DATA I/O CORPORATION 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, impact of COVID-19;Shanghai COVID-19 resurgence lockdown impact and timing; industry prospects and trends; expected business recovery; industry partnerships; future results of operations or financial position; future spending; 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; trade issues and tariffs; expected inventory levels; expectations for unsupported platform or product versions and related inventory and other charges; Russian invasion ofUkraine impacts; supply chain expectations; semiconductor chip shortages; 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, neitherData I/O nor anyone else assumes responsibility for the accuracy and completeness of these forward-looking statements. We are under no duty to update any of these forward-looking statements after the date of this Quarterly Report. The Reader should not place undue reliance on these forward-looking statements. The discussions above and in the section in Item 1A., Risk Factors "Cautionary Factors That May Affect Future Results" in our Annual report on Form 10-K for the year endedDecember 31, 2021 , describe some, but not all, of the factors that could cause these differences. OVERVIEW AtData I/O , we are investing for the long-term to retain and extend our leadership position in automotive electronics and security deployment. On the product side, we continue to invest with a long-term focus towards expanding our markets and creating unique value for our customers. This is true for both our traditional core business as well as the emerging security deployment business. Our strong cash position and balance sheet combined with our long-term view of the market gives us the financial flexibility to make these investments. Our short-term challenge continues to be operating in a cyclical, COVID-19 impacted, uncertain geopolitical, and rapidly evolving industry environment with continued supply chain and semiconductor part shortage issues. We continue to balance industry changes, industry partnerships, new technologies, business geography shifts, travel and customer restrictions, customer shut downs, exchange rate volatility, trade issues and tariffs, COVID-19 impacts, semiconductor chip shortages, increasing costs and strategic investments in our business with the level of demand and mix of business we expect. We continue to manage our costs carefully and execute strategies for cash preservation, protecting our employee base, addressing inflation impacts, and cost control. Many of our employees continue to work remotely from home or on a hybrid basis, with the essential production and process workers onsite as part of our essential operations. We are focusing our research and development efforts in our strategic growth markets, namely automotive electronics and IoT new programming technologies, secure supply chain solutions, automated programming systems and their enhancements for the manufacturing environment and software. We are continuing to develop technology to securely provision new categories of semiconductors, including Secure Elements, Authentication Chips, and Secure Memory and Secure Microcontrollers. We continue to focus on extending the capabilities of our programming systems and supporting the latest semiconductor devices, including various configurations of NAND Flash, e-MMC, UFS and microcontrollers on our newer products. 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. 15 Table of Contents
Although the long-term prospects for our strategic growth markets should be good, these markets and our business have been, and are likely to continue to be, adversely impacted by the global pandemic of COVID-19. Semiconductor chip shortages have caused, and continue to cause issues and some automotive plant interruptions. This appears to be a lower impact, but lingering issue for 2022 and in some cases, drives consumable adapter demand in order to support alternative chips. The Shanghai COVID-19 related lockdown, which impacted ourShanghai facility starting in March, ended in early June, and our facility is currently operational. The facility was operational at all times in the third quarter. Because we have manufacturing facilities inShanghai and Redmond, it has helped us to be part of a resilient supply chain to our customers with dual production of some products and local sourcing of many suppliers. We continue to keep certain COVID-19 safety proceedures and limitations in our facilities as the pandemic continues. All of our facilities are subject to restrictions and closure by governmental entities. The pandemic has and may continue to impact our revenues in some geographies, our ability to obtain key components and to manufacture our products, as well as sell, install and support our products around the world. See also the detailed discussion of the impacts of COVID-19 on our business and markets in Item 1A, Risk Factors in our annual report on Form 10-K. The pandemic could have the effect of heightening many of the other risks described in Item 1A of our Form 10-K. Annual projections on spending, growth, mix, and profitability have been and are likely to be further revised substantially as new information is obtained.
CRITICAL ACCOUNTING POLICY JUDGMENTS AND ESTIMATES
The preparation of financial statements in accordance with accounting principles generally accepted inthe 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, 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 2022 and 2021, 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.
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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 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. 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 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 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.
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 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 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.
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.
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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 pandemic related uncertain
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 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.
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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RESULTS OF OPERATIONS:
NET SALES
Three Months Ended Nine Months EndedNet sales by September 30, September 30, September 30, September 30, product line 2022 Change 2021 2022 Change 2021 (in thousands) Automated programming (2.1 (18.2 systems $ 5,414 %) $ 5,528$ 12,934 %)$ 15,817 Non-automated programming systems 1,798 49.6 % 1,202 4,012 9.6 % 3,661 Total programming (13.0 systems $ 7,212 7.2 % $ 6,730$ 16,946 %)$ 19,478 Three Months Ended Nine Months Ended Net sales by September 30, September 30, September 30, September 30, location 2022 Change 2021 2022 Change 2021 (in thousands) United States $ 684 (25.8 %) $ 922 $ 1,488 (11.2 %) $ 1,676 % of total 9.5 % 13.7 % 8.8 % 8.6 % International $ 6,528 12.4 % $ 5,808$ 15,458 (13.2 %)$ 17,802 % of total 90.5 % 86.3 % 91.2 % 91.4 % Three Months Ended Nine Months Ended Net sales by September 30, September 30, September 30, September 30, type 2022 Change 2021 2022 Change 2021 (in thousands) Equipment (0.9 (19.7 sales $ 4,040 %) $ 4,077 $ 9,274 %)$ 11,554 Adapter sales 2,330 22.6 % 1,901 5,378 (6.5 %) 5,751 Software and maintenance 842 12.0 % 752 2,294 5.6 % 2,173 Total programming (13.0 systems $ 7,212 7.2 % $ 6,730$ 16,946 %)$ 19,478
Net sales in the third quarter of 2022 were$7.2 million , up 7% as compared with$6.7 million in the third quarter of 2021. The increase from the prior year period primarily reflects higher overall demand for equipment, and higher adapter sales from shipping backlog related to the Covid-19 relatedShanghai shutdown from mid-March to mid-June recovery, offset in part by lower revenue as a result of the stronger US dollar. The prior year period included the impact of semiconductor part shortages especially on automotive electronics business. Recurring and consumable revenues, which include adapter sales, represented$3.2 million or 44% of total revenues in the third quarter 2022, as compared with$2.7 million or 39% of the lower third quarter 2021 total. Total capital equipment sales were 56% of revenues, adapters were 32% and software and services revenues were 12% of revenues respectively in the third quarter of 2022 compared with 55% and 30% and 15% respectively for the third quarter of 2021.
On a geographic basis, international sales represented approximately 91% of total net sales for the third quarter of 2022 compared with 86% in the prior year period.
Third quarter 2022 bookings were$7.1 million , up from$5.0 million in the third quarter of the prior year. The current quarter's bookings we believe were impacted by the recovery from the Covid-19 relatedShanghai shutdown, as well as a resurgence of business demand in each of our geographies (Americas ,Europe andAsia ), offset in part by the currency translation impact of the strong dollar. 19 Table of Contents Backlog atSeptember 30, 2022 was approximately$4.9 million , down from$5.8 million atJune 30, 2022 and up from$3.3 million atSeptember 30, 2021 . The backlog draw down fromJune 30th relates primarily to build and shipment of production related to the prior quarter Shanghai Covid shutdown.Data I/O had$2.0 million in deferred revenue at the end of the third quarter of 2022, including one delivered system waiting for final acceptance, as compared with$1.5 million at the end of fourth quarter of 2021. GROSS MARGIN Three Months Ended Nine Months Ended September 30, September 30, September 30, September 30, 2022 Change 2021 2022 Change 2021 (in thousands) Gross (18.6 %) margin $ 4,111 0.6 % $ 4,088 $ 9,172$ 11,263 Percentage of net sales 57.0 % 60.7 % 54.1 % 57.8 % Gross margins at 57.0% in the third quarter were down from 60.7% in the third quarter of 2021. The decrease was primarily due to currency strength of the US Dollar, which is up approximately 15% versus the Euro and Yuan, offset in part by net favorable factory variances. RESEARCH AND DEVELOPMENT Three Months Ended Nine Months Ended September 30, September 30, September 30, September 30, 2022 Change 2021 2022 Change 2021 (in thousands) Research and development $ 1,432 (17.2 %) $ 1,730 $ 4,605 $ 5,009 Percentage of net sales 19.9 % 25.7 % 27.2 % 25.7 %
Research and development ("R&D") expenses in the third quarter of 2022 were $1.4
million and decreased by approximately $298,000 from the prior year period
primarily due to lower incentive compensation and consulting expenses as well as
the impact of the strong US Dollar translation of foreign subsidiary costsand spending discipline.
SELLING, GENERAL AND ADMINISTRATIVE
Three Months Ended Nine Months Ended
September 30, September 30, September 30, September 30,
2022 Change 2021 2022 Change 2021
(in thousands)
Selling,
general &
administrative $ 1,967 (11.2 %) $ 2,216 $ 5,943 (6.1 %) $ 6,332
Percentage of
net sales 27.3 % 32.9 % 35.1 % 32.5 %
Selling, General and Administrative ("SG&A") expenses in the third quarter of
2022 were $2.0 million and decreased by approximately $249,000 from the prior
year period primarily due to lower incentive compensation as well as the impact
of the strong US Dollar translation of foreign subsidiary costs and spending
discipline. The cost control measures have remained in place during the first
three quarters of 2022 and are expected to continue in the fourth quarter of
2022.
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INTEREST
Three Months Ended Nine Months Ended
September 30, September 30, September 30, September 30,
2022 Change 2021 2022 Change 2021
(in thousands)
Interest income $ 9 12.5 % $ 8 $ 11 0.0 % $ 11
Interest income was higher in the third quarter 2022 compared to the same period in 2021 primarily due to interest received on the AMT refund.
INCOME TAXES
Three Months Ended Nine Months Ended
September 30, September 30, September 30, September 30,
2022 Change 2021 2022 Change 2021
(in
thousands)
Income tax
benefit ($181 ($112 ($700 ($219 )
(expense) ) 61.6 % ) ) 219.6 %
Income tax benefit (expense) for the third quarter of both 2022 and 2021,
primarily related to foreign and minor state taxes. For the nine months ended
The effective tax rate differed from the statutory tax rate primarily due to the effect of valuation allowances, as well as foreign taxes. We have a valuation allowance of$8.3 million as ofSeptember 30, 2022 . As ofSeptember 30 , for both 2022 and 2021, our deferred tax assets and valuation allowance have been reduced by approximately$412,000 and$381,000 , respectively, associated with the requirements of accounting for uncertain tax positions. 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
September 30, December 31,
2022 Change 2021
(in thousands)
Working capital $ 16,490 ($1,994 ) $ 18,484
At September 30, 2022 , our principal sources of liquidity consisted of existing
cash and cash equivalents. Cash decreased $3.1 million from December 31, 2021
primarily due to funding the operating loss and 2021 year end accruals.
Net working capital at the end of the third quarter of 2022, compared to
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 industry, significant product development, customer support and selling and marketing efforts, we have required substantial working capital to fund our operations. We have tried to balance our level of development spending with the goal of profitable operations or managing lower business levels related to COVID-19. We have implemented or have initiatives to implement geographic shifts in our operations, optimize real estate usage, reduce exposure to the impact of currency volatility and tariffs, increase product development differentiation, adjust pricing relative to inflation,
and
control costs.
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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 theU.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 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. 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 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
$1.2 million in the third quarter of 2022 compared to $284,000 in the third
quarter of 2021. Adjusted EBITDA, excluding equity compensation (a non-cash
item), was $1.4 million in the third quarter of 2022, compared to $564,000 in
the third quarter of 2021.
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 Nine Months Ended
September 30, September 30,
2022 2021 2022 2021
(in thousands)
Net Income (loss) $ 847 $ 12 ($1,630 ) ($350 )
Interest (income) (9 ) (8 ) (11 ) (11 )
Taxes 181 112 700 219
Depreciation & amortization 148 168 441 516
EBITDA earnings (loss) $ 1,167 $ 284 ($500 ) $ 374
Equity compensation 264 280 935 960
Adjusted EBITDA, excluding
equity compensation $ 1,431 $ 564 $ 435 $ 1,334
New Accounting Pronouncements
See Note 1 of Notes to Condensed Consolidated Financial Statements included in Part 1, Item 1 for a discussion of new accounting pronouncements.
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