Q2 2023 Data I/O Corp Earnings Call
Participants
Anthony Ambrose; President, CEO & Director; Data I/O Corporation
Gerry Ng
Joel S. Hatlen; VP, Chief Operating & Financial Officer, Treasurer and Secretary; Data I/O Corporation
David Marsh; Research Analyst; Singular Research, LLC
Kevin Garrigan; Research Analyst; WestPark Capital, Inc., Research Division
Matthew Winthrop
Unidentified Analyst
Jordan M. Darrow; Founder and CEO; Darrow Associates Inc.
Presentation
Operator
Good afternoon, and welcome to the Data I/O Second Quarter 2023 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, sir.
Jordan M. Darrow
Thank you, operator, and welcome to the Data I/O Corporation's Second Quarter 2023 Financial Results Conference Call. With me today are the company's President and CEO, Anthony Ambrose; and Joel Hatlen, Chief Operating Officer and Chief Financial Officer; as well as Gerry Ng, Vice President of Finance.
Before we begin, I'd like to remind you that statements made in this conference call concerning COVID-19, future revenues, results from operations, financial position, markets, economic conditions, silicon chip shortages, 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 from COVID-19, including the 2022 outbreaks in China, Russian war with Ukraine, including any related international trade restrictions, along with continued reopening and recovery efforts within the relevant global supply chain and among our customer base, levels of orders 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 of these forward-looking statements.
And now I would like to turn the call over to Anthony Ambrose, President and CEO of Data I/O.
Anthony Ambrose
Thank you very much, Jordan. I'll begin my formal remarks by addressing our 2023 second quarter financial and operational performance, and then I'll turn the call over to Joel Hatlen for a more detailed look at our numbers. With us today on today's earnings call for the first time is Gerry Ng, who joined the company as our Vice President of Finance on July 1. Effective August 16, 2023, he'll become our CFO, succeeding Joel Hatlen, who, as we previously disclosed, is retiring after 30-plus years with the company. Until that time, Joel will be handling the full second quarter reporting cycle and driving a smooth transition, including serving in an advisory capacity after the end of the second quarter reporting cycle.
On a personal note, I'd like to thank Joel for his many years of service to the company and its shareholders, and to acknowledge his professionalism expertise and unparalleled character. He's played a pivotal role in defining who we are today and setting us up on our future course. Our staff, customers, partners and shareholders hold him in the highest regard. And on behalf of everyone, we'll be wishing him well in retirement. As for our incoming CFO, Gerry Ng, he's really hit the ground running, and we look forward to his contributions moving forward.
With that, Gerry, would you like to introduce yourself?
Gerry Ng
Thank you, Anthony, for the introduction. I am very pleased to be joining Data I/O team and contributing to the company's continued growth and operational success. The finance team has been tremendously supportive, which I believe is a testament to the tone set by management, and we have a comprehensive plan to ensure a seamless transition. I look forward to speaking with all of you in the future.
With that, I'll pass it back to Anthony.
Anthony Ambrose
Thanks very much, Gerry. Now let's take a look at our numbers here. The second quarter was very strong, which builds on the momentum from our first quarter. Similarly, we maintain our long-term outlook that benefits from secular growth catalysts in automotive, industrial automation, and Internet of Things. I'll start with our SentriX platform where we continue to see strong and increasing recurring revenues. Numbers were strong in Q2 as customers are going into production or increasing production levels as demand for security-enabled IoT devices continue. We also got a repeat order on our SentriX platform in the quarter.
We're also benefiting from solid demand in the industrial sector. This market is being driven by robotics, factory automation advancements and increased demand for security. We also see strength in automotive electronics, which is the market where we generate the majority of our revenues. And it's clear, we're fully benefiting from demand for automotive electronics. This is a long-term continuing growth opportunity where analysts forecast semiconductor growth at 10% to 15% compounded annual growth rate through at least the end of the decade.
The midpoint of that growth are about 12% a year. This triples the size of our market. On top of this, we believe everything will need to be secured as IoT grows, creating SentriX opportunities for us in both markets. Our business model delivered strong operating leverage of about 40% to the bottom line for every dollar of revenue. For the markets we serve, we're the definitive leader and continue to strengthen our position at the top through new customer wins and investments in our products.
Let's take a look at some of the key numbers contributing to our 2Q results. Bookings were $7.6 million, growing by about 32% from the first quarter and 19% from the second quarter of last year. We added 5 new customers in the second quarter, which now brings us to 15 new customers in the first half alone. This is on top of at least 20 new customers in each of the last 2 years. Wins in Q2 include a global OEM leader for electronic vehicles. We're benefiting from very strong demand, excellent products and an improved supply chain for the automotive industry.
Our financial performance for the past 4 quarters shows the progressive factory recovery from supply chain and COVID-related challenges in the prior years. Q2 is an easy comparison to 1 year ago when we were locked down in China for much of the quarter. You'll recall that we estimated this shifted between about $1 million to $1.5 million of revenue from Q2 to Q3 of last year. Even including that adjustment, we're up substantially year-over-year in revenue, bookings and gross margin.
Regionally, we're continuing to see strong reshoring effects to North America. We also saw strength in EMEA, as indicated in our first quarter call. China has been slow in the first half, and we're expecting better results in the second half there. It's important to reiterate that demand for Data I/O products and services in automotive electronics is driven primarily by the semiconductor content per vehicle and the associated long-term growth. Having said this, strong unit momentum for vehicle growth in North America complements the secular growth in semiconductor consumption for autos and is contributing to our strength.
Third-party sources confirm strong automotive silicon demand and strong OEM demand overall within the automotive market. We've heard interesting results from Ford today. We also saw an interesting report published by The Wall Street Journal a couple of weeks ago, where it estimated that new car sales were up 13% during the first half of the year, exceeding industry forecasts. Strong unit growth has been complementing double-digit secular growth in silicon consumption per car, and this combined creates a very encouraging environment for our business as over 63% of Data I/O sales are in the automotive electronics industry.
In addition to Ford, many automotive OEMs reported strong demand in the quarter. Toyota North America unit was up 7%, GM was up nearly 19%, including strong EV growth, Mercedes said its battery electric car sales more than doubled in Q2, and all of these companies reported an improved silicon supply chain. In looking at other key players in our world, Teradyne, a semiconductor test equipment provider, yesterday reported strong sales to automotive customers in their Q2 results. STMicro reported strong Q2 results, again, highlighting the growth driven by automotive and industrial markets. While the automotive and industrial markets are strong, we're paying particular attention to EV developments as there are a significant growth catalyst for us all. Higher demand is based on consumer sentiment, regulatory stimulus and the new models being added almost daily by automotive manufacturers to their portfolios.
In addition to EV, we're also seeing some changes under the hood, so to speak, in automotive electronics. We're seeing the early days of the software-defined vehicle and includes a fundamental structure change to more compute power in fewer domains within the automotive electronics market. This gives us a great opportunity as the programming leader to continue to expand our business in this area as all of these changes require programming at increased speeds with greater and greater amounts of code and data. Data I/O is the gold standard for flash programming to address this demand in the auto industry and the smart vehicle architecture with domain controllers is an exciting growth opportunity for us all.
With that, I'll turn it over to Joel Hatlen for a more detailed look at the numbers.
Joel S. Hatlen
Thank you, Anthony, and good day to everyone. I'll start with the balance sheet and then move to the income statement. However, in my commentary today, and to set the stage for Gerry in the third quarter, we'll focus on specific points of interest and allow you to review our press release for earnings for the comprehensive review of the second quarter financials. Data I/O's financial condition remains strong in the second quarter with $11.9 million in cash, still up $400,000 from $11.5 million December 31. Cash and working capital at $18 million were approximately the same as on March 31. Receivables and inventory both declined from the end of the first quarter, while inventory had been elevated in 2022 to address potential shortage risks. We no longer see the same exposure, so we are managing operations to reduce inventory levels going forward during 2023. Days sales outstanding, or DSO, a receivables collection measure, was at 42 days as of June 30, 2023. This is better than our target range.
As Anthony mentioned, our bookings for the quarter were quite strong and were at the highest quarterly level in 2 years. For the first half of 2023, bookings were $13.3 million, up from $12.6 million in the first half of 2022. Our backlog on June 30, 2023, was $3.8 million, up from $3.2 million on March 31, 2023. As we have noted in the release, a larger share of the backlog is scheduled for Q4 delivery than is typical. Automotive electronic orders represented 63% of year-to-date bookings and continues to be our primary addressable market. For comparison, 61% of our bookings were derived from the automotive sector during the year 2022. On a geographic basis, international sales represented approximately 86.3% of revenue for the second quarter of 2023 compared to 89.2% for the second quarter of 2022.
Gross margins at 59.1% in the second quarter of 2023 were up from 57.8% in the second quarter of 2022, with margins improved by higher sales volumes on relatively fixed costs, product mix, including a recognition of previously deferred rental income as a purchasing credit, and our channel mix, offset in part by less favorable factory variances. For our channel mix, with direct sales from the Americas and parts of Europe being stronger in the second quarter of 2023 and where we can account for selling commissions in our operating expenses, we show a higher level of gross margin as a percentage of sales.
Some of the other factors came into play in our second quarter, which impacted expenses compared to our first quarter run rate, these include about $80,000 in additional R&D expenses as compared to prior quarter as we incurred spending on outside services in support of our product lines. Selling expenses in SG&A were about $60,000 higher due to a higher mix of direct sales as discussed earlier. We had additional onetime IT project and support spend as well as a hiring resulting in $110,000 of additional SG&A. We had a noncash expense of $60,000 for annual stock-based compensation true-up relating to original grant estimates of forfeitures.
Other factors in the second quarter, which were significant relative to the second quarter of 2022. Our second quarter net interest income was up $47,000 compared to the second quarter of 2022 due to higher interest rates applied to our higher invested cash balances. Incentive compensation was $100,000 compared to none in the 2022 period due to that period's loss. Income tax on the profits of foreign subsidiaries, which are not shielded by our U.S. corporate NOLs, resulted in second quarter income tax expense of $109,000 versus $35,000 in the first quarter and $61,000 in the second quarter of 2022. Currency gains based on the falling U.S. dollar of about $196,000 in the second quarter of 2023 as compared with a loss of $74,000 in the first quarter of 2023. And on a strengthening U.S. dollar, $130,000 in the second quarter of 2022. Expenses ran a little hotter in the second quarter, and we have an eye on it.
Adjusted EBITDA earnings of $869,000 in the second quarter of 2023 compares with adjusted EBITDA earnings of $502,000 in the first quarter of 2023 and negative adjusted EBITDA of $65,000 in the second quarter of 2022. So the year-over-year differential was over $930,000. We had 9,18,875 shares outstanding on June 30, 2023. NOLs on June 30, 2023 stood at over $22 million. Overall, we remain very strong financially and continue to have no debt.
Looking forward, with the high level of activity in our sales funnel and fundamental growth catalysts, as Anthony discussed in his remarks, we continue to plan for double-digit revenue growth in 2023. Gross margins are expected to continue to be in a range of mid- to high 50s throughout the year. Operating expenses for the year are now expected to be modestly elevated given some of the inputs from the second quarter, along with higher sales commissions, incentive compensation and the impact of currency changes.
That concludes my remarks for the second quarter of 2023. But before we open up the call for questions, I'd like to comment on my retirement. I am very happy that we've appointed Gerry Ng to replace me, and I'm confident that he and the team will go forward to great success. While I look forward to spending more time with family, I must say that I truly enjoy the people and the passion shared by the Data I/O team for the past 32 years. We absolutely changed the face of programming first in the early 2000s with the mobile phone industry and more recently and into the future for the automotive electronics and the IoT security markets. It has been both challenging and rewarding as we endeavor to create value for customers and shareholders alike. I am grateful for the experiences and with this, all of you, including you, the members of our community, I thank you and wish you all well.
With that said, operator, will you please start the Q&A process.
Question and Answer Session
Operator
(Operator Instructions) Our first question will come from Kevin Garrigan with WestPark Capital.
Kevin Garrigan
Congrats on the strong results. Gerry, congrats on joining the Data I/O team and all the best on retirement, Joel. Yes, absolutely. Just to start off, Anthony, I think in the past, you had noted that SentriX had about 20 customers. Can you kind of give us a sense of that number today? And the 5 new customer wins, does that include any new SentriX customers?
Anthony Ambrose
Yes, Kevin, thanks very much for the comments. On the SentriX, I mentioned earlier that we got actually a repeat order in the quarter. So there's that to add to it. And I also focus on the fact that the units that we're seeing through some of our partners are up pretty sharply. So those are the encouraging things on SentriX for the quarter. I also want to comment just to sort of clarify Joel's comments. We talked about the double-digit growth in margins and expenses. I just want to make sure it was clear. He's referring to the full year with those comments.
Kevin Garrigan
Okay. Got it. Got it. That makes sense. And then the global vehicle OEM that you guys want as a customer, how long were you engaged with that customer before they decided to actually become a customer? And what would you say was kind of the draw?
Anthony Ambrose
Well, we've been engaged with the OEM customer that we referred to for quite some time. And I think the reason that we won the business with them is the reason we win the business with the Tier 1s with EMS companies going into automotive. We're the global leader in automotive. We understand the needs of the automotive industry from not only high-quality programming systems, but the ability to deploy those systems through a resilient supply chain to 5 continents around the world, the ability to service those systems, the ability to add new components to the systems, the ability to respond if there's an issue because it's very costly for automotive supply chain to have any kind of issue that lingers for any length of time. So the same reasons why we have 18 of the top 20 Tier 1s are the reason we were able to add this automotive OEM. We don't have permission to use their name, but you would certainly know who they are to our list of customers.
Kevin Garrigan
Okay. Yes. No, that makes total sense. One for Gerry, if I can, and then I'll hop back in the queue. And Gerry, congratulations again on joining the team. Just what were the top 2 or 3 things that attracted you to Data I/O?
Gerry Ng
Yes. First and foremost, as Anthony indicated, Data I/O is the industry leader in this particular market. And with the high growth potential of the automotive industry, it was an easy decision for me to join the team and continue to contribute to its growth and operational excellence.
Operator
Our next question will come from David Marsh with Singular Research.
David Marsh
Guys. Congratulations on the quarter and just echo the previous caller's comments. Gerry, welcome and Joel congratulations.
Gerry Ng
Thank you.
Joel S. Hatlen
Thanks, David.
David Marsh
So I wanted to start, Anthony, the commentary in your prepared remarks as well as the press release just talking about China and first half being a slower recovery, but it sounds like your expectations for the second half are for demand to pick up over there. Could you put a little bit more color and perhaps like some numbers around that in terms of maybe percentage of revenue or just anything of that nature that would just help us understand kind of exactly how slow it has been in the first half and then kind of how much you're kind of expecting it to pick up in the second half?
Anthony Ambrose
Sure. David, I probably won't go into the level of detail you want on the call. But I think what we saw was what you've probably heard from a number of other companies or sort of an expectation, okay, Q1 is going to be tough, and then it will sort of snap back. I don't really -- haven't seen it snap back. Now having said that, we expect -- Q2 is better than Q1. We expect Q3 to be better than Q2. But I think they'll be more steady and measured as opposed to sort of a V-shaped recovery. Having said that, China is the world's largest automotive market. It's the world's largest market for electric vehicle sales when they think about 3 out of every 5 electric vehicles getting sold in China. So it's a huge contributor. And from our standpoint, just think of what the numbers could look like when China is firing on all cylinders, if you can use that analogy for an EV car, which we expect will happen over time.
David Marsh
Yes, that's pretty helpful. I certainly -- I appreciate you can't get too granular. And then just the other question I had is gross margins in the first half really kind of knocking it out of the park up, above 59% in both quarters. I'm guessing that, that's somewhat driven by mix. I was hoping maybe you could comment a little bit on that. And I noticed a very subtle change in your guidance for the full year, where you had previously been guiding mid-50s for the full year, now mid- to upper-50s. Should we start thinking in that direction that the rest of the year could, in fact, look like the first half towards the upper-50s. And if you could just give us some clarity around how -- what drives that gross margin?
Joel S. Hatlen
Yes. I think, David, we basically saw that our guidance has stayed in the mid- to upper-50s and that's really what it's been all year long. But we have benefited from a number of situations this year where the mix of both customers and channels have been relatively favorable for gross margins. By that, I discussed how Americas and parts of Europe that are -- that we sell to directly contribute a better gross margin having a little bit more operating expenses for selling commissions instead of distributor discounts. So that's a margin benefit. We had some product mix, in particular, a deferred revenue from a lease purchase option that we recognized during the quarter that helped. And I'd say the last piece was really related to just pure sales volume as opposed to a year ago, where the sales volume relative to fixed factory costs were another benefit in the comparison.
Operator
Our next question will come from Matt Winthrop with Equitable.
Matthew Winthrop
Hello, how are you, Anthony?
Anthony Ambrose
Great, Matt. Thank you.
Matthew Winthrop
Fantastic. I was curious, and maybe (inaudible) listen to your comments, Data I/O sale to the marketplace regarding automotive, is it more on volume output or when a car line introduces a new vehicle, Ford has a new electric vehicle, Tesla has a new -- is a new vehicle or a new introduction to the marketplace more favorable to you than more volume of just sales?
Anthony Ambrose
That's a really good question, and let me answer it this way. The overriding factor is that a model that you introduced this year is going to have more silicon in it than last year's model, which has more silicon in it than the prior year model, okay? So every time the auto companies refresh their product line, the car is going to have more silicon in it, and that will mean there's more total demand for programming. So it's this long-term secular growth of 10% to 15% a year that McKinsey has published, a lot of the automotive semiconductor companies have published, that's their target for the silicon growth.
And that's really the fundamental driver for the growth in our business. We're extremely well positioned inside the automotive electronics industry, with the numbers I mentioned earlier, on 18 of the top 20 Tier 1s, increasingly automotive EMS companies, and we're going to be focusing more on some of the OEMs going forward, as they get more focused on their own silicon. So it's really just that simple, there's more stuff, there's more silicon going into the car. And every month, there's another model out there that's replacing a model and the new model has more silicon and more programming, and we get a piece of that, most likely.
Matthew Winthrop
That's a good thing. And that's why I asked you a good question. I'm going to sort of back up on this in the SentriX world because you and I have talked about this. I noticed in your prepared remarks, you didn't mention AI at all. You didn't mention anything regarding that. But I know that there is a connection there. Is there anything that you can add any color that what's going on is going to benefit you guys indirectly or directly.
Anthony Ambrose
Sure. I'm probably the only person in the whole world in the last quarter that didn't mention AI on their earnings call. But we have -- the way we play with AI is if you -- and I think I might have said this in prior calls, in order to do a good job with AI, you have to have a solid training base and especially in machine learning environments that the data structures that you use to train the AI to get the algorithms developed have to be well understood and have to be known and basically cannot be tampered with. So there's an element of security that comes in with AI that is even more important than in other factors. We have had AI customers in that space that are using SentriX to secure their own systems to make sure that they're protected, not only on the algorithms, but the data streams coming in and out of the machines. So as the world does more and more AI, I think they're going to become more acutely aware of security because in a regular world, if you have bad data, it's garbage in, garbage out, in an AI world, if you have bad data coming in and you train the machine improperly, it could be catastrophic.
Operator
(Operator Instructions) Our next question will come from [Chris Bakowski], a private investor.
Unidentified Analyst
Congratulations on great results.
Anthony Ambrose
Thank you.
Unidentified Analyst
I want to ask about China. It seems that even though the Chinese economy is well publicized to be in sort of a slowdown, the electric car sales are doing quite well. So how are they programming those cars? Are they using kind of like other legacy programmers?
Anthony Ambrose
Well, I think what we've seen in China is we have a tremendous presence in China in the automotive industry through Tier 1s, and in some cases, OEMs. So I think the -- we're pretty happy with our penetration in China, and we think that as that market continues to grow, we'll participate in it. I think you recall, we said last quarter that there was some shifting going on in some models. There were new emission standards coming into effect in July, and we think that had some impact in specifically the manufacturing process, dealers wanted to get some of the older cars off of their lots because they would not be able to sell them once the new emission standards came in.
Unidentified Analyst
Okay. So probably maybe they're just not selling the new models as much, all right. And you do expect China to improve in the near future?
Anthony Ambrose
Yes. We believe China will be better in the second half than the first half.
Unidentified Analyst
All right. And in general, I want to ask whether you view yourselves mostly dependent on the number of memory chips in cars or the overall memory in cars. In other words, as software in cars gets more complex and they need more gigabytes of flash to store it. Would that help you?
Anthony Ambrose
Yes, Chris, I think you've hit on a good point there. We've talked about the overall semiconductor content. When I say that, I usually refer to the dollar value. I can probably also refer to the bits to be programmed. We've seen -- there are a number of markets that we play in, in automotive electronics. Infotainment probably has seen the biggest increase in total bits that we can easily see. And you're seeing there more and more 30, 40, 60 gigabytes of data, not only as the size goes up, but the transition of technologies from eMMC to UFS. That's an obvious one. You'll continue to see big memory chips, especially in the software-defined architectures or domain controller architectures. But there's still a lot of microcontroller demand, especially as companies add more and more active safety elements to cars. So it's a combination of both increased memory footprint, more bits, more total systems as well as additional security.
Operator
There are no further questions. This concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks.
Anthony Ambrose
Well, thank you very much, operator. I'd like to thank everyone for joining the call today. And again, thank you, Joel, and welcome aboard, Gerry. With that, this call is now closed.
Operator
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
