DATA I/O CORP - Quarter Report: 2020 September (Form 10-Q)

UNITED STATES

 SECURITIES AND EXCHANGE COMMISSION

 Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)
(X)	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2020
Or
( )	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________________ to ________________

 

Commission file number: 0-10394
DATA I/O CORPORATION
(Exact name of registrant as specified in its charter)
Washington	91-0864123
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
6645 185th Ave NE, Suite 100, Redmond, Washington, 98052 425-881-6444 (Address of principal executive offices, including zip code)
Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock	DAIO	NASDAQ

 

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 ☒ No ☐

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

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

 

Accelerated filer ☐	Smaller reporting company ☒
Large accelerated filer ☐	Emerging growth company ☐
Non-accelerated filer ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

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

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTY PROCEEDINGS DURING THE PREVIOUS FIVE YEARS:

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12,13or 15(d) of the Security Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.  Yes ☐ No ☐

 

Shares of Common Stock, no par value, outstanding as of October 31, 2020: 8,416,335

 

For the Quarter Ended September 30, 2020

 

INDEX
Part I.		Financial Information	Page
	Item 1.	Financial Statements	3
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	21
	Item 4.	Controls and Procedures	21
Part II		Other Information
	Item 1.	Legal Proceedings	22
	Item 1A.	Risk Factors	22
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	22
	Item 3.	Defaults Upon Senior Securities	22
	Item 4.	Mine Safety Disclosures	22
	Item 5.	Other Information	22
	Item 6.	Exhibits	22
Signatures			23

 

 

PART I - FINANCIAL INFORMATION

 

Item 1.   Financial Statements

 

	September 30, 2020	December 31, 2019
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$12,982	$13,936
Trade accounts receivable, net of allowance for
doubtful accounts of $101 and $80, respectively	4,152	4,099
Inventories	5,060	5,020
Other current assets	1,731	924
TOTAL CURRENT ASSETS	23,925	23,979
Property, plant and equipment – net	1,516	1,668
Income tax receivable	-	640
Other assets	1,582	1,994
TOTAL ASSETS	$27,023	$28,281
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable	$1,760	$1,151
Accrued compensation	1,381	1,541
Deferred revenue	1,057	1,387
Other accrued liabilities	1,310	1,372
Income taxes payable	144	31
TOTAL CURRENT LIABILITIES	5,652	5,482
Operating lease liabilities	667	1,178
Long-term other payables	238	91
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, 8,395,600 shares as of September 30,
2020 and 8,212,748 shares as of December 31, 2019	19,700	18,748
Accumulated earnings	190	2,508
Accumulated other comprehensive income (loss)	576	274
TOTAL STOCKHOLDERS’ EQUITY	20,466	21,530
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$27,023	$28,281
See notes to consolidated financial statements

 

 

	Three Months Ended September 30,		Nine Months Ended September 30,
	2020	2019	2020	2019
Net sales	$5,947	$3,808	$15,387	$15,700
Cost of goods sold	2,670	1,806	6,887	6,430
Gross margin	3,277	2,002	8,500	9,270
Operating expenses:
Research and development	1,567	1,507	4,763	4,868
Selling, general and administrative	1,810	1,535	5,324	5,338
Total operating expenses	3,377	3,042	10,087	10,206
Operating income (loss)	(100)	(1,040)	(1,587)	(936)
Non-operating income:
Interest income	4	25	13	47
Gain on sale of assets	-	-	-	60
Foreign currency transaction gain (loss)	(271)	226	(302)	190
Total non-operating income (loss)	(267)	251	(289)	297
Income (loss) before income taxes	(367)	(789)	(1,876)	(639)
Income tax (expense) benefit	(340)	(55)	(442)	(52)
Net income (loss)	$(707)	$(844)	$(2,318)	$(691)
Basic earnings (loss) per share	$(0.09)	$(0.10)	$(0.28)	$(0.08)
Diluted earnings (loss) per share	$(0.09)	$(0.10)	$(0.28)	$(0.08)
Weighted-average basic shares	8,394	8,217	8,305	8,259
Weighted-average diluted shares	8,394	8,217	8,305	8,259
See notes to consolidated financial statements

 

 

  

	Three Months Ended September 30,		Nine Months Ended September 30,
	2020	2019	2020	2019
Net income (loss)	$(707)	$(844)	$(2,318)	$(691)
Other comprehensive income (loss):
Foreign currency translation gain (loss)	482	(478)	302	(468)
Comprehensive income (loss)	$(225)	$(1,322)	$(2,016)	$(1,159)
See notes to consolidated financial statements

 

  

				Accumulated
	Common Stock		Retained	and Other	Total
			Earnings	Comprehensive	Stockholders'
	Shares	Amount	(Deficit)	Income (Loss)	Equity
Balance at December 31, 2018	8,338,628	$19,254	$3,695	$408	$23,357
Repurchased shares	(57,612)	(313)			(313)
Stock awards issued, net of tax withheld	4,046	(8)	-	-	(8)
Issuance of stock through: ESPP	2,763	15	-	-	15
Share-based compensation	-	287	-	-	287
Net income (loss)	-	-	26	-	26
Other comprehensive income (loss)	-	-	-	128	128
Balance at March 31, 2019	8,287,825	$19,235	$3,721	$536	$23,492
Stock options exercised	-	-			-
Repurchased shares	(188,194)	(908)			(908)
Stock awards issued, net of tax withheld	162,071	(228)	-	-	(228)
Issuance of stock through: Employee Stock Purchase Plan	-	-	-	-	-
Share-based compensation	-	364	-	-	364
Net income (loss)	-	-	127	-	127
Other comprehensive income (loss)	-	-	-	(118)	(118)
Balance at June 30, 2019	8,261,702	$18,463	$3,848	$418	$22,729
Stock options exercised	(55,904)	-			-
Repurchased shares	1,672	(244)			(244)
Stock awards issued, net of tax withheld	3,414	(3)	-	-	(3)
Issuance of stock through: Employee Stock Purchase Plan	-	14	-	-	14
Share-based compensation	-	260	-	-	260
Net income (loss)	-	-	(844)	-	(844)
Other comprehensive income (loss)	-	-	-	(478)	(478)
Balance at September 30, 2019	8,210,884	$18,490	$3,004	$(60)	$21,434
Balance at December 31, 2019	8,212,748	$18,748	$2,508	$274	$21,530
Repurchased shares	-	-			-
Stock awards issued, net of tax withheld	5,190	(10)	-	-	(10)
Issuance of stock through: ESPP	3,509	14	-	-	14
Share-based compensation	-	249	-	-	249
Net income (loss)	-	-	(554)	-	(554)
Other comprehensive income (loss)	-	-	-	(265)	(265)
Balance at March 31, 2020	8,221,447	$19,001	$1,954	$9	$20,964
Repurchased shares	-	-			-
Stock awards issued, net of tax withheld	169,496	(163)	-	-	(163)
Issuance of stock through: ESPP	-	-	-	-	-
Share-based compensation	-	481	-	-	481
Net income (loss)	-	-	(1,057)	-	(1,057)
Other comprehensive income (loss)	-	-	-	85	85
Balance at June 30, 2020	8,390,943	19,319	897	94	20,310
Repurchased shares	-	-			-
Stock awards issued, net of tax withheld	4,657	15	-	-	15
Issuance of stock through: ESPP	-	-	-	-	-
Share-based compensation	-	366	-	-	366
Net income (loss)	-	-	(707)	-	(707)
Other comprehensive income (loss)	-	-	-	482	482
Balance at September 30, 2020	8,395,600	19,700	190	576	20,466
See notes to consolidated financial statements

 

 

 

	For the Nine Months Ended September 30,
	2020	2019
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)	$(2,318)	$(691)
Adjustments to reconcile net income (loss)
to net cash provided by (used in) operating activities:
Depreciation and amortization	620	672
Gain on sale of assets	-	(60)
Equipment transferred to cost of goods sold	186	37
Share-based compensation	1,096	911
Net change in:
Trade accounts receivable	18	1,295
Inventories	11	(311)
Other current assets	(140)	27
Accounts payable and accrued liabilities	477	(2,484)
Deferred revenue	(352)	163
Other long-term liabilities	(1,014)	(311)
Deposits and other long-term assets	1,074	33
Net cash provided by (used in) operating activities	(342)	(719)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment	(654)	(456)
Net proceeds from sale of assets	-	60
Cash provided by (used in) investing activities	(654)	(396)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of common stock, less payments
for shares withheld to cover tax	(144)	(211)
Repurchase of common stock	-	(1,465)
Cash provided by (used in) financing activities	(144)	(1,676)
Increase (decrease) in cash and cash equivalents	(1,140)	(2,791)
Effects of exchange rate changes on cash	186	(374)
Cash and cash equivalents at beginning of period	13,936	18,343
Cash and cash equivalents at end of period	$12,982	$15,178
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Income taxes	$338	$178

 

DATA I/O CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

NOTE 1 - FINANCIAL STATEMENT PREPARATION

Data I/O Corporation (“Data I/O”, “We”, “Our”, “Us”) prepared the financial statements as of September 30, 2020 and September 30, 2019 according to the rules and regulations of the Securities and Exchange Commission ("SEC"). These statements are unaudited but, in the opinion of management, include all adjustments (consisting of normal recurring adjustments and accruals) necessary to present fairly the results for the periods presented. The balance sheet at December 31, 2019 has been derived from the audited financial statements at that date. We have condensed or omitted certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America according to such SEC rules and regulations. Operating results for the three and nine months ended September 30, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2020. These financial statements should be read in conjunction with the annual audited financial statements and the accompanying notes included in our Form 10-K for the year ended December 31, 2019.

 

After a weak first half of 2020, business started to recover from COVID-19 related country and customer business shutdowns.  In response to suddenly changing business conditions, we had scaled back planned investments and reduced our current spending.  Despite the spending reductions, we continue to invest with a long-term focus towards expanding our markets and creating unique value for our customers. This is true for both our traditional core business as well as the emerging security deployment business. During Q3, we continued this course of response and actions. Our facilities and operations in the different countries adapted to the local conditions and restrictions. We have, and are, taking advantage of government programs to assist during the pandemic to the extent we are qualified to participate. We have adapted to COVID by embracing virtual and remote operations for our employees, sales, and service and avoid travel and non-social distanced interactions.

 

Revenue Recognition

 

Topic 606 provides a single, principles-based five-step model to be applied to all contracts with customers. It generally provides for the recognition of revenue in an amount that reflects the consideration to which the Company expects to be entitled, net of allowances for estimated returns, discounts or sales incentives, as well as taxes collected from customers when control over the promised goods or services are transferred to the customer.

 

We expense contract acquisition costs, primarily sales commissions, for contracts with terms of one year or less and will capitalize and amortize incremental costs with terms that exceed one year. During 2020 and 2019, the impact of capitalization of incremental costs for obtaining contracts was immaterial. We exclude sales, use, value added, some excise taxes and other similar taxes from the measurement of the transaction price.

 

We recognize revenue upon transfer of control of the promised products or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services. We have determined that our programming equipment has reached a point of maturity and stability such that product acceptance can be assured by testing at the factory prior to shipment and that the installation meets the criteria to be a separate performance obligation. These systems are standard products with published product specifications and are configurable with standard options. The evidence that these systems could be deemed as accepted was based upon having standardized factory production of the units, results from batteries of tests of product performance to our published specifications, quality inspections and installation standardization, as well as past product operation validation with the customer and the history provided by our installed base of products upon which the current versions were based.

 

The revenue related to products requiring installation that is perfunctory is recognized upon transfer of control of the product to customers, which generally is at the time of shipment. Installation that is considered perfunctory includes any installation that is expected to be performed by other parties, such as distributors, other vendors, or the customers themselves. This considers the complexity, skill and training needed as well as customer expectations regarding installation.

 

We enter into arrangements with multiple performance obligations that arise during the sale of a system that includes an installation component, a service and support component and a software maintenance component. The transaction price is allocated to the separate performance obligations on relative standalone sales price. We allocate the transaction price of each element based on relative selling prices. Relative selling price is based on the selling price of the standalone system. For the installation and service and support performance obligations, we use the value of the discount given to distributors who perform these components. For software maintenance performance obligations, we use what we charge for annual software maintenance renewals after the initial year the system is sold. Revenue is recognized on the system sale based on shipping terms, installation revenue is recognized after the installation is performed, and hardware service and support and software maintenance revenue is recognized ratably over the term of the agreement, typically one year. Deferred revenue includes service, support and maintenance contracts and represents the undelivered performance obligation of agreements that are typically for one year.

 

When we sell software separately, we recognize revenue upon the transfer of control of the software, which is generally upon shipment, provided that only inconsequential performance obligations remain on our part and substantive acceptance conditions, if any, have been met.

 

We recognize revenue when there is an approved contract that both parties are committed to perform, both parties’ rights have been identified, the contract has substance, collection of substantially all the consideration is probable, the transaction price has been determined and allocated over the performance obligations, the performance obligations including substantive acceptance conditions, if any, in the contract have been met, the obligation is not contingent on resale of the product, the buyer’s obligation would not be changed in the event of theft, physical destruction or damage to the product, the buyer acquiring the product for resale has economic substance apart from us and we do not have significant obligations for future performance to directly bring about the resale of the product by the buyer. We establish a reserve for sales returns based on historical trends in product returns and estimates for new items. Payment terms are generally 30 days from shipment.

 

We transfer certain products out of service from their internal use and make them available for sale. The products transferred are typically our standard products in one of the following areas: service loaners, rental or test units; engineering test units; or sales demonstration equipment. Once transferred, the equipment is sold by our regular sales channels as used equipment inventory. These product units often involve refurbishing and an equipment warranty, and are conducted as sales in our normal and ordinary course of business. The transfer amount is the product unit’s net book value and the sale transaction is accounted for as revenue and cost of goods sold.

 

 

The following table represents our revenues by major categories:

 

	Three Months Ended			Nine Months Ended
Net sales by type	September 30, 2020	Change	September 30, 2019	September 30, 2020	Change	September 30, 2019
(in thousands)
Equipment	$3,861	146.4%	$1,567	$8,924	1.2%	$8,815
Adapter	1,246	(7.2%)	1,342	3,915	(7.3%)	4,223
Software and Maintenance	840	(6.6%)	899	2,548	(4.3%)	2,662
Total	$5,947	56.2%	$3,808	$15,387	(2.0%)	$15,700

 

Share-Based Compensation

All stock-based compensation awards are measured based on estimated fair values on the date of grant and recognized as compensation expense on the straight-line single-option method. Our share-based compensation is reduced for estimated forfeitures at the time of grant and revised as necessary in subsequent periods if actual forfeitures differ from those estimates.

Income Tax

Income taxes are computed at current enacted tax rates, less tax credits using the asset and liability method. Deferred taxes are adjusted both for items that do not have tax consequences and for the cumulative effect of any changes in tax rates from those previously used to determine deferred tax assets or liabilities. Tax provisions include amounts that are currently payable, changes in deferred tax assets and liabilities that arise because of temporary differences between the timing of when items of income and expense are recognized for financial reporting and income tax purposes, and any changes in the valuation allowance caused by a change in judgment about the realization of the related deferred tax assets. A valuation allowance is established when necessary to reduce deferred tax assets to amounts expected to be realized. The CARES Act, enacted in Q1 2020, accelerated the AMT credit refund of $640,000 to be a current asset instead of non-current.

 

Recently Adopted Accounting Pronouncements

 

None.

 

 

NOTE 2 – INVENTORIES

Inventories consisted of the following components:

	September 30, 2020	December 31, 2019
(in thousands)
Raw material	$2,659	$2,416
Work-in-process	1,712	1,832
Finished goods	689	772
Inventories	$5,060	$5,020

 

NOTE 3 – PROPERTY, PLANT AND EQUIPMENT, NET

Property and equipment consisted of the following components:

 

	September 30, 2020	December 31, 2019
(in thousands)
Leasehold improvements	$403	$395
Equipment	5,832	5,606
Sales demonstration equipment	847	778
	7,082	6,779
Less accumulated depreciation	5,566	5,111
Property and equipment, net	$1,516	$1,668

 

 

NOTE 4 – OTHER ACCRUED LIABILITIES

 

Other accrued liabilities consisted of the following components:

 

	September 30, 2020	December 31, 2019
(in thousands)
Lease liability - short term	$716	$678
Product warranty	367	367
Sales return reserve	82	77
Other taxes	101	126
Other	44	124
Other accrued liabilities	$1,310	$1,372

 

The changes in our product warranty liability for the nine months ending September 30, 2020 are as follows:

 

	September 30, 2020
(in thousands)
Liability, beginning balance	$367
Net expenses	549
Warranty claims	(549)
Accrual revisions	-
Liability, ending balance	$367

 

NOTE 5 – LEASES

Our leasing arrangements are primarily for facility leases we use to conduct our operations. The following table presents our future lease payments for long-term operating leases as of September 30, 2020:

	Operating Lease Commitments
(in thousands)
2020 (remaining)	$196
2021	734
2022	328
2023	98
2024	86
Thereafter	148
Total	$1,590
Less Imputed interest	(207)
Total operating lease liabilities	$1,383

 

Cash paid for operating lease liabilities for the three and nine months ended September 30, 2020 was $194,000 and $568,000, respectively. There was one new lease during the nine months ended September 30, 2020 included in the lease liability for approximately $15,000 relating to a new three automobile lease.

The following table presents supplemental balance sheet information related to leases:

	Balance at September 30, 2020	Balance at December 31, 2019
(in thousands)
Right-of-use assets (Long-term other assets)	$1,163	$1,574
Lease liability-short term (Other accrued liabilities)	$716	678
Lease liability-long term (Long-term other payables)	$667	1,178

 

At September 30, 2020, the weighted average remaining lease term is 2.84 years and the weighted average discount rate used is 5%.

The components of our lease expense for the three and nine months ended September 30, 2020 include operating lease costs were $168,000 and $494,000, respectively, and short-term lease costs of $9,000 and $26,000, respectively.

 

The components of our lease expense for the three and nine months ended September 30, 2019 include operating lease costs were $213,000 and $486,000, respectively, and short-term lease costs of $5,000 and $15,000, respectively.

 

Our real estate facility leases are described below:

 

During the third quarter of 2017, we amended our lease agreement, extending the lease for the Redmond, Washington headquarters facility through July 31, 2022. This lease is for approximately 20,460 square feet.

 

We signed a lease agreement effective November 1, 2015 that extends the lease for a facility located in Shanghai, China through October 31, 2021. This lease is for approximately 19,400 square feet.

 

During the fourth quarter of 2016, we signed a lease agreement for a new facility located near Munich, Germany which was effective March 1, 2017 and extends the lease through February 28, 2022. This lease is for approximately 4,895 square feet.

 

NOTE 6 – OTHER COMMITMENTS

We have 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. At September 30, 2020, the purchase commitments and other obligations totaled $1.2 million of which all but $230,000 are expected to be paid over the next twelve months.

 

NOTE 7 – CONTINGENCIES

As of September 30, 2020, we were not a party to any legal proceedings or aware of any indemnification agreement claims, 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.

 

 

NOTE 8 – EARNINGS PER SHARE

Basic earnings per share is calculated based on the weighted average number of common shares outstanding during each period. Diluted earnings per share is calculated based on these same weighted average shares outstanding plus the effect of potential shares issuable upon assumed exercise of stock options based on the treasury stock method.

Potential shares issuable upon the exercise of stock options are excluded from the calculation of diluted earnings per share to the extent their effect would be anti-dilutive.

The following table sets forth the computation of basic and diluted earnings per share:

 

	Three Months Ended		Nine Months Ended
	September 30, 2020	September 30, 2019	September 30, 2020	September 30, 2019
(in thousands except per share data)
Numerator for basic and diluted earnings (loss) per share:
Net income (loss)	$(707)	$(844)	$(2,318)	$(691)
Denominator for basic earnings (loss) per share:
Weighted-average shares	8,394	8,217	8,305	8,259
Employee stock options and awards	69	25	57	71
Denominator for diluted earnings (loss) per share:
Adjusted weighted-average shares & assumed conversions of stock options	8,463	8,242	8,362	8,330
Basic and diluted earnings (loss) per share:
Total basic earnings (loss) per share	$(0.09)	$(0.10)	$(0.28)	$(0.08)
Total diluted earnings (loss) per share	$(0.09)	$(0.10)	$(0.28)	$(0.08)

 

Weighted average options to purchase 25,000 shares for both the three and nine month periods ending September 30, 2020 and weighted average options to purchase 31,063 and 30,518 shares for the three and nine months ending September 30, 2019, respectively, were excluded from the computation of diluted earnings per share for the periods then ended because the options were anti-dilutive.

 

NOTE 9 – SHARE-BASED COMPENSATION

For share-based awards granted, we have recognized compensation expense based on the estimated grant date fair value method. For these awards we have recognized compensation expense using a straight-line amortization method reduced for estimated forfeitures.

 

 

The impact on our results of operations of recording share-based compensation, net of forfeitures, for the three and nine months ended September 30, 2020 and 2019, respectively, were as follows:

	Three Months Ended		Nine Months Ended
	September 30, 2020	September 30, 2019	September 30, 2020	September 30, 2019
(in thousands)
Cost of goods sold	$12	$6	$33	$22
Research and development	87	61	283	227
Selling, general and administrative	267	193	780	662
Total share-based compensation	$366	$260	$1,096	$911

 

Equity awards granted during the three and nine months ended September 30, 2020 and 2019 were as follows:

 

	Three Months Ended		Nine Months Ended
	September 30, 2020	September 30, 2019	September 30, 2020	September 30, 2019
Restricted Stock Units	-	-	376,200	276,700
Stock Options	-	-	-	25,000

 

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

 

The remaining unamortized expected future equity compensation expense and remaining amortization period associated with unvested option grants, restricted stock awards and restricted stock unit awards at September 30, 2020 are:

 

	September 30, 2020
Unamortized future equity compensation expense (in thousands)	$2,413
Remaining weighted average amortization period (in years)	2.46

 

 

Item 2.    Management's Discussion and Analysis of Financial Condition and Results of Operations

General

 

FORWARD-LOOKING STATEMENTS

 

This Quarterly Report on Form 10-Q includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  This Act provides a “safe harbor” for forward-looking statements to encourage companies to provide prospective information about themselves as long as they identify these statements as forward-looking and provide meaningful cautionary statements identifying important factors that could cause actual results to differ from the projected results.  All statements other than statements of historical fact made in this Quarterly Report on Form 10-Q are forward-looking.  In particular, statements herein regarding economic outlook, impact of novel coronavirus or COVID-19; industry prospects and trends; expected business recovery; industry partnerships; future results of operations or financial position; future spending; breakeven revenue point; expected market decline bottom or growth; market acceptance of our newly introduced or upgraded products or services; the sufficiency of our cash to fund future operations and capital requirements; development, introduction and shipment of new products or services; changing foreign operations; trade issues and tariffs; expected inventory levels; expectations for unsupported platform or product versions and related inventory and other charges; and any other guidance on future periods are forward-looking statements.  Forward-looking statements reflect management’s current expectations and are inherently uncertain.  Although we believe that the expectations reflected in these forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, achievements, or other future events.  Moreover, neither Data I/O nor anyone else assumes responsibility for the accuracy and completeness of these forward-looking statements.  We are under no duty to update any of these forward-looking statements after the date of this Quarterly Report.  The Reader should not place undue reliance on these forward-looking statements.  The discussions above and in the section in Item 1A., Risk Factors “Cautionary Factors That May Affect Future Results” in our Annual report on Form 10-K for the year ended December 31, 2019, describe some, but not all, of the factors that could cause these differences.

 

OVERVIEW

 

After a weak first half of 2020, business started to recover from COVID-19 related country and customer business shutdowns.  In response to suddenly changing business conditions, we had scaled back planned investments and reduced our current spending.  Despite the spending reductions, we continue to invest with a long-term focus towards expanding our markets and creating unique value for our customers. This is true for both our traditional core business as well as the emerging security deployment business. During Q3, we continued this course of response and actions. Our facilities and operations in the different countries adapted to the local conditions and restrictions. We have and are taking advantage of government programs to assist during the pandemic to the extent we are qualified to participate. We have adapted to embrace virtual and remote operations for our employees, sales, and service and avoid travel and non-social distanced interactions.

 

Our short-term challenge continues to be operating in a cyclical, COVID-19 impacted, and rapidly evolving industry environment.  During the first three quarters of 2020, Q2 was the business level bottom for our automotive electronics business, which improved in Q3. We must balance industry changes, industry partnerships, new technologies, business geography shifts, travel and customer restrictions, customer shut downs, exchange rate volatility, trade issues and tariffs, coronavirus impacts, increasing costs and strategic investments in our business with the level of demand and mix of business we expect.  We continue to manage our costs carefully and execute strategies for cash preservation, protecting our employee base and cost reductions. Many of our employees worked remotely from home, with the essential production and process workers onsite as part of our essential operations.

 

We are focusing our research and development efforts in our strategic growth markets, namely automotive electronics and IoT new programming technologies, secure supply chain solutions, automated programming systems and their enhancements for the manufacturing environment and software. We are continuing to develop technology to securely provision new categories of semiconductors, including Secure Elements, Authentication Chips, and Secure Microcontrollers. In Q3, we released updated SentriX hardware and tools which simplify the customer acquisition process, and reduce dependency on third party suppliers. We also upgraded SentriX systems in the field to this new architecture. We plan to deliver new programming technology and automated handling systems for managed and secure programming in the manufacturing environment.  We continue to focus on extending the capabilities and support for our product lines and supporting the latest semiconductor devices, including various configurations of NAND Flash, e-MMC, UFS and microcontrollers on our newer products.

 

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

 

Although the long-term prospects for our strategic growth markets should be good, these markets and our business have been, and are likely to continue to be, adversely impacted by the global pandemic of novel coronavirus or COVID-19.

 

As a global company with 92% of our 2019 sales in international markets, we have been and expect to continue to be significantly impacted by the COVID-19 pandemic, which started to impact us first in China and has since spread to Asia, USA, Europe and all other markets we serve.  During Q3 we have seen that our China operations have resumed onsite quasi-normal activities. Automotive facilities that had largely shut down in Q2 were operating and ramping to more normal production. Our European operations opened up for travel and limited customer site visits for technical support. Our Americas operations continue to be relatively restricted as local areas begin opening but international travel is very restricted or generally banned. Although our facilities in Shanghai, Redmond and Germany are currently operating in pandemic related restricted ways, we believe that our classification as essential by certain U.S. customer groups has and will continue to keep operations open.  We source other components from China and other countries that are used to manufacture our equipment in China and in our Redmond, Washington facility and these components may not be readily available or subject to unpredictable delays.  Many of our employees and executives are working from home and we are limiting visitors to our facilities as the pandemic continues.  All of our facilities are subject to restrictions and closure by governmental entities. The pandemic has and may continue to impact our revenues, our ability to obtain key components and to manufacture our products, as well as sell, install and support our products around the world. We expect to continue to be impacted and respond to customer site restrictions on sales and service visits, travel restrictions, closed borders, cancelled trade shows and industry gatherings, and modifications in our operations to allow social distancing. See also the detailed discussion of the impacts of the coronavirus COVID-19 on our business and markets in Item 1A, Risk Factors in our annual report on Form 10-K. The pandemic could have the effect of heightening many of the other risks described in it. Annual projections on spending, growth, mix, and profitability have been and are likely to be further revised substantially as new information is obtained.

 

 

CRITICAL ACCOUNTING POLICY JUDGMENTS AND ESTIMATES

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires that we make estimates and judgments, which affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to revenue recognition, sales returns, bad debts, inventories, intangible assets, income taxes, warranty obligations, restructuring charges, contingencies such as litigation and contract terms that have multiple elements and other complexities typical in the capital equipment industry. We base our estimates on historical experience and other assumptions that we believe are reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.

 

We believe the following critical accounting policies affect the more significant judgments and estimates used in the preparation of our financial statements:

 

Revenue Recognition: Topic 606 provides a single, principles-based five-step model to be applied to all contracts with customers. It generally provides for the recognition of revenue in an amount that reflects the consideration to which the Company expects to be entitled, net of allowances for estimated returns, discounts or sales incentives, as well as taxes collected from customers when control over the promised goods or services are transferred to the customer.

 

We expense contract acquisition costs, primarily sales commissions, for contracts with terms of one year or less and will capitalize and amortize incremental costs with terms that exceed one year. During 2020 and 2019, the impact of capitalization of incremental costs for obtaining contracts was immaterial. We exclude sales, use, value added, some excise taxes and other similar taxes from the measurement of the transaction price.

 

We recognize revenue upon transfer of control of the promised products or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services. We have determined that our programming equipment has reached a point of maturity and stability such that product acceptance can be assured by testing at the factory prior to shipment and that the installation meets the criteria to be a separate performance obligation. These systems are standard products with published product specifications and are configurable with standard options. The evidence that these systems could be deemed as accepted was based upon having standardized factory production of the units, results from batteries of tests of product performance to our published specifications, quality inspections and installation standardization, as well as past product operation validation with the customer and the history provided by our installed base of products upon which the current versions were based.

 

The revenue related to products requiring installation that is perfunctory is recognized upon transfer of control of the product to customers, which generally is at the time of shipment. Installation that is considered perfunctory includes any installation that is expected to be performed by other parties, such as distributors, other vendors, or the customers themselves. This considers the complexity, skill and training needed as well as customer expectations regarding installation.

 

We enter into arrangements with multiple performance obligations that arise during the sale of a system that includes an installation component, a service and support component and a software maintenance component. The transaction price is allocated to the separate performance obligations on relative standalone sales price. We allocate the transaction price of each element based on relative selling prices. Relative selling price is based on the selling price of the standalone system. For the installation and service and support performance obligations, we use the value of the discount given to distributors who perform these components. For software maintenance performance obligations, we use what we charge for annual software maintenance renewals after the initial year the system is sold. Revenue is recognized on the system sale based on shipping terms, installation revenue is recognized after the installation is performed, and hardware service and support and software maintenance revenue is recognized ratably over the term of the agreement, typically one year. Deferred revenue includes service, support and maintenance contracts and represents the undelivered performance obligation of agreements that are typically for one year.

 

When we sell software separately, we recognize revenue upon the transfer of control of the software, which is generally upon shipment, provided that only inconsequential performance obligations remain on our part and substantive acceptance conditions, if any, have been met.

 

We recognize revenue when there is an approved contract that both parties are committed to perform, both parties’ rights have been identified, the contract has substance, collection of substantially all the consideration is probable, the transaction price has been determined and allocated over the performance obligations, the performance obligations including substantive acceptance conditions, if any, in the contract have been met, the obligation is not contingent on resale of the product, the buyer’s obligation would not be changed in the event of theft, physical destruction or damage to the product, the buyer acquiring the product for resale has economic substance apart from us and we do not have significant obligations for future performance to directly bring about the resale of the product by the buyer. We establish a reserve for sales returns based on historical trends in product returns and estimates for new items. Payment terms are generally 30 days from shipment.

 

We transfer certain products out of service from their internal use and make them available for sale. The products transferred are typically our standard products in one of the following areas: service loaners, rental or test units; engineering test units; or sales demonstration equipment. Once transferred, the equipment is sold by our regular sales channels as used equipment inventory. These product units often involve refurbishing and an equipment warranty, and are conducted as sales in our normal and ordinary course of business. The transfer amount is the product unit’s net book value and the sale transaction is accounted for as revenue and cost of goods sold.

 

Allowance for Doubtful Accounts: We base the allowance for doubtful accounts receivable on our assessment of the collectability of specific customer accounts and the aging of accounts receivable. If there is deterioration of a major customer’s credit worthiness or actual defaults are higher than historical experience, our estimates of the recoverability of amounts due to us could be adversely affected.

 

Inventory: Inventories are stated at the lower of cost or net realizable value. Adjustments are made to standard cost, which approximates actual cost on a first-in, first-out basis. We estimate reductions to inventory for obsolete, slow-moving, excess and non-salable inventory by reviewing current transactions and forecasted product demand. We evaluate our inventories on an item by item basis and record inventory adjustments accordingly. If there is a significant decrease in demand for our products, uncertainty during product line transitions, or a higher risk of inventory obsolescence because of rapidly changing technology and customer requirements, we may be required to increase our inventory adjustments and our gross margin could be adversely affected.

 

Warranty Accruals: We accrue for warranty costs based on the expected material and labor costs to fulfill our warranty obligations. If we experience an increase in warranty claims, which are higher than our historical experience, our gross margin could be adversely affected.

 

Tax Valuation Allowances: Given the uncertainty created by our loss history, as well as the current and ongoing cyclical and COVID-19 related uncertain economic outlook for our industry and capital and geographic spending as well as income and current net deferred tax assets by entity and country, we expect to continue to limit the recognition of net deferred tax assets and accounting for uncertain tax positions and maintain the tax valuation allowances. At the current time, we expect, therefore, that reversals of the tax valuation allowance will take place as we are able to take advantage of the underlying tax loss or other attributes in carry forward or their use by future income or circumstances allow us to realize these attributes. The transfer pricing and expense or cost sharing arrangements are complex areas where judgments, such as the determination of arms-length arrangements, can be subject to challenges by different tax jurisdictions.

 

Share-based Compensation: We account for share-based awards made to our employees and directors, including employee stock option awards and restricted stock unit awards, using the estimated grant date fair value method of accounting. For options, we estimate the fair value using the Black-Scholes valuation model and an estimated forfeiture rate, which requires the input of highly subjective assumptions, including the option’s expected life and the price volatility of the underlying stock. The expected stock price volatility assumption was determined using the historical volatility of our common stock. Changes in the subjective assumptions required in the valuation model may significantly affect the estimated value of the awards, the related stock-based compensation expense and, consequently, our results of operations. Restricted stock unit awards are valued based on the average of the high and low price on the date of the grant and an estimated forfeiture rate. For both options and restricted awards, expense is recognized as compensation expense on the straight-line basis. Employee Stock Purchase Plan (“ESPP”) shares were issued under provisions that do not require us to record any equity compensation expense.

 

 

RESULTS OF OPERATIONS:

NET SALES

 

	Three Months Ended			Nine Months Ended
Net sales by product line	September 30, 2020	Change	September 30, 2019	September 30, 2020	Change	September 30,2019
(in thousands)
Automated programming systems	$4,736	83.1%	$2,587	$11,685	(3.0%)	$12,041
Non-automated programming systems	1,211	(0.8%)	1,221	3,702	1.2%	3,659
Total programming systems	$5,947	56.2%	$3,808	$15,387	(2.0%)	$15,700

	Three Months Ended			Nine Months Ended
Net sales by location	September 30, 2020	Change	September 30, 2019	September 30, 2020	Change	September 30, 2019
(in thousands)
United States	$445	14.4%	$389	$1,007	(25.7%)	$1,355
% of total	7.5%		10.2%	6.5%		8.6%
International	$5,502	60.9%	$3,419	$14,380	0.2%	$14,345
% of total	92.5%		89.8%	93.5%		91.4%