Data I/O Corporation (DAIO) Q2 2019 Earnings Report, Transcript and Summary

Good day, and welcome to the Data I/O Corporation Second Quarter 2019 Financial Results Conference Call and Webcast. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mr. Jordan Darrow, Investor Relations Manager. Please go ahead.

Thank you, and welcome to the Data I/O Corporation second quarter 2019 financial results conference call. With me today are Anthony Ambrose, President and CEO of Data I/O Corporation; and Joel Hatlen, Chief Operating Officer and Chief Financial Officer of Data I/O. Before we begin, I'd like to remind you that statements made in this conference call concerning 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 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. 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'd like to comment on 2019 second quarter results and our outlook on the overall market. And then I'll turn it over to Joel Hatlen for some more detail on specific numbers. For a high-level review of Q2, our revenues were $5.8 million, $5.1 million in bookings. This created a net income of $127,000 or about $0.02 a share, with our adjusted EBITDA excluding equity compensation of about $728,000. Automotive bookings represented approximately 56% of our orders year-to-date. We also note that discretionary and variable spending is down, as designed, as we're focused on continued improvements on efficiencies and profitability through the balance of 2019. During the quarter, we also strengthened our sales and marketing with the addition of Michael Tidwell to our team as Vice President of Marketing and Business Development, as well as bringing on a new channel partner in the Northeast United States Assembly Products. Our SentriX platform continued to gain ground as we brought a system online in Europe during the second quarter, this is our fifth system overall globally, and expanded our support of NXP Semiconductors, core Edge secure elements. This is our fourth unique support for the NXP product lines and their security products. Looking at Q2, our bookings and revenue were down from last year. As we've indicated, the global market for programming capital equipment has been in a down cycle that began last year. Current headwinds include reports about global automotive sales declines, semiconductor cyclicality, and global supply chain uncertainty flowing from tariffs, trade war threats, and the like, none of which are good for CapEx deployment. This is the worst CapEx environment I have seen since 2012, 2013. Forecast of when the sector will recover vary between the second half of this year and early 2020. In spite of the macro conditions, we're pleased to deliver profits, effectively manage expenses, invest in our technology and future products, and maintain a very strong balance sheet in Q2. Margin strength and expense controls led to improved earnings on lower revenue as compared to the first quarter and also last year. During Q2, we won two new deals with customers previously served by a large competitor. Data I/O’s service, support, financial stability continued to be fundamental in winning over these new customers. Our fifth SentriX system overall, third to EMEA, was brought online in Q2. And yesterday, we announced support for the EdgeLock SE050 secure element from NXP Semiconductors. This marks the fourth device we're working on with NXP, all centered around enabling IoT OEMs and electronics manufacturers of all sizes to securely provision and personalize IoT products. As I mentioned earlier, I believe we're in a capital equipment recession. This is the seventh or eighth recession during my professional lifetime in a secular 10 times expansion upward for the overall semiconductor market. While these recessions are never pleasant, good companies take advantage of recessions to improve themselves and improve their competitive position to prepare for the next recovery and up cycle. Some may think that simple spending reductions are all that's required. While we have adjusted spending to reflect our updated view of the business, that's just the beginning. We have a structured plan for recessions as we did 7 years ago. First, you maintain R&D focus on new products as these are the products that customers will buy when the cycle turns. Second, you focus on operational excellence even more perhaps than during normal times. You improve your products, finances, processes, and people, and you hone your systems for better performance in an up cycle. Third, you focus on selling everywhere with a special focus on new customer acquisition to broaden the base when the economy turns. And fourth, you continue to build your team with the best people and make it stronger. We believe the industry will cycle back as it always does. And when it does, we'll be very well positioned. We expect long-term growth in overall semiconductor content per car as well as strong growth in gigabit content of flash memory per car over the long-term. We see continued growth in infotainment systems, as well as a transition to UFS and PCI Express bus solutions and flash memory. We continue to see strong investment in security in semiconductors and a growing total available market for all types of security devices in all channels. The SentriX platform and security provisioning overall continues to be an important and highly active topic of discussion at industry conferences. We're very excited to participate in the Embedded Technologies Expo and Conference in June in San José, California. We had a strong presence with our Chief Technology Officer, Rajeev Gulati, speaking on two separate occasions during the 3-day event. One talk was on manage and secure programming for the automotive world where he addressed technologies for securing the connected car with hardware-based security for a flexible and secure, manufacturing strategy. Advancements in connected and autonomous vehicles are driving new architectural designs for control units that connect various subsystems together and expose them to the outside world over various networks. These advancements increase the risk of threat actors gaining access to the subsystems, establishing need for foundational security requirement, for hardware-based approach to securing the connected car as well as methods to inject cryptographic elements in the ECUs early in production for an end-to-end integrated and flexible security solution. The other presentation by Rajeev was on designing and deploying an end-to-end security solution for microcontrollers in a high-mix, high-volume production environment. He talked about what we view as the natural evolution of our market where high-speed data programming and security provisioning are brought together. Whether this be for automotive electronics, Internet of Things devices, smart factory floors, or just about anywhere else microcontrollers are used. The implications are powerful and we believe we have an early and substantial lead in this market. It's the reason why we continue to invest even during down cycles like the one we're in now to further develop our handling and programming technologies simultaneously with our SentriX platform. Our cash position remains strong at $15.2 million at quarter end, up from about $14.8 million at the end of Q1, even as we bought about $900,000 worth of stock as part of our current repurchase program. With that, I'd like to turn it over to Joel Hatlen, our Chief Operating Officer and Chief Financial Officer to provide more details on the quarter. Joel?

Thank you, Anthony. Good day, everyone. Net sales in the second quarter of 2019 were $5.8 million, as compared with $7.2 million in the second quarter of 2018 and $6.1 million in the first quarter of 2019. Anthony discussed the down cycle in his remarks. On a geographic basis, international sales represented approximately 90% of total net sales for the second quarter, as compared with 87% in the 2018 period. Total capital equipment sales were 61% of revenues, and adapters and consumables were 24% of revenues year-to-date in 2019, compared to 65% and 24% respectively for the full year 2018. For the second quarter of 2019, gross margin as a percentage of sales was 61.4% as compared to 59% in the second quarter of 2018 and 60.8% in the first quarter of 2019. The second quarter gross margin level exceeded the company's anticipated target model due primarily to favorable product mix as well as favorable variances primarily related to overhead and currency. For the full year we continue to model gross margins percentages in the mid to upper 50s. Tariffs have been manageable, but continue to cause uncertainty in our outlook. Operating expenses were down compared to both the prior year and the prior quarter periods. The year-over-year change is primarily related to variable expenses including lower incentive compensation accruals and sales commissions, as well as stock-based compensation. The company continues to actively engage in market development and R&D initiatives as -- for SentriX platform, while emphasizing ongoing expense management practices. Looking forward, we expect operating expenses to be reduced for the third quarter, by about $300,000 compared to the second quarter of 2019. In accordance with U.S. generally accepted accounting principles GAAP, net income in the second quarter of 2019 was $127,000 or $0.02 per diluted share, compared with net income of $486,000 or $0.06 per diluted share in the second quarter of 2018. Bookings in the second quarter of 2019 were $55.1 million compared to $7.2 million in the second quarter of 2018 and $6.2 million in the first quarter of 2019. Backlog at June 30 2019 was $1.4 million compared with $2 million at March 31 2019 and $1.9 million at June 30, 2018. Data I/O had $1.5 million deferred revenue at the end of the second quarter of 2019 compared to $1.6 million at March 31, 2019. Data I/O's financial condition remains strong with cash of $15.2 million at June 30 2019, up from $14.8 million at March 31, 2019. This includes having used $908,000 to repurchase 188,000 shares during the second quarter of 2019. Our Days Sales Outstanding or DSO a receivables collection measure stood at 51 days at the end of the second quarter which was better than our normal expectations. Net working capital at the end of the second quarter of 2019 was $19.5 million down $900,000 from $20.4 million at March 31 2019 and $20.2 million at June 30 2019. The company continues to have no debt. Finally we had 8,261,702 shares outstanding at June 30, 2019. I will be presenting for Data I/O at the Dougherty Conference in Minneapolis during the first week of September and we look forward to meeting any investors there. That concludes my remarks. I will turn the call back to Anthony.

Thank you very much Joel. At this point operator I'd like to open up the call to questions from our investors.

[Operator Instructions] Your first question comes from John Fanning with Dorrington Capital [ph]. Please go ahead.

Hey, good afternoon, guys. Thanks for the detailed overview. I got most of my numbers questions answered. I just want to dive a bit more, if I could, into maybe the longer term, realizing that we're in a very choppy situation that's fluid here in the near term on a lot of the markets that you're going after. And I just want to focus on these competitive advantages. First in automotive, if you could help me understand the transition to UFS and what this means to the market as well as who has competing products? So, I can understand the market just a bit better.

Sure. So as you probably realized in automotive, over the last five or six years, automotive has become our number 1 vertical, and I think it peaked last year at about 60% of our business. It's pulled back just a little bit to the mid-50s in the first half of the year, but obviously still represents the lion’s share of our revenue and bookings. We have, best as we can tell, a little over 100 systems deployed in automotive, maybe another 20 or 30 dedicated to automotive at various programming centers around the world maybe a bit more. So this gives us a very substantial installed base in automotive at the traditional leaders of Tier one automotive electronics suppliers as well as emerging market suppliers in new emerging markets like China. So that gives us an enormous scale advantage. So for example if a customer has three of our systems and they need to buy another system, they'd be very much inclined to simply add another Data I/O system as that is just very much easier than going and putting a second source into the factory. So that's advantage number 1. Our installed base, our global support network, our global supply network, the availability of spare parts, the availability of trained technicians, et cetera. Number two, we have a technology advantage in the equipment itself. Our handlers run faster. Our programming engines are substantially faster, especially on high-density NAND flash memory which is extremely popular in today's automotive infotainment systems and advanced driver assist or ADAS systems. The standard in use up through the end of last year was called eMMC and that's moving to a new standard called UFS which has substantially faster read performance which makes the applications that run on these infotainment systems just appear to perform much faster. And so, customers now are designing in UFS. It takes anywhere from 18 to 24 months for them to go to production. And we have a number of customers that have purchased their first few units to get early engineering work and maybe pre-production out the door, and we would expect them to be upgrading their existing systems to UFS or perhaps buying new systems when they need to go to full production. So it's a combination of installed base, better technology, global support and service. and the financial stability that automotive suppliers demand of their supply chain that gives us a big advantage.

Got it, got it. Thank you so much for the explanation. If I could just quickly touch on a couple of other items, and I hear what you're saying on the capital equipment market. It is -- it's been a very tough run over the last year to year and a half. I'm not going to pin you down with this question, but I'm just hoping to get a sense from your deep perspective and experience with this industry. Can you kind of give me a sense of the demand for equipment once it does come back? And perhaps focusing in terms of what the electronics OEMs might need to accommodate the anticipated growth in the content per vehicle?

Sure. I'd refer you to a number of industry analysts. I think IHS has some good numbers. Dan Niles through the Global Semiconductor Alliance has some good numbers on the historical relationships of the semiconductor unit and dollar shipments as well as the entire semiconductor CapEx industry. What you find is, as I said, over my career, about seven or eight complete cycles with CapEx having a higher beta than the semiconductor market. What we would expect to see over time, right, is a continued long-term secular trend, which is more semiconductor content both in cars and overall. It grows as a percentage of the total value of the products that they go into, and it's grown historically at a substantial rate in terms of total electronics content that goes into products. So those are the long-term secular trends. They're always favorable. It's just that you superimpose a business cycle on there, which can be extremely volatile, as we know, and -- so we just have to prepare for it.

Yeah. No, I can completely understand. If I could just slip in one last question here around SentriX. Can you discuss the semiconductor partners you have and which microcontrollers you are supporting on the SentriX platform?

Sure. We have support for -- let me just run down our list here; Renesas, Infineon, NXP Maxim, Cypress various products. On the microcontrollers, it would be Renesas, Cypress, and NXP. And the others would be secure elements, and there's some overlap in that.

Got it. Thanks Anthony. I know this is a really challenging cycle, but you guys seem to be well positioned for the eventual upturn, continued success.

Thank you very much.

Thank you. Your next question comes from Robert Anderson with Penbrook Management. Please go ahead.

Yes. Good afternoon, gentlemen.

Hi, Bob.

Hi, Bob.

Hi. You did not comment on what's going on with the programming centers. So I'd like to know about that? And then you said you had landed two new customers from other suppliers. I'd like to know a little bit about that? Two-part question.

Sure. So the programming centers, they were sort of not much worse not much better. I think Joel is going to tell me, about 19% is that year-to-date or is that Q2 booking?

Year-to-date of booking.

So, just shy of 20% Bob. But obviously the whole number is down. So it's -- there's just -- they're following the trend. The customers we won back were both automotive customers. These were companies that had locations that had purchased from Data I/O. But these particular locations for a variety of reasons had an installed base determined many years ago with a different supplier. They both decided for related, but different reasons to purchase the next round of equipment from Data I/O. We're very excited about that. Part of it was our natural advantage in support for the whole industry. And then one customer in particular had a specific UFS need, where we were able to meet the demand and our competitor has not yet been able to provide any UFS. So that's how we won.

Okay. Thanks. Could you also comment on the trend towards the Internet of Things? And I think in your press release you said that this was developing a little slower than you'd hoped at least with the SentriX installation. So maybe you could give us some background on that?

Sure. I think we've been pretty pleased with the partnerships we've created with the semiconductor companies. I think if you look back at our original plan that's certainly about where we were expecting maybe even a little bit better. I think the challenge has been the sell-through in order to get these products designed in at the end customer and then have the customer be able to deploy security. And we focused on what we can do which is make our product better easier to use train the people that are working with the customer, but there are also some downstream effects on how these devices and IoT get on-boarded to the Internet. There are some companies trying to simplify that. But I think that that's really been the two-part challenge. We're still very excited about where the market is going long-term and just we're powering through these challenges to break loose and get customers into the market.

And you're still leaning towards the financial model that you've talked about in the past more of a rental model than an outright sale model?

Correct. We would -- as we've talked about in SentriX in a number of calls we would anticipate that the SentriX revenue would be substantially more on a recurring basis than our traditional CapEx model, which is over a long cycle about two-thirds CapEx, one-third recurring.

Okay. Thanks.

Thank you.

[Operator Instructions] Your next question comes from Vishal Mishra [ph], Private Investor. Please go ahead.

Well, hi, Anthony. I'm new to the business, so if you could help me understand this situation, especially the long-term competitive advantage which in the earlier question he was asking. Is -- my understanding is that you -- the security IP you provision the chips and security, but the IP of the security is owned by somebody else like Secure Thingz and you provision the chips with the security. So is there like -- right now the IP is owned by Secure Thingz -- is there a chance like in what cases your customers the OEMs can develop the security IP themselves so that it's not owned by a third-party like currently? So currently, I think you occupied a position between the three people. But if the security IP instead of being owned by a third-party is owned by OEMs maybe your competitive advantage will decrease. But maybe I'm kind of thinking wrong about it, so you will correct me?

So I think on the SentriX, it's important to understand the whole product. As we do on our regular data programming business, we're responsible for the overall product that goes to the customer. Many of the components of that product we choose to build ourselves and many components of a specified function where they might be optional we choose to source those. And in some cases, we have them as a sole-sourced component. In some cases, they become multi-sourced component. So the SentriX I think the important thing to understand is we create the system, we create the software algorithm that the end customer uses to put the security information into the device. We do rely on partners for specific functions around some of the HSM functionality. But again, that's something that we selected them as a supplier a while back. And over time, we're comfortable with our situation in terms of what we do and what we acquire or buy on the market to support the SentriX platform.

Got it. The parts which you outsource can the OEM sort of develop those like software or the IP which you provision in the chips themselves? Or economics does not allow the...

So I want to make sure that I'm answering the right question. The customer in all cases owns their implementation, which could include the selection of keys and certificates. Some customers have that themselves, some choose to buy those keys and certificates from a certificate authority as an example. Customers own the firmware that goes into the product, okay? They develop that themselves. That includes all the security capabilities, the basic operation in the product and also increasingly the firmware associated with how the product is to be onboarded once it's turned on in the IoT and how is it phone home if you will to get onboarded. So there's a lot of different pieces and I think the – I just want to be clear that the end customer is responsible for the selection on things like the certificate authority all of their firmware just as we have today in the data programming model, right? We don't do the data package for customers. We make sure that their package is faithfully programmed onto their devices at high yield and low cost. So I think, if you think of the security model in that light there's some unique enhancements there, because with security you have to involve extra protection things like hardware security modules the front-end tools need to be a little bit more sophisticated. But fundamentally, we look at the problem the same way.

Thank you. Your next question comes from Avi Fisher with Long Cast Advisers. Please go ahead.

Hey, Anthony. Just two quick questions. Did you mention what the utilization was on those five SentriX devices?

No, I did not. It's – as I said in earlier calls its de minimis from production standpoint because this year as we've talked about is primarily a market development year. But we're pleased to have another win in Europe.

All right. As you – so to speak batten down the hatches for this difficult environment can you talk about how you prioritize your cash use between OpEx and buybacks? And if you'll be continuing the buybacks? Thanks.

Yeah. So, in general, the rule on cash overall whether you're in a recession or a boom right is that step one is make sure that when I look at Joel I'd say, Joel, we have enough cash from the business. Joel says, yes sir. So that's number one keep Joel happy, and support the business. And remember, when you eventually come out of a recession and get into a boom right that's when you actually start sucking down cash, because you're buying inventory to build systems and then you provide them to customers. And then they pay you, what's our DSO Joel 60 days on average?

Technically, yes.

So you can figure you're going to be feeding that machine for at least a quarter. And I just encourage you to look at what our cash did in the last boom, right? It took several quarters to catch up to the revenue numbers. So you got to have enough cash not only for today but your anticipated needs when things turn around. Because the last thing you want to do is run out of cash right when you're supposed to be printing money. So that's number one, current and projected to support the business. We always want to have the ability to look at M&A, if it's attractive. I think that's probably a pretty low probability right now. Just – it's real hard to do anything on M&A when you're in a recession unless it's just a screaming hot deal. And then the third would be, if we really think we have a lot more cash than we'd ever want to use we do things like the buyback. And we're still using – we still have room to run on the buyback we announced in Q4 of last year and so we anticipate that will continue.

And have you bought back shares yet in Q3? Can you disclose?

Yeah. We typically don't talk about what we've done in the current quarter Avi. We'll keep you posted when – probably next quarterly call on what we did in Q3. But we told you what we did in Q2 and what we have left to do?

All right. Thanks, Anthony.

Thank you.

Thank you. This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Ambrose for any closing remarks.

Well, given that questions are done, I'd like to thank everyone for joining us on the call. And at this time, I'd like to close the call. Thank you.

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