Data I/O Corp Q3 FY2021 Earnings Call

Good day, and welcome to the Data I/O Third Quarter twenty twenty one 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 Jim Fanucchi, Investor Relations. Please go ahead.

Thank you, and welcome to the Data I/O Corporation third quarter twenty twenty one financial results conference call. This is Jim Fanucchi filling in today for Jordan Darrow, who will be available starting tomorrow. With me today are Anthony Ambrose, President and Chief Executive Officer 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 continued reopening and recovery efforts within the supply chain and among our customer base, levels of orders for the company and the activity level of the automotive and semiconductor industry overall, 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. Now I would like to turn over the call to Anthony Ambrose, President and CEO of Data I/O.

Well, thank you very much, Jim. I'll begin my formal remarks by addressing our twenty twenty one third quarter financial and operational performance, talk a little bit about how we see the long-term future, and then I'll turn it over to Joel for more detailed discussion of the numbers. Company reported good results in twenty twenty one third quarter, driven primarily by the substantial backlog developed during the first half of the year and continuing strong adapter demand. Adapter bookings in the third quarter twenty twenty one continued their strength that we've seen all year. Our increasing installed base of PSV machines provides recurring and consumable revenues which supplement our capital equipment sales. Additionally, we've seen customers qualifying second sources for short semiconductor components, and this requires new design support, and new adapter support from Data I/O. Additionally, we have also seen increased software and services bookings year-to-date, which will translate into increased revenue as it is recognized. Recurring revenue is about forty percent of the total revenue year-to-date, and our long-term goal is for this to continue to increase. On the CapEx side, we had an excellent win rate on new systems where customers actually ordered systems. We did see some customers push some orders out of the third quarter until they had better visibility on their silicon supply chain to justify new capital investment. Earlier today, you may have heard that GM and Ford indicated the worst of the automotive-induced semiconductor shortage was behind them, with full recovery expected sometime in mid-twenty two. Our resilient supply chain delivered extremely well in Q3. Our factories in Redmond and Shanghai were able to ship despite the global supply shortages of semiconductors, shipping issues, and ongoing concerns with COVID-19 in many customer locations. Our strategy to extend our purchase commitments to create inventory for the PSV family late last year has paid dividends for us and our customers. As a result, we're able to maintain our lead times on the PSV family and are ready to respond quickly to the next uptick in orders. So regarding COVID-19 and its associated impacts, all are still safe and our facilities are fully operational. We are over ninety-eight percent fully vaccinated here in Redmond without any company mandate. Global operations are over ninety percent vaccinated and are working without interruption. Our strategy for maintaining our workforce without layoffs during the depths of COVID is continuing to pay off, and our ability to rapidly support operations as well as our continued progress in R&D. Data I/O has formally converted to a hybrid model for the workforce here in the USA, where people work some of the time in the office and some of the time at home unless, of course, they're on the operation floor, where they're here one hundred percent of the time. We are returning to more normalized activities, including participation in trade shows and more business travel. We recently participated in the Nepcon trade show in China and next month will be participating at the Productronica trade show in Germany. Since October, when we reviewed our long-term planning, I’d like to share some of our thoughts and the data we use to plan our business and how we see the future unfolding. As we've been talking about for a long time, at least five years, automotive electronics is our primary market, and we are very bullish about the short, medium, and long-term future in automotive electronics. The automotive semiconductor total available market is expected to grow from thirty-three billion dollars in twenty twenty to fifty-nine billion dollars in twenty twenty-five, representing about a twelve percent compounded annual growth rate over that period, according to IHS Markit, an industry analyst firm. This is right in the middle of the range we have used, which is a ten percent to fifteen percent compounded annual growth rate. Recent Deutsche Bank research is very revealing and validates what we've been talking about and seeing, and also our own forecasts. In almost every quarter going back to twenty seventeen, growth in automotive semiconductor revenues has outperformed global growth in automotive production in terms of units by about ten percentage points. So our main thesis for Data I/O is that the automotive semiconductor market, which requires programming, is growing faster than the unit market; ultimately, that's the source of our optimism in the market. Today, about three hundred dollars to four hundred dollars of semiconductor content goes into a typical mid-range vehicle, according to Deutsche Bank, with the bulk of that in microcontroller and analog parts. IC Insights, another analyst group, reported that microcontroller sales in automotive this year surged twenty-three percent despite the supply chain shortages. Again, we've all been talking about and hearing about shortages in the supply chain. We need to remember that it’s a shortage due to the vastly increased demand, not necessarily short of where they were a year ago. So, what's behind the growth in the automotive silicon demand? The catalyst for growth really revolves around several areas that we've talked about several times: number one, our electric vehicles and alternative energy vehicles; number two, autonomous driving; number three, inclusion of connected and secure vehicles with infotainment options; and number four, advanced safety features. If we delve into each of these, the major bets on EVs and alternative energy are well known to anyone and this is all public information. Toyota plans to spend about thirteen point five billion dollars on EV battery technology. Hyundai plans to launch hydrogen versions of all their vehicles by twenty twenty-eight. On October sixteenth, GM announced plans to double their annual revenues by the end of the decade as it relates to all-electric vision. GM has already announced plans to invest thirty-five billion dollars through twenty twenty-five in all electric and autonomous vehicles and launch more than thirty EVs. As global light sales recover from bouncing around the sub-ninety million units, the penetration of electric vehicles is expected to move from about four percent in twenty twenty to thirty percent by twenty thirty, implying a global fleet of about one hundred and thirty million electric vehicles. Again, this is interesting to us because Deutsche Bank points out that an electric vehicle has a substantially larger silicon content than an internal combustion engine automobile. Therefore, we factor this in; this is why we expect to see automotive silicon content continue to grow ten percent to fifteen percent year over year for a very long time. Moving away just from EVs, there is also silicon growth in advanced driver systems or ADAS, also known as active safety. These are the systems that are necessary to enable autonomous driving. This includes a lot of sensors and a very large amount of flash memory, which we program. We also see file sizes and the number of bits or code in each device growing larger and more complicated regardless of the vehicle type. This is especially true for the infotainment market where hundreds of gigabytes of NAND flash memory are used in each car. Additionally, we are seeing interfaces changing, which represents a technology hurdle that Data I/O has already solved. The market has moved from eMMC to UFS, which we program, and that UFS performance gives customers an even better reason to add more and more content to the car. So, with these new releases of UFS, it gives us good demand not only for capital equipment, but also upgrades to the installed base and new adapter and device support revenue. In addition to these trends going on in automotive, there are other basic trends happening in how programming is being done everywhere. Number one, there is increased connectivity of programming systems to factory MES control systems. In other words, the programming system ten years ago was a separate activity. Fifteen to twenty years ago, it was all manual. We've talked several times over the years about how manual processes have been moving towards automated programming. However, it was still automated programming separate from the SMT line. Now, we are hearing increased demands from customers to link the programming system to their MES shop floor control for better job control, enhanced yield, better asset utilization, and also the ability to connect the data produced from programming into their analytics platforms to better manage their entire process. We're starting to see this happen in automotive and also in leading industrial accounts as well. Additionally, we have discussed security in the SentriX platform; we continue to see across the automotive and industrial space a growing demand to protect the supply chain and protect firmware intellectual property. We're continuing to see additional security requirements arise in the automotive and industrial markets. Our SentriX platform and the ability to upgrade existing PSV family systems in the field is core to our security strategy. These market conditions and our strategies lead us to the following long-term goals. We believe double-digit silicon growth in automotive will lead to double-digit Data I/O revenue growth over a full business cycle. We will continue to see cyclicality, especially acute until the semiconductor shortages are behind us. We believe our operating leverage and scale will drive adjusted EBITDA growth faster than revenue growth. We also see increased recurring revenue in absolute and percentage terms from adapters and services across the growing installed base. As I mentioned, industry market analysts see a decade of ten percent to fifteen percent long-term growth rate in silicon for automotive electronics, and Data I/O is extremely well positioned in this space with over sixty percent of our sales going to the automotive industry and hundreds of programming systems in the installed base. While we expect some short-term turbulence in demand as silicon remains constrained, we're investing for this long-term growth trend. With that, I'll turn it over to Joel Hatlen.

Thank you, Anthony. Good day to everyone. For the first nine months of the year, our financial performance has advanced with meaningful year-to-date growth in revenues, bookings, and backlog. We continue to effectively manage our operating expenses and maintain a strong balance sheet. Now let's look at the third quarter results. Net sales in the third quarter of twenty twenty-one were six point seven million dollars, up thirteen percent from five point nine million dollars in Q3 of last year. We believe the third quarter revenues were constrained by customers' supply chain silicon part shortages and related order deferments by those customers, as described in Anthony’s remarks. Nonetheless, we still came in with revenues that were equal to or higher than the level we achieved in the past eleven quarters. The increase from the prior period primarily reflects the use of our higher backlog at the start of the quarter, stemming from this year's higher demand for equipment, compared to the third quarter of twenty twenty’s reduced business activity in mid-COVID conditions. Revenue growth also benefited from higher adapter sales associated with increased usage and our growing installed base of machines throughout the world. On a geographic basis, international sales represented approximately eighty-six percent of net sales for the third quarter of twenty twenty-one, compared with ninety-three percent in the twenty twenty period. The third quarter of twenty twenty-one bookings were five million dollars, down from five point six million dollars in the third quarter of the prior year. We believe the second quarter benefited from an order pull-in, and we experienced order flow deferments, which impacted the current quarter. Adapter bookings for the third quarter of twenty twenty-one continued to be strong at one point seven million dollars. Backlog at September thirtieth of twenty twenty-one was three point three million dollars, down from five million dollars at June thirtieth and up from two point eight million dollars at September thirtieth of twenty twenty. Gross margin as a percentage of sales in the third quarter was sixty point seven percent, compared with fifty-five point one percent in the prior year period and fifty-seven percent in the second quarter of this year. The difference from the prior periods is primarily due to the impact of higher sales volumes relative to fixed factory costs and favorable factory variances. Regarding the gross margin percentage going forward, we have continued to model a mid to upper fifties range, although the margin profile may improve or vary, as we have seen this past quarter. Operating expenses were three point nine million dollars in the third quarter of twenty twenty-one, compared with three point four million dollars in the year earlier period and three point seven million dollars in the second quarter of this year. Within operating expenses, selling general and administrative expense in the third quarter of twenty twenty-one increased by approximately four hundred and six thousand from the prior year period, primarily due to higher sales volume commissions associated with the channel mix and the higher demand for programming equipment, as well as recording performance-based incentive compensation. R&D expense remains stable running at one point seven million dollars for both the third quarter and the second quarter of twenty twenty-one and one point six million dollars in the third quarter of twenty twenty. As we continue to invest in strengthening our products, operating expenses have been and are expected to be fairly consistent with the variances largely pegged to sales commissions due to volume and channel mix and variable incentive compensation. Taxes during the quarter consisted of foreign taxes, with no U.S. income tax. In accordance with GAAP, net income in the third quarter was twelve thousand dollars, or zero dollars per share. Moving on to the balance sheet, days sales outstanding or DSO, a receivable collection measured at September thirty, twenty twenty-one was below our target measure at fifty-one days. Net working capital at September thirty of twenty twenty-one was eighteen point five million dollars, up from eighteen point two million dollars at the end of the second quarter. Inventory of six million dollars at the September thirty, twenty twenty-one date was approximately four hundred thousand higher than at the end of June and reflects our continuing effort to derisk our supply chain and potential part shortages by higher stocking levels for our key products. Deferred revenue at the end of both the third and the second quarter was one point four million dollars. Data I/O's financial condition remains strong with cash at fourteen point two million dollars at September thirty, which is up from thirteen million dollars at the end of the second quarter, primarily due to collection of a prior year's tax refund of over six hundred thousand dollars and increased accrued expenses not payable until after year-end, as well as our ongoing cash management and expense control practices. Overall, we remain very strong financially, which fortifies our brand as the most technologically advanced, as well as capitalized supplier in the global programming industry. The company continues to have no debt. We had shares outstanding of eight million six hundred and twenty-one thousand and seven shares at September thirty of twenty twenty-one. That concludes my remarks, and I'll turn the call back to the operator to begin the Q&A segment. Operator, will you please start the Q&A process?

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

Hey, guys. Thanks for taking my questions. I just want to start with the supply chain and some of your comments in the prepared remarks. Can you quantify the impact that the supply chain headwinds had in Q3?

Yes, Hi, Jason. This is Anthony. We focused a lot on long-term supply chain stability rather than short-term issues. This was particularly evident with our PSV family, where we ensured we had enough supply. We sold some Road Runner systems this quarter, but we didn't emphasize supply on those, resulting in longer build times. We could have potentially moved one more unit in Q3 if everything had gone perfectly. This had a minor impact overall. The supply chain challenges have largely been minimal for us concerning performance, but our customers are facing difficulties obtaining chips for automotive electronic components. This shortage is hindering their capacity expansions, which is a short-term setback that we anticipate will be resolved by Q4 or early next year. Interestingly, this situation has led to increased demand from customers who are seeking to qualify second source components for their designs due to a lack of support for the components they originally intended to use. Thus, while it's somewhat mixed for us, the impact is felt more on the demand side than the supply side.

Okay. No, that color is helpful. And just to clarify, you did mention some deferments, but have you seen any cancellations at all?

No.

Okay. Perfect. And then last one for me, and I'll jump back in queue. Can you just update us on what you're seeing from an inventory standpoint at the programmers and how that market is shaping up?

Do you mean programming centers?

Yes.

Yeah. I think our programming center business was actually up a little bit in the quarter. Again, I think that's just reflecting the fact that the industry is high utilization of the equipment they have and that's about all I'd read into it.

Okay. Thanks a lot, guys.

Thank you.

The next question comes from Jeff Peterson with Austin Capital. Please go ahead.

Hey. Thanks, guys. In early September, the stock traded over two million shares in one day and the trading was halted. What happened?

We had a situation where on that day, essentially, retail trading took place that really pushed the volume way up and that also moved the shares way up. It got hot enough where the NASDAQ actually shut down trading for a quick limited halt around three seventeen. We recommenced trading about a half hour later. As a company policy, we don't comment on market speculation regarding the trading of the shares, and NASDAQ was never able to notify us of any actions that may have been involved in the trading, but it was something where the intraday high and the close was up substantially, and we always try to keep an eye on unusual moves of our shares.

Thank you. That was helpful. We have seen some insider selling in Q3, why and what is the company's policy here?

Yes. We always have a policy about approving insiders' trading activities, and we actually don't have a requirement, but we strongly recommend that insiders who want to enter into a trading program actually get a formal 10B5-1 plan and have it regulated to ensure that there is no trading on any kind of suspected insider information that may be out there. So those are pre-arranged. We don't actually comment about the officers and other plans, but from time to time, officers will sell stock to diversify their personal individual portfolios. We do have clear trading policies regarding helping officers, directors, and employees. We have pre-clearance arrangements for entering into those agreements in any direct selling that takes place, and clear policies about what we need from people to trade in the stock. But we do not require the use of the 10B5-1 plans as I mentioned. The plans have to be created in an open window, requiring a thirty-day lag before effectiveness, and trading can take place. That kind of trading is one where you have pre-arranged trading dates and/or stock prices and limitations according to those pre-arranged instructions. We always file a Form-4 promptly after those trades take place, and that is noted as a 10B5 transaction.

Thank you. Thank you for the context, and that's all the questions I had at this time.

Thanks, Jeff.

The next question comes from Orin Hirschman with AIGH Investment Partners. Please go ahead.

Hi. How are you?

Hi, Orin.

Hi. Two questions. Do you think that this is a low in the bookings for you this quarter, or could it get worse next quarter?

We typically don't give a bookings forecast. The bookings on CapEx will be driven by customers' perception of their silicon availability predominantly in the automotive space. I think our best estimate right now is what we heard from GM and Ford publicly today, but people have been saying for a while that they think the bottom for them was Q3, and they place themselves largely resolved by the middle of next year. I don't know if there's a straight line from the bottom to the top or if it gets better selectively. But that's the best industry information we have. On things like adapters, right, we've had unusual strength pretty consistently throughout the year. Our services bookings have actually been up again year-over-year pretty nicely as well, and I don't think those will be too much impacted by the silicon shortage.

Okay. In terms of security, it looked like last quarter, you can't get some traction, what about this quarter? I didn’t hear much security or anything about security?

I think on the security side, we actually delivered the system we booked earlier that we talked about, and that was in our numbers for the quarter. We continue to build a pipeline on SentriX. We continue to work with customers on that. We continue to have meetings where we talk about security and interesting applications; had one this morning in automotive. That just has to work through the system. We continue to build on the base we have with SentriX and we'll go forward from there.

So just one more question before I let you go on SentriX. You had the big wins that you'd mentioned. Anything to follow up on those wins in terms of anything additional from those customers, and did that break open any demand from the additional customers or did it not have that effect yet?

I think the big thing for us is when we have wins like that. We had the big win last quarter. We had our first automotive win earlier in the year. We continue to talk to customers about some very nice opportunities. So, I think the word is getting out on SentriX. We've clearly established the proof points of the capability; a security sell is a complex sell. That's definitely one thing we've learned over the past couple of years. We're just trying to get more and more opportunities in front of us where we can sit down with the customer in a very structured way and go forward in there. And we just have to continue to do what we're doing.

Okay, thanks.

Thank you.

The next question comes from Robert Anderson with Penbrook. Please go ahead.

Yes. Good afternoon, Anthony.

Hi, Bob. How are you doing?

And Joel, I'm fine. Thank you. As you said, sixty-one percent of your revenues were from automotive electronics. What was the remaining thirty-nine percent?

Joel, help me out. I think it's about twenty-one percent, twenty-two percent industrial and then seventeen percent programming center.

That's almost exactly it. Yep.

Okay. And do we have any idea or can we indicate what percent of overall revenues is related to SentriX? My makes sense is it’s still pretty small number?

Yeah. We include the SentriX software and services in with the rest of the software and services. The system that we sold to support SentriX actually got counted as a system. So that's in the capital bucket. So a system is a system, but obviously, the SentriX revenue that got wrapped around it and was the reason for the deal gets counted in the software and services. You'll see the pure SentriX revenue in the software and services line and then as we do things like sell equipment to support a SentriX deal, that would go into CapEx line.

And what was the size of the software and services line, Joel?

We actually have not published or put that information out at this point.

But it’s basically the...

Total software services was eleven percent.

Eleven percent, okay. Thank you.

Thank you, Bob.

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

Well, thank you very much, operator. Before we close the call, I'd like to let everyone know, first of all, thank you for joining us in the call today. We look forward to seeing you at the Productronica Trade show in Munich in a couple of weeks. I'll also be in Boston and New York in a week and a half. We've also been invited to present at the Ladenburg, Thalmann Virtual Technology Expo on November eighteenth and the D.A. Davidson, Semi-Cap Laser and Optical conference on December fifteenth. If you would like further information on that, please contact Darrow Associates and we look forward to seeing you. With that, I'd like to conclude the call. Thank you very much.

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