Data I/O Corp Q1 FY2023 Earnings Call

Good day, and welcome to the Data I/O First Quarter 2023 Financial Results Conference Call. Please note, this event is being recorded. I would now like to turn the conference over to Jordan Darrow, Investor Relations.

Thank you, and welcome to the Data I/O Corporation's First Quarter 2023 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 and other regulatory 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 that 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 outbreaks in China, the war with Ukraine, including any related international trade restrictions, along with continued reopening and recovery efforts within the global supply chains and among our customer base, level of orders for the company and the activity level of the automotive and semiconductor industry overall, the 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 described 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.

Well, thank you very much, Jordan, and welcome, everyone. I'll begin my formal remarks by addressing our 2023 first quarter financial and operational performance, and then I will turn over the call to our CFO, Joel Hatlen, for a more detailed look at the numbers. Q1 was an excellent quarter. We reported 46% top-line growth with quarterly revenues reaching the highest first quarter level since 2018. Gross margins were also at the high end of our range, and we're profitable in a traditionally challenging quarter. Year-over-year financial comparisons reflect the fact that we returned to more normal operating conditions compared to the challenges we faced last year in Q1 and Q2. Our worldwide installed base of PSV systems increased to more than 450 machines, aided by 10 new customer wins during the quarter. This is helping to create a more sustainable revenue profile through recurring and consumable sales, which accounted for 44% of our total revenue in the quarter. We continue to lead in automotive electronics, and we're also seeing strong industrial market growth globally. Regionally, we forecasted and observed some softness in China in the first quarter due to the COVID shock in December and January, as well as some upcoming changes in the automotive emissions regulations. We expect China to be a little bit stronger in the second half of the year. Our sales funnel is very strong, and we are reiterating our annual projections from our last call. We believe demand is being driven fundamentally by several factors. The first is long-term secular growth in the automotive electronics market, including a tactical improvement in the supply of silicon products to our automotive electronics customers. This includes applications such as electric vehicles, active safety systems, automotive connectivity, infotainment systems, and increased security. The second major demand driver for us is strength in the industrial sector, including advancements in factory automation and increased demand for security within factories. Third is the acceptance of our products and services, contributing to our consumable and recurring revenue growth. Finally, there's the onshoring to North America, as well as recovery in Europe and demand for security and security-enabled products everywhere. I've talked a lot about the dynamics of the automotive electronics industry and long-term growth prospects. This call, I'd like to share insights from recent third-party announcements that provide context on why we are excited about the long-term opportunity. Teradyne announced and projected a testing market that would be down about 20% this year. However, they noted that while PC and mobile markets are weak, automotive and industrial markets are performing well. General Motors announced that they will design and manage their own software for their instrument clusters and infotainment systems, which creates additional demand for our products. The evolving regulations and government policy around cybersecurity are parts of a larger trend that further validates our position in the market. Our SentriX platform continues to offer strong pay-per-use revenue, and we made significant partnership announcements in the first quarter. We had a very strong marketing momentum and qualified leads for our SentriX platform as well as our traditional data programming business. With that, I'll turn it over to Joel Hatlen for a more detailed look at the numbers.

Thank you, Anthony, and good day to everyone. The first quarter had strong revenues, gross margins, and profitability as well as growth in our cash and working capital. I'll start by discussing the balance sheet and move to the income statement. Data I/O's financial condition improved from the end of last year. We ended the first quarter with $11.9 million in cash, up $400,000 from $11.5 million at December 31. As we typically note each year, the first quarter has certain public company costs and payment of annual accrued items that typically use more cash than other quarters. With continued strength in our business, we were able to actually grow our cash in the first quarter. Net working capital increased from $17.6 million at December 31 to $18 million at March 31. Days sales outstanding, or DSO, was at 51 days as of March 31, 2023. This is on track within our target range. Inventory of $7 million was up slightly from $6.8 million on December 31. This increase in inventory is related to our decisions to hold additional inventory to address shortage risks, improve our resilience as a supplier, and support our robust bookings and backlog levels. Our backlog on March 31, 2023, was $3.2 million, down from $4.8 million at December 31, reflecting a return to more normal levels and normal operations. Now on to the income statement. For the first quarter, revenue of $7.2 million was up from $5 million in the first quarter of 2022 and flat sequentially. This reflected strength across the board, driving us to profitability in Q1. Automotive electronics orders were 63% of 2023 first quarter bookings and continue to be our primary addressable market. First quarter revenue breakdowns were capital equipment 56%, consumables 31%, and software and services 13%. This breakdown was consistent with the percentages for all of 2022. International sales represented about 87% of revenue for the first quarter. I should note that first quarter 2023 bookings were $5.7 million, down from $6.8 million in the fourth quarter and $6.2 million in the first quarter of 2022. We saw expected softness in China as they recovered from COVID and prepared for new automotive emissions regulations effective July 1. Europe was also softer in Q1 after a strong Q4 for bookings. Gross margins were at 59.5% in the first quarter of 2023, an increase from 55.5% in the fourth quarter and 46.4% in the first quarter of 2022. The increase from the fourth quarter was due to favorable currency exchange rates, favorable channel and product mix, and favorable factory variances. Operating expenses for the quarter were $4.1 million compared to $3.4 million in the fourth quarter and $3.7 million in the first quarter of 2022. The primary differences in year-over-year operating expenses are higher channel commissions, trade shows, incentive compensation, and recruiting-related costs. Funding our R&D continues to be a priority. R&D expense was $1.6 million in the first quarter, the same as in Q4 2022 and compared to $1.6 million in the first quarter of 2022. Selling, general and administrative expenses were $2.5 million in the first quarter versus $1.9 million in the fourth quarter and $2 million in the first quarter of 2022. Taxes in the first quarter consisted of foreign taxes on the profits of our overseas subsidiaries and U.S. state income tax. The company had net operating loss carryforwards of approximately $20 million as of March 31. Net income in the first quarter of 2023 was $95,000 or $0.01 per share compared to $510,000 or $0.06 per diluted share in the fourth quarter of 2022. In the first quarter of 2022, we experienced a net loss of $1.8 million or $0.21 per share. Adjusted EBITDA earnings of $502,000 in the first quarter of 2023 compare with adjusted EBITDA earnings of $831,000 in the fourth quarter of 2022 and negative adjusted EBITDA of a loss of $932,000 in the first quarter of 2022. We had 8,818,076 shares outstanding on March 31, 2023. Overall, we remain very strong financially and continue to have no debt. Looking forward, with our continued strong sales funnel, we continue to plan for double-digit revenue growth in 2023. We expect operating expenses to remain flat throughout 2023, with variations due to sales and incentive compensation and the impact of currency changes. Gross margins are expected to stay in the mid- to high-50s throughout the year. That concludes my remarks for the first quarter of 2023. Operator, would you please start the Q&A process?

The first question today comes from David Marsh with Singular Research.

Congratulations on the strong start to the fiscal year.

Thank you very much, Dave.

I guess I wanted to zero in first on first quarter gross margins, which came in really close to 60%, which is a little above the guidance for the year and really up pretty substantially year-over-year. Could you just talk about how you're able to achieve that gross margin level in the first quarter? And how that plays into your expectations for the balance of the year?

I think the number one thing I would say is good revenues and a more normal operating environment enabled this. Our factories worked to clear backlog. We had the benefits of better currency exchange rates compared to the fourth quarter, and we saw favorable factory variances as well as a helpful channel mix. This quarter, we had stronger sales in the Americas, where we typically pay a channel commission rather than a distributor discount predominantly internationally.

So Joel, what you're saying is that's one reason why spending was up in SG&A.

Yes.

And then I guess my second question focuses on your comments regarding the Cybersecurity Act. Can you discuss the timeline for when we might start seeing meaningful shifts in purchases to reflect this new legislation? How long might it take to be reflected in your income statement going forward?

I think nothing moves quickly when it comes to government, except maybe the motion to adjourn for the summer vacation. However, it’s crucial that people understand they will need to design products to comply with expected regulations. Although final regulations may take 1 or 2 years, companies are beginning to design new embedded IoT products with security in mind, due to a heightened awareness of future risks and government oversight. We see this as a long-term tailwind for our SentriX business.

The next question comes from Kevin Garrigan with WestPark Capital.

Great speaking with you again. Let me echo my congratulations on the results. I have a few questions. First, regarding the 10 new customer wins, are the majority of those in automotive or are they evenly split between automotive and industrial sectors? And secondly, concerning the National Cybersecurity Strategy, can you provide more context on the conversations you are having with your customers? Are they enthusiastic about using SentriX, or are they more reserved, waiting for regulations?

Regarding the new wins, the majority were in automotive; we might have had about 6 in automotive and 4 others in industrial. It was actually a really good quarter for us on new customers. As for SentriX, we're experiencing increased conversations as manufacturers add security capabilities to their products. There is broad interest in integrating security, especially following the significant discussions at our trade shows. The silicon is available, and we aim to make the implementation of security capabilities easier for our customers. The regulations are creating a sense of urgency, leading many to consider security as a priority in their designs.

Understood. That makes a lot of sense. As a quick follow-up, looking ahead at the rest of the year, what are one or two factors you're particularly excited about, and what are one or two concerns that keep you up at night?

Every time I turn on the TV news, it's distressing, so I try not to watch too much of that. The general business concerns range from inflation to potential deflation, and the Fed's monetary policy versus recent banking challenges. However, if we focus on the micro view—specifically the behaviors of those purchasing our products—we observe strong demand for our products. While some markets like PCs and smartphones are experiencing weaknesses, we see strengths in automotive and industrial sectors. These trends indicate a bullish outlook for Data I/O as we look ahead.

The next question comes from Chris Bakowski, a private investor.

Congratulations on the great quarter as well. I wanted to ask about the automotive sector in China. There's news regarding production not meeting expectations due to the cessation of subsidies, and Tesla is reportedly asking suppliers for price reductions. Can you elaborate on this situation? You mentioned earlier that you expect improvement in China; what gives you that confidence?

I appreciate the question. The situation in China has seen some turbulence following the reopening in December and January. There was some inventory buildup in Q1, which contributed to business softness. However, we remain confident due to the improving automotive trends we are monitoring for March, which look favorable. Additionally, the upcoming changes in emissions regulations will create localized supply chain disruptions as older models are phased out. Overall, we believe the demand for electric vehicles in China is still robust, and our position within that market remains strong.

The next question comes from Matt Winthrop with Equitable.

I'm a retail broker and have been following your company for a while. It's great to see the progress you're making. I have a two-part question. First, do you rely more on an in-house sales force versus local distributors for most of your products? Secondly, given the consistency in bookings and backlog over recent quarters, what is giving you so much confidence about the marketplace for the remainder of the year?

Thank you, Matt. Our sales model varies by region. In Europe, we prefer a direct sales force. In Asia, we engage strong local distributors for language and service support. In the US, we adopt a mix of representative models. This approach allows us to effectively meet both customer service needs and sales engagement. Regarding our business outlook, the long-term trend indicates that more silicon is being integrated into cars that require programming—this gives us a leading position in the automotive programming market. As we look ahead, factors like improved supply chains, enhanced government policy, and a focus on security solutions suggest a strong demand environment.

The next question comes from Michael Cooper, a private investor.

I wanted to better understand the SentriX product line, specifically regarding your sales cycle. Product designers typically prototype and may take 2 years to go into production. Are you able to influence that cycle? Are you seeing more designers at the front end of your funnel? How many clients are moving to production with your solutions?

Yes, we had good pay-per-use revenue in Q1, and we had several customers start production in Q4, continuing into Q1. On the design cycle, if we engage with customers during their design or new product introduction phases, these lead times can vary from 6 to 18 months before reaching full production. Our collaboration with Nuvoton is an example where we've streamlined the process to reduce the time between engaging with potential customers and their production phase. We recognize that SentriX may require a longer timeline than traditional data programming customers due to its complexity.

The next question comes from Avi Fisher with Long Cast Advisers.

Could you describe what constitutes a customer win? Does it refer to a new client purchasing a PSV or something different?

A customer win is defined as when we sell a system to a new client who does not currently use Data I/O products at that location. For instance, if an existing customer opens up a new location or a brand-new customer starts a factory, that is classified as a customer win. If a client purchases an additional system at a site where we already have sold machines, we do not count that as a new customer win.

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

Thank you very much, operator. Before I close, I'd like to remind everyone that we will be having our Annual Shareholder Meeting on May 18. I'll also be doing a couple of conferences in Q2, May 24 for the Spring Select Conference, and June 22 for the Summer Solstice Conference. I assure you that will be on the longest day of the year. With that, I'd like to conclude today's call and thank everyone very much.

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