Socket Mobile Inc (SCKT) 2004 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen and welcome to the Socket Communications second quarter management conference call. At this time, all participants are in a listen-only mode. Following today's presentation, instructions will be given for the question and answer session.

[OPERATOR INSTRUCTIONS]

As a reminder this conference is being recorded today Wednesday, July 21 of 2004. I would now like to turn the conference over to Ms. Tatia Meghdadi, Marketing and Communications Manager. Please go ahead, ma'am.

Thank you. Good afternoon and welcome to the quarterly conference call for Socket Communications for the second quarter ended June 30, 2004. Earlier today, Socket distributed its earnings release over the wire service and also by e-mail to all of you who have requested such distribution.

Socket has also posted their release on their Web site at www.socketcom.com. And a replay of today's call will be available on CCBN.com shortly after the completion of this call. And a transcript for this call will posted on Socket's Web site on Friday.

We also posted replay numbers in our press release for those wishing to replay this conference call by phone. The phone replay will be available for a week.

Now in a moment management will provide an overview of the results and then we'll open up the lines for Q&A. But before we begin I would like to remind you this conference call will include 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, including forecasts of future financial results, market reactions, and operating activities.

Such statements are based on expectations of the market acceptance of our products, increased supply of handheld computers, growth and demand for our products, the potential for additional revenue growth, expectations regarding timing of the introduction and availability of new products, and expectations regarding our ability to control our operating expenses and improve cash flow.

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.

These factors include, but are not limited to, the risk of delays in the availability of new products due to technological, market, or financial factors including the availability of necessary working capital; our ability to successfully introduce and market future products; our ability to effectively manage and contain our operating costs; the availability of announced handheld computer hardware and software, market acceptance of handheld computers; and emerging standards such as Bluetooth wireless technology and 802.11B and our related connection products; the failure of our strategic partnerships to develop our business as expected, disruptions to our business due to general economy caused by external forces such as terrorist activities or natural disasters, decline in consumer or corporate spending on technology products, or the other factors described in our most recent Form 10-K and 10-Q reports filed with the Securities and Exchange Commission.

With that said, I would now like to introduce management. On the line today are Kevin Mills, President and Chief Executive Officer and Dave Dunlap, Chief Financial Officer.

And at this time I would like to turn the call over to Kevin Mills.

Thank you very much, Tatia.

Today we are announcing our second profitable quarter, another solid growth quarter versus the same period last year.

Socket continues to grow its revenue in a consistent manner. And we are announcing that our quarterly revenue grew by 33% over Q2 last year, as well as 35% for the first half of 2004, compared to the first half of 2003.

This growth is very much in line with the growth we have seen for the past 2.5 years and keeps us on an annual growth rate above 30% for 2004.

In Q2, our revenue was $6.7 million and we experienced growth in every product category compared to this time last year. The highlight of the quarter was our Bar Code Scanning products, which grew at 76% over last year.

Unfortunately, due to the timing of some Bar Code Scanning orders, Q2 was not a record revenue quarter for the company as our revenue was $12,000 less in Q2 than our record revenue number in Q1.

As we have said many times in the past, Socket has limited ability to determine the exact timing of customer sales, particularly in the Bar Code Scanning area, where we are a component of the overall solution and our experience in Q2 is a good example of this.

A number of large deals, which were expected to close in Q2, slipped by a few days and closed in early July, thus preventing us from reporting our sixth consecutive record revenue quarter.

The positive news is that we did close the expected deals and we will benefit from this business in Q3. Dave Dunlap, Socket's Chief Financial Officer will outline the financial results in detail in a few minutes.

As we look at our going forward business, we see a strong market for our products and we expect that the growth trends we have seen over the past two years to continue.

We are particularly pleased with the market opportunity in the data collection category as we continue to see this business strengthening and we feel very positive about the business and our ability to continue to grow our revenue.

Even though we've been in this data collection market for some time, I'm often asked questions at investor meetings about our data collection business. And it is clear from these questions that there remains some misunderstanding about our position and the opportunity Socket has here.

I would therefore like to take a moment to clarify our position and the opportunity.

Socket is servicing and addressing a new category of data collection users, which we like to refer to as the occasional or white-collar data collection market. This segment is unlike the traditional data collection market serviced by companies such as Symbol, Intermec, and Handheld Products. These firms are very focused on logistics and transactional-based Bar Code Scanning, which require ruggedized and dedicated computing devices.

This traditional Bar Code Scanning market continues to be well serviced by these firms and we see very little overlap between this traditional market and the occasional scanning market we are servicing.

So to answer the commonly asked question, Symbol, Intermec, and Handheld Products are not competitors to Socket. In fact, we include all of these traditional Bar Code companies as partners and we sell products to them and work closely with them.

This new occasional scanning market has come about because today almost everything is Bar Coded and more and more organizations are taking advantage of the availability of Bar Codes to improve the overall efficiency of their business processes.

However, their users are not willing to carry a large, dedicated device for this occasional requirement and are using a standard PDA and Socket's plug-in scanners to meet their needs.

The example we often use is the medical sales rep who provides samples of a new drug to a doctor and is required by law to capture the product number, lot number, of the sample in an effective and accurate way so there is traceability in the event of a recall.

Instead of carrying a dedicated device for this requirement, they are simply adding a Socket Bar Code Scanner to their existing PDA to capture this information on an as needed basis. This may be a weekly or daily requirement, depending on the particular individual's job function and activity level.

Obviously the software used to automate this process and to make sure the information that is captured is carried back to the central database and correctly update the appropriate record is a critical element in the overall solution. For this reason, it's important that Socket offers software developer kits and makes the integration of our Bar Code Scanning technology as simple and as easy as possible.

Socket offers a number of plug-in Bar Code Scanning solutions that combined with a standard PDA and application software, provides an extremely compelling solution for these types of applications.

Complexity of these solutions, which is a combination of mobile hardware and software and server based databases, causes the sales cycle to be long. In our experience it takes anywhere from 9 months to a little over a year from the beginning of the sales process to initial deployment.

And this white-collar market is not small. According to a recent report from ZDNet, and we have seen other similar reports, there are over 35 million white-collar mobile professional in the U.S.

Socket has a unique position in the market being the only supplier of these types of plug-in Bar Code scanning solutions in the U.S. And this unique position was strengthened with our announcement today of the acquisition of a U.S. patent, which covers these type of plug-in Bar Code scanners and RFID readers.

Socket continues to have a strong and growing developer base. And today we list over 40 developer partners on our Web site who have developed software solutions for various market segments including asset management, healthcare, sales force automation, to name a few. We also have about 400 developers who have purchased our SDKs for evaluation and development.

We continue to strengthen our position in the mobile data collection market by continuing to add new hardware options for our growing developer community. In late Q2 we released a cordless Bluetooth Bar Code Scanner that can be incorporated into both existing and new application using our proprietary software developer kit SocketScan.

And today we announced our RFID development kit solution, referred to as SocketReader, which will be an extension of our SocketScan solution and will enable white-collar workers to collect data from RFID tags in a similar manner to the Bar Code Scanning solutions available today.

In fact, we will be producing a single product that will be capable of reading both Bar Codes and RFID tags as we feel this will be a requirement for many years.

All of these new products will add incremental revenue in the second half of the year and should add significant revenue in 2005.

Overall, we feel that our data collection business has never been stronger and despite the difficulty of predicting the exact timing of orders, it looks like it will be the dominant driver of our revenue going forward, especially as we received the boost of starting Q3 with a number of large orders originally expected at the end of Q2.

I hope this has helped clarify the great opportunity ahead for Socket in the data collection market.

On the connectivity portion of our business, which includes our family of plug-in connectivity solutions, we are expecting to see continued growth. We are seeing some different dynamics in the wireless and cordless portions of our business as more pocket PC devices come with built-in wireless connectivity options, thus limiting the market for some of our wireless, plug-in connectivity products.

However, we are still seeing a growing market for our cordless, Bluetooth plug-in cards as we are seeing more demand from the industrial handheld customers, who continue to add Bluetooth capabilities to their devices with our plug-in Bluetooth cards.

The SD portion of our Bluetooth business did suffer a little in Q2, as we did not have the benefit of the post-Christmas effect in Q2 and SD is not an established form factor in the industrial market yet.

The wireless LAN portion of our business did well in Q2, despite the increasing number of devices with built-in wireless LAN. But again here we are seeing the emphasis of the business shift away from the individual user and more for the corporate user.

We have been developing a set of wireless LAN utilities that will be released in Q3 and will help us maintain our growth in this portion of our business. These utilities address the many shortfalls with existing WI-LAN implementations relative to enterprise usage and requirements for security, encryption, and certification.

Our external, cordless Bluetooth products, which today consist of our cordless serial adapter, cordless GPS, cordless modem, and our cordless handheld scanner all continue to do well. All of these products were designed and developed with a mobile worker using a PDA in mind, and provides tremendous flexibility for people on the go.

These products are providing Socket with new opportunities outside our traditional market of PDAs. We are finding significant opportunities for these products in the tablet PC and notebook arenas and we will continue to add software to better service these new platform opportunities.

The influence of our various wireless and cordless enabled products continues to grow. And today approximately 40% of our revenue comes from wireless and cordlessly enabled products.

In the embedded side of our business, revenue from our KwikBlue Bluetooth modules and interface ICs grew well and now represent 68% of our business in Q2, and grew by 49% over the same period last year.

During the quarter we received the benefits from increased sales from customers who embedded our Bluetooth solutions in their industrial PDAs. And we expect this business to continue to grow well in 2004 as the many design wins we secured continue to be brought to market by our customers.

As previously stated, we continue to have little control over the timing of new embedded module rollouts, but expect the deployments that have begun to continue over the remaining course of the year, which will provide us with a stronger revenue base in this category.

In conclusion, Q2 was a solid quarter that allowed us to maintain our growth and momentum. Our 35% growth in the first half of 2004 over the same period last year has put Socket on a track for another solid growth year and for our first profitable year.

We see a strong market for our products and we see a great opportunity to expand our business in the data collection category, plus we will continue to expand our available markets by servicing the tablet PC and notebook markets.

I would now like to turn the call over to Dave Dunlap, Socket's Chief Financial Officer, for his review of our Q2 results and his remarks. Dave?

And thank you, Kevin.

Socket's revenue for the second quarter, ended June 30, 2004, was $6.7 million, an increase of 33% over the same period a year ago.

The quarter was Socket's second consecutive quarter of profitability, and albeit a small profit of $43,000, the company is poised for second half growth and improving profitability.

Our formula for this positive momentum has been expanding markets, new and innovative products, a reputation for quality, and control of our expenses.

Second quarter revenue of $6.7 million was the same as the first quarter's revenue. Compared to the previous quarter, we experienced some slow downs in modems sales in our branded connectivity products business as our three largest purchasers of these products all purchased in the first quarter and are back to purchasing in the third quarter.

Offsetting these reductions were increases in our wireless LAN product sales and our serial product sales.

We also experienced delays in receiving Bar Code-scanning orders, so our Bar Code revenue, although higher than the year ago quarter by 77% was flat with the previous quarter's revenue. Some of these orders have caught up in July and our third quarter has started strongly, carrying forward $1.6 million in backlog for orders received by the end of the second quarter but are shippable in the third quarter.

And adding to that total, another $1.5 million in orders received since the first of July for a total of $3.1 million in shippable orders on hand today, a fast start for the third quarter.

Our inventory balances at the end of June increased by $1 million in anticipation of these higher order levels.

As we look ahead to the second half of this year, we see a number of growth dynamics kicking into higher gear. Corporate deployments continue to increase in number and in size of orders as monitored by our activities with the national account groups of Dell and Hewlett Packard, and with systems integrators and value added resellers that assist enterprises in creating new systems and applications for our Bar Code scanning products.

Socket's fasting growing product family continues to be Bar Code scanning, which grew 77% over the same quarter a year ago. At $2.4 million, bar coding was 36% of our second quarter revenue and has now become our largest product family, surpassing our connectivity product family.

The newest product in the family, the cordless hand scanner, using Bluetooth wireless technology, began shipping at the end of the second quarter. Our family of Bar Code scanning products also includes a CompactFlash plug-in laser scanner, a smaller SDIO form factor plug-in Bar Code scanner, a Bar Code-scanning wand, and a laser Bar Code-scanning gun.

Our Bar Code scanning software works across all Bar Code scanning products and pocket PCs. And we will be adding the cordless hand scanner to our Bluetooth software for Windows by the end of the quarter to allow its use with notebooks or tablet computers.

Our SDIO scanner that we introduced at the end of September, which also works on the Palm Tungsten handheld platform, has gained very rapid acceptance and is contributing nicely to our growth in this product category with over $2 million of products sold since its introduction.

We are also well along in the development of an RFID reader. And we announced this morning the availability of a software developer's kit to get developers started on building RFID software applications.

A major dynamic supporting growth within our family of Bar Code scanning products is the pace of development of third party software applications.

As Kevin mentioned, we have shipped more than 400 software developer kits, and we have approximately 40 third-party software applications displayed on our Web site that support the use of Socket products in mobile applications with many more on the way.

Our other industrial product family is our embedded products family consisting of Bluetooth modules and interface chips. In the second quarter, embedded products represented 15% of our revenue and grew by 49% over the second quarter a year ago.

We have over 38 design wins for chips and modules with an increasing number of products now entering the marketplace. We have been particularly strong in becoming the embedded Bluetooth provider for industrial grade PDAs with 20 design wins among 13 companies.

Our third product family, peripheral connection or serial products at $1 million also represented 15% of our revenue. This is a legacy product focused on notebooks that we first introduced in 1993. And until this quarter, it has been on a slowly declining revenue path as USB continues to replace serial as the technology for peripheral connections to notebooks.

However, with the introduction late last year of our cordless serial adapter, which replaces cables with a cordless connection using Bluetooth wireless technology, and with companies such as Stenograph that have adopted our cordless serial adapter to upgrade courtroom environments, replacing cables with Bluetooth, our serial product family has slowed its decline. and in the second quarter actually grew 4% in comparison to the same quarter a year ago.

Our fourth product family, branded connectivity products, at $2.3 million in revenue for the second quarter, represented 34% of our revenue and grew 15% over the same period a year ago. This business was down from the first quarter of 2004 primarily due to the timing or orders for modem products.

Sales of branded connectivity products have been flat in previous second quarters because of strong post-holiday season growth that increased sales during the first quarter, and the pattern this year was a similar one.

We are now back to normal run rates and experiencing excellent growth in our connectivity products, particularly in our wireless LAN and cordless Bluetooth products.

Bluetooth, which we refer to as cordless, is now incorporated into each of our product categories. Our Bar Code scanning product family has a new cordless hand scanner. Our embedded products have our Bluetooth embedded modules. Our serial product family has the cordless serial adapter. And our branded connectivity product family has two standalone products, our cordless GPS receiver and our cordless modem, as well as our Bluetooth plug-in, CompactFlash, and SDIO cards.

Cordless and wireless products are revenue growth drivers for Socket. As Kevin mentioned, cordless and wireless products together represented 40% of our worldwide revenue in the second quarter of 2004, compared to 34% of our worldwide revenue in the first quarter of 2004 and 28% of our revenue in the second quarter a year ago.

We are well positioned to benefit from continued growth of our wireless and cordless products. Our Bluetooth solutions are complete solutions where we have designed and developed both the hardware and software, ensuring that they meet our quality standards of ease of use, interoperability with other Bluetooth enabled devices, rugged design, and low power consumption.

Our Bluetooth software is used with all of our Bluetooth products, including our stand-alone products that are designed to work with mobile computers. Our worldwide distribution channels make our products available to customers around the world. Bluetooth continues to be more widely adopted as the connection of choice between devices that are in close proximity to each other.

Wireless LAN is also benefiting from the increasing deployments by enterprises of wireless LAN networks and by the growth of hot spots enabling individuals to reach the Internet from diverse locations, such as the airport or their favorite coffee shop.

Our wireless LAN plug-in cards in both CompactFlash and SDIO form factor, are recognized as an ideal solution for a handheld computer because they have been designed for handheld computers and particularly their low power consumption.

The Internet is an ideal network to send and receive data because of its higher transfer speeds, about 10 times faster than Bluetooth. Thus an enterprise traveler would traditionally carry a mobile computer, a wireless LAN connection to be able to connect from within a wireless LAN network space, a Bluetooth connection for times when a wireless LAN network was not available and the traveler wishes to connect over a mobile phone network with a Bluetooth enabled phone, and a modem, either wired or Bluetooth, for using a telephone for dialup when neither Bluetooth nor wireless LAN are available.

As Kevin mentioned, one of our current major development initiatives is to add additional security and other user-friendly features to our wireless LAN products as we strive to improve connection experiences for mobile professionals.

Moving on from revenue, our gross margin contribution on sales was 51% of revenue in both the first and second quarters of 2004, compared to 49% in the same quarters one year ago.

We have an active cost reduction program that allows us to pass cost savings on to our customers while maintaining our margins. We expect to continue to post margins in the 50% range.

Managing our expenses has been important to our reaching and maintaining profitability. Our head count has grown about 10% compared to a year ago and our expenses in the second quarter of 2004, compared to the second quarter one year ago, have grown about 18% compared to revenue growth of 33%, which has allowed our faster revenue increases to contribute to our bottom line growth.

In addition to higher personnel costs in engineering, sales and marketing, and operations that have been needed to support our growth, we also experienced increases in contract engineering services.

As we build products that go to new platforms such as Palm and Symbian, increases in advertising and promotion, as we've expanded our distribution channels, and the cost of defending a patent litigation lawsuit initiated by Khyber Technologies in June of 2003.

We are pleased to announce this morning that we have acquired from Khyber the Bar Code-scanning patent that was the subject of the litigation for the sum of $600,000 and the lawsuit has been dropped.

The patent strengthens the company's intellectual property rights associated with our plug-in Bar Code scanners, plug-in Bar Code imager, and future plug-in RFID products and is consistent with our long term commitment to build a strong intellectual property portfolio to protect our considerable investment in these products.

The purchase of the patent will be capitalized as an asset purchase in the third quarter ended September 30, 2004.

Our balance sheet at June 30, 2004 included cash of $7.6 million, a current ratio of 1.7 to 1, equity of $16.7 million, and no long-term debt. We were pleased to make our final note payment to Nokia Corporation in April that completed payment for key Bluetooth technology and a CompactFlash Bluetooth business that we acquired from Nokia in March of 2002.

Our cash flow as measured from the end of last year has been positive, increasing cash from $6.4 million at December 31, 2003 to $7.6 million at June 30, 2004.

Our Series F preferred stockholders from our financing last March a year ago, have converted 69% of their preferred stock into common stock, mostly prior to the end of last year. And they have until March of 2006 to complete the conversion.

At June 30, 2004, the remaining Series F preferred stock converts into approximately 850,000 shares, which will add a little less than 3% to the 30 million common shares we have outstanding.

Our annual meeting of stockholders was held at the company's corporate offices in Newark, California on Wednesday, June 16, 2004. Common and preferred Series F stockholders as of the record date of April 19, 2004, voted their approval for the re-election of directors, the appointment of Moss Adams as the company's independent auditors, and the adoption of a new Omnibus Equity Incentive Plan to replace the company's current stock option plan that was nearing its expiration.

We're now ready to open the conference call to questions. I'll turn the microphone back to the operator.

Thank you, sir. [OPERATOR INSTRUCTIONS]

And our first question is from Brian Swift. Please state your company name followed by your question.

Security Research Associates. Could you be -- can you give us a little breakdown in terms of that $1 million or $1.5 million that kind of moved into the first part of July in terms of what the segments, where these segments came from? You kind of alluded to it between both you, Kevin, and Dave in your remarks. But I can't really quite isolate --

I think the answer to the question, Brian, the large orders we're referring to were all in the Bar Code data collection category.

OK. Good.

I mean I think as we've stated many times, the timing of these orders has always been a difficult thing to predict exactly because there’s often, I would say, complicated deployment. And the orders just got held up for signatures and arrived a few days late.

Now please help me try to figure out, are you on track? Do you feel like that you're on the same track that you were at the end of the first quarter? That you will kind of make up that million or do we just kind of back track?

In other words, where I would be, would have been thinking that this June quarter would have been would have been somewhere around $7.5 million if you just took another increase, the same kind of increase you had in your first quarter over December. And then that would kind of extrapolate out to something in between 8 and 8.5 for the third quarter.

Well I think that the way to answer the question is that I think we'll have similar issues at the end of this quarter and it depends where the orders fall. What we're seeing is that particularly on the Bar Code Scanning side, there seems to be a lot of orders in the last month of the quarter.

Generally speaking, I think June turned out to be a little bit slower than people expected. And as a result I think one of the things that happened is probably that our orders slipped by a few days.

So I don't think it has affected the momentum of our business. And I think a lot will depend on the sentiment in September where if people are feeling that the economy is still good, we could see it all as benefit but we could continue to see some slips if people are still, I would say, cautious.

So overall I think we're very comfortable that the Bar Code Scanning business has never been healthier and looking more promising.

And traditionally, Brian, we find that when we have a strong start to a quarter, the quarter generally turns out to be a strong one throughout. Because starting strongly means that we typically finish strongly gives us two strong elements within the three months. So starting strongly in July as we're doing is a very good sign.

OK. And did you, I may have missed it, did you say what the embedded business was on a dollar amount for the quarter?

It was a little over $1 million. I don’t think we said. We said it was 16% of the overall number, which is about $1,050,000.

Yes, in our press release we broke out the product categories. Embedded was a million, peripheral connection products was a million, Bar Code Scanning was 2.4, and connectivity products was 2.3.

OK. Thank you.

Thanks, Brian.

Thank you. Our next question is from Michael Omni. Please state your company name followed by your question. Mr. Omni, your line is open at this time.

I'm Michael Kim.

Oh, Michael Kim. Hi, Michael.

Michael Kim here at Zurich Security Assets (ph). Sorry, I was confused. Just to clarify then as far as the kind of in terms of numbers for the third quarter. Does it look like an outsized quarter? Or does just everything get pushed to the right?

I think that we're still comfortable that we'll have a good, solid Q3. We're not suggesting everything gets moved to the right. I think we saw some timing issues, really, in Q2. I think we're on track in Q3.

I think what I was trying to point out in Brian's, in response to Brian's question, is that basically it's very hard, it always has been very hard for us to predict exactly when orders come in.

And this Q2 quarter we saw the impact of the swing of several hundred thousand dollars for the sake of essentially two days. And it's difficult for us to predict exactly.

But I think the trend in our business has never been stronger. And we feel very positive about the rest of the year.

So the business we're predicting, we're predicting for the second quarter has all happened. And the timing differences in terms of our ability to ship it by the end of the quarter, which is tied to, of course, when we get the order. That has shifted by a small amount. We're not talking large shifts here. We're talking a week or two for the orders that would normally have come in at the end of June.

So we're not looking at any large shift in the business at this point in time. Hopefully that'll be additive to the quarter. But again, as Kevin points out, we won't know what September looks like until we get closer to September.

And so, at least in terms of inventory level, do you expect returns to sort of return back to normalized levels by the end of this quarter or are we looking maybe ...

Again, if we see the quarter progress in our normal pattern, that inventory will come back down. We had purchased the inventory at higher than normal levels in anticipation of the actual orders that came in and were shipped in the first half of July. So if the pattern goes back to a normal pattern then you'll see our inventory balances come back down.

And maybe just to add, Michael, with the Bar Code Scanning we do have pretty good visibility on what's in the pipeline. Because these projects do take some time and there is a lot of interaction with customers and developers during this time.

The issue really comes down to when the customer finally pulls the trigger. And that's always been a difficult part. And I think the fact that the inventory went up was because of our high confidence that the orders that we expected would arrive.

The fact that they arrived a few days late obviously left us with more inventory and a little bit short on revenue.

But we no longer have that inventory. It's been shipped on to the customers.

OK. Great. And then in terms of the make up of the Bar Code Scanning category, are you continuing to see a shift to ...

Not yet. I think that the laser-scanning portion continues to represent probably greater than 80% of the revenue. We're seeing imaging improving and we only shipped our cordless in the last week of the quarter, so it's too early to say.

But we did mention, as you know in the press release, that our SDIO scanner, which actually works in more platforms including the Palm, we've shipped over $2 million now of that product since its introduction at the end of the third quarter last year.

So it's becoming a more dominant and it's the second largest product category within Bar Code Scanning. And of course our cordless hand scanner, which has been getting extremely good recognition including having been nominated for several awards.

At TechEd in Europe it was nominated for a finalist in the product of the year category.

And it just shipped right at the end of the second quarter. So we'll start to see revenue from that product as well adding to our other Bar Code family product revenue in the third quarter.

And as with most Bar Code products, it will take a few quarters to really get up to speed. But we're expecting that the ease of use of a Bluetooth Bar Code Scanner, which is a very lightweight, easy to hold device, and the ability for it to transmit the scanned information over to a nearby data collection device, whether worn or nearby, is going to be very popular.

OK. Great. And switching gears, are you seeing anything on the competitive landscape? And also if you could speak to sort of a blended ASP erosion quarter to quarter, have you seen any change there or either way?

I think we're not seeing a lot of competitive price pressures. We continue to reduce the price of our products in line with our cost reductions. So I think we're happy with our 51 point gross margin. I think as we've said many times, our target is to be at 50 points. So we're slightly ahead of that. So we actually feel pretty good.

Our, I think, our development efforts are really at this stage on the wireless side geared toward enhancing the value we provide for the dollar as with increased functionality, security, and other things as opposed to lowering the cost. Because I think that the lack of functionality in certain areas is what's needed to drive the market. Not I think just cost reductions.

I'm to assume then that would be the focal point for your product roadmap over the next two to four quarters?

Yes. I think that as a company we're very focused on solving the problem correctly and easily and providing value for the products we provide. Which doesn't always make us the cheapest, but we hope always makes us the best.

OK. Great. And on the embedded side, you mentioned it was just a little over $1 million. That's one category that seems like it has quite a bit of opportunity. Can you talk a little bit more about where you see the opportunities there and just kind of if this is a year when we might see an inflection point in that business or is that more a 2005 type event?

I think that we'll continue to see steady growth. It's hard to predict when the inflection point happens because it all depends on customers selecting devices that have Bluetooth. But we've supplied the Bluetooth to guys like Intermec and Handheld Product.

The deals that we see from these companies are typically large. And then there's a rollout. I think we benefited in Q2 from a 10,000 piece order that one of our customers had in Europe and the subsequent rollout that will continue in Q3.

And as we add more deals, generally the base just rises. So we feel good about it. It's very difficult to predict when these events happen because we're not in a position to monitor them very closely. But we do benefit as they do happen.

But Intermec's another good example. Intermec was the first customer to embed our Bluetooth modules in their Series 700 series PDA. And they did that about 2 years ago. Second quarter two years ago we, actually their first customer, included 10,000 units of Bluetooth enabled printer and 10,000 PDAs. And we did about $600,000 of business on that one order.

So we expect we'll see from time to time large orders and as these products begin to circulate.

Intermec has been announcing new contracts, for example, that involve their 700 Series with military, with other organizations. And to the extent that those customers select the Bluetooth option to be incorporated into the 700 Series PDA, we're going to benefit from that because it would be our Bluetooth module inside.

OK. Great. And I know you guys tend not to give out forward guidance down the road. But I know in the past you mentioned that 40, $45 million is sort of where you really begin to see the leverage in the model, i.e., $10 million a quarter.

Is -- do you guys anticipate being able to kind of get to that range, call it early '05 or given how the Bar Code business has been a little bit delayed this quarter, is it more of a later '05 type of event?

I think that you have to look at the trends. If you look at the trends for the last two years, we've been growing at 33%. We're on a growth path this year of 35%. It's difficult to predict the future.

I don't think the delays we saw for the sake of a few days at this stage reflect any shift in our confidence for the overall year.

And we do expect, Michael, that as our embedded business continues to mature, which will be additive, as we see our newer products continuing to mature, which are adding. And generally as the pace of corporate deployments picks up, which we believe will happen, we would expect to see some upward inflection in those growth statistics.

But judging when and how quickly that will happen is something that has defied many an analyst and we're certainly not going to try to tackle that. But we're prepared for growth.

OK. Fair enough. Thank you very much. That's all the questions I have for now.

Thank you, Michael.

Thank you. Our next question is from Peter Mintz. Please state you company name followed by your question.

Yes, good afternoon. Peter Mintz, Fleetwood Research. Well I did notice that even though the revenue may not quite have been as high as some of us had expected you still were able to get on the bottom line numbers. So that's good.

But it seems that, I guess, you talked about the fact that margins are staying up because of the product cost reduction programs. And I know you spoke to that a little bit.

Can you elaborate a little bit more on that? And how long that can go on? Because it's a -- I assume at some point the margin will erode a little bit. Or can this go on for a long period of time?

Well, I think that we provide a product that really is a combination of hardware and software to provide a complete solution. If we were a software only company, we would expect margins probably in the 80%. And if we were hardware only, we would expect something in the 30%. Blended, that's why we come out at 50 points.

In some ways as we increase our software element, the software portion of our overall solution, it's actually easier to maintain or even grow your margins. I think that we've done a very good job of reducing the hardware portion and we continue to add value in the software.

So I actually feel that we can go quite a long ways in the 50 point gross margin, if we can maintain our discipline on the cost reduction side and our investment on the R&D side.

OK. And just one quick question the Khyber patent that I think Dave said was about $600,000 that you can amortize?

That's correct, Peter. We haven't concluded on the amortization period, but if we should use the remaining life of the patent that would be about 11 years.

OK. I just want wanted to, I mean obviously it's not going to have a major impact long term on earnings, I just wanted to figure out if it was going to hit earnings at all this year. Cause obviously you're going to probably be just at the break-even or just above it.

It will not have a significant impact on our operating results.

OK. That's all I got at the moment. Thanks.

Thanks a lot.

Thank you. [OPERATOR INSTRUCTIONS]

And our next question is from Christopher Swan (ph). Please state your company name followed by your question.

Yes, hi. Christopher Swan from GMT Capital. Quick question on the backlog -- this is the first time I've heard you guys give specific numbers for backlog. Could you give a little bit more flavor, color on that, as far as what causes it, particularly from an order standpoint and how typical has it been historically in the business?

Well we've actually been reporting backlog, at least in our management conference call discussions, for probably the better part of this past year. But it maybe gets buried in that information.

Most of our products go through general distribution. And the order cycle for most of our distributors is ordering once or twice a month. And so we typically, and we normally will get products from the point of receiving an order to the point of getting it out the door in about a week, which means that most of our distributors allow two to four weeks from the time they order to the time they expect to get the products.

So we're seeing orders that distributors want us to ship generally in the first part of the first month of the quarter on hand. But, in many cases, they've not asked us to ship until after the start of the quarter because they'll stage those orders. Or they may come in right at the end and we just don't have the ability to turn them around.

But usually the backlog at 1.6 million has been growing. It was 1.4 million at the end of the first quarter. And I believe it was 1.2 million at the end of last year.

So that's reflecting more the general increases in our business and a fairly consistent reorder pattern on the part of our distribution channel.

OK. I, thank you. And I guess one other question to the Khyber patent.

If you could give a little bit more color onto why you thought strategically this was the best solution from a legal standpoint? Did you feel like, is this a patent that is going to generate significant revenue going forward potentially from a licensing standpoint? Or was this just the best way to resolve the legal dispute?

Well I think it's, there's many elements in the solution. I think it was a combination of the above.

The patent provides clear protection for us in an area that we have invested a considerable amount of money. And I think that we felt it was prudent to not disturb our customers with changes to allow us to continue to grow.

And that when you weigh out the costs of litigation, trials, and the risk associated with it, it was a better overall deal for us to basically negotiate a deal where we ended up owning the patent than trying to defend, redesign, get around it.

So we're actually quite pleased with the outcome. And we think that we have added to the strength of our business. And certainly we'll prevent other people from coming in to try to compete with us as we go forward down the road.

We were capable, Christopher, of redesigning our products to avoid the concerns of infringement. And in this case, we were able to make it more attractive for Khyber to sell us the patent than to try to litigate to earn on our existing products. So I think it was a win-win solution for all the parties.

OK. Thanks. I don't have any further questions.

Thank you. Our next question is from Brian Swift. Please go ahead with your follow-up question.

Yes, could you give us a little color on your distribution system? In other words, where the strengths and weaknesses may be and if you've added some new players in your distribution network?

OK. I think that we're very actually very proud of our distribution system. In the U.S. we have Ingram and Tech Data and D&H, Ingram and Tech Data being the two largest distributors in the U.S. And the model in the U.S. works particularly well because of the efficiencies of the system and large distributors can ship nationwide.

We basically manage the inventory at the distributor level. We only account for sales based on sales out of distribution. So anything that exists in the distribution channel is fully reserved from a -- the gross margin is fully reserved on this inventory.

The situation overseas is somewhat different. We have a total of 50 distributors worldwide. In most countries in Europe we have 2 distributors. Typically the European distributors are more frequent orders, order more frequently. And they don't carry as much stock.

We follow the same policies in terms of fully reserving inventory that is in the channel in Europe or worldwide, for that matter. And we have very good relations with these distributors. We've worked with many of them for many years.

We don't feel that we're losing out due to lack of distribution. We are able to focus on demand generation and use our existing distribution channel to service that.

So overall I think we have a very solid distribution channel. We basically have ourselves in a position to respond quickly to increased demand and we're working on increasing the demand.

One of the major dynamics, Brian, that benefited Socket was back in the '96, '97 time period when we changed our focus from a notebook platform to the newly emerging Microsoft handheld platform. And at that time we went from being the number three or four supplier of plug-in products for notebooks to being the leading supplier of plug-in products for a very small handheld market space.

And what that did though, as the demand for handhelds moved up, is it put us in the top category with distributors around the world. Because the products are differentiated, particularly in terms of low power consumption and in some cases form factor.

As a result, we found instead of our working hard to get into the distribution channels, distributors of our choice, we found distributors, many of them coming to us and wanting us to be their supplier for peripheral products for handhelds.

And as a result, we've been able over the years to upgrade the quality of our distributors to where we think we've got probably the one of the finer distribution groups of distributors in any distribution channels around the world for electronic products.

Is there, like say, from a geographical standpoint, any particular strengths or weaknesses between June quarter and March quarter that you could highlight?

I don't think so. I mean I think that ...

March quarter gets your post-Christmas effect, where a lot of the PDAs that are sold during the Christmas season result in follow on purchases of peripherals in the first quarter. So if you go back for the last couple of years, our strongest quarters have been the fourth and first quarters and our weaker quarter has really been, the weakest quarter has been the second quarter.

Third quarter is varied depending on what's going on in the market space. But last year third quarter was a nice growth quarter because of our Bar Code Scanning growth.

And also you have the launch of the Pocket PC 2003 in June, which helped.

No, I don't think we have any material or concerns in our distribution channel. I think that our channel is very effective and very efficient and that we're very pleased to have such a strong distribution channel worldwide.

We, I would say, have an exceptionally strong channel in the U.S., a very strong channel in Europe. And we're working on increasing our distribution in the Asia-Pacific region.

All right. Thanks.

Thank you, Brian.

Thank you. And there are no further questions at this time. Please continue.

Thank you. And in conclusion I think I would like to point out that Socket has been able to maintain a growth rate for the last two years of approximately 33%. And based on the growth rates for the first six months of this year, we can expect another solid growth year in 2004. And we can expect it to be profitable.

So our focus for the remaining portion of the year is to work hard to increase our growth and continue our profitability.

I'd like to take the opportunity to thank our employees for maintaining this great growth record. And we look forward to reporting continued improving results in our October call.

I'd like to thank everyone for participating in today's call and wish you all a good day.

Thank you, sir.

Ladies and gentlemen, this concludes the Socket Communications second quarter management conference call. You may now disconnect and thank you for using ATT Teleconferencing.