Socket Mobile Inc (SCKT) 2011 Q1 法說會逐字稿

Greetings and welcome to the Socket Mobile First Quarter 2011 Management Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (OPERATOR INSTRUCTIONS.) As a reminder, this conference is being recorded.

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

Thank you, operator. Good afternoon and welcome to Socket's First Quarter Management Conference Call to review financial results for its 2011 first quarter. 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 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 27A of the Securities Act of 1933, as amended; and Section 21E of the Securities and Exchange Act of 1934, as 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, sales and market conditions, and opportunities in the markets in which Socket sells its products.

Such statements involve risks and uncertainties, and actual results could differ materially from the results anticipated in such forward-looking statements as a result of a number of factors, including, but not limited to, the risk that manufacture of Socket's products may be delayed or not rolled out as predicted 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 risk that acceptance of the company's products in vertical application markets may not happen as anticipated; and other risks described in Socket's most recent Form 10-K and 10-Q reports filed 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 now like to turn the call on over to Socket's President and CEO, Kevin Mills.

Thanks, Jim, and thank you for joining us today.

In today's call, we'll 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 first-quarter 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 enabled us to move within $300,000 of positive EBITDA. So we achieved both increased sales and bottom-line improvement during the quarter -- 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-related sales grew to $2.1 million in the first quarter, 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 entering Q1 due to the lack of LCD screens. However, what is much more significant in Q1 are the new bookings we received for the SoMo totaling $2.7 million. With these bookings, we enter Q2 with an even larger backlog than we entered Q1. The demand for the SoMo continues to be very strong, even though the related LCD supply problems have made it challenging to meet demand.

As a result, in Q1, we shipped a total of 2,945 SoMos, which was well below the demand level. The LCD supply situation continues to improve and we have already received over 1,000 units this quarter with an additional 3,000 units-plus expected during the quarter. While this will not 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 re-engage with customers -- always 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 nonexistent. 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 key HP resellers. 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 SoMos. To date, 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 investments.

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 from Epocal and other regular customers remains strong and we are seeing a definite increase in this business as well.

So 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 enter 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 of both 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 phones and tablet computers.

Our cordless hand scanner business continues to be driven by companies collecting data using a combination of mobile phones, tablets, notebooks and desktops, while reading barcodes. Again, our customers require commercial-grade barcode scanning capabilities and (inaudible) they're 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 from many different markets. We continue to see pharmaceutical companies like Medtronic and Smith & Nephew 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 Doggie Day Care Centers logging pets in and out using the cordless barcode scanner and an Apple iPad.

The good news is 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-type interface. To address this demand and to assist the developer community, we've launched a comprehensive Software Developer's Kit, or SDK. This SDK will not only allow developers and customers to 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 about its performance and benefits 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) to a slightly lesser extent. The cordless ring scanner is an excellent product from a technical point of view, but the sales effort for this product tends to be very involved before culminating in a revenue-generating deal. In addition, in this case, one of the industrial handheld manufacturers was the primary handheld supplier on 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 monies 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 expect to see further growth in Q2 and through the end of the year.

We are 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 for 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 are 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 to 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?

Thank you, Kevin.

Our first quarter of 2011 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, introduced 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 units to be manufactured and shipped.

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

With new orders in the second quarter for both handheld computers and cordless barcode scanning products continuing at sustainable, break-even or better levels, we anticipate additional sequential growth in the second quarter 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 the first quarter improved from margins of 35.4% in the previous quarter due to higher first-quarter revenue volume, partially offset by a non-recurring charge of $60,000 -- or 1.5 percentage points -- in the first quarter.

We expect margins to continue to improve as our revenues increase. Our operating expenses in the first quarter 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 first-quarter 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 the second quarter.

Our working capital balances benefited in the first quarter from the release of $711,000 of cash in a restricted note collateral account at the end of the year. Our convertible note balances are secured by qualified receivables and, to the extent necessary, in cash. The higher levels of shipments and revenue in the first quarter and higher receivables at the end of the quarter, in combination with the conversion by the noteholder of $200,000 of outstanding notes during the quarter, enabled the release of all of our collateral cash as of the end of the first quarter. 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 to allow the remaining $800,000 in notes to be converted into common stock. Once the notes have been fully converted, we will be free to re-establish 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 have engaged an analyst to prepare a report on Socket for release during May and to update that report from time to time as we move through the year.

We will also be presenting on May 24 at the Securities Research Associates Spring Growth Stock Conference in San Francisco. The presentation will be webcasted 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 customers' projects in our pipeline that were moving slowly or on hold are now moving forward toward completion and deployment. As Hewlett-Packard continues to phase out sales of its 200 Series Classic handheld computers in selected regions of the world, we are being contacted by more and more businesses looking to use our SoMo 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 SocketScan 10 software with Apple iPads, iPods and iTouch computers running the current Apple operating system. SocketScan 10 will allow developers to easily add barcode scanning to their applications, as is available today for Windows, Windows Mobile, Blackberry and Android devices. Many of these devices, including Apple devices, (inaudible) they 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 us with our SocketScan 10 software.

For the past two years, Socket has operated as a significantly leaner organization, including fewer employees and extensive cost-reduction programs that reduced salaries and discretionary spending. At the same time, we've maintained essential development programs and remain 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 RFID readers on Windows, 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 -- where contract manufacturers have plenty of capacity to support growth -- and on the distribution side, where our many distribution partners and application partners are interacting with customers around the world.

Our annual meeting of stockholders is scheduled for tomorrow, April 27, at the company's facilities in Newark, California. On the ballot this year are the re-election 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 unwavering support we've received from our employees and from our stockholders who share our vision of mobile opportunities in our key vertical markets of health care 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?

Thank you. We will now be conducting a question-and-answer session. (OPERATOR INSTRUCTIONS.) Our first question comes from Brian Swift from Security Research Associates.

Thank you. I wonder if you could 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. Maybe give us a little window on that.

Yes. It would be a pleasure. So the situation has continued to improve. Obviously, in Q4, we had very limited supply. It improved particularly well after Chinese New Year which basically ended middle of February. We received in probably something in the 3,500 range. We recognized revenue on 2,945, 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 they will be delivered largely on time. And we've done the software work, etc. to bring on a second source which we expect to bring June, and then once we have that, I think we'll be out of the woods with regards to the LCD situation.

Okay. And what -- and again, you're being able to a little bit more aggressively market the (inaudible) to these -- to the soon-to-be former HP clients?

Correct. 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 are now receiving in the Japanese market. Unless we can provide samples to potentially new customers, it's very difficult to move forward. We will be in a position, I think, to provide samples, I would say, towards the end of May, early June. 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.

You can see the strength of the activities that we did just in Japan, Brian. In the first quarter, we've received close to a half a million dollars in orders for SoMos -- most of it for delivery in the second quarter -- 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 handhelds 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 us some 45 -- should allow us to ship about 4,500 units just from that supplier, and most of that will be in by the end of May. So we are looking to see if we can add to that from our current supplier or bring our second source into line by the end of the second quarter, but even if we just do the 4,500 units, that again is a 50% increase over what we were able to do in the SoMo category in Q1.

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

We currently have a little over 5,000 units in backlog.

It was about $2.6 million at the end of Q1.

Okay.

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 today and move forward into the backlog that will be coming -- 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 to motivate (inaudible).

And we have a path worn out to Taiwan and back, basically meeting with both our manufacturer as well as suppliers to make sure everything stays on track.

Okay. And I guess, lastly, do you -- all of this is obviously catching up with backlog, but do you -- what's your comfort level of kind of continuing to see the demand side grow as we go to second quarter, third quarter?

Well, I think we're reasonably comfortable on that score also. First of all, the bookings that come in were higher. I think we booked $2.6 million in the category -- 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 -- that we know who the reseller is and what the end-user and potential application that they're using the device for. 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, it's all new business, I would say, and the majority in Europe is new business, whereas Asia -- particularly driven by Japan -- a lot of it's replacement business. So we can -- 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 budgets and the general strength of the economy. So I think that there is a good opportunity here to build the company and that we're not just relying to the HP departure. I think the business would 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.

But the order base has continued robustly in April. So it's the fourth consecutive month since the beginning of January that we've seen that high order base. 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.

Another million dollars to that total for shipment between now and the end of the quarter, the beginning of next quarter. So as long as we continue to see that robust base, we -- so far, that base has been at sustainable break-even or better levels.

And I guess lastly, $5 million roughly is still the break-even level as far as from a --

Yes. So --

(Inaudible) standpoint as opposed to cash standpoint?

Yes. If you just go forward -- and I -- we're using the EBITDA measurement because, while we have these notes outstanding, you have this debt discount amortization and a few other amortizations 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 break-even at about $4.7 million -- bottom line break-even -- and that's pretty close to the cash number as well.

Okay.

But as we convert some of these notes in Q2, it will add a charge that would reduce our earnings but, as Dave points out, it's a 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.

Okay.

Okay?

Alright. Thanks.

Thank you very much, Brian.

Thank you. (OPERATOR INSTRUCTIONS.) Our next question comes from [Bernard Fidel] who is a private investor.

Hello?

Hello?

Hi, Dr. Fidel.

How are you?

How are you doing?

Good.

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

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

Well, it's -- you answered a lot of my questions already so I crossed those out.

Okay. Good.

In the first quarter, if it weren't for the fact about the supply problem, what would the sales have been? A rough figure, I know.

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

We had $1.5 million of shippable orders that we -- in other words, the dates were such that we could have shipped them had we had supply -- which we couldn't ship. So --

Five and a half, in other words.

Well, yes, but you're not going to see all of it recognized. So I think we would have been north of 5 is, I think, a fairer assessment of where we would be, but that would have been profitable operating level.

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 the --

Profitable.

Profitable level. So we're looking to, of course, surpass that and sustain that as we move through the rest of the year.

For the second quarter, assuming you get all the material for the SoMo, etc., what could that add up to? What's the potential for sales in the second quarter?

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 manufacturer that that's possible at this time. So we're assuming we get about 4,500 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 7,000 units. We are backlogged a little over 5,000 and we have two and a half 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 4,500 with some upside potential, but it would be a stretch to go beyond that.

But even with --

If it shipped 4,500, what would that do for sales for the quarter?

Well, essentially, the extra 1,500 units would be an additional -- let's say $750,000 or thereabouts.

Yes, and what it would do is move us up into the $5-million range which is the range we've been talking about as hitting --

EBITDA-positive.

EBITDA-positive results.

Right. Okay. In other words, if you had all the supply, you'd be able to ship 7 -- what's the highest number of SoMos you shipped so far?

In any given quarter -- I don't think we've ever broken 4,000. I think we've gone into the high-3's, but -- so Q2, we would expect to be a record in terms of SoMos shipped. So -- yes.

And you think that if we had the equipment, it would be like 7,000?

Yes. If we had the -- well, but you have to be a little bit careful because you're carrying your backlog that you've 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 7,000 units, I believe you'd be able to ship them all this quarter, but we're not going to have that. So we're getting a little bit ahead of ourselves here.

Okay. No. That sounds good. Remember the contract that was -- the potential contract from last summer about the nursing home contract? It was a fairly large one. How is that getting along?

Sorry. Which one?

There was a nursing home contract.

Oh yes. 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 3 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 is on hold because they've 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 suits 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 see constraint by supply like we are now, and we're looking forward for those type of deals to drive us to the next level.

Right. Well, if they purchased another company, the contract could even expand because they would probably want to put it in their other --

Absolutely.

Facilities, too.

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.

But it's quite active though? It's --

Yes. 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.

Alright. Remember there was a contract -- oh, more than a year ago in England -- for hospitality?

Yes. For the festival.

Yes. How's that (inaudible)?

Again -- I thought you asked this last 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.

And with Hewlett-Packard, is there any rumor or something like that when they -- which country is next that they'll be going out of like Japan?

No. I (inaudible) -- 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. So depending on what level of business you're doing with HP, the information is slightly different. We would expect the consumer category 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 this will get resolved in the next 60 to 90 days and we'll be in a good position. What we do is we track HP on their website and 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 posting on the web pages.

Alright. Two more questions. The shipment for scanners in the second quarter -- should that -- is that strong or there's an improvement as per the first quarter, we'll say?

Yes. We are seeing a lot of people beginning to use iPhones and iPads to do business processes. We have seen a systematic uptick. 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, as a category, is now coming into its own. I think we're -- 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.

Okay. One last one. I think this would be more for the CFO, Dave Dunlap -- a financial thing. In the event -- 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?

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 costs of about $4 million, and our fixed costs, including all the people that we use for -- 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 are already (inaudible) support costs, but let's say the $3.5 million at the $8 million revenue level -- the operating expenses were $2.3 million 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 $0.25, $0.26 a share. And if you take the 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 $0.33. 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, cost of the products. Volume generally means we can some product costs down, but larger deals sometimes get better pricing. And so it's an ongoing process. Mix is a 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 manufacturers a few days longer and our worldwide distribution channel -- again, 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 actually look forward to moving these revenues up. We should be able to handle it just fine.

That adds up to over $1 a share very easily if we get to those levels in profits. I want to ask Kevin one last thing. Kevin -- 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.

Well, again, I think there's two parts to the question. I think what's achievable in the short term, I would be happy if we could start with a 5 in 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 8 to 10-per-quarter range if we want to pay back our shareholders, etc. So I think that this year I would be very happy if we could do 4, 5, 6 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 has 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.

Yes. I'm talking about the second half of the year when your supply is normal, shall we say?

Yes. 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 say, to stage 1 in terms of sustainable business, and if you get to the $40-million-a-year run rate, you'd have a sustainable, highly profitable business. And before we get to a sustainable, highly profitable business, I'd like to get to a sustainable business, though 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.

Okay. That's good. You'll get someone else now. Thank you.

Thank you very much, Dr. Fidel.

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

Gentlemen, what drove the gross profit margin down 5 points relative to 2010 first quarter? That's a big drop-off.

Well, I'll let Dave -- look, there was a few things. Obviously, there's product mix. We had a 2% hit for a one-time charge and, in terms of -- I don't know what else, Dave, we have.

Yes. Well, I think our margins -- some of our newer products, like our 2D scanner, are currently selling at lower product -- lower margins because of -- 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. Our margins for barcode scanning a year ago were in the -- 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.

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 would relate to this category of legacy and it goes to 3% next quarter.

Yes. We -- our OEM wireless business, which is just selling our wireless technologies into third-party devices, was over half a million dollars in the first quarter a year ago, down to about $150,000 first quarter this year. And again, those margins tended to be higher than the margins. So again, it was the 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 [spread] your fixed costs. 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.

Yes. And we would expect Q2 margins to be, I would say, in line or better than the Q1 margins you're looking at right now as we move forward through the year.

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

Yes.

Yes.

I guess the other question I had -- and apologies if this has been asked already -- but on the P&L, you've got a deferred -- I'm sorry -- debt discount amortization of $316,000 for the quarter. Is this a one-time event or is this going to be a recurring charge going forward?

No. We have a conversion of a note and that -- so we don't have control over when the note gets converted. So some of it is one-time related to the conversion; some of it is just amortization.

So the accounting rules, as you -- I 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 since the time you issued the note is treated as an additional debt discount. So with that combination, for a $1-million 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. So --

Whatever (inaudible).

That's your remainder and if it turns out that they're not converting, then that number turns out to be somewhere in the range of $150,000 a quarter. But the reason it's larger in the first quarter is that there was $200,000 of note converted and we had to 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.

Yes. 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.

We would hope.

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

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

We have no current plans to do so.

Okay. Alright. Thanks.

Thank you very much.

Thanks, Steve.

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

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. Bye-bye.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.