COHU INC - 10-Q Quarterly Report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

FORM 10-Q


(Mark One)
þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 26, 2005


o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 1-4298

COHU, INC.

(Exact name of registrant as specified in its charter)


Delaware		95-1934119
(State or other jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

12367 Crosthwaite Circle, Poway, California (Address of principal executive office)		92064-6817 (Zip Code)

Registrant’s telephone number, including area code (858) 848-8100

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).

Yes þ No o

As of March 26, 2005 the Registrant had 21,644,634 shares of its $1.00 par value common stock outstanding.

Item 1.

COHU, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except par value)


	March 26, 2005			December 31, 2004 *
	(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	59,233		$	59,591
Short-term investments		61,863			56,920
Accounts receivable, less allowance for doubtful accounts of $889 in 2005 and $936 in 2004		29,576			32,744
Inventories:
Raw materials and purchased parts		21,014			23,355
Work in process		12,346			9,114
Finished goods		6,968			9,046

		40,328			41,515

Deferred income taxes		15,048			15,048
Refundable income taxes		2,805			812
Other current assets		4,088			4,046

Total current assets		212,941			210,676
Property, plant and equipment, at cost:
Land and land improvements		7,978			7,978
Buildings and building improvements		25,447			25,305
Machinery and equipment		28,659			27,544

		62,084			60,827

Less accumulated depreciation and amortization		(30,765	)		(29,706	)

Net property, plant and equipment		31,319			31,121
Goodwill		8,340			8,340
Other intangible assets, net of accumulated amortization of $1,330 in 2005 and $1,192 in 2004		320			458
Other assets		168			173

	$	253,088		$	250,768


LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	6,463		$	7,712
Accrued compensation and benefits		7,808			9,455
Accrued warranty		4,091			4,209
Customer advances		868			604
Deferred profit		9,662			9,651
Income taxes payable		774			774
Other accrued liabilities		3,051			3,778

Total current liabilities		32,717			36,183
Accrued retiree medical benefits		1,422			1,383
Deferred income taxes		5,090			5,090

Commitments and contingencies
Stockholders’ equity:
Preferred stock, $1 par value; 1,000 shares authorized, none issued		—			—
Common stock, $1 par value; 60,000 shares authorized, 21,645 shares issued and outstanding in 2005 and 21,611 shares in 2004		21,645			21,611
Paid in capital		25,956			25,572
Retained earnings		166,538			161,089
Accumulated other comprehensive loss		(280	)		(160	)

Total stockholders’ equity		213,859			208,112

	$	253,088		$	250,768

Derived from December 31, 2004 audited financial statements.

The accompanying notes are an integral part of these statements.

COHU, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(in thousands, except per share amounts)


	Three Months Ended
	March 26,			March 31,
	2005			2004
Net sales	$	44,396		$	35,939
Cost and expenses:
Cost of sales		26,468			21,017
Research and development		6,680			6,184
Selling, general and administrative		7,307			6,860

		40,455			34,061

Income from operations		3,941			1,878
Interest income		690			620

Income before income taxes		4,631			2,498
Income tax provision (benefit)		(1,900	)		400

Net income	$	6,531		$	2,098


Income per share:
Basic	$	0.30		$	0.10

Diluted	$	0.30		$	0.10


Weighted average shares used in computing income per share:
Basic		21,633			21,419

Diluted		22,108			22,075


Cash dividends declared per share	$	0.05		$	0.05

The accompanying notes are an integral part of these statements.

COHU, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)


	Three Months Ended
	March 26,			March 31,
	2005			2004
Cash flows from operating activities:
Net income	$	6,531		$	2,098
Adjustments to reconcile net income to net cash provided from operating activities:
Depreciation and amortization		1,206			973
Increase (decrease) in accrued retiree medical benefits		39			(5	)
Changes in current assets and liabilities:
Accounts receivable		3,168			(6,484	)
Inventories		757			(1,618	)
Refundable income taxes		(1,893	)		—
Other current assets		(42	)		(62	)
Accounts payable		(1,249	)		2,090
Customer advances		264			235
Deferred profit		11			2,797
Income taxes payable		—			322
Accrued compensation, warranty and other liabilities		(2,492	)		847

Net cash provided from operating activities		6,300			1,193
Cash flows from investing activities:
Purchases of short-term investments		(24,485	)		(83,765	)
Sales and maturities of short-term investments		19,322			75,880
Purchases of property, plant and equipment		(836	)		(755	)
Payments on note receivable		—			8,978
Other assets		5			(29	)

Net cash provided from (used for) investing activities		(5,994	)		309
Cash flows from financing activities:
Issuance of stock, net		418			853
Cash dividends		(1,082	)		(1,071	)

Net cash used for financing activities		(664	)		(218	)

Net increase (decrease) in cash and cash equivalents		(358	)		1,284
Cash and cash equivalents at beginning of period		59,591			7,127

Cash and cash equivalents at end of period	$	59,233		$	8,411


Supplemental disclosure of cash flow information:
Cash paid (received) during the period for:
Income taxes, net of refunds	$	(7	)	$	76
Inventory capitalized as capital assets	$	430		$	—

The accompanying notes are an integral part of these statements.

COHU, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 26, 2005

1.   Basis of Presentation

    The interim condensed consolidated financial statements of Cohu, Inc. as of March 26, 2005, and for the three-month periods ended March 26, 2005 and March 31, 2004, are unaudited, but, in the opinion of management, include all adjustments (consisting only of normal adjustments) necessary for a fair presentation of the financial results for the interim periods. Our results of operations for the three-month period ended March 26, 2005 are not necessarily indicative of the results to be expected for the year ending December 31, 2005. These interim statements should be read in conjunction with the audited financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2004. In the following notes to our interim condensed consolidated financial statements, Cohu, Inc. is referred to as “Cohu”, “we”, “our” and “us”.

    Change in Fiscal Year

    On February 1, 2005, our Board of Directors approved a change in our fiscal year from December 31, to a 52-53 week fiscal year ending on the last Saturday of December. This change is effective for our 2005 fiscal year. As a result of the change, our current fiscal year will contain 52 weeks. The first fiscal quarter of 2005 contained 12 weeks, whereas the first fiscal quarter of 2004 contained 13 weeks.

    Revenue Recognition

    Our revenue recognition policy is disclosed in Note 1 of the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2004. As more fully described in that policy, revenue from products that have not previously satisfied customer acceptance is recognized upon customer acceptance. The gross profit on sales that are not recognized is generally recorded as deferred profit and reflected as a current liability in the consolidated balance sheet.

    We have an $8.5 million contract to provide microwave communications equipment for a border security command center and infrastructure system in the United Arab Emirates. The contract, which utilizes our most advanced microwave communications technology that has not been previously installed in an application of this size and complexity, requires that 40% of the total contract price be paid after the system has been fully accepted by the customer. As a result of these factors and the inability to make reasonably dependable estimates of progress toward completion and acceptance, we will recognize revenue and related costs under this contract in the period the system is accepted by the customer. Through March 26, 2005, we have deferred approximately $8.1 million of revenue under this contract.

    At March 26, 2005, we had total deferred revenue of approximately $22.9 million and deferred profit of $9.7 million. At December 31, 2004, we had total deferred revenue of approximately $22.5 million and deferred profit of $9.7 million.

    Stock-Based Compensation

    We have several stock-based compensation plans that are described more fully in Note 11 to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2004. We account for those plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations, until required otherwise by Financial Accounting Standards Board (“FASB”) Statement No. 123 (Revised 2004), Share Based Payment. Under the intrinsic value method, no stock-based employee compensation cost is reflected in the consolidated statements of income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The proforma information presented in the following table illustrates the effect on net income and net income per share if we had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, as amended by FASB Statement No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure, to stock-based employee compensation.

COHU, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 26, 2005


	Three months ended
(in thousands, except per share amounts)	March 26, 2005			March 31, 2004

Net income, as reported	$	6,531		$	2,098
Less: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effect		(1,030	)		(966	)

Pro forma net income	$	5,501		$	1,132


Net income per share:
Basic-as reported	$	0.30		$	0.10
Basic-pro forma	$	0.25		$	0.05

Diluted-as reported	$	0.30		$	0.10
Diluted-pro forma	$	0.25		$	0.05

    Retiree Medical Benefits

    We provide post-retirement health benefits to certain executives and directors under a noncontributory plan. The net periodic benefit cost during the first fiscal quarters of 2005 and 2004 was not significant.

    Recent Accounting Pronouncements

    In December 2004, the FASB issued Statement No. 123 (Revised 2004) Share-Based Payment, (“Statement No. 123R”). Statement No. 123R addresses all forms of share-based payment awards, including shares issued under employee stock purchase plans, stock options, restricted stock and stock appreciation rights. Statement No. 123R will require that we expense share-based payment awards with compensation cost for share-based payment transactions measured at fair value. Statement No. 123R requires us to adopt the new accounting provisions beginning in our third quarter of 2005. However, on April 14, 2005, the Securities and Exchange Commission announced the adoption of a new rule that amends the compliance date of Statement No. 123R until the beginning of the next fiscal year that begins on or after June 15, 2005. The adoption of this statement is expected to have a material impact on our consolidated results of operations and earnings per share.

    In November 2004, the FASB issued Statement No. 151, Inventory Costs, an amendment of ARB No. 43, which is the result of its efforts to converge U.S. accounting standards for inventories with International Accounting Standards. Statement No. 151 requires idle facility expenses, freight, handling costs, and wasted material (spoilage) costs to be recognized as current-period charges. It also requires that the allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. Statement No. 151 will be effective for inventory costs incurred during fiscal years beginning after June 15, 2005. We are currently evaluating the impact of Statement No. 151 on our consolidated financial statements.

2.   Results of Operations

    In February 2004, we amended a Product Representation Agreement with a foreign sales representative that was originally entered into on April 1, 2003. The amendment reduced the commissions to be paid to the sales representative on certain previously recorded and future sales. In the first fiscal quarter of 2004, we reduced commission expense by $129,000 and $103,000, for commissions previously expensed in 2003 and 2004, respectively. Accordingly, selling, general and administrative expense in the accompanying statement of income for the three months ended March 31, 2004 was reduced by $232,000 as a result of this amendment.

COHU, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 26, 2005

    In 2003, we recorded a charge to cost of sales of approximately $1.7 million as a result of inventory market valuation writedowns. Subsequently, we sold certain of the written down inventory and, as a result, our cost of sales and the related gross profit was favorably impacted by approximately $700,000 for the first fiscal quarter of 2004. There were no sales of the previously written down inventory during the first quarter of 2005.

3.   Income Per Share

    Income per share is computed in accordance with FASB Statement No. 128, Earnings per Share. Basic income per share is computed using the weighted average number of common shares outstanding during each period. Diluted income per share includes the dilutive effect of common shares potentially issuable upon the exercise of stock options. For purposes of computing diluted income per share, stock options with exercise prices that exceed the average fair market value of our common stock for the period are excluded. For the three months ended March 26, 2005, options to purchase approximately 793,000 shares of common stock were excluded from the computation. For the three months ended March 31, 2004, options to purchase approximately 65,000 shares of common stock were excluded from the computation. The following table reconciles the denominators used in computing basic and diluted income per share:


	Three months ended
(in thousands)	March 26, 2005		March 31, 2004

Weighted average common shares outstanding		21,633		21,419
Effect of dilutive stock options		475		656

		22,108		22,075

4.   Income Taxes

    The income tax provision (benefit) included in the statements of income for the three months ended March 26, 2005 and March 31, 2004, is based on the estimated annual effective tax rate for the entire year. These estimated effective tax rates are subject to adjustment in subsequent quarterly periods as our estimates of pretax income or loss for the year are increased or decreased. The effective tax rate for the three months ended March 26, 2005 is less than the U.S. federal statutory rate due to research and development tax credits, export sales benefits and the recently enacted domestic manufacturing activities deduction.

    In March 2005, the Internal Revenue Service completed a routine examination of our consolidated tax returns for the period 2000 through 2002. The examination resulted in no assessment related to our tax returns as filed. Consequently, approximately $3.0 million of accrued taxes related to the examined years were reversed with a corresponding credit to income tax expense in the quarter ended March 26, 2005.

    In accordance with SFAS No. 109, Accounting for Income Taxes, net deferred tax assets are reduced by a valuation allowance if, based on all the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. A valuation allowance of $6,873,000 and $11,704,000 was provided on deferred tax assets at December 31, 2004 and 2003, respectively. The amount of deferred tax assets considered realizable was determined based on (i) taxable income in prior carryback years; (ii) future reversals of existing taxable temporary differences (i.e. offset gross deferred tax assets against gross deferred tax liabilities); (iii) tax planning strategies and (iv) future taxable income, exclusive of reversing temporary differences and carryforwards.

    In evaluating future taxable income for valuation allowance purposes at December 31, 2004 and March 26, 2005, we concluded that it was only appropriate to consider income expected to be generated in 2005. While Cohu has had a long history of profitability, we incurred losses in each of the three years prior to 2004 and were in a three-year cumulative loss position entering 2004. Business conditions in the

COHU, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 26, 2005

    semiconductor equipment industry improved during the first half of 2004 and our operating results benefited from these improved conditions. However, the industry weakened considerably in the last six months of 2004 and the near-term outlook is uncertain. Anticipating income for Cohu beyond 2005 involves substantial risk and a reliable forecast of such income was not possible and, as a result, we believe such income could not be relied upon to support deferred tax assets under the more likely than not realization requirement in SFAS No. 109. In 2005, we will continue to assess the assumptions used to calculate the valuation allowance at December 31, 2004. We may be required to adjust the allowance, if, based on estimates of future income, we conclude that all or a portion of the valuation allowance is no longer warranted. A reduction in the valuation allowance would result in a corresponding credit to income tax expense in the period the allowance is reduced. Conversely, an increase in the valuation allowance would increase income tax expense.

5.   Goodwill, Investments and Other Intangible Assets

    In June 2001, the FASB issued Statement No. 142, Goodwill and Other Intangible Assets. Under Statement No. 142, goodwill and other intangible assets with indefinite useful lives are not amortized, but are reviewed annually for impairment or more frequently if impairment indicators arise. Separable intangible assets that have finite lives are amortized over their useful lives. Under Statement No. 142, goodwill and other intangible assets with indefinite useful lives resulting from acquisitions completed after June 30, 2001 are not amortized. At March 26, 2005, we had goodwill of $8.3 million that resulted from an acquisition completed in July 2001.

    We performed the required annual goodwill impairment test as of October 1, 2004. We did not recognize any goodwill impairment as a result of performing this annual test. A future decline in the fair value of our semiconductor equipment business may indicate goodwill impairment that could result in a charge to our future operating results.

    In the fourth quarter of 2002, we entered into a $1.7 million license agreement for certain intellectual property and know-how from LiveTools Technology SA. We are amortizing the licensed intangible assets to expense over the three-year exclusive license period. Accumulated amortization at March 26, 2005 and December 31, 2004, was approximately $1.3 million and $1.2 million, respectively. Amortization expense was $138,000 in the three-month periods ended March 26, 2005 and March 31, 2004. The estimated remaining amortization expense in 2005 is $320,000.

6.   Geographic Consolidation

    On April 10, 2003 we announced that our Delta Design, Inc. subsidiary was relocating its Littleton, Massachusetts operation to its headquarters facility in Poway, California. The consolidation, which resulted in approximately 50 of the 65 employees being terminated, was substantially completed in March 2004. In the quarter ended March 31, 2004 we recorded charges to operations totaling $188,000 for severance and one-time termination benefits. These charges are included in cost of sales ($57,000), research and development ($58,000) and selling, general and administrative expense ($73,000). There were no additional charges to operations recorded during the first quarter of 2005. Cumulative charges to operations for severance and other exit costs for the period April 10, 2003 to March 26, 2005, were $1,062,000.

    We are currently attempting to sell our Littleton manufacturing facility which we believe has a current fair value in excess of the $3.4 million carrying value at March 26, 2005.

COHU, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 26, 2005

The following table reconciles amounts accrued and paid under the consolidation plan.

Three months ended March 26, 2005

Severance and

Other exit

(in thousands)

other payroll

costs

Total

Liability at January 1, 2005

285

—

285

Costs accrued

—

Amounts paid or charged

(25

)

—

(25

)

Liability at March 26, 2005

260

—

260


Three months ended March 31, 2004	Severance and			Other exit
(in thousands)	other payroll			costs		Total

Liability at January 1, 2004	$	407		$	—	$	407
Costs accrued		188			—		188
Amounts paid or charged		(148	)		—		(148	)

Liability at March 31, 2004	$	447			—	$	447

7. Real Estate Transactions

On January 13, 2003, we extended the term of a $9.2 million promissory note with TC Kearny Villa, L.P. (“TC”). The 8% non-recourse note was secured by a deed of trust on land and buildings in San Diego, California sold by Cohu to TC in April 2001. In February 2004, we entered into an agreement with TC whereby we released our beneficial interest in the property securing the note receivable in exchange for full payment of the note and $272,000 of accrued interest. We received net cash proceeds from TC totaling $9,250,000 on February 19, 2004. The interest received was recorded as income in the first fiscal quarter of 2004.

8. Comprehensive Income

Comprehensive income represents all non-owner changes in stockholders’ equity and consists of, on an after-tax basis where applicable, the following:


	Three months ended
(in thousands)	March 26, 2005			March 31, 2004

Net income	$	6,531		$	2,098
Change in unrealized gain (loss) on investments		(120	)		1

Comprehensive income	$	6,411		$	2,099

Accumulated other comprehensive loss totaled $280,000 and $160,000 at March 26, 2005 and December 31, 2004, respectively, and was attributed to after-tax unrealized losses and gains on investments.

COHU, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 26, 2005

9. Segment and Related Information

The following is a summary of our significant accounts and balances by segment, reconciled to consolidated totals. Intersegment sales were not significant in any period.


	Three months ended
(in thousands)	March 26, 2005			March 31, 2004

Net sales by segment:
Semiconductor equipment	$	37,250		$	28,701
Television cameras		3,786			4,602
Metal detection		1,933			1,692
Microwave communications		1,427			944

Total consolidated net sales and net sales for reportable segments	$	44,396		$	35,939

Segment profit (loss):
Semiconductor equipment		5,885		$	3,486
Television cameras		(428	)		10
Metal detection		26			(145	)
Microwave communications		(786	)		(851	)

Profit (loss) for reportable segments		4,697			2,500
Other unallocated amounts:
Corporate expenses		(756	)		(622	)
Interest income		690			620

Income before income taxes	$	4,631		$	2,498


(in thousands)	March 26, 2005		December 31, 2004

Total assets by segment:
Semiconductor equipment	$	90,551	$	93,489
Television cameras		9,646		10,417
Metal detection		4,716		4,447
Microwave communications		9,199		10,039

Total assets for reportable segments		114,112		118,392
Corporate, principally cash and investments and deferred taxes		138,976		132,376

Total consolidated assets	$	253,088	$	250,768

10. Contingencies

We are currently involved in various legal proceedings, lawsuits and claims that have arisen in the ordinary course of our businesses. Although the outcome of these legal proceedings and claims cannot be predicted with certainty, we do not believe any of these matters will have a material adverse effect on our financial position or results of our operations.

11. Guarantees

Our products are generally sold with a 12-month to 24-month warranty period following sale or installation. Parts and labor are covered under the terms of the warranty agreement. The warranty provision is based on historical experience by product and configuration.


	Page Number
Part I Financial Information

Item 1. Financial Statements:

Condensed Consolidated Balance Sheets March 26, 2005 (unaudited) and December 31, 2004		3

Condensed Consolidated Statements of Income (unaudited) Three Months Ended March 26, 2005 and March 31, 2004		4

Condensed Consolidated Statements of Cash Flows (unaudited) Three Months Ended March 26, 2005 and March 31, 2004		5

Notes to Unaudited Condensed Consolidated Financial Statements		6

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		13

Item 3. Quantitative and Qualitative Disclosures about Market Risk		27

Item 4. Controls and Procedures		27

Part II Other Information

Item 6. Exhibits		28

Signatures		28
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2

Table of Contents

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1.	Basis of Presentation

	The interim condensed consolidated financial statements of Cohu, Inc. as of March 26, 2005, and for the three-month periods ended March 26, 2005 and March 31, 2004, are unaudited, but, in the opinion of management, include all adjustments (consisting only of normal adjustments) necessary for a fair presentation of the financial results for the interim periods. Our results of operations for the three-month period ended March 26, 2005 are not necessarily indicative of the results to be expected for the year ending December 31, 2005. These interim statements should be read in conjunction with the audited financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2004. In the following notes to our interim condensed consolidated financial statements, Cohu, Inc. is referred to as “Cohu”, “we”, “our” and “us”.

	Change in Fiscal Year

	On February 1, 2005, our Board of Directors approved a change in our fiscal year from December 31, to a 52-53 week fiscal year ending on the last Saturday of December. This change is effective for our 2005 fiscal year. As a result of the change, our current fiscal year will contain 52 weeks. The first fiscal quarter of 2005 contained 12 weeks, whereas the first fiscal quarter of 2004 contained 13 weeks.

	Revenue Recognition

	Our revenue recognition policy is disclosed in Note 1 of the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2004. As more fully described in that policy, revenue from products that have not previously satisfied customer acceptance is recognized upon customer acceptance. The gross profit on sales that are not recognized is generally recorded as deferred profit and reflected as a current liability in the consolidated balance sheet.

	We have an $8.5 million contract to provide microwave communications equipment for a border security command center and infrastructure system in the United Arab Emirates. The contract, which utilizes our most advanced microwave communications technology that has not been previously installed in an application of this size and complexity, requires that 40% of the total contract price be paid after the system has been fully accepted by the customer. As a result of these factors and the inability to make reasonably dependable estimates of progress toward completion and acceptance, we will recognize revenue and related costs under this contract in the period the system is accepted by the customer. Through March 26, 2005, we have deferred approximately $8.1 million of revenue under this contract.

	At March 26, 2005, we had total deferred revenue of approximately $22.9 million and deferred profit of $9.7 million. At December 31, 2004, we had total deferred revenue of approximately $22.5 million and deferred profit of $9.7 million.

	Stock-Based Compensation

	We have several stock-based compensation plans that are described more fully in Note 11 to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2004. We account for those plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations, until required otherwise by Financial Accounting Standards Board (“FASB”) Statement No. 123 (Revised 2004), Share Based Payment. Under the intrinsic value method, no stock-based employee compensation cost is reflected in the consolidated statements of income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The proforma information presented in the following table illustrates the effect on net income and net income per share if we had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, as amended by FASB Statement No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure, to stock-based employee compensation.

	Retiree Medical Benefits

	We provide post-retirement health benefits to certain executives and directors under a noncontributory plan. The net periodic benefit cost during the first fiscal quarters of 2005 and 2004 was not significant.

	Recent Accounting Pronouncements

	In December 2004, the FASB issued Statement No. 123 (Revised 2004) Share-Based Payment, (“Statement No. 123R”). Statement No. 123R addresses all forms of share-based payment awards, including shares issued under employee stock purchase plans, stock options, restricted stock and stock appreciation rights. Statement No. 123R will require that we expense share-based payment awards with compensation cost for share-based payment transactions measured at fair value. Statement No. 123R requires us to adopt the new accounting provisions beginning in our third quarter of 2005. However, on April 14, 2005, the Securities and Exchange Commission announced the adoption of a new rule that amends the compliance date of Statement No. 123R until the beginning of the next fiscal year that begins on or after June 15, 2005. The adoption of this statement is expected to have a material impact on our consolidated results of operations and earnings per share.

	In November 2004, the FASB issued Statement No. 151, Inventory Costs, an amendment of ARB No. 43, which is the result of its efforts to converge U.S. accounting standards for inventories with International Accounting Standards. Statement No. 151 requires idle facility expenses, freight, handling costs, and wasted material (spoilage) costs to be recognized as current-period charges. It also requires that the allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. Statement No. 151 will be effective for inventory costs incurred during fiscal years beginning after June 15, 2005. We are currently evaluating the impact of Statement No. 151 on our consolidated financial statements.

2.	Results of Operations

	In February 2004, we amended a Product Representation Agreement with a foreign sales representative that was originally entered into on April 1, 2003. The amendment reduced the commissions to be paid to the sales representative on certain previously recorded and future sales. In the first fiscal quarter of 2004, we reduced commission expense by $129,000 and $103,000, for commissions previously expensed in 2003 and 2004, respectively. Accordingly, selling, general and administrative expense in the accompanying statement of income for the three months ended March 31, 2004 was reduced by $232,000 as a result of this amendment.

	In 2003, we recorded a charge to cost of sales of approximately $1.7 million as a result of inventory market valuation writedowns. Subsequently, we sold certain of the written down inventory and, as a result, our cost of sales and the related gross profit was favorably impacted by approximately $700,000 for the first fiscal quarter of 2004. There were no sales of the previously written down inventory during the first quarter of 2005.

3.	Income Per Share

	Income per share is computed in accordance with FASB Statement No. 128, Earnings per Share. Basic income per share is computed using the weighted average number of common shares outstanding during each period. Diluted income per share includes the dilutive effect of common shares potentially issuable upon the exercise of stock options. For purposes of computing diluted income per share, stock options with exercise prices that exceed the average fair market value of our common stock for the period are excluded. For the three months ended March 26, 2005, options to purchase approximately 793,000 shares of common stock were excluded from the computation. For the three months ended March 31, 2004, options to purchase approximately 65,000 shares of common stock were excluded from the computation. The following table reconciles the denominators used in computing basic and diluted income per share:

4.	Income Taxes

	The income tax provision (benefit) included in the statements of income for the three months ended March 26, 2005 and March 31, 2004, is based on the estimated annual effective tax rate for the entire year. These estimated effective tax rates are subject to adjustment in subsequent quarterly periods as our estimates of pretax income or loss for the year are increased or decreased. The effective tax rate for the three months ended March 26, 2005 is less than the U.S. federal statutory rate due to research and development tax credits, export sales benefits and the recently enacted domestic manufacturing activities deduction.

	In March 2005, the Internal Revenue Service completed a routine examination of our consolidated tax returns for the period 2000 through 2002. The examination resulted in no assessment related to our tax returns as filed. Consequently, approximately $3.0 million of accrued taxes related to the examined years were reversed with a corresponding credit to income tax expense in the quarter ended March 26, 2005.

	In accordance with SFAS No. 109, Accounting for Income Taxes, net deferred tax assets are reduced by a valuation allowance if, based on all the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. A valuation allowance of $6,873,000 and $11,704,000 was provided on deferred tax assets at December 31, 2004 and 2003, respectively. The amount of deferred tax assets considered realizable was determined based on (i) taxable income in prior carryback years; (ii) future reversals of existing taxable temporary differences (i.e. offset gross deferred tax assets against gross deferred tax liabilities); (iii) tax planning strategies and (iv) future taxable income, exclusive of reversing temporary differences and carryforwards.

	In evaluating future taxable income for valuation allowance purposes at December 31, 2004 and March 26, 2005, we concluded that it was only appropriate to consider income expected to be generated in 2005. While Cohu has had a long history of profitability, we incurred losses in each of the three years prior to 2004 and were in a three-year cumulative loss position entering 2004. Business conditions in the

	semiconductor equipment industry improved during the first half of 2004 and our operating results benefited from these improved conditions. However, the industry weakened considerably in the last six months of 2004 and the near-term outlook is uncertain. Anticipating income for Cohu beyond 2005 involves substantial risk and a reliable forecast of such income was not possible and, as a result, we believe such income could not be relied upon to support deferred tax assets under the more likely than not realization requirement in SFAS No. 109. In 2005, we will continue to assess the assumptions used to calculate the valuation allowance at December 31, 2004. We may be required to adjust the allowance, if, based on estimates of future income, we conclude that all or a portion of the valuation allowance is no longer warranted. A reduction in the valuation allowance would result in a corresponding credit to income tax expense in the period the allowance is reduced. Conversely, an increase in the valuation allowance would increase income tax expense.

5.	Goodwill, Investments and Other Intangible Assets

	In June 2001, the FASB issued Statement No. 142, Goodwill and Other Intangible Assets. Under Statement No. 142, goodwill and other intangible assets with indefinite useful lives are not amortized, but are reviewed annually for impairment or more frequently if impairment indicators arise. Separable intangible assets that have finite lives are amortized over their useful lives. Under Statement No. 142, goodwill and other intangible assets with indefinite useful lives resulting from acquisitions completed after June 30, 2001 are not amortized. At March 26, 2005, we had goodwill of $8.3 million that resulted from an acquisition completed in July 2001.

	We performed the required annual goodwill impairment test as of October 1, 2004. We did not recognize any goodwill impairment as a result of performing this annual test. A future decline in the fair value of our semiconductor equipment business may indicate goodwill impairment that could result in a charge to our future operating results.

	In the fourth quarter of 2002, we entered into a $1.7 million license agreement for certain intellectual property and know-how from LiveTools Technology SA. We are amortizing the licensed intangible assets to expense over the three-year exclusive license period. Accumulated amortization at March 26, 2005 and December 31, 2004, was approximately $1.3 million and $1.2 million, respectively. Amortization expense was $138,000 in the three-month periods ended March 26, 2005 and March 31, 2004. The estimated remaining amortization expense in 2005 is $320,000.

6.	Geographic Consolidation

	On April 10, 2003 we announced that our Delta Design, Inc. subsidiary was relocating its Littleton, Massachusetts operation to its headquarters facility in Poway, California. The consolidation, which resulted in approximately 50 of the 65 employees being terminated, was substantially completed in March 2004. In the quarter ended March 31, 2004 we recorded charges to operations totaling $188,000 for severance and one-time termination benefits. These charges are included in cost of sales ($57,000), research and development ($58,000) and selling, general and administrative expense ($73,000). There were no additional charges to operations recorded during the first quarter of 2005. Cumulative charges to operations for severance and other exit costs for the period April 10, 2003 to March 26, 2005, were $1,062,000.

	We are currently attempting to sell our Littleton manufacturing facility which we believe has a current fair value in excess of the $3.4 million carrying value at March 26, 2005.

7.	Real Estate Transactions

	On January 13, 2003, we extended the term of a $9.2 million promissory note with TC Kearny Villa, L.P. (“TC”). The 8% non-recourse note was secured by a deed of trust on land and buildings in San Diego, California sold by Cohu to TC in April 2001. In February 2004, we entered into an agreement with TC whereby we released our beneficial interest in the property securing the note receivable in exchange for full payment of the note and $272,000 of accrued interest. We received net cash proceeds from TC totaling $9,250,000 on February 19, 2004. The interest received was recorded as income in the first fiscal quarter of 2004.

8.	Comprehensive Income

	Comprehensive income represents all non-owner changes in stockholders’ equity and consists of, on an after-tax basis where applicable, the following:

9.	Segment and Related Information

	The following is a summary of our significant accounts and balances by segment, reconciled to consolidated totals. Intersegment sales were not significant in any period.

10.	Contingencies

	We are currently involved in various legal proceedings, lawsuits and claims that have arisen in the ordinary course of our businesses. Although the outcome of these legal proceedings and claims cannot be predicted with certainty, we do not believe any of these matters will have a material adverse effect on our financial position or results of our operations.

11.	Guarantees

	Our products are generally sold with a 12-month to 24-month warranty period following sale or installation. Parts and labor are covered under the terms of the warranty agreement. The warranty provision is based on historical experience by product and configuration.