Annual Report for Fiscal Year Ending 12-11, 2024 (Form 10-K)

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; expected business recovery; industry partnerships; future results of operations or financial position; future spending; expected expenses, 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; taxes, trade issues and tariffs; expected inventory levels; expectations for unsupported platform or product versions and related inventory and other charges; Russian invasion of Ukraine impacts; Israel - Hamas war impacts; supply chain expectations; semiconductor chip shortages and recovery; 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 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.

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OVERVIEW

The automotive and industrial electronics industry is cyclical. With increased market uncertainty and customer capacity expansion slowing in 2024, automated systems shipments declined in the Americas and Europe which was partially offset by revenue growth in Asia. Automotive electronics represented 59% of 2024 bookings compared to 63% for 2023. While automotive system sales were below expectations, the Company continues to expand its sales to service providers (franchise distribution, contract manufacturers and independent providers) and reoccurring revenue offerings. For the full year, consumable adapters and services revenue remained steady, representing 50% of total revenue and helping mitigate the decline in system sales.

COVID-19 impacts in past years were no longer an operational challenge with personnel staffing, inventory levels and supply chain and operational activities returning to normal levels. However late in 2024 with the new incoming United States Administration, geo-political, economic and trade uncertainties have increased. The resulting future impact on the Company's markets, customers, supply chain and operations are uncertain. However, the operational and manufacturing resiliencies gained from the COVID-19 impact and the experience of leadership and operational teams can be leveraged to navigate and mitigate these potential future challenges. As our customers shift their supply chain and manufacturing locations to address changing economic and trade constraints, we will have the capacity and ability to adjust accordingly.

After a period of stability which lasted over a decade, key organizational leadership transition occurred in the fourth quarter of 2024 with the appointment of a new CEO and President, William Wentworth. Subsequent changes have also occurred in the leadership of the Sales, Marketing and Engineering functions and corresponding changes in the strategic and operational direction of these groups. We believe these changes will drive improved revenue growth, higher product innovation, greater operational efficiency and improved financial performance.

We continue to make investments in technologies, products and services to maintain market leadership in our Unified Programming Strategy. This strategy supports our customers' preprogramming supply chain needs, from design to manufacturing and beyond. Our manual programmer offerings, such as LumenX and FlashCore, provide preprogramming solutions for our customers' design, engineering, new product introduction, low-to-medium production, and test needs while our PSV system of products support medium-to-high volume production needs. Our strong cash position and balance sheet, combined with our long-term view of the market, gives us financial flexibility to make these investments.

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, credit losses, inventories, 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: Accounting Standards Codification (ASC) Topic 606, Revenue from Contracts with Customers (ASC 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.

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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 2024 and 2023, 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 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 analysis 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 could include hardware, software, installation, service and support, and extended maintenance components. We allocate the transaction price of each element based on the 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 based on shipping terms, software based on delivery, installation and services based on completion of work and software maintenance and extended warranty support ratably over the term of the agreement, typically one year.

When we license 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 to 60 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 with standard equipment warranty provided 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 Credit Losses: Allowance for credit losses is based on our assessment of the losses collectively expected for the future, as well as 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, or events forecast that collectively indicate some impairment is expected, 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.

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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 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 provided to our employees and directors, including employee stock option awards, performance stock unit 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. Restricted stock unit awards and performance 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 options, performance and restricted stock unit 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.

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RESULTS OF OPERATIONS:

NET SALES

Net sales by product line		2024				Change		2023
(in thousands)
Automated programming systems		$	16,940			(25.7%)		$	22,806
Non-automated programming systems			4,829			(8.2%)			5,258
Total programming systems		$	21,769			(22.4%)		$	28,064

Net sales by location		2024				Change		2023
(in thousands)
United States		$	1,377			(50.8%)		$	2,799
% of total			6.3	%					10.0	%
International		$	20,392			(19.3%)		$	25,265
% of total			93.7	%					90.0	%

Net sales by type		2024				Change		2023
(in thousands)
Equipment Sales		$	10,985			(32.8%)		$	16,343
Adapter Sales			7,250			(11.1%)			8,154
Software and Maintenance Sales *			3,534			(0.9%)			3,567
Total		$	21,769			(22.4%)		$	28,064
* includes an insignificant amount of service and parts sales

Net sales for the year ended December 31, 2024 decreased approximately 22%, to $21.8 million, compared to 2023. In 2024, automotive electronics uncertainty persisted and customer capacity expansion slowed, resulting in lower system shipments in the Americas and Europe which were partially offset by growth in Asia. Automotive electronics represented 59% of 2024 bookings compared to 63% for 2023. While automotive system sales were below expectations, the Company continues to expand its sales to service providers (franchise distribution, contract manufacturers and independent providers) and reoccurring revenue offerings. For the full year, consumable adapters and services revenue remained steady, representing 50% of total revenue and helping mitigate the decline in system sales.

Order bookings were $22.5 million in 2024, down approximately 12.6% compared to $25.8 million in 2023 due to similar market challenges noted for revenue. The order backlog on December 31, 2024, was $3.5 million, up $0.7 million from the fourth quarter of 2023, which will benefit revenue recognition in the first half of 2025 as systems are shipped. Additionally, deferred revenue was approximately $1.6 million on December 31, 2024.

GROSS MARGIN		2024				Change		2023
(in thousands)
Gross margin		$	11,606			(28.3%)		$	16,186
Percentage of net sales			53.3	%					57.7	%

Gross margin as a percentage of sales for the year ended December 31, 2024, was 53.3%, compared to 57.7% in 2023. The decrease in gross margin as a percentage of sales primarily reflects lower sales volume and lower related absorption of fixed manufacturing and service operating costs. Actual 2024 production and service spending decreased by $250,000 or 4% from the prior year.

RESEARCH AND DEVELOPMENT

		2024				Change		2023
(in thousands)
Research and development		$	6,240			(4.4%)		$	6,524
Percentage of net sales			28.7	%					23.2	%

Research and development ("R&D") expense decreased $284,000 for the year ended December 31, 2024 compared to 2023. The decrease was primarily related to contracted services and incentive compensation.

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We believe it is essential to invest in R&D to significantly enhance our existing solutions and create new products as markets develop and technologies change. During 2024, we continued to invest in the creation of new and enhancement of existing capabilities for our PSV family of automated systems, LumenX and FlashPAK family of non-automated programmers and related software. In addition to product development, a significant part of R&D spending is on creating algorithm software and support for new devices introduced by the semiconductor companies. Our R&D spending fluctuates based on the number, type, and the development stage of our product initiatives and projects.

SELLING, GENERAL AND ADMINISTRATIVE

		2024				Change		2023
(in thousands)
Selling, general & administrative		$	8,404			(8.8%)		$	9,214
Percentage of net sales			38.6	%					32.8	%

Selling, General and Administrative ("SG&A") expenses decreased approximately $810,000 thousand for the year ended December 31, 2024 compared to 2023. The decrease was primarily related to lower sales commissions on lower revenue and lower outside services from efficiency improvements and cost controls. Cost control measures remain in effect. Salary and wages remained flat with lower headcount savings offset by staff separation charges of approximately $430,000 in the fourth quarter of 2024.

INTEREST

		2024				Change				2023
(in thousands)
Interest income		$	273				43.7	%		$	190

Interest income was higher for the year ended December 31, 2024 compared to 2023 primarily due to higher average interest rates and higher invested balances.

INCOME TAXES

		2024				Change				2023
(in thousands)
Income tax (expense) benefit		$	(386	)			99.0	%	$	(194	)

Income tax (expense) increased by $192,000 for the year ended December 31, 2024 compared to 2023. The increase was primarily a result of the withholding tax of $337,000 on the repatriation of cash from China subsidiary in 2024. Income tax (expense) in 2024 and 2023 is primarily the result of foreign subsidiary income tax and minimal U.S. state income tax.

The effective tax rate for 2024 of (14.3%) and 2023 of 28.6% differed from the statutory tax rates in our tax reporting jurisdictions primarily due to subsidiary income with consolidated losses and the effect of valuation allowances. We have a valuation allowance of $8.2 million and $8.7 million as of December 31, 2024 and 2023, respectively. Our deferred tax assets and valuation allowance have increased by approximately $442,000 and $430,000 associated with the requirements of accounting for uncertain tax positions as of December 31, 2024 and 2023, respectively. Given the uncertainty created by our loss history, particularly in the U.S., which is where most of our net deferred tax assets are located, and the ongoing uncertain economic outlook for our industry, as well as capital and geographic spending, we currently 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 gains of $58,000 in 2024 and $42,000 in 2023. The transaction gains resulted primarily from translation adjustments to foreign inter-company accounts and U.S. Dollar accounts held by foreign subsidiaries and sales by our German subsidiary to certain customers, which were invoiced in U.S. Dollars. Because approximately 94% of sales are to international markets, volatile exchange rates may also impact our competitiveness and margins. Product and service price increases have been increased in response to cost increases caused by inflation, tariffs and part shortages.

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FINANCIAL CONDITION:

LIQUIDITY AND CAPITAL RESOURCES

		2024				Change		2023
(in thousands)
Working capital		$	16,085			($2,340)		$	18,425

At December 31, 2024, our principal sources of liquidity consisted of existing cash and cash equivalents. Cash at December 31, 2024 and 2023 was $10.3 million and $12.3 million, respectively. Working capital decreased by $2.3 million during 2024 due primarily to the revenue decline and resulting operating loss. Our current ratio improved and was 4.2 and 4.0 for December 31, 2024 and 2023, respectively. The company continues to have no debt.

Although we have no significant external capital expenditure plans currently, we expect to continue to carefully make and manage capital expenditures to support our business. We plan to increase our internally developed rental, sales demonstration and test equipment as we develop and release new products. Capital expenditures are currently expected to be funded by existing and internally generated funds.

As a result of our cyclical and seasonal industry, significant product development, factory resilience strategies, customer support and selling and marketing efforts, we require substantial working capital to fund our operations. We have implemented or have initiatives to implement geographic shifts in our operations, optimize real estate usage, adjust pricing for cost inflation, lower unit costs, lower tariff expenses, reduce exposure to the impact of currency volatility, increase product development differentiation, and reduce other costs. We believe that we have sufficient cash or working capital available under our operating plan to fund our operations and capital requirements through the next one-year period, and beyond.

We may require additional cash at the U.S. headquarters, which could cause potential repatriation of cash that is held in our foreign subsidiaries. For any repatriation, there may be tax and other impediments to any repatriation actions. As many repatriations typically have associated withholding taxes, those withheld will be a current tax without generating a current or deferred tax benefit recognition. In the second quarter of 2024, we completed a $3.4 million dividend distribution from our China subsidiary operation, incurring a $337,000 foreign tax withholding expense. This was undertaken to optimize the cash position and operating needs of each subsidiary, increase the interest earning potential of our cash holdings and ensure available liquidity at the U.S. headquarters to support future strategic and operational initiatives.

Our working capital may be used to fund possible losses, business growth, project initiatives, share repurchases and business development initiatives including acquisitions, which could reduce our liquidity and result in a requirement for additional cash before that time. Any substantial inability to achieve our current business plan could have a material adverse impact on our financial position, liquidity, or results of operations and may require us to reduce expenditure and/or seek possible additional financing.

OFF-BALANCE SHEET ARRANGEMENTS

Except as noted in the accompanying consolidated financial statements in Note 7, "Other Commitments" we had no material off-balance sheet arrangements.

SHARE REPURCHASE PROGRAMS

Data I/O did not have a share repurchase program in 2024 or 2023.

NON-GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP) FINANCIAL MEASURES

Earnings Before Interest, Taxes, Depreciation, and Amortization ("EBITDA") and Adjusted EBITDA excluding equity compensation and impairment & related charges (non-cash, one-time items) are set forth below. Non-GAAP financial measures should not be considered a substitute for, or superior to, measures of financial performance prepared in accordance with GAAP. We believe that these non-GAAP financial measures provide meaningful supplemental information regarding our results and facilitate the comparison of results.

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A reconciliation of net income to EBITDA and Adjusted EBITDA follows:

		For Year Ended December 31,
		2024				2023
(in thousands)
Net Income (loss)		$	(3,093	)		$	486
Interest (income)			(273	)			(190	)
Taxes			386				194
Depreciation and amortization			565				608
EBITDA		$	(2,415	)		$	1,098
Equity compensation			976				1,190
Adjusted EBITDA, excluding equity compensation		$	(1,439	)		$	2,288

NEW ACCOUNTING PRONOUNCEMENTS - STANDARDS ISSUED AND IMPLEMENTED

Effective January 1, 2024, the Company adopted ASU 2023-07, Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures. This update requires entities, including those with a single reportable segment, to disclose significant segment expenses regularly provided to the Chief Operating Decision Maker (CODM) and included in the reported measure of segment profit or loss.

The Company operates as a single reportable segment. The CODM evaluates the Company's performance based on operating income, as presented in the consolidated statements of operations. Significant segment expenses are those that are already disclosed in operating income and regularly reviewed by the CODM for purposes of assessing performance and allocating resources. Additional significant single segment expense categories are provided in Note 13 - Segment Information.

NEW ACCOUNTING PRONOUNCEMENTS - STANDARDS ISSUED AND NOT YET IMPLEMENTED

In December 2023, the FASB issued ASU 2023-09 "Income Taxes (Topics 740): Improvements to Income Tax Disclosures" to expand the disclosure requirements for income taxes, specifically related to the rate reconciliation and income taxes paid. ASU 2023-09 is effective for our annual periods beginning January 1, 2025, with early adoption permitted. We are currently evaluating the potential effect that the updated standard will have on our financial statement disclosures.

In November 2024, FASB issued ASU 2024-03, Income Statement - Reporting Comprehensive Income - Expense Disaggregation (Subtopic 220-40), which requires disclosure of specific information about costs and expenses within relevant expense captions on the face of the income statement, qualitative descriptions for expense captions not specifically disaggregated quantitatively, and the total amount and definition of selling expenses for interim and annual reporting periods. This standard is effective for the annual reporting period beginning January 1, 2027 and interim reporting periods beginning January 1, 2028 and should be applied retrospectively to all comparative periods. Early adoption is permitted. The Company is currently evaluating the effects of adopting this new accounting guidance.