DATA I/O CORP 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations General 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 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. In particular, statements herein regarding economic outlook; 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 2023 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. OVERVIEW First quarter revenue at $6.1 million was down 16% compared with $7.2 million from the prior year period, reflecting lower backlog coming into the period plus timing of shipments from new bookings. First quarter bookings were at $8.1 million, up 41% from the prior year on strong opportunity conversion in Europe and Asia. As a result, backlog increased $1.7 million during the first quarter to $4.5 million as of March 31, 2024. Most of these bookings are expected to be shipped and recognized as revenue in the second half of 2024. Data I/O has a broad product portfolio and diversified international market presence as reflected in our revenue mix by product and geography. The Americas region has seen tremendous growth over the past two years due to capacity expansion and is expected to absorb this capacity in 2024. Our strong first quarter bookings performance was a result of diversification as strength in Europe and Asia offset lower orders in the Americas region. Research and development efforts remain focused on 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. Furthermore, Data I/O remains focused on growth from the Automotive, Industrial and Prorgramming Center markets worldwide combined with spending controls, process efficiencies and operating leverage. 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. In the first quarter of 2024, Data I/O continued to expand its market penetration while reducing operating expenses. This approach to disciplined growth remains a priority in 2024. 15 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 the first quarter of 2024 and 2023, 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, services 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 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. 16 Table of Contents 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. 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 cyclical economic outlook for our industry, 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. 17 Table of Contents RESULTS OF OPERATIONS: NET SALES Three Months Ended Net sales by product line March 31, 2024 Change March 31, 2023 (in thousands) Automated programming systems $ 4,823 (18.6%) $ 5,927 Non-automated programming systems 1,276 (0.5%) 1,304 Total programming systems $ 6,099 (15.4%) $ 7,231 Three Months Ended Net sales by location March 31, 2024 Change March 31, 2023 (in thousands) United States $ 226 (75.9%) $ 937 % of total 3.7 % 13.0 % International $ 5,873 (6.7%) $ 6,294 % of total 96.3 % 87.0 % Three Months Ended Net sales by type March 31, 2024 Change March 31, 2023 (in thousands) Equipment sales $ 3,366 (16.9%) $ 4,051 Adapter sales 1,846 (18.6%) 2,267 Software and maintenance 887 (2.8%) 913 Total $ 6,099 (15.7%) $ 7,231 Net sales in the first quarter of 2024 were $6.1 million, as compared with $7.2 million in the prior year period and $6.9 million in the fourth quarter of 2023. Sales decrease in the first quarter primarily reflects timing of shipments on new first quarter bookings and higher backlog in the prior periods from favorable post-lockdown recovery one year ago. First quarter 2024 bookings were $8.1 million, as compared with $5.7 million in the prior year period and $7.2 million in fourth quarter of 2023. Bookings increase in the first quarter was due to strong sales opportunity conversion in Europe and Asia markets. Backlog increased $1.7 million in the first quarter to $4.5 million as of March 31, 2024 as compared to $3.2 million as of March 31, 2023 and $2.8 million as of December 31, 2023. Data I/O had $1.8 million in deferred revenue as of March 31, 2024 as compared with $2.0 million as of March 31, 2023. On a geographic basis, international sales represented approximately 96% of total net sales for the first quarter of 2024 compared with 87% in the prior year period. Total equipment sales were 55% of revenues, adapters were 30% and software and services revenues were 15% of revenues respectively in the first quarter of 2024 compared with 56% and 31% and 13% respectively for the first quarter of 2023. Automotive electronics represented 49% of orders followed by 37% for programming centers and 14% for IoT for the first quarter of 2024. 18 Table of Contents GROSS MARGIN Three Months Ended March 31, 2024 Change March 31, 2023 (in thousands) Gross margin $ 3,220 (25.2%) $ 4,302 Percentage of net sales 52.8 % 59.5 % Gross margin as a percentage of sales in the first quarter of 2024 was 52.8% as compared to 59.5% in the same period last year and 58% in the fourth quarter of 2023. The decrease in gross margin percentage primarily reflects lower sales volume on relatively fixed manufacturing and service costs, sales channel and product mix impacts. RESEARCH AND DEVELOPMENT Three Months Ended March 31, 2024 Change March 31, 2023 (in thousands) Research and development $ 1,582 (2.6%) $ 1,625 Percentage of net sales 25.9 % 22.5 % Research and development (“R&D”) expenses decreased in the first quarter of 2024 as compared to the same period in 2023. We have maintained our investment in our product development and supporting our growth initiatives while maintaining cost control discipline. SELLING, GENERAL AND ADMINISTRATIVE Three Months Ended March 31, 2024 Change March 31, 2023 (in thousands) Selling, general & administrative $ 2,498 (0.4%) $ 2,508 Percentage of net sales 41.0 % 34.7 % Selling, General and Administrative (“SG&A”) expenses were slightly lower in the first quarter of 2024 as compared to the same period in 2023. First quarter spending reduction reflects higher compensation and inflationary increases offset by continued efficiency improvements and cost reduction efforts. INTEREST Three Months Ended March 31, 2024 Change March 31, 2023 (in thousands) Interest income $ 80 128.6 % $ 35 Interest income was higher in the first quarter of 2024 compared to the same period in 2023 due to higher interest rates and invested balances. 19 Table of Contents INCOME TAXES Three Months Ended March 31, 2024 Change March 31, 2023 (in thousands) Income tax benefit (expense) $ (41 ) 17.1 % $ (35 ) Income tax benefit (expense) for the first quarter of 2024 and 2023 primarily related to foreign and state taxes. 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 $8.9 million as of March 31, 2024. As of March 31, for both 2024 and 2023, our deferred tax assets and valuation allowance have been reduced by approximately $434,000 and $429,000, respectively. 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. Financial Condition LIQUIDITY AND CAPITAL RESOURCES March 31, 2024 Change December 31, 2023 (in thousands) Working capital $ 18,148 (1.5% ) $ 18,425 At March 31, 2024, our principal sources of liquidity consisted of existing cash and cash equivalents. Cash at $12 million decreased $342,000 from December 31, 2023 primarily due to lower revenue and higher first quarter expenditures for public company cost including audit, regulatory filings and stock exchange fees, and annual incentive compensation disbursements. Correspondingly, working capital decreased by $277,000 during the first quarter to $18.1 million as of March 31, 2024. The Company continues to have no debt. Although we have no significant capital expenditure plans currently, we expect to continue to carefully make and manage expenditures to support the business. Engineering and production tooling, test equipment and sales demonstration products will continue to be purchased as we develop and release new products. Capital expenditures are 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 working capital to fund our operations. We have tried to balance our spending with our anticipated revenue levels and the goal of profitable operations. We have implemented or have initiatives to implement geographic shifts in our operations, reduce exposure to the impact of currency volatility, tariffs and taxes, increase product development efficiency, and control 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 amounts 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. 20 Table of Contents 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 ($645,000) in the first quarter of 2024 compared to $253,000 in the first quarter of 2023. Adjusted EBITDA, excluding equity compensation (a non-cash item), was ($364,000) in the first quarter of 2024, compared to $502,000 in the first quarter of 2023. 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. We believe that these non-GAAP financial measures provide meaningful supplemental information regarding the Company’s results and facilitate the comparison of results. A reconciliation of net income to EBITDA and adjusted EBITDA follows: NON-GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP) FINANCIAL MEASURE RECONCILIATION Three Months Ended March 31, 2024 2023 (in thousands) Net Income (loss) $ (807 ) $ 95 Interest (income) (80 ) (35 ) Taxes 41 35 Depreciation & amortization 201 158 EBITDA earnings (loss) $ (645 ) $ 253 Equity compensation 281 249 Adjusted EBITDA, excluding equity compensation $ (364 ) $ 502 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. Item 3 . Quantitative and Qualitative Disclosures About Market Risk Not applicable.