UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

 

 

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ☒ No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “acceleratedfiler”, ”accelerated filer”, “smaller reporting company” and "emerging“emerging growth company"company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  ☐ No ☒

 

Shares of Common Stock, no par value, outstanding as of October 26, 2017:August 2, 2019: 8,205,798

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Data I/O Corporation (“Data I/O”, “We”, “Our”, “Us”) prepared the financial statements as of SeptemberJune 30, 20172019 and SeptemberJune 30, 20162018 according to the rules and regulations of the Securities and Exchange Commission ("SEC"). These statements are unaudited but, in the opinion of management, include all adjustments (consisting of normal recurring adjustments and accruals) necessary to present fairly the results for the periods presented. The balance sheet at December 31, 20162018 has been derived from the audited financial statements at that date. We have condensed or omitted certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America according to such SEC rules and regulations. Operating results for the three and ninesix months ended SeptemberJune 30, 20172019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017.2019. These financial statements should be read in conjunction with the annual audited financial statements and the accompanying notes included in our Form 10-K for the year ended December 31, 2016.2018.

 

 

We recognize revenue atupon transfer of control of the timepromised products or services to customers in an amount that reflects the product is shipped.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 considered a separate element.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 canis expected to be performed by other parties, such as distributors, other vendors, or the customers themselves. This takes into account the complexity, skill and training needed as well as customer expectations regarding installation.

 

We enter into arrangements with multiple deliverable arrangementsperformance 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 valuetransaction 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 components,performance obligations, we use the value of the discount given to distributors who perform these components. For software maintenance components,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 recognized ratably over one year.

 

When we sell software separately, we recognize revenue upon the transfer of control of the software, revenuewhich 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 persuasive evidencethere is an approved contract that both parties are committed to perform, both parties rights have been identified, the contract has substance, collection of an arrangement exists, shipmentsubstantially all the consideration is probable, the transaction price has occurred,been determined and allocated over the price is fixed or determinable,performance obligations, the buyer has paid or is obligated to pay, collectability is reasonably assured,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.

 

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.

 

 

Leases arise from contracts which convey the right to control the use of identified property or equipment for a period of time in exchange for consideration. Our leasing arrangements are primarily for office space we use to conduct our operations. In addition, there are automobiles and a small amount of office equipment leased. We measuredetermine whether contracts include a lease at the inception date, which is generally upon contract signing, considering factors such as whether the contract includes an asset which is physically distinct, which party obtains substantially all of the capacity and recognizeeconomic benefit of the asset, and which party directs how, and for what purpose, the asset is used during the contractual period of use. Our leases commence when the lessor makes the asset available for our use. At commencement we record a lease liability at the present value of future lease payments, net of any future lease incentives to be received. Some of our lease agreements include cancellable future periods subject to termination or extension options. We include cancellable lease periods in our future lease payments when we are reasonably certain to continue to utilize the asset for those periods. We calculate the present value of future lease payments at commencement using a discount rate which we estimate as the collateralized borrowing rate we believe that would be incurred on our future lease payments over a similar term. At commencement we also record a corresponding right-of-use asset, which is calculated based on the amount of the lease liability, adjusted for any advance lease payments paid, initial direct costs incurred or lease incentives received prior to commencement. Right-of-use assets are subject to evaluation for impairment or disposal on a basis consistent with other long-lived assets.

All stock-based compensation expense as required for all share-based payment awards including employee stock options and restricted stock unit awards,are measured based on estimated fair values and estimated forfeiture rate on the date of grant dates.and recognized as compensation expense on the straight-line single-option method. Our share-based compensation is reduced for estimated forfeitures at the time of grant and revised as necessary in subsequent periods if actual forfeitures differ from those estimates.

 

 

Penalties associated withIncome taxes are computed at current enacted tax mattersrates, less tax credits using the asset and liability method. Deferred taxes are classified as generaladjusted both for items that do not have tax consequences and administrative expense when incurred and amounts relatedfor the cumulative effect of any changes in tax rates from those previously used to interest associated with tax matters are classified as interest income or interest expense.  We did not incur any interest or penalties associated with tax matters during the three and nine months ended September 30, 2017.

 

 

 

 

 

 

 

 

 

 

 

Other accrued liabilities consisted of the following components:

 

 

 

 

 

We have commitments under non-cancelableOur leasing arrangements are primarily for facility leases we use to conduct our operations. The following table presents our future lease payments for long-term operating leases and other agreements, primarily for factory and office space, with initial or remaining termsas of one year or more as follows:June 30, 2019:

 

For the years ending December 31:

 

  

 

Non-employee directors Restricted Stock Units (“RSU’s”) vest over one year employeeand options vest over three years and have a six-year exercise period. Employee RSU’s typically vest over four years and employee Non-Qualified stock options typically vest quarterly over 4 years and have a six yearsix-year exercise period.

 

 

 

 

 

 

 

 

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 orand trends; expected revenues; expected level of expense; expected savings;industry partnerships; future results of operations; reversals of tax valuation allowances; breakeven point,operations or financial position; changes in gross margin; economic conditions and capital spending outlook;future spending; breakeven revenue point; expected market growth; market acceptance of our newly introduced or upgraded products;products or services; the sufficiency of our cash to fund future operations and capital requirements; development, introduction and shipment of new products; building lease arrangements; sales channelsproducts 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 weData 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 report.Quarterly Report. The readerReader 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, 20162018, describe some, but not all, of the factors that could cause these differences.

 

 

We arecontinued our focus on automotive electronics and managing the core programming business for growth and profitability, while developing and enhancing both our core products, and our managed and secure programming platformparticularly in security provisioning, to drive future revenue and earnings growth.  We continuegrowth as we invest resources in the security provisioning market. Our challenge continues to be operating in a cyclical seasonal and rapidly evolving industry environment. We attemptcurrently believe we are experiencing a capital spending cyclical 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 current business opportunitieswe expect. We continue to manage our costs carefully and execute strategies for cost reduction.

 

We are concentratingfocusing our research and development efforts in our strategic growth markets, namely automotive electronics and Internet of Things (IoT), focusing onIoT new programming technologies, security provisioning,secure supply chain solutions, automated programming systems and their enhancements for the manufacturing environment and software. We are developingcontinuing to develop technology to securely programprovision new categories of semiconductors, including authentication ICs (especially secure elements)Secure Elements, Authentication Chips, and secure microcontrollers.Secure Microcontrollers. We are deliveringplan to deliver new programming technology and automated handling systems for managed and secure programming in the manufacturing environment. In these new security initiatives, we face a new evolving market; are in a period of rapid learning; and are establishing new industry relationships, business processes, supply chains, and investing heavily in advance of revenue.

 

Our customer focus remainshas been on global and strategic high volumehigh-volume manufacturers in key market segments like automotive electronics, IoT, industrial controls and consumer electronics, as well as programming centers and contract manufacturing.centers.

 

 

 

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, estimating the percentage-of-completion on fixed-price professional engineering service contracts, sales returns, bad debts, inventories, investments, 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:

 

We recognize revenue atupon transfer of control of the timepromised products or services to customers in an amount that reflects the product is shipped.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 considered a separate element.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 canis expected to be performed by other parties, such as distributors, other vendors, or in most cases the customers themselves. This takes into account the complexity, skill and training needed as well as customer expectations regarding installation.

 

We enter into arrangements with multiple deliverable arrangementsperformance 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 valuetransaction 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 components,performance obligations, we use the value of the discount given to distributors who perform these components. For software maintenance components,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. OtherDeferred revenue includes service, revenue issupport and maintenance contracts and represents the undelivered performance obligation of agreements that are typically recognized as it is delivered.ratably over one year.

 

When we sell software separately, we recognize revenue upon the transfer of control of the software, revenuewhich 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 persuasive evidencethere is an approved contract that both parties are committed to perform, both parties rights have been identified, the contract has substance, collection of an arrangement exists, shipmentsubstantially all the consideration is probable, the transaction price has occurred,been determined and allocated over the price is fixed or determinable,performance obligations, the buyer has paid or is obligated to pay, collectability is reasonably assured,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.

 

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.

 

 

 

 

 

 

 

 

 

 

Net sales infor the thirdsecond quarter of 2017 were $9.62019 declined approximately 19.0% to $5.8 million compared with $6.6 million in the third quarter of 2016. Automotive Electronics demand from both OEMs and Programming Centers drove increased revenues primarily related to our PSV family of automated programming systems. Revenues from adapters, a consumable, increased approximately $100,000 from the year earlier period. International sales represented 94% of total sales for the third quarter, compared to 93% during the same period in 2016.2018 primarily as a result of slower Automotive Electronics cyclical demand. The 2018 comparable period sales also benefited from the use of backlog. On a regional basis, Asia was our strongest territory in the second quarter of 2019, despite tariffs.

 

RevenueNet sales for the quarter was approximately 74% equipment, 20% consumables and 6% software and services.first six months of 2019 declined for the same factors as in the second quarter.

 

Order bookings increased 4%in the second quarter of 2019 were $5.1 million, compared to $8.2$7.2 million in the thirdsecond quarter of 2017, a 10-year third quarter high, compared to $7.9 million in the third quarter of 2016. The variation in revenue percentages versus order bookings percentages relates to the change in backlog, deferred revenues and currency translation. Deferred revenue at the end of the third quarter was $1.6 million with all major systems shipments able to be recognized in the quarter. At the end of the second quarter, we had deferred revenue of $2.8 million, including 3 systems that were recognized in the third quarter.2018. Backlog at the end of the third quarterJune 30, 2019 was $4.6$1.4 million, compared to $4.7with $1.9 million at June 30, 2018. Data I/O had $1.5 million deferred revenue at the end of the second quarter and $3.2of 2019, down from $1.6 million at DecemberMarch 31, 2016.

 

 

 

For the thirdsecond quarter of 2017,2019, gross margin as a percentage of sales was 62.1%61.4%, as compared to 55.3% in the third quarter of 2016 and 56.9%59% in the second quarter of 2017.2018. The increase wassecond quarter and first six months of 2019 gross margin percentage level exceeded the Company’s anticipated target model due primarily due to sales volume, which resulted in better fixed factory cost utilization, along with a favorable product mix aas well as favorable sales channel mix (with more direct sales versus distributer sales),variances, primarily overhead and reduced unfavorable factory variances. Distributer sales are net of a distribution discount where direct sales usually result in channel commissions which are included in selling expense. We increased our capacity during the third quarter with virtually no additional investment.

 

 

 

Research and development (“R&D”) increased $456,000expenses were lower in the thirdsecond quarter of 2017and year to date 2019 compared to the same periodperiods in 2016,2018 primarily due to additional and higher personnellower headcount related costs, incentive compensation and stock based compensation as well as SentriX NRE charges, which mostly supported our Managed and Secure Programming initiative.

 

 

 

Selling, General and Administrative (“SG&A”) expenses increased $655,000were lower in the thirdsecond quarter and year to date 2019 compared to the same periods in 2018 primarily due to lower sales commissions on lower sales and headcount related costs including incentive compensation and stock-based compensation.

Interest income was higher in the second quarter of 20172019 compared to the same period in 2016,2018 primarily due to the increased level of business activity and include higher incentive, commission and stock based compensation and depreciation, offsetminor increases in part by lower rent costs.interest rates on invested funds.

 

 

Income tax for both the second quarter of 2019 and the same period in 2018, primarily related to foreign and state taxes, which for the 2019 period the foreign subsidiary income, was much lower than in the previous year for the same period. Income tax for the first ninesix months of 20172019 compared to the same period in 2016,2018, primarily related to 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 increase in SG&A expense was generally due to the same factors discussed above for the third quarter.

 

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 $10.6$7.1 million as of SeptemberJune 30, 2017. Our2019. As of June 30, for both 2019 and 2018, our deferred tax assets and valuation allowance have been reduced by approximately $249,000$325,000 and $226,000$290,000, respectively, associated with the requirements of accounting for uncertain tax positions as of September 30, 2017 and December 31, 2016, respectively.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 associated withincluding 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. We expect to further analyze the level of valuation allowance during the remainder of 2017.

 

 

 

 

At SeptemberJune 30, 20172019, our principal sources of liquidity consisted of existing cash positionand cash equivalents. Cash decreased $3.1 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 six months of 2019 was $15.2 million,similarly due to share repurchases 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 $10.8the result being a gross up on the balance sheet. The liability is comprised of $667,000 in current liabilities and $1.5 million in long term liabilities as of June 30, 2019. The lease accounting adjustments have no impact on our statement of operations, but the USA andrecording of the balance in foreign subsidiaries. The change in cash duringcurrent liability reduces the quarter resulted primarily from earnings for the period and collections of our accounts receivable.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 the goal of profitable operations. We have implemented or have initiatives to implement geographic shifts in our operations, optimizedoptimize real estate usage, reducedreduce exposure to the impact of currency volatility and additionaltariffs, increase product development differentiation, and cost reductions.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 forat the U.S. operations,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.