UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the fiscal year ended December 31, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the period from ___________ to _____________
Commission File No. 0-10394
DATA I/O CORPORATION
(Exact name of registrant as specified in its charter)
Washington 91-0864123
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(State or other Incorporation) Employer Identification Number)
P.O. Box 97046, 10525 Willows Road N.E.,
Redmond, Washington, 98073-9746
(425) 881-6444
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(Address, including zip code, of registrant's principle executive
offices and telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
- --------------------------------------------------------------------------------
NONE
Securities registered pursuant to Section 12(g) of the Act:
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Common Stock (No Par Value)
Series A Junior Participating Preferred Stock
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes [ ] No [X]
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. Yes [ ] No [X]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large accelerated filer ____ Accelerated filer ___ Non-accelerated filer [X]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
Aggregate market value of voting and non-voting Common Stock held by
non-affiliates of the registrant as of June 30, 2005
$20,342,406
8,410,961 shares of Common Stock, no par value, outstanding as of March 27, 2006
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Proxy Statement relating to its May 24, 2006
Annual Meeting of Shareholders are incorporated into Part III of this Annual
Report on Form 10-K.
DATA I/O CORPORATION
FORM 10-K
For the Fiscal Year Ended December 31, 2005
INDEX
Part I Page
----
Item 1. Business ....................................................3
Item 1A. Risk Factors ...............................................10
Item 1B. Unresolved Staff Comments ..................................15
Item 2. Properties .................................................15
Item 3. Legal Proceedings ..........................................15
Item 4. Submission of Matters to a Vote of Security Holders ........15
Part II
Item 5. Market for Registrant's Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity
Securities .................................................16
Item 6. Selected Financial Data ....................................17
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations .......................18
Item 7A. Quantitative and Qualitative Disclosures About
Market Risk ................................................25
Item 8. Financial Statements and Supplementary Data ................25
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure .......................45
Item 9A. Controls and Procedures ....................................45
Item 9B. Other Information ..........................................45
Part III
Item 10. Directors and Executive Officers of the Registrant .........45
Item 11. Executive Compensation .....................................46
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters ................46
Item 13. Certain Relationships and Related Transactions .............46
Item 14. Principal Accounting Fees and Services .....................46
Part IV
Item 15. Exhibits, Financial Statement Schedules ....................47
Signatures .................................................................51
PART I
ITEM 1. BUSINESS
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This Annual Report on Form 10-K and the documents incorporated herein by
reference contain forward-looking statements based on current expectations,
estimates and projections about Data I/O(R) Corporation's industry, management's
beliefs and certain assumptions made by management. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations - Forward Looking
Statements."
GENERAL
Data I/O Corporation ("Data I/O") designs, manufactures, and sells programming
systems used by designers and manufacturers of electronic products. Our
programming system products are used to program integrated circuits ("ICs" or
"devices" or "semiconductors") so that the ICs will function as desired in the
customer's electronic product. They are an important tool for the electronics
industry experiencing growing use of programmable ICs. Data I/O markets and
distributes our programming systems worldwide, and is the global leader in this
market. Data I/O incorporated in the State of Washington in 1969.
Data I/O Mission. Data I/O's mission is to design and deliver innovative
customer-focused programming solutions, which enable customers to manage their
firmware supply chain, getting their products to market faster, while reducing
costs in their process. We align our products and services to make programming
easy, delight our customers and satisfy their whole product needs.
Helping Customers Manage their Firmware Supply Chain. Much of the innovation and
competitive advantage of today's electronic products comes from the software
buried inside the product, which is commonly referred to as "firmware."
Companies use firmware to differentiate their products from their competitors'
products, constantly writing new code to add features. This allows them to build
multiple models with identical hardware and many versions of firmware, all on
one production line. Any improvement in production efficiency boosts the
profitability of all products on that line. Many original equipment
manufacturers ("OEMs") now outsource production to specialists in electronic
manufacturing services ("EMS") to maximize the profit impact from highly
efficient production. The challenges of managing the firmware supply chain
remain, however, and can even increase with this additional interface. Our
systems allow our customers - both OEM and EMS companies - to build products
with the exact firmware features that consumers specify, virtually real-time
with the latest software release. We help our customers eliminate inventory
risks, delays, rework, and lost market opportunities while enabling them to
better serve their customers.
Connected Strategy. There are many providers of device programming tools on the
market today. However, experienced design, test and manufacturing engineering
teams need a comprehensive approach to process management that will assure the
integrity of the product data files from design through manufacturing, assuring
that the production line builds the product in the most cost-effective way,
precisely as designed. Data I/O solutions provide a consistent device
programming methodology from design through prototype and new product
introduction and finally in the high volume manufacturing phase. We call this
approach the `Connected Strategy'. Data I/O's Connected Strategy leverages
network capable products to easily move the customer's intellectual property
securely up and down the supply chain.
Business Restructuring. During 2005, we took restructuring related charges of
$96,000 primarily related to severance and completing actions that had been
started in the second half of 2004. This aligned management operations with the
changes made in 2004 to control costs in North America and Europe and the need
to build staff serving China and Eastern Europe.
INDUSTRY BACKGROUND
Data I/O enables companies to improve productivity and reduce costs by providing
device programming solutions that enable our customers to take intellectual
property (design and data files) and program it into memory, microcontroller and
logic devices. Companies that design and manufacture electronic products that
utilize programmable devices purchase these solutions from us. These companies,
our primary customers, design and manufacture a broad range of electronic
products for both consumer and industrial use. Data I/O also provides services
related to hardware support, system installation and repair, and device
programming.
According to several industry reports, there continues to be forecasted growth
of semiconductors used in consumer electronic products, automotive electronics,
and industrial controls which we believe should continue to drive demand for
programming equipment and services. Programmable devices continue to be
significant and growing segments of the semiconductor industry according to
several published industry reports. Flash memory and programmable
micro-controllers are typical types
3
of these devices. Programmable devices offer advantages to the electronic
product designer allowing them to bring products to market more quickly and
inexpensively than using fixed-function devices, and can offer the advantage of
simpler rapid product upgrades. Programmable devices also offer attractive
functionality to the user of the electronic product, such as storing personal
information or customizing product functionality. As a result, use of
programmable devices is growing rapidly in both high-volume consumer electronic
products and more complex electronic systems.
More than 100 semiconductor manufacturers offer thousands of different
programmable devices. The technology trends driving the programmable device
market result in a broad range of requirements for programming information into
these devices. Programmable memory devices continue to have higher capacity and
occupy smaller circuit board space. Programmable microcontroller devices are now
more prevalent because semiconductor vendors are standardizing their
manufacturing processes. These technology advances require advanced programming
equipment like Data I/O manufactures.
Our automated programming systems integrate programming and handling functions
into one product solution. Quality conscious customers continue to drive this
portion of our business, which includes high-volume manufacturing and
high-volume programming center customers.
PRODUCTS
In order to accommodate the expanding variety and quantities of programmable
devices being manufactured today, Data I/O offers multiple solutions for the
numerous types of devices used by our customers in the various market segments
and applications. We work closely with major manufacturers of programmable
devices to develop our products to meet the requirements of a particular device.
Data I/O's line of programming systems includes a broad range of products,
systems, modules, and accessories, which we group into two general categories:
automated programming systems and non-automated programming systems. We provide
automated programming systems in two categories: off-line and in-line (including
In-system Programming). In addition, we provide device support and service on
all of our products. Device support is a critical aspect of our business and
consists of writing algorithms for devices and developing socket adapters to
hold and connect to the device for programming.
Within the categories of automated and non-automated systems, Data I/O targets
specific solutions at specific market segments. Data I/O optimizes the solution
based on the customer's device, process and business needs. Data I/O's flagship
programming platform, FlashCORE(TM), has the speed and pricing to provide the
best value in the industry, making it the leading choice for high volume
production. Data I/O technical teams work closely with semiconductor
manufacturers to actively plan for programming support of new devices and
physical packages. The FlashCORE platform is used worldwide to program NOR Flash
devices from all providers, including market leaders, Intel, Renesas, Spansion
and Toshiba. Data I/O leads the industry in providing solutions for NAND flash
programming from Hynix, Micron, Samsung, ST Microelectronics, Toshiba, M Systems
DiskOnChip and others. The dynamics of the flash market are changing, blurring
the distinction of NAND and NOR technologies and the emergence of converged
offerings, including Samsung's OneNAND and Spansion's ORNAND, also supported on
FlashCORE systems. Data I/O's strong partnerships with leading semiconductor
companies greatly enhance our ability to serve our mutual customers.
Target customers include electronic product OEM manufacturers of consumer
products, like the fast-growing portable/wireless devices, cellular handsets and
smart appliances. These applications are high volume users of programmable flash
memory devices.
In portable electronics products, shrinking form factors are driving the
shrinkage of device packages. Manual programming and handling of these tiny
packages is increasingly not practical due to quality issues. This trend toward
small packages should drive demand for Data I/O's automated programming systems
in 2006.
Applications targeted for these tiny devices include automotive, consumer
appliances, remote controls, medical devices, portable/personal electronics, PC
peripherals, hand-held and wearable PCs, telecommunications including phones and
pagers, security alarms and sensors.
TaskLink(R) for Windows provides a universal job set-up tool that intuitively
guides users in preparing product data files for programming. TaskLink is also a
key element of our Connected Strategy. Leveraging network connectivity, Data
I/O's TaskLink provides monitoring and control over programming systems anywhere
on the network - providing global companies with greater visibility and control
over remote production lines or contract manufacturing processes.
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AUTOMATED PROGRAMMING SYSTEMS
Data I/O provides our manufacturing and programming center customers with
automated programming systems solutions that include robotic handlers, a variety
of programmers, input and output media handling (such as tray stackers, tubes,
loaders or taping), and marking solutions. Our ProLINE-RoadRunner(TM) is a
unique in-line programming system with programming speed capability, which
approaches the speed at which Flash devices can currently accept data. Many of
our customers need to program Flash and microcontroller devices in large
quantities and very quickly. ProLINE-RoadRunner mounts directly on the assembly
machine in the production line (Siemens, Fuji, Universal, Panasonic and
Assembleon machines) and delivers programmed parts from reels of blank devices
to the production line in a just-in-time fashion. Our ProLINE-RoadRunner
eliminates production bottlenecks associated with high-density Flash and
microcontroller devices, allowing last minute firmware changes and eliminating
programmed part inventories, ultimately streamlining and reducing the customer's
production and process costs. ProLINE-RoadRunner enables customers to implement
lean processes and is a key element in Data I/O's Connected Strategy, allowing
customers and partners to more effectively manage their firmware supply chain.
ProLINE-RoadRunner currently retails from $72,500 to $118,000, depending on
programming capability.
Data I/O's PS family of automated programming solutions offers highly flexible
solutions for off-line batch programming. Data I/O can configure PS systems to
support not only Flash devices, but also a wide variety of other devices, such
as microcontrollers. These systems provide a number of marking, labeling, and
input/output options. Most importantly, customers can make changeovers extremely
fast. This feature allows the customer to rapidly respond to diverse demands
with very little downtime. Customers can optimize the PS family systems for any
job to maximize throughput and, when combined with fast changeover times and
high reliability, provide the highest levels of output during a production
shift. Our latest product, the PS588, integrates the same FlashCORE programmer
we use in our PS288, PS300 FlashCORE, ProLINE-RoadRunner and FlashPAK(TM) and
builds on our Connected Strategy and common architecture. The PS588
significantly improves throughput and lowers the cost per programmed part. The
PS family products range in price from $129,500 to $469,000.
We introduced the ImageWriter 200, our solution for in-systems programming of
programmable microcontrollers serial memory mounted on the printed circuit
board, in the fourth quarter of 2004 and introduced the ImageWriter 300 in 2005.
This solution is designed to be integrated into the line but does no handling.
The primary markets for ImageWriter are microcontroller applications in
automotive electronics, industrial automation and consumer electronics. Pricing
for the ImageWriter starts at approximately $2,000 for the first unit with most
installations requiring multiple units.
NON-AUTOMATED PROGRAMMING SYSTEMS
Our line of non-automated programming systems provides solutions for both
engineering and low to medium-volume manufacturing customers. Non-automated
programming systems require a user to physically handle the devices being
programmed. These types of programmers are also sometimes referred to as
"manual" or "desktop" programmers. We now have three families of non-automated
programmers: Sprint, UniSystem and FlashPAK.
Engineering customers typically use single-site programming systems during the
prototype phase of a new design, and may purchase inexpensive systems for
limited device needs or more expensive systems to support more complex devices
or a large variety of device types. Single-site programming systems can perform
programming on only one programmable device at a time.
Data I/O offers a range of high quality, universal single socket manual
programming solutions through our UniSystem family of programming systems. Our
UniSite and 3980 xpi programming systems offer the highest levels of signal
integrity, which ensure the highest programming standards. Popular in military,
aerospace, telecommunications and other mission critical applications, the
systems range from $15,000 to $35,000.
For more cost constrained or higher volume applications, the Sprint family of
products offers excellent value for the money and versatility. The Sprint Quad
and Octal programming systems offer 4 and 8 socket universal programming
configurations for higher volume applications. The Sprint family of products
range in price from under $1,000 to $20,000 for the multiple socket solutions.
Our newest programmer, the FlashPAK, leverages the high-speed proprietary
FlashCORE programming technology in the ProLINE-RoadRunner system. We believe
FlashPAK, starting at approximately $7,000, is the world's fastest programming
architecture, limited today only by the speed at which Flash devices can accept
data. FlashPAK is another key element of Data I/O's connected strategy,
providing OEMs and new product introduction facilities with a high performance
Flash programming system that can be used to validate designs before moving down
the firmware supply chain. For manufacturing applications, the FlashPAK, a high
speed, multi-socket, small footprint desktop solution, provides manual
programming operations with the highest level of flexibility at the lowest cost
per part. Manufacturers that use manual programming because of lower labor costs
in areas like Asia find FlashPAK an attractive solution.
5
Data I/O supports and completes our product offering with a full range of
software and device update products and worldwide service and repair capability.
CUSTOMERS
Data I/O sells our products to customers worldwide in a broad range of
industries, including wireless handset manufacturers and other telecommunication
companies, consumer electronics, computers, test and measurement, medical,
transportation, military, aerospace, electronic contract manufacturing,
programming centers, and semiconductors. Our principal customers include
Motorola, Nokia, and Siemens. Our customers either design and/or manufacture
electronic products that incorporate programmable devices or provide device
programming services. During 2005, we sold products to over 1,600 customers
throughout the world. There were no customers that accounted for more than 10%
of our 2005 net sales and one customer, Siemens, accounted for 14.5% and 18% of
our 2004 and 2003 net sales, respectively.
Programmable device consumption continues to grow as more and more electronic
product manufacturers take advantage of the flexibility and cost effectiveness
of programmable memory, microcontroller and logic devices. Electronic products
today utilize programmable technology in one form or another, from
microcontrolled home appliance devices to set top boxes and wireless devices,
which use increasingly vast amounts of memory for Internet connectivity and new
leading edge features. Therefore, our customers come from virtually all
industries manufacturing electronic products, and include the consumer
electronic products, cell phone, personal data assistants ("PDAs") and other
wireless device manufacturers, home entertainment product sectors, aerospace and
military applications, the personal computer ("PC") and the PC peripheral
industry, automotive electronics and industrial automation and control.
Flash memory growth. The Flash memory customer segment is experiencing some of
the most impressive growth of all programmable devices. As cell phones, PDAs,
games consoles, set top boxes and other consumer devices become more capable,
powerful and compact, the demand for Flash units and megabytes continues to
grow.
Microcontroller growth. As the demand for smarter electronic devices increases,
demand for greater numbers of microcontroller devices increases. Many household
appliances today contain a microcontroller to control the critical functions of
the product and provide new features. Examples of these appliances include
toasters, refrigerators, garage door openers and even thermostats. This growth
creates new market opportunities for us and we have added support for these
devices in our FlashCORE architecture and our ImageWriter product. In addition,
the number of microcontrollers in automotive electronic applications is growing
rapidly, with some cars having as many as 80 or more microcontrollers that
control functions from airbag and ABS systems to air conditioning, information
centers and entertainment and communication systems. We are also targeting the
automotive segment as a critical and growing target segment for our solutions.
GEOGRAPHIC MARKETS AND DISTRIBUTION
Data I/O markets and sells our products through a combination of direct sales,
internal telesales, and indirect sales representatives and distributors. We
continually evaluate our sales channels against our evolving markets and
customers.
Sales of Data I/O's semiconductor programming equipment products requiring
installation by us that is other than perfunctory were previously recorded when
installation was complete, or at the later of customer acceptance or
installation, if an acceptance clause is specified in the sales terms. After we
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 each of the multiple deliverables has an established fair
market value pursuant to EITF 00-21, Data I/O began in the third quarter of 2005
recognizing revenue for these products at the time of shipment if all of the
other criteria for revenue recognition exist in accordance with SAB 104, Revenue
Recognition. Revenue for the undelivered installation service remains deferred
at time of shipment and is recognized upon completion of the installation.
Revenue for products where installation is considered perfunctory continues to
be recognized at the time of shipment. Installation that is considered
perfunctory includes any installation that can be performed by other parties,
such as distributors, other vendors, or in most cases the customers themselves.
We recognize revenue from the sale of service and update contracts as deferred
revenue, and we recognize it on a straight-line basis over the contractual
period.
U.S. SALES
We market our products throughout the U.S. using a variety of sales channels,
including our own field sales management personnel, independent sales
representatives, and a direct telesales organization. Our U.S. independent sales
representatives obtain orders on an agency basis, with shipments made directly
to the customer by Data I/O. Net sales in the United States for 2005, 2004, and
2003 were $6,386,000, $5,434,000, and $7,263,000, respectively.
6
FOREIGN SALES
Foreign sales represented approximately 78%, 80%, and 70%, of net sales of our
programming systems in 2005, 2004, and 2003, respectively (see Note 15 of "Notes
to Consolidated Financial Statements"). We make foreign sales through our
wholly-owned subsidiaries in Germany, China and Canada, as well as through
independent distributors and sales representatives located in 35 other
countries. Our independent foreign distributors purchase Data I/O products in
U.S. Dollars for resale and we recognize the sale at the time of shipment to the
distributor. As with U.S. sales representatives, sales made by international
sales representatives are on an agency basis with shipments made directly to the
customer by us.
Net foreign sales for 2005, 2004, and 2003 were $21,935,000, $21,876,000, and
$17,424,000, respectively. We determine total foreign sales by the international
geographic area into which the products are sold and delivered, and include not
only sales by foreign subsidiaries but also export sales from the U.S. to our
foreign distributors and to our representatives' customers. Foreign sales do not
include transfers between Data I/O and our foreign subsidiaries. Export sales
are subject to U.S. Department of Commerce regulations. We have not, however,
experienced any difficulties to date as a result of these requirements.
Fluctuating exchange rates and other factors beyond our control, such as
international monetary stability, tariff and trade policies, and U.S. and
foreign tax and economic policies, affect the level and profitability of foreign
sales. We cannot predict the effect of such factors on our business.
COMPETITION
The competition in the programming systems market is highly fragmented with a
large number of smaller organizations offering inexpensive solutions. While we
are not aware of any published industry market information covering the
programming systems market, according to our inside analysis, we estimate that
the total number of programming systems sold during 2005 has been approximately
$110 million, with Data I/O capturing an estimated 25% of the global market.
Over the last four years, based on our analysis, we believe that Data I/O has
gained market share versus our significant competitors.
Competitive factors often include prices, features, device support and
programming speed, as the programming process impacts more on the major
manufacturers' total production process. However, competitive factors are
changing. The added value for customers is becoming the whole product solution
that fits the customer's business processes. As an example, ProLINE-RoadRunner
offers a unique solution, which best addresses the customer's process needs in
high volume Flash applications. To this extent, the value proposition of this
specific programming solution is very different from traditional solutions.
Therefore, addressing customers' process needs is critical to increasing the
opportunity for programming solutions beyond the current amount in this market
niche. We estimate that customers are spending between $2.0 billion to $2.5
billion a year on programming memory, microcontroller and logic devices and much
of this programming is achieved through the use of the customers' test equipment
offered by companies like Agilent and Teradyne or homegrown solutions for
specific markets like automotive. The main competitive solution in the
programmable market is, therefore, the in-house solution, and the opportunity
exists to substitute customers' solutions with more economical and more easily
maintainable solutions to solve the problems, which traditional programmers do
not address. Boundary scan tools also fall into this category, although still a
small market with a number of small companies participating who principally
focus on test solutions. We expect that our new ImageWriter product will offer a
competitive solution for the consumer electronics, automotive electronics and
industrial automation customers in this market.
MANUFACTURING, RAW MATERIALS, AND BACKLOG
Data I/O performs primarily assembly and testing of our products at our
principal facility in Redmond, Washington and we outsource our circuit board
manufacturing and fabrication. We use a combination of standard components,
proprietary custom ICs and fabricated parts manufactured to Data I/O
specifications. An outside supplier located in Germany manufactures our Sprint
non-automated programming systems. Most components used are available from a
number of different suppliers and subcontractors but certain items, such as some
handler and programmer subassemblies, custom ICs, hybrid circuits and
connectors, are purchased from single sources. We believe that additional
sources can be developed for present single-source components without
significant difficulties in obtaining supplies. We cannot be sure that
single-source components will always continue to be readily available. If we
cannot develop alternative sources for these components, or if we experience
deterioration in relationships with these suppliers, there may be delays or
reductions in product introductions or shipments, which may materially adversely
affect our operating results.
In accordance with industry practices, generally all orders are subject to
cancellation prior to shipment without penalty, except for contracts calling for
custom configuration. To date, such cancellations have not had a material effect
on our sales volume.
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To meet customers' delivery requirements, we manufacture certain products based
upon a combination of backlog and anticipated orders. Most orders are scheduled
for delivery within 1 to 60 days after receipt of the order. Our backlog of
pending orders was approximately $1.2 million, $1.5 million, and $1.5 million as
of December 31, 2005, 2004, and 2003, respectively. The size of backlog at any
particular date is not necessarily a meaningful indicator of the trend of our
business.
RESEARCH AND DEVELOPMENT
Data I/O believes that continued investment in research and development is
critical to our future success. We continue to develop new technologies and
products and enhance existing products. Future growth is to a large extent
dependent upon the timely development and introduction of new products, as well
as the development of algorithms to support the latest programmable devices. We
are currently focusing our research and development efforts on strategic growth
markets, namely new programming technology and automated handling systems for
the manufacturing environment, including support for NAND FLASH and for
M-Systems DiskOnChip(R) technology, microcontroller support for FlashCORE,
additional platforms and improvements for ProLINE-RoadRunner, enhancements for
our ImageWriter in-system programming solution and eDSS. We continue to also
focus on increasing our capacity and responsiveness for new device support
requests from customers and programmable IC manufacturers by revising and
enhancing our internal processes and tools. During this past year, our research
and development resulted in these new products: PS 588 and ImageWriter 300.
During 2005, 2004, and 2003, we made expenditures for research and development
of $5,286,000, $5,057,000, and $4,639,000, respectively, representing 18.7%,
18.5%, and 18.8%, of net sales, respectively. Research and development costs are
expensed as incurred.
PATENTS, COPYRIGHTS, TRADEMARKS, AND LICENSES
Intellectual property rights applicable to various Data I/O products include
patents, copyrights, trade secrets and trademarks. Data I/O also relies on
patents, copyrights, trade secrets and trademarks to protect our intellectual
property, as well as product development and marketing skill, to establish and
protect our market position. We also grew our patent portfolio over the past few
years as we developed strategic technologies like the ProLINE-RoadRunner and
FlashCORE that are critical to our Connected Strategy.
We attempt to protect our rights in proprietary software products, including
TaskLink and other software products, by retaining the title to and copyright of
the software and documentation, by including appropriate contractual
restrictions on use and disclosure in our licenses, and by requiring our
employees to execute non-disclosure agreements. Our software products are not
normally sold separately from sales of programming systems. However, on those
occasions where software is sold separately, revenue is recognized when a sales
agreement exists, when delivery has occurred, when the fee is fixed or
determinable, and when collectibility is probable.
Because of the rapidly changing technology in the semiconductor, electronic
equipment and software industries, portions of our products might possibly
infringe upon existing patents or copyrights, and we may, therefore, be required
to obtain licenses or discontinue the use of the infringing technology. We
believe that any exposure we may have regarding possible infringement claims is
a reasonable business risk similar to that assumed by other companies in the
electronic equipment and software industries. However, any claim of
infringement, with or without merit, could be costly and a diversion of
management's attention, and an adverse determination could adversely affect our
reputation, preclude us from offering certain products, and subject us to
substantial liability.
EMPLOYEES
As of December 31, 2005, we had 130 employees, of which 42 were located outside
the U.S. We also utilize independent contractors for specialty work, primarily
in research and development, and utilize temporary workers to adjust capacity to
fluctuating demand. Many of our employees are highly skilled and our continued
success will depend in part upon our ability to attract and retain employees who
can be in great demand within the industry. None of our employees are
represented by a collective bargaining unit and we believe relations with our
employees are favorable.
ENVIRONMENTAL COMPLIANCE
Our facilities are subject to numerous laws and regulations concerning the
discharge of materials or otherwise relating to the environment. Compliance with
environmental laws has not had, nor is it expected to have, a material effect on
our capital expenditures, financial position, results of operations or
competitive position.
8
EXECUTIVE OFFICERS OF THE REGISTRANT
Set forth below is certain information concerning the executive officers of Data
I/O as of March 27, 2006:
Name Age Position
---- --- --------
Frederick R. Hume 63 President and Chief Executive Officer
Joel S. Hatlen 47 Vice President
Chief Financial Officer
Secretary and Treasurer
Harald A. Weigelt 46 Vice President
Worldwide Sales and Services
Frederick R. Hume joined Data I/O as President and Chief Executive Officer in
February 1999. He was appointed to the Board of Directors of Data I/O in January
1999. From 1988 until his retirement in 1998, Mr. Hume served as Vice President
and General Manager of Keithley Instruments in Cleveland, Ohio. From 1972 to
1988, he held various management positions at Fluke Corporation, including Group
Vice President for Manufacturing and Research and Development.
Joel S. Hatlen joined Data I/O in September 1991 and became Chief Accounting
Officer and Corporate Controller in February 1997. In January 1998, he was
promoted to Vice President of Finance and Chief Financial Officer, Secretary and
Treasurer. He began his career at Data I/O as a Senior Tax Accountant and became
Tax Manager in December 1992. From September 1981 until joining Data I/O, Mr.
Hatlen was employed by Ernst & Young LLP, where his most recent position was
Senior Manager.
Harald A. Weigelt joined Data I/O in 1991, and in October 2005, he was appointed
Vice President, Worldwide Sales and Services. Prior to this position, he served
as the Vice President, European Operations and as Managing Director of Data
I/O's operations in Germany. Prior to joining Data I/O, he was employed with
Instrumatic, where he served as Product Manager and was employed with Wavetek as
Product Manager.
9
ITEM 1A. RISK FACTORS
- -----------------------
CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS
Data I/O's disclosure and analysis in this Annual Report contains some
forward-looking statements. Forward-looking statements include our current
expectations or forecasts of future events. The reader can identify these
statements by the fact that they do not relate strictly to historical or current
facts. In particular, these include statements relating to future action,
prospective products, new technologies, establishing foreign operations, future
performance or results of current and anticipated products, sales efforts,
expenses, outsourcing of functions, outcome of contingencies, impact of
regulatory requirements, restructure actions and financial results.
Any or all of the forward-looking statements in this Annual Report or in any
other public statement made may turn out to be wrong. They can be affected by
inaccurate assumptions we might make, or known or unknown risks and
uncertainties can affect these forward-looking statements. Many factors -- for
example, product competition and product development -- will be important in
determining future results. Moreover, neither Data I/O nor anyone else assumes
responsibility for the accuracy and completeness of these forward-looking
statements. Actual future results may materially vary.
We undertake no obligation to publicly update any forward-looking statements
after the date of this Annual Report, whether as a result of new information,
future events or otherwise. The reader should not place undue reliance on such
forward-looking statements. The reader is advised, however, to consult any
future disclosures Data I/O makes on related subjects in our 10-Q, 8-K and 10-K
reports to the SEC and press releases. Also, note that Data I/O provides the
following cautionary discussion of risks, uncertainties and possible inaccurate
assumptions relevant to our business. These are factors that we think could
cause Data I/O's actual results to differ materially from expected and
historical results. Other factors besides those listed here could also adversely
affect Data I/O. This discussion is permitted by the Private Securities
Litigation Reform Act of 1995.
RISK FACTORS
DELAYS IN DEVELOPMENT, INTRODUCTION AND SHIPMENT OF NEW PRODUCTS MAY RESULT IN A
DECLINE IN SALES.
Data I/O currently is developing new engineering and automated programming
systems. Significant technological, supplier, manufacturing or other problems
may delay the development, introduction or production of these products.
For example, we may encounter these problems:
o technical problems in the development of a new programming system platform
or the robotics for new automated handing systems
o inability to hire qualified personnel
o delays or failures to perform by third parties involved in our development
projects
Delays in the development, completion and shipment of new products, or failure
of customers to accept new products, may result in a decline in sales.
QUARTERLY FLUCTUATIONS IN OUR OPERATING RESULTS MAY ADVERSELY AFFECT OUR STOCK
PRICE.
Data I/O's operating results tend to vary from quarter to quarter. Our revenue
in each quarter substantially depends upon orders received within that quarter.
Conversely, our expenditures are based on investment plans and estimates of
future revenues. We may, therefore, be unable to quickly reduce our spending if
our revenues decline in a given quarter. As a result, operating results for that
quarter will suffer. Our results of operations for any one quarter are not
necessarily indicative of results for any future periods.
Other factors, which may cause our quarterly operating results to fluctuate,
include:
o increased competition
o timing of new product announcements
o product releases and pricing changes by us or our competitors
o market acceptance or delays in the introduction of new products
10
o production constraints
o labor or material shortages
o the timing of significant orders
o the sales channel mix of direct vs. indirect distribution
o war or terrorism
o health issues (such as SARS)
o customers' budgets
o adverse movements in exchange rates, interest rates or tax rates
o cyclical nature of demand for our customers' products
o general economic conditions in the countries where we sell products
o expenses and obtaining authorizations in setting up new operations or
locations
Due to all of the foregoing factors, it is possible that in some future
quarters, our operating results will be below expectations of analysts and
investors.
FAILURE TO ADAPT TO TECHNOLOGY TRENDS IN OUR INDUSTRY MAY HINDER OUR
COMPETITIVENESS AND FINANCIAL RESULTS.
Product technology in Data I/O's industry evolves rapidly, making timely product
innovation essential to success in the marketplace. Introducing products with
improved technologies or features may render our existing products obsolete and
unmarketable. Technological advances that may negatively impact our business
include:
o new device package types, densities, and technologies requiring hardware
and software changes in order to be programmed by our products
o electronics equipment manufacturing practices, such as widespread use of
in-circuit programming
o customer software platform preferences different from those on which our
products operate
o more rigid industry standards, which would decrease the value-added element
of our products and support services
If we cannot develop products in a timely manner in response to industry
changes, or if our products do not perform well, our business and financial
condition may be adversely affected. Also, our new products may contain defects
or errors that give rise to product liability claims against us or cause our
products to fail to gain market acceptance. Our future success depends on our
ability to successfully compete with other technology firms in attracting and
retaining key technical personnel.
A DECLINE IN ECONOMIC AND MARKET CONDITIONS MAY RESULT IN DECREASED CAPITAL
SPENDING BY OUR CUSTOMERS.
Our business is highly impacted by capital spending plans and other economic
cycles that affect the users and manufacturers of ICs. These industries are
highly cyclical and are characterized by rapid technological change, short
product life cycles, fluctuations in manufacturing capacity and pricing and
gross margin pressures. As we experienced in recent years, our operations may in
the future reflect substantial fluctuations from period-to-period as a
consequence of these industry patterns, general economic conditions affecting
the timing of orders from major customers, and other factors affecting capital
spending. These factors could have a material adverse effect on our business and
financial condition.
WE HAVE A HISTORY OF RECENT OPERATING LOSSES AND MAY BE UNABLE TO GENERATE
ENOUGH REVENUE TO ACHIEVE AND MAINTAIN PROFITABILITY.
We have incurred net losses in three of the last five years. We will continue to
examine our level of operating expense based upon our projected revenues. Any
planned increases in operating expenses may result in larger losses in future
periods if projected revenues are not achieved. As a result, we may need to
generate greater revenues than we have recently to achieve and maintain
profitability. However, we cannot provide assurance that our revenues will
increase and our strategy may not be successful, resulting in future losses.
11
OUR PRIOR RESTRUCTURING ACTIVITIES MAY HAVE A NEGATIVE IMPACT ON OUR FUTURE
OPERATIONS.
Our restructuring plans may yield unanticipated consequences, such as increased
burden on our administrative, operational, and financial resources and increased
responsibilities for our management personnel. As a result, our ability to
respond to unexpected challenges may be impaired and we may be unable to take
advantage of new opportunities.
In addition, many of the employees that were terminated as a part of our
restructuring possessed specific knowledge or expertise, and that knowledge or
expertise may prove to have been important to our operations. In that case,
their absence may create significant difficulties, particularly if our business
experiences significant growth. Also, the reduction in workforce related to our
restructuring may subject us to the risk of litigation, which could result in
substantial cost. Any failure by us to properly manage this rapid change in
workforce could impair our ability to efficiently manage our business, to
maintain and develop important relationships with third-parties, and to attract
and retain customers. It could also cause us to incur higher operating cost and
delays in the execution of our business plan or in the reporting or tracking of
our financial results.
WE MAY NEED TO RAISE ADDITIONAL CAPITAL AND OUR FUTURE ACCESS TO CAPITAL IS
UNCERTAIN.
Our past revenues have been and our future revenues may continue to be
insufficient to support the expense of our operations and any expansion of our
business. We may therefore need additional equity or debt capital to finance our
operations. If we are unable to generate sufficient cash flows from operations
or to obtain funds through additional debt or equity financing, we may have to
reduce some or all of our development and sales and marketing efforts and limit
the expansion of our business.
We believe our existing cash and cash equivalents will be sufficient to meet our
working capital requirements for at least the next twelve months. Thereafter,
depending on the development of our business, we may need to raise additional
cash for working capital or other expenses. We may also encounter opportunities
for acquisitions or other business initiatives that require significant cash
commitments, or unanticipated problems or expenses that could result in a
requirement for additional cash before that time.
Therefore, we may seek additional funding through public or private debt or
equity financing or from other sources. We have no commitments for additional
financing, and we may experience difficulty in obtaining funding on favorable
terms, if at all. Any financing we obtain may contain covenants that restrict
our freedom to operate our business or may require us to issue securities that
have rights, preferences or privileges senior to our Common Stock and may dilute
your ownership interest.
WE MAY FACE INCREASED COMPETITION AND MAY NOT BE ABLE TO COMPETE SUCCESSFULLY
WITH CURRENT AND FUTURE COMPETITORS.
Technological advances have reduced the barriers of entry into the programming
systems market. We expect competition to increase from both established and
emerging companies. If we fail to compete successfully against current and
future sources of competition, our profitability and financial performance will
be adversely impacted.
IF OUR RELATIONSHIP WITH SEMICONDUCTOR MANUFACTURERS DETERIORATES, OUR BUSINESS
MAY BE ADVERSELY AFFECTED.
We work closely with most semiconductor manufacturers to ensure that our
programming systems comply with their requirements. In addition, many
semiconductor manufacturers recommend our programming systems for use by users
of their programmable devices. These working relationships enable us to keep our
programming systems product lines up to date and provide end-users with broad
and current programmable device support. Our business may be adversely affected
if our relationships with semiconductor manufacturers deteriorate.
OUR RELIANCE ON A SMALL NUMBER OF SUPPLIERS MAY RESULT IN A SHORTAGE OF KEY
COMPONENTS, WHICH MAY ADVERSELY AFFECT OUR BUSINESS.
Certain parts used in our products are currently available from either a single
supplier or from a limited number of suppliers. If we cannot develop alternative
sources of these components, if sales of parts are discontinued by the supplier
or we experience deterioration in our relationship with these suppliers, there
may be delays or reductions in product introductions or shipments, which may
materially adversely affect our operating results.
Because we rely on a small number of suppliers for certain parts, we are subject
to possible price increases by these suppliers. Also, we may be unable to
accurately forecast our production schedule. If we underestimate our production
schedule, suppliers may be unable to meet our demand for components. This delay
in the supply of key components may materially adversely affect our business.
Over estimation of demand will lead to excess inventories that may become
obsolete.
The non-automated programming system products we acquired when we acquired SMS
in November 1998 are currently manufactured to our specifications by a
third-party foreign contract manufacturer. We may not be able to obtain a
sufficient quantity of these products if and when needed, which may result in
lost sales.
12
IF WE ARE UNABLE TO ATTRACT AND RETAIN QUALIFIED THIRD-PARTY DISTRIBUTORS, OUR
BUSINESS MAY BE ADVERSELY AFFECTED.
Data I/O has an internal sales force and also utilizes third-party
representatives, and distributors. Therefore, the financial stability of these
representatives and distributors is important. Highly skilled professional
engineers use most of our products. To be effective, third-party distributors
must possess significant technical, marketing and sales resources and must
devote their resources to sales efforts, customer education, training and
support. These required qualities limit the number of potential third-party
distributors. Our business will suffer if we cannot attract and retain a
sufficient number of qualified third-party distributors to market our products.
OUR INTERNATIONAL OPERATIONS MAY EXPOSE US TO ADDITIONAL RISKS THAT MAY
ADVERSELY AFFECT OUR BUSINESS.
International sales represented 78% of our net revenue for the fiscal year ended
December 31, 2005 and 80% for the fiscal year ended December 31, 2004. We expect
that international sales will continue to be a significant portion of our net
revenue. International sales may fluctuate due to various factors, including:
o migration of manufacturing to low cost geographies
o unexpected changes in regulatory requirements
o tariffs and taxes
o difficulties in establishing, staffing and managing foreign operations
o longer average payment cycles and difficulty in collecting accounts
receivable
o fluctuations in foreign currency exchange rates
o compliance with applicable export licensing requirements
o product safety and other certification requirements
o difficulties in integrating foreign and outsourced operations
o political and economic instability
The European Community and European Free Trade Association ("EU") has
established certain electronic emission and product safety requirements ("CE").
Although our products currently meet these requirements, failure to obtain
either a CE certification or a waiver for any product may prevent us from
marketing that product in Europe. The EU also has directives concerning the
Reduction of Hazardous Substances ("RoHS") from which Data I/O is relying on an
exemption for test and measurement companies. Failure to meet applicable
directives or qualifying exemption may prevent us from marketing certain
products in Europe or other territories with similar requirements.
We operate subsidiaries in Germany, China, Canada and Brazil. Our business and
financial condition is sensitive to currency exchange rates or any other
restrictions imposed on their currencies. Currency exchange fluctuations in
Canada, China, Brazil and Germany may adversely affect our investment in our
subsidiaries.
IF WE ARE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY, WE MAY NOT BE ABLE TO
COMPETE EFFECTIVELY OR OPERATE PROFITABLY.
Data I/O relies on patents, copyrights, trade secrets and trademarks to protect
our intellectual property, as well as product development and marketing skill to
establish and protect our market position. We attempt to protect our rights in
proprietary software products, including TaskLink and other software products,
by retaining the title to and copyright of the software and documentation, by
including appropriate contractual restrictions on use and disclosure in our
licenses, and by requiring our employees to execute non-disclosure agreements.
Because of the rapidly changing technology in the semiconductor, electronic
equipment and software industries, portions of our products might possibly
infringe upon existing patents or copyrights, and we may, therefore, be required
to obtain licenses or discontinue the use of the infringing technology. We
believe that any exposure we may have regarding possible infringement claims is
a reasonable business risk similar to that assumed by other companies in the
electronic equipment and software industries. However, any claim of
infringement, with or without merit, could be costly and a diversion of
management's attention, and an adverse determination could adversely affect our
reputation, preclude us from offering certain products, and subject us to
substantial liability.
13
WE MAY PURSUE BUSINESS ACQUISITIONS THAT COULD IMPAIR OUR FINANCIAL POSITION AND
PROFITABILITY.
We may pursue acquisitions of complementary technologies, product lines or
businesses. Future acquisitions may include risks, such as:
o burdening management and our operating teams during the integration of the
acquired entity
o diverting management's attention from other business concerns
o failing to successfully integrate the acquired products
o lack of acceptance of the acquired products by our sales channels or
customers
o entering markets where we have no or limited prior experience
o potential loss of key employees of the acquired company
o additional burden of support for an acquired programmer architecture
Future acquisitions may also impact Data I/O's financial position. For example,
we may use significant cash or incur additional debt, which would weaken our
balance sheet. We may also capitalize goodwill and intangible assets acquired,
the impairment of which would reduce our profitability. We cannot guarantee that
future acquisitions will improve our business or operating results.
THE LOSS OF KEY EMPLOYEES MAY ADVERSELY AFFECT OUR OPERATIONS.
We have employees located in the U.S., Germany, Canada and China. We also
utilize independent contractors for specialty work, primarily in research and
development and in our Brazilian operation, and utilize temporary workers to
adjust capacity to fluctuating demand. Many of our employees are highly skilled
and our continued success will depend in part upon our ability to attract and
retain employees who can be in great demand within the industry. None of our
employees are represented by a collective bargaining unit and we believe
relations with our employees are favorable though no assurance can be made that
this will be the case in the future. Refer to the section captioned "Our prior
restructuring activities may have a negative impact on our future operations"
above.
FAILURE TO COMPLY WITH REGULATORY REQUIREMENTS MAY ADVERSELY AFFECT OUR STOCK
PRICE AND BUSINESS.
As a public company, we are subject to numerous governmental and stock exchange
requirements, with which we believe we are in compliance. The Sarbanes-Oxley Act
of 2002 and the Securities and Exchange Commission (SEC) have requirements that
we may fail to meet by the required deadlines or we may fall out of compliance
with, such as the internal controls assessment, reporting and auditor
attestation required under Section 404 of the Sarbanes-Oxley Act of 2002, with
which we are not yet required to comply as we are not an accelerated filer. The
compliance date for non-accelerated filers has been extended to the first fiscal
year ending on or after July 15, 2007. Data I/O assumes it will continue to have
the status of a non-accelerated filer based on the aggregate market value of the
voting and non-voting shares held as of June 30, 2005. During the course of our
testing we may identify deficiencies which we may not be able to remediate in
time to meet the deadline imposed by the Sarbanes-Oxley Act of 2002 for
compliance with the requirements of Section 404. We may also incur additional
costs in order to comply with Section 404. In addition, if we fail to achieve
and maintain the adequacy of our internal controls, as such standards are
modified, supplemented or amended from time to time, we may not be able to
ensure that we can conclude on an ongoing basis that we have effective internal
controls over financial reporting in accordance with Section 404 of the
Sarbanes-Oxley Act of 2002. Moreover, effective internal controls, particularly
those related to revenue recognition, are necessary for us to produce reliable
financial reports and are important to help prevent financial fraud. If we
cannot provide reliable financial reports or prevent fraud, our business and
operating results could be harmed, investors could lose confidence in our
reported financial information, and the trading price of our stock could drop
significantly. Our failure to meet regulatory requirements and exchange listing
standards may result in actions such as the delisting of our stock impacting our
stock's liquidity; SEC enforcement actions; and securities claims and
litigation.
OUR STOCK PRICE MAY BE VOLATILE AND, AS A RESULT, YOU MAY LOSE SOME OR ALL OF
YOUR INVESTMENT.
The stock prices of technology companies tend to fluctuate significantly. We
believe factors such as announcements of new products by us or our competitors
and quarterly variations in financial results may cause the market price of Data
I/O's Common Stock to fluctuate substantially. In addition, overall volatility
in the stock market, particularly in the technology company sector, is often
unrelated to the operating performance of companies. If these market
fluctuations continue in the future, they may adversely affect the price of Data
I/O's Common Stock.
14
FAILURE TO SUCCESSFULLY IMPLEMENT A NEW WORLDWIDE INFORMATION SYSTEM MAY
ADVERSELY AFFECT OUR OPERATIONS AND SALES.
We have recently acquired and are currently implementing a new worldwide
information system. Our corporate office began use of the new system in February
2006. We are now in the process of implementing the new system at our subsidiary
locations. Our operations and financial results could be adversely affected if
we are unable to complete the system implement without significant interruptions
in accounting systems, order entry, billing, manufacturing and other customer
support functions. In addition, the costs associated with the implementation and
training could exceed budgeted amounts and adversely affect our profitability
and liquidity. System implementation delays could cause difficulties in our
complying with the internal controls assessment, reporting and auditor
attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002.
MOVING OUR HEADQUARTERS AND MANUFACTURING OPERATION MAY ADVERSELY AFFECT OUR
OPERATIONS AND SALES.
We anticipate moving our Redmond headquarters and manufacturing operation in
mid-year 2006 from our current location to a smaller location in Redmond,
Washington. If we are not able to timely and successfully complete the move, our
short-term ability to manufacture and ship products and our sales could be
adversely affected.
ITEM 1B. UNRESOLVED STAFF COMMENTS
- -----------------------------------
None.
ITEM 2. PROPERTIES
- -------------------
In May 1997, Data I/O completed the sale of the land and building comprising our
Redmond, Washington corporate headquarters and is currently leasing the 96,000
square foot building on a 10-year leaseback agreement with an option to renew
the lease for an additional 10 years. This lease required base annual rental
payments in 2005 of approximately $1,138,000. See Note 7 of "Notes to
Consolidated Financial Statements."
On February 28, 2006, Data I/O entered into a termination agreement for the
Redmond headquarters facility and a five year lease agreement for a 40,000
square foot office space also located in Redmond, Washington. We anticipate a
mid-year move of our corporate headquarters to this new location. We also expect
to enter into a new lease agreement during the first quarter of 2006 for our
offices in Shanghai, China.
In addition to the Redmond facility, approximately 13,000 square feet is leased
at five foreign locations, including our German sales, service and engineering
operations located in Munich, Germany, and three sales and service offices and
an engineering location in China.
ITEM 3. LEGAL PROCEEDINGS
- --------------------------
As of the date of this Annual Report, Data I/O is not a party to any legal
proceedings, the adverse outcome of which in management's opinion, individually
or in the aggregate, would have a material adverse effect on our results of
operations or financial position. From time to time, we may be involved in
litigation relating to claims arising out of our operations in the normal course
of business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------------------------------------------------------------
No matters were submitted for a vote of shareholders of Data I/O during the
fourth quarter of the fiscal year ended December 31, 2005.
15
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
The following table shows, for the periods indicated, the high and low bid
information for Data I/O's Common Stock as reported by the NASDAQ Capital Market
tier of The NASDAQ Stock Market (NASDAQ symbol is DAIO).
Period High Low
------ ---- ---
2005 Fourth Quarter $5.00 $2.08
Third Quarter 2.89 2.20
Second Quarter 4.00 2.02
First Quarter 3.38 2.81
2004 Fourth Quarter $3.85 $2.38
Third Quarter 2.97 1.92
Second Quarter 3.15 2.17
First Quarter 3.70 2.76
The approximate number of shareholders of record as of March 27, 2006 was 689.
Except for a special cash dividend of $4.15 per share paid on March 8, 1989,
Data I/O has not paid cash dividends on our Common Stock and does not anticipate
paying regular cash dividends in the foreseeable future.
No sales of unregistered securities were made by Data I/O during the periods
ended December 31, 2005, December 31, 2004 and December 31, 2003.
See Item 12 for the Equity Compensation Plan Information.
16
ITEM 6. SELECTED FINANCIAL DATA
- -------------------------------
The following selected consolidated financial data should be read in conjunction
with the consolidated financial statements and the notes thereto and the
information contained herein in Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations." Historical results are not
necessarily indicative of future results.
Year Ended
- -------------------------------------------------------------------------------------------------------------------------------
Dec. 31, Dec. 31, Dec. 31, Dec. 31, Dec. 31,
(in thousands, except employee and per share data) 2005(3) 2004 2003 2002 2001(2)
- -------------------------------------------------------------------------------------------------------------------------------
For The Year:
Net sales $28,321 $27,310 $24,687 $22,838 $26,826
Cost of goods sold 12,230 12,726 11,008 11,556 15,078
------------------------------------------------------------------
Gross margin 16,091 14,584 13,679 11,282 11,748
Research and development 5,286 5,057 4,639 5,331 6,740
Selling, general and administrative 10,085 9,036 7,715 8,254 9,707
Net provision (reversal) for business restructuring(1) 96 562 (39) 632 1,211
------------------------------------------------------------------
Operating income (loss) 624 (71) 1,364 (2,935) (5,910)
Non-operating income (loss) 78 (35) (25) (232) 124
------------------------------------------------------------------
Income (loss) 702 (106) 1,339 (3,167) (5,786)
Income tax (expense) benefit (120) 14 (33) 61 (224)
------------------------------------------------------------------
Net income (loss) $582 ($92) $1,306 ($3,106) ($6,010)
At Year-end:
Working capital $9,994 $10,250 $11,032 $9,125 $12,010
Total assets $18,137 $17,847 $18,100 $16,414 $20,387
Stockholders' equity $12,283 $11,470 $11,200 $9,332 $12,201
Number of employees 130 122 127 125 155
- -------------------------------------------------------------------------------------------------------------------------------
Common Stock Data(3):
Basic earnings (loss) per share $0.07 ($0.01) $0.17 ($0.40) ($0.79)
Diluted earnings (loss) per share $0.07 ($0.01) $0.16 ($0.40) ($0.79)
Book value per share at year-end $1.47 $1.42 $1.40 $1.20 $1.60
Shares outstanding at year-end 8,362 8,065 7,976 7,768 7,614
Weighted-average basic shares outstanding 8,226 8,029 7,910 7,704 7,572
Weighted-average diluted shares outstanding 8,532 8,029 8,117 7,704 7,572
- -------------------------------------------------------------------------------------------------------------------------------
Key Ratios:
Current ratio 2.7 2.8 2.9 2.6 2.9
Gross margin to sales 56.8% 53.4% 55.4% 49.4% 43.8%
Operating income (loss) to sales 2.2% (.3%) 5.5% (12.9%) (22.0%)
Income (loss) to sales 2.5% (.3%) 5.3% (13.6%) (22.4%)
Return on average stockholders' equity 4.9% (.8%) 12.7% (28.8%) (39.7%)
- -------------------------------------------------------------------------------------------------------------------------------
Footnotes:
(1) For further discussion, see Note 3 of "Notes to Consolidated Financial
Statements."
(2) In 2001, Data I/O converted to reporting on a calendar year-end basis. The
first quarter of 2001 covered the period December 29, 2000 to March 31,
2001.
(3) The company began recognizing revenue for certain of its equipment
requiring installation at the time of shipment beginning in the third
quarter of 2005. See Note 1 of "Notes to Consolidated Financial
Statements."
17
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K includes forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995. This Act
provides a "safe harbor" for forward-looking statements to encourage companies
to provide prospective information about themselves as long as they identify
these statements as forward-looking and provide meaningful cautionary statements
identifying important factors that could cause actual results to differ from the
projected results. All statements other than statements of historical fact made
in this Annual Report on Form 10-K are forward-looking. In particular,
statements herein regarding industry prospects and trends; future results of
operations or financial position; integration of acquired products and
operations; market acceptance of our newly introduced or upgraded products;
development, introduction and shipment of new products; establishing foreign
operations; and any other guidance on future periods are forward-looking
statements. Forward-looking statements reflect management's current expectations
and are inherently uncertain. Although Data I/O believes 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. Data I/O is under no duty to update any of these forward-looking
statements after the date of this Annual Report. The Reader should not place
undue reliance on these forward-looking statements. The following discussions
and the section entitled "Risk Factors - Cautionary Factors That May Affect
Future Results" describes some, but not all, of the factors that could cause
these differences.
OVERVIEW
In 2005, we continued to focus on our primary goal of managing the business to
achieve profitable operations, while developing and enhancing products to drive
revenue and earnings growth. Our challenge continues to be operating in the
uncertain economic environment, while positioning Data I/O to take advantage of
an anticipated recovery in capital spending. We began to see a recovery in the
first quarter of 2005 which continued throughout the year. We expect that demand
for programming capacity should improve in 2006, in part based on third party
forecasted increased 2006 unit sales for the semiconductor industry, which
should provide improved business opportunities for Data I/O.
We are continuing our efforts to balance increasing costs and strategic
investments in our business with the level of demand in and mix of business we
expect. We are focusing our research and development efforts in our strategic
growth markets, namely new programming technology and automated programming
systems for the manufacturing environment, particularly extending the
capabilities and support for our FlashCORE architecture and the
ProLINE-RoadRunner and PS families. In 2004, we obtained the rights to certain
in-system programming ("ISP") technology. We have incorporated this ISP
technology into our ImageWriter product, and will be required to pay a 4%
royalty on product revenues associated with such technology until March 31,
2007. We began shipments of the ImageWriter 200 in the second quarter of 2005,
and in September we introduced the ImageWriter 300. The related royalties were
not a material amount in 2005. To better support our customers in their
geographic areas and time zones, we have expanded device support operations in
Germany, India and China.
Our customer focus has been on strategic high volume manufacturers and
programming centers and supporting NAND Flash and microcontrollers on our newer
products to gain new accounts and break into new markets, such as
microcontrollers for the automotive market. We continue to expand our China
operations to take advantage of the growth of manufacturing in China. We
continue to focus on building a services business expanding from our existing
service operation model in Brazil. We also increased our efforts to recapture
the Japanese market and have entered into a distribution agreement with Toyo
Corporation in Japan. We continue our efforts to partner with the semiconductor
manufacturers to better serve our mutual customers.
BUSINESS RESTRUCTURING PROGRESS
During 2005, we took restructuring related charges of $96,000 primarily related
to severance and completing actions that had been started in the second half of
2004. This aligned management operations with the changes made in 2004 to
control costs in North America and Europe and the need to build staff serving
China and Eastern Europe.
At December 31, 2005, $33,000 remained as accrued but unpaid restructure
charges, which will be paid in 2006.
During 2004, we took restructuring related charges of $562,000 primarily related
to severance and a small office closure. These actions were taken to lower
production and operating costs to reduce the level of revenue required for our
net income breakeven point, particularly in view of our reduced margins in the
second quarter of 2004; the continued need to control costs in North America and
Europe; and the need to build staff serving China and Eastern Europe.
18
During 2003, we completed the restructuring that began during 2001, which
included actions taken to reduce the level of revenue required for our net
income breakeven point and realign Data I/O with our market opportunities. This
restructuring included the following: a reduction in our global workforce;
discontinuance or reallocation of numerous projects and activities not essential
to our long-term goals; streamlining discretionary activities; consolidation of
numerous functions across the organization to create a team, which was more
productive and able to respond faster to global customer needs; and closure of a
facility in Germany and moving our operations to other locations within Data
I/O. We required this operational repositioning because of the impact of the
economic slowdown and the decline in capital spending across a high number of
customer groups on general demand for programming equipment over the past few
years. Our level of revenue required for our net income breakeven point
increased in 2003, primarily due to cost increases resulting from the impact of
the weaker dollar on foreign currency based costs and from personnel costs due
to raises, incentive compensation and selective hiring of individuals with
critical skills to help position us as the continuing technology leader in our
market.
At December 31, 2003 all restructuring expenses associated with the activities
detailed for 2002 and 2001 had been paid and the excess expense accrual of
$39,000 was reversed during 2003.
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, Data I/O evaluates our estimates,
including those related to 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 telecommunications 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.
Data I/O believes the following critical accounting policies affect the more
significant judgments and estimates used in the preparation of our financial
statements:
Revenue Recognition: Sales of Data I/O's semiconductor programming equipment
requiring installation by us that is other than perfunctory were previously
recorded when installation was complete, or at the later of customer acceptance
or installation, if an acceptance clause is specified in the sales terms.
Beginning in the third quarter of 2005, Data I/O began recognizing revenue for
these products at the time of shipment. We began recognizing revenue at the time
of shipment after we determined that our automated products have 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. When arrangements include multiple elements,
we use objective evidence of fair value to allocate revenue to the elements
pursuant to EITF 00-21, "Revenue Arrangements with Multiple Deliverables," and
recognize revenue when the criteria for revenue recognition have been met for
each element according to SAB 104, "Revenue Recognition." The amount of revenue
recognized is affected by our judgments as to the collectibility of the
transaction or whether an arrangement includes multiple elements and if so,
whether specific objective evidence of fair value exists for those elements.
Changes to the elements in an arrangement and the ability to establish specific
objective evidence for those elements could affect the timing of the revenue
recognition. These conditions could be subjective and actual results could vary
from the estimated outcome.
Installation that is considered perfunctory includes any installation that can
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. The
revenue related to products requiring installation that is perfunctory is
recognized at the time of shipment provided that persuasive evidence of an
arrangement exists, shipment has occurred, the price is fixed or determinable,
and collectibility is reasonably assured.
We record revenue from the sale of service and update contracts as deferred
revenue and we recognize it on a straight-line basis over the contractual
period, which is typically one year. We establish a reserve for sales returns
based on historical trends in product returns and estimates for new items. If
the actual future returns differ from historical levels, our revenue could be
adversely affected.
Allowance for Doubtful Accounts: We base the allowance for doubtful accounts
receivable on our assessment of the collectibility 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 Provision: We base inventory purchases and commitments upon future
demand forecasts and historic usage. Such estimates are difficult to make under
most economic conditions. If there is a significant decrease in demand for our
products
19
or there is a higher risk of inventory obsolescence because of rapidly changing
technology and customer requirements, Data I/O may be required to increase our
inventory provision adjustments and our gross margin could be adversely
affected.
Warranty Accruals: Data I/O accrues 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,
Data I/O expects to continue to limit the recognition of net deferred tax assets
and maintain the tax valuation allowances. We expect, therefore, that reversals
of the tax valuation allowance will take place for the next few years only as we
are able to take advantage of the underlying tax loss or other attributes in
carry forward. 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.
20
RESULTS OF OPERATIONS
NET SALES
(in thousands)
Net sales by product line: 2005 Change 2004 Change 2003
- -------------------------------------------------------------------------------------------------------------------------------
Automated programming systems $16,040 (6.3%) $17,116 23.0% $13,920
Non-automated programming systems 12,281 20.5% 10,194 (5.3%) 10,767
---------------- --------------- ---------------
Totals $28,321 3.7% $27,310 10.6% $24,687
================ =============== ===============
Net sales by location:
United States $6,386 17.5% $5,434 (25.2%) $7,263
% of total 22.5% 19.9% 29.4%
International $21,935 0.3% $21,876 25.6% $17,424
% of total 77.5% 80.1% 70.6%
- -------------------------------------------------------------------------------------------------------------------------------
2005 vs. 2004
- -------------
Revenues increased approximately $1.0 million or 3.7% in 2005 compared to 2004.
The increase in revenue reflects strong sales of our PS systems, FlashPAKs and
related aftermarket products. We benefited from the programming centers adding
capacity during 2005 which represented the major customer group for our PS
systems. While we did experience some decline in RoadRunner revenues as the
demand for automation capacity in the wireless segment declined, the number of
new RoadRunner accounts, especially within the automotive target group,
increased in 2005 as compared to 2004. FlashPAK sales were especially strong in
Asia where manual programming is most common.
International sales increased slightly in total with significant growth in
China. However, our overall Asian sales decreased as we experienced declining
sales in our Japanese and Korean markets. The U.S. dollar strengthened slightly
during 2005, which had an unfavorable effect on our currency translation for
sales denominated in foreign currency, and in particular the Euro, which
accounted for $290,000 offset to our sales increase. Our U.S. sales increased
approximately $950,000 or 17.5%, which we attribute to improved sales to
programming centers and automotive electronics manufacturers.
In 2005, we began to ship the PS588 FlashCORE automated programming system and
the ImageWriter 300, our ISP solution. We expect these products to increase our
revenues; however, partially offsetting this expected increase is the continued
trend of declining sales of our older non-automated product lines.
2004 vs. 2003
- -------------
Revenues increased 10.6% in 2004 over 2003. This increase resulted from our
automated systems sales including growth in the ProLINE RoadRunner, the PS
family (including the PS288 new in 2004) and the related automated systems
aftermarket. Data I/O's non automated systems continued a trend of declining
sales in older products; however FlashPAK, our newer FlashCore based programmer,
continued to show good growth with sales more than doubling in 2004.
International sales grew, particularly in Asia, while sales in the U.S. market
continued to decline. The U.S. dollar continued to weaken in 2004, which we
believe assisted our export sales, due to increased buying power of foreign
currencies and the favorable effect of currency translation for sales
denominated in foreign currency, and in particular the Euro, which accounted for
$784,000 of the sales growth. We see a continuing trend in migration of
customers moving manufacturing operations to low-cost geographies, thereby
increasing international sales opportunities.
21
GROSS MARGIN
(in thousands) 2005 Change 2004 Change 2003
- -----------------------------------------------------------------------------------------------------------------------------
Gross margin $16,091 10.3% $14,584 6.6% $13,679
Percentage of net sales 56.8% 53.4% 55.4%
- -----------------------------------------------------------------------------------------------------------------------------
2005 vs. 2004
- -------------
Gross margins increased in both dollars and as a percentage of sales for 2005
compared to 2004. The increase in gross margin dollars was due primarily to the
additional margin from increased sales volume of approximately $1,400,000
especially for the PS family and FlashCore. The increase in the gross margin as
a percentage of sales results from a favorable average selling price variance of
$807,000, offset by unfavorable currency exchange effects of approximately
$280,000. Similar to 2004, the manufacturing overhead application variance was
$272,000 unfavorable due primarily to decreasing inventory levels and lowering
our rate standards due to productivity.
2004 vs. 2003
- -------------
Gross margins increased in dollars but declined as a percentage of sales for
2004 compared to 2003. The increase in gross margin dollars was due primarily to
the increase in revenue dollars. The decline in the gross margin as a percentage
of sales reflects product mix shifts to those with higher material costs, as
well as unfavorable average selling price variance of $465,000 and unfavorable
manufacturing overhead variance of $260,000. The manufacturing overhead
application variance resulted largely from decreasing our inventory level.
RESEARCH AND DEVELOPMENT
(in thousands) 2005 Change 2004 Change 2003
- -----------------------------------------------------------------------------------------------------------------------------
Research and development $5,286 4.5% $5,057 9.0% $4,639
Percentage of net sales 18.7% 18.5% 18.8%
- -----------------------------------------------------------------------------------------------------------------------------
2005 vs. 2004
- -------------
Research and development ("R&D") spending during 2005 increased by $229,000 or
4.5% over 2004, but remained relatively consistent as a percentage of sales at
approximately 19%. The increase in spending relates primarily to new product
initiatives, particularly new automation solutions, the ImageWriter, our new
in-system programming solution, and the start of engineering operations in
China. We shipped the first PS588 in early 2005 and the ImageWriter 300 product
during the third quarter of 2005. Data I/O's R&D continues to focus on the
FlashCORE architecture, expanding its capability to address newer technologies
as well as microcontroller device support. We expect R&D spending to increase as
we fill open positions. Our R&D spending also fluctuates based on the number and
the development stage of projects.
2004 vs. 2003
- -------------
Research and development ("R&D") spending for 2004 as compared to 2003 increased
9%, however, as a percentage of sales, R&D remained about 19%. The increase in
spending relates primarily to new product initiatives. In particular, the
ImageWriter, our new in system programming solution, and eDSS, a tool suite for
device support, were launched in November of 2004. Data I/O's R&D focused on the
FlashCORE architecture, expanding its capability to address newer technologies
like NAND Flash support for M-Systems DiskOnChip technology as well as
microcontroller device support. New products in the PS family of automated
systems included the PS288 FlashCORE, and, introduced in early 2005, the PS 588
FlashCORE. Also, we released a ProLINE-RoadRunner version for Panasonic CM402
machines. Finally, we completed our initiative to create "global device support
factories" with the creation of our engineering operation in Shanghai, China,
which joins our other locations in Redmond, Washington, Germany, Japan, and
India.
We believe it is essential to invest in R&D to significantly enhance our
existing products and to create new products as markets develop and technologies
change. We are focusing our R&D efforts in our strategic growth markets, namely
new programming technology and automated programming systems for the
manufacturing environment, particularly extending the capabilities and support
for our FlashCORE and programmer architecture; new automated handling solutions;
and enhancing our ImageWriter products.
22
SELLING, GENERAL AND ADMINISTRATIVE
(in thousands) 2005 Change 2004 Change 2003
- ----------------------------------------------------------------------------------------------------------------------------
Selling, general and administrative $10,085 11.6% $9,036 17.1% $7,715
Percentage of net sales 35.6% 33.1% 31.3%
- ----------------------------------------------------------------------------------------------------------------------------
2005 vs. 2004
- -------------
Selling, General and Administrative ("SG&A") expenses increased by $1,049,000 in
2005 compared to 2004 based primarily on our operations in China which include
increased costs of approximately $488,000. In addition, we incurred an
additional $148,000 associated with the new information system which we acquired
in 2005, as well as additional accounting and the hiring of key personnel costs
of approximately $158,000, additional marketing personnel and launch costs of
$83,000, unfavorable currency translation impact of $36,000 from European based
operating costs, an unfavorable administrative overhead application allocation
amount of $254,000 and finally, an increase in senior management incentive pay
of $84,000 related to profitability, offset by lower sales channel commissions
of $138,000.
2004 vs. 2003
- -------------
Selling, General and Administrative ("SG&A") expenses increased by $1,321,000 in
2004 versus the prior year due primarily to our strategic investments in China
totaling $343,000 and the hiring of additional key personnel of $336,000, as
well as the unfavorable currency translation impact of $160,000 from European
based operating costs. In addition, we incurred higher commission costs of
$281,000 based on the higher sales volume and a higher mix of representative
sales than distributor sales and higher travel and entertainment costs of
$184,000. Partially offsetting this was a reduction in bonus incentive
compensation of $244,000 related to the 2004 net loss.
INTEREST
(in thousands) 2005 Change 2004 Change 2003
- ----------------------------------------------------------------------------------------------------------------------------
Interest income $116 50.6% $77 (31.3%) $112
Interest expense ($20) 11.1% ($18) (21.7%) ($23)
- ----------------------------------------------------------------------------------------------------------------------------
2005 vs. 2004
- -------------
Interest income for 2005 increased due primarily to higher yields.
2004 vs. 2003
- -------------
Interest income for 2004 decreased as compared to 2003 primarily due to the
decrease in marketable securities.
INCOME TAXES
(in thousands) 2005 2004 2003
- ----------------------------------------------------------------------------------------------------------------------------
Income tax (expense) benefit ($120) $14 ($33)
- ----------------------------------------------------------------------------------------------------------------------------
2005 vs. 2004 and 2004 vs. 2003
- -------------------------------
Income tax expense or benefit in all years relates to foreign and state income
taxes. Impacting the effective tax rate related to foreign income were
offsetting losses requiring valuation allowances in other countries. We had
income in some foreign operations partially offset by losses in other countries.
For financial reporting purposes, Data I/O established tax valuation reserves
against our deferred tax assets because of the uncertainty relating to the
realization of such asset values. We had valuation allowances of $9.8 million,
$9.8 million, and $9.7 million at December 31, 2005, 2004, and 2003,
respectively. Given the uncertainty created by our loss history, we expect to
continue to limit the recognition of net deferred tax assets and maintain the
tax valuation allowances.
INFLATION AND CHANGES IN FOREIGN CURRENCY EXCHANGE RATES
Sales and expenses incurred by foreign subsidiaries are denominated in the
subsidiary's local currency and translated into U.S. Dollar amounts at average
rates of exchange during the year. We recognized foreign currency transaction
losses of $18,000, $94,000 and $114,000 in 2005, 2004 and 2003, respectively.
The transaction losses resulted primarily from sales by our German subsidiary to
our main customers, which were invoiced in US dollars. We hedge our foreign
currency exposure on sales of inventory and certain loans to our foreign
subsidiaries through the use of foreign currency exchange contracts. See Note 1
of "Notes to Consolidated Financial Statements."
23
FINANCIAL CONDITION
LIQUIDITY AND CAPITAL RESOURCES
(in thousands) 2005 Change 2004 Change 2003
- ----------------------------------------------------------------------------------------------------------------------------
Working capital $9,994 ($256) $10,250 ($782) $11,032
- ----------------------------------------------------------------------------------------------------------------------------
At December 31, 2005, Data I/O's principal sources of liquidity consisted of
existing cash, cash equivalents and marketable securities. Our working capital
decreased by $256,000 and our current ratio decreased from 2.8 in 2004 to 2.7 in
2005.
Our cash and cash equivalents decreased by $1.2 million during 2005 primarily
due to cash used to purchase property, plant and equipment, including software,
totaling $2 million. Major capital purchases included approximately $800,000
related to the Brazilian programming service operation and approximately
$420,000 related to the purchase and set up of our new worldwide information
system. We expect that we will continue to make capital expenditures to support
our business and anticipate that present working capital will be sufficient to
meet our operating requirements. Capital expenditures are expected to be funded
by existing and internally generated funds or lease financing.
We also used approximately $200,000 of cash for operations which primarily
included a $2.6 million increase in accounts receivable, partially offset by a
$417,000 decrease in inventory, $644,000 of demonstration equipment transferred
to cost of goods sold, as we continually need to update to the latest versions
of our equipment. Items not requiring the use of cash in operations were $1.1
million of depreciation and amortization. The increase in accounts receivable
resulted from increased sales especially late in the quarter and the longer
collection times we are experiencing with increased international sales,
especially in China.
During 2004, our cash and cash equivalents increased by $1.2 million primarily
due to a $520,000 decrease in accounts receivable, $500,000 decrease in
inventory, $846,000 of demonstration equipment transferred to cost of goods
sold, offset by a $958,000 decrease in accrued expenses. In addition, we used
$1.2 million of cash in investing activities during 2004 compared to $1.8
million during 2003. The decrease was driven by the level of investment in
marketable securities and the level of cash available from net income.
As a result of our significant product development, customer support,
international expansion and selling and marketing efforts, we require
substantial working capital to fund our operations. Over the last few years, we
restructured our operations to lower our costs and operating expenditures in
certain geographic regions and to lower the level of revenue required for our
net income breakeven point, to preserve our cash position and to focus on
profitable operations. Offsetting these actions are our investments in expanded
operations in China and Brazil, in new system and equipment and hiring new key
personnel. We believe that we have sufficient working capital available under
our operating plan to fund our operations and capital requirements through at
least December 31, 2006. 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 additional financing.
AGGREGATE CONTRACTUAL OBLIGATIONS AND COMMITMENTS
Data I/O has purchase obligations for inventory and production costs as well as
other obligations such as capital expenditures, service contracts, marketing,
and development agreements. Arrangements are considered purchase obligations if
a contract specifies all significant terms, including fixed or minimum
quantities to be purchased, a pricing structure and approximate timing of the
transaction. Most arrangements are cancelable without a significant penalty, and
with short notice, typically less than 90 days. Any amounts reflected on the
balance sheet as accounts payable and accrued liabilities are excluded from the
table below. Data I/O has no long-term debt. Data I/O has commitments under
non-cancelable operating leases and other agreements, primarily for factory and
office space, with initial or remaining terms of one year or more as follows:
For the year ending December 31, 2005 (in thousands):
1 Year 2-3 Years 4-5 Years After 5 Years Total
------------- -------------- -------------- ----------------- -------------
Operating leases $1,512 $392 $18 - $ 1,922
Commitments to suppliers 445 854 - - 1,299
Other purchase commitments 175 - - - 175
-------------- -------------- -------------- ----------------- -------------
Total $2,132 $1,246 $18 - $ 3,396
============== ============== ============== ================= ==============
24
OFF-BALANCE SHEET ARRANGEMENTS
Except as noted above in aggregate contractual obligations and commitments, Data
I/O had no off-balance sheet arrangements.
SHARE REPURCHASE PROGRAM
Under a previously announced share repurchase program, Data I/O is authorized to
repurchase up to 1,123,800 shares of our outstanding Common Stock. We may
execute these purchases through open market purchases at prevailing market
prices, through block purchases or in privately negotiated transactions, and we
may commence or discontinue at any time. As of December 31, 2005, Data I/O has
repurchased 1,016,200 shares under this repurchase program at a total cost of
approximately $7.1 million. Data I/O has not repurchased shares under this plan
since the second quarter of 1997, although it still has the authority to do so.
NEW ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payments." SFAS
No. 123R requires employee stock options and rights to purchase shares under
stock participation plans to be accounted for under the fair value method, and
eliminates the ability to account for these instruments under the intrinsic
value method prescribed by APB Opinion No. 25, and allowed under the original
provisions of SFAS No. 123. SFAS No. 123R requires the use of an option pricing
model for estimating fair value, which is amortized to expense over the service
periods. In March 2005, the SEC issued SAB 107, "Share-Based Payments," which
gives guidance on the application of FAS 123R and extends the required adoption
date to January 1, 2006 for Data I/O. The adoption of SFAS No. 123R is expected
to have a significant effect on the consolidated financial statements of Data
I/O. See Note 1 for the pro forma impact on net earnings (loss) and earnings
(loss) per share from calculating stock-related compensation costs under the
fair value alternative of SFAS No. 123. However, the calculation of compensation
cost for share-based payment transactions after the effective date of SFAS No.
123R and under SAB 107 may be different from the calculation of compensation
cost under SFAS No. 123. Such potential differences have not yet been
quantified. Also, past usage of option plans and stock purchase plans may not
reflect our practices in future periods.
In May 2005, the FASB issued Statement No. 154, "Accounting Changes and Error
Corrections - a replacement of APB Opinion No. 20 and FASB Statement No. 3."
This Statement changes the requirements for the accounting for and reporting of
a change in accounting principle. Statement No. 154 is effective for accounting
changes and corrections of errors made in fiscal years beginning after December
15, 2005. We have not yet assessed the effect of this Statement on Data I/O.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
- -------------------------------------------------------------------
With respect to our foreign currency exchange rate risk, we currently use only
foreign currency hedge derivative instruments, which as of December 31, 2005 and
2004, the notional value of our foreign exchange contracts outstanding was
approximately $503,000 and $1,239,000, respectively, and the estimated fair
value of which was a loss of $3,000 and $33,000, respectively. The weighted
average contract rate at December 31, 2005 and 2004 was 1.18 and 1.32,
respectively.
Data I/O is exposed to interest rate risks. We generally invest in high-grade
commercial paper with original maturity dates of twelve months or less and
conservative money market funds to minimize our exposure to interest rate risk
on our marketable securities, which are classified as available-for-sale as of
December 31, 2005 and December 31, 2004. We believe that the market risk arising
from holdings of these financial instruments is not material.
The table below provides information about our marketable securities, including
principal cash flows and the related weighted average interest rates (in
thousands):
Estimated Fair Estimated Fair
Principal Value at Principal Value at
Cash Flows December 31, Cash Flows December 31,
For 2006 2005 For 2005 2004
--------------- ----------------- --------------- -----------------
Corporate bonds $ - $ - $ 787 $ 787
1.559%
Taxable Auction Securities 800 800 250 250
4.264% 4.264% 2.352%
--------------- ----------------- --------------- -----------------
Total portfolio value $ 800 $ 800 $ 1,037 $ 1,037
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- ----------------------------------------------------
See pages 26 through 44.
25
- --------------------------------------------------------------------------------
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
- --------------------------------------------------------------------------------
To the Board of Directors and Stockholders,
Data I/O Corporation
We have audited the accompanying consolidated balance sheets of Data I/O
Corporation and subsidiaries as of December 31, 2005 and 2004 and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the three years in the period ended December 31, 2005. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Data
I/O Corporation and subsidiaries as of December 31, 2005 and 2004, and the
consolidated results of their operations and their consolidated cash flows for
each of the three years in the period ended December 31, 2005, in conformity
with accounting principles generally accepted in the United States of America.
Our audits were conducted for the purpose of forming an opinion on the basic
financial statements taken as a whole. The financial statement schedule
(Schedule II) is presented for purposes of additional analysis and is not a
required part of the basic financial statements. This schedule has been
subjected to the auditing procedures applied in the audit of the basic financial
statements and, in our opinion, is fairly stated in all material respects in
relation to the basic financial statements taken as a whole.
/S/GRANT THORNTON LLP
Seattle, Washington
March 14, 2006
26
DATA I/O CORPORATION
CONSOLIDATED BALANCE SHEETS
December 31,
- -------------------------------------------------------------------------------------------------------
2005 2004
- -------------------------------------------------------------------------------------------------------
(in thousands, except share data)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $4,362 $5,534
Marketable securities 800 1,037
Trade accounts receivable, net of allowance for
doubtful accounts of $165 and $155 6,828 4,489
Inventories 3,529 4,139
Other current assets 329 652
------------- -------------
TOTAL CURRENT ASSETS 15,848 15,851
Property, plant and equipment - net 2,274 1,970
Other assets 15 26
------------- -------------
TOTAL ASSETS $18,137 $17,847
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $1,608 $1,688
Accrued compensation 1,249 991
Deferred revenue 1,329 1,706
Other accrued liabilities 1,100 1,126
Accrued costs of business restructuring 33 86
Income taxes payable 147 4
Deferred gain on sale of property 388 -
------------- -------------
TOTAL CURRENT LIABILITIES 5,854 5,601
Deferred gain on sale of property - 776
------------- -------------
5,854 6,377
COMMITMENTS - -
STOCKHOLDERS' EQUITY
Preferred stock -
Authorized, 5,000,000 shares, including
200,000 shares of Series A Junior Participating
Issued and outstanding, none - -
Common stock, at stated value -
Authorized, 30,000,000 shares
Issued and outstanding, 8,362,369
and 8,064,696 shares 19,408 19,001
Retained deficit (7,436) (8,018)
Accumulated other comprehensive income 311 487
------------- -------------
TOTAL STOCKHOLDERS' EQUITY 12,283 11,470
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $18,137 $17,847
============= =============
See notes to consolidated financial statements.
27
DATA I/O CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
- --------------------------------------------------------------------------------------------------------------------
For the years ended December 31, 2005 2004 2003
- --------------------------------------------------------------------------------------------------------------------
(in thousands, except per share data)
Net sales $28,321 $27,310 $24,687
Cost of goods sold 12,230 12,726 11,008
----------- ------------ ------------
Gross margin 16,091 14,584 13,679
----------- ------------ ------------
Operating expenses:
Research and development 5,286 5,057 4,639
Selling, general and administrative 10,085 9,036 7,715
Net provision (reversal) for business restructuring 96 562 (39)
----------- ------------ ------------
Total operating expenses 15,467 14,655 12,315
----------- ------------ ------------
Operating income (loss) 624 (71) 1,364
Non-operating income (expense):
Interest income 116 77 112
Interest expense (20) (18) (23)
Foreign currency transaction gain (loss) (18) (94) (114)
----------- ------------ ------------
Total non-operating income (loss) 78 (35) (25)
----------- ------------ ------------
Income (loss) before income taxes 702 (106) 1,339
Income tax (expense) benefit (120) 14 (33)
----------- ------------ ------------
Net income (loss) $582 ($92) $1,306
=========== ============ ============
Basic earnings (loss) per share $0.07 ($0.01) $0.17
Diluted earnings (loss) per share $0.07 ($0.01) $0.16
Weighted-average basic shares 8,226 8,029 7,910
Weighted-average diluted shares 8,532 8,029 8,117
See notes to consolidated financial statements
28
DATA I/O CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
- ------------------------------------------------------------------------------------------------------------------------
For the years ended December 31, 2005 2004 2003
- ------------------------------------------------------------------------------------------------------------------------
(in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $582 ($92) $1,306
Adjustments to reconcile income (loss)
to net cash provided by (used in) operating activities:
Depreciation and amortization 1,118 953 687
Net loss on dispositions - 4 -
Write-off of assets 17 9 -
Equipment transferred to cost of goods sold 644 846 172
Amortization of deferred gain on sale (388) (330) (330)
Net change in:
Trade accounts receivable (2,553) 520 (764)
Inventories 417 501 (111)
Other current assets 257 (230) 95
Accrued cost of business restructuring (53) 86 (204)
Accounts payable and accrued liabilities 210 (517) 609
Deferred revenue (422) 279 (179)
---------------- --------------- --------------
Net cash provided by (used in) operating activities (171) 2,029 1,281
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, plant and equipment (1,846) (2,528) (486)
Purchase of software (203) (30) -
Purchases of available-for-sale securities (1,250) (1,182) (4,815)
Proceeds from maturities of available-for-sale securities 1,492 2,495 3,536
---------------- --------------- --------------
Cash provided by (used in) investing activities (1,807) (1,245) (1,765)
CASH FLOWS FROM FINANCING ACTIVITIES
Sale of common stock 132 154 119
Proceeds from exercise of stock options 275 50 40
---------------- --------------- --------------
Cash provided by financing activities 407 204 159
---------------- --------------- --------------
Increase (decrease) in cash and cash equivalents (1,571) 988 (325)
Effects of exchange rate changes on cash 399 166 322
Cash and cash equivalents at beginning of year 5,534 4,380 4,383
---------------- --------------- --------------
Cash and cash equivalents at end of year $4,362 $5,534 $4,380
================ =============== ==============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest $20 $18 $23
Income taxes $39 ($14) $33
See notes to consolidated financial statements.
29
DATA I/O CORPORATION
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Accumulated
Common Stock Retained Other Total
------------------------ Earnings Comprehensive Stockholders'
Shares Amount (Deficit) Income (Loss) Equity
----------- --------- ---------- ----------------- -----------------
(in thousands, except share data)
Balance at December 31, 2002 7,767,630 18,638 (9,232) (74) 9,332
Stock options exercised 14,189 40 - - 40
Issuance of stock through
Employee Stock Purchase Plan 194,477 119 - - 119
Comprehensive income:
Net Income - - 1,306 - 1,306
Translation adjustment - - - 405 405
Unrealized gain on
Marketable securities - - - (2) (2)
-----------------
Total comprehensive income 1,709
----------- --------- ---------- ----------------- -----------------
Balance at December 31, 2003 7,976,296 18,797 (7,926) 329 11,200
Stock options exercised 27,179 50 - - 50
Issuance of stock through
Employee Stock Purchase Plan 61,221 154 - - 154
Comprehensive income:
Net loss - - (92) - (92)
Translation adjustment - - - 162 162
Unrealized gain on
Marketable securities - - - (4) (4)
-----------------
Total comprehensive income 66
----------- --------- ---------- ----------------- -----------------
Balance at December 31, 2004 8,064,696 19,001 (8,018) 487 11,470
Stock options exercised 240,597 275 - - 275
Issuance of stock through
Employee Stock Purchase Plan 57,076 132 - - 132
Comprehensive income:
Net income - - 582 - 582
Translation adjustment - - - (181) (181)
Unrealized gain on
Marketable securities - - - 5 5
-----------------
Total comprehensive income 406
----------- --------- ---------- ----------------- -----------------
Balance at December 31, 2005 8,362,369 $19,408 ($7,436) $311 $12,283
=========== ========= ========== ================= =================
See notes to consolidated financial statements.
30
DATA I/O CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations
- --------------------
Data I/O Corporation ("Data I/O") designs, manufactures, and sells programming
systems used by designers and manufacturers of electronic products. Our
programming system products are used to program integrated circuits ("ICs" or
"devices" or "semiconductors") with the specific unique data necessary for the
ICs contained in various products, and are an important tool for the electronics
industry experiencing growing use of programmable ICs. Customers for our
programming system products are located around the world, primarily in the
United States, Europe and the Far East. Our manufacturing operations are
currently located in the United States. An outside supplier located in Germany
currently manufactures our Sprint non-automated programming systems.
Principles of Consolidation
- ---------------------------
The consolidated financial statements include the accounts of Data I/O
Corporation and our wholly-owned subsidiaries. Intercompany accounts and
transactions have been eliminated in consolidation.
Use of Estimates
- ----------------
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Stock-Based Compensation
- ------------------------
Data I/O has stock-based employee compensation plans that are described more
fully in Note 12. In accordance with Statement of Financial Accounting
Standards, or SFAS 123, Accounting for Stock-Based Compensation ("SFAS 123"), as
amended by SFAS 148, Accounting for Stock-Based Compensation-Transition and
Disclosure, we elected to continue to account for stock-based compensation using
the intrinsic value method prescribed in Accounting Principles Board, or APB,
Opinion 25, Accounting for Stock Issued Employees, and related interpretations.
Compensation cost for employee stock options is measured as the excess, if any,
of the market price of our common stock at the date of grant over the stock
option exercise price. Any deferred compensation is recognized on a graded
vesting method. Under our plan, stock options are generally granted at fair
market value. The following table illustrates the effect on net income (loss)
and earnings (loss) per share if Data I/O had applied the fair value recognition
provisions of SFAS 123, using the assumptions described in Note 12, to our
stock-based employee plans.
31
Data I/O's pro forma information follows (in thousands, except per share data):
Year Ended December 31,
-------------------------------------------------
2005 2004 2003
--------------- -------------- ----------------
Net income (loss) - as reported $582 ($92) $1,306
Deduct: Total stock-based employee compensation expense
determined under fair value based method for awards
granted, modified, or settled, net of related tax effects (400) (372) (338)
--------------- -------------- ----------------
Net income (loss) - pro forma $182 ($464) $968
=============== ============== ================
Basic earnings (loss) per share - as reported $0.07 ($0.01) $0.17
Diluted earnings (loss) per share - as reported $0.07 ($0.01) $0.16
Basic earnings (loss) per share - pro forma $0.02 ($0.06) $0.12
Diluted earnings (loss) per share - pro forma $0.02 ($0.06) $0.12
Foreign Currency Translation
- ----------------------------
Assets and liabilities of foreign subsidiaries are translated at the exchange
rate on the balance sheet date. Revenues, costs and expenses of foreign
subsidiaries are translated at average rates of exchange prevailing during the
year. Translation adjustments resulting from this process are charged or
credited to stockholders' equity, net of taxes recognized. Realized and
unrealized gains and losses resulting from the effects of changes in exchange
rates on assets and liabilities denominated in foreign currencies are included
in non-operating expense as foreign currency transaction gains and losses.
In an effort to minimize the effect of exchange rate fluctuations on the results
of our operations, Data I/O hedges portions of our foreign currency exposure
through the use of forward exchange contracts, none of which are speculative. At
December 31, 2005, we had a notional value of approximately $503,000 in three
foreign exchange contracts outstanding, the estimated loss in fair value was
recorded as a liability of $3,000. The contract terms are 30-90 days. The hedges
are highly effective, as currency, settlement date and amount of the underlying
receivables and of the forward contracts coincide, and as spot rates are the
same for both the hedge and the hedged item.
Cash and Cash Equivalents
- -------------------------
Cash and cash equivalents are highly liquid investments with maturities of three
months or less at date of purchase.
Marketable Securities
- ---------------------
Data I/O generally invests in debt securities with original maturities of twelve
months or less and money market funds, all of which are classified as
available-for-sale securities and recorded at fair value, as defined below. We
record unrealized holding gains and losses, net of any tax effect, as a
component of accumulated other comprehensive income (loss) within stockholders'
equity. We report interest earned in non-operating income as interest income.
Marketable securities are classified in the balance sheet as current and
noncurrent based on maturity dates and our expectation of sales and redemptions
in the following year.
32
Fair Value of Financial Instruments
- -----------------------------------
The carrying value of cash, cash equivalents, marketable securities and forward
exchange contracts approximates fair value. The fair value of Data I/O's
marketable securities is based upon the quoted market price on the last business
day of the fiscal year plus accrued interest, if any.
Accounts Receivable
- -------------------
The majority of Data I/O's accounts receivable are due from companies in the
electronics manufacturing industries. Credit is extended based on an evaluation
of a customer's financial condition and, generally, collateral is not required.
Accounts receivable are typically due within 30 to 60 days and are stated at
amounts due from customers net of an allowance for doubtful accounts. Accounts
outstanding longer than the contractual payment terms are considered past due.
Data I/O determines our allowance by considering a number of factors, including
the length of time trade accounts receivable are past due, Data I/O's previous
loss history, the customer's current ability to pay their obligation to Data
I/O, and the condition of the general economy and the industry as a whole. Data
I/O writes off accounts receivable when they become uncollectible, and payments
subsequently received on such receivables are credited to the allowance for
doubtful accounts. Interest is allowed to accrue, according to our standard
sales terms, beginning on the day after the due date of the receivable. However,
interest income is subsequently recognized on these accounts either to the
extent cash is received, or when the future collection of interest and the
receivable balance is considered probable by management.
Inventories
- -----------
Inventories are stated at the lower of cost or market with cost being the
currently adjusted standard cost, which approximates cost on a first-in,
first-out basis. We evaluate the need for inventory reserves associated with
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 establish reserves accordingly. See Note 6.
Property, Plant and Equipment
- -----------------------------
Property, plant and equipment, including leasehold improvements, are stated at
cost and depreciation is calculated over the estimated useful lives of the
related assets or lease terms on the straight-line basis. We depreciate
substantially all manufacturing and office equipment over periods of three to
seven years. We depreciate leasehold improvements over the remaining portion of
the lease, or over the expected life of the asset if less than the remaining
term of the lease.
Long-lived assets are evaluated on an annual basis for impairment. Based on this
evaluation, no impairment was noted for the years ended December 31, 2005, 2004,
and 2003.
Revenue Recognition
- -------------------
Sales of Data I/O's semiconductor programming equipment products requiring
installation by us that is other than perfunctory were previously recorded when
installation was complete, or at the later of customer acceptance or
installation, if an acceptance clause is specified in the sales terms. Beginning
in the third quarter of 2005, Data I/O began recognizing revenue for these
products at the time of shipment. We began recognizing revenue at the time of
shipment after we determined that our programming equipment have 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. When arrangements include multiple elements,
we use objective evidence of fair value to allocate revenue to the elements
pursuant to EITF 00-21, "Revenue Arrangements with Multiple Deliverables," and
recognize revenue when the criteria for revenue recognition have been met for
each element according to SAB 104, "Revenue Recognition." The amount of revenue
recognized is affected by our judgments as to the collectibility of the
transaction or whether an arrangement includes multiple elements and if so,
whether specific objective evidence of fair value exists for those elements.
Installation that is considered perfunctory includes any installation that can
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. The
revenue related to products requiring installation that is perfunctory is
recognized at the time of shipment provided that persuasive evidence of an
arrangement exists, shipment has occurred, the price is fixed or determinable,
and collectibility is reasonably assured.
We record revenue from the sale of service and update contracts as deferred
revenue and we recognize it on a straight-line basis over the contractual
period, which is typically one year. We establish a reserve for sales returns
based on historical trends in product returns and estimates for new items. Sales
were recorded net of associated sales return reserves, which were $150,000,
$250,000, and $300,000 at December 31, 2005, 2004, and 2003, respectively.
33
Data I/O's software products are not normally sold separately from sales of
programming systems. However, on those occasions where we sell software
separately, we recognize revenue when a sales agreement exists, when delivery
has occurred, when the fee is fixed or determinable, and when collection is
probable.
Research and Development
- ------------------------
Research and development costs are expensed as incurred.
Advertising Expense
- -------------------
Data I/O expenses advertising costs as incurred. Total advertising expenses were
approximately $238,000, $273,000, and $248,000 in 2005, 2004, and 2003,
respectively.
Warranty Expense
- ----------------
Data I/O records a liability for an estimate of costs that it expects to incur
under our basic limited warranty when product revenue is recognized. Factors
affecting our warranty liability include the number of units sold and historical
and anticipated rates of claims and costs per claim. We periodically assess the
adequacy of our warranty liability based on changes in these factors. Data I/O
normally warrants our products against defects for periods ranging from ninety
days to one year. The FlashPAK, which at introduction, carried a three-year
warranty on some components, now have a one year warranty. We provide currently
for the estimated cost that may be incurred under our product warranties. Data
I/O records revenues on extended warranties on a straight-line basis over the
term of the related warranty contracts. Service costs are expensed as incurred.
Earnings (Loss) Per Share
- -------------------------
Basic earnings (loss) per share exclude any dilutive effects of stock options.
Basic earnings (loss) per share are computed using the weighted-average number
of common shares outstanding during the period. Diluted earnings per share are
computed using the weighted-average number of common shares and common stock
equivalent shares outstanding during the period. Options to purchase 396,181
shares of common stock were outstanding as of December 31, 2005, but were
excluded from the computation of diluted EPS for the period then ended because
the options were anti-dilutive. Options to purchase 1,439,488 shares of common
stock as of December 31, 2004 were excluded from EPS as their effect was
anti-dilutive.
Diversification of Credit Risk
- ------------------------------
Financial instruments, which potentially subject Data I/O to concentrations of
credit risk, consist primarily of trade receivables. Our cash, cash equivalents
and marketable securities consist of high quality financial instruments. Data
I/O maintains cash balances in financial institutions, which at times may exceed
federally insured limits. We have not experienced any losses in such accounts
and believe we are not exposed to any significant credit risk on cash and cash
equivalents. Our trade receivables are geographically dispersed and include
customers in many different industries. We believe that any risk of loss is
significantly reduced due to the diversity of our end-customers and geographic
sales areas. We perform on-going credit evaluations of our customers' financial
condition and require collateral, such as letters of credit and bank guarantees,
whenever deemed necessary.
Derivatives
- -----------
Data I/O accounts for our derivatives using SFAS No. 133, "Accounting for
Derivatives and Hedging Activities." This statement establishes accounting and
reporting standards for derivative instruments and requires recognition of
derivatives as assets or liabilities in the statement of financial position and
measurement of those instruments at fair value.
34
Data I/O utilizes forward foreign exchange contracts to reduce the impact of
foreign currency exchange rate risks where natural hedging strategies cannot be
effectively employed. All of our hedging instruments are fair value hedges.
Generally, these contracts have maturities less than one year and require us to
exchange foreign currencies for U.S. dollars at maturity. The estimated fair
value gain (loss) of the open hedge contracts as of December 31, 2005 is a
liability of $3,000 and is included in accounts payable on the balance sheet.
Data I/O does not hold or issue derivative financial instruments for trading
purposes. The purpose of our hedging activities is to reduce the risk that the
valuation of the underlying assets, liabilities and firm commitments will be
adversely affected by changes in exchange rates. Our derivative activities do
not create foreign currency exchange rate risk because fluctuations in the value
of the instruments used for hedging purposes are offset by fluctuations in the
value of the underlying exposures being hedged. We are exposed to credit-related
losses in the event of nonperformance by counterparties to forward exchange
contracts. However, we have entered into these instruments with creditworthy
financial institutions and consider the risk of nonperformance remote.
New Accounting Pronouncements
- -----------------------------
In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payments." SFAS
No. 123R requires employee stock options and rights to purchase shares under
stock participation plans to be accounted for under the fair value method, and
eliminates the ability to account for these instruments under the intrinsic
value method prescribed by APB Opinion No. 25, and allowed under the original
provisions of SFAS No. 123. SFAS No. 123R requires the use of an option pricing
model for estimating fair value, which is amortized to expense over the service
periods. In March 2005, the SEC issued SAB 107, "Share-Based Payments," which
gives guidance on the application of FAS 123R and extends the required adoption
date to January 1, 2006 for Data I/O. The adoption of SFAS No. 123R is expected
to have a significant effect on the consolidated financial statements of Data
I/O. See Note 1 for the pro forma impact on net earnings (loss) and earnings
(loss) per share from calculating stock-related compensation costs under the
fair value alternative of SFAS No. 123. However, the calculation of compensation
cost for share-based payment transactions after the effective date of SFAS No.
123R and under SAB 107 may be different from the calculation of compensation
cost under SFAS No. 123. Such potential differences have not yet been
quantified. Also, past usage of option plans and stock purchase plans may not
reflect our practices in future periods.
In May 2005, the FASB issued Statement No. 154, "Accounting Changes and Error
Corrections - a replacement of APB Opinion No. 20 and FASB Statement No. 3."
This Statement changes the requirements for the accounting for and reporting of
a change in accounting principle. Statement No. 154 is effective for accounting
changes and corrections of errors made in fiscal years beginning after December
15, 2005. We have not yet assessed the effect of this Statement on Data I/O.
NOTE 2 - CLASSIFICATIONS
Certain prior periods' balances have been reclassified to conform to the
presentation used in the current period.
NOTE 3 - PROVISION FOR BUSINESS RESTRUCTURING
During 2005, we took restructuring related charges of $96,000 primarily related
to severance and completing actions that had been started in the second half of
2004. This aligned management operations with the changes made in 2004 to
control costs in North America and Europe; and the need to build staff serving
China and Eastern Europe.
At December 31, 2005, $33,000 remained as accrued but unpaid restructure
charges, which will be paid in 2006.
During 2004, we took restructuring related charges of $562,000 primarily related
to severance and a small office closure. These actions were taken to lower
production and operating costs to reduce the level of revenue required for our
net income breakeven point, particularly in view of our reduced margins in the
second quarter of 2004; the continued need to control costs in North America and
Europe; and the need to build staff serving China and Eastern Europe.
During 2003, we completed the restructuring that began during 2001, which
included actions taken to reduce the level of revenue required for our net
income breakeven point and realign Data I/O with our market opportunities. This
restructuring included the following: a reduction in our global workforce;
discontinuance or reallocation of numerous projects and activities not essential
to our long-term goals; streamlining discretionary activities; consolidation of
numerous functions across the
35
organization to create a team, which was more productive and able to respond
faster to global customer needs; and closure of a facility in Germany and moving
our operations to other locations within Data I/O. We required this operational
repositioning because of the impact of the economic slowdown and the decline in
capital spending across a high number of customer groups on general demand for
programming equipment over the past few years. Our level of revenue required for
our net income breakeven point increased in 2003, primarily due to cost
increases resulting from the impact of the weaker dollar on foreign currency
based costs and from personnel costs due to raises, incentive compensation and
selective hiring of individuals with critical skills to help position us as the
continuing technology leader in our market.
At December 31, 2003 all restructuring expenses associated with the activities
detailed for 2002 and 2001 had been paid and the excess expense accrual of
$39,000 was reversed during 2003.
An analysis of the restructuring is as follows (in thousands):
2004 2004 Reserve 2005 2005 Reserve
Expenses Payments/ Balance at Expenses Payments/ Balance at
Description Write-offs Dec. 31, 2004 Write-offs Dec. 31, 2005
------------------------------------------------------------------------------------------------------------------------
Downsizing U.S.
Operations:
Employee severance $310 $256 $54 $81 $117 $18
Redmond facility 10 8 2 - 2 -
consolidation
Consulting and legal 15 15 - 15 15 -
expenses
Downsizing foreign
operations 227 196 30 - 15 15
------------ ------------ ------------ ------------ ------------ ------------
Total $562 $475 $86 $96 $149 $33
============ ============ ============ ============ ============ ============
NOTE 4 - MARKETABLE SECURITIES
The estimated fair value of marketable securities consisted of the following (in
thousands):
Dec. 31, Dec. 31,
2005 2004
------------- -------------
Corporate bonds $ - $ 787
Taxable auction securities 800 250
------------- -------------
$ 800 $ 1,037
============= =============
At December 31, 2005, cost approximated market value for Data I/O's portfolio of
marketable securities and there were no significant unrealized gains or losses.
The marketable securities are all classified as current assets due to their
maturity date or because of the available for sale holding intent, as in the
case of corporate bonds which had a maturity date in the second quarter of 2005.
The cost of securities sold is determined by the specific identification method.
36
NOTE 5 - ACCOUNTS RECEIVABLE, NET
Receivables consist of the following (in thousands):
Dec. 31, Dec. 31,
2005 2004
------------- -------------
Trade accounts receivable $6,993 $4,644
Less allowance for doubtful receivables 165 155
------------- -------------
Trade accounts receivable, net $6,828 $4,489
============= =============
Trade receivables relate to sales to Data I/O customers, for which credit is
extended based on the customer's credit history. Changes in Data I/O's allowance
for doubtful accounts are as follows (in thousands):
Dec. 31, Dec. 31,
2005 2004
------------- -------------
Beginning balance $155 $202
Bad debt expense (reversal) 64 (37)
Accounts written-off (64) (10)
Recoveries 10 -
------------- -------------
Ending balance $165 $155
============= ==============
NOTE 6 - INVENTORIES
Net inventories consisted of the following components (in thousands):
Dec. 31, Dec. 31,
2005 2004
------------- -------------
Raw material $2,076 $2,381
Work-in-process 767 899
Finished goods 686 859
------------- -------------
Inventories $3,529 $4,139
============= ==============
Reserves for excess and obsolete inventory were $1,539,000 and $1,915,000 at
December 31, 2005 and December 31, 2004, respectively. The $376,000 decline in
the reserve related primarily to scrapping and disposal of the related inventory
with a reversal of $158,000 in cost of goods sold related to items sold. Our
inventory reserve addresses excess and obsolete inventories. The reserve is not
part of a current lower of cost or market ("LOCOM") evaluation or provision as
the company uses a standard costing system and any associated LOCOM write down
would be permanently made to the item cost. Our reserve generally results in
items being scrapped or disposed of for a small salvage value; however, some
inventory does get eventually used and sold, in which case the reserve would be
credited back to cost of goods sold.
NOTE 7 - SALE - LEASEBACK
In May 1997, Data I/O completed the sale of the land and building comprising our
Redmond, Washington, corporate headquarters. The sale included a 10-year
leaseback of the building to Data I/O. The sale represented an overall pre-tax
gain to Data I/O of $5.6 million. Of this amount, we recognized $2.3 million in
1997, with the remainder being amortized over the life of the lease ending in
2006.
37
NOTE 8 - PROPERTY, PLANT AND EQUIPMENT, NET
Property, plant and equipment consisted of the following (in thousands):
Dec. 31, Dec. 31,
2005 2004
------------- -------------
Leasehold improvements $343 $291
Equipment 9,935 10,065
------------- -------------
10,278 10,356
Less accumulated depreciation 8,004 8,386
------------- -------------
Property, plant and equipment, net $2,274 $1,970
============= =============
Total depreciation recorded for 2005, 2004, and 2003 was $1,107,000, $922,000,
and $602,000, respectively.
NOTE 9 - OTHER ACCRUED LIABILITIES
Other accrued liabilities consisted of the following components (in thousands):
Dec. 31, Dec. 31,
2005 2004
------------- -------------
Product warranty liability $459 $494
Sales return reserve 150 250
Other 491 382
------------- -------------
Other accrued liabilities $1,100 $1,126
============= =============
The changes in Data I/O's product warranty liability are as follows (in
thousands):
Dec. 31, Dec. 31,
2005 2004
------------- -------------
Liability, beginning of year $494 $563
Net expenses 810 896
Warranty claims (810) (896)
Accrual revisions (35) (69)
------------- -------------
Liability, end of year $459 $494
============= =============
38
NOTE 10 - AGGREGATE CONTRACTUAL OBLIGATIONS AND COMMITTMENTS
Data I/O has purchase obligations for inventory and production costs as well as
other obligations such as capital expenditures, service contracts, marketing,
and development agreements. Arrangements are considered purchase obligations if
a contract specifies all significant terms, including fixed or minimum
quantities to be purchased, a pricing structure and approximate timing of the
transaction. Most arrangements are cancelable without a significant penalty, and
with short notice, typically less than 90 days. Any amounts reflected on the
balance sheet as accounts payable and accrued liabilities are excluded from the
below table. Data I/O has no long-term debt. Data I/O has commitments under
non-cancelable operating leases and other agreements, primarily for factory and
office space, with initial or remaining terms of one year or more as follows:
For the years ending December 31, (in thousands):
Purchase Operating
obligations leases
---------------- ----------------
2006 $620 $1,512
2007 854 249
2008 - 143
2009 - 18
2010 and thereafter - -
---------------- ----------------
Total $1,474 $1,922
================ ================
Lease and rental expense before the deduction for the amortization of the
deferred gain was $1,227,000, $1,610,000, and $1,476,000 in 2005, 2004, and
2003, respectively. Data I/O has renewal options on substantially all of our
major leases. The initial lease on the Redmond facility expires on December 31,
2006. On February 28, 2006, Data I/O and our current landlord concurrently
entered into a termination agreement for the Redmond headquarters facility lease
and a five year lease agreement for an approximately 40,000 square foot office
space also located in Redmond, Washington. We anticipate a mid-year move of our
corporate headquarters to this new location. We also expect to enter into a new
lease agreement during the first quarter of 2006 for our offices in Shanghai,
China.
NOTE 11 - STOCK AND RETIREMENT PLANS
Stock Option Plans
- ------------------
At December 31, 2005, there were 1,436,091 shares of Common Stock reserved for
issuance of which 280,646 shares are available for future grant under Data I/O's
employee stock option plans. Pursuant to these plans, options are granted to our
officers and key employees with exercise prices equal to the fair market value
of the Common Stock at the date of grant and generally vest over four years.
Certain options granted during 1998 and 1999 vest over two years. Options
granted under the plans generally have a maximum term of six years from the date
of grant, except for certain options granted in January 1999, which have a
maximum term of ten years.
Employee Stock Purchase Plan
- ----------------------------
Under the Employee Stock Purchase Plan, eligible employees may purchase shares
of Data I/O's Common Stock at six-month intervals at 85% of the lower of the
fair market value on the first or the last day of each six-month period.
Employees may purchase shares having a value not exceeding 10% of their gross
compensation during an offering period. During 2005, 2004 and 2003, a total of
57,076, 61,221, and 194,477 shares, respectively, were purchased under the plan
at average prices of $2.31, $2.52, and $0.61 per share, respectively. At
December 31, 2005, a total of 157,687 shares were reserved for future issuance.
39
Stock Appreciation Rights Plan
- ------------------------------
Data I/O has a Stock Appreciation Rights Plan ("SAR") under which each director,
executive officer or holder of 10% or more of Data I/O's Common Stock has a SAR
with respect to each exercisable stock option. The SAR entitles the SAR holder
to receive cash from Data I/O for the difference between the market value of the
stock and the exercise price of the option in lieu of exercising the related
option. SARs are only exercisable following a tender offer or exchange offer for
Data I/O's stock, or following approval by shareholders of Data I/O of any
merger, consolidation, reorganization or other transaction providing for the
conversion or exchange of more than 50% of the common shares outstanding. As no
event has occurred, which would make the SARs exercisable, and no such event is
deemed probable, no compensation expense has been recorded under this plan.
Director Fee Plan
- -----------------
Data I/O has a Director Fee Plan, not currently in use, which had provided for
payment to directors who are not employees of Data I/O Corporation by delivery
of shares of Data I/O's Common Stock. No shares were issued from the plan for
2005, 2004, or 2003 board service and 151,332 shares remain available in the
plan.
Retirement Savings Plan
- -----------------------
Data I/O has a savings plan that qualifies as a cash or deferred salary
arrangement under Section 401(k) of the Internal Revenue Code. Under the plan,
participating U.S. employees may defer their pre-tax salary, subject to IRS
limitations. In fiscal years 2005, 2004 and 2003, Data I/O contributed one
dollar for each dollar contributed by a participant, with a maximum contribution
of 4% of a participant's earnings. Data I/O's matching contribution expense for
the savings plan was approximately $182,000, $178,000, and $161,000 in 2005,
2004, and 2003, respectively.
Share Repurchase Program
- ------------------------
Under a previously announced share repurchase program, Data I/O is authorized to
repurchase up to 1,123,800 shares of our outstanding Common Stock. These
purchases may be executed through open market purchases at prevailing market
prices, through block purchases or in privately negotiated transactions, and may
commence or be discontinued at any time. In years prior to 2005, we have
repurchased 1,016,200 shares under this repurchase program at a total cost of
approximately $7.1 million. We have not repurchased shares under this plan since
the second quarter of 1997, although we still have the authority to do so.
NOTE 12- STOCK-BASED COMPENSATION
Pro forma information regarding net income and earnings per share is required by
SFAS 123, and has been determined as if Data I/O had accounted for our employee
stock options, employee stock purchase plan options and directors' fee shares
under the fair value method of that Statement (see Note 1). The fair value for
these options was estimated at the date of grant using a Black-Scholes
option-pricing model with the following weighted-average assumptions:
Employee Stock Employee Stock Director
Options Purchase Plan Fee Plan
------------------------------- -------------------------------- -------------------------------
2005 2004 2003 2005 2004 2003 2005 2004 2003
--------- --------- --------- --------- --------- ---------- --------- --------- ---------
Risk-free interest rates 3.72% 3.44% 2.21% 2.00% 1.15% 1.14% N/A N/A N/A
Volatility factors .79 1.03 1.03 .91 1.04 .97 N/A N/A N/A
Expected life of the option 4.61 4.35 4.31 .50 .50 .50 N/A N/A N/A
in years
Expected dividend yield None None None None None None None None None
For purposes of pro forma disclosures, the estimated fair value of the options
granted, which is estimated to be $1.61, $2.15, and $1.01 per share for 2005,
2004 and 2003, respectively, is amortized to expense over the options' vesting
period.
40
A summary of Data I/O's stock option activity, and related information follows:
December 31, 2005 December 31, 2004 December 31, 2003
---------------------------- -------------------------- -----------------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
--------------- -------------- ------------- ------------ --------------- ---------------
Outstanding at beginning of year 1,439,488 $2.27 1,326,805 $2.25 1,141,412 $2.56
Granted 295,500 2.52 313,000 2.91 299,500 1.39
Exercised (421,945) 1.99 (27,179) 1.64 (14,408) 2.40
Expired or forfeited (157,598) 2.47 (173,138) 3.28 (99,699) 3.10
--------------- ------------- ---------------
Outstanding - end of year 1,155,445 1,439,488 2.27 1,326,805 2.25
=============== ============= ===============
Exercisable at end of year 652,573 $2.44 907,533 $2.34 829,572 $2.52
The following table summarizes information about stock options outstanding at
December 31, 2005:
Options Outstanding Options Exercisable
------------------------------------------------------ ---------------------------------
Weighted-
Average Weighted- Weighted-
Remaining Average Average
Range of Number Contractual Exercise Number Exercise
Exercise Prices Outstanding Life in Years Price Exercisable Price
------------- --------------- -------------- ------------- -------------
$1.00 - $1.25 187,224 3.14 $1.04 124,043 $1.06
$1.33 - $1.89 189,245 2.49 1.42 161,755 1.42
$1.94 - $2.49 282,132 4.72 2.43 89,118 2.33
$2.24 - $3.04 302,294 4.66 2.82 101,419 2.84
$3.13 - $5.16 194,550 1.24 4.66 176,238 4.17
------------- -------------
$1.00 - $5.16 1,155,445 3.49 $2.42 652,573 $2.44
============= =============
NOTE 13 - ACCUMULATED OTHER COMPREHENSIVE INCOME
Ending accumulated balances for each item in accumulated other comprehensive
income are as follows:
(in thousands) Dec 31, Dec 31,
2005 2004
------------- -------------
Unrealized currency gain $312 $493
Unrealized loss on marketable securities (1) (6)
------------- -------------
Total accumulated other comprehensive income $311 $487
============= =============
NOTE 14- INCOME TAXES
Data I/O accounts for income taxes using the liability method as prescribed by
Statement of Financial Accounting Standards No. 109, "Accounting for Income
Taxes."
41
Components of income (loss) before taxes:
Year Ended December 31,
---------------------------------------------------
(in thousands) 2005 2004 2003
-------------- --------------- ----------------
U.S. operations $541 $329 $698
Foreign operations 161 (435) 641
-------------- --------------- ----------------
$702 ($106) $1,339
============== =============== ================
Income tax expense (benefit) consists of:
Current tax expense (benefit):
U.S. federal $ - $ - $ -
State 5 - -
Foreign 115 (14) 33
-------------- --------------- ----------------
120 (14) 33
Deferred tax expense (benefit) - U.S. federal - - -
-------------- --------------- ----------------
Total income tax expense (benefit) $ 120 ($14) $ 33
============== =============== ================
A reconciliation of Data I/O's effective income tax rate and the U.S. federal
tax rate is as follows:
Year Ended December 31,
------------------------------------------------
2005 2004 2003
----------- ------------ ----------
Statutory rate 34.0% 34.0% 34.0%
State and foreign income tax, net of
federal income tax benefit (0.1) 27.9 (13.7)
Valuation allowance for deferred tax assets (16.8) (48.8) (17.9)
----------- ------------ ----------
17.1% 13.1% 2.4%
=========== ============ ============
The tax effects of temporary differences that gave rise to significant portions
of the deferred tax assets are presented below (in thousands):
Dec. 31, Dec. 31,
2005 2004
--------------- ---------------
Deferred income tax assets:
Allowance for doubtful accounts $ 15 $ 24
Inventory and product return reserves 853 1,143
Compensation accruals 189 155
Accrued liabilities 532 573
Book-over-tax depreciation and amortization 799 743
Foreign net operating loss carryforwards 259 194
U.S. net operating loss and credit carryforwards 7,149 6,969
Other, net 7 6
--------------- ---------------
9,803 9,807
Valuation allowance (9,803) (9,807)
--------------- ---------------
Total deferred income tax assets $ - $ -
=============== ================
The valuation allowance for deferred tax assets decreased $4,000 during the year
ended December 31, 2005, due primarily to the 2005 book net income that allowed
the utilization of tax deferred assets reducing the related valuation allowance.
The valuation allowance for deferred tax assets increased $107,000 during the
year ended December 31, 2004, due primarily to the 2004 net operating losses
generated that have been reserved for by increasing the valuation allowance. The
net deferred tax assets have a full valuation allowance provided due to
uncertainty regarding Data I/O's ability to utilize such assets in future years.
Credit carryforwards consist primarily of research and experimental and
alternative minimum tax credits. Net operating loss carryforwards expire in 2019
to 2025. Utilization of net operating loss and credit carryforwards is subject
to certain limitations under Section 382 of the Internal Revenue Code of 1986,
as amended.
42
NOTE 15 - SEGMENT AND GEOGRAPHIC INFORMATION
In 2005, no customer accounted for 10% of Data I/O's consolidated revenues and
in 2004 and 2003, one customer, Siemens, accounted for 14.5% and 18.0% of Data
I/O's consolidated revenues, respectively, and no other customer accounted for
more than 10%. Major operations outside the U.S. include sales and service
support subsidiaries in Germany, Brazil, Canada and China.
We present geographic information of our operations for the three years ended
December 31, 2005 in the table that follows. Net sales, as shown in the table
below, are based upon the geographic area into which the products were sold and
delivered. Export sales are subject to U.S. Department of Commerce regulations,
and to the market conditions in the countries in which the products are sold.
For purposes of the table below, the profit on the transfers between geographic
areas has been shown in operating income in the geographic area where the final
sale to non-affiliated customers took place. Certain general corporate expenses
are charged to the U.S. segment. Identifiable assets are those assets that can
be directly associated with a particular geographic area. All Company financial
instruments, consisting of cash and marketable securities, are included in U.S.
operations.
Year Ended December
------------------------------------------------------------------
(in thousands) 2005 2004 2003
--------------- -------------- ----------------
Net sales:
U.S. $6,386 $5,434 $7,263
Europe 11,340 11,156 10,678
Rest of World 10,595 10,720 6,746
--------------- -------------- ----------------
$28,321 $27,310 $24,687
=============== ============== ================
Included in Europe and Rest of World are
the following significant balances:
Germany $8,510 $8,989 $8,765
China $4,458 $2,986 $3,149
Operating income (loss):
U.S. ($394) ($1,526) ($709)
Europe 1,715 2,824 2,848
Rest of World (696) (1,369) (775)
--------------- -------------- ----------------
$625 ($71) $1,364
=============== ============== ================
Identifiable assets:
U.S. $8,351 $9,202 $11,128
Europe 4,882 4,577 3,949
Rest of World 4,904 4,068 3,023
--------------- -------------- ----------------
$18,137 $17,847 $18,100
=============== ============== ================
NOTE 16 - QUARTERLY FINANCIAL INFORMATION (unaudited)
The following table sets forth unaudited selected quarterly financial data for
Data I/O for 2005 and 2004. Although our business is not seasonal, growth rates
of sales and earnings have varied from quarter to quarter as a result of factors
such as stocking orders from international distributors, the timing of new
product introductions, business restructuring, and short-term industry and
general U.S. and international economic conditions. Information as to any one or
more quarters is, therefore, not necessarily indicative of trends in our
business or profitability.
43
(in thousands except per share data) Year Ended December 2005
-----------------------------------------------------------------
For the quarters ended Mar 31 June 30 Sept 30 Dec 31
------------- ------------- ------------- -------------
Net sales(4) $6,737 $6,642 $6,587 $8,355
Gross margin 4,014 3,933 3,756 4,388
Net income (loss) (2) 39 53 127 363
Basic and diluted earnings per share (1) $ 0.00 $ 0.01 $ 0.02 $ 0.07
Year Ended December 2004
(in thousands except per share data)
-----------------------------------------------------------------
For the quarters ended: Mar 31 June 30 Sept 30 Dec 31
------------- ------------- ------------- -------------
Net sales(3) $6,834 $6,896 $7,765 $5,815
Gross margin 3,713 3,510 4,232 3,129
Net income (loss) (2) 296 103 93 (584)
Basic and diluted earnings (loss) per share (1) $ 0.04 $ 0.01 $ 0.01 ($0.07)
(1) The sum of quarterly per share amounts may not equal per share amounts
reported for year-to-date periods. This is due to changes in the number of
weighted-average shares outstanding and the effects of rounding for each
period.
(2) The Company recorded restructure charges of $55,000, $17,000, and $24,000
in the second, third and fourth quarters of 2005, respectively, and
$70,000, $432,000 and $60,400 in the second, third and fourth quarters of
2004, respectively, for charges associated primarily with severance related
charges and a small office closure.
(3) The loss in the fourth quarter of 2004 was primarily related to the
quarter's decline in sales to customers in the wireless market.
(4) Beginning in the third quarter of 2005, we began recognizing revenue for
certain equipment requiring installation at the time of shipment. See Note
1.
NOTE 17 - LONG-TERM DEBT
As of December 31, 2005 and December 31, 2004, Data I/O had no long-term debt
outstanding. Data I/O established a foreign line of credit for 50,000 Euros in
February 2002 that was renewed in January 2003 but not renewed in January 2004.
44
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
- --------------------------------
(a) Evaluation of disclosure controls and procedures.
Under the supervision and with the participation of our management, including
our Chief Executive Officer and Chief Financial Officer, Data I/O evaluated the
effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Exchange
Act) as of the end of the period covered by this report (the "Evaluation Date").
Based upon that evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that, as of the Evaluation Date, our disclosure controls and
procedures were effective in timely alerting them to the material information
relating to Data I/O (or our consolidated subsidiaries) required to be included
in our periodic SEC filings and Form 8-K reports.
(b) Changes in internal controls.
There were no changes made in our internal controls during the period covered by
this report that has materially affected or is reasonably likely to materially
affect our internal control over financial reporting.
We have recently acquired and are currently implementing a new worldwide
information system that will result in changes to our internal controls. Our
corporate office began use of the new system in February 2006. We are now in the
process of implementing the new system at our subsidiary locations. We intend to
include process and internal control improvements as part of the implementation
process.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- ------------------------------------------------------------
Information regarding the Registrant's directors is set forth under "Election of
Directors" in Data I/O's Proxy Statement relating to Data I/O's annual meeting
of shareholders to be held on May 24, 2006 and is incorporated herein by
reference. Such Proxy Statement will be filed within 120 days of Data I/O's
year-end. Information regarding the Registrant's executive officers is set forth
in Item 1 of Part I herein under the caption "Executive Officers of the
Registrant."
Code of Ethics
We have adopted an updated Code of Ethics that applies to all directors,
officers and employees of Data I/O, including the Chief Executive Officer and
Chief Financial Officer. The key principles of the Code of Ethics are to act
legally and with integrity in all work for Data I/O. The Code of Ethics is
posted on the corporate governance page of our website at
http://www.dataio.com/corporate/governance.asp. We will post any amendments to
our Code of Ethics on our website. In the unlikely event that the Board of
Directors approves any sort of waiver to the Code of Ethics for our executive
officers or directors, information concerning such waiver will also be posted on
our website. In addition to posting information regarding amendments and waivers
on our website, the same information will be included in a Current Report on
Form 8-K within four business days following the date of the amendment or
waiver, unless website posting of such amendments or waivers is permitted by the
rules of The Nasdaq Stock Market, Inc.
45
ITEM 11. EXECUTIVE COMPENSATION
- --------------------------------
Information called for by Part III, Item 11, is included in Data I/O's Proxy
Statement relating to Data I/O's annual meeting of shareholders to be held on
May 24, 2006 and is incorporated herein by reference. The information appears in
the Proxy Statement under the caption "Executive Compensation." Such Proxy
Statement will be filed within 120 days of Data I/O's year-end.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED STOCKHOLDER MATTERS
Information called for by Part III, Item 12, is included in Data I/O's Proxy
Statement relating to Data I/O's annual meeting of shareholders to be held on
May 24, 2006 and is incorporated herein by reference. The information appears in
the Proxy Statement under the caption "Voting Securities and Principal Holders."
Such Proxy Statement will be filed within 120 days of Data I/O's year-end.
Equity Compensation Plan Information
- ------------------------------------
The following table gives information about our Common Stock that may be issued
upon the exercise of options and rights under all of our existing equity
compensation plans as of December 31, 2005. See Notes 11 and 12 of "Notes to
Consolidated Financial Statements."
(a) Number of securities (c) Number of securities remaining
to be issued upon the (b) Weighted-average available for future issuance under
exercise of outstanding exercise price of equity compensation plans
options, warrants and outstanding options, (excluding securities reflected in
rights warrants and rights column (a))
------------------------ --------------------- -----------------------------------
Equity compensation plans
approved by the security
holders(1)(3) 1,182,641 $2.41 562,469
Equity compensation plans
not approved by the security
holders(2) 0 $0.00 0
(1) Represents shares of Data I/O's Common Stock issuable pursuant to our 2000
Stock Incentive Compensation Plan, 1986 Stock Option Plan, 1992 Employee
Stock Purchase Plan, and Director Fee Plan.
(2) Director option grant represents a one-time option grant to Directors in
May 1998 prior to shareholder approval of an option plan covering
Directors.
(3) Stock Appreciation Rights Plan ("SAR") provides that directors, executive
officers or holders of 10% or more of Data I/O's Common Stock have an
accompanying SAR with respect to each exercisable option. While the plan
has been approved by the security holders, no amounts are included in
columns (a), (b), or (c) relating to the SAR.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
ITEM 14. PRINCIPLE ACCOUNTING FEES AND SERVICES
The information required by this Item with respect to principal accountant fees
and services is incorporated by reference to the section captioned "Principal
Accountant's Fees and Services" in the Proxy Statement relating to Data I/O's
annual meeting of shareholders to be held on May 24, 2006. Such Proxy Statement
will be filed within 120 days of Data I/O's year-end.
46
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
Executive Compensation Plans and Arrangements
The following list is a subset of the list of exhibits described below and
contains all compensatory plans, contracts or arrangements in which any director
or executive officer of Data I/O is a participant, unless the method of
allocation of benefits thereunder is the same for management and non-management
participants:
(1) Amended and Restated 1982 Employee Stock Purchase Plan. See Exhibit 10.17.
(2) Amended and Restated Retirement Plan and Trust Agreement. See Exhibit 10.2,
10.3, 10.4, 10.8, 10.11, 10.12, and 10.13.
(3) Summary of Amended and Restated Management Incentive Compensation Plan. See
Exhibit 10.9.
(4) Amended and Restated 1983 Stock Appreciation Rights Plan. See Exhibit 10.1.
(5) Amended and Restated 1986 Stock Option Plan. See Exhibit 10.15.
(6) Form of Change in Control Agreements. See Exhibit 10.21 and 10.22.
(7) 1996 Director Fee Plan. See Exhibit 10.14.
(8) Letter Agreement with Frederick R. Hume. See Exhibit 10.16.
(9) Amended and Restated 2000 Stock Compensation Incentive Plan. See Exhibit
10.18.
(10) Form of Option Agreement. See Exhibit 10.20.
(11) Data I/O Corporation Tax Deferral Retirement Plan. See Exhibit 10.19 and
10.24.
(12) Harald Weigelt Employment Agreement. See Exhibit 10.23.
(a) List of Documents Filed as a Part of This Report: Page
(1) Index to Financial Statements:
Report of Independent Registered Public Accounting Firm 26
Consolidated Balance Sheets as of December 31, 2005
and 2004 27
Consolidated Statements of Operations for each of the
three years ended December 31, 2005 28
Consolidated Statements of Cash Flowsfor each of the
three years ended December 31, 2005 29
Consolidated Statement of Stockholders' Equity for
each of the three years ended December 31, 2005 30
Notes to Consolidated Financial Statements 31
47
(2) Index to Financial Statement Schedules:
Schedule II - Consolidated Valuation and Qualifying Accounts 52
All other schedules not listed above have been omitted because the
required information is included in the consolidated financial
statements or the notes thereto, or is not applicable or required.
(3) Index to Exhibits:
3 ARTICLES OF INCORPORATION:
3.1 Data I/O's restated Articles of Incorporation filed
November 2, 1987 (Incorporated by reference to Exhibit 3.1
of Data I/O's 1987 Annual Report on Form 10-K (File No.
0-10394)).
3.2 Data I/O's Bylaws as amended and restated as of
February 2006.
3.3 Certification of Designation, Preferences and Rights of
Series A Junior Participating Preferred Stock
(Incorporated by reference to Exhibit 1 of Data I/O's
Registration Statement on Form 8-A filed March 13, 1998
(File No. 0-10394)).
4 INSTRUMENTS DEFINING THE RIGHTS OF SECURITY HOLDERS, INCLUDING
INDENTURES:
4.1 Rights Agreement, dated as of April 4, 1998, between Data
I/O Corporation and ChaseMellon Shareholder Services,
L.L.C. as Rights Agent, which includes: as Exhibit A
thereto, the Form of Right Certificate; and, as Exhibit B
thereto, the Summary of Rights to Purchase Series A Junior
Participating Preferred Stock (Incorporated by reference
to Data I/O's Current Report on Form 8-K filed on March
13, 1998).
4.2 Rights Agreement, dated as of March 31, 1988, between Data
I/O Corporation and First Jersey National Bank, as Rights
Agent, as amended by Amendment No. 1 thereto, dated as of
May 28, 1992 and Amendment No. 2 thereto, dated as of July
16, 1997 (Incorporated by reference to Data I/O's Report
on Form 8-K filed on March 13, 1998).
4.3 Amendment No. 1, dated as of February 10, 1999, to Rights
Agreement, dated as of April 4, 1998, between Data I/O
Corporation and ChaseMellon Shareholder Services, L.L.C.
as Rights Agent (Incorporated by reference to Exhibit 4.1
of Data I/O's Form 8-A/A dated February 10, 1999).
10 MATERIAL CONTRACTS:
10.1 Amended and Restated 1983 Stock Appreciation Rights Plan
dated February 3, 1993 (Incorporated by reference to
Exhibit 10.23 of Data I/O's 1992 Annual Report on Form
10-K (File No. 0-10394)).
10.2 Amended and Restated Retirement Plan and Trust Agreement.
(Incorporated by reference to Exhibit 10.26 of Data I/O's
1993 Annual Report on Form 10-K (File No. 0-10394)).
10.3 First Amendment to the Data I/O Tax Deferred Retirement
Plan (Incorporated by reference to Exhibit 10.21 of Data
I/O's 1994 Annual Report on Form 10-K (File No. 0-10394)).
48
10.4 Second Amendment to the Data I/O Tax Deferred Retirement
Plan (Incorporated by reference to Exhibit 10.26 of Data
I/O's 1995 Annual Report on Form 10-K (File No. 0-10394)).
10.5 Purchase and Sale Agreement dated as of July 9, 1996
(Relating to the sale of Data I/O Corporation's
headquarters property in Redmond, Washington consisting of
approximately 79 acres of land and an approximately 96,000
square foot building. (Portions of this exhibit have been
omitted pursuant to an application for an order granting
confidential treatment. The omitted portions have been
separately filed with the Commission) (Incorporated by
reference to Exhibit 10.32 of Data I/O's 1996 Annual
Report on Form 10-K (File No. 0-10394)).
10.6 Letter dated as of December 20, 1996, First Amendment and
extension of the Closing Date under that certain Purchase
and Sale Agreement dated as of July 9, 1996. (Portions of
this exhibit have been omitted pursuant to an application
for an order granting confidential treatment. The omitted
portions have been separately filed with the Commission)
(Incorporated by reference to Exhibit 10.33 of Data I/O's
1996 Annual Report on Form 10-K (File No. 0-10394)).
10.7 Letter dated as of February 17, 1997, Second Amendment and
extension of the Closing Date under that certain Purchase
and Sale Agreement dated as of July 9, 1996. (Portions of
this exhibit have been omitted pursuant to an application
for an order granting confidential treatment. The omitted
portions have been separately filed with the Commission)
(Incorporated by reference to Exhibit 10.34 of Data I/O's
1996 Annual Report on Form 10-K (File No. 0-10394)).
10.8 Third Amendment to the Data I/O Tax Deferred Retirement
Plan (Incorporated by reference to Exhibit 10.35 of Data
I/O's 1996 Annual Report on Form 10-K (File No. 0-10394)).
10.9 Amended and Restated Management Incentive Compensation
Plan dated January 1, 1997 (Incorporated by reference to
Exhibit 10.25 of Data I/O's 1997 Annual Report on Form
10-K (File No. 0-10394)).
10.10 Amended and Restated Performance Bonus Plan dated January
1, 1997 (Incorporated by reference to Exhibit 10.26 of
Data I/O's 1997 Annual Report on Form 10-K (File No.
0-10394)).
10.11 Fourth Amendment to the Data I/O Tax Deferred Retirement
Plan (Incorporated by reference to Exhibit 10.27 of Data
I/O's 1997 Annual Report on Form 10-K (File No. 0-10394)).
10.12 Fifth Amendment to the Data I/O Tax Deferred Retirement
Plan (Incorporated by reference to Exhibit 10.28 of Data
I/O's 1997 Annual Report on Form 10-K (File No. 0-10394)).
10.13 Sixth Amendment to the Data I/O Tax Deferred Retirement
Plan (Incorporated by reference to Exhibit 10.29 of Data
I/O's 1997 Annual Report on Form 10-K (File No. 0-10394)).
10.14 Amended and Restated Data I/O Corporation 1996 Director
Fee Plan (Incorporated by reference to Exhibit 10.32 of
Data I/O's 1997 Annual Report on Form 10-K (File No.
0-10394)).
49
10.15 Amended and Restated 1986 Stock Option Plan dated May 12,
1998 (Incorporated by reference to Exhibit 10.37 of Data
I/O's 1998 Annual Report on Form 10-K (File No. 0-10394)).
10.16 Letter Agreement with Fred R. Hume dated January 29, 1999.
10.17 Amended and Restated 1982 Employee Stock Purchase Plan
dated May 16, 2003 (Incorporated by reference to Data
I/O's 2003 Proxy Statement dated March 31, 2003).
10.18 Amended and Restated 2000 Stock Compensation Incentive
Plan dated May 20, 2004 (Incorporated by reference to
Data I/O's 2004 Proxy Statement dated April 12, 2004).
10.19 Data I/O Corporation Tax Deferral Retirement Plan, as
amended (Incorporated by reference to Data I/O's 2004
Annual Report on Form 10-K (File No. 0-10394)).
10.20 Form of Option Agreement (Incorporated by reference to
Data I/O's 2004 Annual Report on Form 10-K
(File No. 0-10394)).
10.21 Change in Control Agreement with Fred R. Hume dated
April 22, 2004 (Incorporated by reference to Data I/O's
2004 Annual Report on Form 10-K (File No. 0-10394)).
10.22 Change in Control Agreement with Joel S. Hatlen dated
April 22, 2004 (Incorporated by reference to Data I/O's
2004 Annual Report on Form 10-K (File No. 0-10394)).
10.23 Harald Weigelt Employment Agreement.
10.24 Data I/O Corporation Tax Deferral Retirement Plan, as
amended.
10.25 Lease Termination Agreement dated February 28, 2006
(Redmond Headquarters).
10.26 Lease, Redmond East Business Campus between Data I/O
Corporation and Carr Redmond PLCC dated February 28, 2006.
21.1 Subsidiaries of the Registrant
23.1 Consent of Independent Registered Public Accounting Firm
31 CERTIFICATION - SECTION 302:
31.1 Chief Executive Officer Certification
31.2 Chief Financial Officer Certification
32 CERTIFICATION - SECTION 906:
32.1 Chief Executive Officer Certification
32.2 Chief Financial Officer Certification
50
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
DATA I/O CORPORATION
(REGISTRANT)
DATED: March 29, 2006 By: //S//Frederick R. Hume
------------------------
Frederick R. Hume
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
NAME & DATE TITLE
- ----------- -----
By: /s/ Frederick R. Hume President and Chief Executive Officer
-------------------------- (Principal Executive Officer)
Frederick R. Hume
By: /s/ Joel S. Hatlen Chief Financial Officer
-------------------------- Vice President of Finance
Joel S. Hatlen Secretary, Treasurer
(Principal Financial and Accounting
Officer)
By: /s/ Paul A. Gary Director
--------------------------
Paul A. Gary
By: /s/ Edward D. Lazowska Director
--------------------------
Edward D. Lazowska
By: /s/ Daniel A. DiLeo Director
--------------------------
Daniel A. DiLeo
By: /s/ Steven M. Quist Director
--------------------------
Steven M. Quist
By: /s/ William R. Walker Director
--------------------------
William R. Walker
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DATA I/O CORPORATION
SCHEDULE II - CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS
Charged/
(Credited)
Balance at to Costs Balance at
Beginning and Deductions- End of
of Period Expenses Describe Period
---------------- ---------------- --------------- --------------------
(in thousands)
Year Ended December 31, 2003:
Reserves and allowances
deducted from asset accounts:
Allowance for bad debts $187 $71 ($56) (1) $202
Inventory reserves $3,267 ($96) ($875) (2) $2,296
Year Ended December 31, 2004 :
Reserves and allowances
deducted from asset accounts:
Allowance for bad debts $202 ($37) ($10) (1) $155
Inventory reserves $2,296 ($80) ($301) (2) $1,915
Year Ended December 31, 2005:
Reserves and allowances
deducted from asset accounts:
Allowance for bad debts $155 64 (54) $165
Inventory reserves $1,915 ($158) ($218) $1,539
(1) Uncollectable accounts written off, net of recoveries.
(2) Obsolete inventories disposed of.
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