Data I/O - Q2 2024

Transcript

Operator (participant)

Good afternoon, and welcome to the Data I/O Second Quarter 2024 Financial Results Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Jordan Darrow, Investor Relations. Please go ahead.

Jordan Darrow (Head of Investor Relations)

Thank you, operator, and welcome to the Data I/O Corporation Second Quarter 2024 Financial Results Conference Call. With me today are the company's President and CEO, Anthony Ambrose, and Chief Financial Officer and Vice President, Jerry Ng. 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, supply chain expectations, estimated impact of tax and other regulatory reform, product releases, new industry partnerships, and any other statements that may be construed as a prediction of future performance or events are forward-looking statements, which involve known and unknown risks, uncertainties, and other factors, which may cause actual results to differ materially from those expressed or implied by such statements.

These factors include uncertainties as to the impact on global and geopolitical events, international trade regulations, order levels for the company, and the activity level of the automotive and semiconductor industry overall, ability to record revenues based on the timing of product deliveries and installations, market acceptance of new products, changes in economic conditions and market demand, part shortages, 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 forward-looking statements. And now, we would like to turn over the call to Anthony Ambrose, President and CEO of Data I/O.

Anthony Ambrose (President and CEO)

Well, thank you very much, Jordan. I'll begin my formal remarks by addressing our second quarter 2024 financial and operational performance, and then I'll turn over the call to Jerry Ng for a more detailed look at the numbers. As we mentioned in the release, bookings and revenue were soft in Q2 and below our expectations. This wasn't monolithic, however, as we saw divergent business conditions across our sales regions and various markets. Throughout the first half of the year, Asia and EMEA sales regions are performing ahead of expectations as the Americas have substantially below plan. By market, we saw strength in programming centers, industrial, IoT, and EMS, and weakness in the automotive sector. We continue to have strong traction in new customer acquisition, with 8 new customer and location wins in Q2, for a total of 13 year to date.

Most of these were in the IoT, industrial, and EMS markets, supporting edge AI applications. This has contributed to our bookings of $13.7 million in the first half of the year, increased slightly from $13.3 million over the prior year period. At the same time we're winning new business, we saw significant pushouts from existing automotive customers who are planning capacity additions, primarily in North America. While system capacity demand slowed, we still saw good bookings for adapters and software and services. Together, they reached 49% of our revenue year to date. Included in that is our SentriX security provisioning platform, and that set a record for units processed by our programming center partners in the second quarter. Moving along to spending, we made significant progress on spending controls, process efficiencies, and reducing direct product costs.

Jerry will go into more details on the spending side, but we are pleased with the progress made in Q2. We're focusing on long-term structural efficiency improvements, including deploying AI and machine learning capabilities and other tools to accelerate these efficiency gains. Our balance sheet remains very strong. We moved cash from China to the USA in Q2 and paid the associated dividend taxes. Having the cash in the USA gives us more flexibility on the balance sheet, as well as an opportunity to earn more on our cash. Looking to Q3 and Q4, all of us are wondering when automotive demand returns. We still see a long-term secular growth in electronics content in cars and view the recent softness as inventory corrections and a change in mix from EV to hybrid and internal combustion engine models.

Automotive nameplates are recalibrating or at least taking a measured approach to their investments in EV development and related capital investments. An example of this is Ford moving their Super Duty production to Oakville Assembly Plant that was originally meant for EV trucks to Super Duty trucks, which is an internal combustion engine product. Political uncertainty around U.S. policy, as well as hopes for an interest rate reduction going forward, may also be holding back capital additions in our customer base. Recent statements by automotive OEMs, Tier 1s, equipment suppliers, and semiconductor companies do not indicate a snapback in automotive demand in Q3 however. Our historical experience shows auto electronics demand moves sharply once they decide to add capacity. We have the capacity in our manufacturing plant in place to move quickly once demand returns.

We also have the right technology for our automotive customers as they begin to add more capacity. This includes recent new releases for our UFS programming technology, as well as entry-level programming trends.... Our focus will continue to be on the things we can control, attracting new customers, making continued progress on spending and cost controls, and being ready with the right products for customers as their capacity needs return. Despite the softness in North American automotive, there's still a significant amount of contractual backlog that's expected to be shipped and recognized as revenue in the second half of 2024. As we ship this backlog, we look forward to benefiting from the operating leverage in our model, especially given the progress made on managing costs and expenses. With that, I'll pass it over to Jerry Ng. Jerry?

Jerry Ng (CFO and VP)

Thank you, Anthony, and good day to everyone. I look forward to outlining and elaborating on our recent financial performance in more detail. My comments today will focus on key points of interest for the second quarter of 2024, and our perspective looking forward, including our progress on spending efficiencies, unit cost reductions, and balance sheet management. Despite the current automotive market headwinds, Data I/O's financial condition remains strong at the end of Q2. We maintain a strong backlog heading into the second half of 2024, a healthy balance sheet, and a lower operating cost structure, which will contribute to improved financial performance as the markets recover, as Anthony commented on earlier. Despite the second quarter revenue shortfall, cash remained relatively steady at $11.4 million as of June thirtieth, down $559,000 from the $12 million at the end of Q1.

Cash benefited from continued strong customer collections and lower operating expenses, which were offset by a $337,000 tax related to a $3.4 million cash dividend repatriated from our China operations. Accounts receivable, at $3.3 million as of June thirtieth, is maintaining a steady days sales outstanding, or DSO, at 55 days, and very low credit loss exposure. Inventory, at $6.7 million, increased from $6.4 million from the beginning of the quarter on lower Q2 sales volume and anticipation of higher sales volume and backlog reductions for system deployments in the second half of 2024. Overall, net working capital at $17.6 million at the end of Q2, declined slightly from the $18.1 million at the end of Q1, 2024. The company continues to have no debt.

Moving to the income statement. Second quarter revenue, at $5.1 million, was down 32% compared with $7.4 million from the prior year period, reflecting sluggishness in the Americas region and extended timing of our backlog conversion to shipments. Second quarter bookings were $5.7 million on strong opportunity conversion in Asia and Europe, as Anthony indicated. Our consumables, software, and services, at 49% of total year-to-date revenue, have provided a steady base of recurring sales, helping offset the current CapEx system softness in the Americas region. Finally, ending Q2 backlog at $5.4 million has increased by $2.6 million from the beginning of the year. Moving on to gross margins. Q2 was at 55%, down three percentage points from the 2023 prior year level, due largely to lower sales volume.

However, our Q2 margins were two percentage points higher than the preceding Q1 2024 quarter, from improved product mix and favorable cost control efforts. The improvement reflects ongoing initiatives to reduce material, manufacturing, and service costs. Product value reengineering, sourcing optimizations, quality improvements, and process streamlining have all contributed to the overall improvement and sustainable impacts. Similarly, I'd like to address the progress we have made on operating expenses. Second quarter operating expenses were $3.3 million, down $886,000, or 21%, from the prior year, and down $757,000, or 19%, from the preceding quarter. Core personnel, facilities, IT, and other outside services costs declined through prioritization of critical initiatives and overall efficiency improvements.

This lower and efficient cost structure has allowed the company to partially mitigate the current revenue decline and will contribute to improved financial performance when the overall market conditions and related system shipments improve. The company incurred a net loss of $797,000 for Q2, compared to a net income of $300,000 in the second quarter of 2023. Again, the decline was due largely to lower revenue, a foreign tax expense for cash repatriated from China, which was partially offset by significantly lower operating expenses and higher interest income. A foreign withholding tax of $337,000 was incurred in China from a $3.4 million dividend paid from our China operations to our parent company in the U.S.

This was undertaken to, number one, optimize the cash position and operating needs of each operation, increase the interest earning potential of our overall cash holdings, and ensure available liquidity in the US to support future strategic and operational initiatives. Overall, we remain very solid financially, with a strong cash position, no debt, and the ability to navigate market opportunities and challenges. Looking ahead, our contractual backlog is expected to be shipped and recognized as revenue in the second half of 2024, as well as leveraging the progress we have made in managing costs that I've discussed earlier. That concludes my remarks for the second quarter of 2024. Operator, would you please start the Q&A process?

Operator (participant)

We will now begin the question-and-answer session. To ask a question, you may press star, then one on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star and then two. At this time, we will pause momentarily to assemble our roster. The first question comes from David Keenan with Keenan Wealth Management. Please go ahead.

David Keenan (Financial Adviser and Director)

Hi, good afternoon, guys. Thanks for taking my questions. Got a couple, and then I'll go back into queue. Jerry, good job on the reduction of expenses and the cost efficiencies, and I'm assuming there's a sustainable benefit to gross margins on a go-forward basis as volumes increase. My first question is, in theory, if revenues were to increase, let's say, from $5 million-$7 million, with the various measures that you've taken in cost of goods, can gross margins get into the high 50s, even 60%, based on significant volume increases?

Jerry Ng (CFO and VP)

Yes, I believe we can. Let me give you a good example. For our current quarter, our revenue was at $5 million, and our operating income was at $400,000 loss. We typically get a 60% fall through on revenue. To the extent that we can maintain our efficient cost structure, we should see, again, a similar future, 60% fall through on revenue increases. So, correspondingly, you know, as our revenue goes from five- six-seven, we should see a comparable and corresponding fall through to the bottom line.

Anthony Ambrose (President and CEO)

Yeah, the only thing I would add there, Dave, is, you know, Jerry's right. It just depends on the mix, the location of the revenue. As you know, we have different margin structures, and we sell through distribution versus selling direct. So just, you know, it assumes a kind of a normal mix, and then I think comments stand.

David Keenan (Financial Adviser and Director)

Okay, so the next question relates to that, and again, we don't know how much is gonna be direct or through distributors, but assuming a normal mix, as you put it, what is the—Jerry, what is the variable expense on the next $1 million of revenue? So let's say, for example, revenues were $6 million instead of $5 million. On that incremental $1 million, what is the variable component? Is it 10, 15%?

Anthony Ambrose (President and CEO)

Yeah. So Dave, I'll interject on this. I think it's primarily gonna be related to, obviously, the sales expenses, and that's the primary variable component. And again, if we're in a situation where we sell directly, those expenses will be higher. If we go through distribution, they'll be lower. But you know, that's. There's not... We're not gonna burn more electricity in the factory. You know, there might be incremental travel, there might be some incremental other G&A to build stuff, depending on how much, not G&A, so much as operations to build the product. But again, I don't anticipate that being very much.

Jerry Ng (CFO and VP)

Yeah, just to add to that, again, material costs, freight, logistical costs, commissions, those are typical variable expenses associated with revenue activity. And again, if you kind of follow our typical, leverage fall through on revenue, we should get a beneficial impact.

David Keenan (Financial Adviser and Director)

Okay. So but what I'm trying to nail down is, with the variable component, assuming a normal mix on that, on a million-dollar delta in revenue, is it 10%, 15%? What is that, approximately? Because SG&A will go up.

Anthony Ambrose (President and CEO)

Historically, we've always told people, Dave, that, you know, the operating leverage is 40%.

David Keenan (Financial Adviser and Director)

Uh-huh.

Anthony Ambrose (President and CEO)

Given where we are, you know, it might be better, but we've always told people, when you net everything out, that's where the operational leverage comes to.

David Keenan (Financial Adviser and Director)

Okay. And then, guys, are there incremental expense reductions or efficiencies that we should see in the back half of the year, or is everything complete at this juncture?

Jerry Ng (CFO and VP)

It will be smaller, as we continue to kind of work through the opportunities. A lot, a lot of these initiatives we have, have some short-term as well as longer-term benefits, particularly on material cost reduction, that may have a longer-term but more sustainable impact. So we expect some continued improvement, as we move forward.

David Keenan (Financial Adviser and Director)

Okay, and then final question, I'll go back into queue, I promise. You know, a lot of hype around artificial intelligence. So, Anthony, if you could sketch out for us the impact of AI on your business. I know you're you guys are using it, but also, can you talk about various enterprises using AI, their deployment of it, and how that affects your business and the opportunity, if any?

Anthony Ambrose (President and CEO)

Sure. And I would refer you and just all investors to our latest investor material on the website. I think it looks like slide eight has some of this conversation and a little bit better graphics. But in short, Dave, there's a series of applications that we've identified, and others use the term as well, called Edge AI. And it's built around a set of products that will require AI implementations to become better, but they will not be able to leverage the AI capabilities in the cloud. And I'll give you an example. So for an automotive application, this would be ADAS, Advanced Driving Assist. You're not gonna go back with a latency and unpredictable connection to go to the cloud for directions on whether you're gonna take a right turn on Main Street or not.

You're not gonna teach the car from the cloud. It's gonna have to come... You're gonna have to learn as you go. There are other applications around smart cities, industrial automation, a lot of the smart metering applications we've talked about, a whole set of other IoT applications, smart homes, et cetera. Now, those applications benefit Data I/O in a number of ways. We've talked a lot about automotive and ADAS and the demand increase that we see there. The code size gets bigger. The minute you add AI or machine learning components, right, you just, you just increase the code size. It also ensures that you're developing newer platforms, replacing some of the older platforms that may have even smaller code size, which again, is good for us.

So the whole AI market that I think will benefit Data I/O more directly is in this segment called Edge AI and in the various segments that I just highlighted.

David Keenan (Financial Adviser and Director)

Got it. Thanks, guys. Good luck.

Anthony Ambrose (President and CEO)

Thank you, Dave.

Jerry Ng (CFO and VP)

Thank you.

Operator (participant)

The next question comes from David Marsh with Singular Research. Please go ahead.

David Marsh (Equity Research Analyst)

Hi, guys. Thanks for taking the questions. So I guess we just started on the automotive side. I mean, you guys specifically said that the Americas is weak. Could you just kind of give us a little bit of a, you know, broader global landscape? You know, I thought you guys had some pretty promising opportunities in China and perhaps India. Maybe you could just talk about those a little bit.

Anthony Ambrose (President and CEO)

Yeah, Dave, so basically, most of the promising opportunities in Asia closed as we expected. Asia is far ahead of their plan for the year, and that's, you know, been on strength in Q1 and Q2, including some strength in China. The Americas, by contrast, it's gone from, you know, a fiesta to a siesta. We've seen. I haven't seen any deals that we know of that went to competition, but they just all got pushed out. And in my checks with, you know, other channel partners, other companies in similar industries, they're seeing a very similar set of activities.

Automotive, after really two big years for us in Mexico, they're just digesting the capacity, and I think trying to figure out, you know, how much they're gonna build in Mexico, how much they might have to build in the U.S., depending on the election. And then also, you know, there's talk-- there's been talk of interest rate reductions. And, you know, corporate CFOs like to pay, you know, 4.5% for something instead of 5% for something if they can. And so I think that's also contributed to some of the potential waiting. You heard comments from Ford, Stellantis, NXP, some of the Tier 1s, really talking about also a product rotation.

So I think all that contributes to, "Hey, let's run the factory with what we've got as long as we can." And then, as you know, our experience is with, especially with the automotive guys, they always seem to come in when they're ready to buy, with demands where I need it right away. We saw that in 2016 and 2017. We saw it in 2020 and 2021. We had a little mini bump, I think, 18 months ago. And so when it comes back, I think it will come back fairly rapidly. But I'm telling you, it was, you know, among the roughest quarters for a region I've ever seen, just in terms of everything got pushed out.

David Marsh (Equity Research Analyst)

Okay, that's, that's really helpful. And then just, you know, obviously, you gotta wait for the 10-Q for the breakdown on revenues, but, can you just give us some sense directionally, with regard-- I guess, specifically with regard to the kind of software-centric business. You know, that's clearly the line you really want to see your growth in because it's kind of more recurring. Can you just talk a little bit about, you know, specifically what's going on there? And I mean, there were -- I did catch some comments there, but I didn't get a lot of details. So just, can you just give us a sense of-

Anthony Ambrose (President and CEO)

Yeah. So from a shipments perspective, we had record units processed by our programming center partners on SentriX. Okay? And, you know, that continues a pretty steady upward ramp there. It's, you know, it's a question of when you look at the SentriX and software overall, combined with our consumable adapters. I don't know if it's a record, but it's pretty close to one if we... I have to go back and look, but it was 49% of our revenue in the first half. And, you know, that's typically been running 43%, 44%, I think, for the year last year. So we talk about a long-term goal of 50/50 split between recurring revenue and systems. We almost hit that so far this year. Now, admittedly, that's because the systems orders were down a bit.

But, you know, it indicates the strength we have in the consumables, which when you combine that with some of the things Jerry's doing on expense reductions, will help us, you know, continue to preserve cash when we have a systems divot, and then be ready to have a couple of really good quarters when the demand turns around.

David Marsh (Equity Research Analyst)

Okay, thank you. And then just one quick last one. I mean, and I'm not trying to read anything into this. I mean, I understand that there was an opportunity there to repatriate that cash from China, and you did it, but that's not by any means, you know, kind of an indicator that you feel like your China business is slowing or, you know, you're not gonna need as much cash over there to support the business operation. It's just you had an opportunity and took advantage of it. Am I reading that correctly?

Anthony Ambrose (President and CEO)

You got it. You know, as Jerry indicated in his earlier comments, we have substantial operations in the U.S., China, and Germany. It's fundamental that we maintain working capital to support those operations flawlessly, and, you know, we continue to do that. But as he indicated, the benefit for us, even though you have to pay the tax, is you get the flexibility of having it in the U.S. and opportunity to earn a little bit more on interest. So, you know, when we just talked this with the board, it's pretty clear, let's go ahead and repatriate the cash and move on.

David Marsh (Equity Research Analyst)

Got it. Okay. Thanks, guys. I'll, I'll yield to other callers. Thank you very much.

Anthony Ambrose (President and CEO)

Thanks, Dave.

Operator (participant)

The next question comes from Kevin Garrigan with West Park Capital. Please go ahead.

Kevin Garrigan (Equity Research Analyst)

Yeah. Hey, Anthony and Jerry. Thanks for letting me ask a couple of questions. Anthony, just to clarify, so in Q1, you had said that your bookings had seen strong demand across all end markets. So compared to three months ago, automotive companies are just kinda waiting to see how things play out in the market, like interest rates, as you mentioned, are they noting a significant decline in demand at all?

Anthony Ambrose (President and CEO)

Yeah, Kevin. I mean, it just disappeared in Q2 in North America. I mean, I can't... You know, I wish I could come up with a softer way of explaining it, but that's basically what happened.

Kevin Garrigan (Equity Research Analyst)

Yeah. No, that makes sense. Okay. Yeah, that, that's what I was kind of wondering. Okay. And then you, you sound pretty confident that you're gonna fulfill backlog orders in the second half of the year. So, I mean, does your backlog consist of non-cancelable orders? Or what kinda gives you the confidence that these orders won't get pushed out or, or canceled?

Anthony Ambrose (President and CEO)

You know, some of the terms are non-cancelable, some are not. But the way our industry has traditionally behaved is people don't cancel orders on us once they place an order, okay? We had one exception when COVID hit and shut down, literally one customer that canceled it four hours after they sent us the order. But, you know, knock on wood, we don't see behavior where customers come in and cancel. Now they have the right to do so under our standard terms, up until we ship, but, it's not something that's, you know, plagued us.

Kevin Garrigan (Equity Research Analyst)

Got it. Got it. Okay, that makes sense. And then just as a last quick, a last quick question, on Dave's question earlier regarding Edge AI. I know automotive and ADAS are, you know, large markets for you guys, but, you know, I would say ADAS might be taking a little bit longer than, you know, expected. Is there another application that you're kinda seeing take off more now, for Edge AI?

Anthony Ambrose (President and CEO)

Well, I went over the list earlier a little bit around, you know, certainly the smart metering. We've won a number of deals there. IoT factory automation, we had a number of factory automation wins over the past couple of years. And, on the new customer, new location wins, I mean, it's skewed more towards everything besides automotive and including Edge AI, in Q2 with the 8 wins. I think, auto was 2 of the 8. So yeah, I mean, it's. It has not displaced automotive. I'm not gonna go that far. I think we're. You know, automotive will come back, hopefully sooner rather than later, but it does represent some interesting growth opportunity for us, and, you know, we're gonna continue to dig a little deeper on that.

Kevin Garrigan (Equity Research Analyst)

Okay, perfect. Thank you.

Anthony Ambrose (President and CEO)

Thank you.

Operator (participant)

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.

Anthony Ambrose (President and CEO)

Well, operator, thank you very much. I'd like to thank everyone who asked questions. And at this point, I would like to-