Data I/O Corp Q1 FY2020 Earnings Call

And welcome to the Data I/O Corporation First Quarter 2020 Financial Results Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Jordan Darrow. Please go ahead.

Thank you, Grant, and welcome everyone to the Data I/O Corporation first quarter 2020 financial results conference call. With me today are Anthony Ambrose, President and CEO of Data I/O Corporation; and Joel Hatlen, Chief Operating Officer and Chief Financial Officer of Data I/O. Before we begin, I'd like to remind you that statements made in this conference call concerning COVID-19, future revenues results from operations, financial position, markets, economic conditions, estimated impact of tax reform, product releases, new industry partnerships and any other statements that may be construed as a prediction of future performance or events are forward-looking statements, which involve known and unknown risks, uncertainties and other factors, which may cause actual results to differ materially from those expressed or implied by such statements. These factors include uncertainties as to the impact from the COVID-19 pandemic along with expected reopening and recovery efforts within the supply chain and among our customer base. Levels of orders, ability to report revenues based upon the timing of product deliveries and installations, market acceptance of new products, changes in economic conditions and market demand, pricing and other activities by competitors and other risks including those described from time-to-time in the company's filings on Form 10-K and 10-Q with the Securities and Exchange Commission, press releases and other communications. The accuracy and completeness of forward-looking statements should not be unduly relied upon. Data I/O is under no duty to update any of these forward-looking statements. Beyond today's conference call, our next interaction with shareholders will be at our Annual Meeting to be held on May 18 at 10:00 a.m. Pacific time at our corporate headquarters in Redmond, Washington. In this event, since our proxy agent was unable to handle mailing of documents to certain shareholders due to COVID-19 challenges, we have made our information available via Internet delivery as needed. We have provided ample time for all shareholders to cast their votes and we hope you do. Shareholders may not come to our offices, but instead may avoid social gathering risk by listening to our annual meeting via conference call. Participation details are available on our website in the Investor Relations section. Now I would like to turn over the call to Anthony Ambrose, President and CEO of Data I/O.

Thank you, Jordan. I want to discuss our first quarter of 2020 and our recent developments, and then I'll hand it over to Joel Hatlen for more details on the numbers. First, I will address the COVID-19 situation. The coronavirus pandemic has affected our customers, suppliers, and facilities. We have developed plans for each of these areas while prioritizing three main goals: ensuring the safety of our people and their families, securing our facilities, and serving our customers. As an essential supplier to the medical and aerospace industries, Data I/O has remained open for business. We have taken precautions to keep our employees and facilities safe by requiring most of our workforce to operate remotely, while maintaining a core on-site team to support our manufacturing, service, and support operations. Our global teams adhere to recommended best practices, often ahead of local government requirements. Local health authorities report steady progress in our operating locations. I want to take this opportunity to acknowledge the efforts of our global workforce who have kept our workplaces, communities, and families safe while continuing to support our customers. We believe our business and operational strategies have been effective in managing the effects of COVID-19. Our global diversification provides us with competitive advantages and mitigates location risk. This diversification covers manufacturing for a multi-source supply chain, engineering, and our customer base across vertical markets and support. Financially, we entered this crisis in a strong position. Data I/O is the largest company in our industry, and we have a robust balance sheet and no debt. At the end of the first quarter, we had $13.8 million in cash, approximately $1.68 per share. We believe we are better prepared than any other company in our industry to face future challenges and are taking proactive steps to ensure this remains the case. Beginning in Q1 and into the second quarter, we initiated cash conservation and expense management measures, including reductions and deferrals in executive and Board compensation. We also reduced work weeks for certain locations and functions. We will continue to assess government programs globally that can help us maintain our workforce and cash flow. However, we do not plan to accept funding from the SBA PPP program in the United States. We remain committed to our long-term business objectives. Unlike other industries, we believe the electronics sector will recover and will continue to need secure high-quality device programming. Data I/O has consistently led the industry, and the first quarter was no exception as we kept investing in our data programming and security platforms. Our innovations and exceptional performance were recognized this quarter, and we are honored to have received the prestigious Service Excellence Award for device program support for the second consecutive year. Our engineering innovations and comprehensive customer support have resonated with clients globally. During the first quarter, our sales channels and high-quality products allowed us to win system orders from new automotive customers in Asia, North America, and Europe, as well as being selected by a global ventilator electronics manufacturer to bolster their ventilator production in response to COVID-19. We are proud to support medical manufacturers and their EMS partners and announced a program to expedite support for clients building COVID-19-related products. Economic conditions may fluctuate, but the reasons customers choose us remain constant: excellent products, exceptional customer support, financial stability, and global reach. Overall, the worldwide automotive electronics market, from which we have generated around half our revenue in recent years, has been significantly impacted by plant closures. Chinese factories are reopening, but facilities in the U.S., Mexico, and Europe are still shut down. Guidance from major customers suggests that European and American locations will reopen soon and gradually ramp up production by late Q2, with a return to normal output expected in Q4 of this year. Within automotive electronics, we believe the sector is poised for substantial multi-year growth in content per vehicle, along with increasing design complexity and programming requirements as we transition from eMMC to UFS flash storage. UFS is the next-generation flash memory designed for the latest automotive specifications to support their anticipated growth and programmable content. While we are still navigating a fluid situation with fluctuations in our short-term sales funnel, we firmly believe the industry will need to reinvest. Regardless of whether we are among the last ones standing, Data I/O will be well-positioned to capture market share with our robust programming advancements. For our other key target markets in the Internet of Things, the rapid shift to remote work during COVID-19 highlights the critical need for security across the entire connected electronics ecosystem. Reports indicate that hacking incidents have surged, not only among remote workers but also concerning IoT devices. Our SentriX platform, a versatile and cost-effective security provisioning and data programming deployment system for authentication devices, secure elements, and secure microcontrollers, has seen steady interest despite current economic challenges. The low capital investment required for the SentriX model is increasingly appealing to companies needing budget-friendly solutions. Our marketing strategy is also adapting in response to COVID-19; while some key conferences have been canceled, we will explore alternative avenues to expand our market presence and enhance our digital marketing efforts. Our ongoing strategy for SentriX is to broaden its reach and simplify and scale the platform throughout 2020. Our solid cash position, reinforced by quick actions and a long-term market perspective, provides us with the financial flexibility to pursue growth as conditions improve. During these uncertain times, we aim to stay agile, refine our processes, adhere to our product roadmaps, maintain our strong financial health, and grow relative to our competitors. Now, I will turn it over to Joel Hatlen, our Chief Operating Officer and Chief Financial Officer, for more details on the quarter.

Thank you, Anthony. Good day to everyone. Net sales in the first quarter of 2020 were $4.8 million as compared with $6.1 million in the prior year's period and $5.9 million in the fourth quarter of 2019. First quarter 2020 bookings were $4.3 million as compared with $6.2 million in the first quarter of 2019 and $6.9 million in the fourth quarter of 2019. On a geographic basis, international sales represented approximately 94.3% of total net sales for the first quarter of 2020 compared with 94.1% in the 2019 period. Total capital equipment sales were 54% of revenues and adapters and service revenues were 28% and 18% respectively of revenues in the first quarter of 2020 compared with 61%, 24%, and 15% respectively of revenues for the first quarter of 2019. Gross margin as a percentage of sales in the first quarter of 2020 was 58.2% as compared to 60.8% in the first quarter of 2019. For the first quarter of 2020, gross margin was primarily impacted by fixed costs being spread over lower revenues and a 2.7% reduction that relates to tariffs on U.S. and China trade. The revenue mix shift to increased percentages of adapters and recurring revenue sales as a percentage of total revenues benefited gross margins as these generally have higher margins as compared to equipment sales. Operating expenses were down, both compared to the prior year and the prior quarter periods. The year-over-year change is primarily related to variable expenses including substantially lower incentive compensation, accruals and sales commissions, as well as stock-based compensation. Cost control measures also significantly contributed to the reduction. With most other expense categories lower than in prior periods. Although R&D spending of $1.6 million was down compared with the prior year period, it came in consistent with the fourth quarter spending as we continue to invest in leading the industry and providing improved solutions for our customers. In accordance with GAAP, net loss in the first quarter 2020 was a loss of $554,000 or $0.07 per share compared with net income of $26,000 or zero per diluted share in the first quarter of 2019. Backlog at March 31, 2020 was $2.3 million as compared with $2.9 million at the end of the year and up from $2 million at March 31 of 2019. Data I/O had $1.5 million in deferred revenue at the end of the first quarter consistent with the end of the fourth quarter of 2019. Data I/O's financial condition remains strong with cash of $13.8 million at March 31, 2020 approximately $100,000 less than at the beginning of the year. Our days sales outstanding or DSO, a receivables collection measure at March 31 were below our target range of 68 with the receivables reduced by $1 million from good collection efforts from the end of the fourth quarter. Payables were reduced to $3.6 million at the end of the quarter compared to $4.1 million at the end of the prior year. Net working capital at the end of the first quarter was $18.4 million down slightly from $18.5 million at 12/31 of 2019. This benefited from the Cares Act acceleration of our alternative minimum tax refund from tax reform back in 2017. Finally, we had shares outstanding of 8,221,000 at March 31, 2020 as compared with 8,288,000 at March 31 2019 with the difference primarily related to the share buyback that we completed during the third quarter of 2019. That concludes my remarks. I'll turn the call back to the operator to begin the question-and-answer segment. Operator, will you please start the Q&A process?

We will now begin the question and answer session. Our first question will come from Jaeson Schmidt with Lake Street. Please go ahead.

Hey, guys. Thanks for taking my questions. Just curious if you could comment on what you're seeing from an order pattern standpoint in the month of April compared to the end of March?

So, Jaeson, that's a good question. I won't get too quantitative. I'll just say this. We're not seeing the end of the world out there. People are still buying things. CapEx was down in Q1. When we put our internal numbers and forecast together for Q2, we assume CapEx would be impacted as well. But it's not the end of the world. We've definitely seen an impact, but it's not like we've fallen off a cliff or anything.

Okay. That's helpful. And then as a follow-up, I know in the script you mentioned an order for an electronics manufacturer in the ventilator market. Just curious if this is more of a one-off win, or if you've seen sort of sustained inbound interest from the health care medical market as a whole?

Well, we haven't talked too much about in the past. We actually have a pretty good medical business. We haven't broken it out. It's been considered part of our industrial business up till now which is run between, I don't know, Joel, 20% and 25% of our overall business for several years in that range.

Yes. It fluctuates 15% to 25%.

Yeah. And then probably some more in the programming centers as well. But we called that the specific win because number one, we put together a program for medical customers to make sure that they could quickly repurpose equipment to support new medical needs. That's actually one of the big advantages of the Data I/O technology is with our pre-programming, you can convert from a part that might be supporting a ventilation system in a car, and in 30 minutes you can be reprogramming now to support a ventilator for a hospital. We can convert the line that quickly. And so a customer came to us, they had a problem. They'd actually prototyped on an alternative programming solution and found that the performance was terrible. They came to us with LumenX and we were able to get them about an 8X performance gain. And they moved very rapidly to place an order with us and get that to support their ramp. And the end customer we don't have the permission to use their name. But if you Google big government orders of ventilators, you can figure out one of the two companies.

Okay. Thanks a lot, guys.

Our next question will come from Keith James with LJ Capital. Please go ahead.

Hi. Can you discuss the margin profile by revenue type for capital equipment sales, adapters, maintenance and software upgrades, and per-click fees for SentriX programming, please? Thanks.

Yes. I won't go into too much detail. But in general, the software obviously carries higher margins. Services tend to carry pretty good margins as well. The capital equipment, it really depends on not only the type of system ordered but the channel. And I'll give you an example. So if we sell through a direct sales channel, we'll tend to have a higher gross margin and also a higher sales expense because we'll pay commissions. If we sell through a distributor, we'll have a lower gross margin on that equipment because we provide the equipment at a discount to the distributor. At the same time, our sales commissions will be much lower because the commission has been taken in the form of a product discount. So it's fairly variable. But within those broad parameters, that's the pattern of our business.

Okay. Thank you. I had one other question as well. You've mentioned the transition from eMMC to UFS. Can you talk more about what this means in the automotive electronics sector with near and longer-term perspectives? And where your technology stands relative to what else is available in the market from your competitors? Thank you.

Sure. So as you know, the semiconductor industry from time-to-time adopts certain standards for widely used components such as flash memory. eMMC was that broadly deployed standard in the PC industry, the mobile phone industry, automotive electronics for the better part of a decade. Starting in mobile phones probably three or four years ago, there was a transition to a new form of memory interface called UFS. Without drilling down too far, it provides a much higher read capability, a much better non-sequential read capability meaning if you switch around from application to application, you get the data faster. And it also is able to operate at lower power. That was very attractive for the mobile phone industry and they adopted it first. And as the industry in general moves towards UFS, the cost patterns and reliability characteristics were consistent with what was required for the automotive industry. And they've been moving a lot of the high-density flash memory applications, such as infotainment in dash computing displays, things like that to UFS. That's actually very good for Data I/O because we're one of the handful of suppliers that can actually program UFS in the market. eMMC pretty much anybody could do it. We did it better, of course, because it's much faster. But right now we're one of two or three suppliers that have announced the capability to support UFS. And when we're able to sit down with customers, we can explain why our approach has some very important technical benefits that maybe some others don't. So the move to UFS, we view generally as very favorable to Data I/O because we have a unique technology position. And also, we're offering upgrades to existing deployed equipment in automotive that make the transition to UFS very cost-effective for the customer.

Thank you very much.

Our next question will come from George Melas with MKH Management. Please go ahead.

Good afternoon, Anthony and Joel.

Hi, George.

Hi. Anthony, you mentioned in the press release and also in your remarks that you had won three new automotive wins in Asia, America and Europe. That seems pretty impressive. Can you talk a little bit about that? I don't know how much detail you can provide but how big those are? And I imagine these are competitive wins.

Exactly, George. And I called it out specifically for that. What was otherwise a pretty dismal quarter for capital purchases. People just were not adding capacity. There's still nonetheless, new applications. We talked about infotainment. We've talked about advanced driver assist. One of them was also in the area of electrification, which is a nice win for us. We hope it's the start of something very nice long-term. We'll see how it plays out. But we've instructed our sales team to continually go after not only the customers they know, but to pursue the new applications. And the good news is in automotive, there are a lot of new applications and we have a very good reputation in that industry.

Okay. Can you explain a little bit what electrification means? What kind of application is that?

So battery-powered cars.

Oh, okay. And is that some of your first win in that space or not?

No. It's not the first, George. But you would recognize the customer's name.

That's great news. Well done. It's impressive to acquire new customers in this environment. Can you explain what the services and maintenance sales are and how they are performing?

Well that includes things that are not capital equipment purchases and not adapter sales. So for example, we offer software contracts. We have customers pay us NRE to do development of algorithms. And other things like that. We have maintenance agreements and things like that. And of course SentriX falls in there as well.

Okay?

Okay. It tends to be a bit more stable because we typically receive an order for an annual contract. If the contract is for $12,000, we take a purchase order for $12,000 and then amortize it at $1,000 a month.

Yeah, yeah.

So it tends to be fairly stable.

Okay. Great, great and then just on SentriX, can you sort of point if there is any sort of meaningful progress in the quarter or some relationships that are deepening? And how do you expect SentriX to play out in 2020?

Well, the interesting thing about SentriX is that if you look at our inbound activity, it's difficult to see any impact from COVID-19 at all. We unfortunately lost a couple of our marketing venues that we were planning on in the first quarter, as well as in the second and third quarters. A trade show is unlikely to be effective for marketing purposes, potentially for the rest of the year, definitely through September. Therefore, we are exploring other promotional strategies. We have made good progress working with semiconductor suppliers, advancing the underlying technology, supporting new devices, and developing new opportunities with end customers and channel partners.

Okay, great. Okay, superb. Thank you very much.

Thank you, George.

Our next question will come from Mark Spiegel with Stanphyl Capital. Please go ahead.

Hi, Anthony, good to speak with you again.

Hey, how are you?

It's been a few days. As you may recall, we're focused on value and sold our stock while it was rising. We're in a good position now, so thank you. My question is general. How much of your business relies on the volume of the end product? For example, if they used your machine to produce the new Mercedes S Class and automotive sales are poor this year, resulting in sales of around 80,000 instead of 100,000, does that impact your business? Or do you simply sell them the tool and the number of units sold doesn't really matter?

We're somewhat insulated from volume changes, but there are still effects to consider. If automotive sales decline, it will definitely influence the purchasing behavior of those buying for production capacity. We recently secured three new contracts, particularly involving new technology. For instance, during a significant model redesign with additional features, manufacturers must establish the capability to produce the vehicle, regardless of whether their sales predictions from six months ago hold true. What we're observing is that customers who initially anticipated a certain volume are now scaling back their forecasts. They will continue to purchase, but possibly at a lower quantity, such as opting for two machines instead of three. So while we’re not completely shielded, it's mainly about volume. Additionally, the quantity of programming required plays a role; if the feature set increases the software code significantly, the demand for programming doubles. Lastly, the type of programming is crucial, as security features typically demand higher costs compared to standard programming, which will also affect our operations. However, it's not entirely predictable, as various factors come into play.

How many machines do you typically sell for a given model? I mean, can one machine handle 100,000 cars or just 50 or 30? I don’t have a clear understanding of that.

Yeah. It really depends on the application. For example, if you're talking infotainment, you might need a couple of machines to support infotainment. And remember we're working with the electronics manufacturer is not the nameplate. So we might see a general class of applications that go into many models from one end customer or many models from different end customers. So it's hard to draw a one-to-one correlation that I think you're looking for. I just can't give that to you.

Is it typical for customers to order multiple machines for the same application? For instance, they might need five, but they only purchase four. Is it often the case that it's not just one machine per application?

I think the typical order is probably one or two per application. However, over time, the factories accumulate multiple versions of our equipment because they are handling various model years and applications.

They couldn't avoid that. So if there's a new model year, are they forced to buy a new machine? I guess it goes back to my original question. I'm wondering, and I know you said it's not one-for-one, but let's say the auto market is down by 25% this year. What would that typically mean for your automotive business? Is it down 5% or 10%, or is it flat because there's more programming happening? I'm just trying to understand that.

That kind of number wouldn't be good. It would probably have a disproportionate impact on the capital equipment sector. We would still sell adapters and services, but it’s not a straightforward correlation. I’m not sure I can provide you with much more detail authoritatively at this moment.

Okay. Last question I know I said the other one was. You said things are not falling off a cliff, but they're being affected. The quarter you just reported is, sort of, off a cliff, a small cliff, anyway relative to the year ago quarter. Do you see this, let's call it, low level of activity continuing? Or is it worse than this?

Well, I think from an automotive perspective, I think the electronics industry bottomed out. Probably April was the bottom, just in terms of their overall impact. They're telling us they're going to be reopening. We've been getting supplier letters, giving us some guidance on what their ramps are, so the auto factories appear to be reopening in Europe and the United States. I understand middle of next month. So that's a good sign. And generally they closed probably the third week of March. So that would be a two-month hiatus. So we're going to have to work through that. And they're not going to come back to 100% right away. So the range of forecasts that we're looking at is extremely wide. And that's why we've taken steps to be ready, save our cash. But at the same time if it turns around quickly, we want to be ready.

Well, okay. So again I'll try to pin you down a little and you can try to unpin yourself.

Our next question will come from Mike Donovan, Private Investor. Please go ahead.

Thank you. Good afternoon, Anthony and Joel. I hope you and your families are doing well. I’m a longtime shareholder. My question is about SentriX. It seems that over time, especially initially, the view of SentriX focused on a machine-centric approach, with some reconfiguring and the establishment of relationships with semiconductor companies regarding provisioning. Additionally, there appears to be a significant shift in the business model related to pricing per unit compared to capital expenditures. I've come across the term "security deployment as a service" in some recent documents. I also noticed your hiring efforts for specific skill sets. Based on this, it seems you’ve gained insights into market security needs, and your strategy and execution are evolving. Is that an accurate observation? If so, could you share what you are seeing in terms of customer needs beyond just the equipment?

You raised some important points. As we refine our market positioning, we have a strong head of marketing and business development, Michael Tidwell, who brings a software-oriented perspective. He has been able to adjust our product positioning accordingly. To get back to basics, last quarter we discussed the need to simplify and scale. The understanding that people need security is becoming more recognized, albeit slowly, but awareness is growing. The significant challenge lies in how customers want to implement security, what is affordable for them, and the customer profiles we can best support. We have found that customers prefer a simplified end-to-end security process. We don't manage the entire process, as we collaborate with several partners with the aim of simplifying it. I could detail the numerous parameters you could adjust on a fully configured secure element, which would take a month to determine, or you could simply instruct to onboard a device to the cloud upon activation or authenticate it at startup while ensuring secure software updates. We aim to clarify for customers that if they prefer such an approach, they should choose a specific pre-configured option or a relevant use case that makes sense. We have started the process of educating customers and hopefully communicating more effectively than in the past. This is what you're seeing with SentriX.

And SentriX falls underneath this 18% of revenues when you look at a portfolio split between CapEx and adapters and software.

That's correct.

Thank you.

Our next question will come from Avi Fisher with Long Cast Advisers. Please go ahead.

Hi. Thank you for taking the question. I'm sorry to mention this how many SentriX units are deployed?

We still have five deployed, Avi.

Okay, five. And are you offering any one-time discounts or financing options?

No. It's an interesting point. We're really trying to be frugal with our cash right now. If I thought we're going to go jump in and out of a V-shaped or section or something I might get more aggressive on something like that. We're going to choose to keep our powder dry at least for a little while.

Awesome. And one last question. This is our third straight quarter of growing consumables revenue. And I'm just trying to understand what takeaway to read from that. It seems like, I know SentriX is in that line item, but I'm not sure that's material yet. I know it reflects capacity utilization by some of your customers. Is there anything you can offer to help understand this sort of positive trend?

Yes. It's a positive trend. But I would caution you not to draw too much or infer too much. We're in crazy times right now. And as I've indicated before, the numbers in any one quarter can bounce around. It's clearly a trend we want. We want the recurring revenue to go up. That's part of the business strategy behind SentriX. And obviously, SentriX is contributing to that. But what I'm saying is don't read too much too fast.

Is it growing because of SentriX? Or is it probably just because your customers are using programming a little bit more and using more of your product?

I think it's growing because as a percentage remember the CapEx has gone down as well.

The other thing that clouds that a little bit was we had a very rough Q3 in terms of our business levels. And you saw that that's been recovering since then.

Correct. So that's a growing use, does that mean your customers have worked off the excess inventory they had?

I think what I'm saying, Avi, is don't draw too many conclusions over the last three quarters.

At this time, I'm showing no more questions in the question queue. This will conclude our question-and-answer session. I would like to hand the conference back over to Anthony Ambrose for any closing remarks.

Thank you very much, Grant. As there are no further questions, I'd like to close the call by thanking everyone for their participation today. I'd also like to remind everyone to vote electronically in the upcoming shareholder meeting May 18, Joel?

May 18.

May 18. And I hope everyone remains safe and productive. Thank you very much.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.