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Executives

Kevin J. Mills - President and Chief Executive Officer

David W. Dunlap - Vice President and Chief Financial Officer

Jim Myers - MKR Group

Analyst

Brian Swift - Securities Research Associates

Bernard Sadel - Private Investor

Socket Mobile, Inc. (OTCQB:SCKT) Q2 2009 Earnings Call Transcript July 23, 2009 5:00 PM ET

Operator

Greetings and welcome to the Socket Mobile second quarter 2009 management conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Jim Myers of the MKR Group. Thank you. Mr. Myers, you may begin.

Jim Myers

Thank you, Operator. Good afternoon and welcome to Socket's conference call to review financial results for its second quarter ended June 30, 2009. Online today are Kevin Mills, President and CEO of Socket and Dave Dunlap, CFO of Socket.

Socket distributed its earnings release over the wire service at the close of market today. The release is also been posted on Socket’s website at www.socketmobile.com. In addition, a replay of today's call will be available at vcall.com shortly after the call's completion and a transcript of this call will be posted on Socket’s website within a few days.

We also posted replay numbers in today's press release for those wishing to replay this call by phone. The phone replays will be available for one week.

Before we begin, I would like to remind everyone that this conference call may contain forward-looking statements within the meanings of Section 27-A of the Securities Act of 1933, as amended, and Section 21-E of the Securities Exchange Act of 1934, as amended. Such forward-looking statements include, but are not limited to statements with respect to the distribution, timing and market acceptance of Socket’s products and statements predicting trends, sales or activity, backlog and market opportunity in the markets in which Socket sells its products.

Such statements involve risks and uncertainties, and actual results could differ materially from the results anticipated in such forward-looking statements as a result of a number of factors including but not limited to the risks that shipments of our products may be delayed or not happened as predicted, if ever, due to technological, market, or financial factors, including the availability of necessary working capital, the risks of the market acceptance and sales opportunities may not happen as anticipated, the risks that the Company's integrator program and current distribution channels may not choose to distribute its product or may not be successful in doing so, the risk that acceptance of the Company’s products in vertical application markets may not happen as anticipated, and other risks described in Socket’s most recent Form 10-K and Form 10-Q reports filed with the Securities and Exchange Commission. Socket does not undertake any obligation to update any forward-looking statements.

With that said, I will now turn the call over to Socket's CEO, Kevin Mills.

Kevin Mills

Thanks Jim. First, I would like to thank everyone for joining us today. I will begin by providing an overview of our results for Q2 2009 followed by our current outlook on our market and business for 2009.

Despite the difficult economy, we continue to see increasing adoption of our SoMo handheld computer. In the second quarter, SoMo sales were up slightly over Q1 to remain at record levels. We sold 3,286 units which is over 60% more from the number of units we sold in the second quarter last year.

We are pleased with the continued SoMo sales momentum we are generating, particularly during a weak overall market environment and globally weak second quarter. Overall, our Q2 results reflect three elements; SoMo sales which grew 5% over the first quarter, our scanning revenue which was down by $350,000 from Q1 and our OEM businesses which remain in condition and was down by $250,000 from Q1. I will now provide more details and outlook on these elements.

Starting with the SoMo. We continue to focus on driving sales of this product line which has continued to grow and represented 39% of Socket's total Q2 revenue. SoMo sales in Q2 reflect market traction in a number of different verticals. With healthcare and hospitality continuing are the two strongest markets where we remain significantly focused. Within healthcare, we continue to build momentum with key partners like Good Samaritan and more recently began deployment in a healthcare related opportunity in Sweden with a government-funded organization that works to improve the quality of life for people with physical handicap.

We also saw deployments continue within the government and education markets working jointly with Plasco ID on a mobile ID solution per school and EnvisionWare in the library services market. Overall, we are pleased with the continued level of deployment though these are preceding at a slower pace than was originally anticipated. As we continue to see spending caution and budget restrictions reflecting the current economic environment. This slower pace has pushed many of the deployment we expected to close in Q2 into third quarter.

The good news is that we are definitely not losing this opportunity to others or alternative solutions. We continue to see companies completing their initial testing or pilot and they continue to report they are happy with the solutions we provide. In Q2, we began shipment of our SoMo 650Rx or healthcare application. We shipped over 250 units to various customers who are evaluating it for both new opportunities and does an upgrade to our existing standard SoMo 650 in the healthcare environment.

We are also seeing market acceptance for our No Radio SoMo which provides our mobile computing solutions in applications or radios are not allowed or required for security and usability reasons. As we look to Q3, we expect to see continued growth in SoMo despite the continuing economic challenges. This growth is expected to come primarily from increasing deployments to customers we already have in place as they continue to rollout their solutions.

We currently have many deals in our pipelines that could generate some accelerated growth in Q3. We are forecasting moderate growth based on our current visibility and are hoping to see some improvement as the quarter evolve. We expect improved momentum as we begin fourth quarter.

Turning to our data collection related business; this business segment saw a decline in Q2 by approximately 20% or $350,000. This weakness was primarily related to our plug-in and scanning business where our SD and CompactFlash Scanners are plugged into a third party host device like an iPod or Motorola MC35. This business was down about 30% which is in line with the general economic slowdown across the AIDC industry. We feel the general slow pace of the business is the primary reason for the lower result and we have no reason to believe that we are losing this opportunity to competitive or alternative solutions.

Our cordless of scanning business was up slightly in Q2 increasing about 7%. We saw significantly different results in Q2 between our more aggressively priced lower performance cordless scanners like the 7M where we saw an increase of 30% over Q1 as oppose to our higher performance, higher priced cordless scanners like the 7P where we saw a decline of 45% over the previous quarter. In the third quarter, Socket is launching our new 7EL, an entry-level laser based scanning device using a new laser engine. This has excellent performance over attending change and it is recently probated as an ideal solution for more than 95% of our customers.

This new laser scanner is aggressively priced with an MSRP which is a $150 below our current 7M scanning solution. This new laser is targeted to many customers who have repeatedly requested a lower-priced laser based scanner so it will also serve the need of our current 7M customers. We feel that the 7EL will enable us to capture a good market share in this entry level highly portable scanning segment. We believe it will enable us to increase our volumes and contribution from cordless scanning.

The launch of the 7EL coincides with the launch of soft scanning product of software scanning product of ScanSource. As many of you know, ScanSource is the largest AIDC distributor in the world and we have worked with ScanSource in Europe for many years. In fact, ScanSource was our largest distributor in the EMEA region last June. We are delighted to now be working with ScanSource in the US and are confident that with their extensive reach and 25,000 resellers, we will see many opportunities for the 7EL as well as our other products. We expect the ScanSource relationship to help our expanding products going forward.

Finally, our 7X which is our new 2D cordless scanner is expected to shift in late Q3 and support the many 2D barcode that are becoming increasingly popular and put us in a position to expect revenue from this product in Q4.

Turning to other segments of the business; our OEM business remains in transition. Our Wireless LAN business continues to grow with Wireless LAN revenue in Q2 increasing by 25% over Q1. The Wireless LAN business now represents 67% of the OEM business. Our Bluetooth business continues to decline and is now reaching a new steady state as we complete our end-of-life delivery and we expect it to stabilize going forward at the current lower level. We expect the Wireless LAN business and overall OEM business to begin to grow going forward and to be a solid contributor to a revenue.

Overall, the economic environment remains very difficult. While we see significant opportunities ahead, budgets and spending remain cautious creating a higher level of uncertainty in closing deals. Even this economic situation and this environment and the current visibility, we are planning on moderate growth and will continue to lower our expenses to achieve cash positive results in Q3. Even though we have taken substantial action to reduce our expenses to achieve both cash positive and breakeven levels in the short term, we have done this without eliminating essential core expertise within the Company and have maintained our core structure so we can ramp up quickly when the economic conditions improve.

I would now like to turn the call over to Dave for his comments.

David Dunlap

Thank you, Kevin. Revenues for the second quarter of 2009 were $4.143 million, a decline of $629,000 or 13% from the previous quarter and a decline of $3.2 million or 43% from the second quarter a year ago. Sales of our SoMo handheld computer of $1.6 million continued to grow, up 5% from the previous quarter and 56% from the second quarter a year ago. Handheld computer sales represented 39% of our total revenue for the quarter and as Kevin mentioned, continues to reflect growing adoption of deployments by businesses particularly in our primary market with healthcare and hospitality fueled by an expanding base of productivity and hefting application from our many application partners.

Except for the SoMo, our product line sales were flat or down reflecting continuation of the economic slowdown in business spending that continue to impact our economy. As reported by many others in our industry that offer data collection products, customers on the whole are deferring the upgrading or expansion of current system and the introduction of these systems or processes. As a result, our barcode scanning sales declined 21% sequentially or $1.7 million in the first quarter of 2009 to $1.3 million in the second quarter and reflect the lower sales of our plug-in barcode scanners. The orders that are being delayed is also reflected on a growing pipeline of sales opportunities for our plug-in and other barcode scanning products and we expect barcode scanning sales to increase going forward.

Our OEM business activity is the other major reason for our revenues declining in the second quarter as the OEM team completed its transition facing our Bluetooth modules that reached their end of life and entering the early stages of a growing Wireless LAN module business that will become the primary product line in our OEM business. OEM sales of $668,000 in the second quarter declined $340,000 or 61% from the previous quarter due to lower Bluetooth product sales that now reflect the absence of end-of-life products and an increase in our Wireless LAN price sales to $453,000 or 25% over the previous quarter.

We also saw a decline in our serial product legacy business. As we look forward, we expect data collection sales to regain momentum as the economy improves [18.21] on assistance by the addition this month of ScanSource as the distributor of our products in North America. ScanSource is the largest North American distributor of data collection products and through them, we have the ability to reach the thousands of customers that they serve. We anticipate continued growth of the SoMo handheld computer reflecting more widespread customer adoption in our key vertical market and the growth of productivity enhancing business applications serving those markets.

In addition, our OEM business having now completed the Bluetooth product transition should be growing as our Wireless LAN products are designed into more and more third party products. Our sales backlog as we enter the third quarter for order shippable in the quarter was within its normal range at about $1.2 million reflecting normal channel stockade orders and continuing orders from OEM customers.

Our margins were also impacted by lower sales including sales of lower margin products making up a higher percentage of our product mix and lower overall sales against which are relatively fixed overhead cost are applied. As a result, margins dropped to 41.4% in the second quarter from 46.6% in the first quarter. We expect our margins to improve with sales growth going forward. Our operating expenses were $2.6 million in the second quarter from 31% lower than operating expenses of $3.8 million in the second quarter a year ago and 9% lower than operating expenses of $2.864 million in the previous quarter.

We have continued to scale back our operating cost in response to current market condition. Lower operating expenses are due to reductions in headcounts in December and earlier this year, the continued salary reductions for current employees, and to a scaling back of discretionary expenditures. We have done so looking to minimize impacts on customer service, essential product development or sales. These programs were made in place and then be phased out overtime as our revenues and bottom line improve.

We strengthened our balance sheet in the second quarter through the completion of the common stock financing of approximately $900,000 after cost and expenses. The financing included substantial participation by management thus total cash log for the second quarter was positive with cash increasing from $1.4 million at March 31 to $1.7 million at the end of June. Approximately, $170,000 of cash was absorbed by operations, another $100,000 was used for investment and property, equipment and tooling and we paid down amounts owed to our vendors and through our bank by nearly $900,000.

On July 7th, we announced a revised agreement with our bank that replaced a quick ratio liquidity covenant that we were not meeting with two covenants that we are better able to handle. The first is the minimum revenue covenant of $4.5 million in the third quarter growing to $5.355 million in the fourth quarter and the second covenant is that we maintain $1 million in cash on hand at all time. Again, our cash balances at the end of June were $1.7 million. As we look back over the past several quarters, we believe we have made the adjustments needed to respond to the slowdown in sale caused by the effects and uncertainties with the worldwide economic slowdown.

We have done so with the support of our vendors, our customers, our bank, our partners and our employees. We have done so in ways that are enabling us to continue to move forward with the essential programs that are establishing to SoMo Handheld computer family as a system of choice in key vertical market, particularly in healthcare and hospitality. We are continuing the development of essential products and product improvement to give pace with newer technologies and the needs of our customers in the vertical markets that we serve.

We are maintaining Socket's standards of quality products and respond to customer support. We look forward to the second half of this year where we see a growing and active pipeline of customers increasingly ready to order products. We are monitoring and supporting continued product development and marketing progress by many of our application partners in bringing productivity enhancing solution into the business mobility market. We are working closely with our newest North American distributor ScanSource in reaching out with our products and solutions to the thousands of ScanSource customers and we continue to tightly manage our cost and expenses and our cash and working capital balances. In particular, we wish to thank our stockholders for their continued support.

Now, let me turn the call back to the operator for your questions. Operator?

Question-and-Answer Session

Operator

(Operator's instruction) Your first question comes from the line of Brian Swift - Security Research Associates.

Brian Swift - Security Research Associates

Could you give a better idea of what your anticipated or breakeven cash level will be or should anticipate for Q3 as your margins were lower than what you have been historically which I assumed gross, partially about what you were talking about with the lower margin products but also from just the fact of utilization as well?

David Dunlap

Brian, with the $4.5 million revenue level, we would expect to be breakeven on cash for both operation and I think our working capital with those levels will also be probably slightly positive. So, I would look at our $4.5 million revenue level is being the approximate cash breakeven level.

Brian Swift - Security Research Associates

And does that assume further reduction from the $2.6 million operating expense number that we saw for Q2?

David Dunlap

Yes, I think you will see our expenses in the third quarter dropping by about the same amount we dropped between the first and second. So, I would look for expenses to be somewhere in the $2.4 million range, perhaps even a little bit lower.

Brian Swift - Security Research Associates

Okay and can you give us an idea of just your OEM number you think now as far as the Bluetooth portion of it is going to be kind of flattish going forward and what do you see as far as your pipeline, you may have a handful of customers here? Visibility is going to be very reasonable on.

Kevin Mills

Yes, we would have like rough 25% Q1, I mean Q2 over Q1. I think it will be about the same on the Wireless LAN portion and again, we believe we have passed off among the Bluetooth and we are now in a flat section and Wireless LAN improved 25% last quarter. We would expect that trend to continue and then I think as we get into Q4, some acceleration.

Brian Swift - Security Research Associates

Well, that is roughly about $100,000 so the SoMo handheld, what do you, you said you got a new distribution agreement for the US I think with ScanSource and…

Kevin Mills

But we would not expect a lot to come out of that on the SoMo side. I mean on the SoMo, we already have a very healthy pipeline and we have a number of customers that have completed both trial and pilot program and are raising fund, are delaying deployment probably waiting for the economic situation to improve. As the sales cycle for SoMo is approximately I would say a year, the distribution we add with ScanSource will not impact SoMo so quickly. Yes, we will get more units out in terms of new customers and new trials beginning, etc, but we already have a pretty healthy pipeline thus, if any of these should close, we would see that picking up.

We think ScanSource will help a lot more on the scanning side as the sales cycle is substantially shorter and they have a tremendous reach on the scanning side but as I mentioned, we are introducing a more aggressively priced laser base scanner which we feel we will do very long.

David Dunlap

Yes, one of the observations, Brian, the SoMo began shipping, yes at the end of September two years ago and you typically see in the third year after you have established these products that you see some acceleration umbrella. We are believing that we will see that because of the number of applications that are now maturing, that are being established in the market and because we continue to be a good replacement for Dell, a good replacement for the Siemens computer systems deluxe that has been pulled off the market and I think we are being favorably looked at even by a number of new attracted customers.

One factor that will moderate that growth in Q3, although we still expect growth, will be that Good Samaritan which has been our units from each quarter for the past year is ramping out now. It is called deployment with over 3,000 units deployed. So, they will be at a lower level in Q3 but again, with the other momentum, we are expecting to see continued growth.

Brian Swift - Security Research Associates

Okay. Just doing the math right here, we are seeing the, in your opening remarks, the amount of two other businesses were down. One was 250, or it was like 350 and then the scanners were up. It seems like that your overall revenues were lower sequential to the math. So, what am I missing?

Kevin Mills

Now, let me just clarify that point. Our cordless scanning was up. Plug-in scanning was basically down by $500,000. So, the plug-in scanning is obviously where we are plugging a SD or CompactFlash scanner into a third party and we saw that fall. The cordless scanning is actually driven more by tablets and smart phones, etc. We see that rising but even within that, we saw the lower priced versions of our scanners rising much quicker at 30% which indicates that people are, I think, being very cautious with their dollars.

What is nice about that is that our new 7EL is actually moving the price point of our laser scanners down by another $150 in units where we think that there is even a better suite spot and therefore, I think that we are expecting some up tick in that area.

David Dunlap

Quickly, data collection, Brian, is very key to our overall results. It was probably the biggest driver of our lower margins because of this product mix shift to more of our entry-level products and if you look into the pipeline, a number of the larger deals that are staged out there are actually data collection product deal that seems to be where we are seeing more of a slowdown obviously than we are seeing in our other products.

So, that could become a very pleasant upside rise for this. Yes, how we deal is very well determined ultimately how well we do in the third quarter.

Brian Swift - Security Research Associates

Are you, I mean, is it your goal to at least to achieve breakeven cash flow for Q3?

David Dunlap

Clearly, yes.

Kevin Mills

Yes.

David Dunlap

And ideally substantially better than that.

Operator

Your next question comes from the line of Bernard Sadel - Private Investor.

Bernard Sadel - Private Investor

Even though we did not as well as we really expected to for this quarter, I am very, I think the SoMo that you people introduced two years ago was becoming quite, say accept the thing in the market in particular, I understand that is a government multi-billion dollar stimulus program for medical technology which should be coming in in the next several months. How will that affect us? Have you thought about how that would affect us as far as the SoMo in regard to the medical use?

David Dunlap

I think a lot of that stimulus goes to stimulus plugs now and there are a lot of pieces that are going in a number of directions but for healthcare, a lot of it is focused on electronic health record and the encouraging medical organizations to put electronic health record fully into operation and of course, once you have that including the networking structure, normally in a hospital or clinical building or the like the Wireless LAN is typically used, from their you need access and the SoMo itself creates an excellent access vehicle to electronic records.

We know from the many years since Palm introduced its pilot a decade or so ago that the devices in the format with the SoMo are highly preferred by professional doctors and others because they fit well with their TUNIX and they are bright screen and easy to use and so, we would expect that the increase in the use of electronic health records in the healthcare industry would certainly have an extremely positive effect on the sale of the products that integrate into that including our SoMo.

Bernard Sadel - Private Investor

Okay and in the last conference, you people mentioned about large orders from Sweden, Germany and I think it was Switzerland for the SoMo. Are those been completed or is that something that is an ongoing thing?

Kevin Mills

It is something that is an ongoing thing and I think, I mentioned today that the deployments in Sweden have started. We have seen the deployment in Germany starts and the ones in Switzerland have been deferred but we are expecting some of them this quarter. I think generally speaking, things could proceed at a slower rate because as it was a little more cautious.

We do not know the full extent of the deployment in Sweden but I believe that we did something in the region of 250 units of an expected thousand unit deployments in Sweden and we saw some units go into the German hospitals but we believe there is a lot more. The Switzerland deployment we had fully expected to come in in the May timeframe. They basically said they are behind in their budgeting and now they are talking about doing it in early August.

I think this kind of reflects the general slowdown. None of the deals have gone away but they are not coming in at the pace that people originally said. Things seem to drag on an extra few weeks or few months and then it will not seems to be spreading their dollars out over a greater period of time.

Bernard Sadel - Private Investor

Right and I understand the Siemens, I was wondering if your large competitors in Europe went out of the so called handheld computer.

Kevin Mills

Yes, we continue to see that companies like Fujitsu Siemens left the market. Their products were used in this area and as people are looking to upgrade or replace. They are now looking to the SoMo and we are seeing it is not just from Fujitsu Siemens but obviously from Dell customers as well as in some cases from the HP customers. So, I will say that our plan as we outlined them continue to come through but at a slower pace than we originally anticipated.

Bernard Sadel - Private Investor

Okay. Now, I know it is pretty early in the third quarter. It is only about three weeks. Have you seen any, or shall we say improvements..?

Kevin Mills

I would say it is too early to say. I think things at the moment are stable and not much better but not much worse but we did see the, I would say situation is being worst probably in April was probably our lowest month and things have gradually got better but much slower than we expect it. We think that July will be, I think okay. I think the bigger test will be August because with vacations. It tends to be a quiet month but based on this economic climate, we are expecting a lot of people not to take vacation.

So, I would say right now, we are kind of on track. Q3 has always been a difficult quarter because of the summer period and a lot of things happen in the later part of Q3, but right now I think we remain cautiously optimistic.

David Dunlap

We are also in a pretty steady contact with the number of our most active partners and others who have expressed an interest in deploying. We do have for not only to ensure that they are getting through their evaluations and that everybody is being responsive and because of that, we get a pretty good visibility of what people's intentions are and so as long as those intentions are filled, those are the basis under which we are expecting moderate growth in this quarter.

Bernard Sadel - Private Investor

So would you say it is fair to say that in the third quarter, you do see some growth as compared to the second?

David Dunlap

Yes. Kevin mentioned and I did as well that we are expecting moderate growth and it is based on a lot of feedback from the pipeline. The pipeline is actually have been growing. You indicate where the activity is, the activity is certainly in the pipeline and we do track that customers move down their evaluation and that process is actually continuing. It is the last step which is placing the order where things tend to be closely evaluated by companies in terms of the priorities for the use of their funds.

Bernard Sadel - Private Investor

Okay, just two more things and I will let somebody get up. The one thing that what I wish you people would be working on is getting out the word in regard to this Company. This is most likely sleeping giant where the potential is absolutely tremendous. I figured out that in the event, in the third quarter of last year, you people have sales of $8 million and this is, and I know there was some various things in it and this is with SoMo was even anywhere where it is right now. I figured out with your new structure, with low cost, if you have the $8 million again, we are talking about close to about $0.30 a quarter and by $0.30 a quarter in profit. And that would be like, so it is likely a phenomenal and if you have true growth and if you ever went to something like $10 million or $11 million, you will have something like a profits of a couple of dollars this year for the year.

David Dunlap

Yes, we frequently pointed out that Socket's dividend structure is highly leveraged and because we work with contract manufacturers in Asia for the major components, we can produce more without increasing our needs for capital equipment, just plenty of capacity and on the sales side because we use general distribution channel, we can certainly increase the volumes without needing to substantially increase the support that is required to move those sales forward.

So, it also gives us a chance to step up and move a lot of those extra dollars through the bottom line. We are looking forward to the opportunity. We have reduced our expenditures in a number of discretionary areas as we noted and one of those areas is in our marketing, not so much to marketing to our customers. We have been very careful not to diminish that area as an example of the second quarter, we have a significant booth at the HIMSS Show which is the large healthcare management show that we attended in early April and that now reaches paid off in terms of number of new contacts and certainly increasing the awareness of the Company to our customers.

In terms of the awareness to our investors, we will put that back and to play much more actively as we see things moving back up again. So hopefully that is not too far off.

Bernard Sadel - Private Investor

Well, I am very encouraged particularly since management board the spot and you guys know exactly what opportunities are transpiring. One last thing and then I will get off. At what level would we be profitable?

Kevin Mills

I think we will be profitable about by 5.3 or 5.4 and so, and that will have…

Bernard Sadel - Private Investor

You think we can be profitable this year?

Kevin Mills

Yes, as I said on my remark. I mean our dilemma here is that we certainly have deals that could come in and accelerate our growth quite substantially. The difficulty in this environment is to determine the timing. Even people that you believe will pull the trigger. What we have been finding over the last six months is that either the controller or CFO or the board has cautioned them to say, "Can you wait another months? Can you wait another quarter?" and we have not seen people loosen up their heartstrings to actually phase the order.

We are going through the avow. We are getting very high marks. People are very happy with illusion but ultimately, you have to spend the money and the environment request that so rate of spending is not great. As people loosen up the heartstring, we would expect to catch up and we do not know when that would happen but I think when it does happen, it will cause us to have some accelerated growth.

Bernard Sadel - Private Investor

Okay, that is good. Okay, good luck and keep working on it.

Operator

Thank you. Gentlemen, at this time, there are no further questions. Do you have any closing comments?

Kevin Mills

Yes, I would just like to thank everyone for participating in today's call and we look forward to the next report in October. Thank you.

Operator

Thank you. Ladies and gentlemen, this concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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Source: Socket Mobile, Inc. Q2 2009 Earnings Call Transcript
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