Earnings Call Transcript - DAIO Q1 2021

Operator, Operator

Good day and welcome to the Data I/O Corporation First Quarter 2021 Financial Results. All participants will be in a listen-only mode. Please note, that this event is being recorded. I'd now like to turn the conference over to Jordan Darrow, Investor Relations. Please go ahead.

Jordan Darrow, Investor Relations

Thank you and welcome to the Data I/O Corporation first quarter 2021 financial results conference call. 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, our 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.

Anthony Ambrose, CEO

Well, thank you very much, Jordan. I'll begin my formal remarks by addressing our 2021 first quarter financial and operational performance, and then I'll turn it over to Joel for a more detailed discussion of the numbers. The 2021 first quarter was our strongest revenue quarter in two years and continues the upward trend in automotive and industrial electronics demand that we have seen since the bottom in Q2 last year. We are coming out of the COVID-19 recession very well and seeing a surge in business in March and April of this year. We believe the positive growth themes that we discussed recently in our year-end conference call are accelerating. There are well-documented short-term supply disruptions caused by sharp increases in automotive electronics demand, supply chain interruptions in the semiconductor supply chain, and other factors. The long-term secular growth for automotive electronics remains intact with industry analysts and customers projecting a compounded annual growth rate of 10% to 15% for the next decade. Clearly, additional capacity is going to be needed throughout the supply chain to support this demand and we are seeing that as key semiconductor companies continue to announce record spending in the tens of billions of dollars for wafer fab and back-end capacity. Data I/O is also answering this call with our most advanced technology supporting all growth areas in automotive including Electrification, Infotainment, Advanced Driver Assist Systems, Security, and Connectivity across flash memory products, microcontrollers, and security devices as well. We're very excited about the business performance in the quarter. During Q1, we won six new customers in Asia across all markets. This illustrates our global strength and the desire of customers to partner with the market leader during these challenging times. We also substantially added to our sales pipeline in Q1 with new prospects and repeat customers alike, in both our traditional business and the SentriX business as well. Overall, we see Asia-Pacific and Americas regions leading the recovery with the Europe, Middle East and Africa region following about one to two quarters behind. During the overall downturn in the past couple of years, Data I/O has remained committed to our strategy of investing in our key technologies and our platforms. R&D continues to be a critical and sustainable competitive advantage for the company. In addition to that, COVID-19 disruption also shows the value of a resilient supply chain, and Data I/O is the only programming supplier in our industry with two manufacturing locations. Recent fires in a semiconductor fab and environmental-induced issues in Texas illustrate the need for a resilient supply chain and our automotive customers clearly value that capability. Regarding SentriX, we had a very nice quarter in Q1 as well. We won our very first SentriX Automotive Electronics customer through a partner in Q1. We also deployed our first field upgrade of the PSV7000 system to a SentriX system for a multinational customer's Asia factory. We're also seeing increased customer activity from both partners and direct engagements on SentriX. As we look ahead, we become even more encouraged by the global economic recovery and the demand from our key vertical markets. With strong operating leverage, Data I/O remains very well positioned to deliver disproportionate improvements in profitability and cash flow, as we continue our cyclical recovery within the framework of the long-term strong growing markets. With that, I'll turn it over to Joel Hatlen. Joel?

Joel Hatlen, CFO

Thank you, Anthony, and good day to everyone. Net sales in the first quarter of 2021 were $6 million, the highest level of revenue in eight quarters and up 26% as compared with $4.8 million in the first quarter of 2020. The increase from the prior period primarily reflects higher overall demand for equipment. Revenue growth also benefited from higher adapter sales associated with the increased usage and growing installed base of machines throughout the world. Recurring and consumable revenues, which include adapter sales, represented $2.7 million or 44% of total revenues for the first quarter of 2021, as opposed to $2.2 million or 46% of the lower first quarter of 2020 total. Adapter sales for the first quarter of 2021 were the highest quarterly sales since the second quarter of 2017. First quarter of 2021 bookings were $5.4 million, up 26% from $4.3 million in the first quarter of the prior year. Backlog at March 31, 2021 was $3 million, down from $3.9 million at the end of December 2020, but up 30% from $2.3 million at the end of the first quarter of 2020. We go into the second quarter with a higher than typical backlog, strong sales funnel additions in March, and a strong start in April orders. On a geographic basis, international sales represented approximately 95% of net sales for the first quarter of 2021 compared with 94% in the 2020 period. Gross margin as a percentage of sales in the first quarter of 2021 was 55.5% as compared with 58.2% in the prior year period. The difference is due primarily to less favorable variances as well as channel and product mix. The gross margin percentage guidance continues to be in the mid to upper '50s. Operating expenses were $3.7 million in the first quarter of 2021. First quarter operating expenses are generally higher than any other quarters of the year due to the inclusion of seasonal costs such as the majority of audit and public company-related costs for the year. This seasonal amount in the first quarter of 2021 was approximately $250,000. Within operating expenses, selling, general, and administrative expense in the first quarter of 2021 increased by approximately $251,000 from the prior-year period, primarily due to higher sales commissions associated with the higher demand for programming equipment. R&D expenses remained stable at approximately $1.6 million in each quarter—this is the first quarter of this year and last year, as well as the fourth quarter of 2020. We are focused on maintaining, if not extending our technological lead in the automated programming and security deployment markets. In accordance with Generally Accepted Accounting Principles (GAAP), the net loss in the first quarter of 2021 was $333,000 or $0.04 per share. This is our smallest net loss since the second quarter of 2019 and reflects our continued efforts to control expenses as our revenues climbed back. Moving onto the balance sheet, days sales outstanding or DSO, a receivables collection measure at March 31, was below our target measure at 49 days, even as receivables increased from the end of the fourth quarter, as our sales grew 22% on a sequential basis. Net working capital at March 31, 2021 remained consistent at $18.1 million from the end of the fourth quarter. Inventory of $5.1 million at March 31, 2021 was approximately $138,000 lower than in December. Data I/O's financial condition remains strong with cash of $13.6 million at March 31 of 2021. This financial strength has allowed us to continue to invest in our business during the downturn and now finance the resumption of growth, and we continue to have no debt. Finally, we had shares outstanding of 8,421,599 as of March 31, 2021. That concludes my remarks. I will turn the call back to the operator to begin the Q&A segment.

Operator, Operator

Certainly. And we will now begin the question-and-answer session. Our first question today will come from Jaeson Schmidt with Lake Street. Please go ahead.

Jaeson Schmidt, Analyst

Hey guys, thanks for taking my questions. Anthony, just want to follow up on your comments about the surge in business starting in March and April. Was that pretty broad-based or was that concentrated among a few customers?

Anthony Ambrose, CEO

It's a good question, Jaeson. As I indicated in my remarks, I think we're seeing most of our strength in Asia and the Americas. As I mentioned, we had a number of new customers and new locations, and I'd say it's a combination of some new customers, some repeat customers, and a couple of multiple system orders in there as well, but it's pretty broad-based.

Jaeson Schmidt, Analyst

Okay. And within that, are you seeing signs of life from the programming centers?

Anthony Ambrose, CEO

A little bit, I think. Remember, the programming centers have a fairly broad capacity and they support a number of customers, including smaller customers. I think it's pretty clear the smaller customers are taking a hit right now due to many of the supply chain issues; obviously, some of the big ones have as well, but larger companies tend to have more leverage when there is a supply shortage. So, I think our programming center revenue has been pretty flat at about 14% for a while, and I think that's pretty consistent. Also, a lot of our programming center revenue tends to come from Europe on balance.

Jaeson Schmidt, Analyst

Okay, that's helpful. And then, just the last one from me. It sounds like there is some nice traction with SentriX. Is the automotive customer? I know you mentioned you won that design through a partner, but how long were they evaluating this system?

Anthony Ambrose, CEO

As you're probably aware, Jaeson, the security sale is a longer sale than a normal data programming sale for a couple of reasons. Number one, the technology is newer. Number two, obviously with security and keys and certificates, people are very concerned about who gets to know about that whole process. And also, we have to explain it to them and show it to them. So it has a longer sales cycle. Having said that, the more customers talk to Data I/O, the more you see the light bulb going off that SentriX is a great solution for a number of customers in the market. It gives them the volume flexibility; they can work through a partner programming center. We've had some customers say, "Now I can just upgrade my PSV 7000 and add the security capabilities I need." And of course, we say, "Yes, that's exactly what you can do." So it's a longer sales cycle, and we're trying to continuously make it simpler and easier, and that's our goal going forward.

Jaeson Schmidt, Analyst

Okay, thanks a lot.

Anthony Ambrose, CEO

Thank you.

Jeff Peterson, Analyst

Hey, thanks guys for taking my questions. With the supply chain shortages, including the wafer fab limitations, what does this mean for equipment makers like Data I/O and where do you fit into this and what should we expect the impact to be?

Anthony Ambrose, CEO

Hey, Jeff. Thanks for the question. There is a lot that's been said about it. Clearly, a number of our end customers, automotive nameplates, and electronics companies have been impacted by the shortage. I think there were some remarks made earlier this week by a major U.S.-based automotive company indicating that it costs billions of dollars. We might be seeing it, but we really haven't seen it in the bookings or the backlog. We do see some customers coming to us for, I'll call it, accelerated support. So they can qualify alternate silicon. So if they're facing a shortage of Component A, they'll come to us seeking programming support for Component B. So they can have an alternate supply arrangement. That's probably the biggest single impact. As I said, big customers are probably faring better overall. We have seen some of the smaller customers getting roughed up a bit with the supply chain, and that's just what happens when these things occur.

Jeff Peterson, Analyst

That's helpful, thanks. Along the lines of the chip shortages issue, are you driving benefits in the form of sales of consumable items such as adapters?

Anthony Ambrose, CEO

What we are seeing in adapters again we mentioned last quarter continues this quarter. One of the early indications of coming out of a recession is customers using the equipment they already have at a higher level of utilization, and that's typically reflected in some of the consumable purchase trends, and that's what we're seeing.

Jeff Peterson, Analyst

Okay, great. Thanks. Can you discuss the six wins in Asia including whether they are new or existing customers through which channels, and any other information you can share, including do you believe that these sales are the result of Asia, excluding India, emerging from COVID with economic development assuming there?

Anthony Ambrose, CEO

Yes, let me start with that. Clearly, there are some regions of the world that have been less impacted or have come out of the COVID-induced recession faster. And I think China is clearly one of those areas. We had a number of wins in China, but we also had a number of wins outside of China in Asia. Among those new wins, they were fairly broadly dispersed. I think most of them were automotive. We had some industrial and some programming centers in there as well. So again, very broad. And I think it reflects a number of trends. When customers are selecting a new partner for programming, they look at us; obviously, they look at our competitors. In Asia, we do extremely well even though most of our competition is domiciled in the Asia-Pacific region, so again, customers that value quality, resilient supply chain, and global capability value Data I/O.

Jeff Peterson, Analyst

That's helpful, thanks. And what's the status of your proxy with respect to the advisory firm recommendations?

Anthony Ambrose, CEO

So we just got our proxy advisory recommendations, I think this week. And right now, it looks like there is sort of a split recommendation. We're trying to figure out why that is. As many of you know, after we prepare and file, our proxy statements are reviewed and opinions are rendered by proxy advisory firms Glass Lewis and ISS. On Tuesday, we figured out that ISS was recommending support for the Board, but not recommending support for our stock plan extension. We dug in and determined that we think they might have missed something on an incorrect assumption about the plan, and we're working with them. We'll see where that goes. Glass Lewis, on the other hand, did not have any issues with either the Board's recommendations or the stock plan we believe at this time. So as I said, we'll dig in and we'll figure out what's going on and we'll update you accordingly.

Jeff Peterson, Analyst

That's all my questions at this time, and thanks.

Anthony Ambrose, CEO

Thank you.

Dave Kanen, Analyst

Hi guys, thanks for taking my questions. My first question is about which end markets showed the most strength in terms of orders.

Anthony Ambrose, CEO

I think we indicated, Joel, was about 56% of the orders were Automotive and I think 30% Industrial. So, Dave, it was pretty consistent with our overall mix. So I think again it's reasonably strong by end market across the board. Again with a strong regional component, I think Asia is clearly ahead of Europe, for example.

Dave Kanen, Analyst

Okay. And then, what percent of your revenue was SentriX?

Anthony Ambrose, CEO

We don't disclose SentriX separately. It's in the software services. SentriX. Joel, what was the number for that for the quarter?

Joel Hatlen, CFO

It was 31% of our business. I'm sorry, 13% of our business.

Anthony Ambrose, CEO

13%, inclusive of the adapter.

Dave Kanen, Analyst

I see. So at this point, SentriX is a de minimis percent of your overall revenue? Just to take a step back and then look at our expense structure, playing devil's advocate as a public company, we have to ask what's the ROI on the investments that we're making? So OpEx has been elevated. If I go back several years ago, you were sub $3 million a quarter in total OpEx, even at times during recessions, even below $2.5 million. So my question is how much of your SG&A total OpEx relates to the SentriX initiative and does it make sense potentially to cut some of the fat?

Anthony Ambrose, CEO

So, I will take the question one at a time. When you look at the overall expense, remember security is where the market is going for the microcontroller industry. It's not a distinct category. It's not something out there that's different than what we do. If you look at all of the major semiconductor product line announcements from microcontroller families, they all have a security component. So to be ahead in security is to be ahead where the 30 billion unit microcontroller market is going. And so, that's a strategic play that we have to have. Now within that, of course, we evaluate how much we spend from time to time. We had to elevate the spending a bit to get our second-generation architecture out for the benefits that we described. And frankly, we're seeing some of the fruits of that in Q1. So if you're saying are we keeping an eye on things and making sure we're spending the right amount and it's evaluated? Absolutely.

Dave Kanen, Analyst

Okay. I mean, is there an opportunity to get back to the $3 million quarterly run rate in operating expenses without sacrificing our future?

Anthony Ambrose, CEO

Short answer is probably no. I don't see that.

Dave Kanen, Analyst

Okay. And so, when do you expect to be GAAP EPS profitable?

Anthony Ambrose, CEO

As soon as possible is always the goal. We don't give forward guidance. I mean, it's always challenging without guidance, but that's something we clearly pay a lot of attention to and are working hard to get there as soon as possible.

Dave Kanen, Analyst

Okay, good luck. Thank you.

Anthony Ambrose, CEO

Thanks a lot, Dave.

Orin Hirschman, Analyst

Hi, how are you?

Anthony Ambrose, CEO

Hi, Orin. How are you?

Orin Hirschman, Analyst

Good. So a couple of quick questions. One is, if I look at the sequential, you made a lot of comments in terms of surging orders, but if we look at the sequential bookings, I believe they are actually down slightly, if I remember correctly. Could you just kind of put that all together with the commentary? Maybe I'm missing something.

Anthony Ambrose, CEO

Sure. In Q1, we always have to deal with the Chinese New Year, which for most businesses in Asia, tends to take away about two weeks of the quarter and very few people buy anything the first week back from the calendar New Year. So Q1 tends to be, for all intents and purposes a tougher quarter to get orders done because not everyone is home all 13 weeks of the quarter. And coming out of Chinese New Year, we have a great sales funnel. It's always a challenge to understand how much of it will actually close in March, and we saw very good closures in March that continued in April. We don't usually talk about the April bookings, but we anticipated your point and wanted to make sure people understood that we see good bookings momentum in the company.

Orin Hirschman, Analyst

Okay. I mean, can we assume that that means the booking should be up sequentially for June if normal seasonality is going on in the macro level?

Anthony Ambrose, CEO

Yes. Again, I don't want to get into the forward guidance but, Joel, do you want to comment on that?

Joel Hatlen, CFO

Yes, no, I just think that with the backlog we have, the strength of the sales level, and the early sales that have taken place so far in April, I think we should be looking at a better quarter.

Anthony Ambrose, CEO

Well, there you go. If Joel said so, let it be done.

Orin Hirschman, Analyst

How fast can you turn around orders? Let's say that you receive orders at the beginning of the quarter. Can April orders still ship in the June quarter?

Anthony Ambrose, CEO

Yes, absolutely. We quote standard lead time that's in the six to eight weeks neighborhood, and we try to do better than that. I think we've done a very good job trying to stay ahead of these component shortages. There is no doubt you can turn April orders into revenue for the current quarter. As you get later in the quarter, they tend to flow into the subsequent quarter.

Joel Hatlen, CFO

As just a general rule, our backlog generally represents about one month's worth of sales. So that means each quarter, we have to hustle for the other two months.

Orin Hirschman, Analyst

Right, got it. SentriX. So you've been working on this for a long time, and it seems like there's a little bit of break in the logjam right now. Can you give us more, let's say, the automotive win? What are they using it for? They're using it for microcontrollers. Why did they go with you? What are their other options? How long have you been doing tests with them? Give us a little bit more color.

Anthony Ambrose, CEO

Yes. So we don't have the ability to use a customer name, but most people would understand who it is. The specific application we're working with them on is a Trusted Platform Module application for very secure components. The reason they came to us, as we announced in Q4, is support for the Infineon TPM. The nice thing about TPM is it's a pretty established market. They're well-known products, and people have been working with them for a long time. With SentriX, you get the ability to have your unique cryptographic and security information provisioned into the chip where you want it in the supply chain. So you don't have to do it too early; you can do it exactly where you want it. And I think the customer valuing our relationship with the chip supplier and, frankly, our detailed understanding of the TPM and how to work with it.

Orin Hirschman, Analyst

Typically, there were some - the equipment sale plus some tiny royalty on a per-chip basis. Is that the case here as well?

Anthony Ambrose, CEO

Yes. Remember with SentriX, we have programming center partners that can provision the devices. We've talked about the general business model, including a pay-per-use component for things like upgrades or equipment in the field or new system purchases by OEMs. There may be additional revenue sources, but in general, that's the model.

Orin Hirschman, Analyst

Okay, meaning there is no reason why you shouldn't get some type of, be it a royalty for this particular customer, but it will be a per-chip type of royalty?

Anthony Ambrose, CEO

Yes. Again, we've indicated in the past and been pretty clear on SentriX, there is a per-part component to the revenue.

Orin Hirschman, Analyst

Is the automotive customer here then selling to the auto OEM? Or is it a design house or an ODM for the OEM? What type of - are they a programming center for the order customer?

Anthony Ambrose, CEO

We've been working with the partner and also the end customer directly, which is pretty typical for SentriX. But we still have to work with the customer directly because they just need to understand, and we need to help them out on how to work with the cryptographic information and things like that.

Orin Hirschman, Analyst

Is the actual programming going to be done by the automotive OEM or is it going to be done by one of their partners?

Anthony Ambrose, CEO

We worked this deal through a partner.

Orin Hirschman, Analyst

The second one was the field upgrade to SentriX for customer Asia. Can you say what industry, and same exact question, is there a per-part aspect to it as well?

Anthony Ambrose, CEO

Well, it's a programming center customer. They had a PSV7000. We did an upgrade, turned it around in a day, and they are extremely happy.

Orin Hirschman, Analyst

And was the customer at the end of the chain - did you work with the end customer at the very end of the chain for the programming center or whoever that is that they are programming for; did you work with that customer at the end of the chain?

Anthony Ambrose, CEO

Yes.

Joel Hatlen, CFO

And then, it's still a pay-per-use situation for us.

Orin Hirschman, Analyst

Okay, great. That's very nice. I mean, keep in mind I need today, but what's next? You indicated within a level, and then a lot of people ask, you indicated that there's more interest in SentriX in the text in your comments. Is it finally beginning to gain steam after all this effort over the last two to three years?

Anthony Ambrose, CEO

Well, I think we're very encouraged by the interest in the product line in Q1. It was substantially above what we saw coming out of last year. But I think it's more a couple of things. We've been very consistent on SentriX. We needed to simplify and scale SentriX. There is no doubt we were early, but at the end of the day, we continue to learn to continue to simplify and continue to make it easier, and that's a virtuous cycle for acquiring new customers and getting them into the market. It's a marathon, not a sprint. And we still believe that. And I'll reiterate my earlier comment, the microcontroller industry is going to a secure microcontroller industry. That's where all the business will be. It might be 5 years out, it might be 10 years out, it might be sooner than that. But that's where all of the business in microcontrollers will be eventually. The other part that I want to indicate is that we're starting to have what I'll call more strategic conversations with customers. Everyone was hunkered down last year with COVID. But we're beginning to have a lot more meaningful conversations on how we can help customers across a broad range of our technologies, which would include us doing things for them that may be unique and for Data I/O becoming more integrated into their overall supply chain in a much broader and strategic way. So, I'm encouraged by that overall. These things take time obviously to develop, but this to me is again one of the indicators that we're coming out of the COVID freeze. People want to talk about what they can do to become an even greater company and how Data I/O can help them out.

Orin Hirschman, Analyst

Actually, two quick very quick follow-ups. One of the automotive customers for SentriX - that is the first automotive customer, is it domestic, Europe, Asia, and one of the quick questions like that?

Anthony Ambrose, CEO

It's North America-based.

Orin Hirschman, Analyst

Okay. And final quick question; in terms of the secular trends within auto, is there something new going on that's really causing the tailwinds in the auto business for you? For example, ADAS or something where you're being used more than in the past because it makes sense on that specific new application?

Anthony Ambrose, CEO

I think we've indicated in some of the earlier calls, we've had a strong position in Infotainment for a while, and that continues to be strong with the second generation and third generation of products. I think Electrification is probably the new interesting thing in terms of demand picking up. Everybody is talking about electrification. Advanced Driver Assist is obviously still very big. Connectivity and security; everything in automotive is pointing towards a massive increase in semiconductor content. We've been talking about that for a couple of years, and I think the shock of COVID and then the automotive industry going down, canceling orders, and struggling to get supply chain back, it just highlights how important semiconductors are in automobiles. It's not a short-term thing. It's a very long-term secular trend. We're also getting the benefit of a cyclical rebound right now, but we're bullish over the long term.

Orin Hirschman, Analyst

Is there any one auto application that's new that's a driver here?

Anthony Ambrose, CEO

Again, if I had to pick one, I'd say Electrification. But I don't want to pick one; I want to pick them all.

Orin Hirschman, Analyst

Got it, okay. Let me allow other people to ask again. I really appreciate it. If anything, I will queue up the question.

Anthony Ambrose, CEO

Thanks, Orin.

Operator, Operator

And this will conclude our question-and-answer session. I'd like to turn the conference back over to Anthony Ambrose for any closing remarks.

Anthony Ambrose, CEO

All right, thank you very much, operator. I'd like to thank everyone for participating today. Before we close the call, I'll just remind everyone we will be at the Needham Conference, I believe that's May 18th. And our Annual Shareholders Meeting will be on May 20th. Thank you very much everyone, and have a good evening. This closes the call.

Operator, Operator

Ladies and gentlemen, the conference has now concluded. Thank you for attending today's presentation. And at this time, you may disconnect your lines.