Good afternoon and welcome to the Data I/O Corporation Second Quarter 2020 Financial Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Jordan Darrow. Please go ahead..

Thank you and welcome to the Data I/O Corporation’s second quarter 2020 financial results conference call. With me today are Anthony Ambrose, President and Chief Executive Officer of Data I/O and Joel Hatlen, Chief Operating Officer and Chief Financial Officer of Data I/O.

Before we begin, I would like to remind you that statements made in this conference call concerning COVID-19, 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 the impact from the COVID-19 pandemic along with the expected reopening and recovery efforts within the supply chain and among our customer base, 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. Now I would like to turn the call over to Anthony Ambrose, President and CEO of Data I/O..

number one, keeping our people and their families safe; number two, keeping our facilities safe and secure; number three, serving our customers, with COVID-19-related customers as our top priority.

Further, as I noted in last quarter’s call, we believe our business and operational strategies have proven helpful as we manage the effects of the pandemic. Under the circumstances, during the better part of the past 6 months, global commerce has been anything but predictable.

In addition to COVID-19, there have been increased trade and geopolitical tensions. Expectations in general have been then reduced, and our performance in the second quarter reflected those reduced business conditions.

As an essential supplier to the medical and aerospace industries, Data I/O has remained open for business in China, the United States and Germany. Within our markets, we have seen recovery in China and some encouraging signs in EMEA. Southeast Asia and the Americas are lagging in terms of recovery from COVID-19.

Overall progress is happening in fits and starts, and this is impacting capital equipment markets all over the world. During the second quarter, COVID-19 negatively affected many of our customers in our business. Capacity-related purchases were being deferred, while new technology-related purchases and process improvements continue.

We saw many automotive manufacturing facilities temporarily closing in the second quarter, delaying equipment and consumable purchases. Within automotive, the market for electric vehicles has been emerging to complement our strength in ADAS and infotainment market segments.

In the second quarter, we shipped the PSV7000 unit for use in a major European OEM’s electrification program. We also had other competitive automotive system wins in Asia and Latin America and additional UFS programming purchases.

While the traditional automotive capital market has been challenging, we experienced pockets of strength within the broader industrial and IoT electronics market as well as from other sectors.

We gained a significant new IoT customer in Asia in the second quarter, and we’re pleased to have reached the milestone of deploying our 300th PSV unit during the second quarter. This is a major milestone for that program. Our SentriX initiatives saw continued progress with our channel partners in the second quarter.

For a programming center partner, we won a significant opportunity in utilities and smart metering. On the semiconductor side, Cypress and Infineon Technologies Company announced in July the production availability of its PSoC 64 Standard Secure Amazon Web Services microcontroller.

This MCU provides secure IoT device management that enables OEMs to safely deploy applications and handle data at scale. We’ve been a partner of Cypress for a couple of years on the PSoC program and are very excited about this announcement. These are just a couple of the highlights in our SentriX ecosystem in Q2 and illustrate its growing presence.

The basic tenets of our success over the years have been well and continue to be rooted in our technology and prudent financial planning with realistic expectations.

Data I/O has built a sustainable and resilient business to withstand down periods, such as the one we’re in, and then to flourish from a proven operational leverage as conditions improve.

The last market cycle upswing for Data I/O was based on our capital equipment and consumable business lines, whereas the next cycle upswing will also include and benefit from our SentriX platform. At the end of the second quarter, we had $13.3 million in cash and no debt.

This provides us with ample liquidity so that we may be flexible in these challenging times and remain committed to our long-term growth objectives. With that, I will turn it over to Joel Hatlen, our Chief Operating Officer and Chief Financial Officer.

Joel?.

Thank you, Anthony. Good day to everyone. Net sales in the second quarter of 2020 were $4.7 million as compared with $5.8 million in the prior year period and $4.8 million in the first quarter of 2020. Second quarter 2020 bookings were $5 million as compared with $5.1 million in the second quarter of 2019 and $4.3 million in the first quarter of 2020.

On a geographic basis, international sales represented approximately 93.8% of total net sales for the second quarter of 2020 compared with 89.6% in the 2019 period.

Total capital equipment sales were 53% of revenues; adapters, 28%; and software/services, 19% of revenues through the second quarter of 2020 compared with 61%, 24% and 15%, respectively, through the second quarter of 2019.

2020 second quarter bookings composition included 49% from the automotive sector; 42% from IoT, industrial and other sectors; and 9% from programming centers. Gross margin as a percentage of sales in the second quarter of 2020 was 52.4% as compared to 61.4% in the second quarter of 2019 and 58.2% in the first quarter of 2020.

For the second quarter of 2020, gross margin was primarily impacted by fixed costs being spread over lower revenues, a less favorable channel and product mix and less favorable factory variances, especially currency related. Operating expenses were down compared to both the prior year and the prior quarter periods.

The year-over-year changes include business-level variable expenses, including lower sales commissions. Reductions in work hours, pay cuts and government assistance programs were cost-saving measures taken in response to COVID-19.

Also, due to COVID-19 limitations, we curbed travel and other trade show and other promotional activities, which led to reduced SG&A costs as compared to both the year earlier and sequential quarter.

R&D spending of $1.6 million in the second quarter of 2020 was flat compared to the first quarter and approximately $66,000 lower than in the first – in the second quarter of 2019. Partially offsetting the reductions I just discussed was higher stock-based compensation, which is a non-cash expense.

In accordance with generally accepted accounting principles, net loss in the second quarter of 2020 was a loss of $1.1 million or $0.13 loss per share compared with a net income of $127,000 or $0.02 per diluted share in the second quarter of 2019.

Backlog at June 30, 2020, was $2.8 million, up 22%, as compared with $2.3 million at March 31 and $1.4 million at June 30, 2019. Data I/O had $1.4 million in deferred revenue at the end of the second quarter of 2020, which was modestly lower than at the end of the first quarter of 2020, which was $1.5 million.

Our days sales outstanding, or DSO, a receivables collection measure, at June 30 were below our target measure at 55 days with receivables reduced by $300,000 from good collections from the end of the first quarter.

Payables were reduced to $3.5 million at June 30, 2020, from $3.6 million at March 31, 2020, and $4.1 million at the end of the prior year. Net working capital at the end of the second quarter was $18 million as compared with $18.4 million at March 31, 2020, and $18.5 million at 12/31 of 2019.

Data I/O’s financial condition remains strong with cash of $13.3 million at June 30, 2020. Our cash position is down from $13.8 million at March 31 and $13.9 million at the beginning of the year. From a financial perspective, we entered the crisis in a position of strength and remain healthy.

We believe that Data I/O is the largest company in our industry with the strongest balance sheet, and we continue to be debt-free. As previously disclosed, early in the second quarter, we implemented cash conservation and expense management initiatives.

Most of these actions are continuing during the third quarter, with expectations there will be some costs resuming as business and travel start resuming. We have not, and still do not, expect to accept funding from the SBA PPP plan in the United States. Finally, we had shares outstanding of 8,391,000 at June 30, 2020. That concludes my remarks.

I will turn the call back to the operator to begin the Q&A segment.

Operator, will you please start the Q&A process?.

[Operator Instructions] And the first question will come from Jaeson Schmidt with Lake Street. Please go ahead..

Hey, guys. Thank for taking my questions. I know it’s probably going to vary by geography. But sort of big picture, curious if you could talk about the linearity of orders in the quarter.

Is it fair to assume it’s sort of bottomed in April, better in May and then best in June?.

I think it depended, Jaeson. It wasn’t that straightforward. Probably we would have to dig in to get any linearity, and it also is dominated by the law of small numbers, certainly from a capital perspective. I think, in general, we have seen China come back fastest. EMEA, at least up until the last few weeks, has done really well as well.

Southeast Asia has lagged. And then Mexico and the U.S. have lagged as well. And we are seeing encouraging signs in those places..

Okay. That’s helpful. And then it seems like the traction with SentriX continues.

Can you remind us the number of engagements you have today? And any sort of goalposts investors should be looking at going forward? And I guess, relatedly, has the macro uncertainty pushed out this opportunity at all in a significant way?.

Well, I think the engagements we have had in terms of system deployed remain unchanged from prior quarters. We keep adding OEM customers through our channel partners. Remember, we are working predominantly through programming centers, and so there’s a two-tier distribution model right now.

We know about most of their customers, if we have to do work with them, if it’s a standard offering, they just take what we have already deployed and go forward from there. But we continue to gain customers through that channel. We did mention that we had a nice win through a channel partner in a big smart meter manufacturer.

We don’t have permission to use their name, but we are very excited about this. And then also, we are very excited about Cypress’ announcement of their PSoC 64 family product that supports the Amazon Web Services integration.

We think that’s another big step forward, and we have been a very good partner of Cypress, which is now an Infineon company, for a couple of years..

Sort of in follow-up to your question was we actually had a couple of SentriX that we had planned to get installed in the late first quarter, second quarter time frame. And the COVID-19 actually shut those down and deferred them until later, hopefully, this quarter. And we will see how it goes.

But yes, the COVID-19 did have an impact in terms of getting some new systems installed..

Okay. That’s helpful. And the last one for me, and I will jump back in the queue, I know you outlined a number of factors that impacted gross margin in Q2.

How should we think about it going forward? Can it get back to that sort of mid-50% level?.

That would certainly be our kind of expectation. So we had – I would say currency were probably the most surprising one. We just really hadn’t planned for the dollar weakening like it did during the quarter.

But the other piece is we are continuing to still have a small impact of tariffs and depending on which channel it is as to whether it’s distributors who you get your revenue net of the distributor discount versus domestic sales, which are generally a rep sale and have selling commissions associated with them.

So yes, there is an expectation that we will improve in our gross margin, but we won’t be getting into the high 55s, in my mind, and above..

Okay. Thanks a lot, guys..

Thank you. Jaeson..

[Operator Instructions] The next question will come from [indiscernible] Smith with LBJ Capital. Please go ahead. .

Yes. Hi, thank you. Congratulations on the deployment of the 300 PSV system.

Can you review the different models and what they are used for and then talk about the IoT deployments in Asia and how that worked out?.

tray, tape, tube, input, output, etcetera, laser marking, 3D inspection, all the things that someone may want to have to not only do programming but media transfer, inspection and marking. We also have the PSV5000, which is more of a standard, I will call it, the 4-door sedan or maybe now the 4-door SUV of the market.

It supports a broad range of customers all over the world that have, I will call it, standard programming needs. And then the PSV3000 is our entry-level product targeted for price-sensitive customers in emerging markets.

All the handlers have the same Data I/O software, the same look and feel, the same access to our programmers, the FlashCORE and the LumenX. So the customer can really mix and match exactly what they need based on things like annual programming volume, capacity and features beyond programming that they wish to do at the same time.

And then the second question on IoT in Asia. Yes, we had a new customer. We worked with them. I was very pleased with our sales team’s efforts during the pandemic. It’s pretty hard to get a sales call face to face these days. And we were able to work with the customer. They purchase multiple systems, and we look forward to a long relationship with them.

We don’t have permission to use their name, but it’s a nice win for us, especially in a challenging quarter..

Thank you. I have a couple other questions if you don’t mind. Typically, you get about 25% or more revenue from services and maintenance, which is sort of, like, recurring consumable sales.

Can you drill down on the amounts for the second quarter, including adapter sales, and what we can expect when the automotive sector picks back up?.

Yes. So I wouldn’t draw any long-term conclusions from Q2. In Q2, we saw a number of our automotive customers actually shut down their factories. And factories that are shut down don’t order consumables. And so there’s a dibit, if you will, in some of the consumables orders in Q2.

Services held in there pretty well, all things considered, and CapEx was obviously down. Going forward, we think adapters and other consumables will get back to more normal order patterns. The CapEx market will recover when people feel confident ordering capacity again.

And then, again, we think services and software is a pretty steady part of our business..

Okay. I had a question on SentriX as well.

Do you consider this to be a platform technology? And I was curious who are your key partners and how the economics work as this service gains more traction?.

Sure. We have a pretty good summary of the partners and the platform. Yes, we do consider it a platform. It builds on our core programming technology with some very comprehensive security additions that are protected by patents, trade secrets and know-how. And we have had that deployed now for a couple of years.

The ramp was a little bit slower than we had anticipated to be perfectly frank about it, predominantly because the initial set of tools were more difficult to use than we would have liked. We have had a major enhancement to our platform that makes it much easier to use, as we have talked about in prior quarters.

This was all about simplifying and scaling in 2020, at least when we started the year. I think the scale part will be delayed a bit due to COVID-19, but we are on track for the simplification.

And we are also starting to see better performance on the marketing side from some of our partners, indicating that they have completed a lot of the parts of the solution where we rely upon them. So it’s a good part of our business, and it’s a long-term part of our overall investor value..

Lastly, on the previous question, you touched on this, and you responded a little bit. I just wondered if there’s any more detail you can provide regarding the launch in the second quarter of Cypress in Amazon Web Services. Specifically, how critical is Data I/O’s SentriX machine for this application? And that will be it for me. Thanks. .

Yes. We have been a partner with them, and we provide the hardware for that program via SentriX through not only working with Cypress, which is an Infineon company, but also their partner, Arrow Electronics. And again, that’s a great partner.

I would encourage you to go look at the announcements, the webinars that are out there, and that will give you a real good idea of exactly the specifics of the product, why they are excited about it and then, obviously, why we’re excited about it..

Thank you..

[Operator Instructions] And the next question will come from Steve Spence with RBC. Please go ahead. There is suspense as your line is muted on your end. Alright we are still unable to hear you we will suspense and we will move on to our next question and that is from Art Winston with Pilot Advisors. Please go ahead..

Hi, guys.

Is there any reason that you could think of to conclude that the worst of the order intake is behind us and that we’re going to do the same or better going forward? Or is there’s just no way to know?.

Art, that’s a $64 question. I think we had a pretty good Q2 all things considered, especially with automotive shutting down. I think it really comes back to the new technology purchases where people have to buy something or absolutely compelling purchases on a process improvement are moving forward and capacity purchases are not.

And again, just given the nature of our business, the funnel mix from quarter-to-quarter will bounce around between various types of projects like that. So again, we’re optimistic in certain parts of the world, and we are cautiously optimistic in other parts of the world..

Does the gear-up on the part of certain customers in electronic vehicles have any bearing on your business?.

Absolutely. We have been telling you for a long time that automotive electronics is a big part of our business. Relatively speaking, it was down probably at the lowest point in, what, Joel, two or three years in Q2 because again, a lot of the automotive electronics plants were closed. But the – we’ve talked about infotainment.

We’ve talked about advanced driver assist. We’ve talked about connected cars and mobility. And I think electrification presents another great opportunity for Data I/O as cars get more and more – either through hybrid technology or 100% electric, that becomes a bigger part of the overall mix in the market.

Just on a personal note, my fiancé swapped out her 15-year-old car for a 4-year-old hybrid. And that thing has just tremendous performance for a car. It’s fun to drive. And the electric motor is a much faster response than even some of the best turbochargers I’ve driven. So they can be a lot of fun, not just environmentally sound.

And maybe someone will figure out how to market that at some point..

Thanks and good luck guys..

The next question will come from Mark Spiegel with Stanphyl Capital..

Thank you. Just wanted to follow-up a little bit on the last question, which is about electric cars since that seems to be what the stock market, frankly, is going nuts over these days.

Is the electric car business additive to you guys? Or is it basically just substituting machines you would have sold that would have gone into internal combustion cars?.

Well, Mark, it’s the – I’ll go back to what I’ve talked about in automotive for years on electronics. If you’re in the tire business, an electric car is a swap for an internal combustion engine as long as they have four wheels. What you find is, in the newer technology, there’s a much greater reliance on electronics content.

So it would be the equivalent of having eight tires in a car instead of 4. Why more electronics content? Well, there’s a lot more software. There’s a lot more – there are a lot more complex systems to control.

If you have a hybrid, you are actually adding an electric motor and an internal combustion engine and then also adding elements to control the interaction between the two. You’ve got dynamic energy recovery on the braking, for example. So you’re adding all these different electronic subsystems that require intelligence.

And as we’ve talked about in the past, where there’s intelligence, there’s code and where there is code, there is bits to be programmed. And that’s our business. So overall, the more interesting they make the car, the better off Data I/O is..

So in a pure battery car, obviously, you don’t need all the intricate stuff controlling the engine to meet emissions requirements, whatever.

Is there still enough extra electronics even net of the, let’s call it, the simplicity of the car that it’s additive for you guys?.

Have you driven a Tesla?.

Sure..

What do you think about all the electronic systems they bolted onto that electric motor?.

Well, I don’t, no. I mean, yes..

Well, no, think about it for a second. So you’ve got the infotainment system. You’ve got all the sensors for advanced driver assist. You’ve got additional complex software for, ultimately, autonomous driving. You’ve got the interactions for a connected car for media, right, all the real-time updates, mapping, right, all that other good stuff..

So basically saying, regardless of the simpler power train, there’s so much other stuff going into all cars that it’s net additive for you, it sounds like you’re saying..

Exactly. And we talked about infotainment and advanced driver assist. I think we’re going to be adding electrification and as a nice theme for us going forward..

Terrific. Thank you very much..

Thank you, Mark..

And the next question will be from Steve Spence with RBC. Please go ahead..

Thank you very much I wonder if you could – I appreciate the comments on the auto industry. It was part of my question for me. Second part of the question was are there other applications in the sense that you see out on the horizon for the technology that is not being – where your technology is not being used today..

locks, lighting, thermostats, appliances, et cetera. And so those are the two big market segments that we believe will power the growth..

And does the cloud fit into that equation on some of them, I would assume?.

Yes, absolutely. And it’s a couple of things because a lot of these IoT devices, people could care less about the device, what they want is the information and then the analytics behind the information to enable decision support.

So for example, if I put a bunch of meters on factory equipment, I really don’t care about the meters on the equipment, what I want to know is if the meter is telling me that I’m going to need to do preventive maintenance on machine 25 in a couple of days, otherwise, it’s going to break down.

And to do that, you need to have the information move off of the premise into the cloud, and it has to be done in a secure way.

That provides opportunities not only for programming of data, which we do, but the fact that, that data must be securely managed means that any firmware updates for the devices also need to be securely managed, and that’s really where our SentriX platform shines.

So again, the two big markets there have a presence both for data and security deployments, which we offer in our product line today..

And are any of those products being sold today? Or is this still in the earlier stages of development and, for example, at Apple watches and phones and so on, mass market?.

Oh, no. We have active deployments with IoT today both in our data programming line, the PSV family of products as well as SentriX, which is our secure deployment platform. There are customers out there today..

Market penetration today, do you have any sense of that? I know it’s hard when the markets – I’m not defining the market very well.

But do you have sense of that?.

Well, the market for IoT is big, and we’re small. So I guess our penetration is pretty low right now, and our job is to make it go up..

Okay.

Last question for you, can you comment on the competitive environment today?.

The competitive environment has changed a little bit overall. What we find is some of the people that were competitors maybe five years ago have fallen by the wayside. Some of these competitors, they don’t just go away. They sort of fade away slowly. We remain the largest company in our industry.

Our balance sheet gives us the flexibility to take a more long-term view than some of these other companies. We have seen some that were – some of the smaller companies in Asia have fallen behind and almost to the point of being a zombie. And – but the – we still have aggressive competitors both domestically and internationally.

And so I think compared to, let’s say, 5 years ago, there are fewer viable competitors, but at the same time, they are enough where we have to be on our toes all the time..

Okay, thank you very much..

Thank you..

And our next question will come from Avi Fisher with Long Cast Advisers..

Thank you. Congrats, Anthony, on your engagement..

Well, thank you..

How many SentriX platforms – did you say there are five units deployed?.

That’s correct, Avi..

So just you’ve elaborated on the market opportunity ahead with electrification, IoT, many others and medical devices.

Can you talk about your expectation on how you’ll meet that demand either by unit sales or by SentriX deployments?.

Sure. So we commented on 300 PSV systems sold this quarter. And so that gives you an idea of the installed base. And that installed base is predominantly in places like automotive suppliers, EMS suppliers and programming centers.

SentriX with five units, we believe, going forward, the idea would be that when the market picks up, if demand explodes, we have an opportunity that we didn’t have before to upgrade a number of our systems in the field that are PSV systems today, we can include that, we can upgrade them to SentriX technology in half a day, okay? So if the market really moves substantially to SentriX, we believe we have a way to manage that demand without choking on it.

Having said that, I think the plan – data will far outweigh security, certainly for this year. We need to get additional engagements. The marketing engines need to pick up on not only our part but also the part of our partners for SentriX, and we’re in the process of seeing some good results there.

So it’s a combination of increased marketing, the ability to satisfy any demand that’s created very easily through an upgrade program that gives me good confidence in SentriX going forward..

Could you talk a little bit about the upgrade program? Because it’s my understanding with SentriX that it’s a – sort of a per unit, it’s a different sales model.

How would an upgrade look relative to your revenue generation?.

Well, it would be something between what we’re doing today where we place the full system and a full system sale, which we do today on the PSV. And I’ll keep the details a little bit hidden since I know a lot of my competitors are on the call. But think of it as a hybrid model..

Okay.

And your technology partner, your secure technology partner, is onboard with doing upgrades for existing systems?.

Well, we didn’t really ask permission from any third parties on our strategy for upgrades. We take care of that ourselves..

Okay, thank you for your time..

Thank you..

Ladies and gentlemen, that is all the time that we have for Q&A today. I’d like to turn the call back over to management for any closing remarks..

Thank you very much, operator. Before we close, I would like to invite any of our Chinese customers that hear this call to meet with us at the NEPCON Shenzhen trade show, which will be upcoming later this month in Shenzhen, China.

I’d also like to let investors know that we’ve been invited to present at the annual MicroCapClub Summit in September, and I hope to see them there. With that, I’d like to close the call and thank everyone for attending..

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