Data I/O Corporation (DAIO) Q1 2014 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Data I/O First Quarter 2014 Financial Results Conference Call. [Operator Instructions] I'll now turn the conference over to your host, Mr. Anthony Ambrose. Please go ahead.

Thank you, and welcome to the Data I/O Corporation First Quarter 2014 Financial Results Conference Call. With me today is Joel Hatlen, Vice President and Chief Financial Officer of Data I/O. Before we begin, I'd like to remind you that the statements made in this conference call concerning future revenues, results from operations, financial position, economic conditions, product releases and any other statement 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 levels of orders, ability to record revenues based upon the timing of product deliveries and installations, market acceptance of new products, changes in economic conditions and market demand, pricing and other activities by competitors and other risks including those described from time to time in the company's filings on Forms 10-K and 10-Q with the Securities and Exchange Commission, press releases and other communications. The accuracy and completeness of forward-looking statements should not be unduly relied upon. Data I/O is under no duty to update any of these forward-looking statements. Before I turn the call over to Joel to discuss the numbers in more detail, I'll add a few comments. Q1 was strong across the board for our bookings. We were up sharply from Q4 2013 as bookings continued their strong upward momentum through Q1, and this has continued into April. Europe was stronger, and our customer mix was much broader compared to last year's first quarter. Our backlog of $2.6 million at the end of Q1 positions us well for sequential growth. I'm especially pleased to see European strength and increased purchases of the PSV7000. The PSV7000 is doing extremely well. During the quarter, we introduced and sold additional media options on the system. We also won 2 more global industry awards, including the Programming Award at APEX, which is a North American trade show in Las Vegas; and the EM Asia award at the Shanghai NEPCON event, recently in April. Winning in China against fierce local and global competition shows the true breakthrough capability of our system and the clear industry leadership and performance in small-parts handling for the PSV7000. We now have won PSV7000 system orders on 4 continents, indicating global appeal. We're winning deals in competitive situations versus our traditional competition in automotive, programming centers, industrial and consumer markets worldwide. We won with the PSV7000 in a highly competitive situations where the customer value Data I/O service and support, as well as a significantly better overall performance and small-parts handling capability of our system. Our traditional customers like the system, as it is faster, more precise and less expensive than previous automated handlers from Data I/O. I'm especially pleased, however, with the reaction from new or inactive customers. Over 50% of the PSV7000 opportunities presently in our sales funnel are from new automated customers or customers that have not purchased automated systems from us in 5 years or more. They especially like the industry-leading small-parts handling capability and reduced total cost of ownership versus the competition. Clearly, they see something in the PSV7000 they have not seen from Data I/O before, and this gives us an opportunity to gain market share and grow the company. Operationally, our team did a very good job to deliver in Q1 and are ramping capacity to deliver Q2. We're starting the quarter with significant backlog, and April was a strong bookings month as well. We do expect to have some of this backlog carry over into the third quarter. Finally, let me talk a bit about industry trends. Our investors are aware that we participate in growth markets, including automotive electronics, consumer devices, smartphones, tablets and entertainment systems. We're seeing a lot of press today about the so-called Internet of Things. This refers to an increasing amount of intelligence and connectivity in devices that were previously standalone. Some examples include smart home automation, wearables, smart grid, sensor networks and similar types of devices and applications. All of these devices need to be programmed. The total available market is expected to move from about $10 billion today to $50 billion over the next 5 years, according to The Economist magazine. While we supply solutions to this market today, we're looking at how best to participate in this explosive growth. Our customers will not only be choosing between Data I/O and our traditional competitors, but between us and substitute methods for programming. Our recent advances in reducing the total cost of programming help us here. We have the technology to program these Internet of Things devices and applications. And we make this technology even more attractive by making it the most secure, managed and cost effective way to program the Internet of Things. You'll hear us talking about more of these trends at upcoming investor events and future earnings call. With that, let me turn it over to Joel Hatlen, our Chief Financial Officer, for a more detailed review of the numbers.

Thank you, Anthony, and good day to everyone. Net sales in the first quarter of 2014 were $4.82 million, up 1% compared to $4.76 million in the first quarter of 2013 and up sequentially compared with $3.33 million in the fourth quarter of 2013. Net loss in the first quarter of 2014 was $343,000 or $0.04 per share compared with a net loss of $459,000 or $0.06 per share in the first quarter of 2013. On a regional basis, net sales increased 50% in Europe, while declining 11% in Asia and 20% in the Americas compared to the first quarter of 2013. International sales were 88% of total sales for the first quarter of 2014 compared to 93% for the first quarter of 2013. Orders for the first quarter of 2014 were $5.8 million, up 21% compared with $4.8 million in the first quarter of 2013 and sequentially up 55% compared to the fourth quarter of 2013. As Anthony noted, we had strong bookings of our new PSV7000 automated programming system during the quarter, as well as PS388 systems and adapters. Backlog was $2.6 million at March 31, 2014, compared to $900,000 at March 31, 2013, and $1.9 million at December 31, 2013. Deferred revenue was at $1.5 million at March 31, 2014, and $1.2 million at December 31, 2013. Gross margin as a percentage of sales in the first quarter of 2014 was 51.8% compared with 53.4% in the first quarter of 2013. The gross margin percentage decreased as a percentage of sales for the first quarter, was primarily due to unfavorable variances and a less favorable product mix. Operating expenses decreased by $160,000 in the first quarter of 2014 compared to the first quarter of 2013, primarily due to cost control and restructure actions, offset in part by higher sales commissions related to the channel mix. Note that first quarter operating costs include seasonally high public company cost. Earnings before interest, taxes, depreciation and amortization, EBITDA, was a loss of $178,000 in the first quarter of 2014 compared to an EBITDA loss of $292,000 in the first quarter of 2013. Equity compensation expense, a noncash item, in the first quarter of 2014 and 2013 was $85,000 and $70,000, respectively. Adjusted EBITDA excluding equity compensation in the first quarter of 2014 and for the first quarter of 2013 was a loss of $93,000 and $222,000, respectively. Please see our press release for a reconciliation of these non-GAAP financial measures. During the first quarter of 2014, cash declined by $1.6 million and accounts receivable grew by $1.6 million, primarily due to late in the quarter shipment and 2 large distributor payments that were not received until April 1, totaling $659,000. The company remains debt free. As of March 31, 2014, the company had 7.79 million shares outstanding. At this time, I'll turn the call back to Anthony.

Thank you, Joel. At this point, I'd like to open up the line for questions from our investors.

[Operator Instructions] We do have a question from Arthur Winston from Pilot Advisors. All right. We will move to the line of David Kanen with Aegis Capital.

First question is in regards to the operating expenses. I had the expectation that they would be lower. I know you said sales commissions -- third-party sales commissions were the main item, as well as public company costs. Can you quantify how much in commissions? And then was there any severance in there related to the last restructuring?

So we had about $12,000 of additional restructuring costs, which was a little bit of severance and some legal fees that came from the final true-up of the restructure back in the fourth quarter. So just a small amount there. With regard to your other question, with regard to the commission expense, that represented about $241,000 for the quarter. If you compare that to last quarter Q4, it was up about $105,000.

I see. Okay. So going into the balance of the year, Joel, with the restructuring behind us, public company costs mostly in Q1, will OpEx get below $2.6 million in subsequent quarters, barring anything unforeseen?

So let me answer that question in 2 parts. So for Q2, we know that based on our backlog, we're going to continue to have a fairly high mix of commission-paying channel orders. So I expect that we'll have a higher commission rate like this quarter in Q2. If I look at a normal -- or what I'd call our normal-type commission blend and things like that, that would have us below the $2.6 million, as you mentioned, in the latter half of the year.

Okay. So somewhere between $2.8 million and $2.6 million, is that fair?

I just didn't say -- I didn't say the actual dollar amount, but we will get below $2.6 million in the last half of the year, assuming we have a normal...

But, Dave, the thing is it's tougher to pin down because, for example, if -- expenses could go down, for example, if we don't sell anything between now and the end of the quarter. Obviously, we hope that doesn't happen. But if flip side happens, we have a very strong quarter and we're able to get that out the door and pay commission on it, then expenses could go up. That's probably the single biggest variable we have in the commissions. I think, Joel, we're not expecting any major changes on G&A, other things. But the sales commission is still a little bit variable for us only 1 month into the quarter.

The other one that's a little bit variable and -- is R&D materials, depending on the phase of development during the quarter. And I do expect that we'll have a pretty good development expense during the quarter.

Okay. Getting back to the sales commission though, which channel is this coming from where you're paying these additional commission? This is -- these are through distributors or VARs?

You have distributors, Dave, typically that gets -- that's not booked as a commission expense. If you have representatives or direct sales, they would earn commissions on sales.

So for example, in the first quarter, we had particularly significant commissions in Latin America and we had significant commissions in Eastern Europe and then we had a couple other orders that had a commission associated with them that would've normally been a distributor sale.

Okay, okay. Next question relates to the PSV7000. Can you tell me, percentage-wise, how much of the PSV7000 sales are coming from the automotive sector, in particular? And then what other verticals are purchasing that product?

Dave, I think I might have talked through that already in the prepared remarks. We've seen a very good broad adoption, automotive programming centers, industrial and consumer. Automotive is by far the biggest set of opportunities for us because those customers value the precision of the system, the quality and the fact that they can reuse their existing adapters and algorithms without having to change them. They just take advantage of the much better handling capability of the system and better value of the system. But we have opportunities that are very broadly distributed for the system because of its capability. But automotive is the single largest market opportunity for us in our sales funnel right now.

Okay. And then I was glad to hear you refer to the opportunity with the "Internet of Things" and giving us some statistics and so forth, which is definitely exciting. Is this a product that can monetize that? Or is -- or do we really need for a lot of these lower-cost products -- do we need a lower-cost programming solution? And then to that point, how far away are we from additional new products?

So let me answer that in 2 parts. I won't talk too much about new products on the earnings call. You know my position on that. We are investing heavily to continue to develop new products. I think with the PSV7000 that's very exciting is the small-parts capability opens up new markets that we've not had access to before. And so depending on the type of devices, small-parts handling is going to be a critical factor in realizing that. The other part, and I think you pointed out, are there other types of products that we need to have there? We're looking at the overall to lower the total cost of programming. We've been able to do that substantially even with the PSV7000 for our highest volume customers. Because of the enormous throughput and capacity of the system, if you're a high volume customer, you've lowered your total cost of programming 30% or 50% in some cases. We believe that, that's the right metric that should be used to evaluate how best to compete. And you can do that by lowering the cost of handlers. You can do that by increasing throughput. You can do that by increasing your program or speed. You can do that by adding more capacity to the system. There are a lot of ways to do that, that all contribute to reduce the total cost of programming. And we've been able to establish some very interesting metrics there. With the PSV7000 now fully loaded, we're able to be at a lower total cost of programming than our manual solutions, even in the lowest labor cost markets. And that's the first time that, that's really happened. So we're excited about that, and we think that gives us even more opportunity in automated handling.

Again, I'd like highlight the fact and commend you for it that you got a new product out the door, created it, got it out the door and ramped it, in really what I consider to be record time and almost unbelievable, unheard of in the industry. So I just wanted to highlight that and congratulate you and your team. The last question, just, Joel, a housekeeping question. What was the share count, I didn't get to -- go through the income statement. I don't recall what it was.

So the share count at the end of the quarter was 7.79 million.

[Operator Instructions] We do go back to the line of Arthur Winston with Pilot Advisors.

Anthony, I was wondering why the -- what's the opportunity in the United States to increase the sales and increase the sales -- restart the sales of our new product? It seems like in the United States, it hasn't going on as much.

Art, that's a really good question. I think a couple of factors there. The United States is a different kind of market, really, in 2 ways. The market for programming tends to be smaller volumes and also has a very efficient programming center capability. We have not done traditionally very well in the programming centers in North America. With the PSV7000 and the small-parts handling capability, we see that changing. And I'm very excited about the opportunities we have in programming centers in North America. And maybe just encourage you to stay tuned to this channel, we might have more to say in the next quarter call.

Excellent. And is it being built in by more of these European manufacturers than the Asian ones so far?

The PSV7000?

Yes.

Yes. I think Europe was extremely strong for us in Q1, Art. And that was across the board, automotive programming centers, industrial customers, just really, really pleased with the uptake of the system. And I'm excited about the team we have in Europe right now on the sales side, and they've really embraced the PSV7000 and been excited about it as well. And then in other regions as well, I think Joel mentioned earlier, Latin America has been very strong for us.

Our next question is from private investor, Tom McGuire [ph].

My question, I just have one, is if you use a baseball game as an analogy for Data I/O and the PSV7000, what inning do you think you're in, in terms of its growth cycle potential, et cetera?

Well, I think Tom [ph], that I'd answer that we're in the early part of the game, might be the first or second inning. You look at a product like this, it will probably have a 10-year -- certainly 5- to 10-year usable life cycle. Just based on the systems we've had, the experience within the past, the 388, the 588 have had about a 10-year life cycle. Joel, is that about right, maybe 10 to 12?

Yes. So the equipment itself is long life. 7 to 12 years is a very common result in the field. However, we typically provide upgrades to programming engines and different capabilities of the machine that generally take place every 3 or 4 years. So it's not something that we don't get a constant stream of capital spending associated with these machines.

Right. But you ought to think of it as early in the game, Tom [ph], and you ought to really think of the PSV7000 as a platform. We can do very interesting things with it, again, because of the capacity and the small-parts handling.

For the next question we go back to David Kanen with Aegis Capital.

Just a follow-up on the backlog and deferred revenue. I know backlog was up from like $900,000 to $2.6 million. What percent of that do you expect to recognize in the current quarter? And then deferred revenue, I know was also up to $1.5 million. Is that primarily maintenance contracts? And will -- when you -- when I see $1.5 million in deferred revenues, does that mean over the next 12 months or you have longer-term contracts?

So we do have a little bit of longer-term contracts. And if you're looking at the balance sheet, they would be -- the majority of what's in the long-term liabilities are the second year maintenance kind of contracts. With regard to the deferred revenue as a total, it's primarily contracts. But this quarter, we had 1 system just under $300,000 that was shipped but not -- and invoiced, but not able to be recognized because they hadn't finished their acceptance testing of the machine. So that remained in deferred revenue. We believe that, that one would be recognized in the next quarter, but we already know that there might be another one that's going to be in that same situation at the end of the second quarter. So I do believe that they'll have a pretty high amount of the backlog that gets recognized, but there is probably, I don't know, maybe 1/3 of it approximately that is likely to be not recognizable until the third quarter.

So the majority of it will be recognized in Q2?

Yes, that is correct.

Okay. And then not to get like overly, overly granular, but, Anthony, you talked about the momentum and acceleration of orders -- momentum of orders carrying into April. Was there an acceleration or more or less it's the same pace or pickup that you saw throughout Q1?

April was very strong, Dave.

And for our next question, we have a follow-up from Arthur Winston with Pilot Advisors.

If order intake remains firm, would it intersect as a good thing and the cash position of the company not grow because you're financing the receivables and, in effect, the shipments?

Art, I think in general, over time, if we stay at high volumes, we'll have positive EBITDA, which means the cash position ultimately should grow for the company. It really depends on the timing, not only of when we get the orders but when we ship the product, when we can recognize it, when we invoice and when we get paid. So it's really a lot of factors. And these typically have a way of not neatly lining up to quarterly boundaries. That as Joel mentioned earlier, for example, we had a very large payment come in the first day of April. Great, we got the cash, again, in Q1. So we're not too concerned about that. Our working capital position is very strong, and so we're able to go after the business and use the working capital to fuel our growth. But over time and certainly when you look at it at a monthly or quarterly snapshot, it can swing pretty wildly.

As your tenure with the company matures, what new opportunities that you haven't realized until now are beginning to surface?

What we've talked about, Art, on the new opportunities, I hinted at this Internet of Things. That's a very longer -- much longer-term opportunity. I think the one in front of us that we're seeing right now is to continue to activate some customers that have been long-term Data I/O customers but perhaps inactive and also meet with new customers on the PSV7000. Also, as we lower the total cost of programming, I think that makes more customers available to us, not only in the United States and Europe, but also in Asia, where I would like to grow our business. And that market tends to be very focused on initial acquisition costs. And we can be more competitive there over time. So I do believe we will continue to expand our served available market meaningfully this year. I believe we can grow it another $10 million in terms of markets that we have not participated in that we can now participate in, and that's a very meaningful expansion of our total available market. So that's the -- that's probably the key thing is let's go pursue more potential business. When customers talk to Data I/O or our representatives, when they evaluate a system and when we know about it, we tend to do extremely well in closing that business. So the key for us is to find more opportunities and talk to more customers and then let our natural closure rate allows us to grow the company.

And there are no further questions at this time. Please proceed.

Okay. If there are no further questions, maybe give it another 5 or 10 seconds. But I want to thank the folks on the line for the nice comments. I'll be sure to pass that along to our engineering and sales teams. They're the ones who have really done all the hard work on PSV7000. And I'm sure they'll be very glad to hear the comments. Operator, any further questions on the line?

There are none at this time.

Okay. Well, I'd like to close the call at this point, and again, thank everyone for participating and encourage everyone that's not done so to be sure to return your investor materials and proxies in time for our Annual Shareholders' Meeting on the 19th of May. Thank you very much, and goodbye.

That does conclude our conference for today. Thank you for your participation and for using AT&T TeleConference. You may now disconnect.