Socket Mobile's CEO Discusses Q1 2011 Results - Earnings Call Transcript

| About: Socket Mobile, (SCKT)

Socket Mobile, Inc. (NASDAQ:SCKT)

Q1 2011 Earnings Call

April 26, 2011 5:00 PM ET

Executives

Jim Byers – SVP, MKR Group

Kevin Mills – President and CEO

Dave Dunlap – CFO, VP - Finance and Administration and Secretary

Analysts

Brian Swift – Security Research Associates

Bernard Fidel – Private Investor

Steve Swanson – Private Investor

Operator

Greetings and welcome to the Socket Mobile Q1 2011 Management Conference Call. (Operator Instructions). It is now my pleasure to introduce your host, Jim Byers of MKR Group. Thank you Mr. Byers. You may now begin.

Jim Byers

Thank you operator. Good afternoon and welcome to Socket’s Q1 Management Conference Call to review financial results for 2011 Q1. On the call today from Socket Mobile are Kevin Mills, President and CEO and Dave Dunlap, CFO.

Socket Mobile distributed its earnings release over the wire service at the close of the market today. The release has also been posted on Socket’s website at www.socketmobile.com. In addition a replay of today’s call will be available at www.Vcall.com shortly after the call’s completion. And a transcript of this call will be posted on the Socket website within a few days. We’ve 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 27-A and the Securities Act of 1933 as amended in section 21-E of the Securities and Exchange Act 1934 is amended. Such forward looking statements include, but are not limited to, statements regarding mobile computer data collection and OEM products including details on timing, distribution and market acceptance of products and statements predicting trends of 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 factors including, but not limited to, the risk that manufacture of Socket’s products may be delayed or not rolled out as projected due to technological, market or financial factors including the availability of product components and necessary working capital. The risk that market acceptance and sales opportunities may not happen as anticipated, the risk that Socket’s application partners and current distribution channels may choose not to distribute the products or may not be successful in doing so.

The risks that acceptance of the company’s products and vertical application markets may not happen as anticipated and other risks described in Socket’s most recent form 10-K and 10-Q reports with the Securities and Exchange Commission. Socket does not undertake any obligation to update any such forward-looking statements.

Now with that said I would like to turn the call over to Socket’s President and CEO, Kevin Mills.

Kevin Mills

Thanks, Jim, and thank you for joining us today. In today’s call we will begin with a short review of Q1 and then outline the business opportunity we see for the rest of 2011.

On a very positive note we generated Q1 revenue of $4 million, a 54% sequential increase over the $2.6 million we reported in the preceding quarter. This solid increase was driven by significant sales increases in both our cordless scanning and handheld computing products. At the same time we further reduced our expenses during the quarter, which enables us to move within $300,000 of positive EBITDA. So we achieved both increased sales and bottom line improvement during Q1; a very positive step in the right direction.

I’ll begin with a review of our current handheld computing business and then provide a going forward outlook. Our handheld computing (inaudible) sales grew to $2.1 million in Q1, a 40% sequential increase over the preceding quarter. This is a significant increase but it doesn’t tell us much about the business since the revenue number was primarily driven by improved supply. You may remember we reported significant back orders enter Q1 due to the lack of LCD screens.

However, what is much more significant in Q1 are the new booking we received for the SoMo totaling $2.7 million. With these bookings we enter Q2 with an even larger backlog then we entered Q1. So demand for the Thermal continues to be very strong even though the related LCD supply problem has made it challenging to meet demand. As a result, in Q1, we shipped a total of 2945 SoMos, which was well below the demand level.

The LCD supply situation continues to improve and we have already received over 1000 units this quarter with an additional 3000 units plus expected during the quarter. While this will now allow us to completely clear our backlog, it will ensure that our SoMo revenue will grow in Q2 and we expect to enter the second half of the year with a manageable backlog.

So what is driving this demand for our SoMo handhelds? It’s a combination of several factors. Certainly the improving economy is helping and we are definitely seeing deals that went dormant over the past two years, come back and lead us to reengage with customers all with a good and positive event.

We are also seeing a positive impact resulting from HP’s exit from the classic PDA market. While HP is not fully out of the market, nor do we expect to see them completely out for another quarter or two, particularly in the US, we are seeing the impact of their departure in markets like Japan where they have already exited. Our bookings in Japan represented over 15% of our total quarterly SoMo bookings in Q1, which is extremely strong especially since historical sales for SoMo units out of Japan were almost non-existent.

As we mentioned in our last call, we strategically targeted Japan as an area of SoMo growth and traveled to Japan late last year and met face to face with (inaudible) HP recover. Our distribution partner there has a great working relationship with HP. We are seeing the positive impact of these efforts in a solid increase in sales and we hope Japan will be representative of the rest of the markets worldwide when it comes to the classic PDA.

We will be better able to test this hypothesis with improved supply of (inaudible). Today we haven’t made a strong push to provide samples and capture the HP business in other markets but we are beginning to reach out via the web to increase awareness of those using the HP device that the SoMo is 100% compatible and will enable them to use their existing software thus leveraging their software investment.

Beginning this quarter with an improved LCD supply situation we will be able to reach out to those potential customers directly to further benefit from the HP departure. Our business (inaudible) and other regular customers remain strong and we are seeing a definite increase in this business as well.

But while demand for our SoMo remains strong in Q2, we still remain limited by supply. We expect to make a significant dent in our backlog during Q2 and through the second half of the year with a manageable backlog and an improved supply situation. We expect further growth in the second half of 2011 assuming a reasonable economy and continued pick up from the HP related business.

Turning to our cordless scanning business, sales of our cordless barcode scanning products were up significantly and reached $1.2 million in Q1 which includes sales (inaudible) our cordless hand scanners and cordless ring scanners. This represents a 265% increase over the preceding quarter and reflects stronger demand for cordless scanners connected to mobile and tablet computers.

Our cordless hand scanner business continues to be driven by companies collecting data using a combination of mobile phone, tablets, notebooks and desktops while reading barcode. Again, our customers require commercial grade barcode scanning capability and use their generally running business critical functions with a software application running on their computing device. We are seeing very strong interest from both Apple and Android customers for many different markets.

We continue to see (inaudible) companies like Medtronic and Smith & Nescue [ph] using the mobile phone cordless scanner combination to track items, perform audits and generally improve information flow.

We are also seeing a variety of opportunities for application in numerous additional markets. For example in the hospitality arena we were recently informed that the PGA will be using a combination of an Apple iPad and our CHS barcode scanners to process tickets at upcoming events. We also have doggy daycare centers logging pets in and out using the cordless barcode scanner and an Apple iPad.

The good news is that the market is just beginning in many of these segments and we are seeing an increasing number of companies interested in our solutions. As it turns out, many of these companies are looking for a more robust and dependable solution beyond what is enabled by a simple keyboard pad interface.

To address this demand and to assist the developer community, we’ve launched a comprehensive software developer’s kits or SDK. This SDK will not only allow developers and customers do build robust barcode scanning solutions but it will also enable them to ensure the integrity of the information they collect. Our current SDK fully supports Android, Blackberry, Windows Mobile and Windows 7 platforms and will help drive sales in the second half of the year and beyond.

We are also working on an Apple specific SDK which we’ll have available in Q3 of this year which will enable Apple developers to build robust solutions with an Apple certified scanner.

With all these positive indicators we are feeling pretty good about our cordless handheld scanning business. We believe we’ve established a foothold in this emerging market and I expect to see excellent long-term growth over the coming quarters and years.

In Q1 we also benefited from a major deployment of cordless ring scanners to a large soft drink manufacturer. After a lengthy evaluation period we are pleased with the extremely positive feedback we received of our performance and benefit, which resulted in a purchase for deployment in over 100 locations throughout the United States. This order positively impacted our Q1 revenue and it will benefit Q2 revenue (inaudible) precisely lesser expense.

The cordless ring scanner is an excellent product from a technical point of view. But the sales efforts of this product tends to be very involved before formulating into a revenue generating deal. In addition, in this case, one of the industrial handheld manufactures with the primary handheld supplier of the deal so the information flow between all parties was challenging.

We’re pleased to have finally been awarded this business. This business category seems to have suffered severely over the past two years from the difficult economy with little money available for new projects of this type. We are unsure if the latest deal is an indication of a change in the tide but we are seeing greater demand than we’ve seen for some time. And when a large company deploys such a solution, there is a tendency for many others to copy their success.

The bottom line on our cordless scanning business is we are very encouraged with the progress we made in Q1. We saw growth in all regions and I expect to see further growth in Q2 through the end of the year.

We’re excited about the growth in both our handheld and cordless scanning business, which combined represent 82% of our total Q1 revenue. Going forward the growth of these two businesses will drive the growth of the company. The remaining 18% of our revenue is made up of service and OEM at 11%. Our legacy revenue has fallen to about 7%, which we expect to fall to less than 3% in Q2.

On the expense side we remain extremely cost conscious and continue to lower our overall cost of operating the business. Further reducing expenses by $400,000 in Q1, which is down 19% from expenses in Q1 last year. At the same time revenues in Q1 increased by 6% as a result of lower expenses and increased revenue. We were within $300,000 of achieving positive EBITDA in Q1.

In summary we believe we can hold expenses at these levels in Q2 and increase our revenue based on the backlog we already have in place. We are seeing a much improved business environment and are benefiting from HP’s departure on the handheld side. We’re also seeing very good demand for our cordless scanning products and expect that this trend will continue.

From our efforts to right size the organization we believe we can achieve positive EBITDA in Q2 of 2011. While the past two or three years have been a tremendous struggle, we believe the worst is now behind us and we look forward to some brighter days ahead.

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

Dave Dunlap

Thank you Kevin. Our Q1 revenue was $4 million, a 54% increase over revenues of $2.6 million in the previous quarter. Sales of our cordless barcode scanning products increased from $457,000 to $1.2 million, representing 30% of total Q1 revenue consisting of $486,000 in sales of our 2D cordless barcode scanners introduces last year, sales of our linear cordless barcode scanners of $259,000 and sales of our cordless ring scanner of $464,000. In addition our handheld computer sales increased from $1.5 million in Q4 to $2.1 million in Q1 representing 52% of our Q1 revenue. As our LCD screen supplier increased shipment, enabling more unites to be manufactured and shipped.

Total orders received during Q1 for all of our products were $5 million resulting in an increase in our backlog of due orders from $2.4 million at the beginning of Q1 to $3.2 million at the end of the quarter. $2.5 million of this order backlog entering Q2 is for handheld computers. As Kevin mentioned, handheld computer revenue continues to be determined by the availability of the LCD screens and our supplier is making progress in catching up on screen shortages.

The due orders in Q2 for both handheld computers and cordless barcode scanning products continuing at sustainable breakeven or better levels. We anticipate additional sequential growth in Q2 with the expectation of achieving positive EBITDA results for the quarter. That growth will drive higher margins as we spread our fixed manufacturing costs over a larger number of units sold. Our margins of 37.5% in Q1 improved from margins of 35.4% in the previous quarter due to the higher Q1 revenue volume partially offset by a non-recurring charge of $60,000 or 1.5 percentage points in Q1.

We’ve set margins to continue to improve as our revenues increase. Our operating expenses in Q1 were $2.1 million down from $2.6 million in the same quarter a year ago and down from $2.4 million in the previous quarter. We will continue to hold down our operating expenses to allow the benefits of growth to pass through to the bottom line.

In our Q1 earnings announcement we reported earnings before interest, taxes, depreciation and amortization, or EBITDA, which is a traditional measurement of operating profitability. At $4 million in revenue, our EBITDA loss was $295,000 with our break-even point for positive EBITDA results being at about $4.7 million in revenue. If the supply channel continues its catch up with screens for our handheld computers as anticipated, we would expect to report positive EBITDA results in Q2.

Our working capital balances benefited in Q1 from the release of $711,000 of cash in restricted note collateral account at the end of the year. Our improvable note balances are secured by qualified receivables and to the extent necessary in cash. The higher level of shipments and revenue in Q1 and higher receivables at the end of the quarter in combination with the conversion by the note holder of $200,000 of outstanding notes during the quarter enabled the release of all of our collateral cash as of the end of Q1.

We also satisfied $500,000 of trade payables to our principal contract manufacturer with the issuance of $500,000 of common stock. As our shipping levels increase we expect positive operating results to contribute to working capital and cash liquidity. We are working with a note investor who allowed the remaining $800,000 in notes to be converted into common stock. Once the notes have been fully converted we will be free to reestablish a working capital bank line to fund anticipated growth. And to assist with building investor interest in our common stock and better tracking our progress, we’ve engaged in analysts to prepare a report on (inaudible) for release during May and update that report from time to time as we move through the year.

We will also be presenting, on May 24th, at the Securities Research Associates Spring Growth Stock Conference in San Francisco. The presentation will be web-casted and we will be able to provide a further update on our second quarter progress.

We continue to see an easing of the slowdown effects of the economic downturn as many customer’s projects in our pipeline that were moving slowly or were on hold, are now moving forward towards completion and deployment.

As Hewlett Packard continues to phase out sales of its 200 series classic handheld computer in selected regions of the world, we are being contacted by more and more businesses looking to use our similar handheld computer in their existing applications. The SoMo 650 is an entirely compatible replacement handheld computer for the HP 200 series, allowing existing applications to run without change.

In our development roadmap for our barcode scanners we are completing, for Q3 delivery, the ability to use our Socket Scan 10 with Apple iPads, iPods and iTouch computers running the current Apple operating system. Socket scan 10 will allow developers to easily add barcode scanning to their application as is available today for Windows Mobile, Blackberry and Android devices. Many of these devices, including Apple devices, can today also accept scans from our barcode scanners as it’s entered through the keyboard using the bluetooth HID protocol.

In Q3 we also expect to release the unique Apple SKU of our 2D scanner, which reads both linear and 2D barcodes for use with our Socket Scan 10 software.

For the past two years Socket has operated as a significant leader organization including fewer employees and exceptive cost-reduction programs the reduced salaries and discretionary spending. At the same time we’ve maintained essential development programs and remained firmly committed to serving the business mobility markets with our mobile handheld computers and data collection devices supporting Windows Mobile applications on our SoMo 650 handheld computer and with our barcode scanners and our ID readers on Windows Mobile, Blackberry, Android and soon Apple applications on a wide range of SmartPhones. We will continue to work closely with developers who wish to incorporate barcode scanning into their applications.

Socket continues to be highly leveraged both on the supply side for contract manufactures to have plenty of capacity to support growth and on the distribution side for our many distribution partners and applications are interacting with customers around the world.

Our annual meeting of stockholders is scheduled for tomorrow, April 27th at the company’s facilities in Newark, California. On the ballot this year are the reelection of our current directors and the ratification of Moss Adams to serve as our independent auditors for 2011.

We continue to receive strong support from our vendors, our customers and our application partners and we are particularly appreciative of the dedicated work and the continued and the unwavering support we receive from our employees and from our stockholders who share our vision of mobile opportunities in our key vertical markets of healthcare and hospitality and the improved productivity that results from enabling mobile workers to collect and process information while mobile.

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

Question-and-Answer Session

Operator

Thank you. We’ll now be conducting the Question & Answer session. (Operator Instructions.) Our first question comes from Brian Swift from Security Research Associates.

Brian Swift – Security Research Associates

Thank you. Can you elaborate a little bit on addressing your display shortage issue in terms of how you’re progressing against working off your backlog and kind of related to when you’re going to be able to more aggressively pursue some of these soon-to-be former HP clients? Can you give us a little color on that?

Kevin Mills

The situation has continued to improve. Obviously in Q4 we had very limited supply. It improved quickly right after Chinese New Year which basically ended middle of February. We received then probably something in the 3500 range. We recognized revenue around $2945 I think as I said in my comments. And the supply continues to come in. We also have a replacement screen or second source, if you will, lined up that we hope to bring online in Q2, towards the end of Q2.

So right now today we have enough supply, well we don’t have enough supply, we have sufficient supply from the existing manufacturer and we have a high level of confidence that those screens are manufactured or in manufacturing. And that they will be delivered largely on time and we’ve done the software work etcetera to bring on a second source which we expect to bring on in June. And then once we have that I think we’ll be out of the woods in regard to the LCD situation.

Brian Swift – Security Research Associates

Okay. And again here being able to a little bit more aggressively market to the soon-to-be former HP clients.

Kevin Mills

Right. I mean we highlighted Japan as an area that we had a good relationship, a special relationship with HP. We went there, we’ve been doing our best to support all the customers we’re not receiving in the Japanese market. Unless we can provide samples to potential new customers, it’s very difficult to move forward. And we will be in a position, I think, to provide samples I would say towards the end of May or early June and most people will take 60 days to evaluate and ensure that the SoMo is in fact 100% HP compatible and then we’ll be in a position to service those orders as we get into the summer months.

Dave Dunlap

You can see the strength of the activities that we did just in Japan, Brian. In Q1 we received close to half a million dollars in orders for SoMos, most of it for delivery in Q2 to former HP customers and as Kevin mentioned, we’d like to think that’s indicative of the type of response that we’ll get as we see HP pulling back their 200 series handheld in other locations of the world. And they are doing that systematically but obviously over an extended period of time.

Our current supplier has already promised to ship about 4500 units just from that supplier and most of that will be in by the end of May. So we’re looking to see if we can add to that from either our current supplier or bring our second source into line by the end of Q2. But even if we just do the 4500 units, that again is a 50% increase over what we were able to do in the SoMo category in Q1.

Brian Swift – Security Research Associates

And what was the backlog that you’re trying to fill (inaudible)?

Kevin Mills

We currently have a little over 5000 units in backlog.

Dave Dunlap

There’s about $2.6 million at the end of Q1. So what that would do is it would bring our revenues in Q2, essentially we’d be able to ship most of the, if not all of the backlog we have on hand as of today and move forward into the backlog that is coming in in April and beyond.

Again, we’re anxious to pick up the pace as quickly as our suppliers are able so we’re paying a lot of attention to both sources of supply to see what we can do.

Kevin Mills

And we have (inaudible) one of the Taiwan and back basically meeting with both of our manufactures as well as suppliers to make sure everything stays on track.

Brian Swift – Security Research Associates

Okay. And I guess lastly all this is obviously catching up with backlog but what’s your comfort level of continuing to see the demand side grow to Q2 and Q3?

Kevin Mills

Well I think we’re reasonably comfortable in that score also. First of all the bookings that come in were higher, I think we booked $2.6 million in the quarter even though we only shipped our service to $2.1. The other thing is we probably have a high degree of visibility on 75% of the business in that we know who the reseller is and what the end user, the type of application, that they’re using the device for. And we have made a conscious effort to track when we’re doing HP replacement business as opposed to new business. Certainly in the US right now (inaudible) new business. I would say and the majority in Europe is new business whereas Asia quickly driven by Japan a lot of its replacement business.

So we have a good feeling of the, I would say, depth of the business. In addition we are seeing a lot of people whose projects were sidelined for the last two years coming back with the same requirements. They were happy that we were able to service them with the SoMo previously. They were limited by (inaudible) and the general uncertainty of the economy. So I think that there is a good opportunity here to build the company and that we’re not just relying on the HP departure. I think the business will be growing even if HP stayed in. I think HP is just adding some winds to our backs in terms of moving the business forward.

Dave Dunlap

But the order phase has continued robustly in April for 4 consecutive months, since the beginning of January that we’ve seen that high order phase. We’ve already received over $1.4 million in new orders since the beginning of April and that doesn’t include the orders from our largest customer, which we anticipate will be coming in shortly which could easily add another million dollars to that total for shipment between now and the end of the quarter and the beginning of next quarter.

So as long as we continue to see that robust pace, so far that pace has been a sustainable breakeven or better level.

Brian Swift – Security Research Associates

And I guess lastly $5 million, roughly, is still the breakeven level as far as from earnings standpoint as opposed to cash standpoint.

Dave Dunlap

Yes. If you just go forward and we’re using the EBITDA measurement because while we have these notes outstanding you have this debt discount amortization and a few other amortization that have no impact on cash and they will vary based on when we convert notes and other things. But if you pull those away from an EBITDA type of calculation, we would have hit breakeven at about $4.7 million bottom line break even and that’s pretty close to the cash number as well.

Kevin Mills

If we convert some of these notes in Q2 it will add a charge that would reduce our earnings with a (inaudible) point of the non-cash charge. And that’s why we’re reporting EBITDA because it keeps it more consistent and people can see the improvement over the various quarters.

Brian Swift – Security Research Associates

Okay. All right, thanks.

Operator

Thank you. (Operator Instructions). Our next question comes from Bernard Fidel who’s a private investor.

Bernard Fidel – Private Investor

It seems like this is the best news we’ve heard in a couple of years.

Kevin Mills

I would second that. It’s certainly been a while since we’ve had such positive news.

Bernard Fidel – Private Investor

You answered a lot of my questions already so I crossed those out. In Q1 if it weren’t for the fact about the supply problem, what would the sales have been, a rough figure I know.

Kevin Mills

Well I would say we would have been north of $5 million and roughly. So we would have been positive in Q1 if we had supplies.

Dave Dunlap

We have $1.5 million dollars in shippable orders that the dates were such that we could have shipped them had we had supplies which we couldn’t ship.

Bernard Fidel – Private Investor

(Inaudible)

Kevin Mills

Well yeah but you’re not going to see all of it recognized. So I think, you know, we would have been north of $5 million I think is a fair assessment of where we would be. But that would have been profitable operating level.

Dave Dunlap

Sure because you had some backlog coming into the quarter as well that was in the same category. But $5 million is sufficient for us to be at a profitable level. So we’re looking to of course surpass that and sustain that as we move through the rest of the year.

Bernard Fidel – Private Investor

And for Q2, assuming you get all the materials for that SoMo etcetera, what could that add up to? What’s the potential for sales in Q2?

Kevin Mills

Well in our planning we are not assuming we get all of the backlog cleared because we don’t have a firm commitment from our manufactures that that’s possible at this time. So we’re assuming we get about 4500 units, which we’re comfortable we can get in Q2. If we had unlimited supply I think we would have the potential to ship probably close to 7000 units. We are backlogged a little over 5000 and we have 2 ½ months to go. And as Dave mentioned, the order pace has remained strong. But I think to expect that number is just unrealistically optimistic when we know that we need to make sure we have a secure supply of screens and other components and today we’re highly confident on 4500 with some upside potential but it would be a stretch to go beyond that.

Bernard Fidel – Private Investor

If you shipped 4500 what would that do for sales for the quarter?

Kevin Mills

Well essentially the extra 1500 units would be an additional, let’s say, $750,000 or thereabout.

Dave Dunlap

Yeah and what it would do is it would move itself into the $5 million range which is the range we’ve been talking about as hitting EBITDA positive results.

Bernard Fidel – Private Investor

Okay, in other words, if you had all the supply you’d be able to ship 7000. What’s the highest number of SoMos you shipped so far; record?

Kevin Mills

Any given quarter I don’t think we’ve ever broken 4000. I think we’ve gone into the high threes but so Q2 we would expect to be a record in terms of SoMos shipped.

Bernard Fidel – Private Investor

And you’re saying that if we had the equipment it would be like 7000?

Kevin Mills

Well yeah but you have to be a little bit careful because you’re carrying a backlog that you built up over basically two and a half quarters. So yes there seems to be stronger demand than we’ve ever seen in the past coupled with we’re carrying backlog. If we could instantly have 7000 units I believe you’d be able to ship them all this quarter. But we’re not going to have that so, you know, we’re getting a little bit ahead of ourselves here.

Bernard Fidel – Private Investor

Okay, no, that sounds good. Remember the contract that was the potential contract from last summer about the nursing home contract with (inaudible), how is that getting along?

Kevin Mills

I’m sorry, which one?

Bernard Fidel – Private Investor

There’s a nursing home contract.

Kevin Mills

Oh yeah, actually I would say interestingly and thankfully it’s actually a little bit on hold right now. The company acquired another company and they’re in the process of digesting it so they put the project on hold for, we believe, about three months, which actually suits us much better because if they needed to go forward right now, we couldn’t service their requirement. So the deal, we believe, is still available to us but it’s on hold because they acquired another company and in the process of, I would say, digesting that. So the project is still very much there but it’s not an imminent project which suites us just fine because we’re not in a position to support it in the short term. We believe, as we get into the second half of the year, we won’t be constrained by a supplier like we are now and we’re looking forward for those types of deals to drive us to the next level.

Bernard Fidel – Private Investor

Right. Well if they purchase another company, that contract would even expand because they would probably want to put it in their other facilities too.

Kevin Mills

And that’s exactly where they are. They have the parent company, if you will, is pretty bullish on a SoMo based solution and they’re now working with their other company to get them all on the same system, which we believe will be SoMo based but they called us up and said they have to do their own work for the next two months so they actually put the project on hold for three months and will get back to us, I would say, towards the end of this quarter.

Bernard Fidel – Private Investor

But it’s quite active though. I mean it’s–

Kevin Mills

Yeah, they’re actively testing and they have a good number of units in daily use that they did have while the project was going forward. Again, for a project of this scale it is typical that they take 100 or so units and put them into one facility and run them for three to six months. We were well down that process when they put it on hold.

Bernard Fidel – Private Investor

All right. Remember there was a contract more than a year ago in England for hospitality?

Kevin Mills

Yeah, for the festival.

Bernard Fidel – Private Investor

Yeah. How’s that getting (inaudible)

Kevin Mills

Again I got (inaudible) call as well. Again, I haven’t really reached out and chased them. We haven’t had a lot of interaction with them. We believe they’re still doing well but it’s very difficult for us to go chasing new business when we can’t service the existing business we have. So my short answer is I don’t know exactly where they are. We have increased our resources in the UK beginning in Q2 and we will have more of an answer, I think, for you on that one at the next call.

Bernard Fidel – Private Investor

And with Hewlett Packard is there any rumor or something like that which country is next that they will be going out of like Japan?

Kevin Mills

No, I mean they’re a huge organization, they’re driven by many things. The regional sales people do have some discretion. They also run out of inventory. Though depending on what level of business you’re doing with HP, the information is likely different. We would expect the consumer has agreed to be where the last of the inventory is sold but the business organizations are being told in different countries that they’re out or going out.

But I would expect that most of it will get resolved in the next 60 to 90 days and will be in a good position. And what we do is we track HP on the websites. When they publish you can go to different websites like Brazil or India or the UK or whatever and you can see the availability of different products. It’s ever changing but certainly the devices are systematically going away based on the information they’re hosting on the web pages.

Bernard Fidel – Private Investor

All right, two more questions. The shipment for scanners in Q2, is that strong or is it an improvement as per Q1 would say?

Kevin Mills

Yeah, we are seeing a lot of people beginning to use iPhones and iPads to do business process. And we have seen a systematic up tick. I think that we would expect to see this continue through the end of the year. I mentioned that we will be shipping SDKs which will make it even easier for people to embed our solutions into their applications. I think this is a category is now coming into its own and I think we’ve established a foothold and we think this is a big business so we’re expecting our cordless scanning to continue to rise in Q2 and through the rest of the year.

Bernard Fidel – Private Investor

Okay, one last one. I think this would be more for the CFO, Dave Dunlap, (inaudible). You know it’s always difficult to equate sales to profitability but let’s assume, and I’m not that far off, you had a sales quarter, which is a potential if not a probability in the near term of, we’ll say, $8 million to $9 million. What would that translate into earnings?

Dave Dunlap

Sure, let me build a simple model for you. Our product contributions before we apply our fixed overhead costs are about 50%. So with $8 million, which is twice what we did this quarter, assume your product cost of about $4 million, and our fixed cost including all the people that we use in the manufacturing area and the like, about half a million. So that would give you a contribution of $3.5 million at $8 million and at $9 million about $4 million.

Our operating expenses which were $2.1 million, we would probably spend a little more on operations because we would look to increase some of the things we curtailed that would help drive additional business and there’s always additional support costs. But let’s say the $3.5 million at the $8 million revenue level, say our operating expenses were $2.3 to $2.5 million, that would leave you earnings, before tax, of $1 million to $1.2 million. $1.2 million with, let’s assume 4.5 million shares outstanding, assuming more note conversions, about $.25 to $.26 per share.

And if you take a higher level, the $9 million, maybe you spend a little more in expenses. Say you have $1.5 million in profit, 4.5 million shares it’s about $.33. So that might be the type of expectation that you would get based on achieving those types of numbers. But, as you know, there are lots of variables including the pricing and cost of the products. Volume generally means we can bring some product costs down but larger deals sometimes get better pricing and so it’s an ongoing process mixed with the factor. But we certainly can grow the bottom line rapidly because we are highly leveraged to go to these higher revenue levels we just simply run the lines with our contract manufactures a few days longer and a worldwide distribution channel, again, in all variable costs.

So nothing that causes us to spend a lot of money on sales force or spend a lot of money on capital equipment or anything else to achieve these higher levels. So we’ve actually looked forward to moving these revenues up, we should be able to handle it just fine.

Bernard Fidel – Private Investor

That adds up to over $1 a share very easily if we get to those levels in profits. I wanted to ask Kevin one last thing. This is the last question; I’ll let someone else go. What do you see, the way things are going now, would be a normal or a good sales quarter, what would you expect in revenue; in gross sales I should say? I’m sorry.

Kevin Mills

Well again I think there’s two parts to the question. I think what’s achievable in the short term I will be happy if we could start with a five on the number on the next quarter that would be, I think, a big step forward. But ultimately I think we have to get up into the eight to ten for quarter range if we want to pay back our shareholders, etcetera. So I think that this year I would be very happy if we could do four, five, six, and then grow from there over the next three quarters. But it’s early in the year, we’re off to a good start, we’re still limited by supply. So I would just say stay tuned. No matter what number you do, the next quarter will have to be higher, that’s what makes companies work. So I don’t think you ever get to a satisfied number but you make progress along a track.

Bernard Fidel – Private Investor

Yeah, I told you about the second half of the year when your supply is normal, shall we say.

Kevin Mills

Yeah again I think we have to get back into the $20 million plus range this year as a goal. Our organization really needs that level to get, I would think, to stage one in terms of sustainable business. And if you get to the $40 million a year run race, you would have a sustainable highly profitable business.

Dave Dunlap

And before we get to a sustainable highly profitable business, I’d like to get to a sustainable business. Although I think we’re well on our way based on what we have in Q1 and what we see in Q2 and I’m sure we’ll be able to give you more color on your answer at the next call.

Bernard Fidel – Private Investor

Okay, that’s good. You get someone else now. Thank you.

Kevin Mills

Thank you very much Mr. Fidel.

Operator

Thank you. Our next question comes from Steve Swanson who’s a private investor.

Steve Swanson – Private Investor

Gentleman what drove the gross profit margin down five points relative to 2010 Q1, it took a drop off.

Kevin Mills

Well I’ll let Dave look at it. Those are a few things. Obviously there’s product make. We had a 2% hit for a onetime charge and in terms of I don’t know what else, Dave, we have.

Dave Dunlap

Yeah well I think our margins, some of our newer products like our 2D scanner are currently selling at lower product margins because it’s really the first edition of that device and we do have scheduled for later this year a cost reduction version that will bring it up to our more traditional margins. You know our margins for barcode a year ago were in, product margins now, without the overhead, were in the 56% – 57% range and they’ve averaged down now to around 51%. So most of that change is in the product mix.

Kevin Mills

The other thing is that we did have a bigger percent of legacy business and the legacy stuff tends to have a higher margin. I think we’re down to 7% of our business how it would relate to this category of legacy and gross 3% next quarter.

Dave Dunlap

Yeah, we, our OEM wireless business which is just selling our wireless technologies into their party devices was over half a million dollars in Q1 a year ago down to about $150,000 Q1 of this year. And again those margins tend to be higher than the margin. So again it was a mix of what we were selling but we constantly have an ongoing program by which we look to cost reduce products that are doing well and I think you’ll see those margins plus volume (inaudible). So I think you’ll see a return of several percentage points with the growth that we’re talking about in Q2 and it should continue upwards from there.

Kevin Mills

Yeah and we would expect Q2 margins to be, I would say, inline or better than the Q1 margins you’re looking at right now as we move forward through the year.

Steve Swanson – Private Investor

As we move forward we should expect margins above 40%?

Kevin Mills

Yeah.

Steve Swanson – Private Investor

I guess the other question I had, and apologies if this has been asked already, but on the P&L you got a debt discount amortization of $316,000 for the quarter, is this a onetime event or is this going to be a recurring charge going forward?

Kevin Mills

We have a conversion of an (inaudible) and so we don’t have control over when the note gets converted. So some of it is one time (inaudible) conversion and some of it is just amortization.

Dave Dunlap

So the accounting rules, if you- you probably want to painfully avoid this but the accounting rules require when you do something other than a straight common stock offering to use fair market value accounting and the warrants are treated as if they were valued at fair market value and they’re treated as a discount from the note. And then in addition any resetting of the conversion pricing below market price at the time you issued the notes is treated as an additional debt discount.

So with that combination, for a million dollar note offering, we actually had $1 million in debt discount that will be amortized along with the notes over an 18-month period. And then the other rule is that if the notes get converted you pick up any remaining unamortized discount on those notes that were converted.

So if we were to convert all the remaining notes, the $800,000 of remaining notes, there would be $628,000 of remaining debt discount that would be taken in. that’s your remainder and if it turns out that they’re not converting then that number turns out to be, you know, somewhere in the range of $150,000 a quarter. But the reason it’s larger in Q1 is that there was $200,000 in notes converted and we have you recognize the debt discount associated with that. So hopefully I’ve been clear on the accounting approach but there’s no cash implication of that charge but it’s still one, that for accounting rules, we have to take.

Steve Swanson – Private Investor

Yeah I understand that. So if things go as well as we all hope they will go, we’re going to take that whole hit over the next several months.

Dave Dunlap

We would love to do that. Obviously the benefit to us is that it would, these were initially notes that were secured with the assets of the company. It would free up that security which then would enable us to move onto a more normal bank line arrangement. And that is really what’s needed to finance growth because it grows right along with the growth of the business.

Steve Swanson – Private Investor

Okay. The other question I had was are we going to convert any of our other tables into stock like we did that one (inaudible).

Kevin Mills

We have no current plans to do so.

Steve Swanson – Private Investor

Okay thanks.

Operator

At this time we have no further questions. I’d like to turn the call back over to management for any closing comments.

Kevin Mills

Okay thank you very much. We would just like to wish everyone a good afternoon and appreciate your continued support and look forward to reporting to you in July. Thanks again.

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