Data I/O Corporation (DAIO) Earnings Call Transcript & Summary

Good afternoon, and welcome to the Data I/O Second Quarter 2024 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, Investor Relations. Please go ahead.

Thank you, operator, and welcome to the Data I/O Corporation's 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, Gerry 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 I would like to turn over the call to Anthony Ambrose, President and CEO of Data I/O.

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 Gerry 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 been 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. Gerry 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 U.S.A. in Q2 and paid the associated dividend taxes. Having the cash in the U.S.A. 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. The 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 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 move 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 America and 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 Gerry Ng. Gerry?

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 financial condition remains strong at the end of Q2. We maintained 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 30, 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 30 is maintaining a steady day 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 3 percentage points from the 2023 prior year level due largely to lower sales volume. However, our Q2 margins were 2 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 optimization, 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 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 reporting 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 U.S. to support future strategic and operational initiatives. Overall, we remain very solid financially, 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 Instructions] The first question comes from David Kanen with Kanen Wealth Management.

Got a couple, and then I'll go back into queue. Gerry, good job on the reduction of expenses and the cost efficiencies. 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 to $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?

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 a $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, as our revenue goes from 5% to 6% to 7%, we should see a comparable and corresponding fall through to the bottom line.

Yes. The only thing I would add there, Dave, is Gerry is 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 -- it assumes kind of a normal mix and then I think comments stand.

Okay. So the next question relates to that. And again, we don't know how much is going to be direct or through distributors. But assuming a normal mix as you put it, what is the -- Gerry, what is the variable expense on the next million dollars 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%?

Yes. So Dave, I'll interject in this. I think it's primarily going to 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 that's there's not -- we're not going to burn more electricity in the factory. There might be incremental travel. There might be some incremental other G&A to build stuff depending on how much -- not G&A, as much as operations but to build the product. But again, I don't anticipate that being very much.

Yes. 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.

Okay. So -- but what I'm trying to nail down is with the variable component assuming a normal mix on $1 million delta in revenue, is it 10%, 15%? What is that approximately? SG&A will go up.

Historically, we've always told people, Dave, that the operating leverage is 40%. Given where we are, it might be better. But we've always told people, when you net everything out, that's where the operational leverage comes to.

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 completed at this juncture?

It will be smaller as we continue to kind of work through the opportunities. 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.

Okay. And then final question, I'll go back into queue, I promise. 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 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?

Sure. And I would refer you and just all investors to our latest investor material on the website. I think it looks like Slide 8 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 going to go back with a latency and unpredictable connection to go to the cloud for directions on whether you're going to take a right turn on Main Street or not. You're not going to teach the car from the cloud. It's going to have to come -- you're going to 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 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 in the various segments that I just highlighted.