What changed in this filing

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Item 7. Management’s Discussion and Analysis

2024-03-27 compared with 2023-03-30 · 69 added, 85 removed, 162 unchanged (49% of the section changed)

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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;

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

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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Russian invasion of Ukraine impacts;

Israel – Hamas war impacts;

supply chain expectations;

semiconductor chip shortages;

currency rates and movements;

semiconductor chip shortages and recovery;

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.

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.

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.

In 2023, most of the direct implications of COVID-19 had passed, and we were dealing with the follow-on impacts or indirect impacts from COVID-19 and the policies put in place to mitigate the disease.

We continued to manage inflation, supply chain impacts and shortages, and the post lock down economic transitions in China and elsewhere.

The strong dollar impact that started to reverse during the fourth quarter of 2022, provided tail winds for revenue in the first and second quarter of 2023, especially versus the Euro.

During the second half of 2023, the U.S.

dollar strengthened again causing revenue head winds.

However, we managed to achieve profitability for the year.

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

On a more positive note, inflation, while still elevated, is diminishing.

Interest rates continue to be higher, but an anticipated recession has not occurred outside of Germany with a current soft landing outlook causing expectations for avoiding a U.S.

COVID-19, semiconductor shortages, shipping & supply chain issues, and domestic labor tightness are improving situations.

Travel, trade shows, and face-to-face customer meetings are happening.

We believe our new supplier resilience, inventory holdings and production in multiple locations, and ability to leverage remote and virtual services, are capabilities to retain and build upon.

We continue to focus on managing our costs carefully and growth-oriented strategies.

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 by the global COVID-19 pandemic and other global political and economic factors.

In particular, 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.

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

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires that we make estimates and judgments, which affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities.

On an on-going basis, we evaluate our estimates, including those related to revenue recognition, sales returns, bad debts, inventories, intangible assets, income taxes, warranty obligations, restructuring charges, contingencies, such as litigation and contract terms that have multiple elements and other complexities typical in the capital equipment industry.

On an on-going basis, we evaluate our estimates, including those related to revenue recognition, sales returns, credit losses, inventories, income taxes, warranty obligations, restructuring charges, contingencies such as litigation and contract terms that have multiple elements and other complexities typical in the capital equipment industry.

We base our estimates on historical experience and other assumptions that we believe are reasonable under the circumstances.

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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.

We allocate the transaction price of each element based on relative selling prices.

We enter into arrangements with multiple performance obligations that arise during the sale of a system that could include hardware, software, installation, service and support, and extended maintenance components.

We allocate the transaction price of each element based on the relative selling prices.

Relative selling price is based on the selling price of the standalone system.

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For software maintenance performance obligations, we use what we charge for annual software maintenance renewals after the initial year the system is sold.

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 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.

Revenue is recognized on the system based on shipping terms, software based on delivery, installation and services based on completion of work and software maintenance and extended warranty support ratably over the term of the agreement, typically one year.

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.

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

Payment terms are generally 30-60 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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The transfer amount is the product unit’s net book value, and the sale transaction is accounted for as revenue and cost of goods sold.

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.

Allowance for Credit Losses:

We base the allowance for credit losses on our assessment of the 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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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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Software and Maintenance Sales

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.

Net sales for the year ended December 31, 2023 increased approximately 16%, to $28.1 million, compared to 2022, primarily as a result of COVID-19 China 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 and continuing in 2023 by fulfilling the backlog built up during the shutdown, improved semiconductor supply, and higher demand in automotive electronics and industrial/IoT.

Order bookings were $25.8 million in 2023, down approximately 2% compared to $26.4 million in 2022.

Automotive Electronics were 63% of total bookings, up 2% from 61% in 2022.

Backlog at December 31, 2023 and 2022 was $2.8 million and $4.8 million, respectively.

Deferred revenue was $1.6 million at December 31, 2023 compared to $1.8 million at December 31, 2022.

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

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Gross margin as a percentage of sales for the year ended December 31, 2023 was 57.7%, compared to 54.5% in 2022.

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.

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

product mix, channel mix, and lower inventory levels (which contributed to lower freight, tariffs, and obsolescence costs.)

Research and Development

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Percentage of net 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.

Research and development (“R&D”) expense increased $441,000 for the year ended December 31, 2023 compared to 2022.

The increase was primarily related contracted services and 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.

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Percentage of net sales

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.

Selling, General and Administrative (“SG&A”) expenses increased approximately $1.3 million for the year ended December 31, 2023 compared to 2022.

The increase was primarily related to higher sales commissions, contracted services and incentive compensation.

Cost control measures remain in effect.

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Interest income

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

Interest income was higher for the year ended December 31, 2023 compared to 2022 primarily due to higher average interest rates and higher invested balances.

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Income tax (expense) benefit

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) decreased by $489,000 for the year ended December 31, 2023 compared to 2022.

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

Income tax (expense) in 2023 and 2022 is primarily the result of foreign subsidiary income tax and minimal U.S.

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Dollar amounts at average rates of exchange during the year.

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.

We recognized foreign currency transaction gains of $42,000 in 2023 and $221,000 in 2022.

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

Dollar accounts held by foreign subsidiaries and sales by our German subsidiary to certain customers, which were invoiced in U.S.

Because approximately 90% of our sales are to international markets, volatile exchange rates may also impact our competitiveness and margins.

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

We increased prices in response to cost increases caused by inflation and part shortages.

FINANCIAL CONDITION:

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Cash at December 31, 2023 and 2022 was $12.3 million and $11.5 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 working capital increased by $846,000 during 2023 due primarily to revenue growth and operating profit improvement.

Our current ratio was 4.0 and 3.8 for December 31, 2023 and 2022, respectively.

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Capital expenditures are currently expected to be funded by existing and internally generated funds.

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, 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.

As a result of our cyclical and seasonal industry, significant product development, factory resilience strategies, customer support and selling and marketing efforts, we require substantial working capital to fund our operations.

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

If this belief is incorrect, 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 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.

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 withheld will be a current tax without generating a current or deferred tax benefit recognition.

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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SHARE REPURCHASE PROGRAMS

Data I/O did not have a share repurchase program in 2022.

Data I/O did not have a share repurchase program in 2023 or 2022.

NON-GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP) FINANCIAL MEASURES

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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).

NEW ACCOUNTING PRONOUNCEMENTS - STANDARDS ISSUED AND IMPLEMENTED

In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (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.

We adopted the new credit loss standard on January 1, 2023.

The new credit loss standard has not had a material impact on our financial condition, results of operations and cash flows, or financial statement disclosures.

NEW ACCOUNTING PRONOUNCEMENTS - STANDARDS ISSUED AND NOT YET IMPLEMENTED

In November 2023, the FASB issued ASU 2023-07 "Segment Reporting (Topic 280):

Improvements to Reportable Segment Disclosures" which expands annual and interim disclosure requirements for reportable segments, primarily through enhanced disclosures about significant segment expenses.

ASU 2023-07 is effective for our annual periods beginning January 1, 2024, and for interim periods beginning January 1, 2025, with early adoption permitted.

We are currently evaluating the potential effect that the updated standard will have on our financial statement disclosures.

In December 2023, the FASB issued ASU 2023-09 "Income Taxes (Topics 740):

Improvements to Income Tax Disclosures" to expand the disclosure requirements for income taxes, specifically related to the rate reconciliation and income taxes paid.

ASU 2023-09 is effective for our annual periods beginning January 1, 2025, with early adoption permitted.

We are currently evaluating the potential effect that the updated standard will have on our 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