Socket Mobile Inc (SCKT) 2006 Q2 法說會逐字稿

Greetings ladies and gentlemen and welcome to the Socket Communications Incorporated Second Quarter Fiscal Year 2006 Earnings Conference Call. [OPERATOR INSTRUCTIONS] As a reminder this conference is being recorded. It is now my pleasure to introduce your host, Mr. Jim Byers with MKR Group. Thank you Mr. Byers you may begin.

Great. Thank you operator. This is Jim Byers with MKR Group Investor Relations for Socket Communications. And good afternoon everyone, welcome to Socket’s quarterly conference call covering their 2006 second quarter end of June 30, 2006.

Earlier today, Socket distributed its second quarter release over the wire service and has posted the release on their Web site at www.socketcomm.com. In addition, a replay of today’s call will be available at vcall.com shortly after the completion of this call. And the transcript of this call will be posted on Socket’s Web site by Friday.

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

Before we begin, I would like to remind everyone that this conference call may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 as amended. And Section 21E of the Securities Exchange Act of 1934 as amended.

Such forward-looking statements include but are not limited to statements indicating a positive outlook for our business and demand for our product, statements regarding our progress toward completion of certain initiatives and product transition and statements predicting trends and opportunities in the market in which we sell our product.

Such statements involve risks and uncertainties and actual results could differ materially from the results anticipated in such forward looking statement as a result of a number of factors including but not limited to the risk that certain market trends and opportunities such as the anticipated completion of the market transition to the Windows Mobile 5.0 Operating System may not materialize as quickly or as robustly as we anticipate, if at all.

The risk that we may not complete the task of converting our products to comply with the reduction of Hazardous Substances Act in Europe as quickly as we anticipate, if at all, the risk that our strategic vertical integrator program may not be as successful as we anticipate. The risk of delays in our ability to design, manufacture, market, and sell new products due to technological, market, or financial factors including the availability of necessary working capital.

Risks related to our ability to effectively manage and contain our operating cost, risk related to the availability of announced hand held computer hardware and software as well as product delays associated with new model introductions and product changeovers continue growth and demand for hand held computers, market acceptance of emerging standards such as Blue Tooth and Wireless LAN, and of our related connection and data connection products and other risks described in our most recent form 10-K and 10-Q report filed with Securities and Exchange Commission.

Now with that said, I would like to introduce Socket Communications Management. On the line today are Kevin Mills, President and Chief Executive Officer and Dave Dunlap, Chief Financial Officer. At this time, I will now turn the call over to Kevin Mills. Kevin?

Thank you very much Jim. I will begin today - this call - with some comments on the second quarter and then follow on with an update on the mobile computing market and the dynamics we expect to see in the second half of the year.

As we had anticipated on our last call, Q2 was a challenging quarter from a revenue perspective primarily due to the lingering effects of the transition to Window’s Mobile 5.0. However, on contending with a few hurdles, we are pleased to have continued our forward momentum from last quarter and generate second quarter revenues slightly above the record we achieved in Q1.

During the quarter, we largely completed the potential task of converting our products to meet the lead free standard in Europe as required under the Reduction of Hazardous Substance Act or ROHS. This necessary transition required a great deal of work and added expense as products needed to be redesigned and requalified. And distribution channels needed to be managed to ensure that non ROHS compliant products were sold through prior to shipping the newer ROHS products.

Socket was able to complete this difficult conversion with minimal impact to its businesses. And we are extremely pleased with our engineering team and product managers for their extra effort.

Additionally, European markets were impacted by the World Cup, which resulted in a slowdown quickly in June as those outside the continental U.S. watched this once every four year event. Over the last eight quarters we have experienced mobile device operating system transition, growth compliance requirement, and device supply constraints. However, these issues have been addressed and hopefully we now have these fully behind us.

As we’ve said before, we expect the second half of the year to be stronger than the first half and look forward to resuming strong business growth. We are seeing encouraging signs on several product fronts. During the quarter, we witnessed our CompactFlash plug in card business strengthen. As HP continued to improve the supply of their pocket PC’s and more and more applications were converted to the recently released Windows Mobile 5.0 Operating System.

This was in line with our expectations, but it is always nice to see these improvements happening after a number of quarters of inconsistent device supply. The improved device supply enabled Socket to grow its CompactFlash plug in card in Q2. We shipped a record number of CompactFlash expansion cards in the quarter, which is very encouraging.

We also saw improving growth in our cordless products in Q2; particularly our cordless handheld camera, which is showing increased market fraction and momentum after establishing itself in the marketplace. Our Cordless Ring Scanner is getting increased attention and is an opportunity still very much in front of us.

This is a new area for Socket as it’s more in the traditional Auto ID market and associated with more ruggedized handheld devices from larger firms like Symbol and Interact. And less associated with the off the shelf PDA’s from Dell and HP. While this is just making its way into early field trials and tests and did not contribute much to our Q2 revenue, we anticipate that it will be a solid revenue growth driver going forward.

Since we launched the product about four months ago, there has been considerable interest from a wide range of ruggedized hand held manufacturers and their broad customer base in many customer markets. We currently have numerous customers evaluating and testing the Cordless Ring Scanner. And the feedback we have received from them is excellent.

We believe there are additional reasons for optimism regarding our going forward process. As I have outlined in a number of calls and conference, Socket’s business is being driven by the automation of mobile business processes. The common scene we continue to see in the many applications and solutions now entering the markets is the elimination of the paper and pen based solutions and their replacement with an electronic or digital equivalence.

We’re seeing more and more solutions based on both traditional PDA’s and PDA’s with mobile phone capability. These devices continue to be this cornerstone of our business. We’ve seen this market evolve and strengthen, all driven by business customers. Today I would estimate that 90% of Socket’s mobile computing business comes from a combination of small and medium sized business supplying mobile solutions.

These solutions are now becoming mission critical to many business and therefore customers are looking for dependable, reliable and robust products that they can depend on to do their job and make their living. All of these requirements play to Socket’s strengths.

Let me illustrate with two solutions highlighted during the quarter. The U.S. Army’s mobile blood management solution, which is based on our Cordless Hand Scanner to 7M and the 3G Touch Delivery and Inventory Management solution, which uses our ST scanner, the 3E.

The U.S. Army mobile blood management system is a lifesaving application for soldiers who are injured in battle. The U.S. Army is using a handheld computer in conjunction with a cordless handheld scanner from Socket, the 7M to manage the distribution of blood in a hostile mobile environment. This solution saves lives and also enables the U.S. Army to significantly reduce their operating costs in the field.

According to Major Tommy Morris, “the annual savings are in the millions of dollars.” Equally important, the efficiencies produced by this move from a pen and paper to an electronic based solution that captures data automatically via barcode as resulted in a 12-24 increase in productivity for the worker. This has an enormous impact on the quality, liability, and speed of service in this life and death application.

Obviously solutions like this are not simple. They take time to deploy and are the result of a lot of software who are coupled with the correct hardware for the application. However, once deployed, and the benefits have been seen first hand, they tend to last a long time. And often, other than copy these concepts for similar applications to realize similar increases in efficiency, which has enormous impact on business [inaudible].

What is extremely encouraging and positive for Socket is we are seeing different solutions from different industries producing similarly impressive productivity and produce. Another solution we highlighted is the 3G Touch application, which is being deployed to replenish shelves in stores like Home Depot. Workers are using a Palm Treo and the Socket SD scanner to maintain correct inventory levels in real time. Resulting in increased efficiency that the customer estimates to be tenfold.

These are just two examples from two different industries both using mobile solutions to produce extraordinary productivity improvement. We believe this represents just the tip of the iceberg and we are seeing similar solutions across a number of different industries and environments. As we’ve noticed before, these solutions take time and considerable effort by those directly engaged in the specification, software development, testing, field trials and deployment.

While these processes may be long, the eventual benefit to the organization can be tremendous. And the ROI’s are usually very attractive. While we may be impatient and anxious to get key solutions into the markets, we do not control the pace of these deployments. We believe we can only be so aggressive and the sales process benefits from patience and ensuring the customer’s comfortable with the solution prior to deploy.

We continue to increase the number of solutions being developed. Another area where we are seeing significant interest and enormous opportunity is the healthcare market. In this market, predictability and accuracy are absolutely needed and our combination RFID Laser Barcode Scanner is especially beneficial. This product, combining an RFID and Laser Barcode Reader provides hospitals the flexibility to upgrade certain portions of their solutions to RFID technology.

As you may know, RFID provides significant benefits for certain applications. Especially in areas of increased complexity like IB based medication. However, these benefits come with an associated cost and therefore healthcare providers need to be selective and continue to use barcodes in less critical situations. The combination provides the flexibility to offer the appropriate solution for each situation.

Within healthcare we also highlight [inaudible] prominent in the medication dispensing area and the fact that their solution is currently under evaluation at over 160 hospitals in the U.S.. Their solution is also being evaluated in the United Kingdom and Japan. So the opportunity for these solutions to have global reach is certainly there.

The significant future potential for these solutions is why we remain very optimistic about our prospect going forward. We anticipate the solution opportunity to continue to cause an increasing base to our business as more and more of them are evaluated and employed by customers. While the exact timing is difficult to predict, the underlying trend is extremely positive and we believe it will continue to strengthen.

Looking ahead we normally expect the summer to be a slow period and Q3 revenue has typically been less than Q2 as there simply is not efficient time to complete the deal with so many people on vacation. This is especially true in Europe however we feel that with the positive momentum we have entering the summer including the Cordless Ring Scanner we are optimistic that we will be able to offset the traditional slow down and enable us to show some growth in Q3.

So we expect Q3 to be a little bit stronger reflecting positive momentum from the Cordless Ring Scanner. We would expect this growth to both continue and accelerate as we enter Q4 especially as we see more and more applications becoming available and the transition should purely be in our rear view mirror by then.

We believe Q4 will be significantly stronger as we should benefit from improving traditional plug in business driven by an increasing number of applications that our SVI’s will be bringing to markets. Plus the benefit of a stronger and more stable pocket PC market and a new product like the Cordless Ring Scanner.

The bottom lines is we remain on course to have a stronger second half, and we remain optimistic about prospect for Socket and it’s business as we move forward in 2006. With that I would now like to turn the call over to Dave Dunlap, Socket’s Chief Financial Officer for his comments.

Thanks Kevin. I’ll start with a review of Socket’s second quarter financial highlights. Second quarter revenue reached a new record level of $6.9 million topping the preceding quarter’s record revenue of $6.8 million. The revenue mix quite product family in the second quarter was very similar to the first quarter. The data collection remaining at 37% of revenue.

Connectivity products represented 31% compared to 30% in the first quarter. OEM embedded products and services remained at 22% of revenue. And our legacy serial business represented 10% of revenue in Q2 compared to 11% in Q1. Our gross margins for the second quarter remained at 50% of revenue.

Our net loss for the second quarter was $448,000 for a loss of $0.01 per share. Of which $311,000 or 1% per share was from the extending of stock options during the quarter. And $137,000 or $0.00 per share was from general operations. Excluding the effective stock option expensing, our operating expenses in the quarter increased by $161,000 or about 5%, primarily in engineering reflecting the many projects that were undertaken and completed during the quarter.

During the quarter we made notable progress on a number of projects that are important to driving revenue in bottom line growth in the second half of this year. Kevin discussed the Cordless Ring Scanner as an important addition to our family of data collection products. And we have been very focused on bringing this product into the market. We now have several hundred units of the Cordless Ring Scanner in the field undergoing evaluation and we are beginning to receive orders for deployment that should begin building revenue in the third and fourth quarters.

The feedback from these trials has been excellent including the lightweight and snappy performance of the product and the extreme durability provided by the liquid metal casing. We expect the Cordless Ring Scanner to be a major revenue contributor for stock as going forward.

Our Strategic Vertical Integrator program now has over 90 partners listed on our Web site reflecting a growing number of business enterprise software solution providers covering a number of vertical markets that are enabling data collection with our family of data collection products. Solutions address asset management, field and sales force automation, retail merchandising, healthcare, and other areas important to productivity improvements in the small and medium business environment.

We posted a total of 14 success stories on our Web site including St. Claire Hospital for managing the administration of patient medication and the U.S. Army for inventorying blood supplies while in the field, both mentioned by Kevin. Other success stories include actions systems, allowing food service to take orders and send them wirelessly to the kitchen, Kobayashi & Company to manage auto car dealership inventories by scanning VIN numbers and Crosslink Orthopedics to track and refill surgical part kits at the hospital.

The common denominator in these success stories is using mobile computers and bar code scanning or RFID to collect and process data and to move data to its next destination with considerable improvements in accuracy and time and cost savings. Many of our partner application programs are in development or are relatively new and will take some time to become established. During the second quarter, more than half of these partners purchased Socket products for their customers.

Today the program represents less than 10% of our revenue, but we expect that it will grow as the applications are completed, deployed, and accepted in the market. Chronic deployment continues to be a high priority at Socket as we evolve our products to incorporate changes particularly as technology standards evolve.

Our new 802.11G Wireless LAN cards are in this category increasing performance by as much as five times over our 802.11D cards that they replaced. Our 802.11G compact flash card began shipping during the second quarter and our SDAO cards will begin shipping this quarter and are expected to drive revenue growth in the second half of this year.

These projects for the many changes in our products required by the European Reduction of Hazardous Substances Act resulted in higher operating costs for the second quarter particularly in engineering. The extent that many of these projects peaked in the second quarter and we expect our engineering costs to reduce in the second half of this year, bringing down our overall operating expenses more in line with first quarter levels.

Finally we began expressing stock options in the first quarter of 2006 resulting in a charge of $325,000 or 1 cent per share in the first quarter and $311,000 or 1 cent per share in the second quarter. These costs are allocated the cost of sales and to each operating department based on the reality waiting of shares vesting during the quarter

We’ve taken a number of steps to reduce the impact of stock option expensing including adopting a lattice binomial valuation method and extending the service period over which options best. But since option expensing was not required last year, these amounts also result in higher operating costs in 2006 compared to last year. Despite our higher operating expenses and a loss of 1 cent per share for the second quarter of 2006, we continue to generate positive cash flow from operations.

For the second quarter of 2006 being our sixth consecutive quarter of positive cash flow from operations. Last year we generated $2.2 million in positive cash flow from operations and we’ve generated approximately $500,000 of positive cash flow from operations in the first six months of 2006. In 2006, we’ve also added approximately $600,000 in cash from the exercise of warrants and options.

We’ve reinvested about $600,000 in equipment including tooling for major products like the Cordless Ring Scanner and reduced a lot of our bank line draw at the end of the second quarter.

Our cash balances at June 30, 2006 remained at a healthy $7.3 million or about $5 million free and clear of the bank line draw that we make at the end of each quarter. We believe our cash balances are adequate for financing our operations. And the liquidity measures of our balance sheet such as the current ratio defined as current assets compared to current liability is a healthy 1.8 to 1.

Socket continues to be well leveraged, which will allow much of the contribution from future revenue growth to reach the bottom line. Our major product components are manufactured by third party manufacturers who are able to run their lines longer to accommodate higher product demands usually at an overall unit cost savings.

And 80% of our products flow through worldwide general distribution. We have in place the infrastructure and resources to manage our worldwide distribution channel and higher product volumes can flow through those channels without needing additional resources. Our objectives are clear; to grow revenue and to improve our bottom line. We look forward to the second half of this year.

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

Thank you. [OPERATOR INSTRUCTIONS] Our first question is from [Richard Syracusa] with Merrill Lynch. Please proceed with your question.

Hey David and Kevin, a couple of questions. On the ring scanner…

Yes.

And I realize it’s a different time frame for different users but what is the time - what is the return on investment done on that scanner time wise?

Oh, I would say certainly in the nine month to six month -- it’s actually quite short. A lot depends on what you’re paying to your people.

Yes, I realize that.

Essentially the way people are looking at it is that they can handle significantly more packages. We’re looking at people who have a requirement to handle up to we’ll say 900 packages per person per hour. And the ability to have the scanner on your finger allows you the affectability to do that. So, that’s one of the areas. And then, because people can handle more packages, you need less people. And there’s your return.

The other area that I think it has significant benefits is in just the accuracy in the many ticking and packing applications, particularly in the pharmaceutical area where people are making shipments to kiosks or small pharmacies and they’re using a series of different drugs are being delivered in a single box.

As you know, eye drops and other small - clinically small packages can be very expensive. And the ability to control these and make sure that they push the eye drops of course cost $35 and not accidentally aspirin or some other thing that may be physically next to those eye drops in the warehouse.

So we’re really seeing people embrace this product more quickly than we initially anticipated. I think the ROI’s are certainly there. I would, you know, as a general kind of broad rule and say something in the six to nine month type area.

Okay, now to…

But it would depend on the situation.

The, you know, the type of orders that you’re anticipating. Other than the, you know, the onesies and twosies type - are there any large -- potentially large -- orders in the pipeline?

Yes. I think this is a product that won’t fall in the onesie, twosies, you know, currently we are selling it in onesie, twosie because people are evaluating it. But I think that I would guess that the average order size for this product order will be in the 200 range and we have a few deals already [inaudible].

Two hundred units or 200,000?

Two hundred units, right. But we already have deals that are well down the qualification process that are in the thousands of view.

And a unit is what? $500, $800?

Approximately $650.

Per unit. Okay, so this could really be the item that drives Sockets revenues up substantially then?

Absolutely, this is an item I think that is a unique product. It - I would say new to world rush in terms of the ability to provide the type of functionality. And the reaction so far has been very good. It’ll take time. One of the things that slows this down is because we’re talking substantial investments, budgeting cycles do come into effect. But overall, I think we’re very pleased with the initial response. And I would describe it as being ahead of plan in terms of where we expect it to be in the market.

Okay. One more question before I turn it over. You know, I remember reading a report, oh, I don’t know several years ago, where the author was looking for Socket to grow at 30% plus growth rate.

Yes.

Is that doable next year?

Yes, I think that, you know, we’ve had a difficult time over the last two years as you know, Dick and the issue was when we didn’t have a difficult time, we did grow for four years at an average rate of around 28% right?

And we had a period of three years where we grew over 30%. I believe that the applications are there to maintain solid growth rates. Especially as we see these applications coming into the markets. So I think we’re capable of drawing at those types of levels if we get a good run here and pull some applications and stability in the market.

Okay. I may come back for more. Thanks.

[OPERATOR INSTRUCTIONS] The next question is from [Ronald Craven] Private Investor. Please proceed with your question.

Thank you gentlemen. And congratulations again on another solid quarter.

Thanks Ron.

If I could follow upon the area of new products. Where are we on the new Wireless LAN modules? The embedded?

Yes. Currently we have those in house and we’re starting to send those out to customers. Essentially we expect to leverage a very good position in the Bluetooth [inaudible] and to service many of the same customers with Wireless LAN modules. So, I would say in Q3 we will be delivering samples and getting initial orders. I would say it’ll have an impact towards the end of the year as these things require a design wind. And they don’t really happen very quickly. So that’s where we’re at.

Okay. And then another one on the new SVIO 802.11G cards. Are those in your channels yet?

No. We expect to ship those next week. Those are the ones that will ROHS compliant. I think that’s one of the last products to be ROHS compliant. So I think our channel is currently out of the 802.11B card, so our plan is the first week of August and we’re on track for that.

Okay. And then if I may go back again on the sculpture with their bare scan and so forth. That to me seems like a huge potential for us in that our product compatibility with their solutions and so forth. Because if I understand right, and Mr. Mills and what they have approximately 160 hospitals that they’re solution is in the innovative stage. And then also they’re looking into the UK and to Japan right?

Correct. It’s a very good example Ron of the process that we go through. And the solution is really driven by a combination of available hardware and the right software. We’ve worked closely with culture, in fact the product that they’re using, this combination RFID barcode reader. We accelerated the development of that specifically because of there requirements.

Obviously hospitals want to make sure systems are up and running and complete before they deploy them. But yes, we’re equally excited about this opportunity. This is an area that I think everyone would agree needs attention as the number of mistakes being made by getting the wrong medication to the patients has enormous impact.

And I read a report recently that the number of people affected in the US is now over a million a year. So we feel it’s an area that is going to get attention, going to get investment, and Solutions Culture has put together in conjunction with our products is an excellent solutions. So, we’re very optimistic. Obviously each hospital has to make their own call as to when they will deploy, but there is pressure to deploy. And I think that we will expect to see that contribute significantly toward the other parts of the year and certainly next year.

I noticed when I heard your conference back in New York a few weeks ago, also the fiscal budgets of a lot of hospitals run from like July 1 onward. So are you seeing them kind of open up their checkbook at this time for those types of solutions and the purchases or not?

Not yet. I think it’s a little bit early. I think that, you know, most people - July generally is pretty slow, particularly the way Fourth of July fell this year. I think a lot people took the first two weeks off. So we expected people to have it in their budget. Some will spend early, some will spend late depending on their particular style.

But I think that, you know, what [inaudible] told us was their expectations were that they expected nothing to happen prior to July because most people were in a budgeting cycle. And they expected things to start to happen after July. So we have to give them a little more time. But that’s the kind of track we’re on.

One last - one more question if I may before I turn it over. I noticed especially in the first six months of the year a dramatic increase in the number of tradeshows and so forth that you’re attending. What’s your overall response on that so far?

Well I think that we have changed our tact to the market slightly. Historically we used to go to one or two tradeshows a year, but they would be big tradeshows like CES, or COMDEX, or CEBIS before you spend a great deal of money. And it’s a general tradeshow. I think as we have more and more SVI’s who have specific virtual applications we’re going to more target us tradeshow because then we can explain specific - how specific applications can benefit people in particular sectors like healthcare or automotive or health management, et cetera.

So I would say that overall, we’re very pleased with this new approach. And it really leverages well, the SVI partners. And in many situations the SVI’s join us and therefore we’re selling a more complete solution. And we’re leaving less up to the, I suppose imagination of the customer and delivering a complete package for them.

So I would say this is working. And we’re making good ground and progress with this new approach. And we’re quite happy with this.

Okay. And then, if I may, with the Odyssey Software announcement that you made in the early part of June, how close are you on getting your complete solution with them available?

This is targeted to be a primarily 2007 initiative. We are seeing as we deploy solutions that people struggle with management of devices. We have worked with Odyssey for many years. We expect to have some Beta software in the markets to test later parts of this year. But in terms of moving forward, it really is a 2007 plan.

Okay.

That’s why we haven’t been talking about it this year.

All righty. Thank you gentlemen.

Thank you very much Ron.

The next question is a follow up from Richard Syracusa with Merrill Lynch. Please proceed with your question.

Yes. On the - getting back to the hospital scanning system with sculptor. I thought there was a deadline as far as a mandatory time frame when hospitals have to convert to scanning?

I actually share that belief, but when I researched that recently, I don’t think that there is a hard deadline. There was a hard deadline that all hospitals must barcode all medications as of April 2006, which has come and been implemented. In fact the deadline was April 2004 with a two year grace period. This was part of an initiative that was setting up the process to make sure that medications could be tracked for this five right managements situation.

Initially maybe I misstated that there was a definite law coming in. But I’ve recently researched that and there is no definite law. There is plans to have a law, but it’s not enacted just yet.

Okay. Now when you analyze the market, how many systems would a hospital - is it based upon systems per floor, per patient? What are we talking about as far as the market side?

Most hospitals would have one system, right? And the system would basically be a server based system that would allow their pharmacy to enter all the prescriptions by patients to make sure that as they dispense medication there is a reference that the nurses can check against. Generally what we’ve seen is people deploy this by either nursing units or by - yes, by nursing units probably. So they’ll put it in Intensive Care, or they’ll put it in general use within the hospital. But you can implement this by any particular group.

For the examples that Culture has shown us, typically there’s six or seven nursing units in a hospital and for a typical hospital you’re talking about, oh, maybe 100 or 150 scanners with PDA’s depending on the size of the hospital. But reciprocal one would be about that with the server components. And the software is charged by bed. So depending on how many beds you are managing, that’s how you pay for the software.

Okay. Thank you very much.

Thank you, Dick.

[OPERATOR INSTRUCTIONS] Gentlemen, I’m showing no further questions in queue.

Okay. So, we would just like to conclude today’s call by thanking everyone for participating. And for those that may not be aware to inform you that Socket will be presenting at the upcoming Research Associates Conference in San Francisco on August 7. And that we look forward to reporting our progress at our QC Reports. And that concludes our call for today. Thank you all very much.

This concludes today’s teleconference. Thank you for your participation.