Data I/O Corp Q3 FY2020 Earnings Call

Good afternoon and welcome to the Data I/O Corporation Third Quarter 2020 Financial Results Conference Call. All participants will be in listen-only mode. Please note, this event is being recorded. I would now like to turn the conference over to Mr. Jordan Darrow. Please go ahead.

Thank you, and welcome to the Data I/O Corporation’s third quarter 2020 financial results conference call. With me today are Anthony Ambrose, President and Chief Executive Officer of Data I/O, and Joel Hatlen, Chief Operating Officer and Chief Financial Officer of Data I/O. Before we begin, I would 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 the continued reopening and recovery efforts within the supply chain and among our customer base, levels of orders, ability to record 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 Forms 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. And now, I would like to turn the call over to Anthony Ambrose, President and CEO of Data I/O.

Thank you very much, Jordan. I’ll begin my formal remarks in a moment including our 2020 Q3 performance recent developments, and then I’ll turn it over to Joel. But once again, I’d like to express our appreciation for the health of our staff, our customers, our partners, and their families, and am grateful for the sacrifices made by healthcare professionals and first responders around the world. The global team here at Data I/O has been truly remarkable, and I personally must commend each and every one of them for a job well done. Before we go into quarterly details, I’d first like to welcome our newest Board Member, Sally Washlow. Sally joined the Board of Directors effective October 28 of this year. As a consultant and former CEO for Cedar Electronics, she brings experience to the Board as an operating leader in the security and automotive electronics markets. From 2015 to 2017, she was the Chief Executive Officer of Cedar Electronics Corporation, the supplier of radar detectors, GPS systems, dash cameras, and other electronic products, and led the integration of the Cobra and Escort electronics businesses. She currently serves on the board of directors of Costar Technologies, which is an OTC market company. She’ll serve on the Nominating and Governance Committee as well as the Compensation Committee here at Data I/O. Sally replaces J.D. Delafield who resigned. We’d like to thank J.D. for his service on the Board and wish him well in his future endeavors. Now on to third quarter results. We reported very strong growth, sequentially from the second quarter in revenues and bookings, and year-over-year sales increased 56% from last year and 26%, sequentially from Q2. Our turnaround in financial performance in the third quarter is bolstered by what appears to be a bottoming out of our primary addressable market in automotive electronics in the second quarter. We’re seeing the earliest and most significant resumption in China and parts of Asia in that business. EMEA, Americas, and other regions within Asia still have impediments to a full recovery, including COVID-19 as well as a cyclical downturn. We’re keeping a close eye on the so-called second wave in EMEA and other countries, and we’re looking forward to see how Q4 unfolds in those regions. Data I/O’s award-winning support, installed base in automotive, and performance for value were key factors in our ability to capture some key customer wins in the third quarter. Among them was a significant multisystem order for UFS and other programming requirements at a large multinational Tier 1 electronics supplier. We also had good order flow throughout the quarter above our internal forecasts. At the end of the third quarter, we deployed our 320th PSV family system. Automotive electronics customers represented about 60% of third quarter bookings, up from 50% in the second quarter. It seems that our commitment to leading the industry with consistently investing in technical innovations, particularly during cyclical downturns, is delivering the intended results for these recent wins and early strength in the recovering automotive electronics sector. On the R&D front, most notable was our continuing advancements made for our SentriX platform. You may have heard me talk about simplifying scale for SentriX as our 2020 strategy. Yesterday, as highlighted in a press release, it showcased what we did in Q3 when we released our next-generation SentriX system and tools. The next-generation SentriX system simplifies end-to-end the provisioning and deployment of robust IoT and automotive security solutions and enables an outsourced as a service business model for our customers. The SentriX product creator is a powerful software suite that enables OEMs to securely, quickly, and easily define the security deployment for their products and to securely deliver their product definitions, secrets, and other certificates and keys to SentriX-enabled production facilities remotely. The new SentriX product creator tool supports two deployment models in cooperation with our leading embedded silicon partners; SentriX GO and SentriX Custom. SentriX GO streamlines IoT security deployment and provisioning using preconfigured use cases and a simplified developer experience. SentriX GO supports the most common use cases for creating and managing device identities, secure boot, cloud onboarding, device authentication, and other use cases. SentriX Custom fully supports custom provisioning definitions. Both models enable product security definition collaboration between OEM, silicon suppliers, and programming partners to easily define, provision, and deploy robust IoT device security solutions. At September 30, our cash position remains strong at about USD 13 million, down about $300,000 from the end of the second quarter, largely due in part to a one-time tax expense of $0.25 million paid to China in order to repatriate over $2 million in cash from that country to the U.S. The cash repatriation will provide additional flexibility and should reduce quarterly currency fluctuations. Joel Hatlen will go into more detail about that in his remarks. And with that, I’ll turn it over to Joel. Go ahead, Joel.

Thank you, Anthony, and good day to everyone. Net sales in the third quarter of 2020 were $5.9 million as compared with $3.8 million in the prior year period and $4.7 million in the second quarter of 2020. Third quarter bookings were $5.6 million as compared with $4.3 million in the third quarter of 2019 and $5 million in the second quarter of 2020. With first quarter 2020 bookings of $4.3 million, we have seen sequential growth during the first three quarters of the year. On a geographic basis, international sales represented approximately 92.5% of total net sales for the third quarter of 2020 compared with 89.8% in the 2019 period. Total capital equipment sales were 65% of revenues, adapters 21%; and software services, 14% of revenues for the third quarter of 2020 compared with 41%, 35%, and 24%, respectively, for the third quarter of 2019. The 2020 third quarter bookings composition included 60% from the automotive sector, 24% from the IoT and industrial controls, and other sectors and 16% from programming centers. Gross margin, as a percentage of sales in the third quarter of 2020 was 55% as compared with 52.6% in the third quarter of 2019 and 52.4% in the second quarter of 2020. For the third quarter of 2020, gross margin was primarily impacted by fixed costs being spread over a higher revenue amount compared with prior periods and a favorable channel and revenue mix as compared to the second quarter of 2020. Operating expenses were $335,000 higher than in the prior year period. R&D was $60,000 higher than the third quarter of 2019 and relates to continued advancements in our technology solutions, as Anthony discussed in his remarks. SG&A of $1.8 million was $275,000 higher than Q3 of 2019, with the primary increases relating to higher stock-based compensation, contractor costs, and business-level variable expenses, such as higher sales commissions related to channel mix and volume. Partially offsetting these were certain reductions in work hours, pay cuts, and various government assistance programs taken in response to COVID-19, which impacted a portion of our Q3 2020 results as this flowed into the period from actions taken during the second quarter. Also due to COVID-19 limitations, we continue to reduce travel, trade show, and other promotional activities. In accordance with Generally Accepted Accounting Principles, GAAP, net income in the third quarter of 2020 was a loss of $707,000 or $0.09 per share compared with a net loss of $844,000 or $0.10 per share in the third quarter of 2019. Foreign currency transaction loss was $271,000 in the third quarter of 2020 as compared with a gain of $226,000 in the prior year period. Due to the repatriation of cash from China to the United States, we were required to pay a dividend withholding tax in China of $240,000, bringing the company’s consolidated income tax for the period to $340,000 as compared with $55,000 in the third quarter of 2019. Backlog at September 30, 2020, was $2.8 million unchanged from June 30, 2020, and up from $2.3 million at March 31 and $1.7 million at September 30, 2019. Data I/O had $1.2 million in deferred revenue at the end of the third quarter of 2020, which was down from $1.4 million at June 30, 2020. Our days sales outstanding, or DSO, a receivables collection measure, at September 30 was below our target measure at 58 days as receivables increased $1.4 million from the end of the second quarter as revenues increased sequentially by $1.2 million from the second quarter. Net working capital at the end of the third quarter was $18.3 million as compared with $18 million at June 30, 2020, and $18.5 million at December 31, 2019. Data I/O’s financial condition remains strong with cash of $13 million at September 30, 2020; our cash position is down from $13.3 million at June 30 and $13.9 million at the beginning of the year. From a financial perspective, we entered into the crisis in a position of strength and remain healthy. We believe that we continue to benefit from Data I/O being the largest company in our industry sector and with a highly resilient business model supported by the strongest financial position, including a large cash balance and no debt. As previously disclosed, early in the second quarter, we implemented cash conservation and expense management initiatives. Most of these actions continued during the third quarter with a minimal amount of costs increasing as business and travel began to resume. We have not and still do not expect to accept funding from the SBA PPP plan in the United States or in any subsequent stimulus bills. At the beginning of the fourth quarter, we issued shares to directors to pay two quarters of deferred compensation and restored the Executive and Board-level compensation, which had been cut 20% since the start of the second quarter as part of our cash conservation and expense management. Finally, we had shares outstanding of 8,395,600 at September 30, 2020. That concludes my remarks, and I’ll turn the call back to the operator to begin the Q&A segment.

Our first question comes from Jaeson with Lake Street.

Hi, guys, thanks for taking my questions. I know there are a lot of moving parts with the macro. But just curious if you could comment on how you’re feeling about your overall visibility? And I guess more specifically, how does visibility compare today, compared to how it was three months ago?

Yes, it’s like saying, if you’re stuck at the bottom of a pool in the dark and you come up and you have a flashlight, you’re better off. So yes, we’re better off clearly than we were three months ago. What appears to be happening, Jaeson, is in Asia, I think we have a little bit better visibility. Business has been pretty good there, reasonably predictable. I won’t say things are back to normal, but they’re reasonably close. I think I was feeling better about Europe until a couple of weeks ago. Now they're having a huge spike in cases. Hopefully, that abates pretty quickly. We’ll just have to see. I think the common thread throughout everything is the automotive electronics industry, which had shut down for a decent portion of Q2, came back in Q3 and is getting closer to full production in Q4. That’s pretty clear. And I think you’ve heard that from maybe some of the other companies that reported today in the automotive electronics segment. So that’s our primary factor on visibility. And then on the SentriX side, obviously, with the new tools announcement, we’re also starting to see some more interesting deal flow in terms of the quantity of potential deals.

Okay. That’s helpful. Can you provide some information regarding the multisystem order win? Is this an existing customer? And how should we consider the delivery timeline?

Yes. It’s an existing customer, and they had to scale out. We’ve had a good relationship with them for a while. It was a good win for us. We had to compete effectively in order to win it, and we did. Think about it hitting in Q4, predominantly; some of them might be in Q1, but that’s pretty typical on these types of orders.

Okay. And the last one from me, and I’ll jump back into queue. I think you mentioned about 16% of bookings were related to programming centers. Can you just provide an update on sort of how you’re thinking about that market coming back online?

I think they generally have adequate capacity. We do a decent business with programming centers. Whether they need capacity or not depends on the consumables and service and support. Some may buy equipment, while others may be fine for a while. I don't see that mix changing significantly in either direction over an extended period. There can always be fluctuations in a quarter that might affect things, but it seems like this will remain steady for a while.

Okay. Thanks a lot guys.

Our next question comes from Jeff Peterson with Olsen Capital.

Thanks Anthony and Joel for taking my questions. I like to ask about how should we think about SentriX. First, you talk about simplifying scale. Can you define what that means relative to the system available for the past year?

Yes, sure. We’ve been talking about that as our strategy for pretty much the balance of 2020. And I would encourage you to read the announcement that we made yesterday. I think that has a lot of the details in it. But what we realized from our early work in SentriX in our Gen One platform is that the product was great. It was highly secured. Customers could make it work. But we found that the customers that were drawn to the product really wanted to have a simpler user experience, a better user experience, one that was a lot easier for them to implement a model where they had to work with perhaps a certificate authority or do things, simple things like get on board to a cloud. And what we decided to do was make the whole tools experience much simpler, not only for the customer, the end customer, but our programming center partners and potentially partners in certificate authorities and other places so that things that you would need to have, to have a successful job created could be easily managed in one place that had a common look and feel and was much easier to use. And that was the biggest thing we’ve done with our SentriX tools, on simplify. On scale, what we’ve done is, as you know, we have about 320 PSV systems around the world, and it’s always been our intent long-term to make those become opportunities to upgrade the SentriX at the right time. And with our second-generation architecture, that becomes a lot easier for us to do, both financially and logistically.

Okay. Thanks. Very helpful. Regarding your announcement earlier this week, did you develop this internally?

Yes. The – what we’ve done is all the tools are common tools flow that’s built around our existing data programming tool flow and our internally developed security tool flow. So that portion of the product has been internally developed. We’ve been working hard on that for a while. And while the world was paying attention to COVID, we had a lot of developers busy getting this thing done.

Great, helpful. Thank you. Last question is, can you talk about your security and how it has evolved with the partnerships you’ve entered into? And are there any key wins you can discuss that demonstrate the key players who are adopting your technology?

Yes. So I think the key thing is; I’d refer you to the announcement we made last quarter, where Cypress, now an Infineon company, announced their support for a direct to Amazon Cloud version of their PSoC 64 microcontroller, and that’s obviously supported on SentriX. And what we’re seeing, again, if you look at the big changes in some of our partners, what they’re trying to do is also pick up on the simplified mantra. If you look at the NXP website, for example, you can see how they’ve broken up their secure elements into a model, where the customer can get predefined use cases done, they can go full custom, they can also go direct to a cloud onboarding. And I think you’re going to see announcements, further announcements, in this regard from the leading secure element and secure microcontroller companies. Again, we’re trying to make it all much easier for the customer to just do what they want quickly, easily, and with minimum designing time.

Thanks and that’s helpful. That’s all the questions.

Thank you.

Operator, would you please take the next caller?

Our next question comes from Mr. George from MKH Management.

Thank you, operator. Hi, Anthony and Joel, how are you?

Hey, George.

Hey, George. How are you doing?

Good, thank you. Quick follow-up on the Tier 1 auto, the multisystem deal. This was an existing customer but did they previously only use your tools? Or did they use competitors’ tools? And is this kind of a win from a unit perspective for you guys?

Well, George, they have been a previous customer; we think, on pre-programming, been largely working with Data I/O. I can’t say it’s 100%. But it was a clear situation where they had a decision to make, and they decided that as they added capacity here, it was best to work with Data I/O going forward. And we’re very grateful to have been selected. This is one of those cases where we talk about it. I hope we’re not getting boring on the subject. But even when times are tough, people need to buy equipment to support new technology, and they’re willing to do that. And if you don’t have the new technology, then you’re not considered. If you do have the new technology, then you’re in the running and then you get to talk about all the other great things you can do for them. So that was the case here. And as I said, we’re very happy to have that in Q3.

Great. And the competitor, the people you were competing with, were they domestic providers? Or was it an international provider?

I think they were more of an upset provider than any of the other two, George.

Okay, great. I have a quick question about SentriX. It seems like the overall market has been slow to embrace this type of technology. Is it because the IoT market isn't sufficiently secure at the moment, or have companies chosen alternative methods to protect their devices and the data they handle?

I think George, when looking at it, we were hoping that SentriX would have ramped up more quickly than it has. We’ve assessed the situation and realized that part of the issue was on our end. We needed to enhance the usability of our tools, which we have now done and announced. Additionally, some of our semiconductor partners have delayed their own products. Furthermore, the market seemed uncertain about implementing security measures, not fully understanding the best approach or recognizing the necessity of it. There has been progress in all three areas, though we wish it were happening faster. We are doing our part and are beginning to see the semiconductor companies contributing as well, not just in terms of launching their products but also in making them more user-friendly and addressing previous concerns, such as enabling direct cloud onboarding. This will facilitate easier actions for customers regarding IoT security. It’s a mix of all three factors, and we hope this will yield better results moving forward.

Okay. Great. Thank you very much. Appreciate.

Thank you, George.

Our next question comes from Mr. Todd from Engage Management.

Hi. Thanks for taking the questions. You talked about the bottoming out in the second quarter of the automotive electronics sector. And I just wonder if you had a few more specifics on what you’ve seen in the industry and Data I/O specifically that may support kind of the ongoing rebound?

Yes, Todd. Thanks very much for the question. As we mentioned earlier, I think Joel had indicated, we’re about 50% of less business in Q2 was automotive, and 60% of more business in Q3 was automotive. So we clearly saw it in the bookings. We also saw it in terms of our customers’ factories actually being opened in Q3. A number of them had closed anywhere between two and six weeks in Q2 for either COVID-related reasons or demand-related reasons. And they largely came back; some of them were operating at less than full capacity, but they were largely back answering the phone, answering emails, things like that and buying consumables. So, those are the big indicators on our side. And then I think you’ve got some confirming indicators from some of the big players. I mentioned NXP, Aptiv, Wistron, were out today with their earnings, and all were positive on automotive electronics.

What might a recovery look like based on prior business cycles? Again, acknowledging we have the COVID with flashlight in the swimming pool, I like that. But do you have some thoughts? I mean, going forward on what that recovery might look like in the automotive?

Yes. As I mentioned earlier, we don’t provide forward guidance since it’s difficult for us to predict accurately. However, if we take a step back and consider insights from sources like Gartner Group and other industry analysts, it appears that semiconductor companies are optimistic about significant growth in automotive electronics over the next five to ten years. Factors such as advances in electrification, autonomous driving, infotainment, connectivity, and mobility support this belief. We see automotive electronics as a key area for growth. When we reflect on previous cycles driven by automotive, we note that strong growth allowed us to achieve substantial operating leverage, with nearly $0.40 of every new revenue dollar translating to operating income. Moving forward, with strategic tariff management, tax planning, and effectively utilizing our net operating losses, we anticipate performing well on the bottom line.

Thanks. One last thing, compared to the previous business cycle, it seems like autonomous driving is starting to emerge. Do you see that as a potential catalyst moving forward? Are there any other specific catalysts that might make this business cycle different from the last, in addition to the opportunities?

I think you are correct. Autonomous driving, as well as the entire advanced driver-assist system marketplace, the infotainment marketplace, and electrification—not just full EVs and hybrids, but also 48-volt systems in internal combustion engines—are all significant factors. That’s why I believe analysts are quite enthusiastic about the long-term prospects for semiconductor content in cars.

Great. Thank you very much.

Thank you very much.

This concludes our question-and-answer session. I would like to turn the conference over to the company for any remarks.

Thank you very much, operator. I’d like to thank everyone for joining the call and appreciate the good questions. At this point, our Q3 earnings call is now closed.

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