Ladies and gentlemen, thank you for standing by, and welcome to the Cohu Incorporated's first quarter 2020 financial results conference call. At this time, all participant lines are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during this session, you'll need to press star one on your telephone keypad. Please be advised today's conference is being recorded. I would now like to hand today's conference to Jeff Jones, Chief Financial Officer. Please go ahead, sir.
Good afternoon, and welcome to our conference call to discuss Cohu's first quarter results and second quarter 2020 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, 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 statement 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 5, 2020, and Cohu assumes no obligation to update these statements for developments occurring after this call. Finally, during the 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?
Hello, everyone. Thanks for joining us. Today I'll describe how Cohu is responding to the COVID-19 pandemic, discuss some of our accomplishments in the first quarter, then I'll provide some perspectives on Q2 and what we expect for the rest of the year. Jeff will later discuss financial results and provide guidance for the second quarter. First and foremost, Cohu is committed to the health and wellbeing of our partners, including our employees, customers, and vendors. As such, we have implemented a strict set of policies at our global sites to safeguard our partners. The COVID-19 pandemic has had some impact to our supply chain in Southeast Asia and to our operations in Malaysia and the Philippines.
Sales in the first quarter were approximately $139 million and about $6.5 m illion lower than expected due to the movement control restrictions imposed during the second half of March in these countries where most of our products are manufactured. Despite these challenges, I'm proud of how we have pulled together globally to ensure business continuity during this unprecedented set of events. Now on to more details on our business results. Q1 marked the second consecutive quarter of record bookings, mostly driven by mobility customers accelerating the adoption of 5G test solutions for RF front-end devices. First quarter orders for our semi tester business was up 70% year-over-year, validating our strategy for high performance measurement instruments at an affordable cost. We're being recognized for enabling our customers to successfully deploy 5G test capability in volume production while optimizing their cost model.
At the same time, our handler business is benefiting from our broad product line with high volume turret and pick-and-place system sales, both for RF as well as mobile processor tests where Cohu's proprietary thermal technology is a key enabler. With book-to-bill close to 1.3 and backlog at record level, overall orders were split 52% systems and 48% recurring, and mobility represented 1/3 of our system bookings. Computing and network were also strong in the quarter, and although 14% of system orders, it represented the largest portion of our recurring revenue. As previously stated, we experienced an uptick in automotive semiconductor business in late fourth quarter that continued into the first half of Q1, closing the quarter at 14% of system orders. Our PCB test business has remained strong at 14% of orders and mostly driven by server and network equipment as well as telecommunications segments.
Late into the first quarter, several of our customers started placing handler and contactor orders for testing semiconductor devices used in medical applications that include ventilators, respirators, pacemakers, and X-ray machines. We categorize these in the industrial and medical semiconductor segment that came in at 11% of system orders. Now turning to second quarter, we expect that supply chain and government-imposed operating constraints at Cohu factories will continue through mid-quarter, with manufacturing progressively increasing to normal output by end of June. Near-term product costs will be higher as we increase outsourcing to compensate for COVID-19 limited production output from our internal operations, particularly in the contactor business. Although this will impact our performance near term, we completed the manufacturing consolidation from the Xcerra acquisition, reduced the cost structure of our products, and expect to see benefits in future quarter performance in line with our financial model.
We forecast end market demand to remain strong in computing and network, with data center growing in 2020 as enterprises add bandwidth and balance their networks to support higher traffic and new applications related to work from home. In mobility, 5G-driven semiconductor content should continue growing in phones, but we expect customers to take a pause to gauge the impact of COVID-19 pandemic on consumer spending. While medical applications are expected to be strong in Q2, these represent a small portion of total semi spend in capital equipment and are not likely to compensate for a decline in industrial-driven segment demand. Automotive is experiencing the greatest negative impact following plant closures by all major auto manufacturers worldwide.
We are unable to predict the rest of the year at this time, but expect computing and network applications to remain strong, some growth driven by new gaming consoles later this year, continued weakness in automotive for the balance of 2020, and a pickup in demand for 5G that should accelerate into 2021 as countries fight to control the communication backbone of the expanded digital economy. While we enter the second quarter with approximately $172 million in cash and a strong backlog, the continuing impact of the COVID-19 pandemic on short-term semiconductor test and inspection demand remains uncertain. As a result, we are proactively managing cash flow and took steps to reduce operating expenses and capital expenditures. We implemented a temporary 20% salary reduction to the CEO and 15% reduction to other executive officers, and proportionally lower reductions to all employees worldwide.
Our board of directors is participating with a temporary 20% reduction to their cash compensation. The Cohu board also authorized suspending our quarterly cash dividend. This will result in approximately $10 million of annualized cash savings, which we expect to utilize for deleveraging and strengthening our balance sheet. While there will be challenges ahead in the second half of this year, I'm very excited and confident about our future. Cohu is well-positioned in mobility, computing, and network semiconductors and PCB test segments. While automotive and industrial are weak for now, we are the handler and contactor leader in these segments and should emerge strong again in an eventual 2021 market recovery. This is simply a delay in our path, and although a crisis is always painful, it also creates an opportunity for the company to become leaner and faster.
Cohu has delivered a strong 21% compounded annual growth rate since 2015. Our strategy remains focused on outperforming the industry growth rate. I would like to turn it over to Jeff to review our first quarter results and provide second quarter guidance.
Okay. Thanks, Luis. As noted earlier, our priorities are the safety and wellbeing of our employees, customers, and suppliers as we work through this challenging and uncertain environment. While we cannot predict how long this pandemic will last, we enter Q2 with strong backlog and cash positions and improved financial flexibility as a result of previously completing the $40 million cost synergies from the Xcerra acquisition, further reducing operating expenses by approximately $3 million per quarter through temporary salary reductions, limiting capital expenditures to critical and strategic projects, and suspending our cash dividend, which preserves approximately $2.5 million per quarter to further strengthen the balance sheet. Before I walk through the Q1 results and the Q2 guidance, let me talk about our GAAP to non-GAAP adjustments. Please note that my comments that follow all refer to non-GAAP figures.
For GAAP to non-GAAP reconciliations and disclosures, see the accompanying earnings release and investor presentation. For Q1, the GAAP to non-GAAP adjustments include approximately $3.6 million of stock-based compensation expense. The GAAP to non-GAAP adjustments, primarily driven by the Xcerra acquisition, include $9.5 million of purchased intangible amortization expense and $2.1 million of restructuring costs. The Q1 2020 net cash impact of the Xcerra acquisition-related restructuring was approximately $1.4 million due to employee severance. The Q1 GAAP to non-GAAP adjustments also include a $3.9 million impairment charge related to in-process R&D assets from the Xcerra acquisition. This is a non-cash charge caused by COVID-19-induced delays in our customers' adoption of products currently in development. Now, turning to Q1 results. Revenue was $138.9 million and approximately $7 million lower than the midpoint of guidance due to COVID-19-related government restrictions in mid-March in countries where we manufacture most of our products.
In Q1, two customers each accounted for more than 10% of sales in the quarter. One customer is in the computing and network segment, and the second customer is in the mobility segment. In Q1, Cohu's gross margin was 41.7% and in line with sales. Operating expenses came in approximately $1 million lower than forecast. First quarter non-GAAP operating income was approximately 4% of sales and adjusted EBITDA was 6% of sales. Consistent with prior quarters, Cohu generated a loss in the U.S. during Q1 and profit from operations outside the U.S. The tax provision is not reduced by U.S. losses due to our deferred tax asset valuation. As a result, the Q1 non-GAAP tax provision was approximately $1 million, resulting in a break-even EPS for the quarter. Now, turning to the business model.
As of the end of fiscal 2019, we completed the actions required to achieve the $40 million of acquisition cost synergies. As we announced earlier, we have implemented temporary salary reductions, which further reduce operating expenses by approximately $3 million per quarter, adding approximately $0.05 of EPS to our model. The temporary cost reductions further structure our expenses to support positive cash flow during periods of low market demand and allow for continued investment in strategic projects while retaining the ability to quickly ramp production in an up cycle. Moving to the balance sheet. Our cash balance increased to $172 million due to strong cash from operations during Q1 of $17.8 million. Free cash flow in the quarter was $16.2 million.
Combining recent cost reduction and cash preservation actions, we've lowered our EBITDA break-even revenue to approximately $110 million per quarter, and cash required to run the business has been reduced to approximately $80 million. For the second quarter, we're guiding sales to be between $130 million and $155 million. We've widened the revenue range to reflect the level of volatility and uncertainty that exists within forecasts in this environment and based on our current understanding of government-imposed restrictions. Gross margin for Q2 is expected to be between 39%-42% and reflects higher outsourcing costs related to COVID-19 factory constraints. Operating expenses are projected to be approximately $49 million and about $3 million lower than Q1 due to temporary salary reductions. We expect Q2 adjusted EBITDA at the midpoint of guidance to be approximately 8%. Similar to previous quarters, the tax provision rate will be abnormally high.
The Q2 forecasted non-GAAP tax rate is approximately 38% at the midpoint of guidance. For modeling purposes, we expect a normalized effective tax rate of approximately 22% on revenue of $170 million or more and profits in line with the business model. The diluted share count for Q2 is expected to be approximately 42.4 million shares. Although there is more volatility and uncertainty in the market, our current view for third quarter revenue is to be about 5%-10% down from the midpoint of Q2 guidance. That concludes our prepared remarks. Now we'll open the call to your questions.
Thank you. As a reminder, if you would like to ask a question, please press star then one on your telephone keypad. Again st ar one for questions. Our first question is going to come from the line of Craig Ellis with B. Riley.
Yeah, thanks for taking the question, and guys, congratulations on executing in a tough environment. Jeff, I might have missed it, but at the midpoint of guidance, what's the degree of allowance that you have for the COVID impact of the business? Clearly, in the deck, you're showing that there's a meaningful manufacturing impact through the quarter that lessens the quarter. Can you just quantify what that nets out to on the top line?
Yeah. The Q2, you're speaking about the Q2 forecast, Craig?
Q2, yeah. Thank you.
For Q2, we're expecting that the factories in the Philippines and Malaysia ultimately get back to sort of normal operations by the end of the quarter. As you can see on part of the IR deck that we've published, that by the end of the quarter, we expect to be back up to full production. There's really no sort of provision, if you will, like we did in Q1. We created the Q2 forecast based on the assumptions that the constraints in the factories will essentially be lifted.
Okay. Just to better understand the endpoints of the range, and it's common for companies to widen the range out, so no surprise there. What would differentiate the performance of the business at the low end of the range versus, say, the high end of the range for 2Q, Jeff?
There's a certain degree of book-to-bill orders in the quarter, those typically carry a higher risk. Of course, that's sort of a quarter-over-quarter instance. In this particular quarter, there's still uncertainty in the supply chain. In addition to book-to-bill for the quarter, there is continued uncertainty with some of our key suppliers.
Okay. Just turn sort of variability and then supply side issues, which we've been seeing. I'll take my last question before I hop back into two, maybe a little bit further out than that. I think I heard you conveyed that the third calendar quarter sales could be down 5%-10%. From the visibility that you have now to that quarter, what would account for the decrease? Is there anything that you see in the business and with the backlog that you have, that would be driving sequential growth quarter-on-quarter for 3Q?
Craig, as we mentioned, we had strong orders in Q1 and Q2, excuse me, Q4 and Q1. That led to a healthy backlog as we enter Q2. What we're seeing is, we're seeing some customer push outs of shipments, and so that's having a sort of muting of the revenue, if you will, in Q2 as well as into Q3. There's still quite a bit of uncertainty, not only in the Q2 forecast, and therefore the wide range, but also, as we move further out, there's definitely more volatility and uncertainty there.
Is that movement occurring in particular verticals, Jeff, like auto or perhaps industrial outside of medical, or is that just across the board with all your verticals?
It's-
Yeah. Hi, Craig, this is Luis.
Hey, Luis.
Hey. A lot of this is auto, as I said in my prepared remarks. Auto is actually gonna be down this year, down significantly relative to the original expectations. As I also said, we do expect that the mobile segment customers will take a pause, try to gauge the COVID-19 impact on consumer demand before they move forward again. I think that's gonna compound a little bit towards the third quarter.
Yeah, that certainly makes sense from all the things that we're seeing, Luis. Guys, thanks so much for the help and congratulations on the good first quarter execution.
Thank you, Craig.
Thanks, Craig.
Thank you. Our next question will come from the line of Krish Sankar with Cowen and Company.
Yeah. Hi, thanks for taking my question. I had a couple of them. Luis or Jeff, I'm kind of a little confused. You are guiding to Q3. I understand it's uncertain environment. Your breakeven is getting lowered, and yet you're suspending the guidance. I'm just trying to figure out, what are the puts and takes on the Q3 comfort level for the revenue, and at what point would the dividend come back?
I'll talk to the Q3 forecast. Yeah, obviously there's a lot of uncertainty related to that, Krish. As we just talked about with Craig, we've seen customers pushing orders out and it's our best view at the moment, right? Understanding the sort of the constraints that we see and where we expect the factories to be, as well as current view of orders in Q2, and then how backlog feathers throughout the Q3 and Q4 time frames.
Krish, let me take the dividend part of the question here. Reality is, I can't provide any date, or assurance at this point about future dividend payments, right? Ultimately, it's going to be reassessment and decision by our board as to what to do long term. Clearly here in the current environment, we've believed it's just in the best interest of our shareholders to prioritize our cash towards paying down debt, and also for future product development and for making other strategic investments. That's the status as of today.
Got it. All right, Luis. Final question from my end. You kind of broke out mobility is roughly a third of your orders. Is there a way to parse it down further and say how much of your bookings or revenue is coming from 5G?
I could, not that I have it handy to answer it to you right now. I can tell you more than half of it was 5G related, because a lot of it was associated with RFIC test, and we had a really strong demand for our testers going into that. We also had a very strong demand for turret handlers that go along for RFIC test. Conversely, on the side, there was also thermal subsystems and pick-and-place handlers going into mobile processor tests. I can't quite define if those were 5G or not. I can tell you, more than half of the orders would've been 5G related.
Got it. Thanks, Luis. Thanks, Jeff.
Thanks, Krish.
Thank you.
Thank you. Our next question will come from the line of Brian Chin with Stifel.
Hi, excuse me. Good afternoon. I'm glad to hear you all seem to be doing well, and thank you for letting us ask a few questions. Maybe first, just for a moment, going back to the reference booking strength in Q1. I guess, how much of that order strength has a 3Q or second half shipment date associated with it, which gives you some level of visibility perhaps in Q3 as you're discussing right now? Do you also just think kind of the timing on those orders were to some degree influenced by sort of your production constraints in terms of the timing and perhaps even magnitude?
In terms of the orders and the percent that applies to future quarters, that was probably closer to 50%-60% of the order book, where 80% typically would be over the next three months. Brian, we're seeing that increase to, I think, closer to 50% is the range.
Got it. Okay. That's helpful. Just quickly, in terms of just shipment linearity or dislinearity in a typical Q2 versus what's not a typical Q2 for you this year, I'm just curious, I'm sure it's reflected somewhat in your guidance, but how back-end skewed might shipments be this quarter, relative to what might be normal?
Yeah, that's a good question. We are more back-end of the quarter skewed this time around, and we are because of supply chain constraints. As you can look at the supply chain and internal operation constraints, and you can look in the IR deck here, we talked about estimated manufacturing output from our Asia factories in Q2, and it's ramping up from April to June. As you can imagine, we have more revenue towards the end of the quarter than we have in the beginning of the quarter as we manage through the reopening process, basically, in these countries where most of our products are manufactured.
Mm-hmm. Okay. It seems like given where you think production will be relative to where it was in the month of June, you said that reflects a little bit of outsourcing, but also, I guess, sort of the trajectory you see in places like Malaysia where they seem to have sort of mid-month, quote-unquote, "reopening dates.
Yeah, Malaysia has already reopened, Brian, and they had restrictions from the middle of March through the end of April. Actually, two different levels of restrictions. As of last week, they announced they're reopening. Now, nevertheless, even though we have a reopening, we have to have the supply chain catch up to our demand and feed our factory. With that in mind, we did model a still sub 100%, in fact, about 85% output out of our Asia factories in May, and then normalizing to 95%+ in June. A lot of this is now based on supply chain catching up with backlog of our orders from our suppliers.
Okay. Thank you. Maybe one question on sort of recurring revenue. Could you help us quantify the impact on recurring revenue in 2Q and perhaps 3Q, since you've extended sort of some visibility there? If more of your direct semi customers, particularly in the automotive markets, idle production as they look to realign with their end customers, vehicle plant shutdowns. If you can kind of give us a sense of what that, maybe that revenue impact that you're contemplating is.
Our recurring revenue from just a couple of quarters ago, from Q3 of 2019, we're down about $14 million or $15 million per quarter. That's about 15%-20% decline from Q3. When we look at Q2, we're seeing the same level of recurring revenue, and Q3, for now, is a similar view.
Just to be clear, you're saying that a few to several quarters ago, you're already kind of down $14 million-$15 million on a run rate basis on the recurring revenue, and you're kind of seeing that sort of still stable 2Q and perhaps into 3Q this year?
Yes, that's right.
Okay. All right. Thanks. Appreciate it.
Our next question will come from the line of Tom Diffely with D.A. Davidson.
Yes. Good afternoon. I guess first talking about the 5G pause that you're seeing starting to form here, is that impacted more by the timing of the release of 5G phones, or is it the projected volume of 5G phones that's the driver behind that pause?
Oh, hi, Tom. This is Luis. What we see is that our customers have gone through a ramp in the first quarter, and everything was actually going pretty well for greater than original projections for 5G phones in 2020. Frankly, I think in general terms, they were heading towards a 250 million units of 5G phones in a year. COVID-19 did change that trajectory a bit, and I think our customers are trying to take a pulse on end market demand before continuing the ramp. I would expect that that action will cause maybe a 3 months, potentially a 6 months delay before the business continues on with additional capacity for 5G-enabled phones. Therefore, more towards the end of the year, I think is Fourth quarter timeframe is where that should pick up the line and continue the ramp.
Okay, you, in a sense, see your networking computer stuff strong today, mobility 5G coming back end of the year, and auto industrial coming back sometime next year.
That's right. Yeah. There are some medical application-related sales happening now that are accelerating. As I made the comment, medical is still a small portion of the total Industrial and Medical segment, if you will. Frankly, probably not enough to offset a decrease in the industrial segment.
Okay. A question on the suspended dividend. It seems like with your cash balance and your need for cash, you had a couple years worth of extra cash. I'm curious, what was in the decision to suspend the dividend versus just tightening down in other areas?
Well, Tom, as I mentioned, we're being conservative and proactively on the cash management side. We have taken several steps to reduce operating expenses, as I outlined on the call. We felt like in addition to that, it would be the right thing to do to put more attention on cash preservation and particularly prioritization of cash for debt repayment, and for maintaining product developments that are necessary for midterm growth of the company. Those are the reasons behind taking the action.
Okay. If you look at your tools in the field today, do you have a sense of what the utilization rates are today versus where they were, say, a quarter ago?
I don't think the current utilization metric is relevant because we had certain customers, particularly in the month of April, they were constrained, operational constrained, from government-imposed restrictions, particularly in Malaysia, also in the Philippines. Those customers weren't able to staff the production floor to output what they needed. I don't think that utilization right now for the month of April would have been a good representation of reality. We're looking forward to more of a May, June utilization metric to see where the industry really stands. I think we have to wait a little bit here to get the pulse on that.
Okay. That makes sense. Finally, despite all the shutdowns and slowdowns, have you been able to make any progress on the contactor business and share gains?
We're still working much on what we have described a quarter ago, which is focusing on gaining some share in the computing and network segment for contactors. Quite honestly, this last quarter has been quite a bit of attention, not only from us, but also even our customers in that segment on getting operations back in line in support to end market demand. Even our customer, in reality, has put a bit of a pause since the middle of March and through most of April on qualification of new products. I think life is, in general, starting to resume now on that front in the month of May for new contactor qualifications.
Okay. No, that makes sense. I appreciate your time today.
Thanks, Tom.
Hi, Christian. Your line's open.
Oh, great. Sorry, I did not hear you say that. I just have one quick question. Most of them have been asked. I'm just trying to figure out if you could give us the negative impact of movement and control and supply chain on your guidance for the June quarter, given record backlog, understanding that automotive was there. How good could it have been, even in this challenging environment, if there was no movement control supply chain issues?
Well, that would be the top end of our range, Christian. That would be the $155.
Okay.
The 130 reflects if issues come to fruition in supply chain.
Okay, perfect. I don't have any other questions. Thanks.
Thank you. Once again, to ask a question, press star one. Our next question comes from Sidney Ho with Deutsche Bank.
Hi, this is Jeffrey Rand in for Sidney. Do you have any visibility into inventory levels at your customers, and are you anticipating that some of the demand in the first half will be used to build buffer inventory at your customers?
I missed a little bit the first part of your question, but as far as the demand, I think the reality is many of our customers are still catching up to their end market demand. We have several customers that were impacted both in China in February as well as in Malaysia, in the Philippines, late March and into April. If anything, our customers have been really hard-pressed to get equipment deliveries so they can catch up to their deliveries. You probably heard some of those earnings release in the last couple of weeks, where major semiconductor manufacturers talked about being able to hit 90%-95% of their demand on time, which means they were 5%-10% behind on scheduling in certain cases. I don't think at this time it's been sort of a buffering, but more so playing catch up.
Great. Thank you. As a follow-up, when you look at your outlook for Q3 right now, is all the pressure you're seeing coming from the demand side, and you assume that supply chain issues have been mostly worked out by then?
Yeah, I think that's a fair statement, Jeff. Actually, the expectations are that with respect to the factories that we're sort of back to 100% by the end of the quarter, and similarly with supply chain by the end of the quarter.
Great. Thank you.
At this time, I have no further questions in the queue.
Okay. I'd like to say thank you for joining today's call. We look forward to speaking with you soon.
Thank you. Once again, we'd like to thank you for participating in today's Cohu Incorporated first quarter 2020 financial results conference call. You may now disconnect.