What changed in this filing

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Item 7. Management’s Discussion and Analysis

2023-03-30 compared with 2022-03-29 · 74 added, 78 removed, 173 unchanged (47% of the section changed)

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In particular, statements herein regarding economic outlook, impact of COVID-19;

Shanghai COVID-19 resurgence lockdown impact and timing;

industry prospects and trends;

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expectations for unsupported platform or product versions and related inventory and other charges;

Russia-Ukraine war impacts;

Russian invasion of Ukraine impacts;

supply chain expectations;

semiconductor chip shortages;

currency rates and movements;

and any other guidance on future periods are forward-looking statements.

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The following discussions and the section entitled “Risk Factors – Cautionary Factors That May Affect Future Results” describes some, but not all, of the factors that could cause these differences.

In 2021, we continued to react to and manage our business relative to the COVID-19 pandemic.

During 2022, we continued to react to and manage our business relative to the COVID-19 pandemic.

During 2020 and throughout 2021, COVID-19 impacted all aspects of our business, from customer demand, to supply chain integrity, employee safety, business processes, and financial management.

As a global company, we had to manage each of these while working within the guidelines of local and national policy in the U.S., China and Germany.

Our philosophy at the start of the outbreak was simple:

Keep our employees and their families safe;

Keep our facilities safe and operational while we serve our customers as an essential business;

Preserve cash.

We have managed the COVID-19 impact successfully to date, with no known employee transmissions in the workplace and significant preservation of our cash and working capital.

Our resilient supply chain model kept our facilities in Shanghai, China and Redmond, Washington open, and serving customers globally, despite sporadic government restrictions on our facilities and vendors.

We face continued international travel restrictions, shipping delays, and inability to meet with customers in person.

As business has recovered, we have been able to respond by having the working capital needed and the workforce in place.

We saw a resurgence of orders in the second quarter of 2021 as vaccinations were occurring and customers resumed business.

Following this, in the third quarter of 2021, we experienced a slowdown of demand as customers, we believe, were unable to secure an adequate semiconductor parts supply for planned capacity expansion.

In supply chains around the world with the re-openings and now, in a believed ripple effect, factories are experiencing the impact of chip shortages on their production plans.

This appears to be a shorter-term issue, but is expected to have some continuing impact into 2022.

However, the outlook by industry analysts for automotive electronics remains strong for a decade.

Waves of COVID-19 infection rates and variants have kept or re-imposed revised travel restrictions.

Customers largely have not permitted in-person sales and other visits.

Converting these interactions to remote and virtual means has meant implementing new processes and technology.

In production, in addition to adding protective health measures for our employees, we have focused on supply chain resilience and duplicating production capability for some products in both our Shanghai, China and Redmond, USA facilities.

We implemented additional supplier financial and other monitoring, as well as adding additional local suppliers and increasing inventory stock levels of key parts.

Other than production employees who are required to be onsite, most other employees are working with hybrid flexibility to be onsite as desired or needed and this is expected to continue.

Our workforce is over 90% vaccinated world-wide.

Our short-term challenge continues to be operating in a cyclical, COVID-19 impacted, and rapidly evolving industry environment, which saw significant improvement of revenue, up 27%, as compared to 2020.

Bookings were up 23% for 2021, compared to 2020, despite the demand decline in the third quarter of 2021 relative to the second quarter, which we believe, was due to semiconductor chip shortages discussed above.

Our focus has been dealing with COVID-19 related issues, especially supply chain shortages and lead-times, which have been managed though carefully maintaining and increasing key inventory levels.

We also continue to balance a host of current issues including industry changes, industry partnerships, new technologies, business geography shifts, travel and customer restrictions, customer shut downs, exchange rate volatility, trade issues and tariffs, semiconductor chip shortages, shipping challenges, increasing costs (inflation) and strategic investments in our business with the level of demand and mix of business we expect.

We continue to manage our costs carefully and execute strategies for cash preservation, protecting our employee base and managing supply chain price increases.

The Russia–Ukraine war has had little direct impact on our business, however, the uncertainty and ripple effects created by it, may have unknown indirect impacts.

During 2022, as a result of vaccinations and the reduced impact of COVID-19, our business started to return to more normal in parts of the world.

As a global company, we had to manage these aspects of our business while working within the guidelines of local and national policy in the U.S., China and Germany.

During parts of the first and second quarters, our Shanghai facility and operations were shut down for two and a half months as required by China’s requirements pursuant to their COVID Zero policy.

This shutdown impacted our supply chains, shipping times, travel, trade shows, and forced remote work.

We were largely able to resume operations and begin recovery late in the second quarter and throughout the third quarter.

For most of 2022, waves of COVID-19 infection and variants have kept or re-imposed revised travel restrictions.

Customers continued to restrict in-person sales and other visits.

We have continued to do business by converting these interactions to remote and virtual means as we have implemented new processes and technology.

Our resilient supply chain model was able to support our customers by having alternate facilities that were open and responded to the critical impacts of the shutdown.

Later in the year China’s COVID Zero policy was effectively cancelled.

In December most of our employees in Shanghai China were out briefly with COVID and then we resumed normal operations.

Other Major Impacts on 2022

The war in Ukraine had many impacts on our business.

While we had little direct impact from Russia or Ukraine, the war’s affect on supply chains, shipping, European economic uncertainty and energy concerns disrupted our business.

Later in the year, the impacts seemed to diminish.

Inflation impacted everyone.

We believe we were able to adequately address inflation with pricing adjustments such that our margins were mostly maintained.

Certain labor markets were tight during the year, with assembly technicians and software development engineers being challenging to recruit.

Interest rate hikes by central banks is a concern especially for cyclical industries with resulting worries about capital spending and planning for recessionary impacts.

Currency changes caused significant headwinds to our translated consolidated revenues.

This resulted from the strengthening of the US Dollar versus most foreign currencies, especially the Euro and Yuan in which our subsidiaries do business.

Later in the fourth quarter and continuing into early 2023, the US Dollar weakened somewhat, providing some tailwinds to revenue growth.

The impact of semiconductor chip shortages that began mid 2021 continued well into 2022 and are not completely resolved going into 2023.

Many of the issues described here in the overview have caused supply chain disruptions and lead time unreliability, which we have managed though carefully maintaining and increasing key inventory levels.

Finally, the continued outlook by industry analysts for automotive electronics remains strong based on the long-term forecast for a decade, which remains our primary market focus.

Moving forward, our short-term challenge continues to be operating in a cyclical, COVID-19 impacted, and rapidly evolving industry environment with volatile currencies, inflation, supply chain issues, and improved but remaining semiconductor part shortages.

We also continue to balance a host of current issues including industry changes, industry partnerships, new technologies, business geography shifts, travel and customer restrictions, trade issues and tariffs, shipping challenges, and strategic investments in our business with the level of demand and mix of business we expect.

We have taken steps to be a resilient supplier to our customers by enhancing our remote service and support capabilities, increased stocking of inventory, and having product production in multiple locations.

We continue to manage our costs carefully and execute strategies for cash preservation, protecting our employee base, and managing supply chain price increases and uncertainties.

Revenues were down 6% for 2022, compared to 2021.

However, bookings were up 4% for 2022, compared to 2021, resulting in an increase in backlog going into 2023.

The second half of the year saw a recovery in demand and quarterly profitability.

Despite negative macroeconomic news, we enter into 2023 with strong sales funnels, more favorable currency rate tailwinds with a weakening US Dollar, and the strong long-term growth outlook for automotive electronics.

We are focusing our research and development efforts in our strategic growth markets, namely automotive electronics and IoT new programming technologies, secure supply chain solutions, automated programming systems and their enhancements for the manufacturing environment and software.

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

We are continuing to develop technology to securely provision newer categories of semiconductors, including Secure Elements, Authentication Chips, and Secure Microcontrollers.

In late 2020, we released updated SentriX hardware and tools which simplify the customer acquisition process, and reduce dependency on third party suppliers.

We also upgraded the SentriX® security deployment systems in the field to this new architecture.

We plan to deliver new programming technology and automated handling systems for managed and secure programming in the manufacturing environment.

We continue to focus on extending the capabilities and support for our product lines and supporting the latest semiconductor devices, including various configurations of NAND Flash, e-MMC, UFS and microcontrollers on our newer products.

We are continuing to develop technology to securely provision newer categories of semiconductors, including Secure Microcontrollers, Authentication Chips, and Secure Elements.

We continue to focus on extending the capabilities and support for our product lines and supporting the latest semiconductor devices, including various configurations of NAND Flash, eMMC, UFS and microcontrollers on our newer products.

Our customer focus has been on global and strategic high-volume manufacturers in key market segments like automotive electronics, IoT, industrial controls and consumer electronics, as well as programming centers.

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

Semiconductor shortages are causing issues and some automotive plant or production shutdowns.

This appears to be temporary and, in some cases for us, drives consumable adapter demand in order to support alternative semiconductors.

CRITICAL ACCOUNTING POLICY JUDGMENTS AND ESTIMATES

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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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Revenue is recognized on the system sale based on shipping terms, installation revenue is recognized after the installation is performed, and hardware service and support and software maintenance revenue is recognized ratably over the term of the agreement, typically one year.

Deferred revenue includes service, support and maintenance contracts and represents the undelivered performance obligation of agreements that are typically for one year.

When we sell software separately, we recognize revenue upon the transfer of control of the software, which is generally upon shipment, provided that only inconsequential performance obligations remain on our part and substantive acceptance conditions, if any, have been met.

Deferred revenue of $1.8 million on December 31, 2022, includes service, support and maintenance contracts and represents the undelivered performance obligation of agreements that are typically for one year.

When we sell software separately, we recognize revenue upon the transfer of control of the software, which is generally upon delivery, provided that only immaterial items in the context of the contract with the customer remain on our part and substantive acceptance conditions, if any, have been met.

We recognize revenue when there is an approved contract that both parties are committed to perform, both parties rights have been identified, the contract has substance, collection of substantially all the consideration is probable, the transaction price has been determined and allocated over the performance obligations, the performance obligations, including substantive acceptance conditions, if any, in the contract have been met, the obligation is not contingent on resale of the product, the buyer’s obligation would not be changed in the event of theft, physical destruction or damage to the product, the buyer acquiring the product for resale has economic substance apart from us, and we do not have significant obligations for future performance to directly bring about the resale of the product by the buyer.

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Software and Maintenance Sales

Net sales for the year ended December 31, 2021 increased approximately 27.1% to $25.8 million compared to 2020 primarily as a result of COVID-19 related recovery in capital spending resulting in higher demand in Automotive Electronics and Programming Centers during 2021.

On a regional basis, net sales increased approximately 21% in Asia and approximately 60% in the Americas and 12% in Europe.

Net sales for the year ended December 31, 2022 decreased approximately 6.3% to $24.2 million compared to 2021 primarily as a result of COVID-19 shutdown in the first half of 2022, economic uncertainty resulting from the war in Ukraine, semiconductor shortages and a stronger dollar, offset in part during the second half of the 2022 by improved semiconductor supply with higher demand in automotive electronics and industrial/IOT.

On a regional basis, net sales increased approximately 15% in Asia and declined approximately 10% in the Americas and 21% in Europe.

Order bookings were $26.4 million for 2022, up approximately 4% compared to $25.5 million in 2021.

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Deferred revenue was $1.8 million at December 31, 2022 compared to $1.5 million at December 31, 2021.

Net sales in 2021 reflected the initial recovery from COVID-19 conditions in 2020.

(in thousands)

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Gross margin as a percentage of sales for the year ended December 31, 2022 was 54.5%, compared to 57.0% in 2021.

The improvement in gross margin percentage was due to the impact of channel and price mix, factory charges, and in 2020, one-time impairment obsolescence of $291,000 for certain end of service support and first generation SentriX parts.

The decline in gross margin percentage was due to the impact of sale volume relative to fixed cost;

currency rate impacts of the strengthening US Dollar, channel mix, and inventory charges.

RESEARCH AND DEVELOPMENT

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Percentage of net sales

Research and development (“R&D”) expense increased $278,000 for the year ended December 31, 2021 compared to 2020.

The increase was primarily related to higher incentive compensation.

R&D as a percentage of sales decreased primarily due to the increase in 2021 sales.

Research and development (“R&D”) expense decreased $552,000 for the year ended December 31, 2022 compared to 2021.

The decrease was primarily related to lower incentive compensation.

We believe it is essential to invest in R&D to significantly enhance our existing products and to create new products as markets develop and technologies change.

During 2021, we continued strategically investing in creating a second generation of SentriX, which was introduced in the fourth quarter.

During 2022, we continued strategically investing in supporting SentriX, ConneX and our LumenX programmer capabilities.

In addition to product development, a significant part of R&D spending is on creating software and support for new devices introduced by the semiconductor companies.

We are currently focusing our research development efforts on strategic growth markets, including automotive electronics and IoT.

We are developing technology and the SentriX product line to securely program new categories of semiconductors, including Secure Elements, Authentication Chips, and Secure Microcontrollers.

We delivered new enhanced programming technology and automated handling systems for managed and secure programming in the manufacturing environment and extending the capabilities and support for our programmer architecture.

We are developing technology and the SentriX product line to securely program new categories of semiconductors, including Secure Microcontrollers, Secure Elements, and Authentication Chips.

Our R&D spending fluctuates based on the number, type, and the development stage of our product initiatives and projects.

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Percentage of net sales

Selling, General and Administrative (“SG&A”) expenses increased approximately $1.5 million for the year ended December 31, 2021 compared to 2020.

The increase was primarily related to higher sales commissions on increased sales volume, higher incentive compensation, consulting and rent, offset in part by lower stock-based compensation and travel related expenses.

Selling, General and Administrative (“SG&A”) expenses decreased approximately $482,000 for the year ended December 31, 2022 compared to 2021.

The decrease was primarily related to lower sales commissions and incentive compensation.

Cost control measures remain in effect.

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Interest income

Interest income was relatively consistent for the year ended December 31, 2021 compared to 2020.

Interest income was slightly higher for the year ended December 31, 2022 compared to 2021 primarily due to higher invested balances.

(in thousands)

Income tax (expense) benefit

Income tax (expense) decreased by $275,000 for the year ended December 31, 2021 compared to 2020.

The decrease was primarily a result of the withholding tax of $257,000 on the repatriation of cash from subsidiaries in 2020.

Income tax (expense) increased by $571,000 for the year ended December 31, 2022 compared to 2021.

The increase was primarily a result of the withholding tax of $442,000 on the repatriation of cash from subsidiaries in 2022.

Income tax (expense) in 2022 and 2021 is primarily the result of foreign subsidiary income tax and minimal U.S.

state income tax.

The effective tax rate for 2021 of (25.4%) and 2020 of (10.8%) differed from the statutory tax rates in our tax reporting jurisdictions primarily due to the effect of valuation allowances.

The effective tax rate for 2022 of (156.3%) and 2021 of (25.4%) differed from the statutory tax rates in our tax reporting jurisdictions primarily due to subsidiary income with consolidated losses and the effect of valuation allowances.

We have a valuation allowance of $9.3 million and $7.9 million as of December 31, 2022 and 2021, respectively.

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Dollar amounts at average rates of exchange during the year.

We recognized foreign currency transaction loss of $(202,000) in 2021 and foreign transaction loss of $(513,000) in 2020.

We recognized foreign currency transaction gain of $221,000 in 2022 and foreign currency transaction loss of $(202,000) in 2021.

The transaction gains or losses resulted primarily from translation adjustments to foreign inter-company accounts and U.S.

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We increased prices in response to cost increases caused by inflation and part shortages and believe we will continue to utilize this strategy.

IMPAIRMENT & RELATED CHARGES

In 2021 we had no substantial impairments.

During the fourth quarter of 2020, we launched a new generation of SentriX tools.

This obsoleted components of the first-generation hardware, software and inventory.

We also ended support for some legacy automated handlers, impairing the remaining service inventory.

As a result, certain capital equipment assets, advance payments and inventory were analyzed and determined to be impaired, totaling $943,000.

This included impairment of $652,000, consisting of $252,000 of equipment and software, $400,000 of prepaid royalties, as well as impairment related charges of $291,000, due to inventory obsolescence (cost of goods sold) for end of certain product support.

FINANCIAL CONDITION:

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Working capital

At December 31, 2021, our principal sources of liquidity consisted of existing cash and cash equivalents which remained relatively unchanged from the December 31, 2020 cash balance.

Our working capital increased in $425,000 during 2021 due to better business conditions, timely collections, and increases in inventories and accounts receivable, and offset in part by accrued incentive compensation and our operating loss.

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

Cash at December 31, 2022 and 2021 was $11.5 million and $14.2 million, respectively.

Our working capital decreased by $905,000 during 2022 due primarily to our operating loss and taxes related to a cash repatriation from China.

Our current ratio was 3.8 and 3.7 for December 31, 2022 and 2021, respectively.

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As a result of our cyclical and seasonal 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 reduce costs.

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, inflation, war in Ukraine impacts, interest rates hikes, currency rate moves, and part shortages.

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

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.

We have not had exposure to recent bank takeovers and have cash holdings in a number of banks.

We may require additional cash at the U.S.

headquarters, which could cause potential repatriation of cash that is held in our foreign subsidiaries.

We have liquidated our subsidiary in Canada and repatriated its cash.

We have repatriated cash from our China subsidiary during 2022 and incurred dividend withholding tax, which was unable to receive a current tax benefit for.

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

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We believe that these non-GAAP financial measures provide meaningful supplemental information regarding our results and facilitate the comparison of results.

During 2021, we analyzed assets for impairment and none were identified as being impaired.

During the fourth quarter of 2020, certain capital equipment assets, advance payments and inventory were analyzed and determined to be impaired totaling $943,000.

This included impairment of assets consisting of $252,000 of equipment and software, $400,000 of prepaid royalties, of $652,000 as well as impairment related charges of $291,000 due primarily to end of certain product support as discussed further above.

A reconciliation of net income to EBITDA and Adjusted EBITDA follows:

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Equity compensation

Impairment & related charges

Adjusted EBITDA, excluding equity compensation and impairment & related charges

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.

Adjusted EBITDA, excluding equity compensation

NEW ACCOUNTING PRONOUNCEMENTS - STANDARDS ISSUED AND NOT YET IMPLEMENTED

In June 2016, the Financial Accounting Standards Board issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326).

Topic 326 is effective (Smaller Reporting Company) for reporting periods beginning after December 15, 2022.

Topic 326 replaces the incurred loss impairment methodology under current Generally Accepted Accounting Principles ("GAAP") with a methodology that reflects expected credit losses and requires the use of a forward-looking expected credit loss model for accounts receivables, loans, and other financial instruments.

The standard requires a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective.

We plan to adopt the new credit loss standard effective January 1, 2023.

We do not expect the new credit loss standard to have a material impact on our financial condition, results of operations and cash flows, or financial statement disclosures.

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-K

Item 7. Management’s Discussion and Analysis