Anthony Ambrose - Chief Executive Officer Joel Hatlen - Vice President & Chief Financial Officer

Arthur Winston - Pilot Advisor Michael Potter - Monarch Capital David Cannon - Unidentified Company

Thank you and welcome to the Data I/O Corporation, second quarter 2014 financial results conference call. With me today is Joel Hatlen, Vice President and Chief Financial Officer of Data I/O.

Before we began I’d 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 maybe 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 fillings 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 as Data I/O is under no duty to update any of these forward looking statements. Now with the Safe Harbor out of the way, let me talk a little bit about our results.

Q2 returned to profitability with the strongest earnings in three years. This shows the progress we’ve made in our turnaround plan focusing on core product development, cost controls and focus on gaining market share.

Q2 was strong for booking led by the PSV7000 automated programming system. We are up from Q1 2014 as bookings continued their strong upward momentum, led by automotive, industrial, and programming center customer segments.

This has continued into July. Europe was stronger, and our customer mix was much broader compared to last year’s Q2.

Our backlog of $2.7 million and substantial differed revenue at the end of Q2 positions us well for future growth. The PSV7000 as I mentioned earlier continues to do extremely well.

As I mentioned last quarter, we are winning deals in competitive situations versus our traditional competition in automotive, programming centers, industrial and consumer markets worldwide. I’d like to call attention to one particular situation.

In Q2 we won with the PSV7000 in a competitive situation, in an automotive infotainment application, where the PSV performed much better than the competitive system in a head-to-head evaluation. This customer was a customer that previously had purchased from another supplier, and in the end they concluded that the PSV7000 was able to do the work of two competing systems at a much lower total cost of ownership.

This was a win back for us, a market share gain and represented a substantial order in the second quarter. Winning new customers is extremely important for us as we provide them a system sale now, but also we build our future revenues in adapter sales, services and potential capacity additions later on.

This is why we are so focused on winning market share with our very competitive new products. Along these lines, I’d also like to highlight our recent announcement yesterday of the PSV3000.

This is our newest automated handler designed and built in China for the Asian market. This system will be only sold in China and our Asian markets.

We believe this opens up a $10 million potential market for us and we are positioning this product for successful new customers against our Asian based competition. In the past customers told us they wanted to buy from Data I/O, they understood our quality advantages and programming engines and mechanical handling, but we were simply too expensive give their budgets.

In many cases these customers bought the bargain handlers and in some cases they differed automation and maintained manual handling. The market clearly needs a cost-effective quality programming system to help customers move from manual to automated programming and achieve high quality results that reduce their lower total cost of programming.

We will be demonstrating this system at NEPCON, in Shenzhen in August. I’ll talk a little bit more about the PSV3000.

This system is a breakthrough for Data I/O. We took a look at what makes a programming system a Data I/O programming system.

The core is the programming engine, our award winning trusted FlashCORE III programming system, along with an intelligent system design and systems integration and proven capabilities in system software. All three of these elements are present in every system we sell today.

In the so-called bargain brands, each of them have fatal flaws in one or more of these areas. To address the China and Southeast Asian markets for customers with a low total cost focus, we needed to preserve the core elements that we do very well and strip out cost everywhere else.

We did this with the PSV3000, and this new product will enable us to compete effectively in Asia versus the local competition. In addition to a great product, we offer local support and service with more engineers and service people present in China, than many of the local competitors.

We’ve already qualified this system for production and shipped the first system already. We do not expect the PSV3000 however to materially impact our Q3 results.

We’re building it for subsequent quarters, 2015 and beyond. Operationally our team did a good job to deliver a strong Q2.

We are planning to stay at high capacity to deliver Q3. We are starting the quarter with a significant backlog and we expect to have some this backlog carry over into Q4.

Finally, let me talk about our investor outreach. Many of you noted that we presented at the B.

Riley event in May in California and plan to present at future events, including the Rodman & Renshaw event in New York in September. There’s a webcast of the B.

Riley event, along with the presentation materials available on our website and I would encourage any investors or potential investors to look at these materials and if you are in New York, schedule some time with me at the Rodman & Renshaw event. With that I’d like to turn it over to Joel Hatlen, our Chief Financial Officer for a more detailed review of the numbers.

Thank you, Anthony and good day to everyone. Net sales in the second quarter of 2014 were $5.6 million, up 6% compared with $5.3 million in the second quarter of 2013 and sequentially up 16% compared with the $4.8 million in the first quarter of 2014.

Net income in the second quarter of 2014 was $447,000 or $0.06 per share, compared with a net loss of $624,000 or $0.08 per share in the second quarter of 2013. On a regional basis, net sales increased 155% in Europe, while declining in part due to system in deferred revenue and backlog in Asia and the Americas compared to the second quarter of 2013.

Sequentially, net sales in the second quarter compared to the first quarter of 2014 were up 29% in Europe, 19% in Asia and flat in the Americas. International sales were 89% of total sales for the second quarter of 2014 compared to 91% for the second quarter of 2013.

Orders for the second quarter of 2014 were $6.3 million, down 7% compared with $6.7 million in the second quarter of 2013 and sequentially up 8.5% compared to the first quarter of 2014. Remember that last year in the second quarter we had the large consumer product order for systems in Asia.

As Anthony noted, we had a strong backlog of our new PSV7000 automated programming system during the quarter, as well as PS388 systems and adapters. Backlog was $2.7 million at June 30, 2014 compared to $2.4 million at June 30, 2013 and $2.6 million at March 31, 2014.

Deferred revenue was $2.1 million at June 30, 2014 compared to $1.2 million at June 30, 2013 and $1.5 million at March 31, 2014. The change in deferred revenue relates primarily to a couple of system sales that had testing requirements for acceptance, where those tests were scheduled to be performed after the end of the quarter.

Gross margin as a percentage of sales in the second quarter was 54%, compared with 55.8% in the second quarter of 2013. The gross margin decrease as a percentage of sales for the second quarter was primarily due to unfavorable variances and a less favorable product mix.

Operating expenses in the second quarter of 2014 were $2.6 million, and compared to $3.5 million, which included a restructuring charge of $642,000 in the second quarter of 2013, which were down $915,000, primarily due to restructuring cost control actions, offset in part by higher incentive compensation. Earnings before Interest, Taxes, Depreciation and Amortization, EBITDA were earnings of $562,000 in the second quarter of 2014 compared to an EBITDA loss of $498,000 in the second quarter of 2013.

Equity compensation, a non-cash item in the second quarter of 2014 and ‘13 was $125,000 and $136,000 respectively. Adjusted EBITDA excluding equity compensation were earnings of $687,000 in the second quarter of 2014, compared to a loss of $362,000 in the second quarter of 2013.

Please see our press release for a reconciliation of these non-GAAP financial measures. During the second quarter of 2014, our working capital increased, however cash decreased $600,000 and accounts receivable increased $1.5 million, primarily due to the build in deferred revenue, as well as an increase of late in the quarter shipments.

We expect cash to increase in third quarter, primarily as deferred revenue is collected and recognized. The company remains debt free.

As of this June 30, 2014 the company had 7.8 million shares outstanding. At this time I’ll turn the call back to Anthony.

Thank you, Joel. At this point I’d like to open up the call to questions and the operator will give you instructions on how to get in the queue.

Good afternoon. Can you guys hear me okay?

You‘re coming through a little soft Dave. Can you speak louder please?

Okay. Our first question is on PSV3000.

Can you share with us what kind of feedback you got from the customer that (inaudible) and do you feel that you have to see ahead of the (inaudible) with the PSV3000 (inaudible) in terms of potential to take market share?

So David, it was real difficult to hear you. Let me make sure I got the question right.

I think your first question was on PSV7000, what’s the feedback from customer and the second question was on what are the competitive advantages of the PSV3000. Are those the questions?

Not exactly. My question is, what kind of feedback did you get from the customer that took the PSV3000 and do you think you have the same competitive advantages with 3000 that you had with 7000, (inaudible)?

Yes, I think I got the question thanks, although it’s difficult to hear you. So as we announced yesterday, we introduced a new product for our Asian markets, the PSV3000.

As I mentioned in my prepared remarks, the basic customer driver for that product is people want to be able to use Data I/O programming engines. They really like our quality, they like our predictability, they like the fact that we support all sorts of devices and they like the fact that our yields are better when they use Data I/O programming equipment than when they use alternative brands.

They are just in markets where they simply have to hit a certain price target. The analogy I would use is when you go into an automotive showroom and look at let’s say, a BMW 7 series, you realize that’s a great and wonderful product, but you may just not have a budget that would allow you to buy that type of car and so you look at a BMW 3 series or a Volkswagen or in some parts of world you look at a Skoda.

The key is to be able to provide a product to the customers based on their ability to afford what you can deliver and deliver the things they really want and need at that price point. So we talked to customers in Asia.

It’s clear they want the Data I/O programming engine. They want a very-very capable mechanical handling system with integrated vision.

A lot of the low cost systems in Asia do not have a vision system and this makes it hard to gets parts precisely aligned into the programming sockets. It causes low yields, it causes lead damages, it causes bunch of other things and I’m sure the competitors that are listening to our earnings call understand this quite well.

So when we talk to our customers, they want to be able to take the Data I/O programming experience and provide it in a robust automated handler that leverages a complete systems integration done by Data I/O and leverages the system software, the job launch software, the job control software that they are very used to as a Data I/O customer. So we think that’s what gives us a big advantage on the PSV3000.

As I mentioned we’ve already qualified the system for production and have it out there, but don’t put too much in for your Q3 estimates on 3000 just yet. Although if you do plan to be in the Hong Kong area or the Shenzhen area, please stop by the Data I/O booth at NEPCON.

We’d be happy to show you the system.

The other question is for Joel. Where do you see the operating expenses...

I think what you’ll see is that if we achieve higher levels of sales that you’ll see the operating expenses stay in line with that, because we’ll continue to control the expenses, but you will see higher incentive compensation and you will see higher sales commissions and again, I can’t tell you the mix, but we typically have sales commissions that end up being 5% to 10% of an increment, based on what channels they are going to go through? I think the second piece is that we were definitely being very careful with our spending and continue to do the different cost control measures that keep that down.

When we were at essentially a $5 million type sales range, we said we were going to be at the $2.5 million, $2.6 million level of expenses. We certainly see that we’ve been over that, but we actually had revenues that were over the $5 million level and I think you’ll see a corresponding amount as we go forward.

Okay, and then if you could just speak to gross margin. In the past we had a target of 50% gross margin.

Do you still think you can get there and if so, at what revenue level?

I don’t have the sensitivity analysis in front of me, but it was something where its north of $7 million per quarter to get to that level and that level still assumes that we have a level of RoadRunner, FlashPAK, some of our higher margins software sales that would be in that. When I look at order sales for this quarter, the PSV and the PS systems which have better margins than they have in the past, but still not up to software and FlashPAK and RoadRunner type margins would be in there.

So I’m kind of guessing that we are going to continue to be in the mid-55% type gross margins, but again that varies based on product mix as well as channel mix.

Okay, two questions Anthony. On the last conference call you alluded to the potential of making sales to the customers outside of the automobile industry or other parts of industrial complex and I was wondering how far along we are in doing this, that was the first question.

And the next one is, when do you think that sales within the United States could begin to rise, two questions?

Sure, thanks Arth and good to hear from you. I think if you look at the sales in Q2 we were very strong in automotive and industrial.

That’s been an extremely strong segment for us and as I mentioned perhaps earlier, we think it’s driven by a secular trend to more content, more electronics in all cars and larger computing systems, which require more programming capacity, so it’s very good for us. I think we are very happy with all the segments, perhaps with the exception of wireless and wireless is a situation where we have in the past had a couple of very large customers and our success in wireless is driven by predominantly their success.

One of those very large customers continues to be very successful and we hope that they will need more capacity going forward in the future and one of those customers in wireless has generally fallen on tough times. We do see some new applications outside of automated in what I’ll call internet of things applications or more industrial intelligent home control and lighting systems.

It was a win for us, as well as we continue to get some very interesting wins in the solar energy control area. So it’s a little bit broader than just automotive, but we are very happy with the automotive strength, because those customers tend to want their systems fully configured.

The second question I think you said was about the USA. We did have some good wins in North America, specifically USA in programming centers and that’s been a tough area for us.

Again, that’s an area where we’ve seen our market share gain for ourselves, but the business level at about 10% in the USA, I don’t see that number moving substantially in the future. Most of our businesses outside, most of the factories that produce products are located outside the USA.

We could see that tick-up as we see more general pick up, but I don’t see that number changing substantially one way or the other.

Well, why not invest in the new system, the cheaper systems programming centers in the U.S.?

It’s a good question, it can’t of begs the question that that’s what it’s designed for. Without going into a whole lot of detail, because my competition likes to listen in on the calls, we really wanted to make sure we got a right for the markets we know exist in Asia, that have been telling us what we need to have to win.

And we did that with the PSV3000. For a variety of reasons it’s focused on the Asian market and that’s where it’s going to be distributed and we think we have plenty of opportunities there.

Okay. Thank you, Tony.

Thanks a lot Arth.

Okay, a follow-up question on the PSV3000. How long do you think it would take to ramp up and then Anthony, if you could give me base ball analysis in terms of the turnaround, what inning are we in right now in Europe?

Okay. So, I said on PSV3000 it won’t be material for Q3 Dave.

I probably just leave it at that for now. The baseball analogy on the turn around, I know you were asking this question before and I’m trying to remember what I said last time you asked it and I’m trying to give a consistent answer.

Let me try to answer it this way. I think, the first step in our program, when we said it was going to be a multi-year program was to focus on getting the product line to be more competitive; getting our cost structure under control and focusing the entire organization on being able to gain market share worldwide.

And I think you’ve seen not only from this quarter’s results, but the trend line, we’ve been able to achieve good results in all three of those areas. So I think the next steps for us are we’re just announcing the PSV3000.

We continue to have interesting product developments to come forward and I don’t think we’ve exhausted the momentum on the PSV7000 by any means. So assuming that we can continue to see a decent macroeconomic environment, there is more room to run.

So I don’t think we are in the ninth inning of the turnaround by any means. I think we are middle innings for the starting pitch.

I don’t think we can declare. We haven’t pitched long enough to get a win yet, but we are off to a great start.

Okay, and then last question on new products. Is there anything else that you would like to have and that your R&D team is working on currently that could potentially help you to gain more market share?

That’s a tricky question David, because you said, is there anything I’d like to have; I’d like to have a lot of things. The hard part is deciding what we need to have and what we can afford to invest in and those are the guard rails we try and operate in.

Again, since this tends to be – the call gets heard by our competitors, let me just say that as we’ve talked about in a number of reports, we invest in handling technology, programming technology, software. We invest in a number of things that we think our customers want and we’re going to continue to do that.

So we are not done by any means in terms of new product announcements and I’ll just leave it at that for now.

Okay, thank you.

Hi Anthony, how are you doing?

Hi Michael

Congratulations on a really nice quarter.

Thank you.

I just had a couple of questions. I think you may have gone into it in the script, but what was the backlog again going into Q3?

$2.4 million. Our backlog was $2.4 million going into the quarter.

Into the quarter, okay and its $2.7 million now going in to the Q3.

Actually I misspoke. It was $2.6 million.

At the end of Q1 Joel it was $2.6 million right?

Yes, at the end of Q1 it was $2.6 million and at the end of the quarter it was $2.7 million.

And at the end of Q2 it was $2.7 million. You got that Michel?

Okay, so your $2.6 million at the beginning or going into Q2 and now its $2.7 million going into Q3.

Correct.

Michel, I think the thing that you really wanted to focus on is the differed revenue piece, because…

That was my next question.

Because we went from $1.5 million to $2.1 million and that really was a couple of systems that we shipped, but have exceptions test that will take some period time that aren’t scheduled here till the third quarter to actually be performed.

Okay. So the $2.1 million will all be realize in Q3?

I know that a good portion of it will be.

But we got to be careful.

We got to be careful, because some of the things could move over.

But Joel, it may be the kind of set the context a little bit, we always have a fairly large differed revenue balance for things like service contracts.

Subscription revenues that we amortize them…

And that’s typically north of $1 million dollars.

Yes.

So that Michael won’t, the differed revenue never goes to zero. So I think what’s probably easier to look at is what’s the delta between where we are now and maybe a more normal run rate.

So I think that’s available to be converted to revenue in the future. I don’t know that all of it gets convert in Q3.

In fact I wouldn’t assume that you would get all that delta converted in Q3, but because for example you could have more customers doing the same type of thing they’ve been doing with the PSV, which would create more differed revenue that we would add to in Q3, just as an example, but I think Joel indicated there were a couple of systems that we certainly hope to convert to revenue in Q3.

Okay, and we are not giving guidance, I know you won’t do that, but what’s your comfort level at this time Anthony, with maintaining profitability or at least this level of profitability I guess going forward for Q3 and Q4? Seasonally our stronger quarters at least historically they’ve been.

Well, Q4 has been rough the last couple of years, but we don’t have a whole lot of visibility into the Q4 at all, so I’ll probably just leave it at that for Q4. But for Q3 I did make a point at calling out that July has been strong in bookings relative to last year.

I feel more comfortable predicting the past than the future, so take that in to advisement. But the challenges and the reason we don’t give guidance is if you look at it, this quarter we are at $5.6 million with $2.7 million of backlog, which means that we still have to book a substantial portion of the business within the quarter and turn it into revenue.

So there is always this very large fraction of our revenue that’s turns business, and because its turns business and it’s lumpy, you get $0.25 million orders here and there. That can happen in the quarter, they can happen in a different quarter, etcetera.

That’s why it’s tough to predict and that’s why we don’t do the guidance. But it’s very clear that I’d say macro economically it feels better this year than last year.

Our customer breadth is much better. We had some nice customer orders last year, but they were highly concentrated.

Our sales funnel is stronger this year than it was last year and by that I mean the total value of deals that we see and again, it’s up to us to convert those in to bookings and ultimately revenue, but those indicators are better than a year ago, our customer base is broader, so that’s how we look at the business right now.

Okay. All right guys, terrific.

I’ll get back into the queue.

Okay, thanks Michael.

All right. Well, if we don’t have any questions, operator what I’d like to do is close the call at this time and thank everyone for joining the call and remind everyone about the replay instructions.