Data I/O Corporation (DAIO) Q4 2018 Earnings Report, Transcript and Summary

Good afternoon, and welcome to the Data I/O Corporation Fourth Quarter 2018 Financial Results Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Jordan Darrow with Investor Relations. Please go ahead, sir.

Thank you, and, again, welcome to everyone to the Data I/O Corporation fourth quarter and year-end 2018 financial results conference call. With me today are Anthony Ambrose, President and Chief Executive Officer of Data I/O Corporation, and Joel Hatlen, Vice President, 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 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 may 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 level 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 Form 10-K and 10-Q with the Securities and Exchange Commission, press releases and other communications. The accuracy -- such 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. I'll start by commenting on 2018's full year results, give a little bit of an outlook on the overall market, what we think about 2019 and then I'll turn it over to Joel for some more detail on specific numbers. So for the full year in 2018, we had revenues of $29.2 million and about $27 million in bookings. Net income for the year was $1.6 million, representing our fifth consecutive year of annual profitability. Our business continues to focus on automotive electronics with automotive bookings now representing 60% of our orders. We also continue to see growth in our new products. We sold about 240 of our PSV family automated programming systems through the end of 2018. Our operating model continue to perform very well. Gross margins for the year were 59.4%, growing about 7 points over the past 4 years. In our SentriX family, we closed the year with SentriX installed in 4 sites with 12 industry partners and a growing list of OEM engagements. So overall, a solid 2018. Now, when we talk about our long-term outlook, I'd like to start with the automotive electronics industry. Data I/O is a key supplier to the growing automotive electronics industry. We've said for many times on this call that we have a thesis for automotive electronics growth and that it will continue to grow and that view is unchanged, and we view it also very positively for us over a long period of time for Data I/O. We're in the midst of new and exciting electronic content, including automotive infotainment systems, instrument cluster applications, advanced driver-assist systems in support of autonomous driving and connected car strategies from leading OEMs. We also see electronics companies focusing on auto electrification and enhanced mobility. These end applications are creating significant growth for all semiconductor devices, but specifically programmable flash and programmable microcontrollers. Industry forecasts from leading automotive OEMs show about a 10% to 15% compounded annual growth rate for semiconductor content in cars and a larger increase of about 30% to 40% compounded annual growth rate in the total market for flash memory in cars. Flash memory forecast to grow to over 1 terabyte per car in the next 7 to 8 years. This growth in programmable content is a key demand driver for us and will lead to capacity additions at current customers and new opportunities as well. Furthermore, leading industry flash memory suppliers are now migrating from eMMC to UFS interfaces in automotive. UFS is faster, lower power and cheaper to build, creating this shift in demand. We won several UFS customers in automotive in 2018 and expect more wins and customers moving into production in 2019 and 2020. The Data I/O programming systems are faster, have more capacity and deliver a lower total cost of ownership than competing systems available. We are also installed in 8 of the Top 9 automotive electronics suppliers. Any of our existing PSV 5000 and PSV 7000 systems are upgradable to support UFS, giving our customers a very strong incentive to stay with Data I/O and expand our presence during this transition. We've mapped out a multi-year strategy to maintain industry leadership in automotive electronics and keep our customers competitive as our flash demand sharply increases and their demand shifts towards UFS. In addition to our previously mentioned product and technology advantages, we were recently recognized for outstanding global service and support, which is very important for these automotive customers. Our second major growth initiative concerns democratizing security for IoT devices to enable a safer connected world. Again, as we've talked about on many calls, the IoT market continues to grow but is lagging in security solutions. The opportunity for Data I/O is to simplify the security provisioning process and make solutions available to customers of all sizes. We're investing to democratize security in a potential market of nearly 4 billion units. This is a very ambitious goal for a company of our size. But we are uniquely qualified to lead in manufacturing and join with our ecosystem partners who share our vision. So why do customers need Data I/O for IoT security? Well, go back to first principles. The reason companies are creating IoT connected devices is they want to have actionable data that they can monetize. You want something connected so you can see what's going on at that site, you can understand the data and take action on it. This can be from a factory or home or car or wearable or any one of a number of other devices. Once you desire the data, you need to make sure it's correct and not tampered with, otherwise no one will pay for the data. Therefore, you need to secure the data stream and secure the software collecting and controlling that data stream. This is where we come in. Once a customer decides to secure a product, they're quickly led to a few immutable points. They need to secure their firmware from design through operation and update. To secure that firmware, they need to have secure hardware, including a secure enclave or trust zone [ph] To have secure hardware, you need to create a strong route to trust for identification and authentication. Data I/O's SentriX provisions this strong route to trust for customers of all sizes and volumes, therefore enabling the secure Internet of Things. We've been very successful partnering with the leading silicon suppliers of authentication ICs and secure microcontrollers. We've made several recent announcements of support in this area and will be demonstrating Cypress and Microchip microcontroller solutions next week as part of the Embedded World event in Germany. Last year, we won the Best of Show Award at the show for SentriX and are building upon it this year with new capabilities and partners. In addition to these demonstrations, we're presenting a jointly authored paper with the leading certificate authority, DigiCert, on the benefits of strong hardware-based security for customers who are already familiar with software-based security. We like our strategy of focusing more on near-term demand creation opportunities with SentriX. In addition to delivering the SentriX platform, we're establishing a new business model with security. We're adding pay per use to our model in exchange for reducing CapEx on SentriX systems. We believe this adds value to our customers who avoid CapEx expenses in early developing markets, and it's also good for Data I/O as we increase our percentage of recurring revenue and somewhat smooth our cyclical business. Turning to 2019. Overall, we expect 2019 to look a lot like 2018. We expect automotive to remain strong with growth in overall semiconductor content per car as well as sharp growth in the number of gigabits of flash memory per car. We see continued growth in infotainment, flash memory requirements as well as a transition to UFS. We see programming centers still absorbing capacity and expect them to be roughly flat to 2018. SentriX will expand device supports, grow our system footprint in strategic locations, gain more OEM driven leads and begin to monetize the funnel created with our strategic supports over the past couple of years. Overall, we like our sales funnel, our products, our markets and are keeping an eye on macro variables like tariffs, trade tension and the late-stage business cycle that could have a potential impact on capital spending decisions from our customers. These factors combine to give us a sales plan with single-digit bookings growth over 2018. In Q1, it feels like an 11 week quarter with New Year's and our Lunar New Year holidays both in Q1. 2019 started out well, and there's a lot of work to do in the next 5.5 weeks. Let me now turn the call over to Joel Hatlen, our CFO, for a more detailed review of the numbers. Joel?

Thanks, Anthony. Good day to everyone. Net sales in the fourth quarter of 2018 were $7.9 million as compared with $8.1 million in the fourth quarter of 2017 and $6.5 million in the third quarter of 2018. The year-over-year decline in sales was a result of the strong cyclical demands during 2017, particularly from programming center customers, while the increase from the third quarter represents growth driven in large part by demand from automotive electronics industry. On a geographic basis, international sales represented approximately 92% of total net sales for the fourth quarter of both 2018 and 2017. Europe was our strongest territory in the fourth quarter of 2018. For all of 2018, net sales were $29.2 million, down 14% from $34.1 million in 2017. Total capital equipment sales were 65% of revenues and adapters and consumables were 24% of revenues in 2018 compared to 71% and 22% respectively in 2017. For 2018 fourth quarter, gross margin as a percentage of sales was 58.2% as compared to 58.5% in the fourth quarter of 2017. The fourth quarter of 2018 level is at the higher end of the Company's anticipated target model due to a favorable mix and currency impacts. Cost reductions and manufacturing effects improved factory utilization also contributed to the strength of gross margins. These initiatives are standard ongoing focuses of our operations team. Data I/O has realized the benefit of these initiatives throughout 2018, although certain tariffs and commodity prices have partially offset the impact. For all of 2018, gross margin was 59.4% compared to 58.9% for the prior year. Total operating expense in the fourth quarter of 2018 were $3.8 million, up from $3.6 million in the 2017 period, and slightly up from $3.7 million in the third quarter of 2018. Spending on research and development, R&D, to support the Company's two primary technology platforms was $1.8 million, which is flat compared to both the fourth quarter of 2017 and the third quarter of 2018. Selling, general and administrative expense of $2 million in the third quarter -- in the fourth quarter of 2018 were up from $1.9 million in the third quarter of 2018 and $1.8 million in the year earlier period, primarily related to variable compensation. The Company continues to actively engage in market development and the R&D initiatives for its SentriX platform, while emphasizing ongoing expense management practices. Total operating expenses for all of 2018 were $15.6 million, up 4% from $15 million in 2017, due primarily to higher marketing expenses and R&D, partially offset by reduced variable compensation. Operating income was $744,000 for the fourth quarter of 2018, up from $404,000 for the third quarter of 2018 and down from $1.2 million in the fourth quarter of 2017. For the full year, operating income was $1.7 million in 2018 as compared with $5 million for 2017. In accordance with US Generally Accepted Accounting Principles, GAAP, net income in the fourth quarter of 2018 was $648,000 or $0.08 per fully diluted share compared with net income of $342,000 or $0.04 per diluted share in the third quarter of 2018 and $1.5 million or $0.18 per diluted share in the fourth quarter of 2017. Included in non-operating income is a currency loss of $98,000 in the fourth quarter of '18, a currency gain of $108,000 in the third quarter of 2018, and a currency loss of $123,000 in the fourth quarter of 2017. Included in fourth quarter of 2017 net income is a one-time net benefit recorded as a result of the Tax Cuts and Jobs Act of 2017 of $531,000. For the year, net income was -- in 2018 -- $1.6 million or $0.19 per diluted share as compared with net income in 2017 of $5.4 million or $0.65 per diluted share. Gains on sales of non-core internet domain assets contributed non-operating income of $366,000 in 2017, while the 2018 gain was $19,000. These sales are now largely complete. Earnings before interest, taxes, depreciation and amortization, EBITDA, was $881,000 in the fourth quarter of 2018 compared to $742,000 in the third quarter of 2018 and $1.2 million in the prior year period. Adjusted EBITDA, excluding equity compensation, was $1.2 million in the fourth quarter of 2018 compared to $1 million in the third quarter of 2018 and $1.4 million in the prior year period. For all of 2018, EBITDA was $2.8 million compared to $6 million for 2017, while adjusted EBITDA, excluding equity compensation, was $4 million in 2018 compared to $6.7 million in 2017. Bookings in the fourth quarter of 2018 were $6.5 million compared to $7.6 million in the fourth quarter of 2017 and $7 million in the third quarter of 2018. Bookings for all of 2018 were $27 million, down from $34.3 million in 2017 and up from bookings of $26.9 million in 2016. Backlog at December 31, 2018 was $1.8 million as compared with $4 million at the December 31, 2017 date. Data I/O had $1.6 million deferred revenue at the end of the fourth quarter of 2018 compared to $1.8 million at December 31, 2017. Data I/O's financial condition remains strong, with cash of $18.3 million at December 31, 2018, down from $18.9 million at September 30, 2018, and $18.5 million at December 31, 2017. Cash at the end of the fourth quarter reflects part of the $2 million share repurchase program authorized in October of 2018. Accounts receivable of $3.8 million at December 31, 2018, increased by $1 million from $2.8 million at September 30, 2018, and was flat compared to the end of the prior year. Days sales outstanding, a receivables collection measure, were very good at 43 days at December 31, 2018, compared to 45 days at December 31, 2017. Net working capital at the end of 2018 was $21.1 million, up from $20.6 million at September 30, 2018, and $19.5 million at December 31, 2017. The Company continues to have no debt and had 8,338,628 shares outstanding at December 31, 2018. Looking forward to 2019, we expect gross margins will remain in the high-to-mid 50% range, depending on revenue product mix, factory utilization and sales channels. At the same time, we continue to focus on COGS reduction initiatives for margin expansion as well as tariff offset. Tariffs remain a significant uncertainty with the US and China potential changes. We have planned for potential tariff changes and our possible reactions to them, which given our production in both countries gives us some supply chain and production flexibility. We are forecasting a slight decrease in our overall operating expense spending in 2019 versus 2018. We expect capital spending and stock compensation expenses to be roughly flat with 2018. As a reminder of our cash balance, repurchases are expected to continue under our stock buyback plan. Also, in the first quarter of each year, Data I/O typically pays a good portion of its annual public company costs as well as making the cash payments of its annual year-end accrued incentive compensation and 401(k) annual matching pension contribution. With that, I'll turn the call back to Anthony.

Thank you very much, Joel. At this time, operator, I'd like to open up the call to Q&A.

Thank you [Operator Instructions] The first question will come from Jaeson Schmidt with Lake Street. Please go ahead.

Hey guys, thanks for taking my questions. Anthony, just want to start with your comments on 2019 sort of shaping up to be similar to 2018. I know there's a lot of moving parts with the macro backdrop and the capacity digestion at the programming centers. But just want to clarify, do you anticipate that revenue or growth directionally being the same in '18? Or could 2019 be a growth year for you guys?

Well, I think what we said, Jaeson -- and thanks for the question. We think double digit bookings, that would give us kind of flattish as a starting point, depending on recognition, backlog, burndown all the things that come into play towards the end of the year. But there are really a couple different factors there. If it goes badly on tariffs and trade positions and we turn out to be very late in the economic cycle, that's probably too aggressive a forecast. On the flip side, if the tariff thing doesn't materialize to be a problem and the economy stays strong, there's probably some upside to that number. So I could build a bearish case and bullish case probably off that and I think we sort of split it down the middle.

Okay. I appreciate that color. And then looking at SentriX, it seems like momentum has picked up here. What tends to be the primary pushback from customers when you kind of talk with them on this product?

There is really -- the pushback is really not pushback. It's just -- I think when we look at it, customers like the flexibility of the SentriX. The semiconductor partners like it because we can do device supports fairly quickly now. The biggest challenge is getting customers that are designing new products with new silicon architectures to get them into the market and get their product ramping. I think we -- realistically, we under-called the time horizon that was going to take to get that done, and that's why you're seeing some of our focus not only being the strategic tops-down with the semiconductor partners. But also we're open for business now, and OEMs specifically come knocking on the door and they may have a device support that we haven't done previously but we can do that now as -- just as we've always done on the data side of the business. So I think that's a very positive sign for us.

Okay. Perfect. I’ll jump back in the queue. Thank you.

[Operator Instructions] The next question will come from James Lieberman with Revere Securities. Please go ahead.

Thank you. I really enjoyed the presentation. And I am especially impressed by the adoption of your technology on various platforms, especially in Europe. And I'm trying to understand from a modeling standpoint, where you see a possible acceleration of revenues? Is that something that you see like over a 3 to 5 year period because the order cycles are so long? And does it come mostly from a licensing, leasing type of technology, an add-on or is there some kind of a different model that I don't quite understand in terms of -- how you derive revenues from all these? Yes.

Sure, sure. Yes. This is Anthony. Let me try and answer your question. So with automotive, we've been saying for a while and I think we continue to believe is that, this is a very long-term secular growth pattern in automotive electronics. We see the move to autonomous vehicles, it occurs in multiple phases, which take five, 10 years to get ultimately to autonomous cars, maybe even a little bit longer. So you're going to see a consistent increase in electronic content per car, which creates demand for our products and growth opportunities for our products. So think of that as the baseline positive macro drop -- backdrop for us. The second one that's on there is much more of a market development activity for us in the SentriX and security platform. The market for microcontrollers, if you follow ABI Research as we do, is in the order of 22 billion, 23 billion units. About 12 billion of those are available for embedded design and over the next several years, 3 billion, 4 billion units of those become security components of one form or another. And ultimately, I think most of the market believes that given the recent announcements of new families of microcontrollers that all pretty much all 12 billion of those will become security microcontrollers over a 10 or 15 year period. So what we're trying to do is be on the front end of that wave as these designs happen with the capability that allows customers to securely provision these new silicon that's available to them. They haven't had an opportunity to do that one chip at a time until now, unless they were doing it, for example, at the end of the line, which is a little bit less convenient, a little bit less secure and doesn't get them really everything they need unlike SentriX. So we have a platform. We're working with our customers. We're working with people that have been programming devices for customers for decades and encouraging them to offer SentriX as a service to now securely provision these parts in addition to managing their supply chain and data programming needs. So that is very much a growth adder on top of the automotive story that -- we're looking at as being very exciting in the, not just the medium-term horizon but also medium and long term. Short term, we just have to get our first wins into production, get the market going and that's taken us some time. But we're very, very excited about where that's going to be medium and long term.

That's a very good help to understand how -- how things are going. I've been reading that the auto industry is in 2020, 2021 is going to be start transitioning from 12 volt to 48 volt batteries for those cars that have multiple supercomputers on board. And as you said, the amount of computing power being brought to bear is truly extraordinary. It's got to be right in your -- falling right in your lap the opportunities.

Yes, well, James, one way to look at it is, every time you add computing power, you have to add storage and I/O bandwidth, right. And the fact that you're not only adding centralized compute power, but you're also adding sensors and other things really creates an opportunity for us to grow the programmable market for Data I/O.

Thank you very much. It’s very helpful.

So actually another point [he] was talking about, what type of revenue it was. If you look at the automotive business, that's going to be more along our standard business model where capital equipment represents about 65% of the sales. Our consumables, primarily adapters, represent 24%, and then contract, software, maintenance and service modules [ph] represent about 11%. In the IoT SentriX world, we actually are changing things up. There are some capital equipment-related costs, but we're primarily focused on a new recurring revenue pay-per-use model we're associating with that new business.

Okay. That I was trying to understand, there. Thank you.

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

Okay. Thank you very much, operator. I appreciate everyone for dialing in. Thank you very much for attending the earnings call, and at this point it will close. Thank you.

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