Management's Discussion and Analysis of Financial Condition and Results of Operations March 28, 2009 This Form 10-Q contains certain forward-looking statements including expectations of market conditions, challenges and plans, within the meaning of
Section 21E of the Securities Exchange Act of 1934, as amended, and is subject to the Safe Harbor provisions created by that statute. Such forward-looking statements are based on management's current expectations and beliefs, including estimates and projections about our industries and include, but are not limited to, statements concerning financial position, business strategy, and plans or objectives for future operations. Forward-looking statements are not guarantees of future performance, and are subject to certain risks, uncertainties, and assumptions that are difficult to predict and may cause actual results to differ materially from management's current expectations. Such risks and uncertainties include those set forth in this Quarterly Report on Form 10-Q and our 2008 Annual Report on Form 10-K under the heading "Item 1A. Risk Factors". The forward-looking statements in this report speak only as of the time they are made, and do not necessarily reflect management's outlook at any other point in time. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events, or for any other reason, however, readers should carefully review the risk factors set forth in other reports or documents we file from time to time with the SEC after the date of this Quarterly Report.
OVERVIEW
Our primary business activity involves the development, manufacture, marketing, sale and servicing of test handling and burn-in related equipment and thermal sub-systems for the global semiconductor industry. This business is significantly dependent on capital expenditures by semiconductor manufacturers and test subcontractors, which in turn are dependent on the current and anticipated market demand for semiconductors that are subject to significant cyclical trends in demand. We expect the semiconductor equipment industry will continue to be cyclical and volatile in part because consumer electronics, rather than personal computers, are the principal end market for integrated circuits and demand for consumer electronic products is difficult to accurately predict and product life cycles have become shorter.
Like other companies in the backend semiconductor equipment industry, our primary business has been severely impacted by the global economic crisis and the dramatic decrease in consumer and business confidence, resulting in lower sales of electronic products and sharply reduced demand for semiconductors and semiconductor equipment. Changes in the semiconductor, electronics, computer and telecommunications industries, as well as rapidly shifting global economic conditions, have had and will continue to have a significant impact on the results of operations of our primary business.
Weak business conditions in the semiconductor equipment industry throughout 2008 were further impacted by the global economic and financial crisis. Customers for backend semiconductor equipment have suspended capital spending for new equipment and reduced purchases of spares and non-essentials as the steep decline in semiconductor demand has created significant idle capacity for integrated circuit manufacturers and test subcontractors. Recently, equipment utilization on some test floors is trending up slightly and while this is encouraging, the business environment remains difficult and equipment utilization is still well below normal levels. Current visibility in the backend semiconductor industry is limited and we expect business conditions to remain difficult, at least for the next several quarters. In response to these weak business conditions, we have taken actions to reduce costs and conserve cash, including headcount reductions, pay cuts, suspension of the company's matching contribution to our 401(k) plan, reduced work hours and mandatory time off. Through this downturn, we plan to continue to invest in new product development and key initiatives to improve gross margin and operating performance that will benefit the results of operations of our primary business when industry conditions improve.
On December 9, 2008 we completed the acquisition of Rasco. Through this acquisition we combine Delta, the leading supplier of logic pick and place IC test handlers, with Rasco, a leading supplier of gravity feed handlers. This expands our semiconductor test handling product line total available market, extends our market leadership in IC test, expands our customer base, broadens our product and technology offerings and further strengthens our global sales and service network.
Our operating results in the last three years have been impacted by charges to cost of sales related to excess, obsolete and lower of cost or market inventory issues. These charges totaled approximately $20.8 million during the three-year period ended December 27, 2008 (and approximately $2.9 million in the quarter ended March 28, 2009) and were primarily the result of decreases or frequent changes in customer forecasts and, to a lesser extent, changes in our sales product mix. Exposure related to inventories is common in the semiconductor equipment industry due to the narrow customer base, the custom nature of the products and inventory and the shortened product life cycles caused by rapid changes in semiconductor manufacturing technology. Increased competition, particularly in the last several years, has also negatively impacted our gross margins on certain products and we believe it is likely these conditions will exist for the foreseeable future.

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Cohu, Inc. Management's Discussion and Analysis of Financial Condition and Results of Operations March 28, 2009 Our non-semiconductor equipment businesses comprised approximately 18% of our consolidated revenues during the last three years (32.8% in the quarter ended March 28, 2009). Customers in our microwave communications and television camera business are primarily government and military in nature and the buying cycles are typically longer than the commercial market place. Improved sales, operating income and orders within our microwave equipment operation during fiscal 2008 have continued into 2009. The operating results of our television camera business during fiscal 2008 and the first quarter of fiscal 2009 were below our expectations and we are focusing on reducing costs within this segment. Customer interest remains strong for new products developed for the high-end security and surveillance markets.
Our management team uses several performance metrics to manage our various businesses. These metrics, which tend to focus on near-term forecasts due to the limited order backlog in our businesses, include (i) order bookings and backlog for the most recently completed quarter and the forecast for the next quarter;
(ii) inventory levels and related excess exposures typically based on the next twelve month's forecast; (iii) gross margin and other operating expense trends;
(iv) industry data and trends noted in various publicly available sources; and
(v) competitive factors and information. Due to the short-term nature of our order backlog that historically has represented about three months of business and the inherent volatility of the semiconductor equipment business, our past performance is frequently not indicative of future near term operating results or cash flows.
Application of Critical Accounting Estimates and Policies Our discussion and analysis of our financial condition and results of operations are based upon our interim condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We base our estimates on historical experience, forecasts and on various other assumptions that are believed to be reasonable under the circumstances, however actual results may differ from those estimates under different assumptions or conditions. The methods, estimates and judgments we use in applying our accounting policies have a significant impact on the results we report in our financial statements. Some of our accounting policies require us to make difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Our most critical accounting estimates that we believe are the most important to an investor's understanding of our financial results and condition and require complex management judgment include:
• revenue recognition, including the deferral of revenue on sales to customers, which impacts our results of operations;

• estimation of valuation allowances and accrued liabilities, specifically product warranty, inventory reserves and allowance for doubtful accounts, which impact gross margin or operating expenses;

• the recognition and measurement of current and deferred income tax assets and liabilities and the valuation allowance on deferred tax assets, which impact our tax provision;

• the assessment of recoverability of long-lived assets including goodwill and other intangible assets, which primarily impacts gross margin or operating expenses if we are required to record impairments of assets or accelerate their depreciation; and

• the valuation and recognition of share-based compensation, which impacts gross margin, research and development expense, and selling, general and administrative expense.

Below, we discuss these policies further, as well as the estimates and judgments involved. We also have other policies that we consider key accounting policies; however, these policies typically do not require us to make estimates or judgments that are difficult or subjective.

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Cohu, Inc. Management's Discussion and Analysis of Financial Condition and Results of Operations March 28, 2009 Revenue Recognition: We generally recognize revenue upon shipment and title passage for established products (i.e., those that have previously satisfied customer acceptance requirements) that provide for full payment tied to shipment. Revenue for products that have not previously satisfied customer acceptance requirements or from sales where customer payment dates are not determinable is recognized upon customer acceptance. For arrangements containing multiple elements, the revenue relating to the undelivered elements is deferred at estimated fair value until delivery of the deferred elements. Accounts Receivable: We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. If the financial condition of our customers deteriorates, resulting in an impairment of their ability to make payments, additional allowances may be required.
Warranty: We provide for the estimated costs of product warranties in the period sales are recognized. Our warranty obligation estimates are affected by historical product shipment levels, product performance and material and labor costs incurred in correcting product performance problems. Should product performance, material usage or labor repair costs differ from our estimates, revisions to the estimated warranty liability would be required.
Inventory: The valuation of inventory requires us to estimate obsolete or excess inventory as well as inventory that is not of saleable quality. The determination of obsolete or excess inventory requires us to estimate the future demand for our products. The demand forecast is a direct input in the development of our short-term manufacturing plans. We record valuation reserves on our inventory for estimated excess and obsolete inventory and lower of cost or market concerns equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future product demand, market conditions and product selling prices. If future product demand, market conditions or product selling prices are less than those projected by management or if continued modifications to products are required to meet specifications or other customer requirements, increases to inventory reserves may be required which would have a negative impact on our gross margin.
Income Taxes: We estimate our liability for income taxes based on the various jurisdictions where we conduct business. This requires us to estimate our
(i) current tax exposure; (ii) temporary differences that result from differing treatment of certain items for tax and accounting purposes and
(iii) unrecognized tax benefits. Temporary differences result in deferred tax assets and liabilities that are reflected in the consolidated balance sheet. The deferred tax assets are reduced by a valuation allowance if, based upon all available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. Establishing, reducing or increasing a valuation allowance in an accounting period results in an increase or decrease in tax expense in the statement of operations. We must make significant judgments to determine the provision for income taxes, deferred tax assets and liabilities, unrecognized tax benefits and any valuation allowance to be recorded against deferred tax assets. Our gross deferred tax asset balance as of December 27, 2008 was $27.6 million, with a valuation allowance of $4.3 million for state tax credit and loss carryforwards. The deferred tax assets consist primarily of deductible temporary differences and tax credit and net operating loss carryforwards. Contingencies: We are subject to certain contingencies that arise in the ordinary course of our businesses. In accordance with FASB Statement No. 5, Accounting for Contingencies, ("Statement No. 5") we assess the likelihood that future events will confirm the existence of a loss or an impairment of an asset. If a loss or asset impairment is probable, as defined in Statement No. 5 and the amount of the loss or impairment is reasonably estimable, we accrue a charge to operations in the period such conditions become known. Goodwill, Intangible and Long-Lived Assets: We are required to assess goodwill impairment using the methodology prescribed by Statement No. 142. Under the provisions prescribed in Statement No. 142 we evaluate goodwill for impairment annually. Our annual testing date is October 1 and we did not recognize any goodwill impairment as a result of performing this annual test in 2008. Other events and changes in circumstances may also require goodwill to be tested for impairment between annual measurement dates. While a decline in stock price and market capitalization is not specifically cited in Statement No. 142 as a goodwill impairment indicator, a company's stock price and market capitalization should be considered in determining whether it is more likely than not that the fair value of a reporting unit is less than its book value. The financial and credit market volatility directly impacts our fair value measurement through our stock price that we use to determine our market capitalization. During times of volatility, significant judgment must be applied to determine whether stock price changes are a short-term swing or a longer-term trend. As of March 28, 2009, we do not believe there have been any events or circumstances that would require us to perform an interim goodwill impairment review, however, a sustained decline in Cohu's market capitalization below book value could lead us to determine, in a future period, that an interim goodwill impairment review is required and may result in an impairment charge which would have a negative impact on our results from operations.

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Cohu, Inc. Management's Discussion and Analysis of Financial Condition and Results of Operations March 28, 2009 Share-based Compensation: Share-based compensation expense related to stock options is recorded based on the fair value of the award on its grant date which we estimate using the Black-Scholes valuation model.
Share-based compensation expense related to restricted stock unit awards is calculated based on the market price of our common stock on the grant date, reduced by the present value of dividends expected to be paid on our common stock prior to vesting of the restricted stock unit.
Recent Accounting Pronouncements: In December 2007, the FASB issued Statement No. 141(Revised 2007), "Business Combinations" ("Statement No. 141R"), which establishes principles and requirements for the reporting entity in a business combination, including recognition and measurement in the financial statements of the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree. This statement also establishes disclosure requirements to enable financial statement users to evaluate the nature and financial effects of the business combination. Statement No. 141R applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008, and interim periods within those fiscal years. Statement No. 141R became effective for our fiscal year beginning in 2009. We expect Statement No. 141R will have an impact on our consolidated financial statements, but the nature and magnitude of the specific effects will depend upon the nature, terms and size of the acquisitions we consummate subsequent to our adoption of the revised standard.
We adopted FASB Statement No. 157, "Fair Value Measurements" ("Statement No. 157") on December 30, 2007, the first day of our fiscal year 2008. Statement No. 157 defines fair value, establishes a methodology for measuring fair value, and expands the required disclosure for fair value measurements. In February 2008, the FASB issued FASB Staff Position No. FAS 157-2, "Effective Date of FASB Statement No. 157," which amends Statement No. 157 by delaying its effective date by one year for non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis. Therefore, beginning on December 30, 2007, this standard applies prospectively to new fair value measurements of financial instruments and recurring fair value measurements of non-financial assets and non-financial liabilities. On December 28, 2008, the beginning of our 2009 fiscal year, the standard also applied to all other fair value measurements. See Note 9, "Fair Value Measurements," for additional information.
In March 2008, the FASB issued Statement No. 161, "Disclosures about Derivative Instruments and Hedging Activities-an amendment of FASB Statement No. 133" ("Statement No. 161"). Statement No. 161 expands the current disclosure requirements of FASB Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities," and requires that companies must now provide enhanced disclosures on a quarterly basis regarding how and why the entity uses derivatives, how derivatives and related hedged items are accounted for under FASB Statement No. 133 and how derivatives and related hedged items affect the company's financial position, performance and cash flows. Statement No. 161 became effective for our fiscal year beginning in 2009. As we do not currently enter into derivative or hedging agreements Statement No. 161 did not have an impact on our financial statements.
In April 2008, the FASB issued Staff Position No. FAS 142-3, "Determination of the Useful Life of Intangible Assets" ("FSP FAS 142-3"). FSP FAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142, "Goodwill and Other Intangible Assets" ("Statement No. 142"). The intent of the position is to improve the consistency between the useful life of a recognized intangible asset under Statement No. 142 and the period of expected cash flows used to measure the fair value of the asset under Statement No. 141R, and other U.S. generally accepted accounting principles. FSP FAS 142-3 became effective for our fiscal year beginning in 2009. FSP FAS 142-3 could have an impact on our consolidated financial statements, but the nature and magnitude of the specific effects will depend upon the nature, terms and size of the acquisitions we consummate subsequent to our adoption of this standard.

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Cohu, Inc. Management's Discussion and Analysis of Financial Condition and Results of Operations March 28, 2009 RESULTS OF OPERATIONS The following table summarizes certain operating data from continuing operations as a percentage of net sales. Three Months Ended March 28, March 29, 2009 2008 Net sales 100.0 % 100.0 % Cost of sales (79.8 ) (64.4 ) Gross margin 20.2 35.6 Research and development (21.8 ) (17.1 ) Selling, general and administrative (24.7 ) (15.4 ) Income (loss) from operations (26.3 )% 3.1 %

In December, 2008, we purchased Rasco. The results of Rasco's operations have been included in our consolidated financial statements since that date. First quarter of fiscal 2009 Compared to First quarter of fiscal 2008 Net Sales
Our net sales decreased 37.4% to $36.6 million in 2009, compared to net sales of $58.4 million in 2008. Sales of semiconductor equipment in the first quarter of fiscal 2009 decreased 45.0% from the comparable 2008 period and accounted for 67.2% of consolidated net sales in 2009 versus 76.5% in 2008. The decrease in sales of semiconductor equipment resulted from weak business conditions in the back-end semiconductor equipment industry and the poor business climate due to the global financial crisis. Consequently customers for backend semiconductor equipment have limited capital spending for new equipment and reduced purchases of spares and non-essentials.
Sales of microwave communications equipment accounted for 22.1% of consolidated net sales in 2009 and decreased 12.9% when compared to the same period in fiscal 2008. The decrease in sales of our microwave communications business during the first quarter of fiscal 2009 was attributable to decreased product shipments to international customers within the public safety sector and the impact of foreign currency translation rates. While the sales recognized by this segment declined in the year over year period, orders within our microwave equipment operation increased from $6.0 million in the first quarter of fiscal 2008 to $10.7 million in the first quarter of fiscal 2009.
Sales of television cameras accounted for 10.7% of consolidated net sales in 2009 and decreased $0.5 million or 11.6% when compared to the same period of fiscal 2008. Television camera sales in the first quarter of fiscal 2008 benefitted from the recognition of $0.5 million in deferred revenue upon the receipt of customer acceptance on a contract with a government subcontractor. Gross Margin
Gross margin consists of net sales less cost of sales. Cost of sales consists primarily of the cost of materials, assembly and test labor, and overhead from operations. Our gross margin can fluctuate due to a number of factors, including, but not limited to, the mix of products sold, product support costs, inventory reserve adjustments, and utilization of manufacturing capacity. Our gross margin, as a percentage of net sales, decreased to 20.2% in 2009 from 35.6% in 2008. During the first quarter of fiscal 2009 our gross margin was impacted by the substantial decrease in the sales volume of our semiconductor equipment segment due to weak business conditions.
Our gross margin has been impacted by charges to cost of sales related to excess, obsolete and lower of cost or market inventory issues. We compute the majority of our excess and obsolete inventory reserve requirements using a one-year inventory usage forecast. During the first quarter of fiscal 2009 and 2008, we recorded net charges to cost of sales of approximately $2.9 million and $0.4 million, respectively, for excess and obsolete inventory. While we believe our reserves for excess and obsolete inventory and lower of cost or market concerns are adequate to cover known exposures at March 28, 2009, reductions in customer forecasts or continued modifications to products, as a result of our failure to meet specifications or other customer requirements, may result in additional charges to operations that could negatively impact our gross margin in future periods. Conversely, if our actual inventory usage is greater than our forecasted usage, our gross margin in future periods may be favorably impacted.

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Cohu, Inc. Management's Discussion and Analysis of Financial Condition and Results of Operations March 28, 2009 Research and Development Expense ("R&D Expense") R&D expense consists primarily of salaries and related costs of employees engaged in ongoing research, product design and development activities, costs of engineering materials and supplies, and professional consulting expenses. R&D expense as a percentage of net sales was 21.8% in 2009, compared to 17.1% in 2008, decreasing in absolute dollars from $10.0 million in 2008 to $8.0 million in 2009. Decreased R&D expense in 2009 was primarily a result of decreased labor and material costs associated with new product development within our semiconductor equipment business as development activities on certain new products decreased as they are nearing completion. Selling, General and Administrative Expense ("SG&A Expense) SG&A expense consists primarily of salaries and benefit costs of employees, commission expense for independent sales representatives, product promotion and costs of professional services. SG&A expense as a percentage of net sales increased to 24.7% in 2009, from 15.4% in 2008. SG&A was approximately $9.0 million in the first fiscal quarter of both 2008 and 2009. While we have reduced costs, total SG&A expense was unchanged as incremental costs associated with Rasco, acquired in December 2008, and one-time severance costs associated with headcount reductions at Delta Design offset these reductions. Interest and other, net
Interest and other, net was approximately $0.5 million and $1.4 million in the first quarter of fiscal 2009 and 2008, respectively. Our interest income was lower in 2009 due to a decrease in our cash and investment balances as a result of the Rasco acquisition which occurred in the fourth quarter of 2008 and lower short-term interest rates. During the first quarter of fiscal 2008 our interest income was negatively impacted by a loss of approximately $0.4 million recorded on our short-term investment portfolio.
Income Taxes
The income tax provision (benefit) included in the condensed consolidated statements of operations for the three months ended March 28, 2009 and March 29, 2008 is based on the estimated annual effective tax rate for the entire year. These estimated effective tax rates are subject to adjustment in subsequent . . .