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Executives

Jim Byers – IR, MKR Group

Kevin Mills – President & CEO

Dave Dunlap – CFO and Secretary

Analysts

Brian Swift – Security Research Associates

Bernard Fidel [ph]

Socket Mobile, Inc. (OTCQB:SCKT) Q4 2009 Earnings Call Transcript February 18, 2010 5:00 PM ET

Operator

Greetings and welcome to the Socket Mobile fourth quarter 2009 management conference call. At this time, all participants are in a listen-only mode. A 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 Byers of MKR Group. Thank you. Mr. Byers, you may begin.

Jim Byers

Thank you, operator. Good afternoon and welcome to Socket's conference call to review financial results for its fourth quarter and year ended December 31, 2009. Online today are Kevin Mills, President and CEO of Socket and Dave Dunlap, CFO of Socket.

Socket Mobile distributed its earnings release over the wire service at the close of market today. The release has also been posted on Socket’s Web site 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 Web site within a few days. We have 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 meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such forward-looking statements include, but are not limited to, statements regarding new mobile computer, data collection and OEM products, including details on the timing, distribution and market acceptance of the products, and statements predicting trends, sales and market conditions and opportunities 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 risk that Socket’s products may be delayed or not rollout as predicted, if ever, due to technological, market, or financial factors, including the availability of necessary working capital, the risk that market acceptance and sales opportunities may not happen as anticipated, the risk that Socket application partners and current distribution channels may choose not to distribute the new products or may not be successful in doing so, the risk that acceptance of new products in vertical application markets may not happen as anticipated, and other risks described in Socket’s most recent Form 10-K and 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 would now like to turn the call over to Socket's CEO, Kevin Mills.

Kevin Mills

Thanks, Jim, and I would also like to thank everyone for joining us today. I will first provide an overview of 2009, followed by our current outlook for our markets and business for 2010.

2009 was a challenging year for many businesses, including Socket’s. Our lower revenue in 2009 reflects the impact of a difficult overall worldwide economy as well as the timing of upgrades and transition of some of our key products, which we now have completed. Despite these challenges, we made significant progress in a number of areas in 2009 that strengthened our business and outlook for 2010.

We grew our SoMo business by 32% in 2009. While this was below our expectation, our current sales pipeline for potential SoMo units is the best it’s ever been. We have maintained our key development programs and completed upgrade transitions with several key products bringing new and enhanced products to the market. We significantly reduced our costs and have carefully managed our cash and working capital with a focus on returning to profitability.

While sales of our SoMo grew 32% for the year, this was well below our expectation. Sales were impacted by delays or postponements in projects and deployments, which were results of the tight credit markets and a freeze in capital spending, especially our new capital equipment and program. The good news is almost none of the projects were lost to competition or alterative solutions and they remain viable and significant opportunities within an improving economy in 2010.

Our data collection business was impacted by the poor economy with limited deployments throughout the year. This business was also impacted by the market transition towards 2D scanners, which is attracting increasing customers seeking for both service new requirements and to future proof their investment.

In 2009, as we were completing development of our own 2D scanner, we saw 2D price point squeeze the price on 1D scanning. To cope with these market courses, we needed to restructure and re-price our 1D laser-based product lines to be more attractive for customers who only needed 1D, and also get a 2D product into the market to take advantage of this market transition and new opportunity. In the fourth quarter, we repositioned this product line for growth and expansion in preparation for the introduction of our new 7X 2D scanner, announced this quarter and now shipping.

Our OEM business was undergoing transition in 2009 as existing products were going end of life and we entered into a new design cycle for our Wireless LAN products. These factors combined to impact sales for the year. But we have made significant investments in our new Wireless LAN products; we expect these products to generate meaningful revenue contribution this year.

In response to the lower revenue, we aggressively lowered our expenses throughout the year through reductions in workforce and salaries and by cutting all non-essential expenses. However, we have maintained three critical R&D projects for development of key products representing significant growth opportunities as the economy improves. These include our 2D bar code scanning, an investment that we view as vital to the health of our data collection business as the market is rapidly changing to 2D.

We also invested in improving the core software on our SoMo mobile handheld computer, which is critical to the stability of our SoMo platform and long-term importance of our PDA business.

Lastly, we invested in our Wireless LAN OEM business, one of our core areas of expertise. Our Wireless LAN development not only benefits our long-term OEM customers and revenue, it is also a core component for our next-generation SoMo devices. Maintaining our investment in all three of these high-tech areas was difficult to balance with there a need to further reduce expenses elsewhere. But these investments significantly strengthen our business and the long-term health of the company. These critical development programs have progressed well and on schedule, and we expect these products will be major contributors to our revenue in 2010 and beyond.

As we look forward, we see exciting opportunities and anticipate a stronger 2010. I’d like to highlight some of the key opportunities that we expect to drive our SoMo business in 2010. The first is Epocal, a Canadian firm focused on the blood analysis market. Epocal uses the SoMo as the computing platform for their device. They developed a product and began delivering it last year with hospitals and clinics primarily in pilots and doing limited deployment.

In November 2009, Epocal entered into an agreement with Inverness Medical to distribute their product worldwide. Inverness has also entered into a definitive agreement to acquire all of the issued and outstanding equity securities of Epocal for a total potential purchase price of up to $255 million if Epocal achieve certain gross margin and other financial milestones on or before October 31, 2014.

We strongly believe that Epocal with the help of Inverness will be a strong growth driver of SoMo this year. We are currently in discussions with them on their requirements for the next 24 months. We expect this opportunity to begin driving SoMo revenue in 2010 and to a greater extent in 2011.

We also see a reemergence of discussions and activity with Hospira, which now seems ready to begin selling their VeriScan medication dispensing system and has recently trained their sales team on the solution. Hospira has indicated that all hospitals will be required to have a closed-loop medication dispensing system such as VeriScan in place by January 1, 2013.

In addition, as part of the stimulus package there is a strong incentive for hospitals to deploy closed-loop medication systems as soon as possible as the government is providing bonus reimbursement for hospitals that have a system in place before January 1 , 2013. These bonus reimbursements are coming from the Obama’s stimulus package. In addition, the government will reduce reimbursement by adding a penalty deduction on all reimbursements after January 1, 2013. We believe these incentives should see the adoption of this system and benefit SoMo sales this year.

We are also seeing increasing sales momentum in the healthcare market in Germany with over 60 hospitals having SoMo-based solutions in trial or limited deployment. Germany was the only country where our business grew last year, primarily on the strength of these trials and limited deployments. We expect our SoMo business to continue to grow in Germany and Northern Europe in 2010.

Finally in healthcare, we have a number of SoMo-based solutions under test in the National Health System in the UK, many of which should move forward this year. We are also seeing very good opportunities in the hospitality markets and expect to fill the sizable deal in the current quarter for our hospitality application we have been working on with a key reseller for six months.

Our SoMo business remains very healthy. We are seeing many of the SoMo-based applications from resellers being deployed, which, we will believe, will increase as the economy improves. While the sales cycle has been longer than expected, it has enabled us to get close to our partners, be more responsive to their needs, complete numerous pilots and know their solutions work well. All of this strengthens our understanding of our key healthcare and hospitality market, and will benefit us as the business climate starts to turn in 2010, and company starts to spend again. While we remain cautious about the pace of spending increases, we are seeing a definite improvement.

Turning to our data collection business, this business consists of two elements; plug-in scanning, which is increasingly driven by our SoMo sales; and our Bluetooth cordless scanning products. Our plug-in bar code scanning business is becoming more robust and more predictable, as some of our stronger customers like Epocal and Hospira use our plug-in data collection peripherals as an integral part of their solution. Our overall plug-in business stabilized in 2009, as companies like Dell and HP either exited the PDA market or reduced their focus on PDA and resellers replaced by SoMo-driven business. Now that this transition has completed, we expect our plug-in business to be more stable and predictable going forward.

Turning to Bluetooth cordless scanning products; in Q4, we reduced the price of our 1D cordless bar code scanners by approximately 30% which will result in higher unit sales going forward. This reduction was made in conjunction with our cost reduction programs and was accomplished without significantly impacting margins. While this change caused a temporary slowdown in cordless 1D scanning sales in Q4, we are seeing a significant pick up in Q1.

In addition, we launched our 2D cordless scanner in January as planned, and we are aggressively promoting this new 2D scanner with good results so far in the market. Our new 2D scanner, the 7X, is the smallest, lightest and most ergonomically developed Bluetooth cordless scanner in the market. It is also aggressively priced at the old price of our high-end laser scanner making it extremely attractive both to new 2D customers and high-end 1D customers who are likely to need a 2D solution in the near future.

As we complete the current evaluation period, we expect to see sales of the 7X build in the March/April timeframe. The new 7X has many new features and can be used to read bar codes of a mobile phone. It also has a presentation mode allowing customers to present their phone to the scanner, so that coupons could be redeemed directly from a mobile phone. The combination of the ability to read all existing 1D bar codes and the ability to read 2D bar codes from mobile computers and paper opens up some exciting opportunities for this scanner, and we expect it to be a leading product and revenue generator before the end of 2010.

In regards to our OEM business, we have been reengineering our solution on a new wireless LAN chipset. We spent much of 2009 dealing with end-of-life issues and developing the replacement radio with all of its advanced features that our customers expect from Socket. The development cycles to the replacement are just wrapping up and early customers already have products and our testing. We expect to announce the replacement product in Q1 and believe this will restore our OEM business to more normal levels in 2010.

To conclude, while 2009 was challenging, we have made significant progress in many key areas, while also reducing costs and improving our ability to leverage higher revenue. We entered 2010 as a much leaner company with the strong portfolio of products that are gaining increasing acceptance in our key target market of healthcare and hospitality.

We have significant opportunities in Q1 and see growth over Q4. We are targeting cash flow positive operation by March and intend to keep our aggressive cost reduction program in place until we achieve this goal.

We are fortunate to have committed employees who continue to work very hard in these difficult times. With our broad portfolio of products and relationships with key customers, we anticipate achieving solid growth throughout 2010, and expect to be profitable before the end of the year.

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

Dave Dunlap

Thank you, Kevin. Our revenue for the year was $17.1 million, a decline of $9.5 million compared to record revenue of $26.6 million in 2008; $6 million of this decline was from our OEM business. OEM revenues increased in 2008 by over $3 million due to last time customer buys of Bluetooth modules that were being phased out in 2008, because the Bluetooth chip used in the module was discontinued by manufacturer.

The drop in Bluetooth revenue in 2009 from $9.3 million to $3.3 million which represented 19% of our 2009 revenue was primarily due to the absence of significant Bluetooth OEM sales in 2009. As Kevin noted, our OEM business also was completing a transition of its wireless LAN products to the latest 802.11 a/b/g chip technology which is now being offered along with our Wi-Fi Companion software with Cisco’s CCX security extension.

OEM sales are design win business, with our product transitioning completed, we are actively seeking new design wins and expect this business to grow over the next several years.

Our data collection product family incurred a drop in revenue of $3.6 million from $9.2 million in 2008 to $5.6 million in 2009, representing 32% of our 2009 revenue. Lower data collection product revenue has been an industry-wide impact caused by business slowdowns in deploying or expanding new mobile systems and an upgrading mobile equipment used in these systems.

As Kevin reported, we have maintained our key development programs for our data collection products during 2009, and have transitioned these products for growth in three major areas. First, with the release of our 2D cordless hand scanner this quarter, an area of growing customer demand because of the greater amounts of data that can be scanned with the 2D bar code scanner. Second with the release last quarter of the new highly ruggedized version of our cordless hand scanner; and third with a replacement of our entry-level non-laser bar code scanners with laser bar code scanners at new attractive entry price points. All of these changes are attracting good customer interest and our major contributor to our growing sales pipeline.

Our third major product family is our SoMo family of handheld-computers; revenues grew 32% in 2009 from $4.7 million to $6.2 million and represented 36% of our 2009 revenue moving ahead of data collection for the first time. As Kevin noted, our base of application partners, strictly those focused on applications in our primary vertical markets of healthcare and hospitality continue to establish and expand their mobile applications using both our SoMo handheld computer and our bar code scanners. Potential orders anticipated from deployments of partner applications in healthcare and hospitality are becoming more significant contributors to our growing sales pipeline.

Our fourth quarter revenues were the lowest of the year at $3.6 million, reflecting further moderate reductions in data collection and OEM sales relative to the previous quarter as customers evaluated our newest product offerings. All of our sales in Europe, including France SoMo delivery were also negatively impacted by severe winter blizzard conditions during the middle of December that continued into the holiday break delaying sales out by which we measure revenue into the first quarter of 2010.

As Kevin reported, our first quarter pipeline activity and orders and shipments to date are all indicating growth in data collection and SoMo sales in the first quarter. Our sales pipeline consists of potential orders from customers that are considering our products for their mobile application deployment. The opportunities in our pipeline today that could close over the next year are double the size of the pipeline measured at the end of June of last year and reflect growing customer interest in new products and growth and expected deployments of partner applications that use our products.

In response to lower revenue, as Kevin noted, we reduced our operating expenses in 2009, 31% from $15.1 million in 2008 to $10.3 million in 2009 through a combination of lower headcount, reduced salary levels for employees and lower discretionary spending.

In addition, we closely managed our working capital to improve our cash balances. For example, we reduced our investment in inventory in 2009 by $1.9 million through improved forecasting and more frequent ordering to better align the receipt of inventories with the delivery of products. And we have continued to receive strong support from our distributors in continuing their long history of timely payments to us for our products.

As is typical of economic recessions, our distribution channels in response to lower business activity has reduced its stocking of our products to about half the level they were holding a year ago, which puts pressure on our cash as we are paid by our distributors when we ship products to them. As the effects of the recession turn around, we would expect to see shipments and distributors stocking levels return to higher levels to the benefit of our working capital and cash balances.

An important element of our working capital is our working capital bank line that enables us to borrow against qualifying receivables and revise the working capital buffer to enable us to pay our vendors for inventory before receiving payment to the products that are shipped to our customers. I am pleased to report that our current bank line is being extended by a year to March of 2011. Its terms are the same as our present line consisting of our maintaining $1 million in cash on hand and meeting end-of-quarter revenue covenants.

For 2010, these covenant thresholds are; first quarter, $4,565,000; second quarter, $5,495,000; third quarter, $6,115,000; and fourth quarter, $6,265,000. Our priorities for 2010 are to grow our revenues above these thresholds and to achieve profitability while we phase our cost reduction program and to maintain an active product development program for 2010 to continue to expand our product offerings with our major product family.

We completed two capital raising events in 2009. The common stock private placement in May 2009 that netted approximately $900,000, and a strategic sale of our serial business at the end of September, which netted a gain of $450,000.

Our cash balances at the end of the year were $1,940,000, an increase of $1.2 million over the previous year end. While our bank line was at the end of each year remained leveled at $1 million.

While no one can predict with certainty the timing of economic recovery, over this past year, we have made significant adjustments in our cost structures and we continued careful management of our costs and expenses and our working capital. We have done so with the support of our vendors, our customer, our bank, our partners and our employees, and we are very appreciative of their unwavering support. And we particularly wish to thank our stockholders for their continued support.

With that support, we have been able to move forward with the essential programs that are continuing to establish SoMo handheld computer family with the data collection options as systems of choice in key vertical markets, particularly in healthcare and hospitality. We are continuing the development of essential programs and product improvements to keep pace with newer technologies and the needs of our customers in the vertical markets that we serve. And we are maintaining Socket's standards of quality products and responsive customers support. We remain focused on further building on the growing an active pipeline of customers showing an increasing interest in ordering our products.

We are monitoring and supporting our solution partners’ product development activities and their marketing progress and providing an environment that encourages them to bring productivity enhancing solutions into the business of mobility markets that we serve.

We are looking forward to a much improved year in 2010 with a combination of new products, anticipation of an improving economy, a maturing base of productivity enhancing applications in our key vertical markets and experiences of operating as a lean organization.

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

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Our first question comes from the line of Brian Swift with Security Research Associates. Please proceed with your question.

Brian Swift – Security Research Associates

Yes, I guess my – kind of a general question, because your comments were basically given on the – pretty much on the year as a whole and in citing how much you were up or down from the various business segments. When you look at the economy, it looks like the – our economy as a whole, first quarter was kind of a low point and then it’s been gradually recovering from there. And yet your fourth quarter was your worst, other than your pipeline growing really nicely. What kind of comfort level can you give us from the standpoint that other than – obviously these series of numbers that you gave out related to your covenants on your bank line must relate to your forecast, the trend is in the wrong direction. So how do you respond to that?

Kevin Mills

Okay. Well, I doubt there is number of questions in there and certainly Q4 was extremely disappointing. I think you have to look at the three elements of the business. Essentially on the SoMo side, I think we had a flat Q4 and it is normal for us to see some pick up in Q4 which we just simply did not see. And also as Dave pointed out, we had some weather related delays, etcetera. But there really was no pick up. We expected that some of the people to spend the money, either they had in their budget or had stored away, which was more historical, and that simply didn’t happen.

I think on the data collection, I think as I pointed out, we needed to realign the business because; a, there is a big trend to move to 2D and we didn’t have our 2D product ready yet because we were still in development; and then we had to realign our pricing to I would say make the 1Ds more attractive. We implemented a 30% cost reduction in the November time frame, but I think that many people don’t buy scanners until they have tested them, and this is the process that takes, I would say, a minimum of 60 days. And a lot of the deals that we had that we expected people to move to a lower cost 1D, they simply tested and they are now started to buy in January, and we certainly lost momentum in the data collection business. On the OEM business, and we had said in advance that we expected lower revenue. So obviously Q4 was disappointing, but I think that the data collection was probably the major contributor to dragging it down plus weather related. And we are seeing those opportunities moving forward in 2010.

Dave Dunlap

And Brian by a way of addition, we track very closely the opportunities that either coming through our distribution channel or that we become aware of through, in some cases of direct contact with potential customers. There were no, what we would like to characterize as significant deals in the fourth quarter. The amount of SoMos that were held up through the winter delays, particularly in Europe, was probably would have increased our computer sales by at least 20% and would have made it the highest quarter results for the year. And that simply has pushed out into Q1. You combine that with the comment that Kevin made that we are in the final stages of working and closing a SoMo opportunity that falls under significant deal category, and those are the sorts of things that gave us a lot of comfort that you are going to see a return to growth in the first quarter in the SoMo category.

We are seeing the same thing with data collection. Again, a lot of the growth in the pipeline is coming from both the newer products like the 7X. We are seeing a pick up in the entry level area. We have actually had to scramble to get additional inventory in build against that demand. So the changes that were made in Q4 are being evaluated positively by the markets and that is now showing up in combination of orders. Our data collection orders internally are actually ahead of our SoMo orders that may not last because SoMo has been stronger, but it is a much stronger start for the data collection area than we historically have seen. So these are just some of the observations that we have internally that suggest that we should return to a growth picture in the first quarter.

Brian Swift – Security Research Associates

Okay. That was the lower levels of inventory at the distribution. How do you increase your – how do you significantly increase your revenues without them – what kind of delivery times are they quoting, which –

Kevin Mills

This brings up a kind of a bigger, I would say, concern is that throughout 2009 all of the supply chain has been stretched. As Dave pointed out, I would say, we are normally keeping about $2 million of reserves against about a $4 million inventory in the channels, which represented basically 65 days. And throughout the year that has been reduced, and lead times gets stretched out. I think we are good at scrambling, but certainly there is no ability in the system right now to instantly come up with big numbers. And we have been explaining these to customers and we expect that the orders will pick up because people need the product in the March/April time frame and the lead times really have gone out to five, six weeks. We still have very good relations with our supply base and they are very responsive. But it is not like before where there was a buffer in the distribution channel; that has largely gone away. But we will need to be built back up this year because it makes operating quite difficult for everybody. But I think as the economy improves, we will expect that buffer in the channels to build which will, I would say, reduce some of the pressures on our cash.

Dave Dunlap

One of the hallmarks, Brian, of Socket’s sales team and the relationships with distribution channel is a very open and proactive line of communication. So we are tracking deals against individual customer situation. We are talking frequently with the distribution channels in regards to how we will fill and with that improvement in forecasting that’s happened as we moved through this last year, it’s also allowed us to anticipate the orders that we anticipate will be coming in and we have a study flow of inventory coming in from our suppliers as well. So it’s only the case where there is an unusual forecasted changed that we would probably get caught short, and we also would certainly work to expedite given that there is a regular flow of inventory that you often can expedite if you need to.

Brian Swift – Security Research Associates

Okay. I will let somebody else ask question. I will come back after.

Operator

(Operator instructions) Our next question comes from the line of Bernard Fidel [ph] who is the private investor. Please proceed with your question.

Bernard Fidel

Hi, fellows. Okay, well I am not concerned any more of the last year 2009, because that’s history. And what I do is I am looking for some questions for the future which I think is most significant for the investor here. Now Kevin, you did mention that you expect to be profitable in this year, 2010, is that correct?

Kevin Mills

That is correct.

Bernard Fidel

Okay. Could you tell me at what point do you expect to be profitable, would that be the second quarter, third quarter or –?

Kevin Mills

Well, I think that we want to be profitable by the end of the year. As I pointed out, we have severely reduced our cost price, so I think our first objective is to be cash positive which we believe we can achieve by March in terms of that month, and we would be cash positive for the remaining portion of the year. And as we have currently our employees on a reduced salary and the plan would be – the plan is to basically get those employees back on to their normal agreed base salary in the second quarter. And the third quarter is generally difficult because we lose our European business and then we will be profitable as of the fourth quarter. So that’s our plans for the year. I don’t think it is possible for us to maintain our employee base as they have been extremely, I would say, gracious in terms of continuing to work through the year at a reduced salary. So I expect to get them back on their agreed base salaries as of, I would say, April. And obviously, if business is stronger, we will be profitable sooner. But the target right now would be October.

Dave Dunlap

Our previous caller Dr. Fidel, Brian Swift, mentioned the bank covenant which I had addressed. Generally, he was looking at how that was set. Generally, the bank looks at our going forward plans and they have set these thresholds at the levels that generally create cash break-even operations for us. And that’s with our planned expenditures which include research and development, it includes restoration of some of the cost reduction programs that phased in over time. Profitability is not whole lot higher than those numbers. First, we have the ability by continuing cost reduction programs to lower the profitability point. But for example, with the second quarter of about $5.5 million of threshold, you can judge that the profitability level would be somewhere around $6 million. So the key for us is how quickly we can grow the business back to the $6 million level or above, and as we continue to grow to make sure the bottom line continues grow along with the other programs that will comes back fully into play.

Bernard Fidel

So it is basically feasible that if things go well that you could be profitable even at the second quarter?

Dave Dunlap

Yes, we would need to hit something in the $6 million level or curtail costs to bring that down.

Bernard Fidel

Okay. The pipeline, either you or Kevin mentioned that it has never been stronger. Is that a fair statement?

Kevin Mills

That is a fair statement.

Bernard Fidel

And you say it is twice as strong as last year?

Kevin Mills

Yes. One other things we do is that we have a CRM system and as we interact with potential customers we track our activities and those activities include the initial contact, the e-mail back and forth, their requirements, their timing, the application and various other things. So this is something that we have a system to track, and we can look to see what’s the expected pipeline is and the timing of various deals. Even though, as I mentioned, through 2009, we’ve tracked a lot of deals that aren’t lost but didn’t close, and we’ve continued to add deals as other customers have come in. So, yes, as we start the year, the pipeline is at twice the level it was at this time last year. And the difficult in this is determining the ways of close. And customers get through a testing period, and they will I would say prototype and do pilot runs, and then they often have to go out and talk to the person who has the money that they would like to deploy this. And I think we’ve a lot of deals stuffed in that space where the CFO or the Accountant or Controller has basically said to their respective teams, “We understand it’s a good idea, but money is tight. Can we wait six months? Wait till things improve.” And we feel that once that starts to loosen up, we should be able to catch up pretty quickly.

Bernard Fidel

Now, you’ve mentioned something about that is a large order in the hospitality area like you’ve want to close in the first quarter, was it?

Kevin Mills

Yes, that is correct.

Bernard Fidel

What is considered a significant order?

Kevin Mills

I would say anything – I would say that we would be raising over 500 units as being significant. So that’s actually –

Bernard Fidel

(inaudible) go through?

Kevin Mills

$250,000 to $300,000. So that would represent certainly more than 5% of the quarter’s revenue. But again, this particular customer hasn’t made up their exact mind on the quantity, but it could be in the 800 unit range. They would be talking about maybe $400,000, which goes a long way to cover –

Bernard Fidel

Yes, it’s significant. Now you said it is going to be a rollover buyout, you couldn't – if it weren't for the bad weather in Europe as you would have had a 20% increase in the SoMo, which is why it’s still over into the first quarter, am I correct?

Kevin Mills

Yes, that’s correct. As you know, we count revenue based on sales out of distribution.

Bernard Fidel

That should really be quite significant for the first quarter then.

Kevin Mills

Yes, we expect some. We were disappointed in Q4, a lot of the shipments that we shipped after December 15 didn’t make it to distribution because of poor weather. And that happened essentially between December 15 and December 24, and most of Europe was closed thereafter. So that certainly impacted our revenue and we will take that up in Q1.

Bernard Fidel

Well, we really should hire our Vice President, Al Gore with his bad weather.

Kevin Mills

Yes, we should. Well, if we could control the weather, I tell you we could control a lot of things.

Bernard Fidel

Right. Okay, now, for the first quarter you expect to be cash break even, is that it?

Kevin Mills

I think we will be close to cash break even. I don’t know that we will get all the way. I think we will be cash positive from operations as of March. Historically, January is the worst month of the year, and not a lot happens, everyone goes into a planning phase; and generally speaking it is a poor month. For us, and certainly in the US, our bookings in January were up 30% over the same period last year. So in that respect, bookings in January at least started off as being solid. But generally speaking, people do not take a lot delivery in January. As often, people either have money, they want to spend in Q4 or they haven’t got their money to spend in the New Year.

Bernard Fidel

It sounds it’s quite significant. So what about February? How is that doing?

Kevin Mills

It’s okay. But it’s still relatively early in terms of the quarter. So we expect to book kind of 30, 30, 40, which is our normal pattern. And right now I would say, February isn’t great, isn’t bad. It’s kind of neutral. But, again, we are expecting this order that we talked about, and certainly if we got that, then February would also be ahead of where we were this time last year by a similar amount.

Dave Dunlap

And orders to date, Dr. Fidel, are tracking – the ship of orders in the quarter are tracking at where we are in a linear basis for the quarter. So we are about half way to our first quarter goal and we are about half way through the quarter. So if we do find as we expect that the second half of the quarter is much stronger, that would pick up the pace and will certainly be positive for us.

Bernard Fidel

Well, one last question. Are there any other large orders that you expect in the near future?

Kevin Mills

Yes, I think I highlighted Epocal. We are working with them closely. They were just acquired by Inverness Medical. And they are putting their requirements together and we would expect them to be a driver of the business. As part of this, I would say we would expect to book a large order through stocks delivering through the end of 2010 and 2011. So I think we would be able to have a more definitive plan as regard to Epocal. But bearing in mind they only got purchased in November 2009. And as we pointed out in the call, they were purchased for $0.25 billion, $255 million subject to meeting certain requirements. They have three large plans and we would be able to tag those plans as they start to deliver more product.

Bernard Fidel

What happened to England, that they were testing the SoMo in the hospitals?

Kevin Mills

We have a lot of hospitals continuing to test. I think the pace of deployment has been much slower than we expected. And we haven’t either lost any of the deals, it’s just that the testing has gone on longer and we still expect them to contribute significantly this year. We are also seeing a similar situation is Germany. And again, certainly UK’s economy has only started to come out of recession. And again, health care I wouldn't say, though, the quickest when it comes to spending money, but we are seeing continued test and we are pretty hopeful that as the money does roll we will be part of their plan.

Dave Dunlap

The trends continued to multiply, Dr. Fidel. For example, Kevin mentioned 60 hospitals in Germany. Many of those hospitals are still in early stages of deployment. So the volume of business into those hospitals and the expansion beyond the 60, all will likely continue to accelerate some activity in northern Europe. Kevin mentioned the National Health Service in his remarks. That's the lot of the UK business that we've talked about is involved with that discussion. You recall there was a press release last fall where we announced that a distributor, Dakota, was working with – in getting health care applications involving our products into the National Health Service system. That has continued forward and many of these opportunities that we are seeing today are result of some of the work on the part of the distributor, which is Dakota that we talked about last fall, so each one of these areas is continuing to grow. The other thing that’s significant, again as Kevin mentioned, is that we are seeing orders coming in now for the 7X, which is a new product area and we are seeing a nice pickup in entry level orders for entry level products. It seemed like the fourth quarter, people needed to take that time to evaluate the restructuring of our data collection product lines and so we did see a drop in the sales in the fourth quarter but the activity in the first quarter has been at a substantially increased pace, and we anticipate that, again, the changes that we made in the fourth quarter will substantially benefit the first quarter and beyond.

Bernard Fidel

So you expect in the first quarter, a record sales on the SoMo, that’s fair?

Dave Dunlap

I think that would be fair. Yes.

Bernard Fidel

Okay. Well, the way it looks to me is that we're starting the year we’re off at – also in the year we are cash break-even, and you expect to turn profitable by the end of the year?

Kevin Mills

That’s a fair assumption.

Bernard Fidel

Okay.

Kevin Mills

Right. Thank you very much.

Bernard Fidel

Okay.

Operator

We do have a follow-up question from the line of Brian Swift. Please proceed with your question.

Brian Swift – Security Research Associates

Yes. I’ve got a couple things. In the larger potential deals, like with Hospira and Epocal were those go through distribution or would they be direct. Do you have any direct type of account?

Kevin Mills

Interesting question. Currently, they all are going through distribution, right? And our requirement is to – our preference is to sell through distribution because it gives us good leverage and gives good flexibility to our partners in growth. That’s the general trend. In the case of Epocal, I think they have some requirements and we are in discussion with them to do an OEM-type deal. But it’s early stage. We would expect certainly through Q1 that it all go through distribution. One of their requirements is that they shift from their facilities in the US to customers overseas, which doesn’t setup well through distribution because we have some legal requirements in terms of the radio and configuration. And it’s not possible to legally ship a product that’s configured for an overseas deployment through a US distribution channel. So right now the plan is distribution as they service North America, but there is a good possibility that we will enter into an OEM-type arrangement with them as they try and service a worldwide requirement. Does that answer your question?

Brian Swift – Security Research Associates

I see. But that was kind of a unique case and is essentially you're going to try to service this market through your –

Kevin Mills

We have good distribution partners and for the likes of Hospira, for example, they generally will use local distribution to buy both the SoMo and the RFID plug-in scanner on an as-need basis. And their business model would be that as they sell their software to a given hospital that hospital may deploy 100 units, right? And as they buy those units, they will get their training and then they’d be delivered locally to wherever the hospital is, in Kentucky or Virginia or wherever it is. And so distribution works well because ultimately it provides the buffer that we talked about. So there is a product available in the channel. They don’t have to wait too long, etcetera. So our distribution strength is a big plus when we go into these deployment phases.

Dave Dunlap

And the only exception, Brian, is our OEM business. We’ve always purchase it direct. You’ve got pre-order customers and their requirements are generally unique enough that it's not a logical step to stock those component parts that go into other manufacturers products in the distribution channel. That number is now at a lower point, 19%. As we move through this next year and couple of years, we expect that number could easily grow although it will be in competition we would have liked to think with growth in our other product families as well. We do ship directly to OEM customers.

Brian Swift – Security Research Associates

All right. Yes, well the distribution is good, I guess, except when they carry on unusually low levels of inventory.

Kevin Mills

And again, just going back to that point. Between our inventory and distribution, the last year at this point there were $6 million in inventory, now there is $3 million. So this will get corrected. I don’t think the current levels are the right levels and certainly if there is any pickup in business. So we would essentially see an improvement in that.

Dave Dunlap

For those of you who like to track this area on the balance sheet, we report deferred income on shipments to distributors. That is the net of our selling price and our cost of goods. So it essentially is the profit margin if you just for ease assume a 50% profit margin on these products, then you would see that at the end of 2008 there was about $4 million in the channel and about $2 million in the channel at the end of 2009. So each time we report on a quarterly basis, you will see how those numbers were fluctuating. We’ve also now because it’s becoming more significant broken out our deferred service revenue, and as you know we are offering extended warranty and service contracts on a number of our major products, data collection and SoMo. And we recognize the revenue – we get paid upfront and we recognize the revenue over the service period, which for our premium SocketCare service is three years. So as we move forward, you will see deferred service revenue is also being a balance sheet element and that will come in over time.

Kevin Mills

Okay. And just maybe to finalize on distribution, as a company, philosophically, we are very much a distribution company, and distribution is every effective from a cost delivery point of view provided your shipping, what we call standard products, which is what we primarily ship SoMo and our plug-in scanners. When the products become unique to a customer, then they really are more suited to OEM, which is why we do our Wireless LAN and other things. And again, we would expect that over time to be about 25% of our business with 75% being pure two-tier distribution.

Brian Swift – Security Research Associates

Okay. You described the – your UK and Germany – what's your – programs you are going as far as trials on hospitals. What’s happening domestically here in terms of what kind of penetration or is that something that's still in the future that like –

Kevin Mills

Again, I think it’s been slow in the US. I think that we can give the example of Hospira. They essentially bought up a company to go after a specific medication dispensing market. We had high hopes for them at the beginning of 2009. We had discussions with them in 2008, 2009. But nothing really happened. In our more recent discussions, I think some of the reasons things didn’t happen is there still is confusion on the impact of the stimulus program and who pays for what and what are the benefits? And they recently, I would say, trained their sales people and now have a more concrete plan to attack its medication dispensing opportunity. The stimulus money is being used to incentivize that. And I still think that the overall electronic health record, there is plenty of opportunities. I think things have just been slow due to the uncertainty and as the uncertainty increases I think some of that will pick up. We're tracking many, many applications in health care in the US. But they have been moving slower than we originally expected. In Europe I think that we probably had lower expectation beginning 2009 and they have been much steadier. But it is a government run program and there hasn’t been the stimulus money. And they have systematically gone down the path to deploy certain applications, whether it be the doctor monitoring system that I believe where you can page doctors. We have a lot in the food services business within hospitals where people are using the SoMo to order lunch and dinner and various other hospital meal, as well as a doctor related activity. So I think the US will catch up this year, but it is slower than we originally expected.

Brian Swift – Security Research Associates

Do you think it will follow the same pattern, do some test marketing or test out the operations of the device and then deploy after some –

Kevin Mills

Well, I think actually we're further along in the US in that a number of people have done their test marketing and actually have, I would say, validated their applications. And it’s a little bit slower I think because of lack of funding as opposed to technical issue and some uncertainty relative to the flow of money. So, again, I think once it starts to go, it will actually go quicker because in all of these things I would say probably 50% plus is technical related issues and there is 50% related to administrative and money related issues. And unless both sides are, I would say, put to bed, nothing really happens. People have done a lot of work on the technical side and now we are stalled. And when we get some clarity I think things will move quickly.

Brian Swift – Security Research Associates

Okay. All right, that’s just from me. Thanks.

Kevin Mills

All right. Thank you very much Brian.

Operator

There are no further questions in the queue. I would like to turn the call back over to management for closing comments.

Kevin Mills

Thank you very much. We would just like to close by thanking everyone for participating in today’s call and to wish you a good day. Thank you.

Operator

Ladies and gentlemen, this does conclude today’s teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.

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Source: Socket Mobile, Inc. Q4 2009 Earnings Call Transcript
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