What changed in this filing

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Item 2. Management’s Discussion and Analysis

2022-08-12 compared with 2022-05-12 · 51 added, 73 removed, 178 unchanged (41% of the section changed)

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The discussions above and in the section in Item 1A., Risk Factors “Cautionary Factors That May Affect Future Results” in our Annual report on Form 10-K for the year ended December 31, 2021, describe some, but not all, of the factors that could cause these differences.

The first quarter of 2022 was very unusual.

It started strongly with orders and new sales funnel prospect additions, which appeared to relate to improved supply chain and semiconductor part shortage problems that had been significant issues in the second half of 2021.

The improvement of business conditions was before the geopolitical issues stemming from the late-February Russian invasion of Ukraine and the mid-March COVID-19 resurgence in China resulting in restrictions and the lockdown of Shanghai.

We discontinued our relationship with our Russian distributor, which represented an immaterial level of business.

We had no distribution or operations in Ukraine.

The lockdown impacted end of quarter shipments that were completed and ready for delivery to customers from Shanghai.

Approximately $1 million of potential revenue, including 5 PSV systems remained in inventory and backlog at the end of the quarter.

No orders were cancelled and we expect to be able to resume shipments later in the second quarter.

The timing of ending the lockdown is uncertain and depending when we are allowed to resume deliveries may result in not having enough time to expect collections to occur in the second quarter.

We expect that we have adequate cash resources and that the collections and cash should be normalized before the end of the third quarter.

In the first quarter of 2022, due to a continued cyclical downturn, Russian invasion of Ukraine impacts particularly on Europe, the COVID-19 related Shanghai lockdown resulting in about $1M of potential revenue not being shipped and realized, combined with continued significant investments in our security deployment business, we incurred operating losses.

Our strong cash position and balance sheet combined with our long-term view of the market gave us the financial flexibility to make these security business investments.

At Data I/O, we are investing for the long-term to retain and extend our leadership position in automotive electronics and security deployment.

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This is true for both our traditional core business as well as the emerging security deployment business.

Our short-term challenge continues to be operating in a cyclical, COVID-19 impacted, geopolitical uncertainties and rapidly evolving industry environment with continued supply chain and silicon part shortages issues.

Our strong cash position and balance sheet combined with our long-term view of the market gives us the financial flexibility to make these investments.

Our short-term challenge continues to be operating in a cyclical, COVID-19 impacted, uncertain geopolitical, and rapidly evolving industry environment with continued supply chain and semiconductor part shortage issues.

We continue to balance industry changes, industry partnerships, new technologies, business geography shifts, travel and customer restrictions, customer shut downs, exchange rate volatility, trade issues and tariffs, COVID-19 impacts, semiconductor chip shortages, increasing costs and strategic investments in our business with the level of demand and mix of business we expect.

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Although the long-term prospects for our strategic growth markets should be good, these markets and our business have been, and are likely to continue to be, adversely impacted by the global pandemic of COVID-19.

Chip shortages are causing issues and some automotive plant interruptions.

Semiconductor chip shortages have, had and continue to cause issues and some automotive plant interruptions.

This appears to be a lingering issue for 2022 and in some cases, drives consumable adapter demand in order to support alternative chips.

As a global company with over 90% of our sales in international markets, we have been and expect to continue to be impacted by the COVID-19 pandemic in all markets we serve, with follow-on waves of impact.

On March 29, 2022 we announced that our Shanghai facility was being closed due to the local government lockdown.

We were unable to ship products valued at $1M, and the facility remains closed.

We are supporting customers from our Redmond, Washington USA facility and dealing with shipping bottlenecks and shutdowns.

We believe that our classification as essential by certain U.S.

customer groups will continue to keep operations open in the USA.

We source other components from China and other countries that are used to manufacture our equipment in China and in our Redmond, Washington facility.

These components may not be readily available or subject to delays.

Our manufacturing facilities in Shanghai and Redmond have helped us to be part of a resilient supply chain to our customers with dual production of some products and local sourcing of many suppliers.

Many of our employees and executives are working from home or on a hybrid basis and we are limiting visitors to our facilities as the pandemic continues.

The Shanghai COVID-19 related lockdown, which impacted our Shanghai facility starting in March, ended in early June and our facility is currently operational.

Because we have manufacturing facilities in Shanghai and Redmond, it has helped us to be part of a resilient supply chain to our customers with dual production of some products and local sourcing of many suppliers.

The lockdown resulted in building up a record backlog.

All unshipped systems in Shanghai at the end of March were shipped in June.

The backlog of adapters is being worked down and is expected to return to normal levels in August.

The backlog level for systems is expected to return to normal levels during the second half of 2022.

The balance sheet impact from the lockdown should return to normal at the end of the third quarter of 2022.

We are limiting visitors to our facilities as the pandemic continues.

All of our facilities are subject to restrictions and closure by governmental entities.

The pandemic has and may continue to impact our revenues in some geographies, our ability to obtain key components and to manufacture our products, as well as sell, install and support our products around the world.

We expect wide-spread vaccinations to help restore business interactions with customers, however we expect to continue to be impacted and respond to customer site restrictions on sales and service visits, travel restrictions, closed borders, cancelled trade shows and industry gatherings, and modifications in our operations to allow social distancing.

The geopolitical uncertainty from the Russian invasion of Ukraine remains a continuing issue.

See also the detailed discussion of the impacts of COVID-19 on our business and markets in Item 1A, Risk Factors in our annual report on Form 10-K.

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Revenue Recognition:

Topic 606 provides a single, principles-based five-step model to be applied to all contracts with customers.

Accounting Standards Codification (ASC) Topic 606, Revenue from Contracts with Customers (ASC 606) provides a single, principles-based, five-step model to be applied to all contracts with customers.

It generally provides for the recognition of revenue in an amount that reflects the consideration to which the Company expects to be entitled, net of allowances for estimated returns, discounts or sales incentives, as well as taxes collected from customers when control over the promised goods or services are transferred to the customer.

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Installation that is considered perfunctory includes any installation that is expected to be performed by other parties, such as distributors, other vendors, or the customers themselves.

This considers the complexity, skill and training needed as well as customer expectations regarding installation.

This analysis considers the complexity, skill and training needed, as well as customer expectations regarding installation.

We enter into arrangements with multiple performance obligations that arise during the sale of a system that includes an installation component, a service and support component and a software maintenance component.

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Net sales by product line

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Net sales by location

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Net sales by type

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Total programming systems

Net sales in the first quarter of 2022 were $5.0 million, as compared with $6.0 million in the prior year period and $6.4 million in the fourth quarter of 2021.

Sales in the first quarter of 2022 were impacted by a resumption of COVID-19 related shut downs in Shanghai.

This resulted in approximately $1 million in potential product revenue that could not ship.

No orders have been cancelled and their shipment is expected later in the second quarter.

First quarter 2022 bookings were $6.2 million, as compared with $5.4 million in the prior year period and $6.2 million in fourth quarter of 2021.

We began the quarter strongly with improved orders and sales funnel additions.

The improvement in the business conditions was before the late February Russian invasion of Ukraine and the mid-March COVID-19 resurgence in China resulting in restrictions and a lockdown in Shanghai.

We believe these events caused uncertainty and a late quarter slowdown in Europe, and shut down related interruptions in our Shanghai business.

The first quarter of 2021 was early in the original COVID-19 recovery with business just resuming.

On a geographic basis, international sales represented approximately 94.2% of total net sales for the first quarter of 2022 compared with 95.3% in the prior year period.

Total equipment sales were 52% of revenues, adapters were 33% and software and services revenues were 15% of revenues respectively in the first quarter of 2022 compared with 56% and 31% and 13% respectively for the first quarter of 2021.

Automotive electronics represented 63% of orders for the quarter.

Backlog at March 31, 2022 was $4.1 million, as compared with $2.9 million at year end and up from $3.0 million at March 31, 2021.

The backlog increase was primarily due to the Shanghai lockdown related $1 million of potential revenue shipments that were caught up in the shutdown and included 5 PSV systems that were complete and ready to ship.

Data I/O had $1.7 million in deferred revenue at the end of the first quarter of 2022 as compared with $1.3 million at the end of the first quarter of 2021.

Net sales in the second quarter of 2022 were $4.8 million, down 29% as compared with $6.7 million in the second quarter of 2021.

The decrease from the prior year period primarily reflects the impact of lower foreign currencies, in particular, unfavorable exchange rates, as reported on a consolidated basis, the previously announced Shanghai COVID-19 restrictions and lockdowns, and the war in Ukraine which impacted European business as well as supply chain, and revenue recognition for shipments that had been held up or delayed.

Recurring and consumable revenues, which includes adapter sales, represented $2.1 million or 45% of total revenues in the second quarter 2022, as compared with $2.6 million or 39% of the higher second quarter 2021 total.

Total capital equipment sales were 55% of revenues, adapters were 30%, and software and services revenues were 15% of revenues, respectively, in the second quarter of 2022 compared with 61%, 29% and 10%, respectively, for the second quarter of 2021.

On a geographic basis, international sales represented approximately 89.2% of total net sales for the second quarter of 2022 compared with 93.0% in the prior year period.

Second quarter 2022 bookings were $6.4 million, down 28% from $8.9 million in the second quarter of the prior year.

Backlog at June 30, 2022 was approximately $5.8 million, up from $4.1 million at March 31, 2022 and $5.0 million at June 30, 2021.

Data I/O had $1.5 million in deferred revenue at June 30, 2022, $1.4 million at June 30, 2021 and $1.5 million at the end of the fourth quarter of 2021.

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Percentage of net sales

Gross margin as a percentage of sales in the first quarter of 2022 was 46.4% as compared to 55.5% in the same period last year.

For the first quarter of 2022, gross margin was primarily impacted by the lower sales volume and mix.

The Shanghai lockdown prevented shipments of approximately $1 million in potential revenue that would have added approximately 5 gross margin percentage points.

Gross margin as a percentage of sales was 57.8% in the second quarter of 2022, as compared to 57.0% in the same period of the prior year.

The change in gross margin as a percentage of sales relates primarily to favorable variances during the quarter, offset in part by the effect of changes in volume relative to fixed costs.

RESEARCH AND DEVELOPMENT

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Percentage of net sales

Research and development (“R&D”) expenses in the first quarter of 2022 were approximately the same as compared to the same period in 2021.

Research and development (“R&D”) expenses in the second quarter of 2022 were relatively consistent compared to the same period in 2021.

We have maintained our investment in our product development and supporting our growth initiatives.

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Percentage of net sales

Selling, General and Administrative (“SG&A”) expenses were approximately the same as compared to the same period in 2021.

The lower sales volume resulted in lower sales commissions, however these were offset by higher marketing and rent costs.

Cost control measures have remained in place during the first quarter of 2022 and are expected to continue in the second quarter of 2022.

Selling, General and Administrative (“SG&A”) expenses in the second quarter of 2022 decreased by approximately $126,000 from the prior year period primarily due to lower sales commissions associated with lower revenue, the channel mix, as well as lower incentive compensation.

Cost control measures have remained in place during the first two quarters of 2022 and are expected to continue in the third quarter of 2022.

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Interest income

Interest income was approximately the same in the first quarter of 2022 as compared to the same period in 2021 and reflects lower invested balances in foreign subsidiary accounts.

Interest income was higher in the second quarter 2022 compared to the same period in 2021.

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Income tax benefit (expense)

Income tax benefit (expense) for the first quarter of both 2022 and 2021, primarily related to foreign and state taxes.

During the first quarter of 2022 a China dividend withholding tax of $442,000 was paid in connection with a dividend repatriation to the US parent company.

Income tax benefit (expense) for the second quarter of both 2022 and 2021 primarily related to foreign and state taxes.

During the first quarter of 2022, a China dividened withholding tax of $442,000 was paid in connection with a dividend repatriation to the US parent company.

The effective tax rate differed from the statutory tax rate primarily due to the effect of valuation allowances, as well as foreign taxes.

We have a valuation allowance of $8.2 million as of March 31, 2022.

As of March 31, for both 2022 and 2021, our deferred tax assets and valuation allowance have been reduced by approximately $399,000 and $371,000, respectively, associated with the requirements of accounting for uncertain tax positions.

We have a valuation allowance of $8.5 million as of June 30, 2022.

As of June 30, for both 2022 and 2021, our deferred tax assets and valuation allowance have been reduced by approximately $405,000 and $376,000, respectively, associated with the requirements of accounting for uncertain tax positions.

Given the uncertainty created by our loss history, as well as the volatile and uncertain economic outlook for our industry and capital spending, we have limited the recognition of net deferred tax assets including our net operating losses and credit carryforwards and continue to maintain a valuation allowance for the full amount of the net deferred tax asset balance.

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Working capital

At March 31, 2022, our principal sources of liquidity consisted of existing cash and cash equivalents.

Cash decreased $1,894,000 from December 31, 2021 primarily from paying off year end accruals for annual incentive compensation of $791,000 and annual 401(k) matching contributions of $224,000, as well as one-time China dividend income withholding tax of $442,000 on the dividend from Shanghai and funding the operating loss.

Our working capital decreased $1,588,000 during 2022, primarily due to the reasons for the cash decline in the period.

The Shanghai lockdown delayed the delivery of approximately $1 million of potential product revenue.

Depending on the timing of the expected reopening later in the second quarter and resumption of shipping, there may not be enough time to expect collections to take place before the end of the second quarter.

We believe we have the funds necessary to accommodate this.

The company continues to have no debt.

At June 30, 2022, our principal sources of liquidity consisted of existing cash and cash equivalents.

Cash decreased $3.9 million from December 31, 2021 primarily from funding the operating loss and 2021 year end accruals.

Net working capital at the end of the second quarter of 2022 compared to December 31, 2021 decreased approximately $2.6 million to $15.9 million, with redeployment of cash and offsetting changes in accounts receivable, inventory and current liabilities.

Although we have no significant external capital expenditure plans currently, we expect to continue to carefully make and manage capital expenditures to support our business.

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As a result of our cyclical industry, significant product development, customer support and selling and marketing efforts, we have required substantial working capital to fund our operations.

We have tried to balance our level of development spending with the goal of profitable operations or managing down business levels related to COVID-19.

We have implemented or have initiatives to implement geographic shifts in our operations, optimize real estate usage, reduce exposure to the impact of currency volatility and tariffs, increase product development differentiation, and controlling costs.

We have tried to balance our level of development spending with the goal of profitable operations or managing lower business levels related to COVID-19.

We believe that we have sufficient cash or working capital available under our operating plan to fund our operations and capital requirements through the next one-year period, and beyond.

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For any repatriation, there may be tax and other impediments to any repatriation actions.

As many repatriations typically have associated withholding taxes, those withheld will be a current tax without generating a current or deferred tax benefit.

As many repatriations typically have associated withholding taxes, those amounts withheld will be a current tax without generating a current or deferred tax benefit.

Our working capital may be used to fund possible losses, business growth, project initiatives, share repurchases and business development initiatives, including acquisitions, which could reduce our liquidity and result in a requirement for additional cash before that time.

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OFF-Balance sheet arrangements

Except as noted in the accompanying consolidated financial statements in Note 6, “Other Commitments”, we have no off-balance sheet arrangements.

Except as noted in the accompanying consolidated financial statements in Note 5, “Leases” and Note 6, “Other Commitments”, we have no off-balance sheet arrangements.

Non-Generally accepted accounting principles (GAAP) FINANCIAL MeasureS

Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”) was ($1,223,000) in the first quarter of 2022 compared to ($105,000) in the first quarter of 2021.

Adjusted EBITDA, excluding equity compensation (a non-cash item), was ($932,000) in the first quarter of 2022, compared to $173,000 in the first quarter of 2021.

Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”) was ($445,000) in the second quarter of 2022 compared to $196,000 in the second quarter of 2021.

Adjusted EBITDA, excluding equity compensation (a non-cash item), was ($65,000) in the second quarter of 2022, compared to $597,000 in the second quarter of 2021.

Non-GAAP financial measures, such as EBITDA and adjusted EBITDA, should not be considered a substitute for, or superior to, measures of financial performance prepared in accordance with GAAP.

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Adjusted EBITDA, excluding equity compensation

NEW ACCOUNTING PRONOUNCEMENTS

On January 1, 2021 the Company adopted ASU 2019-12, Income Taxes (Topic 740):

Simplifying the Accounting for Income Taxes.

This ASU clarifies and simplifies accounting for income taxes by eliminating certain exceptions for intraperiod tax allocation principles and the methodology for calculating income tax rates in an interim period, among other updates.

The adoption of this ASU did not have a material impact on our financial statements.

Recently Adopted Accounting Pronouncements

See Note 1 of Notes to Condensed Consolidated Financial Statements included in Part 1, Item 1 for a discussion of recently adopted accounting pronouncements.

Quantitative and Qualitative Disclosures About Market Risk

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis