What changed in this filing

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Item 2. Management’s Discussion and Analysis

2023-05-15 compared with 2022-11-14 · 88 added, 107 removed, 155 unchanged (56% of the section changed)

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FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

This Annual Report on Form 10-K includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

This Act provides a “safe harbor” for forward-looking statements to encourage companies to provide prospective information about themselves as long as they identify these statements as forward-looking and provide meaningful cautionary statements identifying important factors that could cause actual results to differ from the projected results.

All statements other than statements of historical fact made in this Quarterly Report on Form 10-Q are forward-looking.

All statements other than statements of historical fact made in this Annual Report on Form 10-K are forward-looking.

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

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semiconductor chip shortages;

currency rates and movements;

impacts of new China emission standards;

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

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Moreover, neither Data I/O nor anyone else assumes responsibility for the accuracy and completeness of these forward-looking statements.

We are under no duty to update any of these forward-looking statements after the date of this Quarterly Report.

We are under no duty to update any of these forward-looking statements after the date of this Annual Report.

The Reader should not place undue reliance on these forward-looking statements.

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.

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

On the product side, we continue to invest with a long-term focus towards expanding our markets and creating unique value for our customers.

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

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.

We continue to manage our costs carefully and execute strategies for cash preservation, protecting our employee base, addressing inflation impacts, and cost control.

Many of our employees continue to work remotely from home or on a hybrid basis, with the essential production and process workers onsite as part of our essential operations.

The following discussions and the 2022 Annual Report on Form 10-K section entitled “Risk Factors – Cautionary Factors That May Affect Future Results” describes some, but not all, of the factors that could cause these differences.

The first quarter of 2023 reflects strong revenues, gross margin, and profitability as well as growth in cash and working capital.

It represented the third consecutive quarter of profitability and resumption of much more normal operations.

The prior year comparison reflects COVID-19 and a host of other challenges that have positioned us where we are now in 2023.

COVID-19 Background and Update

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

Early in the year as our business started to return to more normal in parts of the world, challenges arose that had difficulties for our business.

During parts of the first and second quarters of 2022, our Shanghai facility and operations were shut down for two and a half months as required by China pursuant to their COVID Zero policy.

This shutdown impacted our supply chains, shipping times, travel and, 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.

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

We 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 fourth quarter of 2022, China’s COVID Zero policy was effectively cancelled.

In December most of our employees in Shanghai China were out briefly with COVID-19 and we resumed normal operations early in 2023, however between COVID-19 and customers dealing with the implications of new emission standards effective mid-year, our China demand was soft during the first quarter of 2023.

Other Major Impacts

The war in Ukraine starting in early 2022, while having little direct impact on us from Russia or Ukraine, affected supply chains, shipping, European economic uncertainty and energy concerns.

Inflation impacted everyone.

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

The strengthening of the dollar created headwinds for revenues, as typically over 90% of our business is international.

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

Certain labor markets were tight during the year causing recruiting challenges.

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

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

Finally on a brighter note, 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.

In the first quarter of 2023, our operations returned to be much more normal.

The strong dollar impacts started to reverse during the fourth quarter of 2022 and have provided tail winds for revenue sequentially through the first quarter of 2023 especially for the Euro.

Macroeconomic news, while improving, continues to be fairly negative.

Inflation, while still elevated, appears to be diminishing.

Interest rates continue to be higher, but an anticipated recession has not occurred.

COVID-19, semiconductor shortages, shipping & supply chain issues, and domestic labor tightness slowing recruiting, are improving situations and no longer top of mind.

Sales funnels have grown and provide optimism for future business.

In person trade shows are occurring and generating leads.

Industry partnerships are being formed.

Travel and face-to-face customer meetings are happening.

The new capabilities of supplier resilience, inventory and production in multiple locations, leveraging remote and virtual services, are capabilities to retain and build upon.

We continue to manage our costs carefully and execute strategies for growth.

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.

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

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

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 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 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.

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

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

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

The facility was operational at all times in the third quarter.

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.

We continue to keep certain COVID-19 safety proceedures and limitations in 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.

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.

The pandemic could have the effect of heightening many of the other risks described in Item 1A of our Form 10-K.

Annual projections on spending, growth, mix, and profitability have been and are likely to be further revised substantially as new information is obtained.

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 COVID-19 and other global political and economic factors.

CRITICAL ACCOUNTING POLICY JUDGMENTS AND ESTIMATES

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We establish a reserve for sales returns based on historical trends in product returns and estimates for new items.

Payment terms are generally 30 days from shipment.

Payment terms are generally 30 to 60 days from shipment.

We transfer certain products out of service from their internal use and make them available for sale.

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Allowance for Doubtful Accounts:

We base the allowance for doubtful accounts receivable on our assessment of the collectability of specific customer accounts and the aging of accounts receivable.

If there is deterioration of a major customer’s credit worthiness or actual defaults are higher than historical experience, our estimates of the recoverability of amounts due to us could be adversely affected.

We base the allowance for doubtful accounts receivable on our assessment of the credit losses collectively expected for the future, as well as collectability of specific customer accounts and the aging of accounts receivable.

If there is deterioration of a major customer’s credit worthiness or actual defaults are higher than historical experience, or events forecast that collectively indicate some impairment is expected, our estimates of the recoverability of amounts due to us could be adversely affected.

Inventories are stated at the lower of cost or net realizable value.

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Three Months Ended

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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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Software and maintenance

Total programming systems

Net sales in the third quarter of 2022 were $7.2 million, up 7% as compared with $6.7 million in the third quarter of 2021.

The increase from the prior year period primarily reflects higher overall demand for equipment, and higher adapter sales from shipping backlog related to the Covid-19 related Shanghai shutdown from mid-March to mid-June recovery, offset in part by lower revenue as a result of the stronger US dollar.

The prior year period included the impact of semiconductor part shortages especially on automotive electronics business.

Recurring and consumable revenues, which include adapter sales, represented $3.2 million or 44% of total revenues in the third quarter 2022, as compared with $2.7 million or 39% of the lower third quarter 2021 total.

Total capital equipment sales were 56% of revenues, adapters were 32% and software and services revenues were 12% of revenues respectively in the third quarter of 2022 compared with 55% and 30% and 15% respectively for the third quarter of 2021.

On a geographic basis, international sales represented approximately 91% of total net sales for the third quarter of 2022 compared with 86% in the prior year period.

Third quarter 2022 bookings were $7.1 million, up from $5.0 million in the third quarter of the prior year.

The current quarter’s bookings we believe were impacted by the recovery from the Covid-19 related Shanghai shutdown, as well as a resurgence of business demand in each of our geographies (Americas, Europe and Asia), offset in part by the currency translation impact of the strong dollar.

Backlog at September 30, 2022 was approximately $4.9 million, down from $5.8 million at June 30, 2022 and up from $3.3 million at September 30, 2021.

The backlog draw down from June 30 th relates primarily to build and shipment of production related to the prior quarter Shanghai Covid shutdown.

Data I/O had $2.0 million in deferred revenue at the end of the third quarter of 2022, including one delivered system waiting for final acceptance, as compared with $1.5 million at the end of fourth quarter of 2021.

Net sales in the first quarter of 2023 were $7.2 million, as compared with $5.0 million in the prior year period and $7.3 million in the fourth quarter of 2022.

Sales in the first quarter of 2023 were seasonally strong compared to the challenges faced in the first quarter of 2022 with the Shanghai lockdown and the economic uncertainty attributed to the war in Ukraine.

First quarter 2023 bookings were $5.7 million, as compared with $6.2 million in the prior year period and $6.8 million in fourth quarter of 2022.

We experienced softness in China in the first quarter of 2023, as they recovered from COVID-19 and in their preparation for new automotive emission standards.

Longer term, we see potential for more demand driven by new production changes and especially the transition to electric vehicles (EV).

On a geographic basis, international sales represented approximately 87% of total net sales for the first quarter of 2023 compared with 94% in the prior year period.

Total equipment sales were 56% of revenues, adapters were 31% and software and services revenues were 13% of revenues respectively in the first quarter of 2023 compared with 52% and 33% and 15% respectively for the first quarter of 2022.

Automotive electronics represented 63% of orders for the quarter.

Backlog at March 31, 2023 was $3.2 million, as compared with $4.8 million at year end 2022 and $4.1 million at March 31, 2022.

The backlog has returned to more normal levels compared to the build up caused by the COVID-19 Shanghai shutdown in 2022.

Data I/O had $2.0 million in deferred revenue at the end of the first quarter of 2023 as compared with $1.7 million at the end of the first quarter of 2022.

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Percentage of net sales

Gross margins at 57.0% in the third quarter were down from 60.7% in the third quarter of 2021.

The decrease was primarily due to currency strength of the US Dollar, which is up approximately 15% versus the Euro and Yuan, offset in part by net favorable factory variances.

Gross margin as a percentage of sales in the first quarter of 2023 was 59.5% as compared to 46.4% in the same period last year and 55.5% in the fourth quarter of 2022.

The increase from the fourth quarter was primarily due to channel and product mix;

more favorable currency exchange rates;

and favorable factory variances.

In the first quarter of 2022, there were significant issues, COVID-19 and the war in Ukraine that negatively impacted normal operations .

RESEARCH AND DEVELOPMENT

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Percentage of net sales

Research and development (“R&D”) expenses in the third quarter of 2022 were $1.4 million and decreased by approximately $298,000 from the prior year period primarily due to lower incentive compensation and consulting expenses as well as the impact of the strong US Dollar translation of foreign subsidiary costs and spending discipline.

Research and development (“R&D”) expenses in the first quarter of 2023 were approximately the same as compared to the same period in 2022.

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

SELLING, GENERAL AND ADMINISTRATIVE

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Percentage of net sales

Selling, General and Administrative (“SG&A”) expenses in the third quarter of 2022 were $2.0 million and decreased by approximately $249,000 from the prior year period primarily due to lower incentive compensation as well as the impact of the strong US Dollar translation of foreign subsidiary costs and spending discipline.

The cost control measures have remained in place during the first three quarters of 2022 and are expected to continue in the fourth quarter of 2022.

Selling, General and Administrative (“SG&A”) expenses were up in the first quarter of 2023 as compared to the same period in 2022.

This was due to the higher sales volume and channel mix resulting in higher channel and sales commissions, as well as incentive compensation and recruiting costs.

Cost control measures have remained in place during the first quarter of 2023 and are expected to continue in the second quarter of 2023.

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Interest income

Interest income was higher in the third quarter 2022 compared to the same period in 2021 primarily due to interest received on the AMT refund.

Interest income reflects higher rates and invested balances.

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Income tax benefit (expense)

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

For the nine months ended September 30, 2022 tax expense also included dividend withholding tax.

Income tax benefit (expense) for the first quarter of both 2023 and 2022, 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.

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 $8.3 million as of September 30, 2022.

As of September 30, for both 2022 and 2021, our deferred tax assets and valuation allowance have been reduced by approximately $412,000 and $381,000, respectively, associated with the requirements of accounting for uncertain tax positions.

We have a valuation allowance of $9.3 million as of March 31, 2023.

As of March 31, for both 2023 and 2022, our deferred tax assets and valuation allowance have been reduced by approximately $429,000 and $399,000, 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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LIQUIDITY AND CAPITAL RESOURCES

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Working capital

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

Cash decreased $3.1 million from December 31, 2021 primarily due to funding the operating loss and 2021 year end accruals.

Net working capital at the end of the third quarter of 2022, compared to December 31, 2021, decreased approximately $2.0 million to $16.5 million, primarily due to funding the operating loss.

At March 31, 2023, our principal sources of liquidity consisted of existing cash and cash equivalents.

Cash increased $358,000 from December 31, 2022 primarily from profitable operations offset in part paying off year end accruals for annual 401(k) matching contributions .

Our working capital increased $453,000 during 2023, primarily due to the reasons for the cash increase in the period.

The company continues to have no debt.

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 lower 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, adjust pricing relative to inflation, and control costs.

We have tried to balance our level of development spending with the goal of profitable operations..

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 may require additional cash at the U.S.

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

We may require additional cash at the US headquarters, which could cause potential repatriation of cash that is held in our foreign subsidiaries.

We currently do not have plans and/or intentions to make further repatriations.

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

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

As many repatriations typically have associated withholding taxes, those 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 5, “Leases” and Note 6, “Other Commitments”, we have no 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.

NON-GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP) FINANCIAL MEASURES

Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”) was $1.2 million in the third quarter of 2022 compared to $284,000 in the third quarter of 2021.

Adjusted EBITDA, excluding equity compensation (a non-cash item), was $1.4 million in the third quarter of 2022, compared to $564,000 in the third quarter of 2021.

Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”) was $253,000 in the first quarter of 2023 compared to ($1,223,000) in the first quarter of 2022.

Adjusted EBITDA, excluding equity compensation (a non-cash item), was $502,000 in the first quarter of 2023, compared to ($932,000) in the first quarter of 2022.

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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Three Months Ended

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NEW ACCOUNTING PRONOUNCEMENTS

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

For the three months ended March 31, 2023, ASU 326 became effective for the Company.

The adoption of the ASU 326 CECL (Current Estimate of Credit Losses) did not have a material impact to Data I/O Corporation’s consolidated financial statements.

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