Cohu, Inc. (COHU) Q4 2017 Earnings Report, Transcript and Summary

Greetings, and welcome to the Cohu Incorporated Fourth Quarter and Full-Year 2017 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Jeff Jones, Chief Financial Officer. Thank you, Mr. Jones. You may begin.

Good afternoon, and welcome, to our discussion of Cohu’s most recent financial results. I’m joined today by our President and CEO, Luis Müller. Following our opening remarks, we’ll provide details of our performance for the fourth quarter and the full-year 2017 as well as our outlook for the first quarter of 2018. If you need a copy of our earnings release, you may obtain one from our website, cohu.com, or by contacting Cohu Investor Relations. Before we begin, you should all be aware that during the course of this conference call, we will make forward-looking statements reflecting management’s current expectations concerning the Company’s future business. These statements are based on current information that we have assessed, but which by its nature, is subject to rapid and even abrupt changes. Forward-looking statements include our comments regarding growth and market share expansion through our PANTHER and Solstice products, specific share gains goals, increased test contactor sales, first half 2018 sales growth, our Cohu500 mid-term model and associated goals, revenue recognition on increasing Korean customer sales, future results, including Q1 guidance, and any other comments we make about the Company’s future in response to your questions. We encourage you to review the forward-looking statements section of the earnings release as well as Cohu’s filings with the Securities and Exchange Commission, including the most recently filed Form 10-K and Form 10-Q. Our comments speak only as of today, February 15, 2018, and Cohu assumes no obligation to update these statements as a result of developments occurring after this call. Further, our comments and responses to any questions will not make reference to any specific customers, as we are precluded from disclosing such information by our nondisclosure agreements. Finally, during the call today, we will also discuss certain non-GAAP financial measures. Please refer to our earnings release for a reconciliation to the most comparable GAAP measures. Now, I’ll turn it over to Luis. Luis Müller: Thanks, Jeff, and good afternoon, everyone. In today’s call, I’ll review Cohu’s fiscal 2017 performance and business highlights in the fourth quarter. I’ll conclude with our views for 2018 and discuss our strategy. Cohu delivered another year of solid sales and profitability growth in 2017, highlighted by market share gains in test handlers and accelerating growth in the test contactor market. Orders were at record levels with full-year increasing 41% over 2016. Sales were up 25% year-over-year to $352.7 million, and non-GAAP earnings per share increased 126% to $1.54. We generated $39 million in operating cash flow and in the year we had approximately $156 million in cash and investments and a strong balance sheet. Cohu returned $6.6 million to shareholders though quarterly cash dividends. We’re off to a strong start in the first quarter. We forecasted book to bill above 1 and growing traction and the automotive and mobility markets. As we look at the results in more detail. Our test handler business grew year-over-year as we capitalize on a strong investment environment and benefited from market share gains. Our test contactor business grew a 131% year-over-year as we delivered on our strategy to expand in this adjacent market, by selling these consumable products into our large installed base of handlers. Additionally, the acquisition of Kita has proven to be a great success with an over 450% increase in the number of Kita probes incorporated in our contactors and several design winds combined with Cohu handlers. Looking in more detail at full year orders, 59% were systems and 41% recurring. And by device segment, digital and mixed signal represented 21% of system orders, applications processors were 16%, mixed single and RF were 15%, small-signal discrete were 12%, power management and discrete were 11%, sensors were also 11%, and computing processors and LED were each 7% of system orders. In 2017, we introduced two new major products, the PANTHER prober for test and inspection of singulated wafer-level chip scale packages and bumped dies; and Solstice, Cohu’s solution for system level test automation. PANTHER has been deployed at five different customers targeting mobility applications. And as previously mentioned, we also received a new customer order in early fourth quarter for test and inspection of automotive power management devices. Both, PANTHER and Solstice, will be major components of our market share expansion strategy as they address key test requirements aligned with technology trends in advanced packaging for integrated semiconductors. Last year, we also announced a new vision inspection module for enhanced micro-crack detection on wafer-level chip scale packages, called Aquilae. This product has been installed in several Cohu handlers and is being used to improve vision inspection quality of their silicon and LED devices. Transitioning now to the fourth quarter. Orders increased 46% over the prior year and established a new record. Sales were in line with our guidance, and non GAAP gross margin at approximately 42%, once again exceeded our forecast. This was a strong quarter in the applications processor segment as we received a large order for thermal subsystems to support next generation product launches in 2018 along with continued momentum in the automotive market for power management and MEMS sensors. We also saw increase in demand for Cohu handlers in the computing segment that included capturing new business at a leading foundry for testing high-end processors with forecasted volume expansion in the second half of 2018. As we look to the coming year, we started 2018 with a strong backlog, share gain momentum, and customer traction, as evidenced by our recently announced design win of a major European automotive customer with the MATRiX pick-and-place handler combined with our multi-beam test contactors. We expect this win to be key to supporting our handler share gain objectives in 2018 as well as increased test contactor revenue. Additionally, we have been making excellent progress with a major Korean customer who continues to provide repeat orders for a new handler model. As a result, we have been increasing investments to support business prospects with this customer, which is expected to be an important contributor to meeting current projections for about 10% growth in the first half of 2018 over the same period last year. To close up my remarks, I would like confirm our strategic objectives in support of the Cohu500 mid-term model which includes growing share in handlers, expanding in the test contactor market, and making disciplined investments in probe and inspection. We expect the combined handler and test contactor markets to grow by mid single digits year-over-year and Cohu’s plan is to outperform with another 1 to 3 points of share gain in each market. As our model indicates, we are targeting to grow annual sales to $500 million with 45% gross margin and 20% EBITDA, both non-GAAP. Our increased confidence and excitement about the future of Cohu is driven by the successful implementation of fast strategic actions, including the streamlining of our operations and cost structure with over 90% of systems shipments now originating from our Asia operations, increased share in our core handler markets, successful expansion in test contactors with the acquisition of Kita early last year and now representing over 11% of 2017 revenue, as well as new product developments with the introduction of PANTHER, Solstice and Aquilae. Collectively, these initiatives have improved our operating margin and margins, positioning Cohu to deliver continued profitable growth, cash flow and shareholder returns. Now, I’ll turn it over to Jeff for details on the fourth quarter and full-year financials and our Q1 guidance.

Cohu’s Q4 was in line with our expectations, as we generated non-GAAP operating and adjusted EBITDA margins of 11.2% and 12.9%, respectively on sales of $84.1 million. Full-year 2017 operating and adjusted EBITDA margins were 14.4% and 15.8%, respectively, on record sales of $352.7 million. Non-GAAP gross margin for 2017 was 41.2% that’s up 560 basis points from 35.6% in 2016. We generated $39 million of cash from operations in 2017, contributing to an increase of approximately $28 million in our cash balance, net of $12 million used to acquire Kita manufacturing and ended the year with cash of approximately $156 million. Our contactor business was 11% of sales for both the quarter and the year. For Q4, the GAAP to non-GAAP adjustments include approximately $1.7 million of stock-based compensation expense, $1 million of purchased intangible amortization expense, $1.2 million of costs related to the reduction of the tax indemnification receivable recorded in connection with the Ismeca acquisition in Q1 of 2013, $797,000 of other acquisition related costs, primarily related to the valuation earn-out from Kita, and $2 million related to the impact of U.S. tax reform. My comments that follow including the Q1 guidance are all based on Cohu’s non-GAAP results, which exclude the impact of these items. Sales for the quarter were $84.1 million, consistent with our guidance of approximately $84 million, and reflecting expected seasonality. Two customers in Q4, each exceeded 10% of sales, one customer in the automotive market represented approximately 13% of sales, and one customer in the computing market represented 15% of sales. For the full-year, one customer in the automotive market represented approximately 16% of sales and one customer in the computing market represented 11% of sales. Q4 gross margin was 41.9% and above our guidance, primarily due to product mix including higher recurring sales than forecasted. Operating expenses for Q4 were $25.8 million and higher than our guidance due mainly to increased investment to support the growth prospects with our large Korean customer that Luis mentioned previously, combined with a $300,000 foreign currency loss and the timing of certain audit and other outside service fees. As you know, the U.S. Tax Cuts and Jobs Act was enacted on December 22, 2017 and introduced a significant changes to U.S. income tax law. Due to the timing of the enactment and the complexity involved in applying the provision of the tax act, we have made reasonable estimates of the effects and recorded provisional amounts in our financial statements as of December 30, 2017. These provisional amounts totaled a net benefit to GAAP income tax expense of $2 million and included estimates of the one-time transition tax net of foreign tax credits and operating losses on earnings of foreign subsidiaries that were previously deferred from U.S. tax law, the impact of the U.S. tax rate reduction and changes to net operating loss rules on our net deferred taxes, and the accrual of foreign taxes in the event certain funds are repatriated to the U.S. As we complete our analysis of the tax act and incorporate additional guidance that may be issued by the U.S. Treasury Department, the IRS or other standard setting bodies, we may identify additional effects, not reflected as of December 30, 2017, that would be recorded in 2018. The non-GAAP effective tax rate for Q4 was 15.1% and consistent with our previous estimate. The tax rate continues to benefit from profit generated outside the U.S. in countries with lower statutory income tax rates and in certain countries where Cohu has income tax holidays. The tax rate also benefits from profits generated in the U.S. which do not currently incur a tax provision because of our valuation allowance. Looking ahead, we expect our full-year 2018 effective tax rate to be approximately 17%, and slightly higher than 2017 as a result of the expiration of the portion of our tax holiday in Malaysia. Accounts receivable declined sequentially by $5.4 million and DSO improved by four days to 75. Inventory increased by $5.7 million sequentially with inventory days increasing 26 to a 120. Accounts payable days increased by 22 days to 72 days due to a $7.6 million increase at the end of the quarter. Overall, the cash conversion cycle was flat quarter over quarter at a 123 days. Fixed asset additions were approximately $1.4 million for the fourth quarter and $6.1 million for the full year 2017. Fourth quarter depreciation was $1.4 million and $5 million for the full year. Deferred profits at the end of December was $6.6 million compared to $6.7 million at the end of the third quarter. The related deferred revenue at the end of Q4 was $10.4 million up $500,000 sequentially. Cohu’s Board of Directors approved a quarterly cash dividend of $0.06 per share, payable on April 13, 2018, to shareholders of record on February 27, 2018. And now, moving to our guidance for the first quarter. As stated in today’s press release, we expect Q1 sales to be approximately $89 million. There’re several aspects that are factored into our Q1 guidance. First, as many of you know, new revenue recognition rules went into effect on the first day of fiscal 2018. For Cohu, this resulted in approximately $1.3 million of deferred revenue and profit at the end of 2017 that will not be recognized in Cohu’s 2018 income statement but rather will be recorded as a cumulative effect of adoption adjustment within equity in Q1. Additionally, as Luis mentioned, we entered 2018 with a strong backlog and record orders with delivery expected over multiple quarters in 2018. This positions us well for continued growth with the timing of revenue contingent on the quarter in which the backlog shifts and it’s applicable when customer acceptance is received. Additionally, we continue to receive orders and ship product to our large Korean customer and expect our first revenue recognition from those shipments within the first half of this year. As a result of these factors, we expect first half 2018 sales to increase approximately 10% over the same period last year. Gross margin in Q1 is expected to be approximately 50 basis points higher than Q4. Operating expenses for the first quarter are expected to be approximately $2 million higher than Q4, reflecting the continued investments in support of our large Korean customer. That concludes our prepared remarks. And now, we’ll take your questions.

[Operator Instructions] Our first question comes from the line of Edwin Mok of Needham & Company, LLC. Please proceed with your question.

First, I want to understand the broadened focus on the technical and financing timing. I want to understand like this 10% growth in the first half of ‘18. With this quarter being flattish sequentially, if I do my math correctly, your second quarter is going to have a pretty decent growth rate year over year sort of sequentially. Is it just the timing of shipment more back in the June or is it revenue recognition that caused delay into June quarter?

Yes. It’s more about the timing of the shipments. There is also an aspect of revenue recognition. But, I would say, the primary driver is the timing of the shipments and then, secondarily revenue recognition.

And then, if I look at your backlog, there is pretty big message, over $100 million [ph] exiting last year. Right? How much of that will be shipped in this first half or is that the way to think about it just roughly half in the first half? What was it in the first half? Maybe give some color on the backlog.

Yes. Most of it will be shipped in the first half. We do have some that extends out into Q3 and Q4, but 80% to 85% of that will ship in the first half of the year.

And then, maybe, can you maybe provide some color on the European auto customer win, you guys talk about can qualify there. Anyway you can kind of size that opportunity and what type of products you want there would be helpful? Luis Müller: As we announced here, what we did capture was business for our MATRiX pick-and-place handler, which is the most commonly used product today in the industry for automotive device test; in conjunction with we also captured business for our multi-bean test contactors that go with that pick and place handler. As far as the size of the opportunity, it’s part of that 1 to 3 points market share gain that we have projected for 2018 along with the Korean customer that we are still working on in getting a new product acceptance.

And then, on the inspection side, just a quick question in terms of -- you guys provide some comment around that. Just want to kind of understand the progress there. It’s a pretty sizeable market, you guys are coming still with a relatively small share in that space. How do you see cadence of that growth? Is that just block and tackle or do you see some opportunities with more sizeable contract or award once you win certain customer in the ‘18, you can help provide some color on that? Luis Müller: Well, that market, as we’ve said before is about a 140, $150 million for package inception. We are participating today in the space via our turret handlers, in fact to the tune of about a little over $20 million a year in sales. And that is more narrowly focused on small packages, small devices. And so, the efforts that we have here are to develop solutions that expand the field of view for larger perhaps more digital in nature semiconductors as well as solving some of the challenges that people have today, that customers have today such as the one we did last year with the Aquilae module that we are currently shipping with our turret handler. So, there will be sort of a steady progression into that market; that’s how we project it today.

OpEx, I notice non-GAAP OpEx went up quite a bit this quarter and you guide that fourth to go up a notch. Anyway you can talk about how you think for OpEx? Well, first, what happened in the fourth quarter, is it just this investment you talked about? And then, long-term, is there a way to think about how much you think you’ll grow your OpEx?

Okay. In Q4, Edwin, it was mainly driven by the support of a large Korean customer that we talked about, from a product development standpoint but also sort of an onsite support perspective as well. So, when we look at Q2, we’re expecting OpEx to be closer to the Q4 late, it’s about $25 million a quarter. So, expect that beginning in Q2, for Q3 and Q4 as well. For R&D, we’re modeling base line cost to be about what where they were in Q4, likely to grow little bit with revenue as we develop some of these new products in line with the plan that Luis articulated. But on a full year basis, we’re expecting R&D to be approximately 12% of sales. And then, for SG&A, that’s a base line there, quarterly base line of about 13 to $14 million. And again that will grow -- sales grow but the rate of growth there is about 1% for every $3 million increase in sales. For the year, we’re looking at SG&A in the 13% to 15% of sales range. Luis Müller: Just going to add here to what Jeff stated. The momentary increase in R&D spending for this Korean customer, it’s actually to some degree -- we’re happy to see the activity picking up earlier than we had originally anticipated for 2018. Obviously, adds more stress to the organization but the pulling up of the opportunity has been a very good thing for our projection here for the first half of the year.

Our next question comes from the line of David Duley of Steelhead. Please proceed with your question.

I think you mentioned it guys, but could you remind us -- could you say that you thought the handler market would grow 8% or what was the number that you used? Luis Müller: What I said is that, we expect the combined handler contactor market to grow about mid single digit in 2018.

And I guess I’ve seen projections of overall unit volumes of semiconductor growing in the 9% or 10% range and it seems like you’re forecasting a lower growth rate than that. Are you just being conservative or do you think the growth rate isn’t going to be that high, as far as units go? Help me understand how you came to that mid single digit kind of projection. Luis Müller: David, the way we do it is, we poll our customers for a projection for the year. And sort of the collective information we get, shows, I guess that about mid single digit growth in the market for 2018. And along with the, we plan our 1 to 3 points of share gain ahead -- for that market growth and that’s essentially how we derive our projections for this coming year.

Okay. And as far as your 1% to 3% market share gains, help us understand where you thought the overall handler market was in 2017 as far as size goes and what the size of the contactor market was last year as well? Luis Müller: We don’t have -- we have not yet compiled the full data set for 2017. But, I’ll tell you, preliminarily that we believe the market was about $870 million, $880 million for handlers in 2017, and probably on the order of $720 million for contactors.

And as far as -- could you help me understand -- you have mentioned this new Korean customer a couple of different times. What sort of application will you be addressing with that customer? And then, I think you mentioned a foundry win. Could you help us understand what that application is as well? Luis Müller: The initial application in this Korean customer is for small power management semiconductors. These are used in mobile products and I believe also in consumer products, general consumer products. But, those applications are going to be expanding over time. So that’s just a starting point. As far as the foundry customer, that is a computing application, high-end processor application, which we forecast to pick up volume towards the second half or sort of beginning of the second half of this year.

Is that driven by transition to 7 nanometers or 10 nanometers, something like that, or is there some sort of tie to the end market as far as technology transition goes? Luis Müller: No, I don’t believe this one is tied to -- this one in particular, I don’t believe it’s tied to a no transition. More so, the complexity of the device that we have captured, but I don’t think so much driven by no transition on this particular case.

Our next question comes from the line of Craig Ellis of B. Riley and Company. Please proceed with your question.

This is actually Peter Peng calling for Crain Ellis. And thanks for taking our question. Can you give us the primary gives and takes as you think about the business on a sequential basis, on end market basis? Luis Müller: So, we have had a very strong -- I think, I would say, a very strong end market in the fourth quarter across all segments I would say, with the exception of the solid-state lighting or led segment that I would say, was weaker than expected in the fourth quarter. But, the other markets have been very strong. And now, getting into Q1, continue to see strength across all those same markets, so much so that as I stated, we are looking at again a book to bill of about 1 for the fourth quarter and the momentum -- sorry, for the first quarter, and momentum continues from last quarter.

And it seems like there is some high bandwidth memory ramping up. Can you talk about Cohu’s participation in that market? Luis Müller: Cohu is not really participating in the memory market today. We have some applications on high-performance memory but that is -- that’s fairly limited in size and scope, and not really a substantial portion of our revenue today.

And on the contactor business, it seems like that business declined kind of in line with the general handler business. Can you kind of talk about that business and the seasonality, and what do you expect in the first quarter? Luis Müller: Well, that business has -- let me just start there. That business actually grew 131% year-on-year, but obviously within that there has been an acquisition, as you know of Kita in Japan. Kita has achieved the growth objectives for 2017. And organically, post-acquisition, the whole business has grown a little over 20%, year-over-year. On a seasonality basis, we do tend to see a lower consumption of pins, spare pins in the fourth quarter, and then, again, a pick up in the balance -- for the balance of the year, the first three quarters of the year. So, that’s the seasonal pattern that we have observed. But, with that said, we continue to see growth in the business, new design wins, opportunities, new product launches, and continue to model a 20% organic growth rate for 2018 for the total contactor business that we run.

And on the gross margin, it seems like it’s ticked up. Is that due to new product or is that just the Osaka plant ramping up to contactor sales?

Peter, it’s a combination of things. First, it’s leveraging more out of our Malaysia operation and so providing a lower fixed cost or lower product cost. And part of it does have to do with mix as well. So, contactors is a contributor to that increase in margin. And as we look forward to 2018, we’ll see new products that we’ve talked about also contributing to expansion of gross margin.

And one question before I hop back into the queue. That $1.3 million in deferred revenue, is that revrec in second quarter, is it going to be below the line, how should we think about that?

As I stated, it will not go through the income statement. So, we’ll not have the opportunity to recognize that as revenue or profits in 2018. We’ll make an adjustment in Q1 to take the deferred revenue, deferred profit off of our balance sheet -- or excuse me, take the deferred revenue and deferred profit and move it into equity, straight into equity. So, again, we won’t benefit in 2018 on the income statement or EPS from that $1.3 million.

[Operator Instructions] Our next question comes from the line of Patrick Ho of Stifel. Please proceed with your question.

Luis, first off, in terms of the PANTHER and Solstice products, in terms of revenue recognition and the ability to recognize revenues this year, are you going to set any targets for this year? And what are I guess some of the final I guess hurdles you need to get through to get the revenue recognition on the systems you have out on the field? Luis Müller: So, taking one at a time here. For Solstice, we have already recognized a couple of units. I have to go back and look. I think, it was in the third quarter of last year when we had our first revenue recognition for Solstice. For PANTHER, we do have revenues from PANTHER included in our Q1 guidance. And as far as the full year, we’re not going to be giving product-specific revenue targets for the year. But, they’re definitely included in what we’re modeling for 2018, including the growth for the first half of this year relative to first half of last year, of about 10%.

And my follow-up question in terms of the contactor business, I think one of the things you mentioned when you acquired Kita was the leverage your handler business and even your own emerging contactor business to provide that, the Kita business. How much of it from a customer perspective have you seen that pull to date, and is that the biggest driver of growth for the Kita solutions, as we look at 2018 as a whole? Luis Müller: Yes. To start from the end here, the answer is yes. And we are seeing very attractive opportunities at our customer base for handlers, particularly pick-and-place handlers because the Kita pins are predominantly used on digital, some mixed signal applications that go in our pick-and-place products. And more specifically, we’re seeing very good evidence of the thermal requirements in test at the interface layer where the contactors are going. And, we have solutions and products coming out specifically on that front that have been already qualified at one of our major customers that we’re working to promote and get on the floor at some of the other customers. That really ties very nicely the contactor thermal performance with the handler thermal performance, as an augmented solution for, like I said, for our digital mixed signal customers. So, yes this is a very good tie between the Kita and contactors that we build surrounding that with our own pick-and-place handler customers.

We have a follow-up question from the line of Edwin Mok of Needham & Company, LLC. Please proceed with your question.

Hi, guys. So, just a quick follow-up here. For the year, I think, you guys talk about -- you expect the market to grow mid single digit in Asian and you expect to outperform market by 1 to 2 points. So, that would imply you expect the business to grow about high single digit, if you will. Is that a fair way to think about it or am I missing there? I just wanted to understand that. And with the first half growing at 10%, does that mean that second half will see some slower growth there? Just trying to understand that. Luis Müller: Yes. Just one quick correction. I mean, you said 1 to 2 points share gains. We’re actually modeling 1 to 3 points share gain on each of the markets. Frankly, just given our sheer size in handlers, it’s more likely that handlers will be towards the high end of that target, meaning towards the 3 points share gains on the total market. And from a contactor perspective, simply by the fact that our size in the contactor market today, we are looking at about 1 point share gain, which would represent about 20% organic growth. They are also correct about the projected growth for the first half of the year of about 10% relative to last year. No, we are not reporting any number out today for the second half of the year. We are not prepared to do that today, Edwin.

There are no further questions over the audio portion of the conference. I would now like to turn the conference back over to Mr. Jeff Jones for concluding comments.