, increase the spares. Typically, customers end up cannibalizing unutilized equipment for spares and then eventually there is a quick turnaround on that when the utilization picks up as well as device kits and contactors. So at this moment, utilization is stable, so is recurring and we would expect it to return to an increase, particularly when utilization starts to rise again.

Got it. And I guess sort of branching out a bit in terms of going back to your comment about maybe revenues kind of stay at this level, another quarter or two. Is there something after this sort of retrenchment period here in first half in terms of system business, which sort of now is kind of across every end market, right, at this point. When you talk to your customers, what does give you more degrees of optimism in terms of some pickup at some point in the second half?

There are two points to consider. Not every customer recovers at the same time, which has always been the case. However, we are noticing some customers beginning to declare that their inventory corrections are over. Specifically in the IoT sector, we have observed some improvement, to the extent that our mobile segment revenue grew sequentially from Q4 to Q1. While there are still customers at the bottom, they are now reporting stability, which suggests that improvement could be the next step. We are starting to see a shift in the overall situation. As I mentioned earlier, we are at a stage where the headwinds have eased, and some customers are beginning to experience tailwinds. We anticipate that in the coming quarters, more customers will enjoy tailwinds, leading to increased utilization and eventually, capacity purchases. Of course, these capacity purchases depend on existing utilization picking up enough to warrant new equipment. Not all customers will be at the same stage at the same time; this will likely extend over several quarters. Nonetheless, it gives us optimism that better outcomes are on the horizon. I'm uncertain whether it will take one or two quarters before we see significant improvement again.

Okay. Maybe just one quick question. Thanks, Luis, for Jeff. Just obviously, very high gross margins here at trough. I noticed you also raised the target model gross margin to 50%. Anything that goes into that in terms of composition of revenue mix at $1 billion? Or what considerations kind of went into that increase?

Historical results really went into that decision to increase. We've maintained the same mix of product at that billion dollars of revenue with roughly 40% automation and 30% test, 20%, interface, 10% for inspection metrology. So that doesn't change. It's just we've seen better cost profiles, lower cost profiles, better margins. So that gave us the confidence based on what we've achieved here over the last, call it, eight quarters to set the target to 50.

Our next question will come from the line of Ross Cole with Needham.

I'll ask this question on behalf of Charles Chi. So first of all, can you provide some color on what you see on the mobile side of the end market, which drives your tester business? Are you more incrementally positive or cautious here?

Yes, we are somewhat more optimistic about mobile. However, I wouldn't describe this as a widespread market recovery just yet. Specifically, in the IoT devices sector, particularly regarding RF in the mobile field, we've noticed a slight improvement in orders in the fourth quarter and revenue in the first quarter. As I mentioned earlier, the mobile segment is the only area of our market where we experienced an increase in revenue from one quarter to the next. This increase is especially focused on the Android segment and our understanding of customer opportunities for sales in China and Korea, though it’s not a broad-based recovery at this point. I believe mobile will see gradual improvements moving forward, but realistically, a full recovery seems more likely to occur between late this year and 2025.

Great. And if I can ask a second question a little more broadly on what are the ordering or quoting activities like right now, especially relative to 3 months ago? Are you starting to see some green shoots?

The activity continues to concentrate on new technologies and applications, particularly where our customers succeed with specific sockets that generate demand. At this time, I can't indicate that there is a significant increase in overall capacity. We have qualifications and design wins to discuss, including a design win for a MEMS microphone application, which is a newly selected product by our customer. We have already shipped the first system to their lab, with a production system expected to ship in the summer. Additionally, we completed a design win with a qualification for a tester using a new instrument for final testing of display driver ICs, known as P2. This is the same customer who selected us for P1 last year, which generated $20 million in revenue for 2023, and we are now qualified for P2. Essentially, we are seeing new products and opportunities rather than broad-based capacity increases, which aren't significantly developing at this time.

Our next question comes from the line of David Duley with Steelhead Securities.

Yes. I was wondering when business does recover, which segments of your equipment, do you think the handlers or testers will recover first? And perhaps maybe just handicap which end market you think will turn on first for Cohu?

Dave, Luis, again. So we've been thinking that and it's really a good question, but we've been thinking that the mobile segment and computing will start coming in first. With that said, with that comment said, the reality of utilization dynamics today, it is still higher in the Automotive and Industrial segment. When we look at utilization by market, auto and industrial is hovering at about 78%. So it's pretty close to that capacity addition threshold that we call that is at 80%. While computing is much lower at 66% and mobile is at 67%. So it's a tale of two stories here because, one, we believe that the mobile and computing should be the one coming on first. On the other hand, we're a lot closer to that threshold in the auto and industrial. I think that's another way of saying, it could actually flip from what I have originally said. It could come back on the auto ahead of mobile.

Okay. With industrial and automotive utilization rates remaining steady, this indicates that the market has stabilized for you and your customers, and while I don't want to say that we are completely finished with the inventory correction, we have stopped declining in your largest business segment.

I think that's correct, Dave. I believe we've reached a point where we're no longer seeing declines across segments. Mobile has been quite weak for the past three quarters, and auto and industrial are also currently struggling. What’s positive about auto and industrial is that our customers are managing to operate just below the 80% threshold. The utilization hasn’t dropped as significantly as expected. However, customers have mainly stopped purchasing capacity at this time. They are focused on buying specific technologies rather than general capacity. So yes, I am optimistic about the auto and industrial sectors.

Can you remind us what your lead times are now? I imagine they're back to normalized levels, but I'm curious what those levels are currently.

They're largely unchanged from last quarter. It's a bit tricky to discuss lead times when we're selling new technologies. For our handlers, about 15 weeks is a fair estimate, testers around 12 weeks, and contactors about 7 weeks. I should mention that we're selling a lot of new handler configurations, including a high power dissipation T-Core system for processor testing. That's a new thermal system, and the lead time on that is a bit longer. With new technology applications, the lead times tend to be longer. I would expect that if we see more capacity purchases of standard products, despite increased demand, we might initially see lead times decrease a bit before they rise again.

My final question is about the upcoming server upgrade cycle related to artificial intelligence and the components that will be included in the new servers. There will be increased GPU and CPU content. Can you discuss how this upgrade cycle might affect your product lines? Specifically, I would expect that your thermal conditioning handlers could experience increased demand due to the server upgrades. So, how will this phase of the AI server upgrade cycle influence your business?

The server upgrade cycle is expected to benefit us more than the data center cycle. The data center cycle involves lower volumes and high average selling prices for semiconductors, while the server upgrade cycle offers increased volume. In the last quarter, computing accounted for about 5% to 6% of our revenue, but it dropped to around 3% in the first quarter. I anticipate some improvement in the second half of the year, provided that the data center cycle gains significant traction as anticipated.

Our next question comes from the line of Krish Sankar with TD Cowen.

This is Robert. I know some of this has already been addressed. However, regarding the auto and industrial markets, I am curious about how they have developed compared to three months ago. If I recall correctly, sales were down in the December quarter, but test utilization was relatively high. You mentioned that you continue to see slightly higher utilization in the March quarter, even though sales have declined somewhat. I'm trying to understand how you view that business as we enter the June quarter and the second half of the year.

I'm going to start with the first quarter. The utilization is holding up well, but revenue was down in the first quarter compared to the fourth quarter for both the auto and industrial sectors, and at a similar rate. Looking ahead, we don't typically predict revenue by market segment for future quarters. However, based on the order pattern, I would say that the industrial sector may be weaker, while the automotive sector might perform slightly better. The industrial side seems to be losing some ground relative to other markets based on the first quarter orders, which will likely affect second quarter revenue.

Our next question comes from Craig Ellis with B. Riley. Looking ahead, we don't typically provide revenue projections by market segment for future quarters. However, I would suggest that based on the order patterns, the industrial sector may see a decline, while the automotive sector might perform slightly better than industrial. It seems that the industrial sector is continuing to lose ground compared to other markets in first quarter orders, which could affect second quarter revenue.

What I wanted to do, Luis, is just try a shorter-term question. And then a longer-term question and on the shorter-term side. And this one goes back to some of the comments around downstream utilization and where the business is over the next couple of quarters. But assuming utilization is near current levels or maybe drifts up a little bit in a seasonally stronger second half. How do we think about the gives and takes with normal seasonality in the fourth quarter? Typically, the business would be down much more in the systems side than recurring. But typically, that would be off much more significantly inflated levels. So can you just help us understand how we should think about some of the seasonal dynamics given the unusual year we have thus far?

Sure, Craig. As you know, this industry experiences both seasonality and cyclicality. Seasonality refers to the 12-month cycle or pattern in the market, while cyclicality involves a longer, roughly four-year period. These two elements can sometimes obscure each other. This year is a classic example where we may not observe typical seasonality because we are recovering from a low point. All signs indicate that the market will begin to improve in the second half of the year, leading into a recovery in 2025. Therefore, I don't expect to see the usual seasonal patterns this year, especially since the cycle is influencing the market more significantly. Historically, we've seen that you can end the year with strong order momentum heading into the following year, even when typically, the fourth quarter would show weaker seasonal trends. I believe this will happen again this year, with cyclicality overshadowing seasonality in our current environment.

That's really helpful, Luis. And the second question is related to the target model. So great to see the business raise the gross margin target by 100 basis points to 50%. You guys have had really strong trailing 2- to 3-year gross margin execution. So I can see that. My question was more on the line about that revenue. So from third quarter levels, we annualized a little north of $400 million. And so the target is about 2.5x that. And what I wanted to do is give you the opportunity just to talk about the path that you see for the business to go from annualizing at $400 million back to $1 billion? What are some of the things that are going to be the biggest drivers to that growth, whether it's on the product side or other things that you and the team are working on that will in a much better demand environment, deliver revenues that are out on your target?

I can provide some insights on the business dynamics related to reaching that target. You can't pinpoint the lowest point in the cycle and then directly relate it to the $1 billion goal. Instead, you should consider the average performance over the cycle, which usually falls between $750 million and the low $800 million range, what we refer to as normalized revenue levels. To achieve growth from that point, we need to focus on a mix of design wins for our testing equipment, which we are currently achieving, although it's not translating into significant volume yet. We're also seeing consistent performance with our interface solutions, despite the overall low utilization within the industry. Furthermore, expanding our inspection and metrology business is essential. From a market perspective, we are heavily focusing on aligning our efforts with computing applications. We have strong confidence in the long-term potential of computing, not just in AI data centers, which operate at low volumes, but also in the forthcoming phase of edge computing. This includes AI applications that will be integrated into everyday devices like smartphones and cars with advanced levels of autonomous driving, as well as robotic systems and automated manufacturing tools. Essentially, AI at the edge is expected to be a major driver for sensors, communication, and overall computing power. Consequently, one of our key investment areas is the thermal subsystems and their integration into our products to help capture market share and support our customers as they adopt more AI at the edge or increase computing capabilities in consumer products. These are the primary factors that we believe will help us progress toward the $1 billion target.

Our next question comes from the line of Toshiya Hari with Goldman Sachs.

Luis, you've given quite a bit of color in terms of what you're seeing from an end demand or end market perspective. I was hoping you could share what you're seeing by device type. I know you have exposure to various device types, but any specific areas of relative strength or relative weakness MCUs, analog, RF, et cetera, that would be helpful.

I don’t have the exact data on device types in front of me, but I can share that the analog semiconductor sector is currently the weakest. There’s also no significant strength in microcontrollers. The processor space shows interesting dynamics, primarily leaning towards high average selling prices with low quantities, but this is shifting more towards servers, which should lead to some improvement in quantity. Recently, there has been some progress in RFIC manufacturing and a rise in demand for test and handling equipment. Battery management systems, which fall under analog, are weak but might be approaching a new demand threshold. This should give you a better understanding of the device segment. Additionally, we do not participate in the memory sector, so I cannot comment on that.

Sure, that's really helpful. As a quick follow-up, you mentioned your success in display drivers, which you've previously addressed. However, that market is currently dominated by one of your competitors. Your Korean customer must be pleased with your product and technology. My question is, what is the current total addressable market for that segment? I believe it's a couple of hundred million, but if you could confirm that, it would be very helpful. Additionally, how should we view your potential for market share growth over time? I understand it takes time, but having secured one of the larger customers seems to present a promising opportunity for you. I'm just curious about your perspective on that business.

You're right about the total addressable market being around $200 million. The challenge is understanding the current size of that market. On average, we estimate it to be $200 million. Currently, we are providing services to two customers that collectively account for about 50% of that market, translating to approximately a $100 million opportunity for us. However, we don't expect to capture all of it, as we anticipate sharing it with competitors. We have been working closely with a Taiwanese manufacturer and are now also involved with a Korean manufacturer. Last year, we secured our first contract with them, which accounted for about 40% of their capital expenditure and generated $20 million in revenue for us. We have now qualified for their second contract, which is in the final testing stage. We still need to determine how much of the potential remaining opportunity, estimated at around $30 million, we can capture when business conditions improve. Overall, your assessment of the $200 million market is correct, but this year is looking less favorable, and we believe we can serve about $100 million.

That concludes today's question-and-answer session. I'd like to turn the call back to Jeff Jones for closing remarks.

So I'd just like to close with saying thank you for joining our call today, and we look forward to seeing you soon.

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