DATA I/O CORP 10-K

Item 7 . Management’s Discussion and Analysis of Financial Condition and Results of Operations 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 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 including recovery from the shutdown in Shanghai, China; industry prospects and trends; expected business recovery; industry partnerships; future results of operations or financial position; future spending; expected expenses, breakeven revenue point; expected market decline, bottom or growth; market acceptance of our newly introduced or upgraded products or services; the sufficiency of our cash to fund future operations and capital requirements; development, introduction and shipment of new products or services; changing foreign operations; taxes, trade issues and tariffs; expected inventory levels; expectations for unsupported platform or product versions and related inventory and other charges; Russian invasion of Ukraine impacts; Israel – Hamas war impacts; supply chain expectations; semiconductor chip shortages and recovery; and any other guidance on future periods are forward-looking statements. Forward-looking statements reflect management’s current expectations and are inherently uncertain. Although we believe that the expectations reflected in these forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, achievements, or other future events. 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. The Reader should not place undue reliance on these forward-looking statements. 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. OVERVIEW 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. recession. 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. 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 remain good, these markets and our business have been, and are likely to continue to be, adversely impacted by 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. 21 Table of Contents 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, 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. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect the more significant judgments and estimates used in the preparation of our financial statements: Revenue Recognition: 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. We expense contract acquisition costs, primarily sales commissions, for contracts with terms of one year or less and will capitalize and amortize incremental costs with terms that exceed one year. During 2023 and 2022, the impact of capitalization of incremental costs for obtaining contracts was immaterial. We exclude sales, use, value added, some excise taxes and other similar taxes from the measurement of the transaction price. We recognize revenue upon transfer of control of the promised products or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services. We have determined that our programming equipment has reached a point of maturity and stability such that product acceptance can be assured by testing at the factory prior to shipment and that the installation meets the criteria to be a separate performance obligation. These systems are standard products with published product specifications and are configurable with standard options. The evidence that these systems could be deemed as accepted was based upon having standardized factory production of the units, results from batteries of tests of product performance to our published specifications, quality inspections and installation standardization, as well as past product operation validation with the customer and the history provided by our installed base of products upon which the current versions were based. The revenue related to products requiring installation that is perfunctory is recognized upon transfer of control of the product to customers, which generally is at the time of shipment. 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 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 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. For the installation and service and support performance obligations, we use the value of the discount given to distributors who perform these components. 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 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 to 60 days from shipment. 22 Table of Contents We transfer certain products out of service from their internal use and make them available for sale. The products transferred are typically our standard products in one of the following areas: service loaners, rental or test units; engineering test units; or sales demonstration equipment. Once transferred, the equipment is sold by our regular sales channels as used equipment inventory. These product units often involve refurbishing and an equipment warranty, and are conducted as sales in our normal and ordinary course of business. 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 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. Inventory : Inventories are stated at the lower of cost or net realizable value. Adjustments are made to standard cost, which approximates actual cost on a first-in, first-out basis. We estimate reductions to inventory for obsolete, slow-moving, excess and non-salable inventory by reviewing current transactions and forecasted product demand. We evaluate our inventories on an item-by-item basis and record inventory adjustments accordingly. If there is a significant decrease in demand for our products, uncertainty during product line transitions, or a higher risk of inventory obsolescence because of rapidly changing technology and customer requirements, we may be required to increase our inventory adjustments, and our gross margin could be adversely affected. Warranty Accruals: We accrue for warranty costs based on the expected material and labor costs to fulfill our warranty obligations. If we experience an increase in warranty claims, which are higher than our historical experience, our gross margin could be adversely affected. Tax Valuation Allowances: Given the uncertainty created by our loss history, as well as the current and ongoing cyclical and COVID-19 related uncertain economic outlook for our industry and capital and geographic spending, as well as income and current net deferred tax assets by entity and country, we expect to continue to limit the recognition of net deferred tax assets and accounting for uncertain tax positions and maintain the tax valuation allowances. At the current time, we expect, therefore, that reversals of the tax valuation allowance will take place as we are able to take advantage of the underlying tax loss or other attributes in carry forward or their use by future income or circumstances allow us to realize these attributes. The transfer pricing and expense or cost sharing arrangements are complex areas where judgments, such as the determination of arms-length arrangements, can be subject to challenges by different tax jurisdictions. Share-based Compensation: 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 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. 23 Table of Contents Results of Operations: Net Sales Net sales by product line 2023 Change 2022 (in thousands) Automated programming systems $ 22,806 20.5 % $ 18,926 Non-automated programming systems 5,258 (0.6 %) 5,291 Total programming systems $ 28,064 15.9 % $ 24,217 Net sales by location 2023 Change 2022 (in thousands) United States $ 2,799 57.8 % $ 1,774 % of total 10.0 % 7.3 % International $ 25,265 12.6 % $ 22,443 % of total 90.0 % 92.7 % Net sales by type 2023 Change 2022 (in thousands) Equipment Sales $ 16,343 18.4 % $ 13,803 Adapter Sales 8,154 11.2 % 7,336 Software and Maintenance Sales 3,567 15.9 % 3,078 Total $ 28,064 15.9 % $ 24,217 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. Gross Margin 2023 Change 2022 (in thousands) Gross margin $ 16,186 22.5 % $ 13,210 Percentage of net sales 57.7 % 54.5 % Gross margin as a percentage of sales for the year ended December 31, 2023 was 57.7%, compared to 54.5% in 2022. 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 2023 Change 2022 (in thousands) Research and development $ 6,524 7.2 % $ 6,083 Percentage of net sales 23.2 % 25.1 % 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. During 2023, 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 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. 24 Table of Contents Selling, General and Administrative 2023 Change 2022 (in thousands) Selling, general & administrative $ 9,214 17.0 % $ 7,876 Percentage of net sales 32.8 % 32.5 % 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. Interest 2023 Change 2022 (in thousands) Interest income $ 190 458.8 % $ 34 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. INCOME TAXES 2023 Change 2022 (in thousands) Income tax (expense) benefit $ (194 ) (71.6 %) $ (683 ) 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. state income tax. The effective tax rate for 2023 of 28.6% and 2022 of (156.3%) 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 $8.7 million and $9.3 million as of December 31, 2023 and 2022, respectively. Our deferred tax assets and valuation allowance have increased by approximately $430,000 and $422,000 associated with the requirements of accounting for uncertain tax positions as of December 31, 2023 and 2022, respectively. Given the uncertainty created by our loss history, particularly in the U.S., which is where most of our net deferred tax assets are located, and the ongoing uncertain economic outlook for our industry, as well as capital and geographic spending, we currently expect to continue to limit the recognition of net deferred tax assets and maintain the tax valuation allowances. Inflation and changes in Foreign currency exchange rates Sales and expenses incurred by foreign subsidiaries are denominated in the subsidiary’s local currency and translated into U.S. Dollar amounts at average rates of exchange during the year. 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. Dollars. 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. 25 Table of Contents FINANCIAL CONDITION: LIQUIDITY AND CAPITAL RESOURCES 2023 Change 2022 (in thousands) Working capital $ 18,425 $ 846 $ 17,579 At December 31, 2023, our principal sources of liquidity consisted of existing cash and cash equivalents. Cash at December 31, 2023 and 2022 was $12.3 million and $11.5 million, respectively. 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. 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. We plan to increase our internally developed rental, security provisioning, sales demonstration and test equipment as we develop and release new products. 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, 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. 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. 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 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. Any substantial inability to achieve our current business plan could have a material adverse impact on our financial position, liquidity, or results of operations and may require us to reduce expenditures and/or seek possible additional financing. OFF-BALANCE SHEET ARRANGEMENTS Except as noted in the accompanying consolidated financial statements in Note 7, “Other Commitments”, we had no material off-balance sheet arrangements. SHARE REPURCHASE PROGRAMS Data I/O did not have a share repurchase program in 2023 or 2022. NON-GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP) FINANCIAL MEASURES Earnings Before Interest, Taxes, Depreciation, and Amortization (“EBITDA”) and Adjusted EBITDA excluding equity compensation and impairment & related charges (non-cash, one-time items) are set forth below. Non-GAAP financial measures should not be considered a substitute for, or superior to, measures of financial performance prepared in accordance with GAAP. We believe that these non-GAAP financial measures provide meaningful supplemental information regarding our results and facilitate the comparison of results. 26 Table of Contents A reconciliation of net income to EBITDA and Adjusted EBITDA follows: For Year Ended December 31, 2023 2022 (in thousands) Net Income (loss) $ 486 $ (1,120 ) Interest (income) (190 ) (34 ) Taxes 194 683 Depreciation and amortization 608 560 EBITDA $ 1,098 $ 89 Equity compensation 1,190 1,176 Adjusted EBITDA, excluding equity compensation $ 2,288 $ 1,265 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. 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. Item 7A. Quantitative and Qualitative Disclosures About Market Risk Not applicable.