UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes X  No __

Indicate by check mark whether the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes  __ No X

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes X  No __

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).  Yes __ No __

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.X

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

 Large accelerated filer __  Accelerated filer __  Non-accelerated filer __  Smaller reporting company X

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

Aggregate market value of voting and non-voting common equity held

by non-affiliates on the registrant as of June 30, 2010:

$45,713,153

Shares of Common Stock, no par value, outstanding as of March 21, 2011:

9,033,785

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s Proxy Statement relating to its May 17, 2011 Annual Meeting of Shareholders are incorporated into Part III of this Annual Report on Form 10-K.

PART I

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^® 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”) is the global market leader for advanced programming and intellectual property management solutions used in the manufacturing of flash and flash-based intelligent devices.  Data I/O designs, manufactures, and sells programming systems for electronic device manufacturers, specifically targeting high growth areas such as high-volume users of flash memory and microcontrollers.  Virtually every electronic product today incorporates one or more programmable semiconductor devices that contain data and operating instructions essential for the proper operation of the product. 

Data I/O’s mission is to deliver high-value systems, software and services to the rapidly expanding programmable semiconductor market by providing a software-rich programming platform for content delivery.  These programmable solutions are used in devices such as smart phones, MP3 players, gaming systems and automobile electronics.  These solutions, some of which include intellectual property management, secure content management and process control capabilities, enable Data I/O to address the demanding requirements for the electronic device market, where applications and intellectual property protection are essential to our customer’s success.  Data I/O’s largest customers are heavy users of programmable semiconductor devices and include original equipment manufacturers (“OEMs”) in wireless and consumer electronics and automotive electronics, and their electronic manufacturing service (“EMS”) contract manufacturers.

Data I/O was incorporated in the State of Washington in 1969 and its business was founded in 1972.

Business Restructuring

As a result of the business down turn we experiencedin the fourth quarter of 2008 and the uncertain business outlook at that time, restructuring actions were taken to reduce expenses.  This resulted in restructuring charges, primarily related to severance, of $542,000 for the year 2008.  We took additional actions in 2009 totaling $203,000 to flatten and streamline the organization as well as reduce costs by decreasing the size of our Board and abandoning a portion of our building space.  At December 31, 2010, restructure costs of $58,000 remained accrued.

Industry Background

Data I/O enables companies to improve productivity and reduce costs by providing device programming solutions that allow our customers to take intellectual property (large design and data files) and protect and program it into memory, microcontroller and logic devices quickly and cost-effectively.  Data I/O also provides services related to hardware support, system installation and repair, and device programming.  Companies that design and manufacture products ranging from cell phones to automobiles, that utilize programmable electronic devices, purchase these solutions from us.  The trends of increasing device densities and customers increasing their software content file sizes, combined with the increasing numbers of intelligent devices such as smartphones and tablets, are driving demand for our solutions.

Our automated programming systems integrate both programming and handling functions into a single product solution.  Quality conscious customers, particularly those in the field of high-volume manufacturing and programming, continue to drive this portion of our business.

Traditionally, our programming market opportunity focused on the number of semiconductor devices to be programmed, but because of the rapid increase in the density of devices, the focus is shifting to the number of bits per device to be programmed as described in the following table:

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 device mix and volume usage by our customers in the various market segments and applications.  We work closely with leading manufacturers of programmable devices to develop our products to meet the requirements of a particular device.  Our products are positioned and viewed as the “gold standard” for advanced programming equipment and intellectual property management solutions.  Our new FlashCORE III programming technology resulted in industry awards including:

·         SMT Vision Award

·         Circuits Assembly NPI Award

·         EMAsia Innovation Award

·         Global SMT Technology Award

Data I/O’s of programming solutions include a broad range of products, systems, modules, and accessories, grouped into two general categories: automated programming systems and manual programming systems.  We provide two main categories of automated programming systems: off-line and in-line.  Data I/O’s automated programming systems and FlashPAK™ share a common programming platform, FlashCORE™ and Data I/O’s universal job setup tool, Tasklink™ for Windows®.  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 software algorithms for devices and developing socket adapters to hold and connect to the device for programming.

Data I/O’s products have both an upfront solution sale and recurring revenue elements.  Adapters are a consumable item and software and maintenance are typically under annual subscription contracts.

Data I/O’s key products and the customer benefits/key features Data I/O believes are important are described in the following table:

Customers

Data I/O sells our solutions to customers worldwide, many of whom are world-class manufacturers of electronic devices used in a broad range of industries, as described in the following table:

Data I/O’s solutions address a large, growing market.  While the programmable device market contracted in 2009 due to the economic downturn, we saw a strong recovery in 2010.  Growth is projected to continue for 2011 and 2012.

Capital spending is forecast to increase 9% in 2011 and 10% in 2012 according to the Henderson Forecast summary.  Spending for portable media players, set top boxes, LCD televisions, tablet and netbook computers and new household appliances filled with electronics continues to grow.  Smartphone deliveries roughly doubled during Q3 2010 compared to Q3 2009 and accounted for approximately 20% of total mobile phone shipments, according to market research firm Gartner Inc. The world’s appetite for electronics grows despite global economic stress, and this growth is driving the semiconductor industry.

We believe that our sales are driven by the same forces that propel the semiconductor industry.  We sell to the same firms that buy the semiconductors.  When their business grows, they buy more semiconductors which, in turn, require additional programming equipment to maintain production speeds or program new device technologies, driving demand for our products.

Addressing High Growth, High Volume Markets.  Data I/O’s device programming solutions currently target two high growth, high volume markets: flash for mobile devices and microcontrollers for automotive electronics. 

Growth drivers of NAND flash in Mobile Devices

·         Flash unit volume experiencing explosive growth

·         Increasing usage of NAND; replacing NOR due to its lower cost per bit

·         Densities continue to increase beyond 8GB driving the need for more advanced and secure programming capabilities

·         Higher densities driving new usage models such as tablet computers.

·         The shift to the iPhone, Blackberry, Android and other smart phones

Growth drivers of microcontrollers in Automotive

·         Consumers desire advanced car features requiring higher levels of sophistication including infotainment products (audio, radio, satellite, navigation and wireless connectivity) as well as increased safety features and optimized engine functionality

·         ~60 microcontrollers per vehicle

·         Proliferation of programmable microcontrollers to support the next-generation electronic car systems

·         Increasing use of high-density flash to provide memory for advanced applications that require programming

Increasingly, OEMs are outsourcing their device programming needs to EMS contract manufacturers to reduce capital expense and maximize profit margins.  At the same time, these OEMs are also increasing their proprietary software content to accelerate new product introductions with more feature-rich, application-specific versions.  While the outsourcing of manufacturing processes is essential to maximizing an OEM’s profit margin, maintaining the integrity and control of the software, the OEM’s core intellectual property, is increasingly complex in this outsourced environment, especially given the global nature of the manufacturing supply chain.  Data I/O, with its comprehensive programming solution,provides OEM’s with the ability to manage, monitor, audit and secure the software supply chain. 

During 2010, we sold products to over 750 customers throughout the world.  As of December 31, 2010 there were no customers that accounted for more than 10% of our 2010 net sales.  As of December 31, 2009, there was one customer, Flextronics, which accounted for approximately 12% of our 2009 net sales.  In 2008, there were no customers that accounted for more than 10% of 2008 net sales.

As of December 31, 2010 there were no customers that accounted for more than 10% of our accounts receivable balances.  As of December 31, 2009, one customer, Flextronics, represented approximately 23.2% of our accounts receivable balances.  As of December 31, 2008, Flextronics represented approximately 13.3% of our accounts receivable balances. 

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 customersand realign them as necessary to ensure that we reach our customers in the most effective and efficient manner possible.

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 2010, 2009 and 2008 were $3,145,000, $2,268,000 and $4,070,000, respectively.

Foreign Sales

Foreign sales represented approximately 88%, 88% and 85% of net sales in 2010, 2009 and 2008, respectively.  We make foreign sales through our wholly-owned subsidiaries in Germany and China, as well as through independent distributors and sales representatives located in 42 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 2010, 2009 and 2008 were $23,250,000, $16,281,000 and $23,527,000, 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 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, but we try to consider and respond to changes in these factors, particularly as the majority of our costs are U.S.-based while the vast majority of our sales are international. 

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 internal analysis of competitors we estimate that for 2008, 2009 and 2010, Data I/O revenues were at least twice the size of the next largest direct competitor and approximately four times the size of the second largest direct competitor.  

Data I/O primarily focuses on automated programming solutions and believes its solutions offer numerous advantages over alternative solutions as described in the following table:

* Data I/O also offers manual programming solutions.

Manufacturing, Raw Materials, and Backlog

Data I/O strives to manufacture and provide the best solutions for advanced programming.  We received the “Manufacturer of the Year” Award in the category of small manufacturers from the Association of Washington Business in 2010.  Data I/O primarily assembles and tests our products at our principal facility in Redmond, Washington and we outsource our circuit board manufacturing and fabrication.  We have transferred most of our FlashCORE adapter production to China.  We use a combination of standard components, proprietary custom ICs and fabricated parts manufactured to Data I/O specifications.  Two significant outside suppliers of Data I/O proprietary products are located in Germany: Yamaichi manufactures our specialty sockets and Haberer Electronic 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 integrated circuits, 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.  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 $1.6 million, $1.9 million and $2.0 million as of December 31, 2010, 2009 and 2008, 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 new programmer technologies, support for the latest FLASH memories and microcontrollers, additional platforms and improvements for ProLINE-RoadRunner, and new software capabilities.  We also continue to focus on increasing our capacity and responsiveness for new device support requests from customers and programmable integrated circuit manufacturers by revising and enhancing our internal processes and tools.  During this past year, our research and development efforts resulted in the release ofProLINE- RoadRunner versions for MYDATA and Siemens SIPLACE X-Series placement machines, as well as additional enhancements to our new FlashCORE III programming architecture.

During 2010, 2009 and 2008, we made expenditures for research and development of $4,159,000, $4,128,000 and $4,464,000, respectively, representing 15.8%, 22.3% and 16.2% of net sales, respectively.  Research and development costs are expensed as incurred. 

Patents, Copyrights, Trademarks, and Licenses

Data I/O relies on a combination of 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 have continued to add new patents to our patent portfolio over the past few years as we developed strategic new technologies.

In March 2008, we closed the sale of selected patents and patent applications to Leannoux Properties AG L.L.C.  for net proceeds of approximately $3.3 million and reported a net gain of approximately $2.1 million.  The patents and patent applications sold relate primarily to technology used in Data I/O’s ProLINE-RoadRunner product line.  Data I/O retains a non-exclusive, royalty-free license to use the technology covered by these patents and applications.

Most of the patents sold relate to technology that Data I/O has been using for a number of years.  The sale monetizes the value of these patents, avoids future annual maintenance and patent defense expenses, and allows Data I/O royalty-free use of them.  The sale did not include technology related to the firm’s most recent development programs.

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 typically sold separately from sales of programming systems.  However, on those occasions where software is sold separately, revenue is recognized when a sales agreement exists, delivery has occurred, the fee is fixed or determinable, and collectability is probable.  For certain contract software development projects, revenue is recognized using the percentage-of-completion methodology.

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 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, 2010, we had a total of 95 employees, of which 39 were located outside the U.S. and 5 of which are part time.  We also utilize independent contractors for specialty work, primarily in research and development, and utilize temporary workers to adjust capacity to fluctuating demandand for special projects.  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.  In foreign countries we have employment agreements or, in China, the Shanghai Foreign Services Co., Ltd.  (“FSCO”) labor agreement.

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.  See Item 3, Legal Proceedings, regarding the Rowley Properties, Inc. claim. 

Executive Officers of the Registrant

Set forth below is certain information concerning the executive officers of Data I/O as of March 21, 2011:

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 and Corporate Controller in December 1993.  From September 1981 until joining Data I/O, Mr. Hatlen was employed by Ernst & Young LLP as a Certified Public Accountant, where his most recent position was Senior Manager. 

Gordon B. Bluechel joined Data I/O in November 1992 and was named an executive officer in November 2008.  He currently serves as the Vice President of Operations and Administration.  Prior to his current role, he served as Vice President/Director of Operations beginning in 2007, Director of Operations from 2005 to 2007, General Manager of In-System Programming from 2004 to 2005, Director of Americas Sales and Service from 2002 to 2004, Director of Worldwide Service from 2001 to 2002, General Manager of Sprint Operations in Germany from 2000 to 2001.  Prior to being named General Manager of Sprint Operations, Mr. Bluechel held various management and staff positions with Data I/O Corporation. 

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 unduly rely on our 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  Reform Act of 1995.

RISK FACTORS

A decline in economic and market conditions may result in decreased capital spending and delayed or defaulted payments from our customers.

Our business is highly impacted by capital spending plans and other economic cycles that affect the users and manufacturers of integrated circuits.  These industries are highly cyclical and are characterized by rapid technological change, short product life cycles, and fluctuations in manufacturing capacity and pricing and gross margin pressures.  As we experienced in recent years and are currently experiencing, 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.  In a difficult economic climate it may take us longer to receive payments from our customers and some of our customers’ business may fail, resulting in non-payment.  These factors could have a material adverse effect on our business and financial condition.

Delays in development, introduction and shipment of new products or services may result in a decline in sales.

Data I/O develops new engineering and automated programming systems and services.  Significant technological, supplier, manufacturing or other problems may delay the development, introduction or production of these products or services.

For example, we may encounter these problems:

·         technical problems in the development of a new programming system platform or the robotics for new automated handing systems

·         inability to hire qualified personnel

·         delays or failures to perform by third parties involved in our development projects

·         development of new services that are not accepted by the market

Delays in the development, completion and shipment of new products or services, or customers not accepting 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:

·         increased competition

·         timing of new product announcements

·         product or service releases and pricing changes by us or our competitors

·         market acceptance or delays in the introduction of new products or services

·         production constraints

·         quality issues

·         labor or material shortages (such as supply chain disruptions from the earthquake in Japan)

·         the timing of significant orders

·         the sales channel mix of direct vs. indirect distribution

·         civil unrest, war or terrorism

·         health issues (such as the H1N1 virus)

·         customers’ budgets

·         adverse movements in exchange rates, interest rates or tax rates

·         cyclical nature of demand for our customers’ products

·         general economic conditions in the countries where we sell products

·         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 and service technology in Data I/O’s industry evolves rapidly, making timely product innovation essential to success in the marketplace.  Introducing products and services with improved technologies or features may render our existing products obsolete and unmarketable.  Technological advances that may negatively impact our business include: 

·         new device package types, densities, and technologies requiring hardware and software changes in order to be programmed by our products

·         electronics equipment manufacturing practices, such as widespread use of in-circuit programming

·         customer software platform preferences different from those on which our products operate

·         more rigid industry standards, which would decrease the value-added element of our products and support services

If we cannot develop products or services in a timely manner in response to industry changes, or if our products or services do not perform well, our business and financial condition may be adversely affected.  Also, our new products or services 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.

We have a history of recent operating losses and may be unable to generate enough revenue to achieve and maintain profitability.

We have incurred operating losses in two of the last five years and five of the last ten 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 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.

We may need to raise additional capital and our future access to capital is uncertain.

Our past revenues have occasionally been, and our future revenues may again 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 given the current economic climate 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, and our suppliers may experience financial difficulties which could effect their ability to service Data I/O’s needs.

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, if we experience deterioration in our relationship with these suppliers, or if these suppliers require financing which is not available 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 with our acquisition of 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.

If we are unable to attract and retain qualified third-party distributors and representatives, our business may be adversely affected.

Data I/O has an internal sales force and also utilizes third-party distributors and representatives.  Therefore, the financial stability of these distributors and representatives is important.  Their ability to timely pay Data I/O and to acquire any necessary financing may be affected by the current economic climate.  Highly skilled professional engineers use most of our products.  To be effective, third-party distributors and representatives 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 and representatives.  Our business will suffer if we cannot attract and retain a sufficient number of qualified third-party distributors and representatives to market our products.

Our international operations may expose us to additional risks that may adversely affect our business.

International sales represented 88%, 88% and 85% of our net revenue for the fiscal years ended December 31, 2010, December 31, 2009 and December 31, 2008, respectively.  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:

·         migration of manufacturing to low cost geographies

·         unexpected changes in regulatory requirements

·         tariffs and taxes

·         difficulties in establishing, staffing and managing foreign operations

·         longer average payment cycles and difficulty in collecting accounts receivable

·         fluctuations in foreign currency exchange rates

·         compliance with applicable export licensing requirements

·         product safety and other certification requirements

·         difficulties in integrating foreign and outsourced operations

·         civil unrest, political and economic instability

Because we have customers located throughout the world, we have significant foreign receivables.  We may experience difficulties in collecting these amounts as a result of payment practices of certain foreign customers, the availability and reliability of foreign credit information, and potential difficulties in enforcing collection terms. 

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.  China is implementing similar requirements.  Failure to meet applicable directives or qualifying exemptions may prevent us from marketing certain products in Europe or other territories with similar requirements. 

We have subsidiaries in Germany, China, Hong Kong, Brazil, and Canada.  Our business and financial condition is sensitive to currency exchange rates or any other restrictions imposed on their currencies.  Currency exchange fluctuations in these countries 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, our intellectual property software, 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 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.

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:

·         burdening management and our operating teams during the integration of the acquired entity

·         diverting management’s attention from other business concerns

·         failing to successfully integrate the acquired products

·         lack of acceptance of the acquired products by our sales channels or customers

·         entering markets where we have no or limited prior experience

·         potential loss of key employees of the acquired company

·         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, and China.  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, though no assurance can be made that this will be the case in the future.  In China, our workers are “leased” with the arrangements made under the Shanghai Foreign Services Co., Ltd.  (“FSCO”) labor agreement and we could be adversely affected if we were unable to continue that arrangement. 

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 auditor attestation required under Section 404 of the Sarbanes-Oxley Act of 2002, with which we are not currently required to comply as we are a smaller reporting company.  Data I/O assumes it will continue to have the status of a smaller reporting company based on the aggregate market value of the voting and non-voting shares held as of June 30, 2010.  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.  Regulatory and other requirements related to climate change may impact certain of our customers which might impact the demand for certain of our products.

Government regulations regarding the use of "conflict" minerals could adversely affect our prospects and results of operations.

Proposed regulatory developments regarding the use of “conflict” minerals mined from the Democratic Republic of Congo and adjoining countries could affect the sourcing and availability of minerals used in the manufacture of certain products. Although we do not buy raw materials, manufacture, or produce any electronic equipment using conflict minerals directly, the proposed regulation may affect some of our suppliers. As a result, there may only be a limited pool of suppliers who provide conflict free metals, and we cannot assure you that we will be able to obtain products in sufficient quantities or at competitive prices. Also, because our supply chain is complex, we may face reputational challenges with our customers and other stakeholders if we are unable to sufficiently verify the origins for all metals used in the products that we sell.

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 or services 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.

Item 1B.  Unresolved Staff Comments

None.

Item 2.  Properties

Data I/O has a lease agreement for the Redmond headquarters facility lease for a 40,000 square foot office space located in Redmond, Washington, expiring in 2011.  The lease base annual rental payments during 2010, 2009 and 2008 were approximately $587,000, $570,000 and $556,000, respectively. 

In addition to the Redmond facility, approximately 14,000 square feet is leased at three foreign locations, including our German sales, service and engineering operations located in Munich, Germany, under a five-year lease starting in 2010, a sales, service, and engineering office located in Shanghai, China under a two-year lease starting in 2009 and a logistics office located in Hong Kong under a one-year lease starting in 2010.

In February 2011, Data I/O entered into a lease amendment for the Redmond headquarters facility lease, extending it to August 2016, lowering the square footage to 33,676 and lowering the rental rate.

Item 3.  Legal Proceedings

As of December 31, 2010, Data I/O was not a party to any legal proceedings, the adverse outcome of which in management’s opinion, individually or in the aggregate, would have a material adverse effect on our results of operations or financial position. 

From time to time, we may be involved in litigation relating to claims arising out of our operations in the normal course of business. 

As previously disclosed, on January 22, 2008, our former landlord, (now known as Rowley Properties, Inc.), filed a Complaint in the Superior Court of Washington for King County (No. 08-2-03518-2SEA) against Data I/O, Robert/Barbara Hiester and Steven/Jane Doe Hiester.  The claims against Data I/O include breach of agreement, waste, and an environmental remediation claim for contribution under RCW 70.105D.080.  No claim amount was specified in the Complaint.  The claims relate to a former circuit board fabrication business that Data I/O operated from 1978 to October 1988.  We sold that business to Circuit Partners whose officers and principal shareholders were Robert and Barbara Hiester.  We agreed to settle this case with Rowley Properties, Inc. with the settlement amount paid by our insurer.  In April of 2009, Rowley Properties, Inc. and Data I/O entered into a mutual release and settlement agreement in which they released each other from claims related to this case and Rowley Properties, Inc. indemnified Data I/O against any claims from the other defendants related to this case.

Item 4.  [Removed and Reserved]

PART II

Item 5.  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

The following table shows, for the periods indicated, the high and low price information for Data I/O’s Common Stock as reported by the NASDAQ Capital Market (NASDAQ symbol is DAIO).  The closing price was $5.74 on December 31, 2010. 

The approximate number of shareholders of record as of March 21, 2011 was 573.

Except for special cash dividend of $4.15 per share paid on March 8, 1989, Data I/O has not paid cash dividends on our Common Stock and does not anticipate paying regular cash dividends in the foreseeable future. 

No sales of unregistered securities were made by Data I/O during the periods ended December 31, 2010 and December 31, 2009. 

See Item 12 for the Equity Compensation Plan Information.

Share repurchase program

On January 27, 2010 Data I/O’s board of directors authorized a stock repurchase program of up to 1 million shares of common stock during 2010.  The shares could be purchased in the open market, by block purchases or in private transactions, based on prevailing market conditions and price limits.  The program could be suspended or discontinued at any time.  The shares repurchased could be available for re-issuance to satisfy employee stock plans and for other corporate purposes.  The board also approved entering into a Rule 10b5-1 trading plan, which allows Data I/O to repurchase our common stock in the open market during periods in which stock trading is otherwise closed for the company.  The discretionary repurchase provisions and the 10b5-1 provisions of the program became effective in March 2010.  As of December 31, 2010, no shares have been repurchased under this program.

Item 6.  Selected Financial Data

Not applicable.

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 economic outlook, industry prospects and trends; future results of operations or financial position; breakeven revenue point; integration of acquired products and operations; market acceptance of our newly introduced or upgraded products or services; development, introduction and shipment of new products or services; changing foreign operations; and any other guidance on future periods are forward-looking statements.  Forward-

looking statements reflect management’s current expectations and are inherently uncertain.  Although Data I/O believes that the expectations reflected in these forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, achievements, or other future events.  Moreover, neither Data I/O nor anyone else assumes responsibility for the accuracy and completeness of these forward-looking statements.  Data I/O is under no duty to update any of these forward-looking statements after the date of this Annual Report.  The Reader should not place undue reliance on these forward-looking statements.  The following discussions and the section entitled “Risk Factors – Cautionary Factors That May Affect Future Results” describes some, but not all, of the factors that could cause these differences.

OVERVIEW

We continued to focus on our primary goal of managing the business to grow profits while developing, launching and enhancing products to drive revenue and earnings growth.  Our challenge continues to be operating in a cyclical and rapidly evolving industry environment.  We are continuing our efforts to balance business geography shifts, increasing costs and strategic investments in our business with the level of demand and mix of business we expect.  We have retained TM Capital as a financial advisor to assist with developing a range of strategic options for Data I/O.

We are focusing our research and development efforts in our strategic growth markets, namely new programming technology, and automated programming systems for the manufacturing environment.  We continue to focus on extending the capabilities and support for our FlashCORE architecture, and the ProLINE-RoadRunner, FLX, PS and FlashPAK product lines.  Our applications innovation strategy provides complete solutions to target customer’s business problems.  These solutions generally have a larger software element, may involve third-party components, and in many cases, will be developed or customized to address the specific requirements of individual customers.  We believe by adding these features to our strategic product platforms, we will continue to set ourselves apart from other product suppliers and elevate our relationships with our customers to a partner level. 

Our customer focus has been on strategic high volume manufacturers in key market segments like wireless, automotive, industrial controls and programming centers and supporting NAND Flash and microcontrollers on our newer products to gain new accounts.  We continued to expand our China operations to take advantage of the growth of manufacturing in China and to operate close to our customers.  In August 2010, we added Dr. Qinghua (Ching) Ma to our management team as General Manager of Data I/O China. 

We continued to address the effectiveness of our sales and marketing organization and sales channels by adding and changing channels and by providing all of our channel partners with extensive product and sales training.  We recognized the need to diversify our customer base and are continuing to take steps to broaden and improve our channels of distribution and representation to reach a greater number of customers.  We believe these channel changes helped us grow our business more rapidly, both by adding new customers and increasing penetration of existing accounts.

BUSINESSRESTRUCTURING PROGRESS

As a result of the business down turn we were experiencing in the fourth quarter of 2008 and the uncertain business outlook at that time, restructuring actions were taken to reduce expenses.  This resulted in restructuring charges, primarily related to severance, of $542,000 for the year 2008.  We took additional actions in 2009 totaling $203,000 to flatten and streamline the organization as well as reduce costs by decreasing the size of our Board and abandoning a portion of our building space.  At December 31, 2010, restructure costs of $58,000 remained accrued, which will be paid in 2011 or incorporated in a lease amendment in February 2011.

cRITICAL aCCOUNTING pOLICY jUDGMENTS AND eSTIMATES

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

Data I/O believes the following critical accounting policies affect the more significant judgments and estimates used in the preparation of our financial statements:

Revenue Recognition:  Sales of Data I/O’s semiconductor programming equipment are recognized at the time of shipment.  We have determined that our automated products have reached a point of maturity and stability such that product acceptance can be assured by testing at the factory prior to shipment and that the installation meets the criteria to be considered a separate element.  These systems are standard products with published product specifications and are configurable with standard options.  We have based this determination upon the following: standardized factory production of the units; results from batteries of tests of product performance to our published specifications; quality inspections and installation standardization; past product operation validation with customers and the history provided by our installed base of products upon which the current versions were based.  When arrangements include multiple elements, we use objective evidence of fair value to allocate revenue to the various elements and recognize revenue when the criteria for revenue recognition have been met for each element.  The amount of revenue recognized is affected by our judgments as to the collectability of the transaction or whether an arrangement includes multiple elements and if so, whether specific objective evidence of fair value exists for those elements.  The measure of stand alone fair value of the product versus the service installation value component is determined by the amount Data I/O pays to independent representative service groups or the amount of additional discount given to independent distributors, to provide the service installation.  Changes to the elements in an arrangement and the ability to establish specific objective evidence for those elements could affect the timing of the revenue recognition.  These conditions maybe subjective and actual results may vary from the estimated outcome. 

Installation that is considered perfunctory includes any installation that can be performed by other parties, such as distributors, other vendors, or in most cases the customer themselves.  This takes into account the complexity, skill, and training needed as well as customer expectations regarding installation.  The revenue related to products requiring installation that is perfunctory is recognized at the time of shipment provided that persuasive evidence of an arrangement exists, shipment has occurred, the price is fixed or determinable, and collectability is reasonably assured.

We record revenue from the sale of service and update contracts as deferred revenue and we recognize it on a straight-line basis over the contractual period, which is typically one year.

When we sell software separately, we recognize software revenue upon shipment provided that no significant obligations remain on our part, substantive acceptance conditions, if any, have been met and when the fee is fixed and determinable and when collection is deemed probable.

Certain fixed-price engineering services contracts that require significant production, modification, or customization of software, are accounted for using the percentage-of-completion method.  We use the percentage-of-completion method of accounting because it is the most accurate method to recognize revenue based on the nature and scope of certain of our fixed-price engineering services contracts. It is a better measure of periodic income results than other methods and it better matches revenue recognized with the cost incurred.  Percentage-of-completion is measured based primarily on input measures such as hours incurred to date compared to estimated total hours at completion, with consideration given to output measures, such as contract milestones, when applicable.  Significant judgment is required when estimating total hours and progress to completion on these arrangements which determines the amount of revenue we recognize as well as whether a loss is recognized if expected to be incurred upon project completion.  Revisions to hour and cost estimates are incorporated in the period the amounts are recognized if the results of the period have not been reported; otherwise, the revision of estimates are recognized in the period in which the facts that give rise to the revision become known.

We establish a reserve for sales returns based on historical trends in product returns and estimates for new items.  Data I/O has a stated return policy that customers can return standard products for any reason within 30 days after delivery, provided that the returned product is received in its original condition, including all packaging materials, for a refund of the price paid less a restocking charge of 30% of the total amount invoiced for the product returned, unless such restocking charge is waived by Data I/O.  For us to recognize revenue, the price is fixed or determinable at the date of the sale, the buyer has paid or is obligated to pay and the obligation is not contingent on resale of the product, the buyer’s obligation would not be changed in the event of theft, physical destruction or damage to the product, the buyer acquiring the product for resale has economic substance apart from Data I/O and we have  no contractual obligations for future performance to directly bring about the resale of the product by the buyer. 

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

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

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

Tax Valuation Allowances:  Given the uncertainty created by our loss history, as well as the cyclical nature of our industry and capital spending in general, Data I/O expects to continue to limit the recognition of net deferred tax assets and accounting for uncertain tax positions and maintain the tax valuation allowances.  We expect, therefore, that reversals of the tax valuation allowance will take place as we are able to take advantage of the underlying tax loss or other attributes in carry forward.  The transfer pricing and expense or cost sharing arrangements are complex areas where judgments, such as the determination of arms-length arrangements, can be subject to challenges by different tax jurisdictions. 

Share-based Compensation:  We accounted for share-based awards made to our employees and directors, including employee stock option awards and restricted and performance share awards, using the estimated grant date fair value method of accounting.  We estimate the fair value using the Black-Scholes valuation model, which requires the input of highly subjective assumptions, including the option’s expected life and the price volatility of the underlying stock.  The expected stock price volatility assumption was determined using the historical volatility of the Company’s common stock.  Changes in the subjective assumptions required in the valuation model may significantly affect the estimated value of the awards, the related stock-based compensation expense and, consequently, our results of operations.  Beginning in the second quarter of 2006, restricted stock awards were granted.  Employee Stock Purchase Plan (“ESPP”) shares were issued under provisions that do not require us to record any equity compensation expense.

Results of Operations

Net Sales

For the year ended December 31, 2010, compared to the same period of 2009, revenues increased by approximately $7.9 million or 42.3% for the year.  The increase is the result of the economic recovery that began in the third quarter of 2009 and continued through 2010.  We experienced higher revenues across all of our FlashCore product families and sales geographies.   Automated systems posted the strongest gains in 2010.  Wireless smart phone-related business was our strongest customer segment and was the first segment to adopt our new FlashCORE III technology.  Automotive and programming center-related business showed some recovery in 2010, and tablet computer manufacturers represented a new growth area, as they also selected our new FlashCore III platforms.  For non-automated systems, our FlashPAK family, primarily manual manufacturing use systems, used especially in Asia, increased 70% while our legacy Unifamily systems declined 10%.

International sales for the year ended 2010 were 88.1% of sales.  International sales increased by approximately 42.8% compared to the same period in 2009.  By geographic region, sales in Asia increased 87%, sales in Europe increased 42%, and sales in the Americas increased by 15%.  Sales in the Americas were impacted by a decline in sales in Mexico, which we attribute primarily to the violence taking place there during 2010, which impacted our customer’s location of new projects there.  Our backlog was $1.6 million on December 31, 2010 compared to $1.9 million on December 31, 2009.  Deferred revenue was $1.6 million on December 31, 2010, compared to $1.5 million on December 31, 2009.

During 2010, FlashCORE III was an important driver of business as it is focused on programming the latest high density flash devices.  It also gives us an opportunity to replace or upgrade our installed base of systems for customers using these newer devices.  During 2011, we plan to introduce additional new product solutions, software and product enhancements.

We believe that the forecast growth in the semiconductor industry, as well as expectations for capital equipment spending growth of 9% in 2011 and 10% in 2012 and the attractive growth forecast for our wireless and consumer electronics customers, combined with our new products, bodes well for growing dem and for our systems during the coming year. 

Gross Margin

Gross margins increased by approximately $5.4 million for the year ended December 31, 2010.  Gross margin as a percentage of sales in 2010 was 58.1%, compared with 53.7% in 2009.  This gross margin percentage increase, compared to 2009,was primarily due to the impact of increased sales volume relative to fixed operating costs, lower factory variances, increased software revenues and a higher-margin product mix.  These margin improvements were offset in part by the additional engineering costs associated with custom development contracts.

Research and Development

Research and development (“R&D”) spending for the year ended December 31, 2010 increased by $31,000 compared to the same period in 2009.  We increased our spending on R&D to accelerate new product initiatives, especially for outside contractor and professional services spending. Partially offsetting this was the reclassification of approximately $402,000  in engineering spending on certain custom development contracts to operating cost in cost of goods sold for 2010.  R&D spending as a percentage of sales decreased, due to the increased revenue for the year, falling back in line with our business model target of 15%.  Data I/O’s R&D objectives are focused on the development of new hardware and software offerings, as well as continued platform enhancements and application innovation for our existing product lines.

Our R&D spending also fluctuates based on the number and the development stage of projects.  New products introduced in 2010 included ProLINE-RoadRunner versions for MYDATA and SIPLACE X-Series placement machines and enhancements to FlashCORE III, our new programming architecture.

We believe it is essential to invest in R&D to significantly enhance our existing products and to create new products as markets develop and technologies change.  In addition to product development, a significant part of R&D spending is on creating software and support for new devices introduced by the semiconductor companies.  We are focusing our R&D efforts on strategic growth markets, including new programming technology and automated programming systems for the manufacturing environment; particularly extending the capabilities and support for our FlashCORE programmer architecture and automated handling solutions. 

Selling, General and Administrative

Selling, general and administrative (“SG&A”) expenses were up $1.2 million or 18% for the year 2010 compared with 2009.  The primary items resulting in this increase were:

• Higher incentive compensation of $427,000, due to improved and above-target financial results
• Increased sales commissions of $222,000, due to increased commissionable sales volume
• Increased personnel costs of $322,000 due to new hires, raises, benefits and unused vacation accruals 
• Increased use of professionals and consultants of $190,000 for information technology projects, investor relations, training, recruiting and board consultants

Interest

Interest income increased by $1,000 for the twelve month period ending December 31, 2010 compared to the same period in 2009 due to the higher cash balance.  Interest expense decreased for the twelve month period ending December 31, 2010 compared to the same period in 2009 due to lower balances on the equipment capital lease.

Income Taxes

Income tax expense for 2010 relates to foreign and state income taxes and the Federal alternative minimum tax.  For 2009, income tax expense was related to foreign and state income taxes. 

For financial reporting purposes, Data I/O established tax valuation reserves against our deferred tax assets because of the uncertainty relating to the realization of such asset values.  We had valuation allowances of $9.0 million and $9.3 million at December 31, 2010 and 2009, respectively.  Given the uncertainty created by our past loss history and the cyclical nature of the industry in which we operate, we expect to continue to limit the recognition of net deferred tax assets and maintain the tax valuation allowances.

Inflationand 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 and (losses) of ($268,000) and $176,000 in 2010 and 2009, respectively.  The transaction gains or losses resulted primarily from translation adjustments to foreign inter-company accounts; sales by our German subsidiary to certain customers, which were invoiced in US dollars; and unhedged Brazilian intercompany balances.   

Financial Condition

Liquidity and Capital Resources

At December 31, 2010, Data I/O’s principal sources of liquidity consisted of existing cash and cash equivalents.  Our working capital increased by approximately $3.9 million during 2010 and our current ratio was 5.2 for both 2010 and 2009. 

For the year ended December 31, 2010, our cash and cash equivalents increased by $3.3 million, primarily due to cash received from operating activities totaling approximately $4.3 million.

We used approximately $1.1 million of cash from investing activities during the year ended December 31, 2010 to purchase property, plant and equipment.  We expect that we will continue to make capital expenditures to support our business and anticipate that present working capital will be sufficient to meet our operating requirements.  Capital expenditures are expected to be funded by existing and internally generated funds or lease financing.

As a result of our significant product development, customer support, international expansion and selling and marketing efforts, we require substantial working capital to fund our operations.  Over the last several years, we restructured our operations to lower our costs and operating expenditures in certain geographic regions and to lower the level of revenue required for our net income breakeven point, to preserve our cash position and to focus on profitable operations.  Offsetting these actions are our investments in expanded operations in China, equipment, and hiring new key personnel.  Given our strong cash position of $18.9 million as of December 31, 2010, we believe that we have sufficient working capital available under our operating plan to fund our operations, business investment and capital requirements through at least December 31, 2011.  Any substantial inability to achieve our current business plan could have a material adverse impact on our financial position, liquidity, or results of operations and may require us to reduce expenditures and/or seek additional financing.

Long-term debt

During the third quarter of 2006, the Company entered into a five year capital lease agreement in the amount of $591,145.  The lease was used to fund new equipment and installation associated with our move to the new facility in July of 2006.  The remaining amount accrued relating to this lease is in the current portion of long-term debt.

OFF-balance sheet arrangements

Except as noted in Note 8, “Operating Lease and Other Commitments,” Data I/O had no off-balance sheet arrangements.

Share repurchase program

On January 27, 2010 Data I/O’s board of directors authorized a stock repurchase program of up to 1 million shares of common stock during 2010.  Shares could be purchased in the open market, by block purchases or in private transactions, based on prevailing market conditions and price limits.  The program could be suspended or discontinued at any time.  The shares repurchased could be available for re-issuance to satisfy employee stock plans and for other corporate purposes.  The board also approved entering into a Rule 10b5-1 trading plan, which allows Data I/O to repurchase our common stock in the open market during periods in which stock trading is otherwise closed for the company.  The discretionary repurchase provisions and the 10b5-1 provisions of the program became effective in March 2010.  As of December 31, 2010 no shares have been repurchased under this program.

Share holder Rights Plan

Data I/O’s Shareholder Rights Plan dated April 4, 1998 was scheduled to expire on April 4, 2008.  Data I/O’s Board of Directors amended and extended the Shareholder Rights Plan for an additional 10-year term on April 3, 2008.

NEWACCOUNTINGPRONOUNCEMENTS

In January 2010, the FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements ("ASU 2010-06"), which amends the disclosure guidance with respect to fair value measurements. Specifically, the new guidance requires disclosure of amounts transferred in and out of Levels 1 and 2 fair value measurements, a reconciliation presented on a gross basis rather than a net basis of activity in Level 3 fair value measurements, greater disaggregation of the assets and liabilities for which fair value measurements are presented and more robust disclosure of the valuation techniques and inputs used to measure Level 2 and 3 fair value measurements. ASU 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2009, with the exception of the new guidance around the Level 3 activity reconciliations, which is effective for fiscal years beginning after December 15, 2010.  The impact of adoption of this standard had no financial effect on the accompanying consolidated financial statements.

In October 2009, the FASB issued ASU No. 2009-13, Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements (“ASU 2009-13”). It provides amendments to the criteria for separating consideration in multiple-deliverable arrangements. This standard establishes a selling price hierarchy for determining the selling price of a deliverable. The selling price used for each deliverable will be based on vendor-specific objective evidence if available, third-party evidence if vendor-specific objective evidence is not available, or estimated selling price if neither vendor-specific objective evidence nor third-party evidence is available. This standard also replaces the term fair value in the revenue allocation guidance with selling price to clarify that the allocation of revenue is based on entity-specific assumptions rather than assumptions of a market participant. It also eliminates the residual method of allocation and requires that arrangement consideration be allocated at the inception of the arrangements to all deliverables using the relative selling price method. This standard will be effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Early adoption is permitted. We are currently assessing the potential impact that adoption of this standard may have on our consolidated financial statements.

In October 2009, the FASB issued ASU No. 2009-14, Software (Topic 985): Certain Revenue Arrangements That Include Software Elements (“ASU 2009-14”).  According to this update, tangible products containing software components and non-software components that function together to deliver the tangible product’s essential functionality are no longer within the scope of the software revenue guidance. This standard requires that hardware components of a tangible product containing software components always be excluded from the software revenue guidance. It provides additional guidance on how to determine which software, if any, relating to the tangible product also would be excluded from the scope of the software revenue guidance. This standard will be effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Early adoption is permitted. This standard shall be adopted in the same period using the same transition method as indicated in the update to revenue arrangements with multiple deliverables. We are currently assessing the potential impact that adoption of this standard may have on our consolidated financial statements.

Item 7A.  Quantitative and Qualitative Disclosures About Market Risk

Not applicable.

Item 8.  Financial Statements and Supplementary Data

See pages 26 through 42.

Board of Directors and Stockholders
Data I/O Corporation

We have audited the accompanying consolidated balance sheets of Data I/O Corporation and subsidiaries (the Company) as of December 31, 2010 and 2009, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the two years in the period ended December 31, 2010.  Our audits of the basic consolidated financial statements included the consolidated financial statement schedule (Schedule II).  These consolidated financial statements and consolidated financial statement schedule are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these consolidated financial statements and consolidated financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting.  Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting.  Accordingly, we express no such opinion.  An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Data I/O Corporation and subsidiaries as of December 31, 2010 and 2009, and the consolidated results of its operations and its consolidated cash flows for each of the two years in the period ended December 31, 2010 in conformity with accounting principles generally accepted in the United States of America.  Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.

See notes to consolidated financial statements

See notes to consolidated financial statements

DATA I/O CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations

Data I/O Corporation (“Data I/O”) designs, manufactures, and sells programming systems used by designers and manufacturers of electronic products.  Our programming system products are used to program integrated circuits (“ICs” or “devices” or “semiconductors”) with the specific unique data necessary for the ICs contained in various products, and are an important tool for the electronics industry experiencing growing use of programmable ICs.  Customers for our programming system products are located around the world, primarily in the United States, Europe and the Far East.  Our manufacturing operations are currently located in the United States, with most of our FlashCORE adapters manufactured in China.  An outside supplier located in Germany currently manufactures our Sprint non-automated programming systems.

Principles of Consolidation

The consolidated financial statements include the accounts of Data I/O Corporation and our wholly-owned subsidiaries.  Intercompany accounts and transactions have been eliminated in consolidation.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.

Significant estimates include:

·         Revenue Recognition

·         Allowance for Doubtful Accounts

·         Inventory

·         Warranty Accruals

·         Tax Valuation Allowances

·         Share-based Compensation

Foreign Currency Translation

Assets and liabilities of foreign subsidiaries are translated at the exchange rate on the balance sheet date.  Revenues, costs and expenses of foreign subsidiaries are translated at average rates of exchange prevailing during the year.  Translation adjustments resulting from this process are charged or credited to stockholders’ equity, net of taxes recognized.  Realized and unrealized gains and losses resulting from the effects of changes in exchange rates on assets and liabilities denominated in foreign currencies are included in non-operating expense as foreign currency transaction gains and losses.

Cash and Cash Equivalents

All highly liquid investments purchased with an original maturity of 90 days or less are considered cash equivalents.  The Company maintains its cash and cash equivalents with major financial institutions in the United States of America, which are insured by the Federal Deposit Insurance Corporation (FDIC), and foreign jurisdictions.  Deposits in U.S. banks may exceed the FDIC insurance limit.  The Company has not experienced any losses on its cash and cash equivalents.  Cash and cash equivalents held in foreign bank accounts totaled $6,943,755 at December 31, 2010.

Fair Value of Financial Instruments

Certain financial instruments are carried at cost on the consolidated balance sheets, which approximates fair value due to their short-term, highly liquid nature.  These instruments include cash and cash equivalents, accounts receivable, accounts payable and accrued expenses, other short-term liabilities, and capital lease obligations.

Accounts Receivable

The majority of Data I/O’s accounts receivable are due from companies in the electronics manufacturing industries.  Credit is extended based on an evaluation of a customer’s financial condition and, generally, collateral is not required.  Accounts receivable are typically due within 30 to 60 days and are stated at amounts due from customers net of an allowance for doubtful accounts.  Accounts receivable outstanding longer than the contractual payment terms are considered past due.  Data I/O determines the allowance by considering a number of factors, including the length of time trade accounts receivable are past due, the industry and geographic payment practices involved, Data I/O’s previous bad debt experience, the customer’s current ability to pay their obligation to Data I/O, and the condition of the general economy and the industry as a whole.  Data I/O writes off accounts receivable when they become uncollectible, and payments subsequently received on such receivables are credited to the allowance for doubtful accounts.  Interest may be accrued, at the discretion of management and according to our standard sales terms, beginning on the day after the due date of the receivable.  However, interest income is subsequently recognized on these accounts either to the extent cash is received, or when the future collection of interest and the receivable balance is considered probable by management.

Inventories

Inventories are stated at the lower of cost or market with cost being the currently adjusted standard cost, which approximates cost on a first-in, first-out basis.  We estimate changes 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  an adjustment (lower of cost or market) accordingly.

Property, Plant and Equipment

Property, plant and equipment, including leasehold improvements, are stated at cost and depreciation is calculated over the estimated useful lives of the related assets or lease terms on the straight-line basis.  We depreciate substantially all manufacturing and office equipment over periods of three to seven years.  We depreciate leasehold improvements over the remaining portion of the lease or over the expected life of the asset if less than the remaining term of the lease.

The Company regularly reviews all of its long-lived assets, including property, plant and equipment, and amortizable intangible assets, for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. If the total of future undiscounted cash flows is less than the carrying amount of these assets, an impairment loss, if any, based on the excess of the carrying amount over the fair value of the assets, is recorded.  Based on this evaluation, no impairment was noted for the years ended December 31, 2010 and 2009.

Intangible Assets

Intangible assets include capitalized costs, technical and product rights, patent, trademarks, and other intellectual property.  Intangible assets are stated at cost and amortized to operations over their estimated useful lives or statutory lives, whichever is shorter.  Capitalized intangible assets are included in other long term assets on the balance sheet.  We evaluate our intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable using a fair value approach.  No such impairment was recognized for the years ended December 31, 2010 and 2009.

Patent Costs

We expense external costs, such as filing fees and associated attorney fees, incurred to obtain patents. We also expense costs associated with maintaining and defending patents subsequent to their issuance.

Income Taxes

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 realizability of the related deferred tax assets.  A valuation allowance is established when necessary to reduce deferred tax assets to amounts expected to be realized. 

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. 

Revenue Recognition

Data I/O recognizes revenue at the time the product is shipped.  We have determined that our programming equipment has reached a point of maturity and stability such that product acceptance can be assured by testing at the factory prior to shipment and that the installation meets the criteria to be considered a separate element.  These systems are standard products with published product specifications and are configurable with standard options.  The evidence that these systems could be deemed as accepted was based upon having standardized factory production of the units, results from batteries of tests of product performance to our published specifications, quality inspections and installation standardization, as well as past product operation validation with the customer and the history provided by our installed base of products upon which the current versions were based.   When arrangements include multiple elements, we use objective evidence of fair value to allocate revenue to the elements and recognize revenue when the criteria for revenue recognition have been met for each element according to U.S. GAAP.  The amount of revenue recognized is affected by our judgments as to the collectability of the transaction or whether an arrangement includes multiple elements and if so, whether specific objective evidence of fair value exists for those elements.  The measure of standalone fair value of the product versus the service installation value component is by the amount the Company pays to independent representative service groups or the amount of additional discount given to independent distributors to provide the service installation (published price).

Installation that is considered perfunctory includes any installation that can be performed by other parties, such as distributors, other vendors, or in most cases the customers themselves.  This takes into account the complexity, skill, and training needed as well as customer expectations regarding installation.  The revenue related to products requiring installation that is perfunctory is recognized at the time of shipment provided that persuasive evidence of an arrangement exists, shipment has occurred, the price is fixed or determinable, and collectability is reasonably assured.

We record revenue from the sale of service and update contracts as deferred revenue and we recognize it on a straight-line basis over the contractual period, which is typically one year.  We establish a reserve for sales returns based on historical trends in product returns and estimates for new items.  We have a stated return policy that customers can return standard products for any reason within 30 days after delivery provided that the returned product is received in its original condition, including all packaging materials, for a refund of the price paid less a restocking charge of 30% of the total amount invoiced for the product returned, unless such restocking charge is waived by us. We recognize revenue when, the price is fixed or determinable, the buyer has paid or is obligated to pay and the obligation is not contingent on resale of the product, the buyer’s obligation would not be changed in the event of theft, physical destruction or damage to the product, the buyer acquiring the product for resale has economic substance apart from the Company and we do not have significant obligations for future performance to directly bring about the resale of the product by the buyer. 

Sales were recorded net of actual sales returns and changes to the associated sales return reserve.  Sales return reserves were $66,000 and $102,000 at December 31, 2010 and 2009, respectively. 

When we sell software separately, we recognize software revenue upon shipment provided that no significant obligations remain on our part, substantive acceptance conditions, if any, have been met and when the fee is fixed and determinable and when collection is deemed probable.

Certain fixed-price engineering services contracts that require significant production, modification, or customization of software, are accounted for using the percentage-of-completion method.  We use the percentage-of-completion method of accounting because it is the most accurate method to recognize revenue based on the nature and scope of certain of our fixed-price engineering services contracts. It is a better measure of periodic income results than other methods and it better matches revenue recognized with the cost incurred.  Percentage-of-completion is measured based primarily on input measures such as hours incurred to date compared to estimated total hours at completion, with consideration given to output measures, such as contract milestones, when applicable.  Significant judgment is required when estimating total hours and progress to completion on these arrangements which determines the amount of revenue we recognize as well as whether a loss is recognized if expected to be incurred upon project completion.  Revisions to hour and cost estimates are incorporated in the period the amounts are recognized if the results of the period have not been reported; otherwise, the revision of estimates are recognized in the period in which the facts that give rise to the revision become known.

Data I/O transfers certain products out of service from their internal use and makes them available for sale.  The products transferred are 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.

Research and Development

Research and development costs are expensed as incurred.

Advertising Expense

Data I/O expenses advertising costs as incurred.  Total advertising expenses were approximately $197,000 and $97,000 in 2010 and 2009, respectively. 

Warranty Expense

Data I/O records a liability for an estimate of costs that it expects to incur under our basic limited warranty when product revenue is recognized.  Factors affecting our warranty liability include the number of units sold and historical and anticipated rates of claims and costs per claim.  Data I/O normally warrants our products against defects for periods ranging from ninety days to one year.  We provide for the estimated cost that may be incurred under our product warranties and periodically assess the adequacy of our warranty liability based on changes in the above factors.  Data I/O records revenues on extended warranties on a straight-line basis over the term of the related warranty contracts.  Service costs are expensed as incurred. 

Earnings (Loss) Per Share

Basic earnings (loss) per share exclude any dilutive effects of stock options.  Basic earnings (loss) per share are computed using the weighted-average number of common shares outstanding during the period.  Diluted earnings per share are computed using the weighted-average number of common shares and common stock equivalent shares outstanding during the period.  The common stock equivalent shares from equity awards used in calculating diluted earnings per share were 125,089 and 0 for the years ended December 31, 2010 and 2009 respectively.  Options to purchase 48,148 and 739,777 shares of common stock were outstanding as of December 31, 2010 and 2009, respectively, but were excluded from the computation of diluted EPS for the period then ended because the options were anti-dilutive. 

Diversification of Credit Risk

Financial instruments, which potentially subject Data I/O to concentrations of credit risk, consist primarily of trade receivables.  Our trade receivables are geographically dispersed and include customers in many different industries.  At December 31, 2010, there were no customers that represented 10% or more of our total consolidated accounts receivable balance.  As of December 31, 2009, the combined subsidiaries accounts receivable of one customer, Flextronics, represented approximately 23.2% of our total consolidated accounts receivable balance and there were no other customers that represented 10% or more.    We believe that risk of loss is significantly reduced due to the diversity of our end-customers and geographic sales areas.  We perform on-going credit evaluations of our customers’ financial condition and require collateral, such as letters of credit and bank guarantees, or prepayment whenever deemed necessary.

Derivatives

Data I/O accounts for derivative instruments and hedging activities under ASC 815 “Derivatives and Hedging Activities.”  These standards require recognition of derivatives as assets or liabilities in the statement of financial position and measurement of those instruments at fair value. 

In 2009, Data I/O utilized forward foreign exchange contracts to reduce the impact of foreign currency exchange rate risks in situations where natural hedging strategies cannot be effectively employed.  All of our hedging instruments, when used, are fair value hedges.  Generally, these contracts have maturities less than one year and requireus to exchange foreign currencies for U.S. dollars at maturity.  As of December 31, 2009 we had closed out all hedges and had no foreign exchange contracts outstanding.  We did not employ foreign currency hedging in 2010.

Data I/O does not hold or issue derivative financial instruments for trading purposes.  The purpose of our hedging activities is to reduce the risk that the valuation of the underlying assets, liabilities and firm commitments will be adversely affected by changes in exchange rates.  Our derivative activities help minimize foreign currency exchange rate risk because fluctuations in the value of the instruments used for hedging purposes are offset by fluctuations in the value of the underlying exposures being hedged.  We are exposed to credit-related losses in the event of nonperformance by counterparties to forward exchange contracts.  However, we have entered into these instruments with creditworthy financial institutions and consider the risk of nonperformance remote. 

New Accounting Pronouncements

In January 2010, the FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements ("ASU 2010-06"), which amends the disclosure guidance with respect to fair value measurements. Specifically, the new guidance requires disclosure of amounts transferred in and out of Levels 1 and 2 fair value measurements, a reconciliation presented on a gross basis rather than a net basis of activity in Level 3 fair value measurements, greater disaggregation of the assets and liabilities for which fair value measurements are presented and more robust disclosure of the valuation techniques and inputs used to measure Level 2 and 3 fair value measurements. ASU 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2009, with the exception of the new guidance around the Level 3 activity reconciliations, which is effective for fiscal years beginning after December 15, 2010.  The impact of adoption of this standard had no financial effect on the accompanying consolidated financial statements.

In October 2009, the FASB issued ASU No. 2009-13, Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements (“ASU 2009-13”). It provides amendments to the criteria for separating consideration in multiple-deliverable arrangements. This standard establishes a selling price hierarchy for determining the selling price of a deliverable. The selling price used for each deliverable will be based on vendor-specific objective evidence if available, third-party evidence if vendor-specific objective evidence is not available, or estimated selling price if neither vendor-specific objective evidence nor third-party evidence is available. This standard also replaces the term fair value in the revenue allocation guidance with selling price to clarify that the allocation of revenue is based on entity-specific assumptions rather than assumptions of a market participant. It also eliminates the residual method of allocation and requires that arrangement consideration be allocated at the inception of the arrangements to all deliverables using the relative selling price method. This standard will be effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Early adoption is permitted. We are currently assessing the potential impact that adoption of this standard may have on our consolidated financial statements.

In October 2009, the FASB issued ASU No. 2009-14, Software (Topic 985): Certain Revenue Arrangements That Include Software Elements (“ASU 2009-14”).  According to this update, tangible products containing software components and non-software components that function together to deliver the tangible product’s essential functionality are no longer within the scope of the software revenue guidance. This standard requires that hardware components of a tangible product containing software components always be excluded from the software revenue guidance. It provides additional guidance on how to determine which software, if any, relating to the tangible product also would be excluded from the scope of the software revenue guidance. This standard will be effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Early adoption is permitted. This standard shall be adopted in the same period using the same transition method as indicated in the update to revenue arrangements with multiple deliverables. We are currently assessing the potential impact that adoption of this standard may have on our consolidated financial statements.

NOTE 2 – RECLASSIFICATIONS

Certain prior periods’ balances have been reclassified to conform to the presentation used in the current period. 

NOTE 3 – PROVISION FOR BUSINESS RESTRUCTURING

As a result of the business down turn we were experiencing in the fourth quarter of 2008 and the uncertain business outlook at that time, restructuring actions were taken to reduce expenses.  This resulted in restructuring charges, primarily related to severance, of $542,000 for the year.  We took additional actions in 2009 totaling $203,000 to flatten and streamline the organization as well as reduce costs by decreasing the size of our Board and abandoning a portion of our building space.  At December 31, 2010, restructure costs of $58,000 remained accrued.

An analysis of the restructuring is as follows (in thousands):