Data I/O Corporation — Q3 2017 Form 10-Q Summary
Business Context and Reporting Period
Data I/O Corporation designs and sells automated and non-automated semiconductor programming systems, consumables, software and services. The filing covers the three and nine months ended September 30, 2017, compared with the same periods in 2016. The company is focused on automotive electronics, Internet of Things, secure programming, authentication ICs and manufacturing automation.
Key Financial Metrics
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Net sales | $9.6 million | $6.6 million | $26.0 million | $17.0 million |
| Gross profit | $6.0 million | $3.6 million | $15.3 million | $9.3 million |
| Gross margin | 62.1% | 55.3% | 59.0% | 54.5% |
| Operating income | $1.8 million | $0.6 million | $3.9 million | $0.8 million |
| Operating margin | 19.0% | 9.4% | 15.0% | 4.9% |
| Net income | $1.7 million | $0.6 million | $3.9 million | $0.9 million |
| Diluted EPS | $0.20 | $0.08 | $0.47 | $0.11 |
| Operating cash flow | Not separately provided | Not separately provided | $5.4 million | $0.5 million |
Third-quarter sales increased 45.7%, while nine-month sales increased 52.7%. Automated programming systems generated $7.8 million in third-quarter sales, up 49.5%, and $21.2 million in nine-month sales, up 58.0%. International sales represented 93.6% of third-quarter revenue and 91.3% of nine-month revenue.
Management attributed the gross-margin improvement to higher volume and fixed-cost utilization, favorable product and sales-channel mix, more direct sales and reduced unfavorable factory variances. Research and development expense increased 33.6% in the quarter and 40.4% year to date, reflecting personnel, incentive, share-based compensation and SentriX development costs. SG&A increased 39.4% in the quarter and 32.2% year to date.
EBITDA was $2.1 million in Q3 and $4.7 million for the first nine months, compared with $0.8 million and $1.3 million, respectively, in the prior-year periods. Adjusted EBITDA, excluding equity compensation, was $2.3 million in Q3 and $5.3 million year to date.
Liquidity, Capital Resources and Balance Sheet
- Cash and cash equivalents were $15.2 million at September 30, 2017, compared with $11.6 million at December 31, 2016. Approximately $10.8 million was held in the United States, with the balance in foreign subsidiaries.
- Working capital was $18.4 million, up from $14.6 million at December 31, 2016.
- The filing does not show conventional debt or borrowings. Long-term other payables were $0.4 million.
- Operating cash flow of $5.4 million was partly offset by $1.3 million of investing outflows, including $1.6 million of capital expenditures, and $0.9 million of financing outflows related primarily to shares withheld for taxes.
- Management believes existing cash and internally generated funds are sufficient to fund operations and capital requirements for at least the next year, but notes that additional cash could be required for U.S. operations, growth, acquisitions, share repurchases or business initiatives.
- Operating lease commitments totaled $3.9 million, and purchase commitments and other obligations totaled $2.1 million, substantially all payable within twelve months.
Material Changes Versus the Prior Comparable Period
- Revenue growth was driven primarily by automotive electronics demand from OEMs and programming centers, particularly for the PSV automated programming systems.
- Gross margin improved 680 basis points in Q3 and 450 basis points for the first nine months.
- Operating income increased from $0.6 million to $1.8 million in Q3 and from $0.8 million to $3.9 million year to date.
- Net income increased from $0.6 million to $1.7 million in Q3 and from $0.9 million to $3.9 million year to date.
- Order bookings were $8.2 million in Q3, up 4% year over year and described as a ten-year third-quarter high. Backlog was $4.6 million at quarter-end versus $3.2 million at December 31, 2016.
- Deferred revenue declined to $1.6 million from $2.8 million at the end of the second quarter, as three systems were recognized in the third quarter.
- Shares outstanding increased to 8.24 million at September 30, 2017 from 8.02 million at December 31, 2016.
Outlook, Risks, Contingencies and Unusual Items
The filing provides no formal quantitative revenue or earnings guidance. Management expects continued investment in secure programming, automotive electronics, IoT and related product development, while noting that the industry is cyclical, seasonal, rapidly evolving and affected by capital-spending trends, geographic shifts and foreign-exchange volatility.
- New security initiatives involve an evolving market, rapid learning, new industry relationships and substantial investment ahead of revenue generation.
- Future gross margins may vary with sales volume, product mix, channel mix, pricing, inventory levels, warranty costs, factory variances and currency movements.
- Inventory obsolescence, warranty claims, customer credit risk and changes in demand could adversely affect margins and results.
- The company maintained a full valuation allowance against deferred tax assets; the allowance was $10.6 million at September 30, 2017. Management expected to reassess potential reversals during the remainder of 2017.
- Unrecognized tax benefits were $249,000. U.S. tax years 2014 through 2017 remained open for examination, with older years potentially relevant if loss carryforwards are used.
- The company recognized a $363,000 gain on sale of assets in the first nine months and recorded foreign-currency transaction losses of $158,000 year to date.
- The company reported no material pending legal proceedings, no material indemnification claims and no material changes to the risk factors in its 2016 Form 10-K.
- The company plans to adopt the new revenue-recognition standard on January 1, 2018, using the modified retrospective method, but could not yet reasonably estimate the financial statement impact. The new lease standard becomes effective January 1, 2019 and was still under evaluation.
- Management concluded that disclosure controls and procedures were effective, and reported no material changes in internal control over financial reporting.
Investor Verification Items
- Verify whether the strong 2017 revenue growth and 62.1% quarterly gross margin are sustainable after considering cyclicality, product mix and backlog conversion.
- Assess the conversion of the $4.6 million backlog and $1.6 million deferred revenue into future revenue and cash flow.
- Monitor demand in automotive electronics and secure programming, particularly the timing of revenue from newer security initiatives.
- Review the potential impact of the January 1, 2018 revenue-recognition adoption and the January 1, 2019 lease standard.
- Evaluate the recoverability of deferred tax assets and the possible effect of valuation-allowance changes on future tax expense.
- Consider international concentration, foreign-exchange exposure, inventory obsolescence, warranty obligations and the company’s reliance on internally generated cash.