Data I/O Corporation (DAIO) Q1 2018 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Data I/O First Quarter Financial Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, instructions will be given at that time. [Operator Instructions] As a reminder, this conference is being recorded. I’ll now turn the meeting over to our host, Investor Relations Manager, Jordan Darrow. Please go ahead, sir.

Thank you. And welcome to the Data I/O Corporation first quarter 2018 financial results conference call. With me today are Anthony Ambrose, President and CEO of Data I/O Corporation; and Joel Hatlen, Vice President and Chief Financial Officer and Chief Operating Officer of Data I/O. Before we begin, I’d like to remind you that statements made in this conference call concerning future revenues, results from operations, financial position, markets, economic conditions, estimated impact of Tax Reform, product releases, new industry partnerships, and any other [Technical Difficulty] 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, other 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. I would now like to turn the call over to Anthony Ambrose, President and CEO of Data I/O.

Thank you very much, Jordan and welcome everyone. I'd like to comment on 2018's first quarter results and our outlook on the overall market. Then I'll turn it over to Joe Hatlen for some more detail on our specific numbers. Our first quarter highlights includes revenues of $7.6 million up 5% over Q1 last year. $6.2 million in bookings reflecting our seasonal performance and predicted softness in programming centers. We also had major new announcements on SentriX platform including NXP, [indiscernible] semiconductor, ARM Holdings and IR assistance. We also signed up another major programming center partner on SentriX and anticipate their public announcement in Q2. We also had some nice wins at competitive accounts, we continue to look forward and capture market share expansion as customers are currently buying from competitors, or who are bringing in automated programming for the first time. We are focused on our target markets, automotive, internet of things and programming centers. Moving now towards the outlook, over the past five years we have almost doubled the Company revenues from 2012 to 2017 full year and change from a wireless focused to an automotive focused company. 2017 automotive represented just over half of our revenue and programming centers were about a quarter of our revenue. In the call last quarter, we discussed 2018 we’ll start with programming center demand lagging, on last year's rate due in part due to the strong growth of about a 150% over the past two years. As expected, we did see programming centers lag in Q1 and expect the programming centers segment to lag as well and stay soft in Q2. We also discussed our intention of increasing operating expenses in R&D and marketing to strengthen our leading position in the automotive electronics market and establish the SentriX platform. Our long-term thesis about automotive growth remains unchanged. Industry forecast of leading automotive OEMs show a 10% to 15% growth rate for semiconductors in cars. And a much larger increase of 30% to 40% growth rate in the flash memory market sharing cars. Leading suppliers such as Mercedes and and industry suppliers such as Toshiba are forecasting growth to over 1 to 2 terabytes of flash memory in cars in the next seven years. Along with this growth leading flash suppliers are planning to migrate from the technology standard known as EMMC to the next generation standard called UFS in their automotive products. We’re continuing our investments in automotive technology in all areas of our business, programming technology, handling technology, systems integration, factory automation software and global service and support. We have mapped out a multiyear strategy to extend our industry leadership in the automotive segment and keep our customers competitive as our flash demand sharply increases. For internet of things we believe that market continues to grow, but the main problem is the lack of real security solutions for the vast majority of customers. The opportunity for Data I/O is to simplify the security provisioning process and make solutions available to customers of all sizes. To do this we have developed a SentriX security provisioning platform. We are continuing to invest to lead the industry here and a potential market of nearly 4 billion units of authentication ICs, embedded secure elements and secure micro controllers in the next five years. Those numbers are courtesy of AVI Research. Regarding SentriX, we had a very big event in February at the embedded world where we won best of show in our category and demonstrated real operation of the SentriX system with our partners Infineon and NXP. We have been extraordinarily successful partnering with these leading silicon suppliers of authentication ICs and secure micro controllers. At the show and preceding the show we made several announcements of support in this area including Renesas, Infineon, NXP Arm, Cypress Semiconductor, IR Systems, Secure Things, Maxim, EVV, Silica and [indiscernible]. We expect more announcements in Q2. We are well aligned to take full advantage of our silicon partners design win and design-in efforts as they launch these new products into their distribution channels. As I mentioned earlier we also signed a contract with another leading programming center in Q1 and expect that name to be public in the second quarter. We continue to work the leading tools and security software suppliers in this eco-system to simplify and streamline security process for IoT devices. Given the traditional long lead times for new designs, 2018 will continue to be primarily a market development year for SentriX. We're very pleased with the progress made to date, which includes our first deployments. With that, I'd like to turn the call over to Joel Hatlen, our CFO for more detailed review of the numbers.

Thank you, Anthony and good day to everyone. Revenues for the first quarter of 2018 increased to $7.6 million another multi-year high for the first quarter as compared with $7.2 million for the first quarter of last year. The nearly 6% year-over-year increase was primarily result of automotive electronics demand from OEMs, many of which have been placing orders for our PSV family of automated systems. As previously expected and discussed, programming center business was down. Revenues from adapters increased to approximately $1.7 million, up $74,000 or 5% from the year earlier period. Total revenue was comprised of capital equipment 67%, adaptors 23% and software 10% in the first quarter. On a geographic basis, international revenue represented approximately 95% of total revenue for the first quarter of 2018 as compared with 90% in the first quarter of 2017. Revenue growth was strongest in Asia, which increased 38% from last year. In Americas sales grew by 3% year-over-year while Europe experienced 10% decline. Order bookings were $6.2 million in the first quarter of 2018, down from the prior year period, but seasonally remaining in a higher range than that of a few years ago due to our presence in the automotive sector. The variation in revenue percentages versus order percentages relates to changes in backlog, deferred revenues and currency translation. I'll speak more about currencies in just a moment. Data I/O had $1.7 million in deferred revenue at the end of the first quarter of 2018 compared with $1.8 million at the end of the fourth quarter of 2017. Backlog at the end of the first quarter of 2018 was $2.7 million compared with $4 million at the end of the fourth quarter of 2017 and $4.9 million at the end of the first quarter of 2017. For the first quarter of 2018, gross margin as a percentage of sales was 57.9% compared to 57.7% in Q1 of 2017. This margin profile remains within our target range of mid to upper 50s. the increase in gross margin as a percentage of revenues was primarily due to favorable product mix during the quarter as well as the impact of higher sales volume which resulted in better factory, fixed factory utilization. Gross margin was $4.4 million in dollars for the first quarter, an increase of 6% as compared to $4.2 million in the prior year period. Operating expenses were $4.1 million in the first quarter of 2018, compared to $3.6 million in the fourth quarter of 2017, and $3.4 million in the first quarter of last year. Operating expenses as a percentage of sales were 53.4% in Q1 up from 44.2% in the fourth quarter of '17 and 46.6% in the first quarter of '17. Amid our planned continued investments in automotive electronics and our next generation SentriX security provisioning platform. The operating expense increase in Q1 of 2018 over Q1 of 2017 was attributable to additional engineering and R&D spending of approximately $334,000 associated primarily with our new security provisioning or SentriX platform and other automotive related technology innovations. R&D increased 22% for the first quarter year-over-year. Sales, general and administrative expenses increased from $1.8 million to $2.2 million for first quarter year-over-year comparison. Included in the sales and marketing, we’re increased variable sales channel commissions and incentive compensation reflecting the channel mix and higher sales. The increased business development efforts associated primarily with our SentriX security provisioning platform along with trade shows and other marketing activities. In accordance with general accepted accounting principles GAAP, net income in the first quarter of 2018 was a $130,000 or $0.02 per diluted share compared with net income of $979,000 or $0.12 per diluted share in the first quarter of 2017. Included in non-operating income for the first quarter of 2017 was a gain of $210,000 from the sale of non-core Internet domain assets, included in the non-operating expense for the first quarter of 2018 was a charge of approximately a $176,000 associated with the devaluation of the US dollar against foreign currencies during the first quarter. This was primarily related to the China RMB. We've taken additional actions to reduce our exposure to US dollar amounts in our foreign subsidiaries that are required to be translated into their local functional currencies. EBITDA or interest earnings before interest taxes, depreciation and amortization, a non-GAAP measure was approximately $397,000 in the first quarter of 2017 compared to EBITDA of one $1.1 million in the first quarter of 2017. Equity compensation expense, a non-cash item during the first quarter of 2018 and 2017 was $177,000 and $97,000 respectively. Adjusted EBITDA excluding equity compensation was approximately $574,000 in the first quarter of 2018 compared with $1.2 million in the first quarter of 2017. Please see our press release or SEC filings for discussion and reconciliation of these non-GAAP financial measures. Moving on to the balance sheet, receivables of $4.4 million at the end of the first quarter of 2018 were up from $3.8 at the beginning of the year, but down from $5.3 million at the end of first quarter of 2017, despite our higher percentage of international sales during the quarter, DSO or day sales outstanding and measure of collections was very good, averaging 45 days down from 55 days for the first quarter of last year. The company's cash position at March 31st 2018 was $16.8 million down from $18.5 million at December 31st of 2017 and up from $10.5 million at the end of the prior fiscal year quarter. From the end of the fourth quarter, cash was used to pay a large portion of our annual accrued incentive compensation and 401(k) matching pension contributions due for 2017, which were larger than the prior year reflecting the strong 2017 performance. With these annual payments out of the way we expect to grow our cash balance throughout the balance of the year. 10.2 million of our cash was in United States and the balance in the foreign subsidiaries. Note that no actual subsidiary cash movement has yet taken place as part of the tax reform repatriation deemed dividend discussed on our last call. Working capital was 20.1 million, up from 19.5 million at the end of 2017 and 14.6 million at the end of last year. The company remains debt-free and had 8,275,000 and 26 shares outstanding at March 31, 2018 and no debt. That concludes my remarks, we now like to respond to any questions from our listeners on the call. So, operator will you please begin the Q&A segment.

[Operator Instructions] And our first question from the line of James Anderson with R.F. Lafferty. Your line is now open.

Congratulation on the strong top line growth year-over-year and thanks for taking my question. I was just wondering obviously you guys are seeing continued strong demand from the automotive sector and there seems to be a little bit of digestion going on in the programming center segment. I wonder how long you expect that to persist, I know you said that Q2 is likely to be a little bit soft or do you think that maybe that will be the last quarter of digestion going forward.

James thank for the kind words and we will talk a little bit about how we see Q2. In general, we have several different kinds of customers, we get the best visibility from people that own their own factories, it’s the nature of how they plan their business and probably the least notice we get is for programming center customers that you know add capacity when they needed. And sometimes they get deals that they work forecasting. We need to respond very quickly. So, in general, you know we don't see great visibility in programming centers, based on it we know right now they are still digesting, but they can turn around faster than pretty much any of our other segments.

And in terms of the increase in operating expenses to speed along market development of the centers security and provisioning platform is it sort of a new run rate going to the rest of the year, I mean I think it's up 21%, 22% where it was, is this sort of how we should be looking at the rest of the quarter, did you guys continue to invest in medium and longer-term growth.

I think that's pretty much the case know. We have some variable things that are like different travel or different R&D materials that can be a little bit lumpy between quarters. But for the most part I think that that's about as good as forward-looking pieces, you can take.

Thank you. Our next question is from the line of David Kanen with Kanen Wealth Management. Please go ahead.

First question is the increase in OpEx about $700,000 how much of that is related to your new growth initiative and then how much is just general inflation and operating expenses, and as far as the comment in the prepared remarks about expecting meaningful revenue next year in your management superior programming initiative can you give us some sense -- can you quantify what meaningful is and do you expect any revenue this year?

So Dave let me start with the second question, we do expect revenue this year and we want to set expectations about I’ll call for ramp into the revenue, we haven’t given guidance for 2019 yet and we won’t plan to do that on this call, I think on the question you had on the R&D or the contribution of the OpEx it’s -- R&D probably a little bit maybe 50%, little bit more than 50% the rest is in the marketing and business development, it’s not only to support the SentriX. Although I think that's probably a big chunk of that increase it’s also to support the growth in automotive which includes not as large flash that I’ve talked about, it includes micro controllers as well and our ability to support customers also with service and support globally. So, it’s really a combination of supporting both of our initiatives, obviously the automotive is here now and growing. And then we’ve made a big bet on SentriX for the future.

So, does OpEx go down at some point later this year after -- is there certain amount that you spend on the R&D to get the products to where they need to be or is it sort of the recurring nature?

I think the best forecast for that is probably flattish from where you see it right now. If business conditions change we have levers we can used to move it as it needs to but I think for planning purposes flat is the way to go.

And then as far as I recall meaningful revenue is that like in excess of 15% of your total revenue now, and then would you consider 15% meaningful or could it be less than that?

I understand why you want me to quantify it Dave but I'm not going to do it on this call.

Thank you. And our next question is from the line of Joel [indiscernible] Oracle. Please go ahead.

I guess I am going to sort of approach the question from a different angle, I am just kind of curious in your press release you say that in the vehicles, the flash memory could go from being approximately 50 gigabytes today to 1 terabyte by 2025 and could you translate that into what does that mean dollar per car for your guys, and then also..

So, if you look at it I would encourage you to look at some of the materials we’ve put up on our website for investor briefings. We’ve got a little bit more detail on their and some materials that we used that were originally presented by Mercedes and also Toshiba. The Flash is growing because people want more infotainment in their cars that systems that you use today that are analog or moving to completely digital systems that look a lot more like a computer or video game than the old analog systems. And these being developed by the traditional suppliers as well as some new entrants into the market. And pretty much all the semiconductor companies that have a microcontroller or a microprocessor or graphics processor capability are going after automotive business. And all that increased performance demands more memory, which you find in computing generally is you balance out IO. So, think of cars going to things like 5G you might hear that. They're going to need more memory and then they'll have more computing power to deal with all that data. So, what it means for us is if you assume that that's going to go up to 30% to 40% a year, that would be the growth in bits that would be available to us. Now we don't think that we're going to be able to hold the average pricing per bit that we have to today. Given all that growth we're going to have to come up with a very aggressive plan to provide increased performance to our customers. But we should be able to capture a reasonable portion of that 30% to 40% that allows our customers to make the investments in Data I/O in a very cost-effective way and allows us to participate in the growth. That's how we look at the flash market for automotive. And that's part of the reason why you seen us continue to make the investment we made in things like our UFS flash products which I should have mentioned earlier one just one I award in Shanghai, at the Shanghai -- event. So that's why we're so excited about Flash memory in cars just at one piece of the automotive business.

And I'd like to just add one of the other big trends in driving is the [indiscernible] so that the advanced driving assist systems and that sort of autonomous car type transition, that's going to get big user of that memory. And then the other piece is we've been able to articulate to our automotive customers the roadmap that we have particularly with our UFS strategy and how our current PSV technology will be able to help them have a roadmap and path to go from today's production standards to that terabyte type level of data.

Okay, that helps a lot. So, do you actually price your service by the bit. I mean is the average price per bit going, is that how you guys actually…

No, when customers make a decision, believe they look at the lowest total cost of programming. Because they can use our technology, they can use competitor systems that fundamentally use the similar type of technology or they can use alternative methods to program parts. And the best way to evaluate those is to look at essentially what does it cost you to put all the data into a part. We started using this several years going with our customers and it helped them understand why buying a Data I/O system might be more cost effective then using end of line programming or programming off site. And we continue to use those metrics with our customers. What we're trying to say here is that we believe with this massive increase in the total amount of bits to be programmed, the customers will be demanding very cost-effective ways to program that. So, on a per basis, the cost will come down as it often does in semiconductors. We think that the total value of the programming segment will go up given the substantial increase in capacity required.

Thank you. And we'll go Arthur Winston with Pilot Advisors. Your line is open.

Hi Tony. I was curious what the relationship is with all these partnerships you announce every month with the semiconductor companies to future sales and profits. What does this partnership mean exactly?

So, Arthur if you look at what we've announced that we have relationships that we've announced with essentially three different kinds of companies. So, the first would be semiconductor companies and the semiconductor companies, the ones who build the products that we provide, the programming and security provisioning service on those products. I should say support on those products. So, for example, Infineon has the OPTIGA and Trust X authentication ICs. We provide the support for those, so customers for those products can get security provisioning done on a data centric system. For NXP, for example, we support the A70 and A71 authentication ICs. For Maxim we support the deep core family. And we just announced that we will be supporting the future Cypress Semiconductor PSOC 6 and we've announced support already for the Renesas Synergy family of secure microcontrollers. So those are products and as those companies sell their products, they create demand in the market as they sell the products for those products to have security provisioning done. So that's a very important partnership. The second set of partnerships are in what we call franchise distribution with programming centers and we've announced publicly can use their name, Avnet, Avnet Silica and EBV, which is an Avnet company. They provide the design win and design-in support for customers as well as the programming services that they actually do the programming work using their SentriX equipment. And then the third set of partnerships is around companies that are, I'll call them security experts in ecosystem partners. These are people that don't necessarily directly by or specify data IO but they are very influential in the market. So that includes people like arms systems. We've announced that we're working with them to support their platform security architecture. This is a very important strategic announcement because PSA is arms methodology that they'll be deploying to the arm licensees on the next generation of arm core micro-controllers that's very, that's several years out. But you know, we're -- our goal is to make sure that when that gets deployed, those products can be provisioned on the centric system. We also work with companies like Secure Things, which is now part of IAR systems, IAR systems is as leading tool supplier, we work with them because customers need to use design tools to get their board level products done and validated and by working with IAR we greatly simplify the handoff, if you will, from the design phase in the tools market to the manufacturing in first article phase and provisioning. So really the partnerships are designed as part of a comprehensive strategy to put together the entire ecosystem that's necessary to deploy security provisioning. You have the silicon suppliers. You have the distribution channels and you have the security experts and fellow travelers if you will that allow us to make our product more effective.

In the case of the semiconductor partners, I don’t understand what they get out of it, I assume the sales from SentriX could be what’s the advantage to Cyprus or [indiscernible].

Sure, the advantage to the semiconductor companies is really twofold. Number one of the current technology that you can use the provision security is really effective only at a wafer level, which means it's very good for markets that are highly concentrated in customers that have very high predictable volumes. It’s not really effective for smaller customers, customers with unpredictable demand or customers that have special use cases. So, we provide them with a way to offer the security capabilities they already build into the silicon to an expanded set of the market that happens to be the market profile, it fits the Internet of Things, a lot of small customers. It is very different for example then the mobile market, which is highly concentrated. So, we are offering access to allow the silicon suppliers to sell more value on the silicon they've already designed and enable a service for security provisioning through their channel partners that allow them to create a much higher value product within their existing channel.

[Operator Instructions] Our next question comes from Jaeson Schmidt, Lake Street Capital Markets. Your line is now open.

I apologize if this is already being addressed but just curious if you could pick a step back and look at the big picture market. If you could comment on how and if your visibility has changed over the past three months through the year of the whole.

Jason, good to hear from you. I think our visibility is I wouldn't say it's changed dramatically other than you were three months into the year. As I mentioned earlier on the call, the programming centers tend to be the least predictable and demand to respond on a shorter leash automotive can be a bit more predictable but you see this across all the industries in capital equipment. For the most part, people are booking and shipping within the quarter, you see this, not only in programming systems, but increasingly in the tester market. And so, you know we built our business around that capability. So, we like to have things visibility is something that we don't have a whole lot of visibility outside of the maybe the current quarter.

Okay that makes sense and then wondering if you've seen any significant changes in the competitive landscape at all.

Changes I think the competitive landscape, what we see is thanks to us talking about automotive for years on the on these calls, we do run into people in automotive, most of the opportunities for us well known in that industry. But everybody's trying to go after that space right now we’re focused on making sure that we can continue to be the preferred supplier across automotive and we are also running into situations now where we are able to get into places that maybe we haven’t been in before. Because they understand that Data I/O offers such a compelling product in automotive. As I mentioned earlier, we do have a focus on not only supporting our current good customers but also may be educating the customers that have not yet purchased the Data I/O system or customer locations that have not purchased the Data I/O system. Why that would be a really good thing for them to do? So, market is very competitive today. I anticipate it will stay very competitive in the future.

We’ve a question from Avi Fisher with Long Cast Advisers Advisors. Please go ahead.

Can you talk a little bit about when the SentriX systems and you see the revenue ramp, as I understand it the way you recognize revenue is going to change a little bit, can you just talk about what that looks like next year?

So, Avi I think as we get revenue I know there’s some new accounting rules Joel, 606. I don’t think that’s going to be a big change for us.

I think the real change is whether or not the current go to market strategy, which is to say, we would like to make sure that there's almost no barriers to adoption. So we’re placing these machines out there as opposed to selling them like a cap equipment sale and trying to go on a tapered use models to take the customer's risk out but that also has a benefit to us if that’s something that’s able to take hold, greatly increasing our recurring revenue streams. So that is the process by which we’re looking at trying to get the revenue ramp done over the next year year-and-a-half.

When will we know if that’s kind of working or if you’re going to stick with this test or strategy or…?

We have contracts right now, so it’s working right now.

So, the revenue you’re seeing from the SentriX model is not coming from the capital sales. It’s coming from a per chip per unit sale?

Well we get per unit but we also -- we might be able to charge maybe some NRE, consumables, things like that. So, I think you're seeing just the CapEx contribution of SentriX would be substantially lower and the recurring piece to be substantially higher.

And then finally, I appreciate the answer there, can you talk a little bit about any substantial uses for your cash, any appetite from the board to resume the buyback?

I think most of the people on the call know we’ve done buybacks in the past, we’ve no buyback plans buyback plans right now, and I think that's probably the best thing I can say on the cash.

So, in regard to that we do have a policy that we actually don't comment about that until we actually have something to say, so I think you have just to stand, board and listen.

And I’ll turn it back to our speakers for any closing remarks.

Okay great thank you very much operator. I’d just like to thank everyone for joining us, and before we close the call I’d just like to remind everyone that our annual shareholders meeting will be May 21st at 10 O’clock in the morning here at Data I/O in Redmond, Washington. Please come by if you can and please vote your shares prior to that meeting. With that I’d like to close the call. Thank you very much.

Thank you. And ladies and gentlemen, this conference call will be made available for replay [indiscernible] today April 26th at 7 pm Eastern. The replay of the conference runs until May 10th at Midnight Eastern. You can access the AT&T teleconference replay system by dialing 1-800-475-6701 and entering the replay access code 446996. International participants may dial 1-320-365-3844 with the access code 446996. The numbers again are domestic 1-800-475-6701 international callers 320-365-3844 and the access code for the replay 446996. And that concludes our teleconference for today. Thank you for using AT&T executive teleconference. You may now disconnect.