Data I/O Corp (DAIO) 2010 Q4 法說會逐字稿

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  • Operator

  • Ladies and gentlemen, thank you for standing by and welcome to the Data I/O fourth-quarter, financial results conference call.

  • (Operator Instructions)As reminder, today's call is being recorded.

  • I will now turn the call over to your host, President and CEO, Fred Hume.

  • Please go ahead, sir.

  • - President and CEO

  • Thank you, Kevin, and welcome to the Data I/O Corporation fourth-quarter and 2010 financial results conference call.

  • With me today is Joel Hatlen, Vice President and Chief Financial Officer of Data I/O.This afternoon Joel and I will discuss the fourth quarter of 2010 operating results and present it in the context of the whole year as well as the operating environment of 2011.

  • Before we begin, I would like to remind you that the statements made in this conference call concerning future revenues, results from operations, financial position, economic conditions, product releases and any other statement that may be construed as a prediction of future performance or events are forward-looking statements, which involve known and unknown risks, uncertainties and other factors which may cause actual results to differ materially from those expressed or implied by such statements.

  • These factors include uncertainties as to levels of orders, ability to record revenues based upon the timing of product deliveries and installations, market acceptance of new products, changes in economic conditions and market demand, pricing and other activities by competitors, and other risks including those described from time to time in the Company's filings on Forms 10-K and 10-Q with the Securities and Exchange Commission, press releases and other communications.

  • The accuracy and completeness of forward-looking statements should not be unduly relied upon.

  • Data I/O is under no duty to update any of these forward-looking statements.

  • Revenues for the fourth quarter of 2010 were $6.9 million, up 40% compared to $5 million in the fourth quarter of 2009.

  • Net income in the fourth quarter was $611,000 or $0.07 per diluted share compared with net income of $6000 in the fourth quarter of 2009.

  • For the year, revenues were $26.4 million, up 42% from the revenues of $18.5 million recorded in 2009.

  • Net income for the year was $3 million compared to a loss of $811,000 recorded in 2009.

  • Cash increased $1.4 million in the quarter to end at $18.9 million, compared to $15.6 million at the end of 2009.

  • Orders for the fourth quarter of 2010 were $6.6 million.

  • Backlog at the end of the quarter was $1.6 million.

  • During 2010, our business rebounded sharply from the depths of the 2009 recession, with a marked improvement starting right from the first quarter.

  • The momentum continued throughout the year.

  • While orders in the fourth quarter of 2010 were down from the $7.3 million recorded in the third quarter, they were consistent with the industry wide seasonal dip in electronics production that occurred in late November and December as reported in the Henderson electronic market forecast.

  • We are already seeing the signs of a rebound from that momentary pause and believe that 2011 will be another good year for us.

  • Consistent with our recent order patterns, JPMorgan's global manufacturing index jumped to 57.2 in January from 55.6 this past December.

  • Yet Henderson says that in 2011, quote, A happy confluence of economics and product innovation will drive demand.

  • His forecast of 50% growth in smart phones combined with explosive growth in new mobile devices portends a good year ahead for us.

  • He estimates the global electronics production will expand 9% in 2011 off of the recovered base of 2010.

  • And that capital equipment, such as ours, and consumer durables, will be the engines of growth for the next three years.

  • 2010 was a great year of accomplishments for us at Data I/O.

  • Our Asia sales team was successful with manufacturers in Asia, building Android handsets, handsets for Apple, tablet computers and products for Microsoft including Kinect.

  • In addition to record sales in Asia and a very strong rebound in Europe, we had great success in capturing many new customers.

  • Our sales channels in the Americas brought us 28 new accounts in the fourth quarter alone.

  • Our FlashCORE three programmer launched at the end of 2009, contributed to our growth and success with new accounts.

  • We continue to build on its capability with support for embedded flash media.

  • We introduced three new versions of our ProLINE RoadRunner product and made good progress on several of the new business initiatives that will result in new products for 2011.

  • We also made great progress on our security and process control software initiatives, generating more than $1 million in revenue from custom software modules that will be integrated into a software suite that we will introduce to the market later this year.

  • In the fourth quarter we expanded our use of outside contractors to accelerate the schedules of our growth initiatives.

  • Although this short-term expense impacted the fourth-quarter results, the additional expense will more than offset the additional growth -- by the additional growth profit generated from new products to be introduced in 2011.

  • In 2010, we continued to strengthen the organization for future growth.

  • We replaced the leader of our China subsidiary with Dr.

  • Qinghua, a great addition to our team.

  • Ching has increased our level of engagement with Asian customers and we had a record year for sales and shipments in China.We hired a new leader for our software engineering team in Redmond that has been very effective in building new competencies.

  • We were saddened with the passing of the leader of our service team in Europe last year, but we have hired an excellent replacement and have strengthened our service organization in the USand are sending one of our service engineers based here, to spend the next year in Shanghai.

  • By the end of the year, we had completed our vision 2015 plan.

  • This unifying vision builds on the financial leverage we have created in the past three years as the platform for our ten new product business initiatives that will propel our growth over the next five years.

  • In 2010 we were honored with numerous awards.

  • The Association of Washington Business, an industry association with 7,300 member firms, named us as manufacturer of the year in recognition of our commitment to business excellence, entrepreneurial spirit and our ability to successfully and creatively find solutions to challenges that raise or enhance the industry standard.

  • We won the NPI award and the SMP vision award, both at the APEX trade show and the EMAsia Innovation award, all for the FlashCORE III.

  • Our Board of Directors has recently retained the services of TM Capital to help us explore strategic options that will enable us to deliver ever greater levels of shareholder value.

  • The principles of TM Capital are working closely with the management team in this endeavor.

  • I'm also pleased to announce that Douglas W.

  • Brown has been appointed to the Board of Directors, effective April 1, of this year.

  • Doug is the President and CEO of All Star Directories, an Internet services business in Seattle.

  • Under Doug's leadership All Star Directories has become one of the fastest growing firms in the region.

  • Before joining All Star in 2005, Doug was the President of Go Ahead Software, President of a division of Leggett and Platt, a fortune 500 manufacturer, a principal with Phoenix Partners, a venture capital firm and CFO of Seattle Silicon.

  • Doug was named the Ernst & Young Entrepreneur of the Year and is the former Chairman of the MIT Enterprise Forum.

  • He is a CPA with proven financial acumen and has been on the Board of ten venture funded and bootstrapped companies.

  • I have known Doug for many years.

  • He will add substantial value to our Company as a new Director.

  • At this time, I'll ask Joel to provide you with more information about the fourth-quarter and the full-year 2010 financial results.

  • Joel?

  • - VP and CFO

  • Thank you, Fred.

  • Good day to everyone.

  • Revenues for the fourth-quarter of 2010 were $6.9 million, up 40% compared to the $5 million in the fourth quarter of 2009, and up 5% sequentially compared to the $6.6 million in the third quarter of 2010.

  • International sales represented 89% of total sales for the quarter.

  • Revenue increased in Asia 70% and in Europe 72%, while the Americas declined by 8% compared to the fourth-quarter of 2009.

  • The America sales were impacted by a decline in the sales in Mexico that we believe is attributed to the effect of the violence that has been taking place there.

  • Orders increased 11% in the fourth-quarter 2010 compared to the same period in 2009, with Asia up 47%, Europe up 18% and the Americas down 21%.

  • The variation in sales percentages versus order percentages relate to the changes in backlog and deferred revenues.

  • Backlog at the end of the quarter was $1.6 million, down from $1.7 million at the start of the quarter and from $1.9 million on December 31, 2009.

  • Deferred revenue at the end of the quarter was $1.6 million, down from $1.9 million at the start of the quarter, as we were able to recognize a large PS system that was shipped and invoiced in the third quarter but the customer's timing of installation and acceptance took place in the fourth quarter.

  • We saw our PS family as particularly benefiting from the growth in demand from Europe and Asia with smart phones, tablet computers and automotive applications driving a more than 45% increase in our automated product lines in the fourth quarter 2010 compared to the same period in 2009.

  • The gross margin, as a percentage of sales, was 56.4% for the fourth quarter 2010, up from 53.4% for the fourth quarter 2009.

  • The primary causes for the improvements were due to the effect of increased sales volume relative to fixed factory and service costs as well as the product and sales channel mix.

  • Partially offsetting this was the inclusion of additional development costs, charged operations associated with software contract revenues.

  • Operating expenses were $3.3 million in the fourth quarter 2010 compared to $2.8 million in the fourth quarter 2009.

  • The increase in research and development of $260,000 was primarily due to the use of outside resources to accelerate our growth initiatives.

  • The increase in sales, general and administrative expense was related to increased use of outside professional consultants and contractors, higher compensation costs, and higher incentive compensation based on financial results.

  • In accordance with US generally accepted accounting principles, GAAP, net income was $611,000 or $0.07 per diluted share for the fourth quarter of 2010, compared to a net income of $6,000 or no cents per share for the fourth quarter of 2009.

  • Earnings per share included the impact of equity compensation expense of $0.01 per share for both the fourth quarter of 2010 and 2009.

  • We had an income tax provision for the quarter due to taxable profits in foreign locations as well as certain states and the federal alternative minimum tax.

  • We have net operating loss carry forward, NOLs, of $16 million as well as other credit carry forwards that in the United States are available to offset future US net income.

  • And we will continue to analyze and manage taxes to take advantage of these tax attributes.

  • For the year ended December 31, 2010, revenue increased 42% to $26.4 million from $18,5 million for 2009, reflecting the recovery that is taking place in the electronics industry as well as the success of our award-winning FlashCORE III technology in the market.

  • For the year 2010, net income increased to $3 million or $0.33 earnings per share from a net loss of $811,000 or $0.09 loss per share for 2009.

  • For the year, gross margin as a percentage of sales was 58.1% compared with 53.7% in 2009.

  • The change in gross margin percentage for the year 2010, was again, primarily due to the impact of increased sales volumes relative to fixed operating costs while lower factory variances, increased software revenues and a higher margin product mix contributed to the increase.

  • These increases were offset in part by the additional engineering costs associated with the software development contracts.

  • Operating expenses increased due to commissions on higher sales volumes, higher incentive compensation based on financial results, and higher compensation expense in the use of additional professional consultants and contractors.

  • Data I/O's cash increased to $18.9 million at the end of the fourth quarter.

  • Accounts receivable decreased to $5 million from $5.5 million last quarter primarily due to the collection of deferred revenues during the quarter as well as sales taking place relatively early in the quarter allowing collections to occur.

  • Inventories decreased to $3.6 million at the end of the fourth quarter compared to $3.9 million at December 31, 2009, reflecting our efforts to reduce inventory levels and compared to $3.9 million at the end of the third quarter, due to the reduced deferred revenue related inventory.

  • At this point, I'll turn the discussion back to Fred.

  • - President and CEO

  • Thank you, Joel.

  • Thank you very much for being with us today and at this time we would like to take your questions.

  • Kevin?

  • Operator

  • (Operator Instructions)Your first question is from the line Dave Kanen, First Midwest.

  • Please go ahead.

  • - Analyst

  • Good afternoon, gentlemen.

  • Congratulations.

  • - President and CEO

  • Thank you, Dave, very much.

  • - Analyst

  • First, I missed some of the commentary that you gave previously.

  • I noticed OPEX was up to about $3.3 million.

  • Was there anything -- you gave an explanation; I kind of missed it.

  • Could you just take me through that again, please?

  • - President and CEO

  • Sure, Dave.

  • Joel, would you cover that?

  • - VP and CFO

  • Operating expenses went up by $490,000 during the quarter, with research and development going up $260,000.

  • That was primarily due to the use of outside resources.

  • That is contractors, patent attorneys, consultants, those types of activities to help us, basically, accelerate our growth initiatives.

  • The increase that was relative to sales general and administrative expense, was related, again, to increased use of professional consultants, higher compensation costs and higher then incentive compensation based on our financial results.

  • - Analyst

  • Okay, is some of that OPEX at $3.3 million somewhat anomalous or is this going to be the new level going forward?

  • Will you drop back down to $3 million and below?

  • - President and CEO

  • Dave, we took advantage of an opportunity to bring in some outside talent to help us accelerate some of our critical growth initiatives for 2011, new products that we plan to release in 2011.

  • So, these are not permanent additions to staff but these are outside contractors that provide some additional resource to help us accelerate things in 2011.

  • We do not view it as a long-term addition to our run rate.

  • - Analyst

  • Okay.

  • So, Joel, can you break out for me how much was year-end bonus versus these outside contractors and some of these projects for your growth initiatives?

  • So I can get a sense as to where we normalize going forward?

  • - VP and CFO

  • Yes, for the quarter we had incentive compensation of $171,000 compared to $77,000 a year ago.

  • - Analyst

  • Okay.

  • And then, how about some of these project related costs that you think are, at some point, nonrecurring?

  • - VP and CFO

  • I don't have those in particular with me.

  • If I look at the total amount of those, of the $260,000, less than half of it was related to our internal type expenses and well over half of that amount was related to software contractors that we hired, patent attorneys that we brought in, other technical experts we got to consult on getting things moved forward.

  • Is that helpful?

  • I can try and do something further if there's a specific question.

  • - Analyst

  • Yes, I get an idea.

  • Okay.

  • And then Fred, if you can comment more on the higher retention of TM Capital and you exploring a range of strategic options, included in that would also be the potential sale of the Company.

  • Would that be one of the options or is that not on the table?

  • - President and CEO

  • Dave, you know, I do not really want to comment on it specifically other than to say that, strategic alternatives represents a broad variety of things that we're looking at.

  • As I mentioned earlier, we have 10 different growth initiatives.

  • We have a number of things that we are doing right now.

  • We've have added a new director.

  • So, there's just a range of things that we need some assistance on.

  • - Analyst

  • Okay.

  • So, it could be an acquisition but it could also could be you being acquired?

  • It could be just advice on where to deploy your resources for growth.

  • Everything is on the table, is that what you are saying?

  • - President and CEO

  • Yes.

  • There is a wide number of the things that we have asked them to look at for us.

  • - Analyst

  • Okay.

  • I am going to go back into listening mode.

  • I may have a follow-up.

  • Thanks.

  • - President and CEO

  • Okay.

  • Operator

  • Our next question is from the line of Paul Johnson.

  • Please state your company name, sir.

  • - Analyst

  • He doesn't want to.

  • Nicusa Capital.

  • Fred, Joel.

  • - President and CEO

  • Hi, Paul.

  • How are you?

  • - Analyst

  • I wanted to follow-up on one of the questions that Dave just talked about and then ask a slightly different question.

  • On R&D side, what was the critical factor that was going on in your own internal development that prompted you to go and get additional help?

  • Is just that you see the market opportunity developing faster than you thought?

  • You've gotten some feedback from beta customers that the product has got a better market potential than you thought, so you want to get it to market quickly?What was the event that said, hey wait a minute, we should accelerate this.

  • Let's go outside get the help we need to accelerate it now.

  • - President and CEO

  • Good question.

  • Thank you for asking it.

  • I think the thing that if you look back in time, nearly two years ago now we launched a major software initiative to bring some new software offerings to the marketplace.

  • And during 2010 we were very successful with customers, select customers that we showed this software to, demonstrated capability and got a strong acceptance from those customers.

  • In fact, we generated about $1 million in contract revenue from selected pieces of this software.

  • And the confirmation that we got from delivering the software, the elements that we did deliver, gave us assurance that we really needed to accelerate the introduction of this software because of its impact on, really all of our product lines.

  • And so, you know, it was a unique opportunity.

  • It was an opportunity where we had reduced the risk of uncertainty way down by a very extensive engagement with existing customers and that gave us the confidence to bring on these outside resources, would really help us accelerate the time to market.

  • So, those were the driving forces.

  • - Analyst

  • Not that you want to pre announce anything, I understand that.

  • Timing of when you would have some of this capability?

  • I assume it's in '11.

  • I assume it's by summer.

  • But is that too aggressive?

  • - President and CEO

  • What we've said Paul, is that we expected to make a significant contribution to the second half.

  • - Analyst

  • In terms of revenues?

  • - President and CEO

  • That is correct.

  • - Analyst

  • And not to belabor the obvious but this is a software product delivered as software, so traditional software gross margins?

  • - President and CEO

  • That's correct.

  • - Analyst

  • All right.

  • Thank you.

  • - President and CEO

  • You're welcome.

  • Operator

  • The next question is from the line of Dennis Van Zelfden with Brazos Research.

  • Please go ahead.

  • - Analyst

  • Good afternoon gentlemen.

  • - President and CEO

  • Good afternoon, Dennis.

  • - Analyst

  • Just going briefly back to R&D, Joel.

  • You all said that those incremental expenses would continue for a while.

  • Should we model roughly $1.3 million for R&D for the first two or three quarters of this year?

  • - VP and CFO

  • I would not expect quite that much.

  • A lot of these were, what I call those one time consulting type pieces.

  • Things like recruiting fees for the hiring of that software manager that Fred mentioned.

  • And a lot of different, I would call it assessment type technology issues.

  • So ,we have been having a significant chunk of our R&D getting allocated up to Op' s, as we get those software projects done, those dollars will be coming back to R&D.

  • So, I would probably guess that we would probably be in that 1.1 to 1.2 range for R&D type things.

  • - Analyst

  • Okay.

  • And just one house keeping, what was depreciation in the quarter?

  • - VP and CFO

  • I don't have that number right off the top of my head but it's really almost identical to what it was last quarter.

  • - Analyst

  • Okay.

  • Moving on to gross profit margin.

  • While very good and up over last year, the 56.4% margin was below what I was anticipating, given the last couple quarters and how you had achieved 60% earlier in the year.

  • Now, I know in the release it said something, channel mix issue, but you also said you sold some higher end systems.

  • Can he go through that a little bit more in detail?

  • - VP and CFO

  • Sure.

  • The channel mix meant that we had a little bit more sales through distributors this quarter than we had taken direct.

  • When we take a direct, we pay a sales commission and so we had lower sales commissions this quarter, but much higher distributor discount this quarter.

  • The second piece that we had, is we had much more sales of our PS family of products and those don't have quite as high gross margin as our RoadRunner series of automated handlers.

  • And that difference is probably one of the bigger chunks of that.

  • That accounted for a couple margin points because of the higher direct materials associated with the PS series and the FLX series than our RoadRunner and our software.

  • So, there was a little less software this quarter and the other piece is that we still had those software engineering costs being reclassified to operations instead of being down in R&D, because they were associated with those software contract revenues for the development of these custom modules.

  • And that will be basically going away middle of the first quarter because we will complete those particular development efforts, as we speak, this next week.

  • - Analyst

  • Okay.

  • And I know that gross profit also depends on the total level of revenue.

  • Going back to the revenue for the fourth quarter, if we back out the system that was essentially booked in the fourth quarter and put it back in the third quarter probably where it belonged, it was a essentially a down quarter.

  • I know Fred talked about how industry weakened a little bit in the fourth quarter.

  • I guess my question is, has it rebounded?

  • It, meaning the industry.

  • - President and CEO

  • Dennis, the answer to that is yes.

  • The industry, you know, the signs that we look at -- we look at a couple of things.

  • And I referred to at Ed Henderson's electronic market forecast.

  • He probably does the best job of tracking the monthly changes in electronics production and he indicated that January, overall from an industry standpoint, had rebounded substantially.

  • And we, as I commented on, we saw that in our order pattern as well.

  • JPMorgan's Global Manufacturing Index jumped back to 57.2 in January from 55.6 in December.

  • So, what I think we are seeing is not idiosyncratic.

  • It is reflective of, generally, the industry trends.

  • And we think that this first quarter is going to be a good first quarter, just like they year.

  • And frankly, the fourth quarter has always been somewhat of a seasonably difficult quarter for us but our strongest quarter typically being in the third quarter and we often see this pattern of electronics production dropping off in the November and December timeframe.

  • And it was clearly that case again this past year.

  • - Analyst

  • Is the first quarter typically a seasonally slow quarter compared to the third and fourth quarters of the year?

  • - President and CEO

  • It has been, Dennis.

  • It's typically been our weakest quarter.

  • Last year, the first quarter rebounded fairly quickly and I think that this year it's going to happen as well, just simply because there's just so many new products being introduced, significant new products that are driving market demand.

  • - Analyst

  • Okay, so we should not necessarily expect a sequentially down quarter in terms of revenue compared to the fourth?

  • - President and CEO

  • I wouldn't.

  • - Analyst

  • Okay.

  • Can you give us any general thoughts on your revenue trends for the year?

  • - President and CEO

  • Well, we don't actually give guidance with respect to revenues, Dennis.

  • We can only really talk about it the size of the Company and the lumpiness of our large capital equipment sales.

  • We can really only talk about general industry trends.

  • And as I said, everything that we studied from what our customers are telling us and what the market analysts tell us, indicate that this is going to be a good year.

  • The as the electronics production has forecasted overall, globally to be up 9% and it's going to be up much greater than that in some of our key markets like Asia where we are doing very well.

  • And also in Western Europe.

  • So, we look for a good year.

  • And I think we -- in 2010 we were just getting back, the industry overall was just getting back to the level of where it was in 2008.

  • And so with 2010 we expect to see some significant movement up and above the level of the previous highs of 2008.

  • - Analyst

  • Okay.

  • Just regarding -- what kind of visibility do you have beyond your current backlog number?

  • Can you see out three or four months?

  • I think when you talk about orders are typically get an order and ship it within the same quarter.

  • What kind of visibility do you have beyond one or two or three months?

  • Is there any visibility?

  • - President and CEO

  • Yes, there is visibility.

  • We have an order pipeline, Dennis, that we break down every two -- we break down by our geographical regions.

  • And we update that order pipeline every two weeks.

  • And, that order pipeline typically has close to 100 different order potentials that we are tracking, following.

  • And our sales managers use that to work with the sales team and our channels to you, look at the calls, the number of calls, what the issues are, where that business is.

  • And so, in some cases we will have visibility that will stretch out six, nine months.

  • In other cases it is much shorter than that.

  • And then, of course, we have another source of intelligence which is our customers themselves and what we know is happening in their business.

  • For example, Pegatron, one of our customers in China builds iPhones.

  • So, we know what is generally happening with the trend in that business.

  • So, we can pretty well get a sense of what that means for our business with a particular customer.

  • And since we have not just the revenue from the sale of equipment but also the revenues from the consumables portion an after market ongoing revenue stream.

  • That's important to us so that is another source of visibility that we have.

  • - Analyst

  • Okay.

  • I have several more but I will let someone else ask.

  • Thank you.

  • - President and CEO

  • You're welcome.

  • Operator

  • Our next question is from the line of Tom McGuire, a private investor.

  • Please go ahead.

  • - Analyst

  • Okay, thanks Fred and Joel for taking my question.

  • - President and CEO

  • You're welcome.

  • - Analyst

  • Good call.

  • My question, my first one is, if you look at your President's perspective, and I do look forward to reading those because it gives a lot of information.

  • The one that you came out with in December, you talked about the biggest lineup of new product introductions that Data I/O has experienced since you joined the Company will occur in 2011.

  • I'm curious, what you can say about these products.

  • Are they evolutionary or are they new products?

  • What kind of traction should we see in this year or will they require a longer sales cycle?

  • Can you just get a little more color on that?

  • - President and CEO

  • Oh, boy, Tom.

  • That's a tough one.

  • First of all, we really don't talk about new products before we introduce them.

  • But I can put a little bit of color around it that may be helpful.

  • About two years ago we really ramped up our work in new product developments.

  • We were successful in stealing more money away from sustaining engineering and from device support and re-purpose it into areas that we call core and into whitespace areas.

  • So, we kept depending on these 10 initiatives fairly low for period time while we were really going out spending a lot of time talking to customers and non customers and getting their inputs and going back and forth.

  • And virtually every member of the management team has been engaged in that process over the last, almost three years now.

  • And every member of our management team, operations, HR, IT, sales, marketing, finance, just basically everyone goes out and spends time with customers and non customers.

  • And the whole organization is engaged in this activity and in all of these initiatives.

  • So, we have made great progress and as we make progress, as we reduce risk and uncertainty then we look for opportunities where we can accelerate things by moving things forward.

  • And it just turns out that timing is one of those things that a lot of these things are just coming to the point of completion and fruition now in 2011.

  • So, that is kind of the macro sense.

  • We've already talked about some of the software initiatives at least as much as we can.

  • Some of these things are in areas where their enhancements of existing products lines and expansions beyond that.

  • And in some areas they take us into whole new areas and in some cases you know, we expect the adoption cycle to be very fast, very quick, almost overnight, if you will.

  • In other cases it's going to be longer.

  • So, there's sort of a blend with these activities.

  • - Analyst

  • Okay, that's helpful.

  • My next question is concerning your last President's perspective, where you answered a number of investors questions.

  • You brought up the topic of M&A.

  • And I look at Data I/O and I see a quality, small Company that is performing well and has a lot of cash.

  • In my investing experience, I have always companies make a hell of a lot better decisions when they don't have a lot of cash than when do have a lot of cash.

  • And so, with that in mind, how can we as outsiders and shareholders take comfort that if Data I/O does make acquisitions that they won't be at the ranch or they won't overpay or you won't incur significant dilution, et cetera.

  • How can I be assured that any acquisition strategy follows a very disciplined approach?

  • - President and CEO

  • Well, Tom, I can tell you that I have been involved in a number of M&A activities over 35 years of general management experience.

  • I am not a particular fan of acquisitions because I know how much work they are and I know how difficult it is to find good ones.

  • And I can assure you one thing, that the management team does not feel that it has a gun at its head saying, oh, you got this cash your pocket, you better go spend it.

  • That certainly is not the situation at all.

  • On the other hand, we are constantly looking for opportunities and ways where we can get a significant return on the shareholder investments.

  • And in the case of -- I will just relate back into the case of when the Company acquired SMS back in 1998.

  • We acquired a company based in Europe.

  • It was a regional competitor and it had some interesting products.

  • We bought the Company for about $5 million.

  • It was doing about that in revenue at the time and within two years we'd ramped that business up to $20 million.

  • So, that was a very significant accretion that came about as a result of that transaction.

  • So there are opportunities that can turn out good and you just have to be really patient.

  • And I've just --I've never been one that ever felt that I wanted to get myself in a situation where I couldn't walk away if the deal didn't smell right.

  • And I have walked away from a lot more deals than that I have actually been involved with when it just wasn't right.

  • And so, because I just know how difficult it is to extract value and gain synergies and deliver accretion to the results.

  • In some cases there is a very simple make versus buy decision which is, in some cases we need new technology.

  • We need certain technologies to support our existing product development plans, our existing growth plans.

  • And there is always opportunities to look at those plans and say okay, should we develop our own resources, acquire, spend more money in R&D and add a bunch of engineers and develop that technology inside?

  • Or is it possible to buy that technology on the outside and amortize it over a period of time and accelerate what would take otherwise a considerable length of time if we were to do it on our own?

  • And so the Company has to make those kinds of simple make, buy decisions all the time and we do that.

  • - Analyst

  • Okay.

  • Good answer, Fred.

  • Thank you.

  • And along the lines on M&A, regarding the retention of TM Capital, I just kind of wonder out loud to myself, how likely are they to bring you a potential acquisition?

  • Considering your experience and longevity in the electronics industry.

  • You must know every player and person and company out there and you must already have a really good idea of what is out there.

  • So, I am just thinking out loud, what do they add in terms of that?

  • - President and CEO

  • Well, Tom, there are a number of things.

  • I want to be a little careful because I don't want to mislead anyone.

  • And I think there's a couple of things I think I can say that could be helpful.

  • One is,, sometimes it is very difficult to approach a potential firm that you want to acquire using your own name.

  • If you do, sometimes that jacks the price up by a factor of two.

  • They look at your deep pockets and they say, okay, this Company can pay a whole bunch more.

  • So, I never like to go into looking at an opportunity where the firm or the technology that we might be acquiring knows it's us.

  • That is just one point.

  • So, it's always valuable to be able to go through a third-party.

  • And I think the other reason is that in some cases the activity that you need to be involved with is not in the United States, but it is overseas.

  • In particular, in places like China and those are areas where relationships with TM Capital and their strength in the international market with M&A international brings an awful lot to the party.

  • - Analyst

  • Okay.

  • Thank you.

  • One more question.

  • Going back through your filings over the years, just trying to get a better view of the Company and understand it better.

  • I was struck in the third quarter 2008 Q, which is coincidently marks the top of the market or right around there before the economy just fell out of bed.

  • You were talking about the amount of programmable content and it's growing very fast and you mentioned in the overview of that Q that the installed based of programming solutions will be consumed rapidly when and if this growth continues and if you mentioned some industry sources and projections, et cetera.

  • My question is, we had the collapse in the economy and now we are having the recovery.

  • But where do we stand in terms of capacity utilization of the installed base currently?

  • And when do we get that leg up in terms of capacity additions and such?

  • - President and CEO

  • Well, that's a really good question, Tom.

  • I am glad you raised that.

  • I can tell you that probably the programming centers are the best indicator of the general overall state of capacity utilization.

  • And during the depths of the recession, we know that some of the programming centers, some of the major programming centers had capacity utilization of the installed base that was down well below 50% capacity utilization.

  • In some cases even half that amount.

  • So very, very low levels of capacity utilization.

  • And it wasn't that the demand was that weak, at least in terms of the end-user level.

  • But there was such a constriction that took place instantaneously in the supply chain that, really inventory was being run out at virtually every level.

  • And that just reduced the level of activity down to almost nothing.

  • So, to show you how much things have improved, we are now seeing programming centers spend the money again at the level I haven't seen since really way back before the recession and with capacity utilization rates up around well -- certainly over 80%.

  • Which is sort of a point at which they have to be expanding their capacity because if they are not expanding capacity when they get to 80% they do not have the capacity to take on additional jobs and compete effectively in the marketplace.

  • So, we are seeing this real ramp up of spending now by the programming centers.

  • And that's a very good sign which gives us the sense that capacity is really returning.

  • The second factor, we haven't completely seen yet, is we haven't seen yet the full impact of the higher density file sizes that is going into many of these leading-edge products.

  • And as these leading edge things like smart phones begin to replace a lot at the low-end phones, the low-end mobile devices, we are going to see these larger file sizes demanding more and more programming capacity.

  • So, we have not seen that yet but we have seen the programming center rebound and that is very encouraging.

  • - Analyst

  • Okay.

  • And then one follow-up on that and then I'll get back in queue.

  • So, currently when you're selling machines, do you have a feel, how much is a replacement versus how much is for new capacity?

  • - President and CEO

  • Well, boy.

  • We certainly see that in some cases.

  • So, for example, we have been having a program, while we launched the FlashCORE III, to do trade in' s of older PP 100 and early PS systems, where instead of upgrading the machine with new programmers they are taking the whole machine now and going with a new machine.

  • So, there is a good example of where we're actually taking some capacity out while we're upgrading the customer with the latest technology.

  • - Analyst

  • Okay.

  • Thank you both for answering my question and putting on the call.

  • - President and CEO

  • Thank you very much, Tom.

  • Operator

  • (Operator Instructions)We do have a question from Dennis Van Zelfden with Brazos Research.

  • Please go ahead.

  • - Analyst

  • Just a couple quick follow-ups, gentlemen.

  • Fred, are your competitors doing anything irrational in terms of pricing and are you worried about that at all?

  • - President and CEO

  • We do have some competitors that compete primarily on the basis of price.

  • And, it is an irritant, there is no question about it.

  • And they try to drive down the value proposition and take business by basically coming in at the lowest price.

  • Our sales team has become pretty adept at challenging that and really asking the customer, if this competitor comes and drops their price 20% to try to get the order, what does that say about what they were charging you before?

  • And do you really want to do business with them, compared to doing business with Data I/O, which is a solid company, well established, a strong balance sheet, profitable.

  • Because, when a company buys a piece of programming equipment and they are going to use that equipment for five years, in some cases more.

  • They really depend on the Company being around to provide device support and provide updates and all of the other things that you need to ensure the productivity of that equipment over a period of time.

  • So, we are pretty effective at challenging it, Dennis.That said, there are times that we lose orders to a competitor that is willing to take business at any price to basically stay alive.

  • And that is an irritant.

  • I wouldn't say it is any more today than it was three or four years ago.

  • But it's always there.

  • On the other hand, we try to not worry that much about competitors, direct competitors.

  • We are really focused more on showing how our solutions are better in many cases than alternative programming solutions like, programming after placement with existing automatic test equipment or programming at the end of the line.

  • Or outsourcing to a programming center when that doesn't make sense.

  • Outsourcing to a programming center makes a lot of sense when your volumes are small and there's not a lot of value in what you are outsourcing.

  • But if you have to protect your intellectual property and your volumes are growing, outsourcing really isn't necessarily a good alternative.

  • And that's when you need to be spending the money and bringing the programming in-house.

  • So, we try to focus on that.

  • Focus on helping our customers understand what's the best programming strategy for them.

  • And by working with them in very much of a consultant to the way, it really shifts the focus away from price.

  • - Analyst

  • Okay, last question goes back to the software because that seems to be a pretty exciting growth area.

  • Can you elaborate a little bit more about how that's going to be sold?

  • Isn't going to be incorporated into the machine and you will just essentially charge for it?

  • Is it a retrofit type product where you can put it on all of the old machines?

  • Is it going to be sold at kind of a one-time licensing fee or is it going to be a subscription where you can get some kind of annual recurring revenue off of it?

  • Just elaborate a little bit, if you could.

  • - President and CEO

  • Sure.

  • Well, there is -- there's a number of elements to it.

  • One, there's a certain amount of software that customers get when they buy any of our equipment.

  • So, we are not talking about that.

  • We are talking about a level of software that goes beyond that.

  • And it's a level of software that deals with things like security and process control and traceability.

  • Things that are very important to people higher up in the management chain.

  • You know, a production manager on a production floor may not be too concerned about intellectual property protection and security, but the general counsel probably is and the CEO is probably is and the executive vice president is.

  • And, so these are things that are really moved to sail beyond what you would call something that goes along with the equipment, although it is supported by the equipment.

  • It satisfies a set of needs that go way beyond just what you think of when you talk about programming devices.

  • It's really related to the overall management of intellectual property.

  • Because when a company develops software that's going to go in their products, and virtually every electronic product today has some software that gets embedded in that product in the form of firmware.

  • During the time that software is being developed, there is a lot good controls and things that get wrapped around it that protect it and ensure the protection of the intellectual property.

  • Make sure that is secure from injection of malware.

  • And then, all of a sudden, at some point, engineering has to release that software to manufacturing and say, now go put this in all of the products that you're building.

  • And at that point, where the software is released to manufacturing, that is really where this software that we're talking about takes over.

  • And it wraps around the software that needs to get programmed into the products and provides the security level, it provides this process and control level to make sure that in a decentralized, manufacturing supply chain where manufacturing might be done in several places around the world, that you can still maintain control over their software.

  • And that is a very high value added thing, and it's something that goes way beyond just something that works with our equipment.

  • And so it is an additional software sale.

  • It's a very high margin piece of software.

  • And there is a recurring license stream associated with that.

  • And I really can't give you all of the details because we have not introduced it yet and we really don't -- we try to not talk much about the specifics until we actually announce the product.

  • - Analyst

  • Okay.

  • But can it be retrofit on an older machine?

  • Or is it something only for the newer machine?

  • - President and CEO

  • Yes, it can be retrofitted on the older machines.

  • - Analyst

  • Okay.

  • And did you say when that is coming out?

  • Or is that the one you said it will just benefit you in the second half of 2011?

  • - President and CEO

  • Yes, I said it would generate significant impact on financial results in the second half.

  • - Analyst

  • In the reception, kind of characterize the reception you've had to this software.

  • Do the customers just absolutely love it they're going to take it, kind of, almost no matter what the price or what?

  • - President and CEO

  • Well, I would say we've obviously sold it at a high prices is already and the customers are very happy with it.

  • So, we are tickled with that.

  • And I don't know, Joel, what else should I say?

  • - VP and CFO

  • We have to finish our pricing validation before we answer that question.

  • - President and CEO

  • Yes, this is -- these are good questions.

  • - Analyst

  • I guess, suffice it to say, the customers really want a product.

  • Correct?

  • - President and CEO

  • Yes.

  • And I would say that, when we started out in this area back, oh my goodness -- almost 10 years ago the customers that saw value in these kind of things with the set-top box manufacturers.

  • And they were very concerned because they had to program in an encrypted serial number into the set top boxes that was a key to the pay-per-view.

  • And we sold that to set-top box manufacturers and some other folks in the gaming industry and so forth and along came a computer manufacturer that is very successful in selling consumer electronics.

  • And they needed some security software so we sold it to them.

  • And, we have enhanced and built upon that and built in more security features.

  • And because of the nature of the product and what it does, there are some things we cannot say about it.

  • Because it is related to security.

  • But it's also related to process control in the sense of what it brings to that side of the game as well.

  • And so, what's happened, Dennis, over time, is that more and more customers in different fields are becoming sensitive to this need, where the automotive industry didn't perceive a need in this area a few years ago now when you start to have an automobile which is a connected product that connects into the outside world either through Bluetooth or WiFi or some other form of communications mechanism and there is always the potential to stream or to inject software into the automobile from the outside world.

  • Then all of a sudden there's a whole new set of security concerns that get raised.

  • And so more and more companies are sensing the need for this.

  • And while we knew all along that he was going to be important to the wireless handset manufacturers to protect the security of e-mail communication, for example, that goes back and forth in the wireless handsets.

  • It's really expanded quite a bit beyond that to reach whole different new sets of customers.

  • - Analyst

  • Okay, thanks gentlemen.Good luck.

  • - President and CEO

  • Thank you.

  • Operator

  • Our next question is from the line of Dave Kanen with First Midwest.

  • Please go ahead.

  • - Analyst

  • Just a quick follow up on this commercial roll-out of your software initiative.

  • You're saying, you said you expect a very positive impact, a significant contributor.

  • Is that in the range of 15% to 20% of revenues or more than that?

  • Can you give me some sense when you start rolling this out as to what percent of your overall makes you think software will be?

  • - President and CEO

  • Let's see.

  • Dave, that is really hard to quantify right now.

  • I think as we get closer to the introduction, we will probably share a little bit more about it.

  • It is very sensitive.

  • It's not that we are trying to withhold information, but I want you to understand that this software impacts all of our products and we cannot say anything about it until we are ready to introduce because of its potential impact on all of our product lines.

  • It's not an isolated thing, it's something that is very significant.

  • It layers on top of everything we do.

  • And, there is an Osborne effective kind of thing that goes on here.

  • And so it puts us at significant risk as a company if we talk much about it.

  • It's not that we don't want to share.

  • It's just that we're -- it's compromising the Company and the Company's position if we talk very much about it.

  • - Analyst

  • I understand.

  • Okay.

  • So I will just take a very positive impact at face value, whatever that means.

  • - President and CEO

  • All right.

  • And we will definitely be sharing more with you as we get closer to the introduction.

  • - Analyst

  • Okay.

  • And we should expect standard software margins from this?

  • - President and CEO

  • Yes.

  • - Analyst

  • Okay.

  • And when you say the second half of this year, meaning starting in Q3, we should expect the rollout?

  • - President and CEO

  • Well, I don't want to get pinned down with respect to the day of introduction because I have already talked about the Osborne effect and the impact it could have on potential customers.

  • I only want to be quoted as what I have said ,which is we believe it is going to make a significant impact to the financial results in the second half.

  • - Analyst

  • Okay.

  • All right.

  • Congratulations and thanks for the update.

  • Good luck.

  • - President and CEO

  • Thank you.

  • - VP and CFO

  • Thank you.

  • Operator

  • Thank you.

  • At this time there are no further questions in queue.

  • - President and CEO

  • Oh, well, thank you very much for attending the conference call today and thank you for all of the excellent questions, and we look forward to talking with you at the end of the next -- at the end of this quarter.

  • Bye-bye.

  • Operator

  • Thank you ladies and gentlemen, that does conclude your conference.

  • We thank you for joining.

  • You may now disconnect.

  • Have a good day.