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; industry partnerships; future results of operations or
financial position; future spending; breakeven revenue point;
expected market conditions, decline 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; 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 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 ended December 31, 2018, describe some,
but not all, of the factors that could cause these
differences.
OVERVIEW
We
continued our focus on automotive electronics and managing the core
programming business for growth and profitability, while developing
and enhancing products, particularly in security provisioning, to
drive future revenue and earnings growth as we invest resources in
the security provisioning market. Our challenge continues to be
operating in a cyclical and rapidly evolving industry environment.
We currently believe we have and are experiencing a capital
spending cyclical downturn. We hope that the improvement in orders
that occurred in September and continued in October means that we
have experienced the worst of the capital equipment downturn. We
are continuing our efforts to balance industry changes, industry
partnerships, new technologies, business geography shifts, exchange
rate volatility, trade issues and tariffs, 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 cost reduction.
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 Microcontrollers.
We plan to deliver new programming technology and automated
handling systems for managed and secure programming in the
manufacturing environment. 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, 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.
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. 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: The adoption of Topic 606,
“Revenue from contracts with customers”, did not have a
material impact on our 2018 financial statement line items, either
individually or in the aggregate. We have elected the practical
expedient to 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 nine months
ended September 30, 2019 and
2018, there were no contract acquisition costs capitalized.
In 2018, we made a sales tax policy election to 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
where we are not responsible for the installation. This takes into
account 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. The transaction price is allocated to the
separate performance obligations on relative standalone sales
price. 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 or acceptance provisions, 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 unaccepted delivered systems,
service, support and maintenance contracts and represents the
undelivered performance obligation of agreements that are typically
recognized ratably over 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, metered 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.
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
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 allows 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, which requires the input of highly
subjective assumptions, including the option’s expected life
and the price volatility of the underlying stock. The expected
stock price volatility assumption was determined using the
historical volatility of our common stock. Changes in the
subjective assumptions required in the valuation model may
significantly affect the estimated value of the awards, the related
stock-based compensation expense and, consequently, our results of
operations. 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.
RESULTS OF OPERATIONS:
NET SALES
|
|
|
|
|
Net
sales by product line
|
|
|
|
|
|
|
|
(in
thousands)
|
|
|
|
|
|
|
|
Automated
programming systems
|
$2,587
|
(50.2%)
|
$5,195
|
$12,041
|
(28.5%)
|
$16,849
|
|
Non-automated
programming systems
|
1,221
|
(8.7%)
|
1,338
|
3,659
|
(19.0%)
|
4,518
|
|
Total programming
systems
|
$3,808
|
(41.7%)
|
$6,533
|
$15,700
|
(26.5%)
|
$21,367
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales by location
|
|
|
|
|
|
|
|
(in
thousands)
|
|
|
|
|
|
|
|
United
States
|
$389
|
(51.9%)
|
$809
|
$1,355
|
(51.6%)
|
$2,802
|
|
% of
total
|
10.2%
|
|
12.4%
|
8.6%
|
|
13.1%
|
|
|
|
|
|
|
|
|
|
International
|
$3,419
|
(40.3%)
|
$5,724
|
$14,345
|
(22.7%)
|
$18,565
|
|
% of
total
|
89.8%
|
|
87.6%
|
91.4%
|
|
86.9%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales by type
|
|
|
|
|
|
|
|
(in
thousands)
|
|
|
|
|
|
|
|
Equipment
sales
|
$1,567
|
(61.3%)
|
$4,047
|
$8,815
|
(36.4%)
|
$13,861
|
|
Adapter
sales
|
1,342
|
(17.8%)
|
1,632
|
4,223
|
(16.7%)
|
5,072
|
|
Software and
maintenance
|
899
|
5.3%
|
854
|
2,662
|
9.4%
|
2,434
|
|
Total programming
systems
|
$3,808
|
(41.7%)
|
$6,533
|
$15,700
|
(26.5%)
|
$21,367
|
|
|
|
|
|
|
|
|
Net
sales in the third quarter of 2019 were $3.8 million, as compared
with $6.5 million in the third quarter of 2018. The year-over-year
decline in sales was a result of a cyclical downturn in capital
spending that began at the end of 2017 and has most recently had
demand impacted by international trade and geopolitical issues in
2019. Equipment sales, in general, correlate to new capacity or
technology related demand. Adapter sales correlate to usage or new
projects. Capacity and usage demand typically are most impacted in
a downturn.
Net
sales for the first nine months of 2019 declined for the same
factors as in the third quarter.
Order
bookings in the third quarter of 2019 were $4.3 million, compared
to $7.0 million in the third quarter of 2018. Backlog at September
30, 2019 was $1.7 million, compared with $3.1 million at September
30, 2018 and $1.4 million at June 30, 2019. Data I/O had $1.7
million deferred revenue at the end of the third quarter of 2019,
up from $1.5 million at June 30, 2019. Segment bookings for the
first nine months of 2019 were attributed to 57% automotive, 16%
programming centers and 27% other (IOT, industrial, consumer and
wireless), compared to the full year of 2018 of 60%, 13% and 27%,
respectively.
GROSS MARGIN
|
|
|
|
|
|
|
|
|
|
|
|
|
(in
thousands)
|
|
|
|
|
|
|
|
Gross
margin
|
$2,002
|
(51.4%)
|
$4,118
|
$9,270
|
(27.5%)
|
$12,783
|
|
Percentage of net
sales
|
52.6%
|
|
63.0%
|
59.0%
|
|
59.8%
|
For the
2019 third quarter, gross margin as a percentage of sales was
52.6%, as compared to 63.0% in the third quarter of 2018. The third
quarter gross margin was primarily impacted by fixed costs being
spread over lower revenue.
Gross
margin for the first nine months of 2019 declined for the same
factors as in the third quarter.
RESEARCH AND DEVELOPMENT
|
|
|
|
|
|
|
|
|
|
|
|
|
(in
thousands)
|
|
|
|
|
|
|
|
Research and
development
|
$1,507
|
(17.5%)
|
$1,826
|
$4,868
|
(12.3%)
|
$5,550
|
|
Percentage of net
sales
|
39.6%
|
|
28.0%
|
31.0%
|
|
26.0%
|
|
|
|
|
|
|
|
|
Research
and development (“R&D”) expenses were lower in the
third quarter and year to date 2019 compared to the same periods in
2018 primarily due to lower headcount related costs, incentive
compensation and stock-based compensation.
SELLING, GENERAL AND ADMINISTRATIVE
|
|
|
|
|
|
|
|
|
|
|
|
|
(in
thousands)
|
|
|
|
|
|
|
|
Selling, general
&
|
|
|
|
|
|
|
|
administrative
|
$1,535
|
(18.7%)
|
$1,888
|
$5,338
|
(14.4%)
|
$6,239
|
|
Percentage of net
sales
|
40.3%
|
|
28.9%
|
34.0%
|
|
29.2%
|
Selling,
General and Administrative (“SG&A”) expenses were
lower in the third quarter and year to date 2019 compared to the
same periods in 2018 primarily due to lower sales commissions on
lower sales, certain lower headcount related costs, incentive
compensation and stock-based compensation. Most discretionary and
variable expenses declined compared to the prior year
periods.
INTEREST
|
|
|
|
|
|
|
|
|
|
|
|
|
(in
thousands)
|
|
|
|
|
|
|
|
Interest
income
|
$25
|
150.0%
|
$10
|
$47
|
80.8%
|
$26
|
Interest
income was higher in the third quarter and year to date 2019
compared to the same periods in 2018 primarily due to increased
minor increases in interest rates on invested funds.
INCOME TAXES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in
thousands)
|
|
|
|
|
|
|
|
Income tax benefit
(expense)
|
$(55)
|
(69.4%)
|
$(180)
|
$(52)
|
(80.5%)
|
$(267)
|
Income
tax for both the third quarter of 2019 and the same period in 2018,
primarily related to foreign and state taxes in addition to the US
domestic benefit realized from converting remaining sequestered AMT
credits, that had a full valuation allowance on such credits, into
a receivable of approximately $42,000, resulting from IRS rule
changes allowing the release of previously sequestered AMT
credits.
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 $7.3 million as of
September 30, 2019. As of September 30, for both 2019 and 2018, our
deferred tax assets and valuation allowance have been reduced by
approximately $335,000 and $298,000, 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
|
|
|
|
|
|
(in
thousands)
|
|
|
|
|
Working
capital
|
$18,413
|
$(2,652)
|
$21,065
|
At
September 30, 2019, our principal sources of liquidity consisted of
existing cash and cash equivalents. Cash decreased $3.2 million
from December 31, 2018 primarily from paying for 2018 accrued
incentive compensation and share repurchases under the share
repurchase program.
The
working capital decline in the first nine months of 2019 was
similarly due to share repurchases and to fund the loss for year to
date 2019, as well as to new GAAP accounting for leases (ASC 842)
that went into effect on January 1, 2019 which recognizes a
right-of-use asset and a corresponding lease liability, with the
result being a gross up on the balance sheet. The lease liability
is comprised of $661,000 in current liabilities and $1.3 million in
long term liabilities as of September 30, 2019. The lease
accounting adjustments have no impact on our statement of
operations, but the recording of the current liability reduces the
working capital calculation.
Although
we have no significant external capital expenditure plans
currently, we expect that we will continue to make 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, 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
current or growth in future profitability. We have implemented or
have initiatives to implement geographic shifts in our operations,
optimize real estate usage, reduce exposure to the impact of
currency volatility and tariffs, increase product development
differentiation, and reduce costs.
We
believe that we have sufficient cash or working capital available
under our operating plan to fund our operations and capital
requirements through at least the next one-year period. We may
require additional cash at the U.S. headquarters, which could cause
potential repatriation of cash that is held in our foreign
subsidiaries. Although we have no current repatriation plans, there
may be tax and other impediments to any repatriation actions. 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.
SHARE REPURCHASE PROGRAMS
On
October 31, 2018, our Board of Directors approved a share
repurchase program with provisions to buy back up to $2.0 million
of our stock during the period from November 1, 2018 through
October 31, 2019. The program was established with a
10b5-1 plan under the Exchange Act to provide flexibility to make
purchases throughout the period. For the quarter ended September
30, 2019, 55,904 shares of stock were repurchased at an average
price of $4.37 for a total of $244,197 including $1,176 in
commissions and charges. The $2.0 million buyback program was
completed during the third quarter of 2019. The following is a
summary of the stock repurchase program from November 1, 2018
through September 30, 2019:
|
Repurchases by
Month
|
Total Number of
Shares Purchased
|
Average Price Paid
per Share
|
Total Number of
Shares Purchased as Part of Publicly Announced Repurchase
Program
|
Approximate Dollar
Value of Shares that May Yet Be Purchased under the
Program
|
|
|
|
|
|
|
|
December
2018
|
101,975
|
$5.25
|
101,975
|
$1,464,470
|
|
January
2019
|
43,701
|
$5.39
|
43,701
|
$1,229,115
|
|
March
2019
|
13,911
|
$5.49
|
13,911
|
$1,152,793
|
|
April
2019
|
69,141
|
$5.34
|
69,141
|
$783,687
|
|
May
2019
|
69,798
|
$4.63
|
69,798
|
$461,417
|
|
June
2019
|
49,255
|
$4.44
|
49,255
|
$244,197
|
|
July
2019
|
55,280
|
$4.37
|
55,280
|
$2,798
|
|
August
2019
|
624
|
$4.32
|
624
|
$3
|
|
Total
|
403,685
|
$4.95
|
403,685
|
|
|
|
|
|
|
|
OFF-BALANCE SHEET ARRANGEMENTS
Except
as noted in the accompanying consolidated financial statements in
Note 6, “Operating Lease Commitments” and Note 7,
“Other Commitments”, we have no off-balance sheet
arrangements.
NON-GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP) FINANCIAL
MEASURES
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
EndedSeptember 30,
|
Nine Months
EndedSeptember 30,
|
|
|
|
|
|
|
|
(in
thousands)
|
|
|
|
|
|
Net Income
(loss)
|
$(844)
|
$342
|
$(691)
|
$958
|
|
Interest
(income)
|
(25)
|
(10)
|
(47)
|
(26)
|
|
Taxes
|
55
|
180
|
52
|
267
|
|
Depreciation
& amortization
|
248
|
230
|
672
|
736
|
|
EBITDA earnings
(loss)
|
$(566)
|
$742
|
$(14)
|
$1,935
|
|
|
|
|
|
|
|
Equity
compensation
|
260
|
282
|
911
|
932
|
|
Adjusted EBITDA
earnings (loss),
|
|
|
|
|
|
excluding
equity compensation
|
$(306)
|
$1,024
|
$897
|
$2,867
|
|
|
|
|
|
|
Recently Adopted Accounting Pronouncements
We adopted the new lease accounting standard, ASC 842, on January
1, 2019 using the modified retrospective transition method, and
recorded a balance sheet adjustment on the date of adoption. In
2018, we accounted for leases under ASC 840. The new lease standard
requires lessees to recognize right-of-use assets and lease
liabilities on the balance sheet for operating leases, and also
requires additional quantitative and qualitative disclosures to
enable users of the financial statements to assess the amount,
timing and uncertainty of cash flows arising from leases. In
adopting ASC 842, we utilized certain practical expedients
available under the standard. These practical expedients include
waiving reassessment of conclusions reached under the previous
lease standard as to whether contracts contain leases, not
recording right-of-use assets or lease liabilities for leases with
terms of 12 months or less, how to classify leases identified and
how to account for initial direct costs incurred. We also utilized
the practical expedient to use hindsight as of the date of adoption
to determine the terms of our leases and to evaluate our
right-of-use assets for impairment.