Data I/O Corp (DAIO) 2011 Q3 法說會逐字稿

Ladies and gentlemen, Welcome to the Data I/O third quarter 2011 financial results conference call.

At this time, all participants are in 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, this conference is being recorded today, Thursday, October 20, 2011.

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

Thank you, and welcome to the Data I/O Corporation third quarter financial results conference call.

With me today is Joel Hatlen, our Vice President and Chief Financial Officer of Data I/O.

I will provide an overview of the quarter and some thoughts on the balance for the year.

Joel will provide additional information on the financial results.

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 the 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 third quarter of 2011 were $7.1 million, compared to $6.6 million in the third quarter of 2010.

Net income in the third quarter, was $130,000 or $0.01 per diluted share; compared with net income of $833,000, or $0.09 per share in the third quarter of 2010.

The decline in net income is attributed primarily to higher development expenses associated with the RoadRunner3 and the Factory Integration Software that were released in the third quarter, and other products that will be released in the future.

Gross margin was 56% for the quarter, compared to 58% in the third quarter of 2010, and compared to 60% in our financial model.

The lower gross margin, in comparison with the second quarter, was due primarily to the unique product channel mix we experienced, and is not indicative of any long-term trend.

Cash at the end of the quarter was $18.4 million, up from $17.5 million at the end of the third quarter of 2010, and up $1.4 million from the previous quarter.

Backlog was $1.3 million at the end of the quarter, down from $1.4 million at the end of the second quarter.

Joel will provide additional information regarding the third-quarter financial results in a few minutes.

Orders worldwide, in the third quarter of 2011 were $7.1 million, driven by orders from our automotive customers in the Americas and Europe, and by Smartphone and Tablet customers in Asia.

Asia has been a very strong sales region in 2011.

While orders from customers in Asia were down 26% in the third quarter of 2011 from the very strong third quarter 1 year ago, the decline was offset by orders in the Americas that were up 13%, and in Europe that were up 17% from the third quarter of 2010.

Orders for our Automated product category, consisting of PS Systems, RoadRunners, and the FLX systems, were up 19% from the second quarter, while orders for our Manual product category, including Legacy products were down 43%, with most of the decline occurring in Asia.

Orders for our consumable adapters were flat, with the second quarter reflecting relatively stable capacity utilization of our equipment by our customers.

In the third quarter, we completed a thorough review of our potential sales channels in Brazil, and selected a new channel that is planned to come onboard in this quarter.

We also booked another Automated system order in Brazil during the third quarter, and our sales managers expect our business there to expand considerably in the coming months.

On August 1, we introduced the RoadRunner3, a new version of our proprietary In-line programming solution.

RoadRunner3 provides new features and capabilities beyond the existing RoadRunner that satisfy demanding process control requirements, particularly in automotive applications.

We also introduced our Factory Integration Software, FIS, that works with RoadRunner3, as well as the previous versions of RoadRunner.

We have booked business for both the RoadRunner3 and the FIS software, and a version of the latter was installed at a customer facility in Europe during the third quarter.

Additional versions of the FIS software, with expanded capability, will be introduced over the coming months, starting with the Productronica Trade Show in Munich next month.

Many of you will recall that we announced the purchase of software technology used for electronics systems design and other applications such as robotics earlier this year.

A version of that software, named Azido, has been released to more than 30 selected users through a secure website.

The base of users will be expanded considerably this quarter, and their feedback is being used to evaluate user experience.

Data I/O joined the National Science Foundation's Center for High Performance Reconfigurable Computing, CHREC, during the third quarter.

We have a number of industry luminaries that have spoken favorably of the software, and we have also determined that several federally-funded projects are likely to make use of this software, providing a substantial base of support for this software platform in 2012.

Meanwhile, the Azido software is being used internally on new development projects.

As we have commented in several previous calls, we committed to a short-term increase in R&D spending this year, to support the introduction of several new products, including the RoadRunner3 and its process-control software.

This involved the use of outside consultants and contractors to accelerate the development schedules.

With the release of the RoadRunner3 and the Factory Integration Software, the use of outside resources has been scaled back substantially.

We expect the quarterly operating expenses in this current quarter, to return to a level approximately equal to that of the fourth quarter of last year.

Walter Custer, a leading electronics manufacturing analyst, reported yesterday that the electronics end-market expansion has lost steam, and that electronics production in Asia experienced a weak September at a time when the typical fall seasonal upturn would normally occur, and as semiconductor shipments have also flattened.

Despite this, our order funnels remain strong, and do not appear to have been impacted by global economic woes.

Our largest markets -- smartphones, tablet computers, and automotive electronics -- performed well in the third quarter and remain healthy.

Orders for the first half of October are ahead of the same period last year.

We have an exciting line-up of new products to be introduced in the coming months that will strengthen the existing business, expand it, and will open attractive new markets for the Company.

I'm also pleased to announce that the Board of Directors has authorized the Company to repurchase $1 million of its common shares during the next four quarters.

This plan will result in share repurchases.

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

Thank you, Fred.

Good day to everyone.

Revenues for the third quarter of 2011 were $7.1 million, up 7%; compared with $6.6 million in the third quarter of 2010, and $6.8 million in the second quarter of 2011.

International sales represented 86.8% of total sales for the quarter.

Revenue increased in Europe 39%, and in the Americas 13%, but declined in Asia 17%, compared to the third quarter of 2010.

As Fred mentioned, the European sales increase was attributed to automotive-related demand.

Sequentially, revenue in the Americas increased 33% over the second quarter of 2011; while Europe declined 3%, and Asia declined 10%, compared to the second quarter of 2011.

As Fred discussed, orders were $7.1 million for the third quarter of 2011, compared to $7.3 million in both the third quarter of 2010, and the second quarter of 2011; with Asia down 26%, Europe up 17%, and the Americas up 13%, compared to the third quarter of 2010.

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

Backlog at the end of the quarter, was approximately $1.3 million, down from $1.4 million at the start of the quarter, and $1.7 million at the end of the third quarter of 2010.

From a product perspective, we saw automotive and programming-centered related business drive strong growth in PS family sales.

Gross margin as a percentage of sales in the third quarter of 2011 was 55.9%, compared with 57.9% in the third quarter of 2010, and 58.5% in the second quarter of 2011.

This gross margin decrease, compared to the third quarter 2010, was primarily due to the impact of increased direct-material costs, as a result of the overall product mix.

Higher service-personnel costs compared to the third quarter of 2010, were offset by lower contract software development costs, and lower labor and overhead costs.

Operating expenses were $3.6 million, compared to $2.9 million in the third quarter of 2010.

This reflects approximately $250,000 of expense related to Azido, our new name for the software technology purchase we announced back in May, $200,000 of increased contractor and consultant-related expense, and $128,000, less contract software engineering development cost charged to cost of sales; as well as higher R&D, materials, and personnel cost.

As Fred mentioned, we anticipate over $250,000 in reduced operating expenses during the fourth quarter, with the completion of consulting engagements and less accelerated development spending associated with our product development.

Net non-operating expense of $165,000 included $178,000 of currency exchange volatility-related expense, primarily related to cash balances denominated in US dollars in foreign subsidiaries; and inter company balances denominated in other currencies.

Our income tax provision for the quarter was primarily due to taxable profit in foreign locations, especially China and Germany for the quarter, as well as certain state and federal minimum tax.

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

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

In accordance with US Generally Accepted Accounting Principles, GAAP, net income in the third quarter of 2011 was $130,000, or $0.01 per diluted share; compared with net income of $833,000, or $0.09 per diluted share, in the third quarter of 2010.

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

The Company's cash position at September 30, 2011, was $18.4 million, up $1.4 million from the second quarter of 2011.

Accounts receivable decreased to $4.8 million at September 30, 2011, compared to $5.3 million at June 30, 2011; and $5.5 million at September 30, 2010, primarily due to improved collections.

Inventory decreased slightly to $3.8 million at September 30, 2011, from $3.9 million at both June 30, 2011 and September 30, 2010.

Deferred revenue was $1.4 million at both the beginning and end of the third quarter of 2011.

Earnings before income taxes, depreciation, and amortization, EBITDA, were $521,000.

The depreciation in amortization included in that calculation was $339,000, which included $111,000 related to the Azido Software Technology acquisition.

A share repurchase program was authorized by the Board of Directors, with provisions to buy back up to $1 million of stock over 4 quarters.

The program will be established under a 10b5-1 plan under the Exchange Act to provide flexibility to make purchases throughout this period.

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

However, I will be at the Singular Research Conference next week, presenting on October 26th.

I look forward to meeting any of you who will be attending.

We plan to post a new version of our Investor Presentation next week, so stay tuned.

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

Thank you, Joel.

At this time, we'll take your questions.

(Operator Instructions)

David Cannon, Williams Financial.

Good afternoon, gentlemen.

Good afternoon, Dave.

First question is in regards to the new software for RoadRunner 3.

Were you able to sell any to your existing installed base -- retro-fit business, so to speak?

Yes, Dave, we were, and we have many additional ones in the pipeline.

Okay.

Was it a nominal amount or was it material?

I would say it was a nominal amount, because it was a purchase of once, for them to test it, before they placed an order for their factory.

I see.

Do you have confidence that you'll be able to sell software, in the current quarter, as a standalone to your existing installed base?

Yes.

Okay.

And then, Joel, can you just elaborate more on the increase in direct material costs and the way it affected gross margin?

Yes.

About 2 margin points were associated with the fact that we had a number of systems that sold that had, either more expensive options from a cost standpoint, or were part of systems that don't have quite as high a gross margin as some of our other products.

So we had this unique product mix, this quarter, that just actually drove our direct margin -- our direct materials margin down 2 points.

That is not something where we had prices going up or costs going up, it was strictly a mix of the product line during the quarter.

Okay.

Now, let's say on a go-forward basis, now that your model, really, is going to be changing over the next year; as you roll out software for all of your systems, inevitably some customers in your existing installed base are going to purchase that without the equipment.

Of course you'll get orders with the equipment, but my question is on software standalone.

Let's say, for example, you were to sell software for 40 RoadRunners -- approximately, of that revenue, what percent would be gross margin be on that?

I want to get a flavor for the contribution to profitability, on software sales, to your existing installed base.

Well, other than a service component and a CD-type thing, that is it -- so 95%.

I see, so if we get, in theory, $300,000 or $400,000 of software-alone revenue, 95% of it roughly will go to the bottom line.

That would be the case with any of the purchases of the software.

Certain software elements might be for more, what I would call, most services if we were to do some integration work; so, you could have some of those sales that would be accompanied by some consulting services that wouldn't have that same margin, but the software itself would have a 95%-type gross margin.

Okay.

And then, also, the affect of selling the new automated systems, like let's say the RoadRunner 3 -- what will be the delta between gross margin on, let's call it New RoadRunner 3 business versus old RoadRunner product?

How many gross margin points will you pick up selling them RoadRunner 3 with the software wrapped around it?

I don't exactly have the exact margin points here, Dave, but it's about $15,000 of more gross margin associated with each RoadRunner sold under the new RoadRunner 3.

Okay.

Did you guys sell any meaningful quantities of RoadRunner 3 in Q3?

Well, you know, Dave, we have taken business for RoadRunner 3, but I think it's important to recognize that RoadRunner, in and of itself, is basically a processed-changed product, and customers either have to go through the process of implementing a new manufacturing process; or, in the case of their existing RoadRunner customers, and they want the capability of the RoadRunner 3, you know, then it's a little bit easier for them to adopt the new unit.

I can tell you that we have had some very favorable response from the existing customers that have RoadRunner, that need the capability of RoadRunner 3, and we believe it will contribute a significant amount of revenue in the fourth quarter.

Okay.

But in Q3 --

It was a small amount.

Very small amount.

I'm just trying to get my head around the gross margins, also.

It makes sense, that is why gross margins were a few points lower.

Going forward, if you're selling software to your existing installed base, plus selling the new systems with the software, gross margins have the potential to go well above 60%, correct?

That is the goal.

Absolutely.

And then, I looked up Q4 of last year, and it looks like OpEx was around, a little over $3.2 million, so you guys are comfortable that we're going to at least get -- OpEx is going to drop back down to that level in the current quarter?

Approximately that level.

That's correct, Dave.

It's a -- you know, we can't nail it down to the last $1,000; but, you know, as close as we can account for here, you know, we're at basically the same level.

Okay.

I mean it's a transitional year.

I mean it's -- frankly, it's been a little bit disappointing.

You have made investments, which in the long term should make the Company much stronger.

However, for what it's worth, from my perspective, I don't know what is going to happen in terms of bonus accruals in Q4, but I would say I probably speak for most shareholders.

You know, overall, it was a disappointing year, although there's a good explanation for it, and I think -- I don't know what's in your comp plan, but, from my perspective, I don't think -- I'm hoping not to see a meaningful amount of bonus accrual in Q4.

Is that going to be the case?

Well, I would certainly expect it down from all the other quarters.

Dave, put it in this perspective; the Management team's incentive is based on 2 things -- revenue growth and profitability.

And, the Management team made a very conscious decision, early this year -- actually starting late last fourth quarter -- to increase operating expenses to accelerate some new products, even though it was going to take money out of the Management Incentive Compensation Plan that would go into their pockets this year.

We made a decision to forego short-term compensation for the long-term benefit of the shareholders.

Okay.

Enough said.

And, Joel, do you think that going into 2012, we can get back to OpEx levels, sub $3 million per quarter, or $3.25 million is kind of the levels that are here to stay for now?

I really don't think that it's -- I have the visibility to be able to talk out that far.

Structurally, the biggest single item that has changed in our operating expense profile has been the addition of Azido, which this last quarter had about $250,000 worth of expense associated with it.

And the other pieces -- it's very hard for me to go out and say when we'll be done with certain ones and when we need to use consultants.

So, Dave, I would love to be able to tell you I know when that is, but I just don't think it's reality for me to make that projection.

Okay.

And then, do you think you can generate any revenue this year from the Azido acquisition, that software specifically?

And then, the follow-up to Azido is -- you made reference to something, I believe it was with the US Military, that there would be some applications there.

Could you give me a little bit more color, and give me a sense as to what the revenue opportunity is there, and the time frame?

Well, Dave, I can give you a couple of data points -- one, that the US Government Military has, in the past, purchased more than $2 million worth of this software.

So, we think there is a significant revenue opportunity there.

There are substantially other government agencies that could contribute similar amounts of money during 2012 -- significant amounts.

So, we -- that's really part of the plan.

Now, we have not rolled out this product in terms of a commercial release yet.

And we have not established the date for the roll-out of the commercial release.

As I said in my comments, we have over 30 users now of this software that are using it through our secure website; and, we expect to be adding about 15 users a week, which is about the maximum we can support with our resources at this point in time.

But, at some point, we'll have built-up several hundred users, at which point we'll be ready to begin to roll things out with a public introduction and commercialization.

And we'll just have to keep you attuned as to how that progresses.

Sounds exciting.

I'll let somebody else ask questions at this point.

Thank you.

Michael Potter, Monarch Capital Group.

Joel, I think you answered it during the script, but what was the adjusted EBITDA for the fourth -- for the third quarter?

It was $521,000, and that included $339,000 of depreciation and amortization.

What was the number again?

$339,000 of depreciation and amortization, and the actual EBITDA number was $521,000.

Were there any other non-cash expenses, stock options, anything like that?

Yes, there was a, basically, $0.01 worth of stock option equity compensation expense during the quarter.

So, about $90,000?

I think it's a little over $100,000.

About a $100,000, then?

I don't know that number off the top of my head, but in that range.

So, on an adjusted EBITDA basis, it was about $621,000 then?

Yes.

Are you including the stock option expense in the $520,000?

No, stock option isn't included.

This is just backing out the interest, taxes, depreciation and amortization.

Okay.

What was it for the Q3 last year?

I have that right here at my fingertips, and that is -- I thought I had it here.

I'll get back to you in just a second.

Okay.

Mike, as you can imagine, we have several piles of paper on the table in front of us, so Joel is taking a moment to find the document.

Okay.

I must have left this one on my desk.

I apologize.

I don't seem to have that number here with me.

Okay.

It would be helpful -- I know we have brought it up in the prior conference calls -- if it was included in the release.

That way we could see what cash earnings are a little bit more closely.

With regards to the RoadRunner 3, Fred, did I understand correctly?

We had 1 unit sale and it was a test unit in Q3?

I didn't say that, Mike.

We have booked the sale as of this date.

We have booked a sale.

We did not have any revenue associated with it in Q3.

And we have many others in the pipeline.

Okay.

So, I just want to be clear though, because it was obviously a very, very important event for this Company.

Something that we have all been waiting for, for a long time.

So, how many units of the RoadRunner 3, with the new software package, were sold during Q3?

None.

Zero.

Okay.

How many do we currently have in the field?

You have to separate that because -- well, we did have a sale of the software, independent of the RoadRunner 3.

Okay.

So we had 1 software sale?

2.

2 software sales.

And those were both in Q3?

There was revenue from 2 units -- there was revenue from 1unit, there was 2 sales.

Okay.

But, Mike, I want to be careful here; because, from a competitive standpoint, we're not going to be telling people, every quarter, how many units that we have sold.

You know, it's just -- we don't have any public competitors.

All of our information that we put out is public information, and it's just a competitive issue.

So, we're not going to be, on a routine basis going forward, telling specifically how many units of particular models that we have sold.

Understood.

But I'm trying to get an understanding of the market acceptance of this product.

Obviously, a lot of investment and a lot of time went into it, and a lot of attention -- not just by the Management team, but by the investors as well -- went into the launch of this product.

So, you know, it's been built up to be something major and a changing event for our Company.

And, obviously, we have to have a way of measuring whether or not it's successful.

Yes.

Well, you're going to see it, ultimately, in the revenue growth and the improvement of margins.

I can tell you that we have a very good pipeline for that product, with numerous accounts, that we expect to close in the fourth quarter.

So we feel good about where we are.

But, as I explained earlier, the RoadRunner is not just a product.

The RoadRunner, RoadRunner 3, and particularly the Factory Integration Software, is a complete process change for customers.

So, it's not something that you can just deliver and, on the day you deliver it, somebody can use it.

It has to be integrated with the manufacturing process, and so forth.

So, it's more of an enterprise level sale than just a product sale.

Okay.

I understand.

So, we had 1unit delivered in Q3, but it had 2 software sales on it?

2 different companies.

2 different companies.

Okay.

But, no revenue derived from the RoadRunner 3, itself, during Q3?

That's correct.

All right.

And so, we're a month into Q4, so far.

Do we have any RoadRunner 3 sold, so far, this quarter?

Yes.

And the same thing, where it's a separate software sale?

That was a RoadRunner 3, which included the software.

Yes, it included the software.

Okay.

The RoadRunner 3 comes with the Factory Integration Software.

Now, customers can buy the Factory Integration Software independently, which is what a customer did in the third quarter.

Okay.

And, how would you measure the success of the RoadRunner 3, and the software component to it?

I think, Mike, first of all, there's a number of customers that are going to be perfectly happy with the existing RoadRunner.

They don't need the additional capability of the RoadRunner 3.

And so, the RoadRunner 3 will be sold to customers that have specific requirements for some of the new capability that we put in the RoadRunner -- the higher through-put, the particular ability to handle different geometry devices.

There are some unique capabilities that the RoadRunner 3 offers; and, of course, it comes automatically with the Factory Integration Software.

But, we will be continuing to sell the existing RoadRunner product, and many of the existing customers will continue to buy it, but many of them will also choose to adopt the Factory Integration Software.

So, we are going to look at it from the standpoint of the overall RoadRunner family revenue, the incremental revenue that we get from the end-margin that we get from the RoadRunner 3, as well as the incremental sales of the Factory Integration Software that we have going to the existing RoadRunner customer base.

And, of course, we're going to be rolling that Factory Integration Software out over more products.

So, we'll be looking at the individual pieces to measure the overall results.

Okay.

And then, on the other software line, Azido, can you give us a little bit more details of exactly what the software does?

And, I know on prior conference calls, I believe it was Joel that mentioned you guys were anticipating commercialization and some revenue recognition before the end of the year.

Is that still the plan?

When I had talked about that, back in the summer, we had hoped that there would be a few more opportunities for possible, some of these special military or special single-account sales.

We really are still in the stage of fine-tuning whether, and when, we're ready to do the launch of something where we're selling it on a -- just a standard user basis.

I think, Mike, I could say, that we had a very, very minimal amount in our plan for the fourth quarter, so anything that we don't achieve in the fourth quarter has little impact on what the financial model that we had projected looked like.

I'm really not at liberty to say exactly what this software does.

We have not introduced it publicly yet.

Everything that we have done has been under terms of a nondisclosure agreement.

So, you know, I'm not really able to tell you exactly what it does, other than the fact that it is design software that allows you to design electronic systems, with things like CPUs and GPUs and FPGAs.

And it's got broad application in many areas beyond electronic systems design; and, apart from that, I really can't say anything more exact at this point, until we're ready to talk publicly about it.

Can you give us a sense of the size of the market that we're selling into, for this, I guess, design software?

How large is the market, and how large -- is it in the billions, is it in the hundreds of millions?

And, what can we anticipate or hope we will achieve as far as market share goes, 3 years out, 5 years out?

Well, Mike, I can tell you that there are hundreds of thousands of potential users of this software.

And, what we can address -- you know, we're still trying to determine that, based on the early feedback we get from users.

Over the next 3 or 4 months, as we get several hundred users using the software, and we get to evaluate their experience and any difficulties they have had with adoption, then we'll be able to refine our adoption model.

You know, we had a pretty clear adoption model going in, in terms of the potential market and who we thought would adopt it, and we're tracking against that model pretty closely.

But we're not really at a point where we are in a position to talk publicly about what that might be, except to simply say that, yes, the market is very large.

Okay.

I'll get back in queue.

Dennis Van Zelfden, Brazos Research.

Fred, regarding those 2 software sales that you made in the quarter, were they -- do they happen to be to those existing customers that were testing it, for the last 6 or 9 months or so?

These are customers that we have had a long-term relationship.

These are customers that have used RoadRunner in the past.

They are customers that we have had a good relationship with, and that we knew had a requirement.

They are both automotive customers that have demands for quality control, process monitoring; and they need Factory Integration with their system to -- essentially, with the combination of the RoadRunner, along with this Factory Integration Software, basically makes the possibility for operator mistakes -- it drives it down to about zero.

And that is really important for automotive customers that face the potential for a recall if there is an operator mistake on the line and something gets misprogrammed.

So, these were known customers that we went after, because we knew that they had requirements.

We had an established relationship with them; and we were delighted because, when we asked them about their requirements for this kind of software and we went down the list and ticked off what they said they wanted, we were able to say done, done, done, done.

So, it was quite gratifying with these customers; and so we're confident now that we can take this to the other customers just like them that we have relationships with and roll this out very successfully.

Okay.

Talking about selling the software to your installed base, do you -- and you said you've got a lot of interest or orders, or whatever you said -- do you think this is going to be a long sales cycle?

Wow.

No, it's not going to be a long sale cycle to customers that are already using RoadRunner.

It can be a fairly quick sale, very quick sale, in that instance.

Where it is going to be a longer sale is if a company is considering the adoption of RoadRunner 3 with the Factory Integration Software, and they have not been doing online programming.

There, it really is a significant process change, and it takes a while for them to fully understand what the implications are, and plan for the adoption and actually buy the software.

There it can easily be 3 months, 6 months in the gestation period; but for existing customers it's going to be much faster than that.

And we're, of course, seeing that already in our funnels.

Okay.

Let's talk about those funnels.

Over the last couple of quarters now you have stated that your sales funnels are full and/or strong -- or some kind of words to that effect -- and yet sales were up only 4% in the second quarter, and 7% in the third quarter.

I guess, it may be more of what full means to me versus what it means to you.

But it means to me that there is really no demand issue.

Essentially that you might be able to sell everything that you can make.

So, help me reconcile when you talk about how sales funnels are full, but we're only getting 4% or 7% sales growth.

Okay, so, Dennis, maybe the way to answer it is this.

If you were to look at our sales funnels, which, of course, they are not public information.

But if you were to look at our sales funnels, you might see, around the world, at least in terms of the major things, and we identify -- typically we track, maybe, at any point in time, we have got 50 major pieces of business in our funnels.

And we track those, and we track those by bucket, in terms of when they -- when we have made the initial sales call.

We track when we have completed the management presentation.

We track when we have actually delivered a formal quotation to purchasing, and then we track when we're actually in negotiation with that business.

So, what our funnels tell us is, they tell us the number of prospects that we have and the stage that they are in, but they can't really tell us the velocity at which business is actually going to move through the funnel, and that depends a lot upon the economic conditions at a particular account.

Let's take an automotive account.

Let me just pick a General Motors, for example.

We might have a potential order with General Motors that sits in the funnel for 3 months, 4 months, 5 months, and it may move along through the funnel very slowly, and it might take 4 or 5months for that order to move potentially through the funnel, or in some cases it may just completely fall out if the project gets canceled.

Then other projects might move through the funnel, the 4 stages of the funnel -- it might move through the 4 stages in a week or 2 weeks.

So, it's very difficult for us to predict.

But what we know is, that when there's economic uncertainty out there, customers don't typically move things through the funnel.

There's not the acceleration.

There's not the urgency with which that we might see business move through the funnel in a more demanding environment.

And so, that's just a reality.

That velocity through the funnel, is something that is different than, actually, what the strength of the funnel is, which is the total number of opportunities that we have in the funnel.

Does that answer your question?

Yes, it does, thanks.

Just a follow-up on, again, selling software to the installed base of the RoadRunner machines.

Do you have a separate sales force to do that?

Or let me just ask a more general question.

Who is selling it?

Who is selling it?

Dennis, around the world, we have channels.

So, we have 30 or so representatives and distributors, around the world; and, in the case of the existing customers -- existing RoadRunner customers, where this software would be generally appropriate, if they are located in Germany, where we have our own direct sales operation, then our own direct salespeople are directly in touch with those customers on a frequent basis.

In the case of some large global account -- let's take a company like a Bosch, for example, or a Continental Automotive.

Those companies have operations around the world, and our regional managers -- we have about 11 people in the management team, in our sales organization -- those regional managers keep those, what we call, global accounts tied together and share information.

And, in many cases, the customers have groups; so, within a company like a Continental, for example, there are advisory groups within the company, where they share information about best practices and adoptions of new technology, and so forth, within the divisions.

So, we have a feet-on-the-street sales organization with our channels, our representatives, and distributors that maintain frequent accounts presence.

And then, we have our regional managers that go in occasionally to work much higher level presentations, or respond to high-level management questions.

And so it's really a combination.

Does that answer the question?

Yes, that's fine.

1 last question for Joel.

Joel, going back to this EBITDA question --

Okay.

If I take $360,000 operating income, add the $339,000 of depreciation and amortization, and add the $100,000 in stock comp, I am getting $799,000 worth of EBITDAS, which is just the stock compensation on the end of it.

That is correct, right?

Or am I double counting something?

Because I get more than what your number was.

Well, you would start actually with the $130,000 of net income.

You would add back the taxes.

Then you add back the depreciation and amortization, and then you would add up that net interest of $13,000, and that should get you that same number.

What about the stock-based compensation?

That is not part of EBITDA.

Okay.

I'll just have to talk to you at a different time.

Thanks a lot, guys.

Good luck.

Thank you.

Steve Spence, RBC Wealth Management.

Thank you.

Good afternoon.

Can you help us a little bit?

As you might imagine, there's a lot of moving parts here and as we are looking into next year -- I know it's early in the budgeting process, but can you speak a little bit as to what you expect to budget, with respect to R&D and SG&A as percent of sales?

Well, Steve, I can't respond to the specific numbers, but what I can tell you is that our goal is to get back to our operating model, which would be 15% R&D, over time; and that is going to come about as some of these new projects take hold.

And we don't anticipate any significant ramp-up in expense now.

We think that the major expense bubble, we have been through, and we're in the process of winding that back down.

So, that is the plan going forward.

(multiple speakers)

If you look at our SG&A, we're pretty much on track for being able to stay within our model at 30% of a target for SG&A.

So, it's really going to be a question of how quickly we're able to get the R&D spending and the revenue aligned; and that means, in essence, new revenues from the Azido-type project, so they can offset the roughly $250,000 worth of Azido-type expenses there.

And, again, how quickly things like RoadRunner 3 and Factory Integration Software contribute to that growth in that, so that we can actually be in accordance with a revenue and R&D relationship that is at the 15% level instead of the 21% level that we were this current quarter.

We know it's going to be going down, because of our R&D spending going down, but that is still a revenue correlation.

Okay.

I would have expected that you might have been establishing some new goals, as you get your managing back towards your gross margin with the Company, next year and in the following years, because of a dramatic shift in product mix; and so I would have expected that we would have seen these numbers at lower levels.

What am I missing?

Steve, you know, I think that 2011 is really a transition year for Data I/O.

Up until this last year, we have had a fairly consistent business model, and we're working to a very specific business model in the existing programming business.

And I think what we tried to put out for you earlier this year, is that we made conscious decisions to expand the business, and also to enter some new business.

And, so, we are really in the process of a transition and I think that we will have some new goals.

We'll have some new plans in place, but we're not at the point -- we're in the middle of this transition and we haven't reached a point of stability, if you will, on the other side of that transition.

But, I can tell you that, from a -- overall financial standpoint, our goal is to get the R&D expense, once we get through this transition, back into the 15% region, which was our goal, and back down from the 20% level that we're running right now.

And that will drop another 5 percentage points of profit to the bottom line.

That is the goal.

I think what we are not comfortable yet, is giving you a date at which that is going to happen, and I wish I could, but I just can't.

There's just too many moving parts right now with the roll-out of these new products and other things that we have going on.

I can certainly understand that.

If I inferred I was asking for dates, I certainly wasn't.

It's more of a directional issue.

Right, the direction --

Help me understand again, now, in terms of sales leverage, and leveraging cost of goods sold, R&D -- particularly with the integration of products, where the cost of goods sold is so little -- as a part of the product mix.

Why would we expect those levels to return to historic norms, let's say from 2010, with what you anticipate being such a dramatic shift in sources of revenue and margins?

I'm looking for operating leverage.

Well, I think Dave Cannon raised the question earlier on the call, Steve, with respect to the gross margin; and as we responded, with respect to Dave's question, we expect very high gross margins on this new software that we are rolling out, the Factory Integration Software.

We expect when we finally roll out the Azido software to the customer base, we're going to have very high margins on that software, as well.

One of the reasons for the investment is actually to drive those gross margins very high, so I think, directionally, you're absolutely right.

Directionally, we see the gross margin going up and we see the operating expense coming down.

And, that is the model.

All right.

Thank you.

I look forward to seeing how all of it unfolds.

Can you bring this up to Dave a little bit?

I think it was in the first quarter that you announced that you had acquired the services of a consultant to help you with respect to strategic measures that the Company might follow.

And I wonder what you might do to update us on the progress, or some of the work that has come from that engagement.

Yes, Steve, I can.

We engaged TM Capital, as I mentioned earlier in the year, and TM Capital did a considerable amount of work with us throughout the second and the third quarter.

And we brought the -- their effort to conclusion, we got what we were hoping for out of that work and we asked them to explore a number of strategic alternatives for the Company, which they did, and they made a number of recommendations to us.

So, the results are what we had hoped.

Joel, do you want to add anything else to that?

No, just that if you remember right or if you saw it, we did notify everybody in the 10-Q back in the second quarter that, that was a completed project and that spending was done.

So, that really was one of the things that we're looking forward to -- less consulting and less contractor-type expenses going forward.

Okay.

I had taken those comments to relate to software development as opposed to strategy.

Well, there was a chunk of money that was associated with consultants that were GNA, and we talked about that in the SG&A Section of the 10-Q, that by terminating those engagements or their completion, that we were going to have some savings on a going-forward basis after Q3.

Okay.

Thank you for that.

And then -- checking my notes here, I'm sorry.

I have one additional question for you.

I'll go ahead and cede the space to others, and I can get back to you.

Thank you.

You're welcome.

Tom McGuire, a private investor.

Hi.

Good afternoon, Joel and Fred.

Thanks for the call and taking my question.

I gather that, you know, you still are as optimistic as ever on your software initiatives and new products that you're coming out with, from what I have heard so far.

I don't think anything has changed, has it?

No.

Okay.

I have a couple big-picture questions I would like you to address, if possible.

You know, with the continued growth of the smart wireless products market, and your new product line-up that you are introducing as we go along -- if we have another recession, which some think tanks are saying we will, do you think you have enough going for you with the new products and, hopefully, less cyclicality that you could maintain profitability or at least cash flow neutrality in a downturn?

You know, Tom, it really depends on the behavior of companies with respect to capital spending.

At the end of the day, a substantial amount of our business is still capital equipment.

And, in many cases, the software also is a capital purchase.

So, it really depends on how companies behave in a downturn.

One of the easiest things for a company to do when a recession occurs, a downturn comes, is to freeze capital spending -- a lot of companies do that.

And if they do that, that impacts us directly, and it doesn't matter whether or not you have got a good financial justification.

Look, if you -- many of our customers, they'll do a return on investment calculation.

They'll say they can get a return on investment in the purchase of a RoadRunner in 6 months.

But, in a real downturn, where CFOs are unwilling to spend capital money, it doesn't matter whether they can pay back the investment in 6 months or 7 months.

Very often the CFOs will just simply say, we're not going to spend any cash.

So, that is the issue that we face and makes it very difficult to know.

I think it depends on how severe the downturn is.

I mean, certainly in the case of September of 2008, when Lehman Brothers went down, there was just a very tremendous amount of uncertainty about what was going to happen.

We saw companies basically respond by just stepping on the fiscal hose and shutting off all capital monies; and, of course, that took our revenue down 50% between the third quarter of 2008 and the second quarter of 2009.

So, it depends on the severity and it depends on the behavior of people.

I think that we're seeing a little bit more balanced judgment right now and we don't see -- even though there's a lot of economic uncertainty, we don't see a lot of people panicking like we did in 2008.

One thing that we have really done a lot to ensure is that we have a process sales where it's for cost reduction or whether it's for technology upgrade, but, you know, there's a different basis other than capacity-related sales that we are working on.

And then, one of the things that we did a lot during the last downturn was focus on getting more feet on the street and a broader sales channel, so that if our existing accounts weren't buying, we were bound and determined to find new accounts that were going to be buying.

So, those are a couple of the tactics.

The other thing is that we're fairly conservative about making sure we're watching, very carefully, expenses and that we're also taking action as early as we see appropriate with regard to making sure that we're very measured with matching our expense levels with our revenue opportunities.

Okay.

Great, guys.

Another big-picture question I have is -- you know, your stock is not a very good trader.

In fact it's really, really hard to get a position and once you have a position, it's really, really hard to get out, and you guys can see what happened recently in the marketplace, where the stock went from the high 5s to below 4 on very little volume.

But, you know, my experience, over the years, with thinly traded stocks, is that they become more liquid as the stock price moves up, and the higher the price, the more people are willing to trade.

You know, if it's moving up, there are people out there that want to buy it, and if it's up, people who have had it for a long time want to sell it, so the liquidity increases.

So, realizing that the market is pretty fickle, do you envision that investors can become as excited with Data I/O's prospects as you guys are?

And I'm thinking of the fickleness of the market.

Everybody wants to see at least a mid double-digit teenage-type growth rate out there.

And, if you can do that with expanding margins through costs getting better in line, and your gross margin increasing, I mean, I can see investors getting excited.

I guess, to make it short, is a mid-teens growth rate something that you can attain for and see in a regular -- in a normal economy, whatever that is now?

Certainly with the new products coming online we can see that, Tom.

If we hadn't taken the action that we did, to both expand our market presence with new products that expand the addressable market, and if we hadn't made the investments to actually enter new markets, it would have been very difficult to deliver that growth.

You know, programming has been devalued substantially.

If you look back over the last dozen years or so, at least since I have been here, we used to be able to extract more than $0.50 a device for our programming capability.

It's way less than -- it's more than down by a factor of 10 today.

And if you look at on the basis of a bits program, it's like a 1000 to 1 difference.

And it's because that there are so many alternatives to the traditional programming technology that Data I/O has had in the past.

There is competition from programming centers.

There's competition from after-placement programming.

There's competition from the ATE manufacturers.

So there's just been a lot of forces that have really devalued programming, in terms of how much money you can extract from it.

And it makes growth very challenging, particularly when some of the Legacy business goes away, and so that is another factor that plays into it.

And, so really, part of the strategy about expanding the marketplace and entering new markets was to really create new opportunities for growth for Data I/O shareholders.

Okay.

Then 1 last question on your answer there.

So, the value -- you're losing, like you said, you went from years ago, $0.50 a device to now, a factor of I think you said 0.10 of that or something like that.

Yes.

Why don't we see that in the gross margin?

Why is the gross -- because there are very few technology companies that can support a 60% gross margin.

Why don't we see the competitive nature in the gross margin?

Well, the reason you don't see it so much in the gross margin is because the tremendous investment that we have made in R&D, to drive the through-put of our solutions, the performance of our solutions up to offset the competitive factors.

And so, it's taken a substantial investment to keep us at the forefront and that is really what we have tried to do.

So, the customers that have the most demanding requirements, they buy our equipment, our higher performance solutions, because we can address the more complex devices, the more challenging devices.

Okay.

Thanks a lot, guys.

You're welcome.

Michael Donovan, a private investor.

Good afternoon, Fred and Joel.

Thanks for taking my call.

Fred, I have been a shareholder as long as I think you have been at Data I/O.

I think you have just sort of mentioned it yourself, 1999 or so; and I guess my question is, the little bit of due diligence that I have been able to do around -- I got my head around the software initiative with the existing business and the Factory Integration Software.

It makes tremendous sense, and all the best to the changes that it's going to bring to the firm.

But, when I look at Azido, and the little bit of due diligence that I have been able to do on it, because I think you were aware it's had a rich history.

It is not something that was developed yesterday.

It's been around for a while.

It's burned through its fair amount of cash without really becoming commercially relevant, at least from what I can tell.

What do you see now or what can Data I/O do with this software that, either previous owners could not do, or is it something that has changed in the market that you see, is going to trigger like a paradigm shift.

And thanks for the answer.

Oh, sure.

Well, first of all, I think it's important to understand that -- and I don't know exactly what research you have done, but in its previous life, it was never sold commercially, as independently as software.

The previous company used the software, but they used it as part of a hardware platform that they had.

We had no interest in the hardware platform.

There's nothing in the hardware platform that had any value to us.

But we saw the tremendous value in the software.

And any company that is developing a product that are field-programmable gate array based, FPGA-based, has a tremendous difficulty in ever reusing the software, or ever pouring it from one architecture to another.

You may not know this, but all of our programming technology is based on field-programmable gate arrays.

And it costs us a substantial amount of money.

We have invested millions of dollars, and similarly in my response to Tom McGuire on his earlier question, in keeping our technology at the forefront, the leading edge.

That takes a tremendous investment, because every time we roll out a new FPGA design, there is a tremendous amount of testing that has to be done against the thousands of algorithms that we have already in the base.

So, we justified the acquisition of this software, just purely on the basis of the savings that we could achieve in our own developments associated with the programming business; and rolling it out as a commercially available software offering is just frosting on the cake, over and above the deed that we had for our own applications.

I mean to that -- to that notion, is this software really part of a paradigm shift that may or is desired by the market to occur in terms of FPGA over microprocessors or CPU use.

What do you guys see that -- I assume that others might have had a bite at this apple.

And, for whatever reason, they either got a better solution or -- not invented here kind of thing, but do you see something that is unique because of where Data I/O fits in the food chain?

Yes.

We had some very unique opportunities and we saw some particular things that other people did not see.

And we had an awful lot of opportunity to validate this technology, my goodness, with just --

Industry luminaries.

Industry luminaries.

People that, if I mentioned their name, anyone would know immediately who these people are.

And, very often there's a certain amount of disbelief, at first, when some people see it and see the capability, but once they understand the mathematical underpinnings of this, suddenly a light comes on and it becomes very significant.

So, we believe that there is something very fundamental here.

It's a strategic interest to the US Government.

There are just many things that are very significant about this; and, as much as I'd like to talk about it --

I would say there's 1 other big thing and that is the area of high performance computing, in terms of things like multi-core processing, FPGA, parallel computing.

These are all complexities that are demanding tools that can deal with the level of abstraction that people need to move away from that complexity, and this is the kind of tool that is out and available to deal with that, that's really just not elsewhere.

Just piggy-backing on Joel, it's not just relevant to FPGAs -- it's relevant to CPUs, it's relevant to GPUs.

It's even relevant beyond the area of electronics.

One outstanding luminary looked at it, and he said, my goodness, you could design plumbing systems with this.

It illustrates the fact that this is very fundamental technology that we have been very fortunate to acquire and we hope to make very good things out of it.

Well, all the best, I wish you well.

And from a shareholder who's bought from $3 to $0.75 to $5, I hope you're right.

Thank you.

Steve Spence, RBC Wealth Management.

Thank you.

Can you help us a little bit with the sales channel for these 2 products and how you are managing that?

When you say these 2 products, Steve, which ones are you referring to?

With the addition of Azido.

Azido?

I really can't respond to that, right at this point in time, other than to say we do plan on using a completely different business model for this that has no similarity whatsoever to Data I/O's traditional capital equipment sales, and it's going to be substantially different than the kinds of approaches that are taken by other software companies that might be in related space.

Would it be reasonable, without disclosing what that channel is, that the costs are comparable to your existing channel, or will it vary materially?

We think it will be substantially lower.

Okay.

Thank you for that.

1 last question for you.

In following companies like TriQuint, down the road from you, selling into the wireless market, they're seeing what you folks sell into as well.

I think, in your current release, it's one of the markets that you mentioned that are growing, you're selling into it, and the automotive market that is having, certainly, an excellent year this year.

Can you help us to understand the issue of your own unit sales -- forgetting for the moment issues relating to margin, and some of the SG&A issues that you are dealing with now -- why we might not have seen a higher volume of unit sales in the current climate, given the intensity of the use of programmable devices in the automotive and the wireless markets?

I would just say overall, Walter Custer made the comment yesterday that roughly $2.0 trillion of electronic equipment is going to be produced in 2011, which at a cost in exchange rate is up 5.7%.

So, the overall electronics production is not up very much, compared with 2010.

And, as I think I mentioned, in his comment, he says, a global slowdown is certainly now upon us as world manufacturing growth had flattened by September, and he has some charts in his report that he released yesterday that illustrate that.

The electronics end-market expansion has also lost steam -- regional 3-month growth rates for electronic equipment shipments were down 16.1% in July for Japan; 11.4% up in August for Europe; and down 0.4% in August for the USA;, and slightly up at 0.2% in September for Taiwan and China.

And that Southeast Asia, including Taiwan and China, had a very weak September, at a time when the typical fall seasonal upturn would normally occur.

So, I think what you see, at least in terms of our business, is that you see that reflected in the sense that while we have a significant presence in smartphones, we have a significant presence in tablet computers, and we have a significant presence in automotive electronics, there's close to a half of our business that is not in those areas, which is not having a very good year.

You know, the other thing I would say is, you also have TriQuint, you used as an example, and they are a seller of devices and components, as opposed to capital equipment.

So, for example, in Asia, we actually had an enormous amount of capacity being added into programming centers and other electronics manufacturers with the number, in particular, of FlashPAKs that went into that area.

So, the timing of people's purchase in capital equipment is at a different rate than when they actually buy some of the components; so, again, it makes it a little harder to make these comparisons.

Yes, I agree.

The reason I use that as an example is simply because it's a fairly pure wireless application.

And their growth rate reflects that.

How would we reconcile, however, the growth rate, in terms of share of circuit board that wireless devices have?

I don't know what the numbers estimate to be for the year this year.

I fully expect that it's well above the 5% or 6% rate that you're citing.

You know, I think, Steve, I don't happen to have those.

Well, I might have those numbers.

Let me just see here.

I don't have them right at my fingertips.

But, I think I could say that we have had -- most of our wireless business is in Asia.

And, we have had a very strong year, in growth in Asia, related to wireless business.

Now, we saw exactly what Walter Custer commented on, in our business in Asia in September, which was a very quick fall-off in September.

And that is clearly related to the stretching out of orders and certain things that we see happening.

Apple was reducing orders in their supply chain, reportedly.

There were a number of things going on and we saw a very sharp drop-off in September in that area, consistent with what Custer reports.

But, I would say that if we look at the year to date, all things considered, we have done very well in wireless in Asia for the year.

Okay.

Thank you very much.

You're welcome.

David Cannon, Williams Financial.

I had to step away from the call and I just got back on.

I don't know if anyone addressed this.

In regards to the $1 million stock buy-back, from my perspective -- and I have spoken with other large shareholders -- I think it's really very small and almost meaningless.

For what it's worth -- and if your Board of Directors is listening, if they listen to the replays on the call -- if you guys really believe your stock is cheap, you guys should buy back a meaningful quantity of shares.

My suggestion is a Dutch Tender, something to the magnitude of, maybe, 1.5 million shares, which, let's say at $4.50 or $4.75, is around $7 million.

With $18.5 million in cash and growing, and the confidence you have for the future, I don't see why you can't go down to that level; but, the sure thing is, if operating income is flat, you'll get a 16%, 17% bump-up in earnings per share.

These opportunities don't come around that often.

It would make a more meaningful statement, but it would also improve the earnings.

A $1 million buy-back is purely esthetic in my opinion.

I'm not even going to ask you to comment on it, but that is my perspective and I think it's shared by many shareholders, because I've thrown it out there in the past.

Thank you.

Do we have any other questions?

Michael Potter, Monarch Capital Group.

I just wanted to kind of second what David just mentioned.

A $1 million share buy-back when we have the amount of cash that we do have, and growing, it is somewhat meaningless.

I would like an answer of why the Management and Board has decided to do such a small amount and, especially, I think the last time the Company had a share buy-back, I don't think it even executed on its buy-back and the stock traded down at the cash value at one point.

Why didn't the Company go through -- move forward with a meaningful Dutch auction of stock?

Well, Mike, I can tell you that there are a number of factors that the Board considered in doing what it has done.

And I can tell you that, unlike the previous plans, this plan will result in the buy-back of shares.

So, whether you're happy with the amount or not, I can assure you that this plan will result in repurchases.

That is one point.

And it will be a significant plan in the sense that it will be in place for 4 quarters.

So, that is another significant thing, from my perspective.

Now, in terms of picking the amount, the Board of Directors considers a number of things, many of which we, frankly, are not at liberty to talk about in a public setting.

We cannot disclose at this point, and so I really can't offer anything other than to say that the Board considered a number of factors in deciding how much money it wanted to set aside for share repurchases.

Would you suggest that any questions that we have should be directed directly towards the Board of Directors?

It's ultimately a Board decision.

Management really doesn't have any decision-making power with respect to this.

It is purely a Board decision.

All right.

So, I appreciate the recommendation.

I guess the shareholders that are frustrated with this ongoing issue should express their frustration directly to the Board.

Yes.

Okay.

Thank you.

Other questions?

There are no further questions in my queue at this time.

Well, thank you very much for joining us today.

We look forward to talking to you at the end of the fourth quarter.

Ladies and gentlemen, this does conclude our conference for today.

We thank you for your participation.