Data I/O Corp Q2 FY2022 Earnings Call

Good afternoon and welcome to the Data I/O Second Quarter 2022 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, Investor Relations. Please go ahead.

Thank you, operator and welcome to the Data I/O Corporation second quarter 2022 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, silicon chip shortages, supply chain expectations, 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 COVID-19, including the 2022 outbreaks in China; the Russian war with Ukraine including any related international trade restrictions along with continued reopening and recovery efforts within the relevant global supply chains 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 on the timing of product deliveries and installations; market acceptance of new products; changes in economic conditions and market demand; part shortages; 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 over the call to Anthony Ambrose, President and CEO of Data I/O.

Thank you very much, Jordan. I'll begin my formal remarks by addressing our 2022 second quarter financial and operational performance and then I'll turn over the call to Joel Hatlen for a more detailed look at the numbers. Strong bookings for the first half of the year and an encouraging business development pipeline and record backlog at June 30th, 2022 are expected to give rise to significantly improved financial performance in the second half of 2022. It appears as if the slowdown in the automotive industry during the past three years is slowly beginning to unwind with semiconductor allocations gradually returning as consumer electronics and enterprise demand wanes. For example, Bloomberg reported last month that Mercedes-Benz, Daimler Truck Holding, and BMW are among automakers now getting enough of their high-tech components to produce at full capacity after experiencing crippling outages for months. BMW expressed similar optimism, saying all plants are up and running and the company is not experiencing any stoppages due to chip supplies. Additionally, NXP announced a few days ago that their quarterly results highlighted strength in automotive and industrial markets. We think there's a pattern here. Data I/O has seen firsthand the same positive indicators. For the third consecutive quarter, we've achieved bookings in excess of $6 million, with second-quarter bookings of $6.4 million reaching the highest level within this nine-month period. Automotive electronics represented 58% of all of our orders so far in 2022. We had six new customer wins this quarter alone. Our new business success was distributed across automotive, industrial, medical, and a new programming center customer. Our sales funnel in the second quarter continued the momentum from the first quarter when we added millions of dollars of new opportunities. Increased demand is coming primarily from customers in Asia and the Americas. This has been partially offset by weakness in Europe due to the war, currency adjustments, inflation, and other factors. Bookings were back-end loaded in the second quarter, with nearly 50% coming in June, contributing to our very high backlog. Data I/O's Shanghai operations partially reopened in May and fully reopened in June following the most recent COVID-19 lockdown restrictions imposed by the Chinese government. From an operations perspective, lead times are now back to normal, although we still see some spot shortages in parts and assemblies. So, from an operational perspective, we're nearly back to normal. From a balance sheet perspective, we expect accounts receivable, inventories, and cash flow to return to more normal levels by the end of the current third quarter. On SentriX, we had a customer go into volume production and have orders for two SentriX ready systems. These are data programming customers looking to add SentriX capability in the future. We also received patent extensions in the United States and a new SentriX patent from China. Throughout the unusual circumstances of a pandemic and ensuing supply chain issues, global economic gyrations, and the Russia-Ukraine war, I once again would like to acknowledge the great performance of our team, particularly in China. Many of our team members made personal sacrifices to support operations and customers from home while they were locked down. Turning now to our 50th anniversary celebration. As you know, we've been planning to have celebration activities throughout the year and we're conducting a series of interviews that we've dubbed fireside chats. The formats are open and informal, focusing on specific topics with leaders in media, finance, and technology. In June, we published the first interview, which talks about Data I/O's opportunity as a business and an investment. The guest host was Tim Weintraut of Alpha Wolf Trading. Then earlier this month, we published the second installment entitled The Future of Semiconductors for Automotive Electronics, guest-hosted by Suji DeSilva, an equity research analyst at ROTH Capital. We liked that. We've had a lot of fun and the session was highly informative. During the session, we covered how Data I/O ascended to become the leader in automotive technology for programming. We discussed the long-term growth rate we've seen in semiconductors of between 10% and 15% for automotive electronics. We talked about growth catalysts, including electrification, secure programming, autonomous driving, connectivity, and other factors. We also talked about how Data I/O's PSV family of programming systems has become the platform of choice for automotive electronics manufacturers. Additionally, we touched on the global semiconductor supply chain and capacity in automotive, which appears to be improving as I discussed earlier. We have several additional fireside chats planned for the year, and I look forward to them. Looking out towards the second half, there are really two competing global narratives. The first one is the weak macroeconomic picture discussed daily in the business press, focusing on inflation, stagflation, recession, war in Europe, and other negative indicators. The other narrative is what we see in our business: a very strong backlog with a solid sales funnel, as we observe Data I/O's specific items being much stronger than the general macro picture. Other companies reported automotive and industrial, which are our largest markets, are strong relative to consumer and enterprise right now. Automotive electronics supply chains are also benefiting from drops in demand elsewhere. The ability of automotive electronics and industrial companies to be better supported with chips means they ultimately need more programming capacity. Our plan is to stay very close to the market, continue to expand our available markets wherever possible, and prepare our operations to meet the demand we already have in backlog and that we see in our sales funnel. Q3 orders tend to be back-end loaded in September, and by then, we'll have a more structured look at the second half demand overall. To net it out, supported by a very significant backlog, we're more optimistic for the second half than the general stagflationary business conditions would indicate. With that, I'll turn it over to Joel Hatlen.

Thank you, Anthony, and good day to everyone. I would like to begin by reviewing our second quarter of 2022, starting with the cash on our balance sheet and then discussing the income statement. Data I/O's financial status remains robust, with cash at $10.3 million as of June 30, 2022, down from $12.3 million at March 31, 2022, $14 million at the end of last year, and $13 million at the end of the second quarter of 2021. The decrease in cash compared to prior periods is mainly due to the Shanghai COVID shutdown and a one-time China dividend withholding tax of $442,000 imposed in the first quarter of 2022. As part of our global positioning strategy, the Shanghai COVID shutdown necessitated adjustments in working capital as we processed delayed shipments and collected payments regarding the $1 million in order delays that we mentioned last quarter. We expect this situation will stabilize by the end of the third quarter, with most revenue recognized at shipment, offsetting inventory and receivables based on shipping schedules, followed by cash collection. The days sales outstanding in receivables collection measured at June 30, 2022, was 74 days, reflecting the unusual quarter. Our net working capital on June 30, 2022, was $15.9 million, down from $16.9 million at March 31. Inventory stood at $6.9 million on June 30, which was about $1.3 million higher than at the end of the prior year and an increase of $300,000 compared to the start of the quarter. This rise in inventory was a strategic decision to hold more stock to mitigate shortage risks and enhance our resilience as a supplier to accommodate our record backlog. Turning to the income statement, our revenue for the second quarter was $4.8 million, a 28% decline from $6.7 million in the second quarter of 2021. This decrease was attributed to weakness in Europe due to the economic turmoil stemming from the war, a roughly 12% decline in currencies, and shipping delays caused by the lockdowns in China. It is important to remember that around 90% of our revenues come from outside the United States, and many overseas currencies, especially in Europe, have weakened against the dollar; therefore, our reported revenues will reflect this decrease, even though our regional market share and operations in local currencies remain unaffected. Automotive orders accounted for 58% of year-to-date bookings and continue to be our primary target market. Consumables have risen to 31% of revenue year-to-date, an increase from 30% in the previous period. Revenues from software and services reached 15% of the total revenue for the second quarter, up from 11% in the same period last year. International sales made up about 89.2% of revenue in the second quarter, down from 92.5% in the same quarter last year. Bookings for the second quarter of 2022 totaled $6.4 million, an increase from $6.2 million in the first quarter but a decrease from $8.9 million in the second quarter of 2021, when our business cycle seemed to be improving after over three years of decline, although it has recently been disrupted by supply chain shortages and additional COVID-19 variant issues, as well as the war. While business activity in Asia was significantly impacted by COVID containment measures in China during parts of the first and second quarters, it has seen a notable resurgence in recent months. Activity in the Americas has also been stronger over the past several months, while European activity has been subdued due to local economic conditions, currency fluctuations, and effects from the Russia-Ukraine conflict. The lockdown in China contributed to shipping delays, leading to an increase in backlog, which rose to $4.1 million at the end of the first quarter of 2022. As operations and shipping in Shanghai resumed later in the second quarter, our backlog grew to $5.8 million by June 30, 2022, an increase from $5 million at the end of the second quarter of 2021, despite that period seeing $8.9 million in bookings. Our gross margins for the second quarter were 57.8%, slightly up from 57% in the same quarter last year. This increase was mainly due to favorable variances, albeit partially offset by the impact of reduced fixed-cost sales volume. We continue to prioritize funding for our R&D as a vital part of our growth initiatives, with R&D expenses at $1.6 million in the second quarter, down from $1.7 million in the prior year. Selling, general, and administrative expenses were $1.9 million in the second quarter of this year, compared to $2.1 million in the same period last year. The comparable SG&A in the second quarter of 2021 included higher sales commissions resulting from a favorable channel mix and increased demand for programming equipment, as well as greater incentive compensation given that the company had returned to operating profitability at that time. Deferred revenues reached $1.5 million at the end of the second quarter of 2022, down from $1.7 million at the end of the first quarter, but up from $1.3 million at the end of the second quarter of 2021. The taxes for the quarter were limited to foreign taxes, with no U.S. income tax. In the first quarter of 2022, a dividend withholding tax of $442,000 was levied on the repatriation of the China dividend. The net loss in the second quarter of 2022 was $176,000, or $0.08 per share, compared to a net loss of $29,000, or $0.00 per share in the second quarter of 2021. We had 8,814,279 shares outstanding on June 30, 2022. The adjusted EBITDA loss of $64,000 in the second quarter of 2022 contrasts with adjusted EBITDA earnings of $597,000 during the same period last year. Overall, we remain financially strong and have no debt. This, combined with our resilient supply chain strategy, provides us with key competitive advantages as the best-capitalized supplier and a reliable manufacturer in the global programming industry. This concludes my remarks for the second quarter. Before we return the call to the operator, I want to remind investors of our long-term projections and metrics, particularly as we've faced some very unusual circumstances over the past few quarters. On the top line, we believe we can track the growth in our primary market for automotive electronics long-term. As Anthony mentioned earlier, we anticipate a compound annual growth rate of 12% to 15% for semiconductor content in automobiles in the coming years. However, due to delivery uncertainties that are beyond our control, like those we've faced this year, our quarterly results may fluctuate. Therefore, we advise investors to model expectations on a 12-month basis. We expect our record backlog to return to normal levels by year-end. By mid-August, the large backlog for consumables should return to typical levels. These orders will primarily ship during the quarter, and we anticipate that a considerable backlog is likely to accumulate in September, extending into Q4 before stabilizing. For gross margins, we typically see them in the mid to high 50s range. R&D expenses have maintained a consistent level of $1.6 million to $1.7 million per quarter. SG&A expenses are generally under $2 million per quarter on average, except for January in the first quarter, with variations mostly related to sales commissions and incentive compensation. Regarding taxes, we strive for efficiency, which is supported by our carry forward of U.S. net operating losses, approximately $18 million as of June 30, leading to no current U.S. taxes. We expect to incur taxes on the operating income from our foreign subsidiaries, similar to previous periods without the dividend withholding tax. Moving on to cash flow and the balance sheet, capital expenditures have focused on traditional investments in property, plant, equipment, as well as the building of demo and trial sales units that can be monetized later. For property, plant, and equipment alone, we invested about $0.5 million per year. We are a capital equipment light technology company and operate very efficiently in terms of capital. By the end of the second quarter, we had $10.3 million in cash and expect to restore approximately $600,000 during the quarter. We have no debt and do not foresee taking on debt unless it's part of a significant and transformative acquisition. In terms of collections and receivables, DSO typically averages around 55 days, and we expect to return to that level in the quarter. Net working capital is expected to rebound to the mid to upper $16 million range, which should provide a good framework for modeling our growth going forward.

We will now start the question-and-answer session. Our first question will come from Craig at Capital. Please proceed.

Hello, thanks for taking my call. Can you hear me okay?

Yes.

Great. I'm a little new to the story and may have missed some of what you said earlier. Considering your markets and the fact that you supply a lot to automotive OEMs, I would assume you're influenced by capital equipment cyclicality. Besides the unusual factors from the past few years like the pandemic and supply chain issues, are you confident that you're moving back toward the revenue levels you achieved around 2017 and 2018? Is that accurate?

I think what we're trying to indicate is that since COVID hit we've had a number of additional items on top of the normal industry cyclicality. The semiconductor industry has been cyclical ever since it began. I think I've been through nine complete cycles in my business career. And COVID has just thrown additional items on top of that — between the lockdowns and the shortages for automotive. What we're seeing here is that, you know, we thought we were coming out of it last year, then I think the shortage has really impacted automotive. We thought we were coming out of it earlier this year and then the China lockdown hit in Shanghai in Q2. Assuming we can stay open and we don't have any reason to doubt that, we have a tremendous backlog, our operations are open, and they’re well supplied with products to build our systems. So we think we can just focus on shipping product and getting orders for products that we have in our funnel that people are telling us they want to buy. We should have a very strong second half. Beyond that, I'm hoping the cycles begin to dampen out just a little bit. Partly, because we see again a long-term trend of substantially increased semiconductor content in cars, and we also see our business overall becoming a little less cyclical on the CapEx side. In 2017, we were, I think, almost 70% CapEx at the top of the cycle; our long-term model. Today, we're closer to 55% CapEx and our long-term model is to be closer to 50% CapEx and 50% consumables, software, and other recurring items.

Okay. Great. That makes sense. Just a couple of other questions here you have a good you know, you have a solid backlog as you mentioned. And, with the lockdowns in China, and with the supply chain constraints, it is interesting that customers have continued to place orders, put their payments even while goods are sitting in port. So is that just being driven by robust demand? Are you doing anything now to try and alleviate these bottlenecks that you've experienced in the first six months of the year?

That's a good question. We see again, our customers in China and Asia have been pretty strong through the first half, and we put in a good growth plan for the year for them. We're actually exceeding that now, which shows we continue to get good signals for demand formation. So, that held up very well through the lockdowns. I think it's important to remember that, you know, the lockdowns didn't hit every city all at once in China. Chinese growth will be lower this year; I think that's pretty clear. We're still seeing good demand from our customers, and you know, that's reflected in our sales funnel. On the semiconductor shortage, I think my remarks earlier around, perhaps some of the weakness in consumer and enterprise are freeing up capacity for automotive and industrial appears to be a theme that we're hearing a lot in the industry.

Okay. And you mentioned earlier that you want to have, I guess, long-term, roughly 50% of the business tied to CapEx? Can you just give some color about the other markets, revenue potential, and just what you see going forward in the capital equipment space?

Sure, well, in addition to selling the capital, we have adapters and other consumable items. And as our installed base grows, we have over 420 PSV systems in the field, and you know, that continues to grow. It provides a great base for us to have improved consumable sales every quarter. That’s been a long-term focus for us. So we expect that to continue to grow, consumables were 31%, Joel, I think in this quarter, you know, that’ll bounce around a little bit, but long-term that will trend upward. And that’s a key component to getting us to 50% recurring revenue.

Great. Thank you so much.

Thank you.

Our next question will come from MaryEllen Cushing, Private Investor. You may now go ahead.

Yes, thank you. I wanted to touch upon R&D for a moment, please. I know you've stayed reasonably close to breakeven in some of the most challenging business climates of the modern era.

Operator, we lost the line.

…. a little bit? Would you like me to repeat the question?

Yeah, please go ahead.

I'm sorry about that. Okay, can you hear me fine?

Yep.

Okay. Great. I wanted to talk about R&D, you've stayed reasonably close to breakeven in some of the most challenging business climates of the modern era. Yet at the same time, you've maintained your R&D spending, you said to the same level at about approximately $1.6 million per quarter. Can you discuss your strategy behind this investment in the company's future, please?

Sure. One of the things I learned early on is in a cyclical business that's heavily dependent on R&D. You can't manage R&D. In a cycle, you have to set priorities, be consistent, hire the right people, keep them on board, and keep them focused. So we believe R&D is very important because innovation drives design wins, revenue, and margin. We're focused on leading in programming, primarily supporting automotive and industrial industries. We think that's the best place to be in the market. In addition to our programming investments around handling technology, programming technology, and systems integration technology, we've added other SentriX platform, which is really secure provisioning technology, and integrated all those together. We see the market continuing to demand programming technology, and more and more that will require security capabilities, seamlessly integrated into what's known today as data programming.

Okay. All right, two more questions. What is your overall IP position, including the number of patents, and what sort of moat does this create for you from a competitive positioning standpoint?

So we think we have an increasing moat around the business, to use your terminology, and more importantly, around security provisioning. We have over 20 U.S. international patents for SentriX and security provisioning technology. As I mentioned earlier, we got some extensions and enhancements here in the U.S., as well as a groundbreaking patent awarded in China. We also have over 50 patents overall on programming technology, which we believe is more than anyone else has in the industry. This gives us a good position. We want to increase the moat, but at the same time, we want to use the R&D dollars to make sure that we can deliver capabilities that customers want to buy in their systems. So it's a balancing act; we think we have a very good moat and we plan to increase it while keeping the R&D investment focused on features and capabilities that customers can pay for.

Our next question will come from David Wright with Henry Investment Trust. You may now go ahead.

Anthony Joel, good afternoon.

Good afternoon.

Good afternoon.

Hey, question, the fireside chat series that you're on, are you hoping for that to result in any analyst coverage? And if so, have you made any progress that way?

I think the fireside chats' primary objective is to inform investors, potential customers, and really use it as a platform to articulate a vision of where we see things are going. I've been thinking about this for a while, and we finally got around to doing it this year in our 50th anniversary. As far as analyst coverage, you know, we're always looking to talk to firms that want to provide coverage. Increasing analyst coverage is something I think that we might be in a position to see more of in the third quarter; just stay tuned to this channel. We’re always willing to talk to firms that want to do coverage. The big challenge right now is firms getting stretched really thinly. They tend to focus their energy, and this is completely understandable from their part on clients that need banking services. As Joel mentioned earlier, we have plenty of cash; we really have no need for banking services to raise money right now. We don't need to offer debt and we don't plan to go into debt. That would all change, of course, if we found something out there that we really wanted to buy. But really, a lot of firms want to tie analyst coverage to banking services, and so that's something that we need to be cognizant of going forward.

Okay. Well, I'll look forward to anything that might develop in the third quarter. Thanks for that answer, and good luck going forward.

Thank you.

Thank you. Ladies and gentlemen, this will conclude our question-and-answer session. I would like to turn the conference back over to Anthony Ambrose for any closing remarks.

Operator, thank you very much. And I'd like to thank everyone who joined the call and asked the questions. What I'd like to do is remind everyone that our next fireside chat will be with guest host Gene Inger of Inger Newsletter, and that should appear about August 17. With that, I'd like to conclude today's call. Thank you very much.

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