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DATA I/O CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations
(Edgar Glimpses Via Acquire Media NewsEdge)
General
Forward-Looking Statements
This Quarterly Report on Form 10-Q includes forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995. This Act
provides a "safe harbor" for forward-looking statements to encourage companies
to provide prospective information about themselves as long as they identify
these statements as forward-looking and provide meaningful cautionary statements
identifying important factors that could cause actual results to differ from the
projected results. All statements other than statements of historical fact made
in this Quarterly Report on Form 10-Q are forward-looking. In particular,
statements herein regarding industry prospects or trends; expected revenues;
expected level of expense; future results of operations, restructuring
implications; breakeven point, or financial position; changes in gross margin;
economic conditions and capital spending outlook; market acceptance of our newly
introduced or upgraded products; the impact and integration of acquisitions;
development, introduction and shipment of new products; 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 report. The reader should not place undue reliance on these
forward-looking statements. The discussions above and in the section in Item
1A., Risk Factors "Cautionary Factors That May Affect Future Results" in the
Company's Annual report on Form 10-K for the year ended December 31, 2011
describe some, but not all, of the factors that could cause these differences.
OVERVIEW
Starting during the second half of 2011 and continuing during 2012, we
experienced a decrease in customer demand. We believe the decline in orders and
revenue is due primarily to overcapacity in the installed base of programming
equipment causing reduced capital spending. We believe the underlying decrease
in demand is due to a downturn in Asia-based electronics manufacturing caused in
part by the economic uncertainty related to the European sovereign debt
situation. We continued to focus on our primary goal of profitably managing the
business, while developing, launching and enhancing products to drive revenue
and return to profitability.
Our challenge continues to be operating in a cyclical and rapidly evolving
industry environment. Although our solutions address the growing flash and
microcontroller markets and the resulting need for programming, our opportunity
to experience significant growth occurs when there is increased capacity needed
to address the combination of growing file sizes and the growth in the flash and
microcontroller markets. However, we compete for this capacity growth against
alternative methods of loading data, such as programming after placement, or the
increased efficiency of the installed base of equipment, which has and continues
to constrain the programming equipment market. Additional factors impacting
demand for our solutions other than capacity, include quality and yield
requirements; process alternatives; new device and handling technologies and
factory integration. We are continuing our efforts to balance market forces,
business geography shifts, increasing costs and strategic investments in our
business with the level of demand and mix of business we expect.
We continue to focus on extending the capabilities and support for our FlashCORE
architecture, and the RoadRunner, FLX, PS and FlashPAK product lines as well as
developing new product platforms. Our applications innovation strategy provides
complete solutions to target customer's business problems. These solutions
generally have a larger software element, may involve third-party components,
and in many cases will be developed or customized to address the specific
requirements of individual customers. We believe by adding these features to
our strategic product platforms, we will continue to set ourselves apart from
other product suppliers and elevate our relationships with our customers to a
partner level. We consider the Azido technology, which we acquired in April
2011, to be a strategic platform for programmer and product development.
Our customer focus has been on strategic high volume manufacturers in key market
segments like wireless, automotive, industrial controls and programming centers
and supporting e-MMC, NAND Flash and microcontrollers on our newer products to
gain new accounts. We also provide product solutions used by electronics design
engineers. We continued to leverage our China operations to take advantage of
the growth of manufacturing in China and to operate close to our customers. We
continued to address the effectiveness of our sales and marketing organization
and sales channels, including evaluating alternative or supplemental channels,
to reach a larger number of customers and providing our channel partners with
extensive product, sales and service training.
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As a result of the business downturn we experienced this year and the uncertain
business outlook, we took restructuring actions in September 2012 expected to
reduce quarterly operating expenses and production costs by approximately
$300,000, with $47,000 of that amount already included in the third quarter
results. These actions included reductions in personnel and the use of
contractors, professionals, and consultants, as well as focusing our development
efforts on a smaller number of projects.
On October 25th, 2012, we announced the appointment of Anthony Ambrose as
President and Director effective immediately and as Chief Executive Officer
effective November 14, 2012. Prior to joining Data I/O, Mr. Ambrose, age 51,
was Owner and Principal of Cedar Mill Partners, LLC a strategy consulting firm.
Until 2011, he was Vice President and General Manager at RadiSys Corporation
where he led three product divisions and worldwide engineering. Until 2007,
Anthony was general manager and held several other progressively responsible
positions at Intel Corporation. Currently, he is familiarizing himself with our
business and evaluating our strategies for profitability and growth.
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 revenue recognition, estimating the
percentage-of-completion on fixed-price professional engineering service
contracts, sales returns, bad debts, inventories, investments, intangible
assets, income taxes, warranty obligations, restructuring charges, contingencies
such as litigation, and contract terms that have multiple elements and other
complexities typical in the capital equipment industry. We base our estimates
on historical experience and other assumptions that we believe are reasonable
under the circumstances. Actual results may differ from these estimates under
different assumptions or conditions.
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: Data I/O generally recognizes revenue at the time products
are shipped. We have determined that our programming equipment has reached a
point of maturity and stability such that product acceptance can be assured by
testing at the factory prior to shipment and that the installation meets the
criteria to be considered a separate element. These systems are standard
products with published product specifications and are configurable with
standard options. The evidence that these systems could be deemed as accepted
was based upon having standardized factory production of the units, results from
batteries of tests of product performance to our published specifications,
quality inspections and installation standardization, as well as past product
operation validation with the customer and the history provided by our installed
base of products upon which the current versions were based.
The amount of revenue recognized is affected by our judgments as to the
collectability of the transaction, the existence of an acceptance clause or
whether an arrangement includes multiple elements and if so, whether specific
objective evidence of selling price exists for those elements. Allocation
between multiple elements is done based on objective evidence of selling price
based on a selling price hierarchy, including discounts.
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 collectability is reasonably assured. The measure of standalone fair value
of the product versus the service installation value component is by the amount
we pay to independent representative service groups or the amount of additional
discount given to independent distributors to provide the service installation
(published price).
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. Service revenue from time and materials
contracts and training services is recognized as services are performed. We
recognize software revenue upon shipment provided that no significant
obligations remain on our part, substantive acceptance conditions, if any, have
been met and when the fee is fixed and determinable and when collection is
deemed probable.
Certain fixed-price engineering service contracts that require significant
production, modification, or customization of software, are accounted for using
the percentage-of-completion method. We use the percentage-of-completion method
of accounting because it is the most accurate method to recognize revenue based
on the nature and scope of our fixed-price professional engineering service
contracts; it is a better measure of periodic income results than other methods
and it better matches revenue recognized with the costs incurred. Percentage of
completion is measured based primarily on input measures such as hours
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incurred to date compared to total estimated hours to complete, with
consideration given to output measures, such as contract milestones, when
applicable. Significant judgment is required when estimating total hours and
progress to completion on these arrangements, which determines the amount of
revenue we recognize as well as whether a loss is recognized if one is expected
to be incurred upon project completion. Revisions to hour and cost estimates
are incorporated in the period the amounts are recognized if the results of the
period have not been reported; otherwise, the revision of estimates are
recognized in the period in which the facts that give rise to the revision
become known.
We establish a reserve for sales returns based on historical trends in product
returns and estimates for new items. Data I/O has a stated return policy that
customers can return standard products for any reason within 30 days after
delivery provided that the returned product is received in its original
condition, including all packaging materials, for a refund of the price paid
less a restocking charge of 30% of the total amount invoiced for the product
returned, unless such restocking charge is waived in writing by Data I/O. For
us to recognize revenue, the price is fixed or determinable at the date of the
sale, the buyer has paid or is obligated to pay and the obligation is not
contingent on resale of the product, the buyer's obligation would not be changed
in the event of theft, physical destruction or damage to the product, the buyer
acquiring the product for resale has economic substance apart from Data I/O and
we have no contractual obligations for future performance to directly bring
about the resale of the product by the buyer.
Allowance for Doubtful Accounts: We base the allowance for doubtful accounts
receivable on our assessment of the collectability of specific customer accounts
and the aging of accounts receivable. If there is deterioration of a major
customer's credit worthiness or actual defaults are higher than historical
experience, our estimates of the recoverability of amounts due to us could be
adversely affected.
Inventory: Inventories are stated at the lower of cost or market. Adjustments
are made to standard cost, which approximates actual cost on a first-in,
first-out basis. We estimate reductions to inventory for obsolete, slow-moving,
excess and non-salable inventory by reviewing current transactions and
forecasted product demand. We evaluate our inventories on an item by item basis
and record inventory adjustments accordingly. If there is a significant
decrease in demand for our products 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 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, as
well as the current uncertain economic outlook for our industry and capital
spending, Data I/O expects to continue to limit the recognition of net deferred
tax assets and accounting for uncertain tax positions and maintain the tax
valuation allowances. We expect, therefore, that reversals of the tax valuation
allowance will take place 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.
Share-based Compensation: We account for share-based awards made to our
employees and directors, including employee stock option awards and restricted
and performance share awards, using the estimated grant date fair value method
of accounting. We estimate the fair value using the Black-Scholes valuation
model, which requires the input of highly subjective assumptions, including the
option's expected life and the price volatility of the underlying stock. The
expected stock price volatility assumption was determined using the historical
volatility of the Company's common stock. Changes in the subjective assumptions
required in the valuation model may significantly affect the estimated value of
the awards, the related stock-based compensation expense and, consequently, our
results of operations. Beginning in the second quarter of 2006, restricted
stock awards were granted. Employee Stock Purchase Plan ("ESPP) shares were
issued under provisions that do not require us to record any equity compensation
expense.
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Results of Operations
Net Sales
Three Months Ended Nine Months Ended
Net sales by product September 30, September 30, September 30, September 30,
line 2012 Change 2011 2012 Change 2011
(in thousands)
Automated programming
systems $2,780 (43.4%) $4,914 $8,399 (38.9%) $13,746
Non-automated
programming systems 1,531 (28.4%) 2,137 4,951 (31.2%) 7,197
Total programming
systems $4,311 (38.9%) $7,051 $13,350 (36.3%) $20,943
Three Months Ended Nine Months Ended
September 30, September 30, September 30, September 30,
Net sales by location 2012 Change 2011 2012 Change 2011
(in thousands)
United States $831 (10.5%) $928 $2,057 0.8% $2,041
% of total 19.3% 13.2% 15.4% 9.7%
International $3,480 (43.2%) $6,123 $11,293 (40.3%) $18,902
% of total 80.7% 86.8% 84.6% 90.3%
Revenues for the third quarter of 2012 were $4.3 million, down 39% compared with
$7.1 million in the third quarter of 2011, and down 20% from $5.4 million in the
second quarter of 2012. We believe the decline in revenue compared to last year
relates primarily to reduced capital spending resulting from a downturn in
Asia-based electronics manufacturing and economic uncertainty related to the
European sovereign debt situation. Our revenues were impacted by the change in
the Euro translation rate, compared to one year ago, with the Euro devaluation
resulting in $151,000 less revenue in the third quarter of 2012. Backlog at
September 30, 2012 was $1.0 million.
On a regional basis, revenue declined in Asia 57%, Europe 40% and the Americas
17% compared to the third quarter of 2011. On a product basis, the revenue
decrease was primarily from our automated PS and FLX families as well as
FlashPak, offset in part by higher revenues from our RoadRunner family, compared
to the third quarter of 2011.
For the first nine months of 2012 compared to 2011, the decrease in revenues are
primarily attributed to the same factors as the third quarter of 2012.
Gross Margin
Three Months Ended Nine Months Ended
September 30, September 30, September 30, September 30,
2012 Change 2011 2012 Change 2011
(in thousands)
Gross margin $1,927 (51.1%) $3,943 $6,809 (43.8%) $12,116
Percentage of net sales 44.7% 55.9% 51.0% 57.9%
Gross margin as a percentage of sales in the third quarter of 2012 was 44.7%,
compared with 55.9% in the third quarter of 2011. This decrease, both in
dollars and as a percentage of gross margin, was primarily due to the decreased
sales volume in relation to certain fixed manufacturing costs, as well as an
excess and obsolete inventory charge of $164,000.
Gross margin as a percentage of sales for the nine months ending September 30,
2012 was 51.0%, compared to 57.9% during the same period in 2011 primarily due
to same factors as in the third quarter of 2012.
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Research and Development
Three Months Ended Nine Months Ended
September 30, September 30, September 30, September 30,
2012 Change 2011 2012 Change 2011
(in thousands)
Research and development $1,429 (3.6%) $1,482 $4,248 3.4% $4,109
Percentage of net sales 33.1% 21.0% 31.8% 19.6%
Research and development ("R&D") spending in the third quarter of 2012 decreased
by $53,000 compared to the same period in 2011 primarily due to $94,000 lower
consultant and contractor expense and $29,000 less R&D materials, offset in part
by higher depreciation and travel.
R&D expenses increased $139,000 for the first nine months of 2012 compared to
the same period in 2011. The increase includes higher Azido related costs of
$214,000, $47,000 higher patent related fees, $85,000 less engineering labor
charged to cost of goods sold, and higher depreciation expense of $83,000,
offset in part by $280,000 lower consultant and contractor expense.
Other than spending variations on R&D projects, we expect that our restructuring
actions should result in reduced R&D expense going forward.
Selling, General and Administrative
Three Months Ended Nine Months Ended
September 30, September 30, September 30, September 30,
2012 Change 2011 2012 Change 2011
(in thousands)
Selling, general &
administrative $1,656 (21.2%) $2,101 $5,901 (9.1%) $6,490
Percentage of net
sales 38.4% 29.8% 44.2% 31.0%
Selling, general and administrative ("SG&A") expenses in the third quarter of
2012 decreased by $445,000 compared to the same period in 2011 primarily due to
$126,000 lower professional and contractor fees, $105,000 lower sales
commissions resulting from lower sales volume, $85,000 lower incentive
compensation, $62,000 lower Azido consulting expense, and $33,000 lower
depreciation expense.
Excluding the CEO search firm and separation expense of $468,000 this year, SG&A
expenses for the first nine months of 2012 decreased by $1,057,000 compared to
the same period in 2011, primarily due to $280,000 lower incentive compensation,
$223,000 lower professional and contractor fees, $169,000 lower commissions,
$136,000 lower payroll related costs, and $71,000 lower Azido related costs.
Interest
Three Months Ended Nine Months Ended
September 30, September 30, September 30, September 30,
2012 Change 2011 2012 Change 2011
(in thousands)
Interest income $31 138.5% $13 $238 428.9% $45
Interest income for the third quarter of 2012 increased by $18,000 compared to
the same period in 2011 primarily related to interest received related to a
German tax refund and higher invested balances in foreign accounts.
Interest income for the first nine months of 2012 increased by $193,000 compared
to the same period in 2011, primarily due to the same factors as in the second
quarter of 2012.
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Income Taxes
Three Months Ended Nine Months Ended
September 30, September 30, September 30, September 30,
2012 Change 2011 2012 Change 2011
(in thousands)
Income tax (expense)
benefit $44 (167.7%) ($65) $321 (225.9%) ($255)
Income tax (expense) benefit recorded for the third quarter and first nine
months of 2012 and 2011 resulted primarily from foreign taxes on income and tax
refunds in our foreign subsidiaries. During the second quarter of 2012, we
prevailed in tax issues from the 1995-1998 years related to an acquisition and
we received refunds from German tax authorities of approximately $318,000.
The effective tax rate differed from the statutory tax rate primarily due to the
effect of valuation allowances, as well as foreign taxes and refunds. Data I/O
has a valuation allowance of $10.2 million as of September 30, 2012. Our
deferred tax assets and valuation allowance have been reduced by approximately
$138,000 associated with the requirements of accounting for uncertain tax
positions as of September 30, 2012. Given the uncertainty created by our past
loss history and the cyclical nature of the industry in which we operate, we
expect to continue to limit the recognition of net deferred tax assets and
maintain the tax valuation allowances.
Financial Condition
Liquidity and Capital Resources
September 30, December 31,
2012 Change 2011
(in thousands)
Working capital $14,398 ($7,957) $22,355
The Company's cash position at September 30, 2012 increased slightly during the
third quarter to $11.2 million. The change in cash was primarily attributable
to decreasing accounts receivable by $596,000 to $3 million and inventories by
$567,000 to $4.1 million at September 30, 2012, offsetting the loss for the
quarter. The Company remains debt free as of September 30, 2012.
For the nine months ending September 30, 2012, the decrease in working capital
primarily relates to cash used in our share repurchase programs of $6.0 million
completed in the first quarter of 2012 and due to our year to date net losses.
Although we have no significant capital expenditure plans currently, we expect
that we will continue to make capital expenditures to support our business.
Capital expenditures are expected to be funded by existing and internally
generated funds or lease financing.
As a result of our significant product development, customer support,
international expansion and selling and marketing efforts, we have required
substantial working capital to fund our operations. Over the last few years, we
restructured our operations to lower our costs and operating expenditures in
some geographic regions, while investing in other regions, and to lower the
level of revenue required for our net income breakeven point or offsetting in
part costs rising over time, to preserve our cash position and to focus on
profitable operations. We believe that we have sufficient working capital
available under our operating plan to fund our operations and capital
requirements through at least the next one-year period. Approximately $9.5
million of our cash is located in foreign subsidiary accounts at September 30,
2012. Subsequent to the end of the quarter ended September 30, 2012, we
repatriated $1 million of cash without foreign tax pursuant to a tax holiday
incentive arrangement, representing full distribution of earnings under that
arrangement. Although we have no other current repatriation plans, there may be
tax and other impediments to repatriating the cash to the United States. Our
working capital may be used to fund share repurchases and growth initiatives
including acquisition, which could reduce our liquidity. 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.
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Share Repurchase Programs
The $1 million dollar share repurchase plan announced in October of 2011
resulted in $42,000 of stock buybacks during the first quarter of 2012. This
program was cancelled in January 2012, after the new expanded $6 million dollar
repurchase program announced in January 2012 went into effect. Share
repurchases for $6 million were made during the first quarter of 2012,
completing this program. These programs were made under 10b5-1 plans that
allowed purchases to take place at any time. See accompanying consolidated
financial statements Note 12, "Share Repurchase Programs".
OFF-Balance sheet arrangements
Except as noted in the accompanying consolidated financial statements in Note 7,
"Operating Lease Commitments" and Note 8, "Other Commitments", Data I/O had no
off-balance sheet arrangements.
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2012, the FASB issued ASU No. 2012-02, Intangibles-Goodwill and Other
(Topic 350) - Testing Indefinite-Lived Intangible Assets for Impairment. The
objective of this update is to reduce the cost and complexity of performing an
impairment test for indefinite-lived intangible assets. The amendments in the
update permit an entity to first assess qualitative factors to determine whether
it is more likely than not that an indefinite-lived intangible asset is impaired
as a basis for determining whether it is necessary to perform a quantitative
impairment test. The amendments in this update are effective for annual and
interim impairment tests performed for fiscal years beginning after September
15, 2012, and early adoption is permitted. We believe the adoption of this
update will not impact our financial statements.
In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic
820): Amendments to Achieve Common Fair Value Measurement and Disclosure
Requirements in US GAAP and International Reporting Standards ("ASU
No. 2011-04") which amended the guidance regarding fair value measurement and
disclosure. The amended guidance clarifies the application of existing fair
value measurement and disclosure requirements. The amendment was effective for
us at the beginning of January 2012. The adoption of this amendment did not
materially affect our financial statements.
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