Socket Mobile Inc (SCKT) 2011 Q3 法說會逐字稿

Operator: Greetings and welcome to the Socket Mobile Third Quarter 2011 Management 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 the MKR Group.

Thank you, operator. Good afternoon and welcome to Socket's conference call to review financial results for its 2011 third 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 www.vcall.com shortly after the call's completion and a transcript of the 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 of sales and market conditions, and opportunities in the markets in which Socket sells its products.

Such statements involve risks and uncertainties, and actual results could differ materially from the results anticipated in such forward-looking statements as a result of a number of factors, including, but not limited to, the risk that manufacture of Socket's products may be delayed or not rolled out as projected due to technological, market or financial factors, including the availability of product components and necessary working capital; the risk that market acceptance and sales opportunities may not happen as anticipated; the risk that Socket's application partners and current distribution channels may choose not to distribute the products or may not be successful in doing so; the risk that acceptance of the Company's products and vertical application markets may not happen as anticipated; and other risks described in Socket's most recent Forms 10-K and 10-Q reports with the Securities and Exchange Commission. Socket does not undertake any obligation to update any such forward-looking statements.

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

Thanks, Jim, and thank you for joining us today. In today's call, we will begin with a short review of Q3 and then outline the business opportunities we see for the rest of this year. We are pleased to report for Q3 our second consecutive quarter of positive EBITDA and continued sequential growth in revenue. Our increase in positive EBITDA was achieved through a combination of increased revenue, increased margins, and continued tight management of expenses. Remaining EBITDA positive is critically important to achieving our goal of profitability, which we hope to reach in Q4.

I will begin with a review of our current Handheld Computing business and then provide a going forward outlook. Our Handheld Computing rate of sales, which include our handheld computers and plug-in barcode scanners grew to $2.8 million for the third quarter, a 9% sequential increase over the preceding quarter. While this is a solid increase, sales in the third quarter were still constricted by limited supply, an issue we have mentioned before.

I am pleased to note that the LCD supply issues were resolved in Q3, but unfortunately it was a few weeks later in the quarter than originally anticipated. The result of these few weeks is that over 1,000 SoMos, which were shipped in Q3, did not get recognized as revenue in the quarter as there was not enough time to clear the distribution channels before the quarter ended. The positive news is that our many customers did receive their units in early Q4 which is very important to the health of both our businesses. We believe the LCD supply problems are behind us and we continue to catch up during Q4.

On the demand side, we are continuing to see good demand driven by several factors. Currently, the impact of HP's exit from the classic PDA market is now clearly a positive influence in driving demand. We have many customers or potential customers looking to replace their HP iPAQs with Socket's SoMo handheld. The full impact of this effect is still difficult to determine given our own supply issues. But, we have many customers that have received sample SoMos they are evaluating as the ideal replacement.

We have already established the SoMo as the default replacement in some markets, such as Japan, where HP exited late last year. In other markets, including in the US, we are still in an evaluation phase and are focused on demonstrating to customers that the SoMo is fully compatible and in many ways better than the iPAQ and that Socket is a credible supplier.

As mentioned, we have significantly improved product availability in Q3 and expect further improvements in Q4. So, to summarize on our SoMo, demand remains strong and supplies have substantially improved in late Q3, early Q4. Customers and potential customers are substantially happier with the SoMo and Socket. We expect to further improve our delivery performance in Q4 and to enter 2012 with a manageable backlog.

Turning to our Cordless Scanning business, sales in the third quarter of our cordless barcode scanning products, which include sales of both our cordless hand scanners and cordless ring scanners were up by 25% over the preceding quarter primarily driven by the positive effect of Apple's certification on our cordless, hand-scanning sales. Our cordless hand scanner business continues to be driven by companies that collect data using a combination of mobile phones and Tablets while reading barcodes. The cordless hand scanner portion of our Cordless Scanning business was up by 50% sequentially and will remain the primary driver of our Cordless Scanning business going forward.

In this mobile phone centric market, we are serving customers who require commercial grade, barcode scanning capabilities. Users are generally running business-critical functions with a software application running on the mobile device. As we noted in our last call, we are seeing very strong interest from both Apple and Android customers representing many different market segments with medical and pharma-related representatives being the first group to begin rollout.

In early Q3 we introduced and began shipping our Apple Software Developer Kit or SDK for Socket's Scan10. We then announced that Apple had approved our 7Xi Scanner which allowed us to label the units as iPhones, iTouch and iPad certified and ensured developers that they would be able to fully manage the scanner and associated data from their Apple application. The 7Xi and the 7XiRX scanners all contain extra components that make this certification possible.

We also announced both our first SDK development and 7Xi customer win with COOK Medical. COOK Medical has an application that is centered in the pharma market with over 500 medical representatives using the solution to audit over 1,000 hospitals on a daily basis. This is just one of the many applications we are seeing the markets and we expect to generate continued traction going forward.

In our previous call, we noted that we are seeing many developers beginning to use our Software Development Kit and incorporate robust scanning into their applications, a very exciting trend that we see continuing.

Finally, within the cordless hand scanning category, we announced the 7C Scanner. We expect this scanner to be the one to help us break into the sub-$200.00 category for a robust and dependable cordless scanner. The 7C is about 25% less in price than our current 7E scanner with slightly better performance. We believe the 7C is an exciting product at a very attractive price point that we expect will be a volume product for Socket next year.

We expect continued growth in our cordless scanning business going forward with sales of our Cordless Scanning expected to be up sequentially in both Q4 and Q1 as we continue to build momentum as more and more apps are developed and deployed. We are excited about the growth in both our Handheld and Cordless Scanning businesses, which combined represented 88% of our total Q3 revenue. Going forward, we believe the growth of these two businesses will drive the growth of the Company. The remaining 12% of our revenue is made up of service, Legacy products, and OEMs.

There are two additional very important achievements that I would also like to mention. We converted our $1 million note into common stock in Q3, which made it possible to reestablish our bank line with Silicon Valley Bank in early Q4. I believe these two accomplishments are critical to the future success as they enable us to fund our growth going forward. Dave will talk about these items in greater detail in a few minutes. But, let me say that I believe we are a substantially stronger Company now that we have eliminated our debt and restored our credit line.

In summary, Q3 was very positive on a number of fronts that included increased sales in key areas, increased EBITDA, and improved supply. In addition, we substantially improved our balance sheet, increased the confidence of both suppliers and customers, and making it substantially easier to grow the business going forward.

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

Thank you, Kevin. Our third quarter 2011 revenue was $4.7 million, a 37% increase over third quarter revenue a year ago, and an 8% increase over second quarter's revenue of $4.4 million. We are pleased to report our second consecutive quarter of positive earnings before interest, taxes, depreciation and amortization, or EBITDA, which totaled $142,000 or $0.03 per share for the third quarter, up from $73,000 or $0.02 per share in the second quarter. And, although our revenue from the third quarter only grew by $323,000 or 8% over the previous quarter, we shipped an additional $800,000 of product that did not clear the distribution channel by the end of the quarter, an increased shipping pace of 25% quarter over quarter.

We defer revenue recognition until our products clear distribution and many of our products shipped too late in the quarter to clear the channel by quarter end and will qualify as revenue in the fourth quarter. We resolved our LCD screen shortage in the latter part of August and our contract manufacturer has been steadily manufacturing our SoMo 650 Handheld computers since that time.

We ended the quarter with an order backlog of $3.4 million and exited the quarter with an order backlog of nearly $3 million. We expect to significantly reduce that backlog as our shipments continue to catch up with customer demand during the fourth quarter.

New orders received during the third quarter were $5.7 million, up from $5 million in the second quarter. As Kevin mentioned, the pace of handheld computer orders continues to benefit from Hewlett Packard discontinuing its Classic PDA Model 200 series. Our handheld computer, the SoMo 650, is a logical replacement running the same Windows mobile operating system in a similar-sized computer and designed for use by mobile workers while mobile.

Our barcode scanner orders are also benefiting from our Apple-certified barcode scanners, certified during the third quarter by Apple for use with Apple products to scan both linear and 2D barcodes. More than 100 Software Developer Kits have been acquired by developers looking to add our sophisticated barcode scanning software to applications running on a wide range of devices including handheld computers, smart phones and tablets on a variety of operating systems including Apple, Android from Google, BlackBerry from Research and Motion and Windows and Windows Mobile from Microsoft.

Our most recent announcement of a new low-cost barcode scanner priced in the low $200 range that'll ship by the end of this year should further expand our barcode scanner sales at the entry level.

In both the second and third quarters of 2011, our SoMo-related revenues which includes our plug-in barcode scanner which is used primarily with our handheld computers approximated 60% of our revenue. Cordless scanning revenues grew at a more rapid pace, increasing from 23% of our revenue in the second quarter to 27% of our revenue in Q3. Thus, our primary products, both of which are growing, now represent nearly 80% of our revenues with the balance being OEMs, Legacy and service.

We expect those trends to continue in the fourth quarter. Momentum in our sales pipeline is being generated by demand for the Apple cordless barcode scanners and momentum in our handheld computer sales pipeline being generated by both new applications and Hewlett Packard's departure from the Classic PDA markets. With both of our major product lines growing we are enjoying watching the race between them to grow the fastest and to become the largest product line.

Approximately one third of our revenue in the third quarter came from international customers. Asia Pacific was our fastest growing international region in the third quarter where the SoMo Handheld Computer is becoming well established as a replacement for the HP 200 Series Handheld Computer, particularly in Japan.

I also want to mention our SocketCare service program. We encourage our customers to purchase extended warranty and accidental breakage coverage at the time they purchase our handheld computers and barcode scanners. One of Socket's hallmarks is providing its customers with timely and responsive (technical difficulty) and we announced during the third quarter an expansion of that program to include additional products and to provide more options, including the ability to further extend SocketCare coverage beyond its initial three-year term.

The program is a good source of revenue for the Company, assists companies in covering repair and maintenance by purchasing SocketCare, and reflects our confidence in both the quality and the durability of our products.

Our third quarter was a positive momentum quarter for the Company in many other respects. In addition to increased demand for our products and increased shipments, with growth we continued to improve our dollar margin contribution, up 47% from the third quarter a year ago and up 9% from the immediately preceding period.

Our third quarter operating expenses were flat for the third quarter a year ago and up just 5% from the immediately preceding quarter, allowing much of the improving contribution margin to pass through to the bottom line.

Our bottom line included a number of non-EBITDA/non-cash charges; the largest being a charge for unamortized debt discount of $564,000, or $0.13 per share, and stock option expense of $189,000, or $0.04 per share. The unamortized debt discount was associated with convertible notes issued in November 2010. We were successful by calling the notes and with the cooperation of the note holder in converting all of our remaining notes into common stock during the third quarter and thus removing its overhang from our balance sheet. With the notes fully converted we were able to announce in October the reinstatement of a revolving bank line of credit of $2.5 million that we will use as a working capital line to help fund our growth, particularly in assuring our vendors of timely payments for our products.

For the past two years, Socket has operated as a significantly leaner organization, including fewer employees and extensive cost-reduction programs that reduce salaries and discretionary spending. At the same time, we've retained key employees and funded the essential development programs that are benefitting us today and will benefit us in the future.

We remain firmly committed to serving the business mobility markets with our mobile handheld computer and data collection products. We support Windows Mobile applications on our SoMo 650 handheld computer. Our linear and 2D barcode scanners and our RFID readers with our sophisticated but easy to incorporate SocketScan software are compatible with Windows Mobile, Windows, BlackBerry, Android and Apple operating systems running on a wide range of smartphones, tablets, notebooks and other mobile computing devices.

Socket continues to be highly leveraged, both on the supply side with its contract manufacturers who have plenty of capacity to support growth and on the distribution side with our many distribution partners and application partners that are interacting with customers around the world. Our goal remains to continue to grow our revenue and bring growing, sustained profitability to the bottom line.

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

Thank you. (Operator Instructions). Ladies and gentlemen, at this time, we will be conducting a question-and-answer session. (Operator Instructions). Our first question comes from the line of Brian Swift with Security Research Associates.

A couple of things, can you elaborate a little bit on how you're progressing in terms of -- since you sell through distribution how you're contacting some of the Hewlett Packard customers that you're going to try to make the transition from the HP product line into the SoMo.

We've done a number of things. One is that we have acquired a number of adwords and others and others, so people who are searching on Google or other search engines are able to find SoMo even if they start out in their search looking for HP. That alone has increased our traffic by about 5% to our site where people actually start out looking for an HP device, whether it be the device with a battery and end up coming to our site and finding the alternative.

We've also worked with our distributor partners and to date we haven't worked as aggressively in all countries as we need to because we didn't have the supply. It's our intention as we enter Q4 and we fix our supply problems that we would reach out to the many customers who did buy from distribution. We have access to those lists and now that we're I would say not impinging or infringing on any HP business, our distribution partners are happy to work with us to make sure customers find the device that will work for them in their applications.

In certain countries, Japan is the best example, obviously we've done more because we had supply and we had good relationships. Then, I think the last which is not insignificant, is that HP salespeople have been quietly recommending the SoMo to a number of their customers and many of the calls that come into Socket now, when we ask the question how did they hear of the SoMo, the response is that they were advised by an HPR or HP representatives to contact Socket.

So I would say there's still more activity to be done to get HP customers across to Socket and we'll pick up the pace of that in Q4, now that we're better able to service the business.

Can you just add on to that, what are the alternatives for these HP customers besides switching over to Socket? Are you the last man standing?

You're never the last man standing and people always have choices. I think that most people are married to their software. They have a big investment in their software application and if they've made the proper application on a Windows Mobile platform there are limited supply choices available going forward. Certainly, Motorola, Intermec, Scientech Logic still make and sell many Windows Mobile-centric devices, as do we, as did HP.

I think that the difficulty many people have is the price points. HP had a very attractive price point at around $400.00. We have a very attractive price point at around $500.00, maybe $520.00. We're certainly closest to what HP had in the market and we believe we have enough benefits and features to cover this additional $100.00 in expense. Most of the ruggedized devices, whether they be from Motorola or Intermec or Scientech Logic start above $1,000.00 and people simply don't have the money.

So the first choice is do you want to stick with Windows Mobile and a lot of people do because getting mobile applications up and going is quite difficult. Once you have it up and going you're not anxious to change it. The alternative then is that you decide to rewrite your application into the Apple world or into the Google world, etc., and with all these there are tradeoffs.

In many of the applications, for example, you need to change the battery during the shift or during the work. If you need to change the battery, that eliminates all the Apple devices that you're not allowed to change the battery. On the Google Android devices, I would say there's still a lot of development work being done and the way that which the operating system is being upgraded it's quite scary for people who want to deploy. So, we've seen in the last year Androids go from probably 1.5 to 3 point something, and in that there's been at least I would say 10 iterations. The difficulty you have is when you deploy mobile solutions into a non-homogenous environment, then your tech support and usability issues go through the roof.

So there are other choices. I think that we are the easy option for people coming from the HP world and I think we're the easy option for people who are looking for a very stable platform, which I think Windows Mobile has established [us as that]. Certainly, if people have more money they can go up into more ruggedized devices, but there the price felt is significant.

So we feel we're in a pretty solid position for the moment and we have to continue to work at it to basically endear ourselves to these customers and ensure that they understand we're both committed to this space long term, as well as we're a credible and reliable supplier. I think we're doing the right things now to make this happen. I would have to admit that over the last six months we haven't been the best supplier due to our supply problems, but as we said we believe this is now behind us.

Okay and one more. Maybe you can help us set our expectations as far as the December quarter. If we look at September and based on what you shipped, maybe not recognized, it's a variable to recognize that you would have been around $5.5 million. I guess for a going-forward standpoint I assume that all the product that was shipped is now recognized. Then from the standpoint that you want to reduce your backlog some, I guess one would kind of drive us to thinking that your fourth quarter should be something in the $6 million area?

I think our primary objective in Q4 is to get profitable. Again, I think we have to fill up our distribution channels and we're continuing to ship well in October and we expect November to be equally strong. I would I say I would pleased with a profitable Q4. Certainly, based on where we started the year I think a lot will have been achieved if we exit 2011 profitable with our bank lines in place and no debt. I think that would be a very good result for the year and I think that's within our grasp right now.

Right and something a little over $5 million is your breakeven level?

Yes, something over $5 million is a breakeven level; probably something in the region of about $5.5 million, and I think that's well within our scope in Q4. It would be a very good year for Socket to go from where we started at the beginning of 2011 to exit the year profitable and with the ability to grow the business rapidly now that we have bank lines in place.

Interestingly, Brian, our third quarter was a loss of $0.16 a share, but $0.13 of that was discount amortization which now that the notes are converted goes away. So we were at essentially $0.03 a share loss.

It's $125,000.00.

Yes and so our ability to move it up moves up quickly, but we also have -- typically our third quarter is one of our least expensive quarters. We start to incur more audit-related costs when we get into the fourth quarter. Our development programs vary quarter to quarter, so there are always some fluctuations but certainly $5.5 million is probably a good target for breakeven and of course we'd like to beat that.

Yes, it seems like your expenses would have to go up quite a bit to push the breakeven to $5.5 million. Are the other areas that you expect to -- are you going to bring back some more people now?

Yes, but not aggressively. I mean I think we will continue to manage expenses very tightly. We are spending a little more in R&D, as has been our trend for the last year. I mean if you look at our expenses for the last nine months versus nine months of a year ago, essentially we have reduced our expenses by over $550,000 in sales and marketing and put some of that expense into R&D. I think that we're comfortable now that we have the structure in place to be very efficient in the sales and marketing area and we need to just finish a few projects in the R&D area so that we have new products like the 7C continue to come out as we start 2012.

Okay, I'll let somebody else ask some questions and I'll come back if I think of something else.

Okay, thank you very much, Brian.

Laura Engel with Stonegate Securities.

You mentioned overall increasing gross margins. Did you give a gross margin number that I missed, or can you give us a ballpark figure on the margins?

The gross margin of the third quarter was 42.7%, up from 42% even in the second quarter. The things that affect gross margin, of course, are both product mix as well as volume, because we have a large fixed component to our cost of service and sales revenue area representing the people who are processing and moving inventory. That group is fairly steady, but as volumes go up you can spread those costs over a much larger base. So we did see upwards of about 42.7% and with growth we generally tend to improve that.

On the other hand, some of our fastest growth right now is in some of the newer product areas and typically our newer products have a slightly lower gross margin. Then as we cost reduce them they come back up to more of our norm. So it's always a balancing act, but we've been fairly consistent over the last couple of quarters in the low- to mid-40% range.

Okay and then back to the topic of operating expenses you mentioned they were flat. Was there any variation quarter over quarter between the categories, or were they generally in line with the previous quarter?

We're talking third quarter compared to the previous quarter, yes, your research and development was up about $50,000. Sales and marketing was up about $60,000 or $70,000. We did add some additional people in sales to help respond to the increasing call volume and interest that we're seeing from HP and other customers. In our R&D area, again, some of the projects that we have going called for some additional expenditures. General and administrative costs were down. Again, the things that drive those tend to be things like the audit, which start to pick back up again in the fourth quarter. So overall increase, we had operating costs in the second quarter were $2,038,000. We were $2,139,000 in the third quarter.

So about $100,000.

About $100,000.

As far as the top line, how do you analyze it as far as internally the areas that were driving growth, by industry or by acquisition of the additional HP customers? Is there a way to kind of give us I guess broader ways to look at that and what's driving that than just additional units?

Yes, so we're continuing to see a lot of interest on the handheld side, both from the healthcare and the hospitality markets. In the healthcare, it's the number of apps, including things like lab work, taking orders from patients for their meals in hospitals, and various types of medication dispensing, as well as long-term care.

If I look at Japan as a good example, the main driver is long-term healthcare and where HP had a pretty large install base, and we're picking up both the replenishment of units that are failing or being dropped or destroyed, coupled with new deployments. We're seeing similar situations in Australia. A lot of it is what I described as long-term healthcare or clinical work.

On the cordless scanning side, it's a huge mix and we already have a lot of industries looking to use the iPhones and Android phones or tablets to improve efficiency. I think what stands out is that the pharmaceutical companies, whether they be COOK Medical, Smith & Nephew, Johnson & Johnson, Harvard Labs, they seem to be the leaders in having solutions ready for their salespeople, whether they're using an iPhone or an Android phone coupled with our scanners to monitor the progress of [add-ins], the sell-by date hasn't been violated and no recalls, etc. So we have a lot of salespeople who are adding an auditing/inventory and asset management function to their job in conjunction with mobile phones.

We're seeing a lot of outside salespeople using the scanning stuff, whereas most of the handheld stuff is in-building. I don't know if that gives you a better flavor? We can certainly go through in great detail now that we have reasonable numbers out there from our registration databases, etc. We can see what people are doing with these devices and that certainly helps us to plot our strategy going forward to better serve the markets who are already doing well.

Just one last question on the SocketCare program, what are the expectations for increasing those revenues, or is the way you analyze it to look at by offering that that's going to be driving the units basically the program covers? What's the outlook for that program and extending that offering to your customers?

We are expecting to see our service revenues grow as an overall percentage of our total revenue. Each day our total revenues that we're recognizing are somewhere in the 4% to 5% of revenue range. We have not been shipping the quantities of SoMos, particularly the handheld computers, that are excellent candidates for that type of extended warranty coverage. So as you start to improve the shipments and the volume you get a natural increase in the amount of SocketCare services that are being purchased at the same time.

I may just add if you look at other customers, Motorola or Intermec, they'll have between 20% and 30% of their revenue come from services. As Dave mentioned, we're probably in the 5% range right now, and also people generally purchase these contracts as part of their deployment. As we see deployments pick up, we've optimized the program to better suit what we feel the market is asking for. So the announcement of this new program makes it a little more competitive with a little more coverage and we feel we're able to move that percentage from the 5% range up hopefully into the 10% to 15% range, which would be more like what other people who deploy handhelds are getting.

Every two categories of coverage the SocketCare program itself we will advertize the revenue over the life of the warranty coverage, so typically that's three years. But we also provide repairs and upgrades for out-of-warranty products and customers pay for those as they go and that tends to also be a major part of our service revenue category.

The announcement, I think you saw it earlier this quarter, reflected some nice improvements in our SocketCare program to cover more products, to extend the coverage with more variations for customers to tailor to their own needs and the ability to extend the program beyond the initial three years. So we've always focused on providing good customer care and customer support for our products and we find with the quality of the products and the durability of the products that these extended warranty programs work well for both us as well as for the customer that's able to build the coverage into their initial budgeting and planning cycle and not have to worry about ongoing costs as they go throughout the cycle of those products.

Thank you for taking my questions today. I appreciate it and, again, I can't wait to see the fourth quarter. Thanks so much.

Thanks, Laura.

Richard Siragusa, Merrill Lynch.

Congratulations on what appears to be the turning quarter. Kevin, you had mentioned that you would be entering 2012, and I think you referred to as a manageable backlog. And I wasn't sure if that was hoping it would be manageable or confident that it would be manageable?

Confident that it would be manageable. I think one of the painful lessons we learned in this whole supply issue is that in some ways we were shipping very aggressively against orders which resulted in our distribution down, particularly overseas having very little inventory. Then when we went into a shortage situation, as can happen occasionally, there was no buffer in the channel. Whereas when I look at the US, they generally carry four weeks of inventory and, therefore, you have a little bit of time to recover.

Our going-forward strategy is to basically operate to a four-week lead time and to be consistent to that lead time where people can absolutely count on getting their products in the four weeks and to have our distribution partners carry a little more inventory. Today, I don't think we're at that point. Certainly, for the first nine months of the year our lead times have probably been closer to 12 weeks than they have been to 4 weeks. I think right now we're probably between 8 and 6 weeks and we will get to 4 weeks before the end of the year.

What I want to make sure is people understand we're going to try and keep a manageable backlog, which I would say is four weeks of orders on hand and then use distribution to service our customers. This gives us enough flexibility and also allows us a little safety margin in the event we're delayed for a week because of a component or other unforeseen issues. So ideally, I would like our backlog to be about $2 million, maybe a little bit less; maybe $1.8 million at the end of the year and I think we're on track to achieve that.

Thank you. Secondly, I don't know if you can answer the question, but is there any way to quantify the software developments that are going on with Apple as far as market potential, market size, etc.?

The short answer is, I think not at this time, but I can give you a few examples. I think the fundamental difference between the Apple environment and the rest of the world is that it is possible to do an application for a targeted market and I can give you one or two examples. One of the things I did in early October was I went to see our customers in Europe, including the customer who developed the first Apple-certified third-party app, to answer some of the questions that I think you're asking us and we were asking them. They do a hospitality application, but their target is for people who are running corporate events between I would say 100 and 350 people. Okay and they've done all this software that allows them to check them in, check them out, run marketing campaigns and better service that group of people.

As they explained it to me, there's a lot of software available if you're running a 2000-person event and there's very little software if you're running 300-person event or 100-person event, even though people often spend tens and in some cases hundreds of thousands of dollars on these 300-person events. I think what Apple has enable people to do is to target a segment of the market, whether it be hospitality -- we have people are collecting wine and other collectible that again can write an app and people can quickly adopt it. Some of the applications, I went to a large retail customer, as they are a large Safeway-type company, and they have done an application for their high-end customers that allows them to check out using the iPhone and now they need a scanner.

I think one of the things that's particularly exciting is that this middle market of people who are a group of 500 or 1,000 can write an app that's custom to their requirements and then add scanning and they don't have to buy the hardware. So I don't know if it's one big thing. I think it's lots of little things, which is actually much better from our point of view. As Dave mentioned, we shipped over 100 applications in distribution already so people are out there and basically starting the development. It's something we will definitely monitor and we can report on going forward, but today it's still too early as developers tend to be very secretive until they have their product in the market.

Mike Schillinger, Private Investor.

I have two questions. First of all, to what extent beyond the $800,000 were revenues constrained by your production capability? Are you still in a mode where you're not actively going after customers, or at least were in Q3, just because you have difficulty in servicing them? Can you kind of characterize that?

Okay, interesting question. In addition to the $800,000 that we shipped and didn't recognize, we were probably constrained by at least another $1 million, in that we had orders that we didn't have components for and due to the fact of being a few weeks later in the quarter when we got our issues resolved. So I would say there was another $1 million of shortages on top of the $800,000.

I think that's reflected in a couple of the comments you've already had. I'll put the pieces together for you. I mentioned that we left the third quarter with a backlog of about $3 million, and Kevin mentioned in answer to some of the questions that he's believing about $1.8 million is about the right level of backlog for us to carry.

So the difference of your $1.2 million is the extent to which we will be catching up. The rest of it depends on the pace of orders coming in. We have seen orders increasing quarter over quarter. We did see orders of $5.7 million this third quarter. So we'll have to see again whether we can see continued growth or if it flattens or whatever. The backlog itself that we should be catching up will be in the $1 million range.

To answer your question about how much outreach we have done, we haven't done all the outreach we need to do to capture the HP customers. We will pick up the pace of this in Q4, but we felt it was somewhat pointless to go and capture these customers unless we had product to deliver to them when they were ready to go. We will be in that position I would say starting in November and it's our intention to reach out to those customers.

We're fortunate in that overseas in particular, and actually in the US, many of our distributors were also distributing the iPAQ and, therefore, it's not a huge reach to actually run some campaigns to reach out to the existing HP iPAQ customers to let them know there are alternatives. We just haven't done that yet.

My second question, the $800,000, is it correct to assume that that's in the $3 million of backlog, or is that in addition to the $3 million of backlog.

No, that would be in addition.

There's a cross-backlog because we'd shipped this.

The way we work once we ship the product to the distributor we create the receivable. They owe us the money and they'll pay us under normal payment terms, but usually the other side of that receivable become sales. We defer the sales. We also relieve the inventory. The other side of that is typically cost of sales and that gets deferred. On our balance sheet, you'll see a deferred income on shipments to distributors and that's the net of your sales and cost of sales. Our total inventory in the channel at the end of September was about $2.4 million, up from about $1.5 or $1.6 million at the end of the previous quarter. So that was the $800,000 bulge that you're seeing.

The question is what is the right stockage level in the channels? It's probably about right now as business picks up, but we expect that bulge is now working its way through and where it winds up at the end of December will be a function of what the stocking expectations and needs of our distributors are; probably much more so than availability of supply. We expect to be able to be back on a normal delivery schedule by the end of this quarter.

Thank you, great.

Thank you very much, Mike.

Thank you. There are no further questions in the queue at this time. I would like to turn the call back over to management for closing remarks.

Thank you very much. We would just to thank everyone for their participation on the call today and wish you all a good afternoon. Thank you.

Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.