ITEM 1. BUSINESS
This Annual Report on Form 10-K and the documents incorporated herein by
reference contain forward-looking statements based on current expectations,
estimates and projections about Data I/O(R) Corporation's industry, management's
beliefs and certain assumptions made by management. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations - Forward Looking
Statements."
GENERAL
Data I/O Corporation ("Data I/O") designs, manufactures, and sells programming
systems used by designers and manufacturers of electronic products. Our
programming system products are used to program integrated circuits ("ICs" or
"devices" or "semiconductors") so that the ICs will function as desired in the
customer's electronic product. They are an important tool for the electronics
industry experiencing growing use of programmable ICs. Data I/O markets and
distributes our programming systems worldwide, and is the global leader in this
market. Data I/O incorporated in the State of Washington in 1969.
Data I/O Mission. Data I/O's mission is to design and deliver innovative
customer-focused programming solutions, which enable customers to manage their
firmware supply chain, getting their products to market faster, while reducing
costs in their process. We align our products and services to make programming
easy, delight our customers and satisfy their whole product needs.
Helping Customers Manage their Firmware Supply Chain. Much of the innovation and
competitive advantage of today's electronic products comes from the software
buried inside the product, which is commonly referred to as "firmware."
Companies use firmware to differentiate their products from their competitors'
products, constantly writing new code to add features. This allows them to build
multiple models with identical hardware and many versions of firmware, all on
one production line. Any improvement in production efficiency boosts the
profitability of all products on that line. Many original equipment
manufacturers ("OEMs") now outsource production to specialists in electronic
manufacturing services ("EMS") to maximize the profit impact from highly
efficient production. The challenges of managing the firmware supply chain
remain, however, and can even increase with this additional interface. Our
systems allow our customers - both OEM and EMS companies - to build products
with the exact firmware features that consumers specify, virtually real-time
with the latest software release. We help our customers eliminate inventory
risks, delays, rework, and lost market opportunities while enabling them to
better serve their customers.
Connected Strategy. There are many providers of device programming tools on the
market today. However, experienced design, test and manufacturing engineering
teams need a comprehensive approach to process management that will assure the
integrity of the product data files from design through manufacturing, assuring
that the production line builds the product in the most cost-effective way,
precisely as designed. Data I/O solutions provide a consistent device
programming methodology from design through prototype and new product
introduction and finally in the high volume manufacturing phase. We call this
approach the `Connected Strategy'. Data I/O's Connected Strategy leverages
network capable products to easily move the customer's intellectual property
securely up and down the supply chain.
Business Restructuring. During 2005, we took restructuring related charges of
$96,000 primarily related to severance and completing actions that had been
started in the second half of 2004. This aligned management operations with the
changes made in 2004 to control costs in North America and Europe and the need
to build staff serving China and Eastern Europe.
INDUSTRY BACKGROUND
Data I/O enables companies to improve productivity and reduce costs by providing
device programming solutions that enable our customers to take intellectual
property (design and data files) and program it into memory, microcontroller and
logic devices. Companies that design and manufacture electronic products that
utilize programmable devices purchase these solutions from us. These companies,
our primary customers, design and manufacture a broad range of electronic
products for both consumer and industrial use. Data I/O also provides services
related to hardware support, system installation and repair, and device
programming.
According to several industry reports, there continues to be forecasted growth
of semiconductors used in consumer electronic products, automotive electronics,
and industrial controls which we believe should continue to drive demand for
programming equipment and services. Programmable devices continue to be
significant and growing segments of the semiconductor industry according to
several published industry reports. Flash memory and programmable
micro-controllers are typical types
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of these devices. Programmable devices offer advantages to the electronic
product designer allowing them to bring products to market more quickly and
inexpensively than using fixed-function devices, and can offer the advantage of
simpler rapid product upgrades. Programmable devices also offer attractive
functionality to the user of the electronic product, such as storing personal
information or customizing product functionality. As a result, use of
programmable devices is growing rapidly in both high-volume consumer electronic
products and more complex electronic systems.
More than 100 semiconductor manufacturers offer thousands of different
programmable devices. The technology trends driving the programmable device
market result in a broad range of requirements for programming information into
these devices. Programmable memory devices continue to have higher capacity and
occupy smaller circuit board space. Programmable microcontroller devices are now
more prevalent because semiconductor vendors are standardizing their
manufacturing processes. These technology advances require advanced programming
equipment like Data I/O manufactures.
Our automated programming systems integrate programming and handling functions
into one product solution. Quality conscious customers continue to drive this
portion of our business, which includes high-volume manufacturing and
high-volume programming center customers.
PRODUCTS
In order to accommodate the expanding variety and quantities of programmable
devices being manufactured today, Data I/O offers multiple solutions for the
numerous types of devices used by our customers in the various market segments
and applications. We work closely with major manufacturers of programmable
devices to develop our products to meet the requirements of a particular device.
Data I/O's line of programming systems includes a broad range of products,
systems, modules, and accessories, which we group into two general categories:
automated programming systems and non-automated programming systems. We provide
automated programming systems in two categories: off-line and in-line (including
In-system Programming). In addition, we provide device support and service on
all of our products. Device support is a critical aspect of our business and
consists of writing algorithms for devices and developing socket adapters to
hold and connect to the device for programming.
Within the categories of automated and non-automated systems, Data I/O targets
specific solutions at specific market segments. Data I/O optimizes the solution
based on the customer's device, process and business needs. Data I/O's flagship
programming platform, FlashCORE(TM), has the speed and pricing to provide the
best value in the industry, making it the leading choice for high volume
production. Data I/O technical teams work closely with semiconductor
manufacturers to actively plan for programming support of new devices and
physical packages. The FlashCORE platform is used worldwide to program NOR Flash
devices from all providers, including market leaders, Intel, Renesas, Spansion
and Toshiba. Data I/O leads the industry in providing solutions for NAND flash
programming from Hynix, Micron, Samsung, ST Microelectronics, Toshiba, M Systems
DiskOnChip and others. The dynamics of the flash market are changing, blurring
the distinction of NAND and NOR technologies and the emergence of converged
offerings, including Samsung's OneNAND and Spansion's ORNAND, also supported on
FlashCORE systems. Data I/O's strong partnerships with leading semiconductor
companies greatly enhance our ability to serve our mutual customers.
Target customers include electronic product OEM manufacturers of consumer
products, like the fast-growing portable/wireless devices, cellular handsets and
smart appliances. These applications are high volume users of programmable flash
memory devices.
In portable electronics products, shrinking form factors are driving the
shrinkage of device packages. Manual programming and handling of these tiny
packages is increasingly not practical due to quality issues. This trend toward
small packages should drive demand for Data I/O's automated programming systems
in 2006.
Applications targeted for these tiny devices include automotive, consumer
appliances, remote controls, medical devices, portable/personal electronics, PC
peripherals, hand-held and wearable PCs, telecommunications including phones and
pagers, security alarms and sensors.
TaskLink(R) for Windows provides a universal job set-up tool that intuitively
guides users in preparing product data files for programming. TaskLink is also a
key element of our Connected Strategy. Leveraging network connectivity, Data
I/O's TaskLink provides monitoring and control over programming systems anywhere
on the network - providing global companies with greater visibility and control
over remote production lines or contract manufacturing processes.
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AUTOMATED PROGRAMMING SYSTEMS
Data I/O provides our manufacturing and programming center customers with
automated programming systems solutions that include robotic handlers, a variety
of programmers, input and output media handling (such as tray stackers, tubes,
loaders or taping), and marking solutions. Our ProLINE-RoadRunner(TM) is a
unique in-line programming system with programming speed capability, which
approaches the speed at which Flash devices can currently accept data. Many of
our customers need to program Flash and microcontroller devices in large
quantities and very quickly. ProLINE-RoadRunner mounts directly on the assembly
machine in the production line (Siemens, Fuji, Universal, Panasonic and
Assembleon machines) and delivers programmed parts from reels of blank devices
to the production line in a just-in-time fashion. Our ProLINE-RoadRunner
eliminates production bottlenecks associated with high-density Flash and
microcontroller devices, allowing last minute firmware changes and eliminating
programmed part inventories, ultimately streamlining and reducing the customer's
production and process costs. ProLINE-RoadRunner enables customers to implement
lean processes and is a key element in Data I/O's Connected Strategy, allowing
customers and partners to more effectively manage their firmware supply chain.
ProLINE-RoadRunner currently retails from $72,500 to $118,000, depending on
programming capability.
Data I/O's PS family of automated programming solutions offers highly flexible
solutions for off-line batch programming. Data I/O can configure PS systems to
support not only Flash devices, but also a wide variety of other devices, such
as microcontrollers. These systems provide a number of marking, labeling, and
input/output options. Most importantly, customers can make changeovers extremely
fast. This feature allows the customer to rapidly respond to diverse demands
with very little downtime. Customers can optimize the PS family systems for any
job to maximize throughput and, when combined with fast changeover times and
high reliability, provide the highest levels of output during a production
shift. Our latest product, the PS588, integrates the same FlashCORE programmer
we use in our PS288, PS300 FlashCORE, ProLINE-RoadRunner and FlashPAK(TM) and
builds on our Connected Strategy and common architecture. The PS588
significantly improves throughput and lowers the cost per programmed part. The
PS family products range in price from $129,500 to $469,000.
We introduced the ImageWriter 200, our solution for in-systems programming of
programmable microcontrollers serial memory mounted on the printed circuit
board, in the fourth quarter of 2004 and introduced the ImageWriter 300 in 2005.
This solution is designed to be integrated into the line but does no handling.
The primary markets for ImageWriter are microcontroller applications in
automotive electronics, industrial automation and consumer electronics. Pricing
for the ImageWriter starts at approximately $2,000 for the first unit with most
installations requiring multiple units.
NON-AUTOMATED PROGRAMMING SYSTEMS
Our line of non-automated programming systems provides solutions for both
engineering and low to medium-volume manufacturing customers. Non-automated
programming systems require a user to physically handle the devices being
programmed. These types of programmers are also sometimes referred to as
"manual" or "desktop" programmers. We now have three families of non-automated
programmers: Sprint, UniSystem and FlashPAK.
Engineering customers typically use single-site programming systems during the
prototype phase of a new design, and may purchase inexpensive systems for
limited device needs or more expensive systems to support more complex devices
or a large variety of device types. Single-site programming systems can perform
programming on only one programmable device at a time.
Data I/O offers a range of high quality, universal single socket manual
programming solutions through our UniSystem family of programming systems. Our
UniSite and 3980 xpi programming systems offer the highest levels of signal
integrity, which ensure the highest programming standards. Popular in military,
aerospace, telecommunications and other mission critical applications, the
systems range from $15,000 to $35,000.
For more cost constrained or higher volume applications, the Sprint family of
products offers excellent value for the money and versatility. The Sprint Quad
and Octal programming systems offer 4 and 8 socket universal programming
configurations for higher volume applications. The Sprint family of products
range in price from under $1,000 to $20,000 for the multiple socket solutions.
Our newest programmer, the FlashPAK, leverages the high-speed proprietary
FlashCORE programming technology in the ProLINE-RoadRunner system. We believe
FlashPAK, starting at approximately $7,000, is the world's fastest programming
architecture, limited today only by the speed at which Flash devices can accept
data. FlashPAK is another key element of Data I/O's connected strategy,
providing OEMs and new product introduction facilities with a high performance
Flash programming system that can be used to validate designs before moving down
the firmware supply chain. For manufacturing applications, the FlashPAK, a high
speed, multi-socket, small footprint desktop solution, provides manual
programming operations with the highest level of flexibility at the lowest cost
per part. Manufacturers that use manual programming because of lower labor costs
in areas like Asia find FlashPAK an attractive solution.
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Data I/O supports and completes our product offering with a full range of
software and device update products and worldwide service and repair capability.
CUSTOMERS
Data I/O sells our products to customers worldwide in a broad range of
industries, including wireless handset manufacturers and other telecommunication
companies, consumer electronics, computers, test and measurement, medical,
transportation, military, aerospace, electronic contract manufacturing,
programming centers, and semiconductors. Our principal customers include
Motorola, Nokia, and Siemens. Our customers either design and/or manufacture
electronic products that incorporate programmable devices or provide device
programming services. During 2005, we sold products to over 1,600 customers
throughout the world. There were no customers that accounted for more than 10%
of our 2005 net sales and one customer, Siemens, accounted for 14.5% and 18% of
our 2004 and 2003 net sales, respectively.
Programmable device consumption continues to grow as more and more electronic
product manufacturers take advantage of the flexibility and cost effectiveness
of programmable memory, microcontroller and logic devices. Electronic products
today utilize programmable technology in one form or another, from
microcontrolled home appliance devices to set top boxes and wireless devices,
which use increasingly vast amounts of memory for Internet connectivity and new
leading edge features. Therefore, our customers come from virtually all
industries manufacturing electronic products, and include the consumer
electronic products, cell phone, personal data assistants ("PDAs") and other
wireless device manufacturers, home entertainment product sectors, aerospace and
military applications, the personal computer ("PC") and the PC peripheral
industry, automotive electronics and industrial automation and control.
Flash memory growth. The Flash memory customer segment is experiencing some of
the most impressive growth of all programmable devices. As cell phones, PDAs,
games consoles, set top boxes and other consumer devices become more capable,
powerful and compact, the demand for Flash units and megabytes continues to
grow.
Microcontroller growth. As the demand for smarter electronic devices increases,
demand for greater numbers of microcontroller devices increases. Many household
appliances today contain a microcontroller to control the critical functions of
the product and provide new features. Examples of these appliances include
toasters, refrigerators, garage door openers and even thermostats. This growth
creates new market opportunities for us and we have added support for these
devices in our FlashCORE architecture and our ImageWriter product. In addition,
the number of microcontrollers in automotive electronic applications is growing
rapidly, with some cars having as many as 80 or more microcontrollers that
control functions from airbag and ABS systems to air conditioning, information
centers and entertainment and communication systems. We are also targeting the
automotive segment as a critical and growing target segment for our solutions.
GEOGRAPHIC MARKETS AND DISTRIBUTION
Data I/O markets and sells our products through a combination of direct sales,
internal telesales, and indirect sales representatives and distributors. We
continually evaluate our sales channels against our evolving markets and
customers.
Sales of Data I/O's semiconductor programming equipment products requiring
installation by us that is other than perfunctory were previously recorded when
installation was complete, or at the later of customer acceptance or
installation, if an acceptance clause is specified in the sales terms. After we
determined that our programming equipment has reached a point of maturity and
stability such that product acceptance can be assured by testing at the factory
prior to shipment, and each of the multiple deliverables has an established fair
market value pursuant to EITF 00-21, Data I/O began in the third quarter of 2005
recognizing revenue for these products at the time of shipment if all of the
other criteria for revenue recognition exist in accordance with SAB 104, Revenue
Recognition. Revenue for the undelivered installation service remains deferred
at time of shipment and is recognized upon completion of the installation.
Revenue for products where installation is considered perfunctory continues to
be recognized at the time of shipment. Installation that is considered
perfunctory includes any installation that can be performed by other parties,
such as distributors, other vendors, or in most cases the customers themselves.
We recognize revenue from the sale of service and update contracts as deferred
revenue, and we recognize it on a straight-line basis over the contractual
period.
U.S. SALES
We market our products throughout the U.S. using a variety of sales channels,
including our own field sales management personnel, independent sales
representatives, and a direct telesales organization. Our U.S. independent sales
representatives obtain orders on an agency basis, with shipments made directly
to the customer by Data I/O. Net sales in the United States for 2005, 2004, and
2003 were $6,386,000, $5,434,000, and $7,263,000, respectively.
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FOREIGN SALES
Foreign sales represented approximately 78%, 80%, and 70%, of net sales of our
programming systems in 2005, 2004, and 2003, respectively (see Note 15 of "Notes
to Consolidated Financial Statements"). We make foreign sales through our
wholly-owned subsidiaries in Germany, China and Canada, as well as through
independent distributors and sales representatives located in 35 other
countries. Our independent foreign distributors purchase Data I/O products in
U.S. Dollars for resale and we recognize the sale at the time of shipment to the
distributor. As with U.S. sales representatives, sales made by international
sales representatives are on an agency basis with shipments made directly to the
customer by us.
Net foreign sales for 2005, 2004, and 2003 were $21,935,000, $21,876,000, and
$17,424,000, respectively. We determine total foreign sales by the international
geographic area into which the products are sold and delivered, and include not
only sales by foreign subsidiaries but also export sales from the U.S. to our
foreign distributors and to our representatives' customers. Foreign sales do not
include transfers between Data I/O and our foreign subsidiaries. Export sales
are subject to U.S. Department of Commerce regulations. We have not, however,
experienced any difficulties to date as a result of these requirements.
Fluctuating exchange rates and other factors beyond our control, such as
international monetary stability, tariff and trade policies, and U.S. and
foreign tax and economic policies, affect the level and profitability of foreign
sales. We cannot predict the effect of such factors on our business.
COMPETITION
The competition in the programming systems market is highly fragmented with a
large number of smaller organizations offering inexpensive solutions. While we
are not aware of any published industry market information covering the
programming systems market, according to our inside analysis, we estimate that
the total number of programming systems sold during 2005 has been approximately
$110 million, with Data I/O capturing an estimated 25% of the global market.
Over the last four years, based on our analysis, we believe that Data I/O has
gained market share versus our significant competitors.
Competitive factors often include prices, features, device support and
programming speed, as the programming process impacts more on the major
manufacturers' total production process. However, competitive factors are
changing. The added value for customers is becoming the whole product solution
that fits the customer's business processes. As an example, ProLINE-RoadRunner
offers a unique solution, which best addresses the customer's process needs in
high volume Flash applications. To this extent, the value proposition of this
specific programming solution is very different from traditional solutions.
Therefore, addressing customers' process needs is critical to increasing the
opportunity for programming solutions beyond the current amount in this market
niche. We estimate that customers are spending between $2.0 billion to $2.5
billion a year on programming memory, microcontroller and logic devices and much
of this programming is achieved through the use of the customers' test equipment
offered by companies like Agilent and Teradyne or homegrown solutions for
specific markets like automotive. The main competitive solution in the
programmable market is, therefore, the in-house solution, and the opportunity
exists to substitute customers' solutions with more economical and more easily
maintainable solutions to solve the problems, which traditional programmers do
not address. Boundary scan tools also fall into this category, although still a
small market with a number of small companies participating who principally
focus on test solutions. We expect that our new ImageWriter product will offer a
competitive solution for the consumer electronics, automotive electronics and
industrial automation customers in this market.
MANUFACTURING, RAW MATERIALS, AND BACKLOG
Data I/O performs primarily assembly and testing of our products at our
principal facility in Redmond, Washington and we outsource our circuit board
manufacturing and fabrication. We use a combination of standard components,
proprietary custom ICs and fabricated parts manufactured to Data I/O
specifications. An outside supplier located in Germany manufactures our Sprint
non-automated programming systems. Most components used are available from a
number of different suppliers and subcontractors but certain items, such as some
handler and programmer subassemblies, custom ICs, hybrid circuits and
connectors, are purchased from single sources. We believe that additional
sources can be developed for present single-source components without
significant difficulties in obtaining supplies. We cannot be sure that
single-source components will always continue to be readily available. If we
cannot develop alternative sources for these components, or if we experience
deterioration in relationships with these suppliers, there may be delays or
reductions in product introductions or shipments, which may materially adversely
affect our operating results.
In accordance with industry practices, generally all orders are subject to
cancellation prior to shipment without penalty, except for contracts calling for
custom configuration. To date, such cancellations have not had a material effect
on our sales volume.
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To meet customers' delivery requirements, we manufacture certain products based
upon a combination of backlog and anticipated orders. Most orders are scheduled
for delivery within 1 to 60 days after receipt of the order. Our backlog of
pending orders was approximately $1.2 million, $1.5 million, and $1.5 million as
of December 31, 2005, 2004, and 2003, respectively. The size of backlog at any
particular date is not necessarily a meaningful indicator of the trend of our
business.
RESEARCH AND DEVELOPMENT
Data I/O believes that continued investment in research and development is
critical to our future success. We continue to develop new technologies and
products and enhance existing products. Future growth is to a large extent
dependent upon the timely development and introduction of new products, as well
as the development of algorithms to support the latest programmable devices. We
are currently focusing our research and development efforts on strategic growth
markets, namely new programming technology and automated handling systems for
the manufacturing environment, including support for NAND FLASH and for
M-Systems DiskOnChip(R) technology, microcontroller support for FlashCORE,
additional platforms and improvements for ProLINE-RoadRunner, enhancements for
our ImageWriter in-system programming solution and eDSS. We continue to also
focus on increasing our capacity and responsiveness for new device support
requests from customers and programmable IC manufacturers by revising and
enhancing our internal processes and tools. During this past year, our research
and development resulted in these new products: PS 588 and ImageWriter 300.
During 2005, 2004, and 2003, we made expenditures for research and development
of $5,286,000, $5,057,000, and $4,639,000, respectively, representing 18.7%,
18.5%, and 18.8%, of net sales, respectively. Research and development costs are
expensed as incurred.
PATENTS, COPYRIGHTS, TRADEMARKS, AND LICENSES
Intellectual property rights applicable to various Data I/O products include
patents, copyrights, trade secrets and trademarks. Data I/O also relies on
patents, copyrights, trade secrets and trademarks to protect our intellectual
property, as well as product development and marketing skill, to establish and
protect our market position. We also grew our patent portfolio over the past few
years as we developed strategic technologies like the ProLINE-RoadRunner and
FlashCORE that are critical to our Connected Strategy.
We attempt to protect our rights in proprietary software products, including
TaskLink and other software products, by retaining the title to and copyright of
the software and documentation, by including appropriate contractual
restrictions on use and disclosure in our licenses, and by requiring our
employees to execute non-disclosure agreements. Our software products are not
normally sold separately from sales of programming systems. However, on those
occasions where software is sold separately, revenue is recognized when a sales
agreement exists, when delivery has occurred, when the fee is fixed or
determinable, and when collectibility is probable.
Because of the rapidly changing technology in the semiconductor, electronic
equipment and software industries, portions of our products might possibly
infringe upon existing patents or copyrights, and we may, therefore, be required
to obtain licenses or discontinue the use of the infringing technology. We
believe that any exposure we may have regarding possible infringement claims is
a reasonable business risk similar to that assumed by other companies in the
electronic equipment and software industries. However, any claim of
infringement, with or without merit, could be costly and a diversion of
management's attention, and an adverse determination could adversely affect our
reputation, preclude us from offering certain products, and subject us to
substantial liability.
EMPLOYEES
As of December 31, 2005, we had 130 employees, of which 42 were located outside
the U.S. We also utilize independent contractors for specialty work, primarily
in research and development, and utilize temporary workers to adjust capacity to
fluctuating demand. Many of our employees are highly skilled and our continued
success will depend in part upon our ability to attract and retain employees who
can be in great demand within the industry. None of our employees are
represented by a collective bargaining unit and we believe relations with our
employees are favorable.
ENVIRONMENTAL COMPLIANCE
Our facilities are subject to numerous laws and regulations concerning the
discharge of materials or otherwise relating to the environment. Compliance with
environmental laws has not had, nor is it expected to have, a material effect on
our capital expenditures, financial position, results of operations or
competitive position.
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EXECUTIVE OFFICERS OF THE REGISTRANT
Set forth below is certain information concerning the executive officers of Data
I/O as of March 27, 2006:
Name Age Position
---- --- --------
Frederick R. Hume 63 President and Chief Executive Officer
Joel S. Hatlen 47 Vice President
Chief Financial Officer
Secretary and Treasurer
Harald A. Weigelt 46 Vice President
Worldwide Sales and Services
|
Frederick R. Hume joined Data I/O as President and Chief Executive Officer in
February 1999. He was appointed to the Board of Directors of Data I/O in January
1999. From 1988 until his retirement in 1998, Mr. Hume served as Vice President
and General Manager of Keithley Instruments in Cleveland, Ohio. From 1972 to
1988, he held various management positions at Fluke Corporation, including Group
Vice President for Manufacturing and Research and Development.
Joel S. Hatlen joined Data I/O in September 1991 and became Chief Accounting
Officer and Corporate Controller in February 1997. In January 1998, he was
promoted to Vice President of Finance and Chief Financial Officer, Secretary and
Treasurer. He began his career at Data I/O as a Senior Tax Accountant and became
Tax Manager in December 1992. From September 1981 until joining Data I/O, Mr.
Hatlen was employed by Ernst & Young LLP, where his most recent position was
Senior Manager.
Harald A. Weigelt joined Data I/O in 1991, and in October 2005, he was appointed
Vice President, Worldwide Sales and Services. Prior to this position, he served
as the Vice President, European Operations and as Managing Director of Data
I/O's operations in Germany. Prior to joining Data I/O, he was employed with
Instrumatic, where he served as Product Manager and was employed with Wavetek as
Product Manager.
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ITEM 1A. RISK FACTORS
CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS
Data I/O's disclosure and analysis in this Annual Report contains some
forward-looking statements. Forward-looking statements include our current
expectations or forecasts of future events. The reader can identify these
statements by the fact that they do not relate strictly to historical or current
facts. In particular, these include statements relating to future action,
prospective products, new technologies, establishing foreign operations, future
performance or results of current and anticipated products, sales efforts,
expenses, outsourcing of functions, outcome of contingencies, impact of
regulatory requirements, restructure actions and financial results.
Any or all of the forward-looking statements in this Annual Report or in any
other public statement made may turn out to be wrong. They can be affected by
inaccurate assumptions we might make, or known or unknown risks and
uncertainties can affect these forward-looking statements. Many factors -- for
example, product competition and product development -- will be important in
determining future results. Moreover, neither Data I/O nor anyone else assumes
responsibility for the accuracy and completeness of these forward-looking
statements. Actual future results may materially vary.
We undertake no obligation to publicly update any forward-looking statements
after the date of this Annual Report, whether as a result of new information,
future events or otherwise. The reader should not place undue reliance on such
forward-looking statements. The reader is advised, however, to consult any
future disclosures Data I/O makes on related subjects in our 10-Q, 8-K and 10-K
reports to the SEC and press releases. Also, note that Data I/O provides the
following cautionary discussion of risks, uncertainties and possible inaccurate
assumptions relevant to our business. These are factors that we think could
cause Data I/O's actual results to differ materially from expected and
historical results. Other factors besides those listed here could also adversely
affect Data I/O. This discussion is permitted by the Private Securities
Litigation Reform Act of 1995.
RISK FACTORS
DELAYS IN DEVELOPMENT, INTRODUCTION AND SHIPMENT OF NEW PRODUCTS MAY RESULT IN A
DECLINE IN SALES.
Data I/O currently is developing new engineering and automated programming
systems. Significant technological, supplier, manufacturing or other problems
may delay the development, introduction or production of these products.
For example, we may encounter these problems:
o technical problems in the development of a new programming system platform
or the robotics for new automated handing systems
o inability to hire qualified personnel
o delays or failures to perform by third parties involved in our development
projects
Delays in the development, completion and shipment of new products, or failure
of customers to accept new products, may result in a decline in sales.
QUARTERLY FLUCTUATIONS IN OUR OPERATING RESULTS MAY ADVERSELY AFFECT OUR STOCK
PRICE.
Data I/O's operating results tend to vary from quarter to quarter. Our revenue
in each quarter substantially depends upon orders received within that quarter.
Conversely, our expenditures are based on investment plans and estimates of
future revenues. We may, therefore, be unable to quickly reduce our spending if
our revenues decline in a given quarter. As a result, operating results for that
quarter will suffer. Our results of operations for any one quarter are not
necessarily indicative of results for any future periods.
Other factors, which may cause our quarterly operating results to fluctuate,
include:
o increased competition
o timing of new product announcements
o product releases and pricing changes by us or our competitors
o market acceptance or delays in the introduction of new products
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o production constraints
o labor or material shortages
o the timing of significant orders
o the sales channel mix of direct vs. indirect distribution
o war or terrorism
o health issues (such as SARS)
o customers' budgets
o adverse movements in exchange rates, interest rates or tax rates
o cyclical nature of demand for our customers' products
o general economic conditions in the countries where we sell products
o expenses and obtaining authorizations in setting up new operations or
locations
Due to all of the foregoing factors, it is possible that in some future
quarters, our operating results will be below expectations of analysts and
investors.
FAILURE TO ADAPT TO TECHNOLOGY TRENDS IN OUR INDUSTRY MAY HINDER OUR
COMPETITIVENESS AND FINANCIAL RESULTS.
Product technology in Data I/O's industry evolves rapidly, making timely product
innovation essential to success in the marketplace. Introducing products with
improved technologies or features may render our existing products obsolete and
unmarketable. Technological advances that may negatively impact our business
include:
o new device package types, densities, and technologies requiring hardware
and software changes in order to be programmed by our products
o electronics equipment manufacturing practices, such as widespread use of
in-circuit programming
o customer software platform preferences different from those on which our
products operate
o more rigid industry standards, which would decrease the value-added element
of our products and support services
If we cannot develop products in a timely manner in response to industry
changes, or if our products do not perform well, our business and financial
condition may be adversely affected. Also, our new products may contain defects
or errors that give rise to product liability claims against us or cause our
products to fail to gain market acceptance. Our future success depends on our
ability to successfully compete with other technology firms in attracting and
retaining key technical personnel.
A DECLINE IN ECONOMIC AND MARKET CONDITIONS MAY RESULT IN DECREASED CAPITAL
SPENDING BY OUR CUSTOMERS.
Our business is highly impacted by capital spending plans and other economic
cycles that affect the users and manufacturers of ICs. These industries are
highly cyclical and are characterized by rapid technological change, short
product life cycles, fluctuations in manufacturing capacity and pricing and
gross margin pressures. As we experienced in recent years, our operations may in
the future reflect substantial fluctuations from period-to-period as a
consequence of these industry patterns, general economic conditions affecting
the timing of orders from major customers, and other factors affecting capital
spending. These factors could have a material adverse effect on our business and
financial condition.
WE HAVE A HISTORY OF RECENT OPERATING LOSSES AND MAY BE UNABLE TO GENERATE
ENOUGH REVENUE TO ACHIEVE AND MAINTAIN PROFITABILITY.
We have incurred net losses in three of the last five years. We will continue to
examine our level of operating expense based upon our projected revenues. Any
planned increases in operating expenses may result in larger losses in future
periods if projected revenues are not achieved. As a result, we may need to
generate greater revenues than we have recently to achieve and maintain
profitability. However, we cannot provide assurance that our revenues will
increase and our strategy may not be successful, resulting in future losses.
11
OUR PRIOR RESTRUCTURING ACTIVITIES MAY HAVE A NEGATIVE IMPACT ON OUR FUTURE
OPERATIONS.
Our restructuring plans may yield unanticipated consequences, such as increased
burden on our administrative, operational, and financial resources and increased
responsibilities for our management personnel. As a result, our ability to
respond to unexpected challenges may be impaired and we may be unable to take
advantage of new opportunities.
In addition, many of the employees that were terminated as a part of our
restructuring possessed specific knowledge or expertise, and that knowledge or
expertise may prove to have been important to our operations. In that case,
their absence may create significant difficulties, particularly if our business
experiences significant growth. Also, the reduction in workforce related to our
restructuring may subject us to the risk of litigation, which could result in
substantial cost. Any failure by us to properly manage this rapid change in
workforce could impair our ability to efficiently manage our business, to
maintain and develop important relationships with third-parties, and to attract
and retain customers. It could also cause us to incur higher operating cost and
delays in the execution of our business plan or in the reporting or tracking of
our financial results.
WE MAY NEED TO RAISE ADDITIONAL CAPITAL AND OUR FUTURE ACCESS TO CAPITAL IS
UNCERTAIN.
Our past revenues have been and our future revenues may continue to be
insufficient to support the expense of our operations and any expansion of our
business. We may therefore need additional equity or debt capital to finance our
operations. If we are unable to generate sufficient cash flows from operations
or to obtain funds through additional debt or equity financing, we may have to
reduce some or all of our development and sales and marketing efforts and limit
the expansion of our business.
We believe our existing cash and cash equivalents will be sufficient to meet our
working capital requirements for at least the next twelve months. Thereafter,
depending on the development of our business, we may need to raise additional
cash for working capital or other expenses. We may also encounter opportunities
for acquisitions or other business initiatives that require significant cash
commitments, or unanticipated problems or expenses that could result in a
requirement for additional cash before that time.
Therefore, we may seek additional funding through public or private debt or
equity financing or from other sources. We have no commitments for additional
financing, and we may experience difficulty in obtaining funding on favorable
terms, if at all. Any financing we obtain may contain covenants that restrict
our freedom to operate our business or may require us to issue securities that
have rights, preferences or privileges senior to our Common Stock and may dilute
your ownership interest.
WE MAY FACE INCREASED COMPETITION AND MAY NOT BE ABLE TO COMPETE SUCCESSFULLY
WITH CURRENT AND FUTURE COMPETITORS.
Technological advances have reduced the barriers of entry into the programming
systems market. We expect competition to increase from both established and
emerging companies. If we fail to compete successfully against current and
future sources of competition, our profitability and financial performance will
be adversely impacted.
IF OUR RELATIONSHIP WITH SEMICONDUCTOR MANUFACTURERS DETERIORATES, OUR BUSINESS
MAY BE ADVERSELY AFFECTED.
We work closely with most semiconductor manufacturers to ensure that our
programming systems comply with their requirements. In addition, many
semiconductor manufacturers recommend our programming systems for use by users
of their programmable devices. These working relationships enable us to keep our
programming systems product lines up to date and provide end-users with broad
and current programmable device support. Our business may be adversely affected
if our relationships with semiconductor manufacturers deteriorate.
OUR RELIANCE ON A SMALL NUMBER OF SUPPLIERS MAY RESULT IN A SHORTAGE OF KEY
COMPONENTS, WHICH MAY ADVERSELY AFFECT OUR BUSINESS.
Certain parts used in our products are currently available from either a single
supplier or from a limited number of suppliers. If we cannot develop alternative
sources of these components, if sales of parts are discontinued by the supplier
or we experience deterioration in our relationship with these suppliers, there
may be delays or reductions in product introductions or shipments, which may
materially adversely affect our operating results.
Because we rely on a small number of suppliers for certain parts, we are subject
to possible price increases by these suppliers. Also, we may be unable to
accurately forecast our production schedule. If we underestimate our production
schedule, suppliers may be unable to meet our demand for components. This delay
in the supply of key components may materially adversely affect our business.
Over estimation of demand will lead to excess inventories that may become
obsolete.
The non-automated programming system products we acquired when we acquired SMS
in November 1998 are currently manufactured to our specifications by a
third-party foreign contract manufacturer. We may not be able to obtain a
sufficient quantity of these products if and when needed, which may result in
lost sales.
12
IF WE ARE UNABLE TO ATTRACT AND RETAIN QUALIFIED THIRD-PARTY DISTRIBUTORS, OUR
BUSINESS MAY BE ADVERSELY AFFECTED.
Data I/O has an internal sales force and also utilizes third-party
representatives, and distributors. Therefore, the financial stability of these
representatives and distributors is important. Highly skilled professional
engineers use most of our products. To be effective, third-party distributors
must possess significant technical, marketing and sales resources and must
devote their resources to sales efforts, customer education, training and
support. These required qualities limit the number of potential third-party
distributors. Our business will suffer if we cannot attract and retain a
sufficient number of qualified third-party distributors to market our products.
OUR INTERNATIONAL OPERATIONS MAY EXPOSE US TO ADDITIONAL RISKS THAT MAY
ADVERSELY AFFECT OUR BUSINESS.
International sales represented 78% of our net revenue for the fiscal year ended
December 31, 2005 and 80% for the fiscal year ended December 31, 2004. We expect
that international sales will continue to be a significant portion of our net
revenue. International sales may fluctuate due to various factors, including:
o migration of manufacturing to low cost geographies
o unexpected changes in regulatory requirements
o tariffs and taxes
o difficulties in establishing, staffing and managing foreign operations
o longer average payment cycles and difficulty in collecting accounts
receivable
o fluctuations in foreign currency exchange rates
o compliance with applicable export licensing requirements
o product safety and other certification requirements
o difficulties in integrating foreign and outsourced operations
o political and economic instability
The European Community and European Free Trade Association ("EU") has
established certain electronic emission and product safety requirements ("CE").
Although our products currently meet these requirements, failure to obtain
either a CE certification or a waiver for any product may prevent us from
marketing that product in Europe. The EU also has directives concerning the
Reduction of Hazardous Substances ("RoHS") from which Data I/O is relying on an
exemption for test and measurement companies. Failure to meet applicable
directives or qualifying exemption may prevent us from marketing certain
products in Europe or other territories with similar requirements.
We operate subsidiaries in Germany, China, Canada and Brazil. Our business and
financial condition is sensitive to currency exchange rates or any other
restrictions imposed on their currencies. Currency exchange fluctuations in
Canada, China, Brazil and Germany may adversely affect our investment in our
subsidiaries.
IF WE ARE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY, WE MAY NOT BE ABLE TO
COMPETE EFFECTIVELY OR OPERATE PROFITABLY.
Data I/O relies on patents, copyrights, trade secrets and trademarks to protect
our intellectual property, as well as product development and marketing skill to
establish and protect our market position. We attempt to protect our rights in
proprietary software products, including TaskLink and other software products,
by retaining the title to and copyright of the software and documentation, by
including appropriate contractual restrictions on use and disclosure in our
licenses, and by requiring our employees to execute non-disclosure agreements.
Because of the rapidly changing technology in the semiconductor, electronic
equipment and software industries, portions of our products might possibly
infringe upon existing patents or copyrights, and we may, therefore, be required
to obtain licenses or discontinue the use of the infringing technology. We
believe that any exposure we may have regarding possible infringement claims is
a reasonable business risk similar to that assumed by other companies in the
electronic equipment and software industries. However, any claim of
infringement, with or without merit, could be costly and a diversion of
management's attention, and an adverse determination could adversely affect our
reputation, preclude us from offering certain products, and subject us to
substantial liability.
13
WE MAY PURSUE BUSINESS ACQUISITIONS THAT COULD IMPAIR OUR FINANCIAL POSITION AND
PROFITABILITY.
We may pursue acquisitions of complementary technologies, product lines or
businesses. Future acquisitions may include risks, such as:
o burdening management and our operating teams during the integration of the
acquired entity
o diverting management's attention from other business concerns
o failing to successfully integrate the acquired products
o lack of acceptance of the acquired products by our sales channels or
customers
o entering markets where we have no or limited prior experience
o potential loss of key employees of the acquired company
o additional burden of support for an acquired programmer architecture
Future acquisitions may also impact Data I/O's financial position. For example,
we may use significant cash or incur additional debt, which would weaken our
balance sheet. We may also capitalize goodwill and intangible assets acquired,
the impairment of which would reduce our profitability. We cannot guarantee that
future acquisitions will improve our business or operating results.
THE LOSS OF KEY EMPLOYEES MAY ADVERSELY AFFECT OUR OPERATIONS.
We have employees located in the U.S., Germany, Canada and China. We also
utilize independent contractors for specialty work, primarily in research and
development and in our Brazilian operation, and utilize temporary workers to
adjust capacity to fluctuating demand. Many of our employees are highly skilled
and our continued success will depend in part upon our ability to attract and
retain employees who can be in great demand within the industry. None of our
employees are represented by a collective bargaining unit and we believe
relations with our employees are favorable though no assurance can be made that
this will be the case in the future. Refer to the section captioned "Our prior
restructuring activities may have a negative impact on our future operations"
above.
FAILURE TO COMPLY WITH REGULATORY REQUIREMENTS MAY ADVERSELY AFFECT OUR STOCK
PRICE AND BUSINESS.
As a public company, we are subject to numerous governmental and stock exchange
requirements, with which we believe we are in compliance. The Sarbanes-Oxley Act
of 2002 and the Securities and Exchange Commission (SEC) have requirements that
we may fail to meet by the required deadlines or we may fall out of compliance
with, such as the internal controls assessment, reporting and auditor
attestation required under Section 404 of the Sarbanes-Oxley Act of 2002, with
which we are not yet required to comply as we are not an accelerated filer. The
compliance date for non-accelerated filers has been extended to the first fiscal
year ending on or after July 15, 2007. Data I/O assumes it will continue to have
the status of a non-accelerated filer based on the aggregate market value of the
voting and non-voting shares held as of June 30, 2005. During the course of our
testing we may identify deficiencies which we may not be able to remediate in
time to meet the deadline imposed by the Sarbanes-Oxley Act of 2002 for
compliance with the requirements of Section 404. We may also incur additional
costs in order to comply with Section 404. In addition, if we fail to achieve
and maintain the adequacy of our internal controls, as such standards are
modified, supplemented or amended from time to time, we may not be able to
ensure that we can conclude on an ongoing basis that we have effective internal
controls over financial reporting in accordance with Section 404 of the
Sarbanes-Oxley Act of 2002. Moreover, effective internal controls, particularly
those related to revenue recognition, are necessary for us to produce reliable
financial reports and are important to help prevent financial fraud. If we
cannot provide reliable financial reports or prevent fraud, our business and
operating results could be harmed, investors could lose confidence in our
reported financial information, and the trading price of our stock could drop
significantly. Our failure to meet regulatory requirements and exchange listing
standards may result in actions such as the delisting of our stock impacting our
stock's liquidity; SEC enforcement actions; and securities claims and
litigation.
OUR STOCK PRICE MAY BE VOLATILE AND, AS A RESULT, YOU MAY LOSE SOME OR ALL OF
YOUR INVESTMENT.
The stock prices of technology companies tend to fluctuate significantly. We
believe factors such as announcements of new products by us or our competitors
and quarterly variations in financial results may cause the market price of Data
I/O's Common Stock to fluctuate substantially. In addition, overall volatility
in the stock market, particularly in the technology company sector, is often
unrelated to the operating performance of companies. If these market
fluctuations continue in the future, they may adversely affect the price of Data
I/O's Common Stock.
14
FAILURE TO SUCCESSFULLY IMPLEMENT A NEW WORLDWIDE INFORMATION SYSTEM MAY
ADVERSELY AFFECT OUR OPERATIONS AND SALES.
We have recently acquired and are currently implementing a new worldwide
information system. Our corporate office began use of the new system in February
2006. We are now in the process of implementing the new system at our subsidiary
locations. Our operations and financial results could be adversely affected if
we are unable to complete the system implement without significant interruptions
in accounting systems, order entry, billing, manufacturing and other customer
support functions. In addition, the costs associated with the implementation and
training could exceed budgeted amounts and adversely affect our profitability
and liquidity. System implementation delays could cause difficulties in our
complying with the internal controls assessment, reporting and auditor
attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002.
MOVING OUR HEADQUARTERS AND MANUFACTURING OPERATION MAY ADVERSELY AFFECT OUR
OPERATIONS AND SALES.
We anticipate moving our Redmond headquarters and manufacturing operation in
mid-year 2006 from our current location to a smaller location in Redmond,
Washington. If we are not able to timely and successfully complete the move, our
short-term ability to manufacture and ship products and our sales could be
adversely affected.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
