Data I/O Corp (DAIO) 2011 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Data I/O second-quarter 2011 financial results conference call.

At this time, all participants are in a listen-only mode.

Later we will conduct a question and answer session, and instructions will be given at that time.

(Operator Instructions).

As a reminder, today's conference is being recorded.

I would now like to turn the conference over to our host, President and CEO, Mr.

Fred Hume.

Please go ahead.

Thank you, Tricia.

Welcome to the Data I/O Corporation's second-quarter financial results conference call.

With me today is Joel Hatlen, Vice President and Chief Financial Officer.

I will provide an overview of the quarter and some thoughts on the balance of the year with a particular emphasis on the introduction of new products.

Joel will provide additional information on the financial results.

Before we begin, I would like to remind you that 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 the levels of orders; ability to record revenues based upon the timing of new 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 second quarter of 2011 were $6.8 million compared to $6.6 million in the second quarter of 2010.

Net income in the first quarter was $398,000 or $0.04 per diluted share compared with net income of $859,000 or $0.08 in the second quarter of 2010.

The decline in net income is attributed primarily to higher development expenses associated with new products released in the coming quarters.

Cash at the end of the quarter was $17 million, up from $16.8 million at the end of the second quarter of 2010.

Backlog was $1.4 million at the end of the quarter, up $0.5 million at the end of the first quarter.

Orders worldwide in the second quarter of 2011 were $7.3 million, up 11% from the $6.5 million booked in the second quarter of 2010 and up 19% from the $6.1 million booked in the first quarter of 2011.

Asia's orders were up 50% from the second quarter of 2010.

The strength of our business in Asia is the result of several factors.

Asia consumes 57% of the world's output of high density Flash memory used in products such as smartphones and tablets computers.

Data I/O with its FlashCORE III is the undisputed world leader in solutions for programming high-density Flash memory.

Secondly, we have been very successful in breaking into many new accounts such as Pantech in Korea and are working with new partners such as NVIDIA, a key supplier to firms such as Apple, Lenovo and Hewlett-Packard.

Thirdly, we have been successful in extending our penetration in South Asia.

Orders in Europe were up 5% from the same quarter of last year.

They were strong in our director territories of Germany and Eastern Europe, but weak in the rest of Europe.

The German economy remains very strong with unemployment at the lowest level in many years.

We added a new sales manager to our team in Europe in the second quarter that has been successful in cracking new accounts in a very short time.

Our business with programming centers in Europe has been strong throughout the first half of 2011.

The Americas, particularly in Canada and Mexico, were down 17% from the same quarter of last year, but up 47% over the first quarter of this year.

The automotive and wireless industries drove the growth in bookings, and key customers in Latin America, specifically EMS companies, continue to add programming capacity.

To some extent, the continued migration of high volume electronics production to Asia is reflected in our strong order growth in Asia and the decline in the Americas.

Comparable financials for the Americas are also difficult because this region had extraordinarily strong performance in the first half of 2010 with the contract software development orders that we mentioned previously.

Jim Spray, our Regional Manager for the Southwest and Latin America regions, retired at the end of June.

Jim was our longest-serving employee with 31 years of service.

While we will miss Jim, I'm pleased to report that we have hired a highly qualified replacement, [Juge Fivierdo] that is fluent in Portuguese and Spanish.

We believe Juge will strengthen our business, particularly in the rapidly growing South American region.

On August 1, we will introduce the Roadrunner 3, a completely new version of our proprietary in-line programming solution protected by a portfolio of 21 patents.

Roadrunner 3 upgrades six previous versions of Roadrunner used with [C Plays], Fuji, Panasonic and MYDATA SMT machines with a single model.

As many of you know, Roadrunner has been our most profitable product line, generating greater than $40 million in gross margin over the past 10 years.

We now have many hundreds of units in operation around the world.

Roadrunner 3 is also the first of our products to incorporate the new process [controls] factory-integration software we have told you about in previous calls.

This new software running on Roadrunner 3 makes it virtually impossible to have an incredibly program device flow into the production line.

Customers that are on previous versions of Roadrunner can gain the same benefits this software provides with Roadrunner 3 by purchasing the new software and upgrading their base at existing units.

More information about this software will be released with the introduction of Roadrunner 3 on August 1.

In addition to this primary benefit of error proofing the process, Roadrunner 3 provides higher throughput and adds several important features developed in close collaboration with several of our customers.

Roadrunner 3 is priced approximately 10% higher than the existing versions and will be ready to ship to customers in August.

The next major release of this software will occur in November when we introduce it with other products.

Again, we have very high confidence in this software since, as in the case with Roadrunner 3, we have versions of this software operating successfully with other products at selected customer sites.

During the second quarter, we acquired software and patent technology that changes the way software is developed for embedded systems that incorporate FPGAs, graphics processing units and other multicore processors.

This technology will improve the performance of our existing business as we use it in our FPGA-based next-generation programmer development.

It will be incorporated into new products to be released over the coming quarters, and we will introduce a version of this software as a product apart from our existing business.

In the 11 weeks since the acquisition, we've demonstrated the technology the technical experts and CTO's of major corporations.

Their feedback has been very gratifying.

This software technology is different from and should not be confused with the process control and factory integration software mentioned previously.

In the second quarter, we secured outstanding talent to help us with this initiative.

I'm pleased to report that we have a highly successful business executive leading the team to bring this software to market in the near future.

As we had mentioned in the last call, we committed to a short-term increase in R&D spending to support the introduction of several new products, including Roadrunner 3 and its process control software to be introduced over the next few months.

This involves the use of outside consultants and contractors rather than increased fixed expenses.

The additional investment of approximately $400,000 per quarter will continue for a couple more quarters as we roll out the additional new products.

This is an exciting time at Data I/O as we are in the middle of transforming our business, something I look forward to sharing with you in more detail in the coming months.

Our existing markets are healthy, and the markets for our new offerings to be introduced in the coming months are highly attractive.

Four years ago, we told you that our strategy was to build financial leverage into the business model and then use that leverage to drive growth.

Following that strategy, we feel that we can expand our addressable market nearly tenfold over the next five years.

Our shareholders will begin to reap the benefits of that strategy with the introduction of the Roadrunner 3 and the process control and factory integration software on August 1.

At this time, I will ask Joel to expand on the second quarter's financial results.

Thank you, Fred.

Good day to everyone.

Revenues for the second quarter of 2011 we're $6.8 million, up 4% compared with $6.6 million in the second quarter of 2010, but down sequentially from $7 million in the first quarter of 2011.

International sales represented 91.5% of total sales for the quarter.

Revenue increased in Asia 48% but declined in Europe 3% and the Americas 26% compared to the second quarter of 2010.

The Americas sales decline was again due to the less-custom software sales and by a decline in sales in Mexico that we believe is attributed to the effect of violence that has taken place there.

Sequentially, revenue in the Americas increased 24% over the first quarter 2011, which is attributed to demand from the automotive-related business.

As Fred noted, orders increased 11% in the first quarter of 2011 compared to the same period in 2010 with Asia up 50%, Europe up 5% and the Americas down 17%.

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

Backlog at the end of the quarter was approximately $1.4 million, up from $900,000 at the start of the quarter, and the same as $1.4 million at the end of the second quarter of 2010.

Deferred revenue at the end of the quarter was $1.4 million compared to $1.6 million at the start of the quarter.

From a product perspective, we again saw our FlashPAK and FLX product lines and adapter sales benefiting from the increased demand in Asia.

Meanwhile, automotive and programming centers-related business resulted in good PS family sales.

Gross margin as a percentage of sales in the second quarter of 2011 was 58.5% compared with 58.4% in the second quarter of 2010 and 59.1% in the first quarter of 2011.

While flat compared to the second quarter of 2010, higher service-related labor, recruiting and relocation costs, were offset by $94 million in reduced custom software engineering development costs.

The decrease compared to the first quarter of 2011 in gross margin percentage was primarily due to the product mix, more FLX and FlashPAKs, less roadrunners, increased service labor-related costs and $50,000 in engineering tracked custom software cost, offset in part by favorable factory variances.

Operating expenses increased by $655,000 in the second quarter of 2011 to $3.5 million compared to $2.8 million in the same period of 2010 but were flat compared to the first quarter of 2011.

The $315,000 increase in research and development, R&D expense, compared to the second quarter of 2010 was primarily due to the use of outside resources to accelerate our growth initiatives and $94,000 less cost transferred to operations on those software contracts.

Included in the second quarter of 2011 R&D cost was two months' amortization of the software technology acquisition of $73,000 and a credit for capitalized acquisition-related costs of $83,000.

R&D was down $77,000 from the first quarter of 2011, primarily due to fewer materials used.

Sales, general and administrative, SG&A, expense, increased to $2.2 million in the second quarter of 2011 from $1.9 million in the same period of 2010 due to increased use of outside professional consultants, higher compensation, the China office move and travel costs, offset by $169,000 of lower incentive compensation.

SG&A was flat compared to the first quarter of 2011 but had higher marketing costs due to software acquisition-related personnel additions, higher sales, travel and retirement transition compensation, higher consulting fees and the China office move, offset in part by lower audit fees and public company costs.

We had finished two consulting projects that cost $90,000 in the second quarter this month, which will result in lower costs going forward.

During the quarter, we entered into a two-tier Shanghai office lease and completed the office move to a different floor in the same building.

In accordance with US Generally Accepted Accounting Principles, GAAP, net income in the second quarter of 2011 was $398,000 or $0.04 per diluted share, compared with net income of $859,000 or $0.09 per diluted share in the second quarter of 2010.

Earnings per share included the impact of equity compensation expense of $0.01 per share for both the first quarter of 2011 and 2010.

We had an income tax provision of effectively 20% for the quarter due to higher taxable profits in foreign locations, especially China and Germany for the quarter, as well as certain states and the federal alternative minimum tax.

We had net operating loss carry forwards of approximately $16 million, as well as other credit carry forwards in the United States that are available to continue to offset our future US net income.

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

The company's cash position at June 30, 2011, was $17 million.

That is down $2 million due to the cash used in the software technology acquisition on April 29, 2011.

Accounts receivable decreased to $5.3 million at June 30, 2011, compared to $5.5 million at March 31.

Inventories increased to $3.9 million at June 30 from $3.5 million at March 31, 2011, due to materials for new product initiatives, primarily the Roadrunner 3, and in response to certain suppliers' longer lead times, particularly for our PS family.

Deferred revenue was $1.4 million at June 30, 2011, compared to $1.6 million at March 31, 2011.

Earnings before interest, taxes, depreciation and amortization, EBITDA, was $802,000.

The depreciation and amortization included in that calculation was $317,000, including $75,000 related to the software technology acquisition in the quarter.

At this point, I will turn the discussion back to Fred.

Thank you, Joel, very much.

Tricia, at this time, we would be happy to take questions.

(Operator Instructions) Dennis Van Zelfden, Brazos Research.

Good afternoon, Fred and Joel.

Let's first talk about revenue.

I guess I was a little surprised that revenue was down sequentially from the first quarter, kind of given particularly your comments about the sales funnels being full in the last couple of quarters.

Let me first ask, were there any delayed shipments for any reason?

Yes, there was one delayed shipment; we had an FLX that we had planned to get out the door at the end of the quarter, but it didn't pass one of our service tests to make sure it had the right quality, so we held it up until here in July.

And what are we talking about in terms of revenue there, roughly?

I don't know the exact one on that.

It is under $100,000.

But I would say, Dennis, I mean generally, we ended the quarter with a backlog of $1.4 million.

And that is up $0.5 million from the previous quarter.

And it is just really hard for us, depending on the availability of materials; we have seen the supply chain stretch out over the last few months so there are just challenges in us being able to always match the availability of inventory, particularly with the complexity of our business, where each individual device that we support requires a special socket.

So, if we're not able to get sockets in terms of the delivery, we just can't necessarily match the shipments with the orders as fast as we would like.

And that is always an issue in our business.

So the sequentially-down revenue has nothing to do in your opinion with any kind of slowdown in the macro environment?

No.

In fact, our orders were up sequentially from the first quarter.

It is purely an issue of timing with respect to delivery of goods, with respect to when the order is entered and the availability of material to satisfy those orders.

I'm also wondering, might there have been some customer delays on say a Roadrunner product because they knew the new Roadrunner 3 with the new software was coming.

Is that possible?

No.

We've been pretty -- pretty careful except with very selected customers to release any information about Roadrunner 3.

It's -- everything is pretty much in escrow, if you will, until August 1 when we release all of the information about the pricings and the configurations.

But that being said, obviously, in many key locations, key accounts, we have been working selectively with customers on upgrade plans and so forth.

But

Okay; so there is not even as of yet any orders for the new machine?

No, there won't be because we are -- we have not opened the system to allow orders to be entered until August 1, the introduction date.

Okay.

Moving on to the software initiative, and I'm talking about the security control software that we've been talking about for several quarters -- over the last couple of quarters, I mean you've been pretty excited I think about the potential of this software and even sometimes using words such as 44 Magnum with respect to the impact it might have on your company.

I'm wondering if you grew not only the software but all of the new products that you are going to come out with over the next, however long, six months or whatever, can you quantify what kind of impact it might have on revenue?

Now I understand you don't want to give guidance.

I understand that in the slide shows, you've given some increased potential markets.

And you made the comment earlier that I don't know 10 times the potential market.

But can you quantify it a little bit more for us say over the next couple of years, what impact it might have?

No, Dennis, honestly, we can't do that.

We just don't give that kind of forward-looking guidance.

We can talk qualitatively about it.

We can describe generally what we expect to happen, but honestly, we just can't put out quantitative numbers on that.

Okay.

Last question for me then -- going -- again one more question on the software initiative.

Is the software that you're putting into the new Roadrunner 3 -- is it available say on August 1 to ship to existing machines out there?

Yes, it is.

Okay.

So the new markets -- I mean it's ready for new machines and old machines?

That's correct.

Okay.

Thank you.

David Kanen, Williams Financial.

Good afternoon, gentlemen.

First question is, what were adaptor sales for the quarter?

$1.8 million.

And then, what were service or maintenance contract revenues for the quarter?

You know, I don't have that breakout here.

It was pretty much an average piece because we saw very little change in our deferred revenue during the quarter.

So I know that didn't answer your question but it's not going to have been a significant change in that rate.

$300,000 or $400,000?

Yes, again, I just need to go look up something on that because I don't have that information (multiple speakers)

(multiple speakers) no problem.

Dave, it's been running typically 15% of our sales.

And off the top of my head, I don't see any really meaningful change in that in the second quarter from previous quarters.

And a follow-up on the question that the last caller asked about the installed base of Roadrunners.

What is your sense of the opportunity in going back to this installed base?

And what is the installed base?

How many machines do you think you have out there?

And what is the opportunity for selling them the software upgrade?

Dave, we have hundreds, many hundreds of machines, installed around the world.

Every one of those installed machines could potentially benefit from this software.

So you know I would like to say the potential is literally selling hundreds of upgrades to this new software.

Now, practically speaking, not all customers are going to convert an upgrade and so that is the reality of life.

But certainly we're going after the hundreds.

So is it safe to say you guys are pretty excited about the opportunity to sell the Roadrunner 3 but then also to have your sales people to go into your existing installed base that maybe wasn't ready to add capacity and say, hey, we can offer you this software.

Is it generally a very upbeat tone and are you guys pretty positive about that?

Yes.

Dave, I think -- the wonderful thing about this new software operating with Roadrunner 3 or incorporated back into earlier versions of Roadrunner is that it makes it virtually impossible to get a misprogrammed part on a board out on the production line.

It allows certain number of features which will explain when the introduction occurs on August 1, just 11 days from now, that really provides a level of quality control and factory integration that raises quality to a whole new level.

It raises assurance to a whole new level.

And this is very important to automotive customers; we have many, many, many automotive customers using Roadrunner around the world.

And we believe that they have already adopted Roadrunner because of its error-proofing methodology.

And now this just takes it to a whole new level, and we see a lot of potential for it, yes.

Have you engaged in any preliminary discussions with customers where you have a sense as to what the uptake is going to be within the installed base, or you've been sort of waiting and tight lipped about this until August 1?

We've been very tight lipped with respect to any kind of general release, but we have had very selective engagements with specific customers during the last year as we have been developing the software, testing the software, getting it ready for market release.

We've actually taken contracts and delivered some of the software under special contracts so customers could take advantage of the software earlier before general introduction.

So we're very confident in this software.

We've used some very sophisticated software development technologies with respect to agile software development methods, with respect to automated testing of the software, so we're very confident in the rollout and the impact that this software will have on our business.

Okay.

Could you give me a sense of the financial impact on a per-machine basis if I want to purchase the software?

Let's say I have a Roadrunner that I bought from you three, four years ago and I want to retrofit the software.

How would that impact you financially?

Are we talking like $20,000 and then also the margin impact and the effect on overall gross margins?

Dave, I can't comment on that.

That will be made public on August 1.

As you know, we have had some significant initiative teams working on both developing the Roadrunner 3 and the software product; they have been working long hours.

They've spent many, many months now on the integration plans and the rollout strategy.

And for me to say anything about that would take away their thunder and it's their opportunity to shine on August 1.

And so I just can't comment about anything specific with respect to the product features or pricing or any of that until they roll it out.

And again, we have very sensitive customer relations in many cases.

And the salespeople need to be able to engage with those customers and not be surprised.

Okay.

But it sounds like not just with Roadrunner but as you roll out this software on the other platforms like PS systems and the FLX, that this should really drive higher your overall gross margins as software sales become a higher percentage of your overall revenue.

In general, is that a safe assumption on my part?

That is clearly the direction we're moving in, yes, absolutely.

Okay.

Okay, well, that's exciting.

So these will be traditional software-type margins in the 90%s, in other words?

Yes.

Okay, excellent.

And I think overall OpEx came down like just a hair I think sequentially from Q1 to Q2.

I know you're rolling out -- I know you still are rolling out the software for the other system, PS, FLX, etc.

But should -- and I think you said you alluded to OpEx still being higher in the second half of the year.

But should it step down slightly on a sequential basis, maybe $50,000 to $100,000, as you get the heavy lifting behind you?

Or it should remain at these similar levels and then really drop off into 2012.

Dave, I would say when you're talking about $50,000, you're kind of in the margin where it's hard for us to even forecast or fine tune much closer than that.

So, I would just give you some measure of caution on that.

Joel may want to add some flavor to it, but clearly, our intention is as things get completed now over the next few months to roll that down.

At the same time, we do have some development expense associated with this other new product, this software technology that we acquired in the second quarter, and its rollout plan for the next few months.

And so there is going to be some additional expense associated with that that is maybe going to keep it a little higher than we would have liked to have been able to achieve at the end of the year.

But Joel, do want to add anything?

I think that is really about the right piece.

So we are continuing to use temporary resources on these development acceleration pieces.

We have added people with regard to the software technology initiative.

And so -- but on the whole, we're trying to keep our spending at about that level that we've been talking about for the last quarter and two.

Okay.

So on a net basis, it should be similar to the first half of the year?

That's really what we're trying to keep it (technical difficulty)

Okay.

And then if you could just sort of qualitatively, as best as you can, sketch out for me -- when you say -- you add a little color to the comment your adjustable market -- is 10 times what it was.

It sounds like you are on the cusp of some very big things here.

What can you tell me?

Give me some more color on why your addressable market is so much bigger and specifically what verticals and so forth that you weren't in before?

Well, Dave, I think that maybe I would start by just refreshing a little bit the perspective with respect -- if you look backward in time, what you see is that there is not a lot of value in programming solutions for older devices, established technologies, low-density Flash memory, low-density microcontrollers.

You know, there's a lot of solutions out there that address those programming needs.

And it's really hard to get a differentiated advantage in those areas where you can strengthen your share.

The addressable market is limited.

We think about programming as being roughly a $2.5 billion plus business.

You know a lot of the value in the equipment side of that has really been driven out with respect to the older technologies, the older devices, the low-density devices.

And really where we've been able to secure a strong position is with the portion of the business that is growing, which is very high density Flash, more complex microcontrollers.

Those are the areas where Data I/O has been able to generate and sustain a competitive advantage.

And so our focus has been to obviously maintain our footprint in the older business, but address segments where there is potential for growth.

And so everything that we have been doing with our FlashCORE III programming engine and with other new technologies related to sustaining our position as the leader in the emerging segment, and at the same time, to expand our programming footprint into other areas of programming and other areas where we can add more value, such as in the process control and factory integration software that takes the value proposition to a different level and allows us to sell to people that are not just interested in what the programming machine does in terms of programming a device, but they're much more interested in how that fits into their overall factory or operating environment.

And then the third prong, really, has been to break into new areas where we can leverage our strength and our competencies and build on those in areas where there is really market conditions that are very favorable and things that are in transition.

And I will really be able to speak much more specifically about that.

It's not that we don't know but, obviously, for competitive reasons and in terms of the disruptive power of what it is we're bringing to the market, if I were to be more specific, I would reveal competitive information that just wouldn't be appropriate for where we are at this point in time.

We can't disrupt our introduction plans by saying too much that would be specific and would give competitors, would-be competitors, people in these existing market spaces an opportunity to second-guess what we're doing and potentially cut us off at the pass.

Understood.

Okay.

As far as the software acquisition which is not to be confused with software for your systems, where do we stand right now?

I mean it's only been -- it hasn't even been a full quarter yet, but what kind of progress are we making there?

And when do you expect we will start recognizing our first revenue?

And can you give me some sense as to who the customers might be?

Are we getting into -- it sounds like we're getting into new areas that we haven't touched before.

Yes.

Well, let me see, how to answer this, David.

This is kind of a challenge to tell you something that is going to be meaningful and yet not go into areas that I can't talk about until we introduce it in the coming months.

But I can tell you that we have a pretty robust software platform.

We have technology that is proven technology.

We have technology that has been accepted by important government agencies; some government agencies we can't talk about for obvious reasons; government agencies that have funded pieces of the expansion of this technology.

We have been able to go into major companies, major technology companies that are at the forefront of technology, and we have been able to demonstrate it to CTO-level, high-level technical people, people that run significant research groups at probably now a dozen universities across the world.

And we have very strong reception to what it is that we're going to be rolling out.

We're going to be confidentially rolling this technology out to roughly 100 users before we ever get to the introduction date, so that we have lots of good, internal understanding of the rollout process.

We have brought on board a very accomplished business leader that really understands business models and software businesses, and -- with a rich experience in this area, and he is leading this team.

We just finished our quarterly off-site management meeting last week, and we were just delighted in the tremendous progress this team has made in the last 10 weeks since we acquired the software technology.

And I would say we have engaged what I would consider to be a world-class group of experts that have wanted to become part of the team that are going to help us with the rollout of this.

So, we're pretty bullish about what we have accomplished in just 10 weeks since we acquired the technology.

Okay.

And then as far as the source revenue being recognized is more of a 2012 event or is it sooner?

Well I think in terms of any significant revenue it will probably be 2012.

You know I probably shouldn't say anything more.

I wouldn't rule out the fact that we could have some revenue in 2011, but clearly, our focus is on building a business platform and having a software business that will generate significant revenue and significant growth in the years to come.

Joel, when you say significant, we're talking about revenue contributions in numbers above and beyond what you paid for this acquisition?

Correct.

Oh my goodness, yes.

And at very significant software-type margins in the 90%s.

Right.

Okay.

That's exciting.

So it sounds like we're right on the cusp of a transformation of the company.

I guess we have to keep the faith.

We haven't seen it come down to the bottom line yet, but it sounds like we're right on the verge of some exciting things.

So good luck, guys, and I'm not going to monopolize the call anymore.

Okay.

Thank you, Dave.

Michael Potter, Monarch Capital Group.

Hey, guys.

Just a couple of questions and I wanted to follow up, I guess, both from Dennis and David's question to some degree.

Fred, just to get back from your commentary of the addressable market being tenfold I guess from our existing market.

And I also am trying to understand one, what the addressable market is, and two, obviously, how you're measuring that, how we're coming up to that type of number.

Okay.

So I think the easy way to do it, Mike, is this way.

I mentioned earlier that the programming business, if you put an equivalent value on it, would be roughly $2.8 billion a year.

But if you look at the actual programming equipment part of that, excluding now the automatic test equipment that might be used for programming devices after placement, during test, or elsewhere, but purely direct just programming equipment, if you go down the list of 35 or so companies that build that programming equipment and add up all the numbers, you get an equipment value of about $100 million, which isn't really very interesting.

And so I think that is one of the things that we started out addressing a number of years ago with our plans, which was to really transform the company, as Dave said earlier, so that we could get a much larger share of the programming business as opposed to just pure programming equipment business, and also at the same time, use the wherewithal of the company to address larger markets outside of purely what we think of as programming, and yet, do it in a way in which there are a lot of common things, particularly from a technology standpoint, so we can mitigate technology risk.

And so that is really how we have come about with the strategy of making certain technology acquisitions that allows us to build on known technology that has been proven and apply it in a way that strengthens us that reduces development risk, development time and so forth.

And so I think as I articulated in the most recent investor presentation, when we laid out the existing business, the expanded business, and then what we call new business, and we identified many of the areas in which that new business resides, and -- such as security and trusted silicon and some of those things.

And again I have to be really careful about saying too much because I don't want to preempt product introductions that we have coming up in the next few months.

I understand the need to want to be careful, but obviously, we are shareholders, owners, of this company that have been incredibly patient.

And my concern is I don't understand what the market is.

And to say that we have a tenfold opportunity, so that means $1 billion addressable market up from the $100 million where our current hardware sits, I'm just trying to understand, one, I guess with that addressable market is and what kind of expectations we can have for our company to get a realistic percentage of that market.

Well, Mike, as we outlined in the investor presentation, that is our best estimate of what the addressable market is when you combine the three areas -- basically, our existing business, our expanded business and this new business area or areas between now and 2015.

And in the context of the five-year expansion, Mike, we're going to be rolling things out here in just the next few months.

So as the months go on, very soon now, just like we're starting with the August 1 with Roadrunner 3 and the process control and factory integration software, you are going to be getting windows; we're not asking you to fly blind until 2015.

You're going to be getting pretty clear windows as we roll out these new products.

But just like Apple is very circumspect with respect to releasing information about new products before they introduce them, I cannot preempt our product development plans by being specific about those products until we actually introduce them.

All right.

With regards to I guess the acquisition that we made of the software company back in I guess it was April or May, can you -- how many people are currently supporting that -- the development of that product?

We have four people engaged in that directly, Mike.

But I think that that is kind of that is a snapshot.

And I think what our goal is to have many people in the existing organization fully engaged with that software in the coming months.

So we don't plan on adding a lot of outside resources, but we plan to use, to a substantial extent, many resources we already have.

Okay.

So it will go from four up to a few more employees, but you're going to take those additional employees from other areas inside the company?

Yes, because, honestly, this software has links into many of the products that are in development.

Okay.

And I guess part of my concern is that we're in a macro environment -- as I guess Dennis asked -- where that is very, very strong right now, at least it seems, but our top line doesn't seem to be growing on the equipment sales.

Is there any particular reason that -- or hurdle that we're having to overcome, or anything else that we could do?

Or really is the growth of the company going to be predicated on the rollout of the software products?

You know, Mike, I don't know exactly how to answer that question, but a lot of the software products will be rolling out over the next few quarters.

And those will all continually add to growth because they are basically incremental-type business items.

They add new features, new functionality, but they are related to programming equipment.

Now the new software technology acquisition we made, that, when we start kicking in, that's a whole new area, a whole new business, a whole new customer set type piece.

So that is, again, an area where that is all growth, but then when you talked about the programming side of things, it is one of those ones where you actually have to have growth in chips and chip sales that are in essence going above the current run rates because that's when they add capacity or there's new features that are being added.

And so one of the things that you will notice, for example, in our investor presentation, is that we have these charts that talk about the trends in high-density Flash shipments, in particular bits shipped.

And that, in my mind, is most correlated with the change from smartphones to -- from ordinary handsets to smartphones and the sheer number of bits that are going to need to be programmed as a result of that shift from the non-feature phones to these very significant operating systems and functionality that get programs into the smartphones and the tablets.

No, I fully understand, and I remember that exact slide in the presentation.

I guess all the more reasons, back to the question of, no question we're in a macro environment where more and more high-density Flash chips are being used in a number of different products, but our equipment sales seem to be pretty flat right here.

Okay, Mike, this is a very good point, and what I'm going to do is take a few minutes to try to explain that, and let me do it in this context.

There were about 22 -- actually 23 billion, but let's use 22 billion for a moment because it makes it easy, programmable devices shipped last year, according to the Semiconductor Industry Association's Blue book.

And I think that is as accurate a number as we can get.

And if you take the 22 billion devices shipped in 2010 and then let's say that went to 24 billion in 2011, and then it went to 26 billion in 2012 and it went to 28 billion in 2013 and it went to 30 billion in 2014, so what you see is that every year, there is a growth in the -- there is an actual increase in the number of devices shipped of 2 billion units.

So the delta between every year is 2 billion units.

And if you realize that in 2010 there was enough programming capacity in the world to satisfy the demand for the 22 billion units that were shipped, then the growth is really this delta, this 2 billion units, but what it shows you is the demand is flat because each year in the example I gave you, the difference between the years is only 2 billion devices even though the actual number of total devices shipped is increasing.

So it translates into a fixed level of demand for programming equipment.

And I recognize this is hard for people to understand.

I get this question often.

How was it that the number of devices is growing every year by 2 billion devices or 3 billion devices or 4 billion devices and yet in terms of programming equipment demand, the programming equipment demand appears to be flat?

And it's the reason because it is the increment, and unless that increment is increasing significantly every year, you don't get any fundamental increase in the demand for programming capacity.

It remains relatively flat.

And that is very much what you see.

And if you looked across all of the programming equipment manufacturers, you would basically see that pattern.

And so if you want to break out of that, if you want to get out of that trap where your sales are purely driven by capacity, which is essentially a flat factor, it isn't going to provide any growth, you have to move into areas where you can extract more value.

And the value isn't in the equipment.

The equipment value is getting driven down and driven down every year.

So you have to get into areas like software and other areas where you can actually extract more value from the value chain.

No, no, I completely understand.

That was very helpful, and I agree with you 100% on the move to higher-margin software and add-ons to our core business.

But I -- and I understand what you're saying with regards to the delta.

But if we take that what equates to approximately, in the example that you gave, a 4% increase, I would have to -- and I'm assuming by this -- that high-density Flash is growing at a much higher rate than the overall programmable market.

No question about it.

For example --

And that is the market that we serve, right?

That is the market that we serve.

And of course, some of that can be addressed by installed equipment that is already in the field.

And it is really -- when they get to the point that the existing equipment just doesn't cut it, doesn't have adequate throughput for the high-density devices where we really have the opportunity to shine, and that is where we have with major accounts like Apple and others, and that replaces the business that you are not going to get because the equipment that is already installed is good enough to satisfy the demand for those old technology devices.

So is that where we are at, Fred, where I guess a lot of the older equipment is still usable for programming the existing high-density Flash requirements in the market?

Oh, absolutely.

I mean we have equipment in the field today in the Flash area that has been out there for at least as long as I've been here, for 12 years and customers are still using it very productively.

And it was used -- if you go back to 2000 when -- the year 2000, when 32 megabit devices were the leading-edge technology, we were at the forefront of that capability to be able to program 32 megabit devices.

Well, there are still a lot of 32 megabit devices that are shipped in the world, and that equipment that we installed a dozen years ago is still perfectly capable of programming those 32 megabit devices, but it is really not effective at all for programming what is now 40% of the market which are devices that have densities greater than 8 gigabits.

And that is really where we are selling the new equipment, is into the applications where the memory densities are really high and the file sizes are long.

And if we weren't doing that, our business would be falling like a rock.

Okay, thanks, guys.

I will get back in queue.

(Operator Instructions), [Tom McGuire], a private investor.

Hi, Fred; hi, Joel.

For such a small company, you sure got a lot of things going on.

You know I'm just going to ask one question just to clarify your last description of growth and such.

You've mentioned before -- because I've had the same kind of question to you, why aren't we seeing more growth.

And you've mentioned before that you need -- in order to get more growth you have got to change the slope of the curve.

And when the file sizes grow and the devices grow to the extent that the industry needs more capacity, then that curve shoots up the slope, increases.

So -- and you have said from looking at industry reports, etc., that sometime in 2012, it looks like that is when the experts project something like that will happen.

Is that still in the cards?

Do you think it is going to occur quicker than 2012 or what?

Can you just talk about that and then I will stop.

Tom, that is a good question.

I think we have a sufficient data to tell us that we are at that inflection point now.

We're seeing it with the leading-edge customers that we're dealing with, particularly in Asia for the smartphone space.

And I think the other data point which is just so profound is if you look at the SIA Blue Book for 2009 and then look at the Blue Book for 2010, the results of the two previous years, and look at the shift in the density of Flash memory devices between the two years, you can see that the devices that had densities greater than 80 gigabits increased from 20% of the shipments in 2009 to 40% of the shipments in 2010.

So this huge shift occurred just between those two years, in terms of the shift to higher densities.

And we're seeing now densities with some of our customers in the area of 16 gigabytes, 32 gigabytes, in terms of file sizes and densities to support all kinds of applications like navigation and so forth.

And while it is still a small percentage of the marketplace that demands a very -- that utilizes very large file sizes like that, it is the fastest growing segment of the market.

And so I continue to be more convinced about the inflection and the change that we're going to see over the next few months than I have ever been.

Thanks a lot, Fred, Joel.

Dennis Van Zelfden.

Yes, Fred, I think in past conference calls, you alluded to that you had roughly 10 new products coming out.

First of all, let me make sure that's correct, right?

Yes.

Are all of those products going to be out in the second half of the year?

No.

Okay, can you tell us how many of them of the 10?

You know, I don't want to give a specific answer on that, Dennis.

It's not that I'm trying to be evasive, but on some of these things it's just really hard to talk quantitatively about it, because if the product is right at the moment of introduction, you have a fairly high degree of confidence on the timing.

And if they were developed we would have no uncertainty and we would be talking about them now.

But the fact that many of these products are still in development, that means there are unknowns.

And while we have projections in terms of what is our best guess and what we're thinking about and we have development teams engaged and in work, they are not pressured in the sense that they can always anticipate every single nuance.

And so to say that we were going to have seven of them between now and November or whatever would be to add a granularity or a specificity to something we just can't be that specific about.

okay, well, that's fair.

But again in past quarters, and in fact I think I asked the call on the last quarter about -- you are still confident that the fruit, meaning the revenue and the earnings associated with it, from these new products, however many there are, will in fact still show up in the second half of the year?

Oh, yes.

I mean you're going to see an impact right away from the introduction of the Roadrunner 3 and the new process control and factory integration software.

I mean that is going to start showing up when we start shipping things in August.

And I guess the last couple of questions are for Joel.

Joel, regarding the extra amortization for the acquisition, is that amortization of purchased intangibles?

That is correct.

And that was two months' worth in the second quarter; that was about $73,000 with regard to the intangible technology software.

And then that will be going up to three months going forward.

So you will be just under $100,000 and $510,000, that range.

And I guess that will continue for quite a while?

That will continue for quite a while.

However, that is going to show up in research and development right now because that is where we're using the software.

At the time that we take that to market as a product, at that time, we will be classifying all or some of that up to operations as part of cost of goods sold.

So again, it's going to be a little tricky here as we transition over the next couple of quarters.

Okay.

And then lastly, go over once again what you said regarding the $94,000 less in costs absorbed by software contracts?

Yes.

A year ago in the second quarter, we had $144,000 worth of engineering labor associated with working on that contract custom software piece.

This year in the second quarter, we had roughly $50,000 that was put up into cost of goods sold associated with that custom software development.

So there was, in the second quarter of 2011, $94,000 less cost of goods sold, and accordingly, $94,000 more engineering dollars left down in the engineering bucket.

It is one of these balloon squeezes as to whether or not it is just true development that stays down in R&D or whether it is cost of goods associated with a custom software deal that gets balloon squeezed up to cost of goods sold.

All right.

Well good luck to both of you.

Thank you very much, Dennis.

At this time, there are no other questions in queue.

Please continue.

Thank you very much, Tricia.

And thanks to all of you for joining us on this conference call today.

And we look forward to talking to you again in the next three months and reporting on some exciting results for the third quarter.

Thank you.

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