What changed in this filing

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Item 2. Management’s Discussion and Analysis

2023-08-14 compared with 2023-05-15 · 95 added, 78 removed, 165 unchanged (51% of the section changed)

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Forward-Looking Statements

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

This Quarterly Report on Form 10-Q 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 Annual Report on Form 10-K are forward-looking.

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

Shanghai COVID-19 resurgence lockdown impact and timing;

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

In particular, statements herein regarding economic outlook, impact of COVID-19 including shutdown in Shanghai, China and related recovery;

industry prospects and trends;

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future spending;

breakeven revenue point;

expected expenses, breakeven revenue point;

expected market decline, bottom or growth;

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changing foreign operations;

trade issues and tariffs;

taxes, trade issues and tariffs;

expected inventory levels;

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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 Annual Report.

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

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

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.

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, 2022, describe some, but not all, of the factors that could cause these differences.

The second quarter of 2023 reflects strong revenues, gross margin, and profitability.

It represented the fourth consecutive quarter of profitability and more normal operations.

The prior year comparisons reflect impacts from COVID-19, Ukraine war 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.

Early in the year as our business started to return to more normal in parts of the world, challenges arose that were difficult 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 zero-COVID 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 of 2022.

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

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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.

Later in the fourth quarter of 2022, China’s zero-COVID 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.

We believe that our China demand was soft during the first and second quarter of 2023 due to both COVID-19 recovery in China and customers dealing with the implications of new emission standards effective mid-year.

Other Major Impacts

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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.

The strengthening of the dollar in 2022 created headwinds for revenues, as typically over 90% of our business is international.

Interest rate hikes by central banks were 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.

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

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

We believe there is less risk exposure on these issues and we are now reducing inventory levels and expect to continue reducing inventory through 2023.

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

During both the first and second quarter of 2023, our operations were 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 second quarter of 2023, especially for the Euro.

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

On a more positive note, inflation, while still elevated, appears to be diminishing.

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

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 think our 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 focus on managing our costs carefully and executing 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.

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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 COVID-19 and other global political and economic factors.

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 COVID-19 and other global political and economic factors.

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.

CRITICAL ACCOUNTING POLICY JUDGMENTS AND ESTIMATES

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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.

When we license 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.

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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Allowance for Doubtful Accounts:

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.

We base the allowance for doubtful accounts receivable (Current Estimate of Credit Losses) 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.

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Share-based Compensation:

We account for share-based awards made to our employees and directors, including employee stock option awards and restricted stock unit awards, using the estimated grant date fair value method of accounting.

We account for share-based awards made to our employees and directors, including employee stock option awards, performance stock unit awards and restricted stock unit awards, using the estimated grant date fair value method of accounting.

For options, we estimate the fair value using the Black-Scholes valuation model and an estimated forfeiture rate.

Restricted stock unit awards are valued based on the average of the high and low price on the date of the grant and an estimated forfeiture rate.

For both options and restricted awards, expense is recognized as compensation expense on the straight-line basis.

Restricted stock unit awards and performance stock unit awards are valued based on the average of the high and low price on the date of the grant and an estimated forfeiture rate.

For options, performance and restricted stock unit awards, expense is recognized as compensation expense on the straight-line basis.

Employee Stock Purchase Plan (“ESPP”) shares were issued under provisions that do not require us to record any equity compensation expense.

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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

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.

Net sales in the second quarter of 2023 were $7.4 million, up 55% as compared with $4.8 million in the second quarter of 2022.

The dramatic comparison reflects the continued second quarter of 2022 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.

Revenues also benefited from the impact of the weakening US Dollar for translation of foreign subsidiary amounts.

Recurring and consumable revenues, which includes adapter sales, represented a more normal proportion at 41% of revenues in the second quarter of 2023, as compared with 45% of the second quarter of 2022.

Year-to-date, total capital equipment sales were 59% of revenues, adapters were 29%, and software and services revenues were 12% of revenues, respectively, in the second quarter of 2023 compared with 54%, 31% and 15%, respectively, for the second quarter of 2022.

On a geographic basis, international sales represented approximately 86.3% of total net sales for the second quarter of 2023 compared with 89.2% in the prior year period.

Second quarter 2023 bookings were $7.6 million, as compared with $6.4 million in the prior year period.

Year-to -date bookings were $13.3 million, as compared with $12.6 million in the prior year-to date period.

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

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

Backlog at June 30, 2023 was approximately $3.8 million, up from $3.2 million at March 31, 2023 and down from $5.8 million at June 30, 2022, which reflected the build up from the Shanghai shutdown.

Data I/O had $1.6 million in deferred revenue at June 30, 2023, down from $2.0 million at March 31, 2023 due to a lease to purchase conversion with a large deferred credit recognition, and $1.5 million at June 30, 2022.

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Percentage of net sales

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 .

Gross margins as a percentage of sales were 59.1% in the second quarter of 2023 as compared to 57.8% in the same period of 2022 with margins improved by higher sales volume 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 stronger in the second quarter of 2023, and where we account for selling commissions in our operating expenses, we show a higher level of gross margin as a percentage of sales.

Year-to-date gross margins were similar for the three- and six-month periods of 2023, but the same periods in 2022 were impacted by the Shanghai COVID-19 shutdown, sales volume relative to fixed costs, currency effects and factory variances.

RESEARCH AND DEVELOPMENT

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Percentage of net sales

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

Research and development (“R&D”) expenses in the second quarter of 2023 were up compared to the same period in 2022, with additional outside services in support of our product lines, as well as incentive compensation where there was none in 2022 due to losses.

Year-to-date R&D expense changes were primarily due to the same factors as in the second quarter.

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 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.

Selling, General and Administrative (“SG&A”) expenses in the second quarter of 2023 increased by approximately $561,000 from the prior year period primarily due to higher channel and sales commissions associated with higher revenue;

recruiting fees;

outside services;

and additional information technology projects and support, as well as incentive compensation where there was none in 2022 due to losses.

Year-to-date SG&A expenses varied primarily due to the same factors as in the second quarter.

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

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Interest income

Interest income reflects higher rates and invested balances.

Interest income was higher in the second quarter of 2023 and year-to-date compared to the same periods in 2022 due to higher average interest rates and higher invested balances.

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Income tax benefit (expense)

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.

Income tax benefit (expense) for the second quarter of both 2023 and 2022 primarily related to foreign and state taxes.

Year-to-date income tax benefit (expense) was primarily due to the same factors as in the second quarter, as well as 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 $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.

We have a valuation allowance of $9.6 million as of June 30, 2023.

As of June 30, for both 2023 and 2022, our deferred tax assets and valuation allowance have been reduced by approximately $437,000 and $405,000, 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, 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.

At June 30, 2023, our principal sources of liquidity consisted of existing cash and cash equivalents.

Cash at $11.9 million has increased $360,000 year-to-date, but was approximately the same as on March 31, 2023.

Net working capital at June 30, 2023 was $18.0 million, up $0.4 million compared to December 31, 2022, and approximately the same as on March 31, 2023.

Receivables were reduced $267,000 compared to December 31, 2022.

Collection of receivables was good during the second quarter of 2023 with DSO (Days Sales Outstanding, a collections metric) well below our target.

Inventory increased by $150,000 compared to December 31, 2022.

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.

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..

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.

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

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 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 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 $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.

Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”) was $490,000 in the second quarter of 2023 compared to ($445,000) in the second quarter of 2022.

Adjusted EBITDA, excluding equity compensation (a non-cash item), was $869,000 in the second quarter of 2023, compared to ($65,000) in the second 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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Adjusted EBITDA, excluding equity compensation

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.

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