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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10Q

  For the quarterly period ended June 30, 2003

OR

Commission file number 1-13810

SOCKET COMMUNICATIONS, INC.
(Exact Name of Registrant as Specified in its Charter)

 

Delaware	94-3155066
(State or other jurisdiction of incorporation or organization)	(IRS Employer Identification No.)

37400 Central Court, Newark, CA 94560
(Address of principal executive offices including zip code)

(510) 744-2700
(Registrant's telephone number, including area code)

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES[X] NO[  ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES[X] NO[  ]

Number of shares of Common Stock ($0.001 par value) outstanding as of August 5, 2003 was 27,812,211 shares.

1

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

SOCKET COMMUNICATIONS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS
	(Unaudited) June 30, 2003	December 31, 2002*
ASSETS
Current assets:
Cash and cash equivalents	$ 3,259,512	$ 3,146,483
Accounts receivable, net	2,998,956	2,308,101
Inventories	1,476,347	2,128,339
Prepaid expenses and other current assets	385,491	604,236
Total current assets	8,120,306	8,187,159
Property and equipment:
Machinery and office equipment	1,656,993	1,711,740
Computer equipment	661,758	622,422
	2,318,751	2,334,162
Accumulated depreciation	(1,662,094)	(1,545,157)
Net property and equipment	656,657	789,005
Intangible technology, net	904,249	1,121,685
Goodwill	9,797,946	9,797,946
Other assets	155,138	171,352
Total assets	$ 19,634,296	$ 20,067,147
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK, AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses	3,030,840	3,267,015
Accrued payroll and related expenses	637,545	494,453
Bank line of credit	$ 1,520,370	$ 1,906,000
Deferred revenue	738,417	530,780
Current portion of capital leases and equipment financing notes	29,307	31,728
Current portion of note payable	1,154,811	1,692,636
Total current liabilities	7,111,290	7,922,612
Long term portion of capital leases and equipment financing notes	--	12,710
Commitments and contingencies
Series E Redeemable Convertible Preferred Stock,    $0.001 par value: Authorized shares - 100,000, Issued    and outstanding shares - 26,634 at June 30, 2003 and    100,000 at December 31, 2002, Redemption    amount - $266,340 at June 30, 2003 and $1,000,000    at December 31, 2002	187,211	731,187
Stockholders' equity:
Series F Convertible Preferred Stock, $0.001 par value:       Authorized Shares - 276,269, Issued and outstanding shares -       276,269 at June 30, 2003	276	--
Common stock, $0.001 par value: Authorized shares -       100,000,000, Issued and outstanding shares - 24,978,659 at       June 30, 2003 and 24,113,998 at December 31, 2002	24,979	24,114
Additional paid-in capital	45,892,309	43,386,956
Accumulated deficit	(33,581,769)	(32,010,432)
Total stockholders' equity	12,335,795	11,400,638
Total liabilities, redeemable convertible preferred stock,       and stockholders' equity	$ 19,634,296	$ 20,067,147
_________________________
*Derived from audited consolidated financial statements included in form 10-K for the year ended December 31, 2002, filed with the Securities Exchange Commission.

See accompanying notes.

2

SOCKET COMMUNICATIONS, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
	Three Months Ended June 30,		Six Months Ended June 30,
	2003	2002	2003	2002
Revenues:	$ 5,074,835	$ 4,558,496	$ 9,953,400	$ 8,570,366
Cost of revenue	2,584,119	2,365,796	5,060,832	4,377,777
Gross profit	2,490,716	2,192,700	4,892,568	4,192,589
Operating expenses:
Research and development	793,210	873,966	1,714,151	1,772,753
Sales and marketing	1,228,041	1,203,266	2,511,627	2,816,330
General and administrative	736,753	500,949	1,410,547	1,127,353
Amortization of intangibles	101,068	143,040	217,436	206,271
Total operating expenses	2,859,072	2,721,221	5,853,761	5,922,707
Operating loss	(368,356)	(528,521)	(961,193)	(1,730,118)
Interest income and other	6,566	6,559	13,776	17,434
Interest expense	(20,875)	(34,559)	(47,755)	(44,458)
Net loss	(382,665)	(556,521)	(995,172)	(1,757,142)
Preferred stock dividends	(58,259)	--	(90,259)	--
Preferred stock accretion	(102,008)	--	(485,906)	--
Net loss applicable to common stockholders	$ (542,932)	$ (556,521)	$ (1,571,337)	$ (1,757,142)
Basic and diluted net loss per share applicable to common stockholders	$ (0.02)	$ (0.02)	$ (0.06)	$ (0.07)
Weighted average shares outstanding	24,532,654	24,046,754	24,370,029	23,848,110

See accompanying notes.

3

(Index)

SOCKET COMMUNICATIONS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
	Six Months Ended June 30,
	2003	2002
Operating activities
Net loss	$ (995,172)	$ (1,757,142)
Adjustments to reconcile net loss to net cash used in operating   activities:
Depreciation and amortization	284,940	212,683
Net gain on foreign currency translations	(38,298)	(31,076)
Gain on forward exchange contract	(74,930)	--
Foreign currency exchange loss on note payable	65,840	--
Amortization of intangibles	217,436	206,271
Accrued interest on notes payable	--	30,510
Changes in operating assets and liabilities:
Accounts receivable	(679,074)	(798,608)
Inventories	651,992	(409,463)
Prepaid expenses	131,975	(268,822)
Other assets	16,214	10,923
Accounts payable and accrued expenses	(281,176)	1,585,066
Accrued payroll and related expenses	143,092	163,737
Deferred revenue	207,637	30,883
Net cash used in operating activities	(349,524)	(1,025,038)
Investing activities
Purchase of equipment	(152,592)	(171,433)
Acquisition of Nokia CompactFlash Bluetooth business	--	(875,170)
Net cash used in investing activities	(152,592	(1,046,603)
Financing activities
Payments on capital leases and equipment financing notes, net	(15,131)	(12,604)
Payments on notes payable	(603,665)	--
Net proceeds from sale of foreign exchange contract	161,700	--
Gross proceeds from bank lines of credit	3,015,501	3,845,770
Gross payments on bank lines of credit	(3,401,131)	(2,899,706)
Proceeds from stock option and warrant exercises	131,774	84,526
Net proceeds from sale of preferred stock and warrants to     purchase common stock	1,544,838	--
Net proceeds from sale of common stock and warrants to     purchase common stock	--	419,326
Redemption payments on Series E redeemable convertible     preferred stock	(200,000)	--
Dividends paid on Series E redeemable convertible preferred     stock and Series F convertible preferred stock	(50,369)	--
Net cash provided by financing activities	583,517	1,437,312
Effect of exchange rate changes on cash and cash equivalents	31,628	--
Net increase (decrease) in cash and cash equivalents	113,029	(634,329)
Cash and cash equivalents at beginning of period	3,146,483	4,815,245
Cash and cash equivalents at end of period	$ 3,259,512	$ 4,180,916
Supplemental cash flow information
Cash paid for interest	$ 47,755	$44,458
Acquisition of Nokia CompactFlash Bluetooth business with     notes payable	$ --	$ 1,754,830
Warrants issued in conjunction with preferred stock financing	$ 662,827	$ --
Warrants issued in conjunction with common stock financing	$ --	$ 195,269

See accompanying notes.

4

(Index)

SOCKET COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 1 - Basis of Presentation

The accompanying unaudited consolidated financial statements of Socket Communications, Inc. and its wholly owned subsidiaries (the "Company") have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for fair presentation have been included. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 2002.

NOTE 2 - Summary of Significant Accounting Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported amounts of revenue and expense during the reporting period. Actual results could differ from those estimates, and such differences may be material to the financial statements.

In April 2003, the Financial Accounting Standards Board issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities". SFAS No. 149 amends and clarifies the accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No.149 is generally effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. The Company is currently evaluating the effect that the adoption of SFAS No. 149 will have on its results of operations and financial condition.

In May 2003, the Financial Accounting Standards Board issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150 requires that certain financial instruments, which under previous guidance were accounted for as equity, must now be accounted for as liabilities. The financial instruments affected include mandatorily redeemable stock, certain financial instruments that require or may require the issuer to buy back shares in exchange for cash or other assets and certain obligations that can be settled with shares of stock. SFAS No. 150 is effective for all financial instruments entered into or modified after May 31, 2003 and must be applied to existing financial instruments effective July 1, 2003, the beginning of the first fiscal period after June 15, 2003. The Company is currently evaluating the effect that the adoption of SFAS No. 150 will have on its results of operations and financial condition.

5

(Index)

The Company accounts for employee stock options in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB No. 25), and has adopted the disclosure-only alternative described in Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (FAS 123). The Company has elected to follow APB No. 25 and related interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under FASB Statement No. 123, "Accounting for Stock-Based Compensation," requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. Pro forma information regarding net loss and loss per share is required by Statement 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of that Statement.

Had compensation cost for the Company's stock-based compensation plans been determined based on the fair value at the grant dates for awards under those plans consistent with the method of Statement 123, the Company's net loss per share would have increased to the pro forma amounts indicated below:

The fair value of these options was estimated at the date of grant using the Black-Scholes option pricing model. Weighted average assumptions for the periods presented are as follows:

6

(Index)

The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility and expected option life. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.

NOTE 3 - Inventories

Inventories consist principally of raw materials and sub-assemblies, which are stated at the lower of cost (first-in, first-out) or market.

NOTE 4 - Bank Financing Arrangements

In March 2003, the Company renewed and extended its Credit Agreement with its bank, which will now expire on April 15, 2004, provided no material adverse change occurs in the Company's financial condition or ability to perform under the Credit Agreement as determined by the lender. The credit facility under the Credit Agreement allows the Company to borrow up to $4,000,000 based on the level of qualified domestic and international receivables ($2,500,000 and $1,500,000, respectively), at the lender's index rate which is based on prime plus 0.75% and 0.5%, respectively, on domestic and international receivables. The rates in effect at June 30, 2003 were 4.75% and 4.50% on the domestic and international lines, respectively. At June 30, 2003, outstanding amounts borrowed under the lines were $842,678 and $677,692, respectively, which were the approximate amounts available on the lines. These amounts outstanding at June 30, 2003 were repaid in July 2003. Under the new Credit Agreement, the Company must maintain cash and available credit under the line in excess of two times the Company's net loss, adjusted for non-cash charges including depreciation and amortization, for the preceding four quarters. The Company was in compliance with this requirement at June 30, 2003. The remaining terms of the Credit Agreement remain unchanged from the previous Credit Agreement.

7

(Index)

NOTE 5 - Series E Redeemable Convertible Preferred Stock

On October 3, 2002, the Company sold 100,000 shares of Series E redeemable convertible preferred stock in a private placement financing at a price of $10.00 per share, for total proceeds of $1.0 million. The sale included a five-year warrant to acquire 250,000 common shares at a price of $0.957 per share. The preferred stock converts into shares of Socket Communications common stock or will be redeemed for cash in fifteen equal monthly installments commencing January 31, 2003. Conversion may be accelerated at the option of the holder. Each share of preferred stock converts into approximately 11.5 shares of common stock (a conversion price of $0.87 per common share) if the market price of the Company's common stock at the time of conversion is 125% (approximately $1.09 per share) or more of the conversion price. The preferred stock carries a cumulative dividend preference of 12% per year payable monthly commencing December 31, 2002. Dividends for the three and six months ended June 30, 2003 were $18,369 and $45,985, respectively, which were paid in cash. Accretion charges for the three and six months ended June 30, 2003 were $102,008 and $189,412, respectively, arising from accreting the value of the preferred stock up to its redemption value. The Company elected to make monthly installment payments totaling $200,000 during the first quarter of 2003. During the second quarter of 2003, the Series E holder elected to convert 53,366 shares of preferred stock resulting in the issuance of 613,400 shares of common stock during the quarter.

NOTE 6 - Series F Convertible Preferred Stock

On March 20, 2003, the Company sold 276,269 units at a price of $7.22 per unit (total of $2,000,000 gross cash proceeds) pursuant to Section 4(2) of the Securities Act of 1933, as amended (the "Securities Act"). Each unit consisted of one share of the Company's Series F Convertible Preferred Stock (the "Series F Preferred Stock") and a three-year warrant to purchase three shares of the Company's common stock. Two directors of the Company invested an aggregate of $115,000 in the financing. Each share of Series F Preferred Stock is convertible into 10 shares of common stock at the option of the holder, in whole or in part, at any time for a period of three years following the date of sale with a mandatory conversion date three years from date of sale. The Series F Preferred Stock is convertible into a total of 2,762,690 shares of common stock at a conversion price of $0.722 per share, subject to certain adjustments. An additional 828,807 shares of common stock are issuable upon exercise of the warrants at an exercise price of $0.722 per share. In addition, the Company issued five-year warrants to the placement agent, Spencer Trask Ventures, Inc., to acquire up to 718,300 shares of common stock at $0.722 per share. The value of the warrants were determined using the Black-Scholes valuation model with the following assumptions: 0.0% dividend yield rate, risk free interest rates of 1.9% and 2.81%, respectively, for the investors and placement agent, $0.73 per share fair value of common stock, $0.722 exercise price, a life of 3 years and 5 years, respectively, for the investors and placement agent, and a volatility of 0.911. The investor and placement agent warrants were valued at $348,099 and $366,333, respectively. A one time accretion charge of $296,494 in the first quarter of 2003 reflects the discount from market after giving effect to an allocation to the investor warrants of $296,494 of the proceeds of the Series F issuance.

The Series F Preferred Stock automatically converts into common stock three years after sale and automatically converts earlier in the event of a merger or consolidation of the Company, subject to certain conditions. The holders of Series F Preferred Stock have voting rights equal to the number of common shares issuable upon conversion. In the event of liquidation, holders of Series F Preferred Stock are entitled to liquidation preferences over common stockholders equal to their initial investment plus all accrued but unpaid dividends. Dividends accrue at the rate of 8% per annum and are payable quarterly in cash or in common stock, at the option of the Company. Dividends for the second quarter 2003 were $39,890 and were paid in common stock resulting in 26,265 shares issued subsequent to the end of the second quarter.

8

(Index)

NOTE 7 - Note Payable to Nokia

On March 16, 2002, the Company acquired from Nokia Corporation its CompactFlash ("CF") Bluetooth® Card business including a product line and a sole, non-exclusive, nontransferable, worldwide license to make, use and sell the related product line technology. The purchase price was three million Euros of which two million Euros was in the form of a note payable to Nokia. In August 2002, payment of the balance was revised to fifteen monthly installments of 100,000 Euros due each month beginning September 11, 2002 with a final installment of 500,000 Euros due on December 11, 2003. Outstanding balances under the note accrue interest at an annual rate of 6% and the accumulated interest is payable at the time of each installment payment. Interest charges for the three and six months ended June 30, 2003 were $19,277 and $42,874 compared to $30,510 and $36,340 for the same periods in 2002.

The Company is using foreign currency forward exchange contracts for Euros in order to mitigate the impact of currency fluctuations between the Euro and the U.S. dollar on the future payments to Nokia. Due to the change in the payment schedule with Nokia these derivatives do not qualify for SFAS 133 hedge accounting treatment. Accordingly, the changes in fair value of these derivatives were recorded to earnings. In the second quarter of 2003 the net of the currency exchange loss on the note payable of $61,340 and the gain on the forward exchange contracts of $64,760 was included in interest and other income. At June 30, 2003 the Company had forward purchase contracts to buy Euros with a nominal U.S. dollar value equivalent to $1,151,000. The fair value of these forward purchase contracts at June 30, 2003 was approximately $184,940, and such value is included in other current assets in the accompanying balance sheet.

NOTE 8 - Intangible Assets

During the first quarter of 2002, the Company acquired intangible assets in conjunction with the acquisition of Nokia's CompactFlash Bluetooth Card business and related product line technology. These intangible assets were valued at $980,000, and consist of purchased technology and a licensing agreement. Estimated useful lives of the acquired assets ranged from one to three years. Intangible assets of $835,125 from a prior acquisition consist of developed software and technology, and have estimated lives ranging form 2.5 to 8.5 years. Amortization of these intangible assets for the three and six months ended June 30, 2003 were $101,068 and $217,436 compared to $143,040 and $206,271 for the same periods in 2002.

Intangible assets as of June 30, 2003 consisted of the following:

9

(Index)

Based on definite lived intangible assets recorded at June 30, 2003, and assuming no subsequent impairment of the underlying assets, the annual amortization expense is expected to be as follows:

NOTE 9 - Net Loss Per Share

The Company calculates earnings per share in accordance with Financial Accounting Standards Board Statement No. 128, Earnings per Share.

The following table sets forth the computation of basic and diluted net loss per share:

The diluted net loss per share is equivalent to the basic net loss per share because the Company has experienced losses since inception and thus no potential common shares from the exercise of stock options, warrants, or conversion of preferred stock have been included in the net loss per share calculation. Options and warrants to purchase 7,996,429 and 5,810,523 shares of common stock at June 30, 2003 and 2002, respectively, 306,140 shares of common stock issuable at June 30, 2003 upon conversion of Series E redeemable convertible preferred stock, and 2,762,690 shares of common stock issuable at June 30, 2003 upon conversion of Series F convertible preferred stock, have been omitted from the loss per share calculation as their effect is antidilutive.

10

(Index)

NOTE 10 - Comprehensive Loss

The components of comprehensive income, net of tax, were as follows:

At June 30, 2002, accumulated other comprehensive loss included in stockholders' equity consisted of the accumulated net unrealized loss on the translation adjustment, net of tax. There were no elements of comprehensive income or loss for the three and six months ended June 30, 2003.

NOTE 11 - Income Taxes

Due to the Company's loss position, there was no provision for income taxes for the three and six months ended June 30, 2003 and 2002, and the Company maintained its full valuation allowance for all deferred tax assets.

NOTE 12 - Segment Information

The Company operates in one segment, connection solutions for mobile computers and other electronic devices. The Company markets its products in the United States and foreign countries through its sales personnel and distributors. Information regarding geographic areas for the three and six months ended June 30, 2003 and 2002 are as follows:

Export revenues are attributable to countries based on the location of the customers. The Company does not hold long-lived assets in foreign locations.

11

(Index)

Major customers who accounted for at least 10% of the Company's total revenues during the three and six months ended June 30, 2003 and 2002 were as follows:

NOTE 13 - Related Party

The Company had outstanding accounts payable to the Impact Zone, an engineering design and consulting services company, of $38,750 and $30,625, at June 30, 2003 and 2002, respectively. The Company received services during the three and six months ended June 30, 2003 valued at $38,750, $106,250, respectively, and for the three and six months ended June 30, 2002, $82,500 and $139,481, respectively. The Impact Zone's principal stockholder, Dale Gifford, is a sibling of Micheal L. Gifford, Executive Vice President and Director of Socket. See also Note 6.

NOTE 14 - Legal Issues

On June 30, 2003, Khyber Technologies Corporation filed a complaint against us in the United States District Court, Northern District of Ohio, alleging that we had infringed a patent held by Khyber in manufacturing, using and selling our portable bar code scanners. We are currently in the process of analyzing the merits of the complaint.

NOTE 15 - Subsequent Event - Common Stock Financing

On August 5, 2003, the Company sold 1,729,957 shares of common stock in a private placement financing at a price of $2.37 per share. Total proceeds were $4.1 million and estimated net proceeds after costs and expenses were $3.6 million. In conjunction with the financing, the Company issued five-year warrants to investors to acquire an additional 518,987 shares of common stock at $2.73 per share, and issued a five-year warrant to the placement agent and its assignee to acquire 172,996 shares of common stock at $2.73 per share.

12

(Index)

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operation

This Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The forward-looking statements involve risks and uncertainties, including, among other things, the uncertainties associated with forecasting future revenues, costs and expenses. Our actual results may differ materially from the results discussed in the forward-looking statements. You are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date of this report. Factors that might cause such a difference include, but are not limited to, those discussed below and under "Other Factors Affecting Future Operations." We assume no obligation to update such forward-looking statements or to update the reasons why actual results could differ materially from those anticipated in such forward-looking statements.

You should read the following discussion in conjunction with the interim condensed consolidated financial statements and notes included elsewhere in this report and in other reports and documents filed from time to time with the Securities and Exchange Commission.

Revenue
We design, manufacture and sell products for connecting handheld and notebook computers to computer networks and peripherals. Total revenue for the three and six months ended June 30, 2003 of $5.1 million and $10.0 million, respectively, represented increases of 11% and 16% over revenue of $4.6 million and $8.6 million for the corresponding periods a year ago.

Our products cover a wide range of connection solutions in four product families:

• Our network connection products are connection devices that can be plugged into standard expansion slots in handheld and notebook computers. They allow users to connect their computers to the Internet or to private networks, or to communicate with other electronic devices such as desktop computers and printers. Our products offer both wireless and cable connections to external devices such as cell phones and printers. Wireless connection products include cards using the Bluetooth wireless technology standard for short-range wireless connectivity, and cards for connecting to local wireless networks using the Wireless LAN (or WiFi) standard.
  
• Our bar code scanning products plug into handheld or notebook computers and turns them into portable bar code scanners that can be used in various retail and industrial workplaces.
  
• Our peripheral connection products add connection ports to a notebook or handheld computer that allow users to connect these portable computers to standard peripherals.
  
• Our embedded products and services allow manufacturers of wide area networks, handheld computers and other devices to build wireless connection functions into their products.

Our network connection product revenues were $2.0 million and $4.0 million, respectively, for the three and six month periods ended June 30, 2003, compared to $1.7 million and $3.2 million for the same periods a year ago. In the fourth quarter of 2002 we introduced our Bluetooth GPS receiver with navigation kit. Revenue growth of $1.3 million in the first six months of 2003 from this new product and $0.4 million of growth from our modem cards were partially offset by declines in the sales of our Ethernet plug-in cards, Wireless LAN plug-in cards, and our Bluetooth plug-in cards, due primarily to affects of competitive pricing and slower than anticipated rollout of Bluetooth enabled mobile phones.

13

(Index)

Our bar code scanning product revenues were $1.4 million and $2.7 million, respectively, for the three and six month periods ended June 30, 2003, compared to $0.9 million and $2.0 million for the same periods one year ago. Revenue growth for the six months was due primarily to increased sales of our bar code laser scanner system, which is a laser gun attached via a cord to a CompactFlash card with PC adaptor. Revenue from our primary scanning product, the In-Hand Scan card, which is a laser scanner incorporated into a CompactFlash card that plugs into a Pocket PC, notebook, or other mobile computer to turn the computer into a portable laser scanner, was flat for the six month comparable periods. These products are sold both through general distribution and through Value Added Resellers who contract with customers to provide scanning solutions for lightweight portable scanning.

Our peripheral connection card revenues were $0.9 million and $1.9 million, respectively, for the three and six month periods ended June 30, 2002, compared to $0.8 million and $1.8 million for the same periods one year ago. Peripheral connection cards are primarily used to connect peripheral devices or other electronic equipment to notebook computers. Sales volumes for both our standard serial PC Card products and our newer CompactFlash card products slightly increased and were partially offset by declines in custom serial card product sales.

Our embedded products and services revenues were $0.7 million and $1.3 million respectively, for the three and six month periods ended June 30, 2003, compared to $1.1 million and $1.6 million for the same periods a year ago. Revenue declines were primarily in engineering services, accompanied by slight declines in sales of our Bluetooth modules and sales of our proprietary ASIC chip, due primarily to initial rollout of design wins in the prior period.

Gross Margins
Gross margins for the three and six month periods ended June 30, 2003 were 49% for both periods, compared to margins of 48% and 49% for the same periods in 2002. We generally price our products as a markup from our cost, and we offer discount pricing for higher volume purchases. The increase in margins for the second quarter compared to the same period a year ago is due to higher volumes of our higher margin peripheral products and improved margins on our network connection products, partially offset by higher volumes of our lower margin bar code products and our Bluetooth GPS receiver introduced in the fourth quarter of 2002. Newer products tend to have a higher initial cost and lower gross margin until unit sales volumes increase.

Research and Development Expense
Research and development expense in the three and six month periods ended June 30, 2003 was $0.8 million and $1.7 million, respectively, a decrease of 9% and 3% compared to research and development expense for the corresponding periods in the previous year. The decrease is primarily due to lower consulting and professional fees resulting from the completion of the development of our next generation proprietary ASIC chip at the end of the first quarter 2003.

Sales and Marketing Expense
Sales and marketing expense for the three and six month periods ended June 30, 2003 was $1.2 million and $2.5 million, respectively, an increase of 2% and a decrease of 11% compared to sales and marketing expense in the corresponding periods one year ago. Slight increases in personnel expenses in the second quarter were partially offset by decreased advertising and promotional activities compared to the same period a year ago. Almost half of the decrease in the comparable six month periods is due to a reduction in payroll expenses related to a workforce reduction at the end of the first quarter 2002 and the associated one time costs. Additional decreases were in reduced advertising and promotional activities, reductions in the use of consultants and outside services, equipment expenses, and occupancy costs.

14

(Index)

General and Administrative Expense
General and administrative expense for the three and six month periods ended June 30, 2003 was $0.7 million and $1.4 million, respectively, an increase of 47% and 25% compared to the general and administrative expense for the same periods one year ago. Increased use of legal and professional fees in the second quarter and increased investor relation activities were partially offset by reduced occupancy costs compared to the same period a year ago.

Amortization of Intangibles
In March 2002, the Company acquired its CompactFlash Bluetooth Card business from Nokia, including a product line and a sole, non-exclusive, non-transferable, worldwide license to use, make and sell the related product line technology. The total purchase price was $2.6 million, of which approximately $1.0 million was attributed to intangible technology and licensing. The intangible assets are being amortized over their estimated useful lives of 1 to 3 years. Amortization charges for the three and six month periods ended June 30, 2003 were $75,000 and $150,000, respectively, compared to $102,000 and $123,000, respectively, for the same periods a year ago.

In October 2000, the Company acquired 3rd Rail Engineering, an engineering services firm specializing in embedded systems engineering design and integration services for Windows CE and other operating system environments. The acquisition was valued at $11.3 million, of which approximately $1.1 million was attributed to intangible intellectual property. The intangible assets are being amortized over their estimated useful lives of 3 to 8 years. Amortization charges for the three and six month periods ended June 30, 2003 were $26,000 and $67,000, respectively, compared to $41,000 and $83,000, respectively, for the same periods a year ago.

Interest Income, Interest Expense, Net
Interest income reflects interest earned on cash balances. Interest income of $3,200 and $4,700 for the three and six month periods ended June 30, 2003 compared to $6,500 and $17,400 for the same periods one year ago, reflecting a lower level of cash on hand during the first two quarters of 2003 compared to the first two quarters of 2002. Other income of $3,400 and $9,100 for the three and six month periods ended June 30, 2003 were the result of net currency gains on foreign currency contracts partially offset by the loss on the Euro note payable to Nokia. Interest expense of $20,900 and $47,800 for the three and six month periods ended June 30, 2003 compared to $34,600 and $44,500 for the same periods one year ago. Interest expense is related to interest on equipment lease financing obligations assumed from 3rd Rail Engineering, and interest on the outstanding notes payable balances due to Nokia for acquisition of its Bluetooth CompactFlash Card business and related product line technology in March 2002.

Preferred Stock Dividends and Accretion of Preferred Stock
Preferred stock dividends for the three and six months ended June 30, 2003, reflect dividends of $18,400 and $46,000, respectively, accrued at the rate of 12% per annum on Series E redeemable convertible preferred stock issued in October 2002, and dividends of $39,900 and $44,300, respectively, accrued at the rate of 8% per annum on Series F Preferred Stock issued in March 2003. Dividends for Series E were paid in cash for each of the first and second quarters of 2003. Dividends for Series F were paid in cash in the first quarter of 2003, and second quarter dividends were paid in common stock resulting in 26,265 shares issued subsequent to the end of the second quarter. Preferred stock accretion for the three and six months ended June 30, 2003 was $102,000 and $189,400, respectively, arising from the accounting for the redemption of the Series E issuance, and a one time accretion charge in the first quarter of $296,500 reflecting the discount from market after giving effect to an allocation to the investor warrants of $296,500 of the proceeds of the Series F issuance.

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Income Taxes
There were no provisions for Federal or state income taxes as the Company incurred net operating losses in all periods, and the Company maintained its full valuation allowance for all deferred tax assets.

Liquidity and Capital Resources
We have historically financed our operations through the sale of equity securities, equipment financing, and revolving bank lines of credit. Since our inception we have raised approximately $50 million in equity capital and preferred stock. We have incurred significant quarterly and annual operating losses in every fiscal period since our inception, and we may continue to incur quarterly operating losses through the third quarter of 2003 and possibly longer. We have historically needed to raise capital to fund our operating losses.

Cash used in operating activities was $0.3 million in the first half of 2003 compared to $1.0 million in the first half of 2002. The use of cash resulted from financing our net loss of $1.0 million in the first half of 2003 and $1.8 million in the first half of 2002. Adjustments for non-cash items, including depreciation and amortization, amortization of intangibles, gains on the foreign currency forward exchange contracts, and foreign currency losses on the Euro note payable to Nokia totaled $0.4 million in both the first half of 2003 and 2002. Changes in working capital balances resulting in a source of cash of $0.2 million in the first half of 2003 primarily from decreases in inventories and prepaid expenses, increases in deferred revenue and accrued payroll and related expenses, partially offset by increases in accounts receivables and decreases in payables. Changes in working capital balances resulting in a source of cash of $0.3 million in the first half of 2002 were primarily from increases in payables and accrued payroll and related expenses partially offset by increases in accounts receivables, inventories and prepaid expenses.

Cash used in investing activities was $0.2 million in the first half of 2003 compared to $1.0 million in the first half of 2002. Investing activities in the first half of 2003 primarily reflect the cost of new computer hardware and software, and tooling costs. Investing activities in 2002 were primarily due to the acquisition of Nokia's Bluetooth CompactFlash Card business and related product line technology, as well as purchases of equipment. The majority of the equipment purchases in 2002 were tooling purchases related to the acquisition.

Cash provided by financing activities was $0.6 million in the first half of 2003 and $1.4 million in the first half of 2002. Financing activities in 2003 consist primarily of the net proceeds from the issuance of Series F Preferred Stock and the exercise of previously issued warrants partially offset by payments on the note payable to Nokia, redemption payments made on the Series E redeemable convertible preferred stock, and reductions of the amount outstanding under our bank lines of credit. Financing activities in 2002 consisted primarily of the net proceeds from the issuance of Common Stock in a private placement financing and an increase in the amount outstanding under our bank credit lines.

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Our cash balances as of June 30, 2003 were $3.3 million, including cash of $1.5 million drawn against our bank line of credit. In March 2003, we renewed our bank line of credit which now expires on April 15, 2004, provided no material adverse change occurs in our financial condition or ability to perform under the Credit Agreement as determined by the lender. On August 5, 2003, we issued common stock and warrants in a private placement financing to further increase our capital balances by $3.6 million, net of issuance costs. We have warrants outstanding from our private placement financings and outstanding employee stock options that, if exercised, would further increase our cash and equity balances. We believe our existing cash, the cash we raised in August, plus our ability to reduce costs, and the renewed bank line will be sufficient to meet our funding requirements at least through December 31, 2004. Although we do not anticipate the need to raise additional capital during this time to fund operations, we may raise additional capital if market conditions are appropriate. If we cannot achieve profitability, we will not be able to support our operations from positive cash flows, and we would use our existing cash to support operating losses and make debt payments to Nokia. Should the need arise, we cannot assure you that additional capital will be available on acceptable terms, if at all, and any such terms may be dilutive to existing stockholders

Our contractual cash obligations at June 30, 2003 are outlined in the table below:

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Other Factors Affecting Future Operations

We have a history of operating losses, we cannot assure you that we will achieve ongoing profitability and we have monthly payment obligations.

We have incurred significant operating losses since our inception. We may continue to incur operating losses through the third quarter of 2003 and possibly longer. For the fiscal year ended December 31, 2002 and the first six months of 2003, we incurred net losses of $2,971,830 and $995,172 respectively. To obtain profitability, we must accomplish numerous objectives, including the development of successful new products. We cannot foresee with any certainty whether we will be able to achieve these objectives in the future. Accordingly, we cannot assure you that we will generate sufficient net revenue to achieve ongoing profitability.

We also have debt payment obligations to Nokia Corporation under a Business Transfer Agreement that we entered into with Nokia in March 2002. These payments are in the amount of approximately $107,300, plus accrued interest, per month through November 2003, with a final payment of approximately $437,300 plus accrued interest, due in December 2003. If we cannot achieve profitability, we will not be able to support our operations from positive cash flows, and we would use our existing cash to support operating losses and make debt payments to Nokia. We do not anticipate the need to raise additional capital through 2004 to fund our operations, but should the need arise we cannot assure you that additional capital will be available on acceptable terms, if at all, and any such terms may be dilutive to existing stockholders. If we are unable to secure the necessary capital, we may need to suspend some or all of our current operations.

We may require additional capital in the future, and we cannot assure you that capital will be available on reasonable terms, if at all, or on terms that would not cause substantial dilution to your stock holdings.

We have historically needed to raise capital to fund our operating losses. We may continue to incur operating losses through the third quarter of 2003 and possibly longer. Our forecasts are highly dependent on factors beyond our control, including market acceptance of our products and sales of handheld computers. If capital requirements vary materially from those currently planned, we may require additional capital sooner than expected. There can be no assurance that such capital will be available in sufficient amounts or on terms acceptable to us, if at all. Any sale of a substantial number of additional shares will cause dilution to our stockholders' investments and could also cause the market price of our Common Stock to fall.

A significant portion of our revenue currently comes from two distributors, and any decrease in revenue from these distributors could harm our business.

A significant portion of our revenue comes from two distributors, Ingram Micro and Tech Data, which together represented approximately 40 percent of our worldwide revenue in the first six months of 2003, and 30 percent of our worldwide revenue in fiscal 2002. We expect that a significant portion of our revenue will continue to depend on sales to Ingram Micro and Tech Data. We do not have long-term commitments from Ingram Micro or Tech Data to carry our products, and either could choose to stop selling some or all of our products at any time. If we lose our relationship with Ingram Micro or Tech Data, we could experience disruption and delays in marketing our products.

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If the market for handheld computers fails to grow, we might not achieve our sales projections.

Substantially all of our products are designed for use with mobile personal computers, including handhelds, notebook computers and tablets. If the mobile personal computer industry does not grow or if its growth slows, we might not achieve our sales projections.

Our sales would be hurt if the new technologies used in our products do not become widely adopted.

Many of our products use new technologies, such as the Bluetooth wireless standard and 2D bar code scanning, which are not yet widely adopted in the market. If these technologies fail to become widespread, our sales will suffer.

If third parties do not produce and sell innovative products with which our products are compatible, we may not achieve our sales projections.

Our success is dependent upon the ability of third parties in the mobile personal computer industry to complete development of products that include or are compatible with our technology and to sell their products into the marketplace. Our ability to generate increased revenue depends significantly on the commercial success of Windows-powered handheld devices, particularly the Pocket PC, and other devices, such as the new line of handhelds with expansion options offered by Palm. If manufacturers are unable to ship new products such as Pocket PC and other Windows-powered devices or Palm devices on schedule, or if these products fail to achieve or maintain market acceptance, the number of our potential new customers would be reduced and we would not be able to meet our sales expectations.

We could face increased competition in the future, which would adversely affect our financial performance.

The market for handheld computers in which we operate is very competitive. Our future financial performance is contingent on a number of unpredictable factors, including that:

• consolidation among our competitors is resulting in companies with greater financial, marketing, and technical resources than ours;
  
• we periodically face intense price competition, particularly when our competitors have excess inventories and discount their prices to clear their inventories; and
  
• certain original equipment manufacturers of personal computers, mobile phones and handheld computers may make our products less significant by incorporating built-in functions, such as Bluetooth wireless technology and WiFi, into their products.

Increased competition could result in price reductions, fewer customer orders, reduced margins, and loss of market share. Our failure to compete successfully against current or future competitors could harm our business, operating results, or financial condition.

If we fail to develop and introduce new products rapidly and successfully, we will not be able to compete effectively, and our ability to generate sufficient revenues will be negatively affected.

The market for our products is prone to rapidly changing technology, evolving industry standards and short product life cycles. If we are unsuccessful at developing and introducing new products and services on a timely basis that include the latest technologies conforming with the newest standards and that are appealing to end users, we will not be able to compete effectively, and our ability to generate significant revenues will be seriously harmed.

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The development of new products and services can be very difficult and requires high levels of innovation. The development process is also lengthy and costly. Short product life cycles expose our products to the risk of obsolescence and require frequent new product introductions. We will be unable to introduce new products and services into the market on a timely basis or compete successfully, if we fail to:

• identify emerging standards in the field of mobile computing products;
  
• enhance our products by adding additional features;
  
• invest significant resources in research and development, sales and marketing, and customer support;
  
• maintain superior or competitive performance in our products; and
  
• anticipate our end users' needs and technological trends accurately.

We cannot be sure that we will have sufficient resources to make adequate investments in research and development or that we will be able to make the technological advances necessary to be competitive.

If we do not correctly anticipate demand for our products, our operating results will suffer.

The demand for our products depends on many factors and will be difficult to forecast. We expect that it will become more difficult to forecast demand as we introduce and support more products and as competition in the market for our products intensifies. If demand increases beyond forecasted levels, we would have to rapidly increase production at our third-party manufacturers. We depend on suppliers to provide additional volumes of components, and those suppliers might not be able to increase production rapidly enough to meet unexpected demand. Even if we were able to procure enough components, our third-party manufacturers might not be able to produce enough of our devices to meet our customer demand. In addition, rapid increases in production levels to meet unanticipated demand could result in higher costs for manufacturing and supply of components and other expenses. These higher costs could lower our profit margins. Further, if production is increased rapidly, manufacturing yields could decline, which may also lower operating results.

If demand is lower than forecasted levels, we could have excess production resulting in higher inventories of finished products and components, which could lead to write-downs or write-offs of some or all of the excess inventories. Lower than forecasted demand could also result in excess manufacturing capacity at our third-party manufacturers and in our failure to meet some minimum purchase commitments, each of which may lower our operating results.

We depend on alliances and other business relationships with a small number of third parties, and a disruption in any one of these relationships would hinder our ability to develop and sell our products.

We depend on strategic alliances and business relationships with leading participants in various segments of the communications and mobile personal computer markets to help us develop and market our products. Our strategic partners may revoke their commitment to our products or services at any time in the future or may develop their own competitive products or services. Accordingly, our strategic relationships may not result in sustained business alliances, successful product or service offerings, or the generation of significant revenues. Failure of one or more of such alliances could result in delay or termination of product development projects, failure to win new customers, or loss of confidence by current or potential customers.

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We have devoted significant research and development resources to design activities for Windows-powered mobile products and, more recently, to design activities for Palm devices. Such design activities have diverted financial and personnel resources from other development projects. These design activities are not undertaken pursuant to any agreement under which Microsoft or Palm is obligated to continue the collaboration or to support the products produced from the collaboration. Consequently, Microsoft or Palm may terminate their collaborations with us for a variety of reasons including our failure to meet agreed-upon standards or for reasons beyond our control, such as changing market conditions, increased competition, discontinued product lines, and product obsolescence.

We rely primarily on distributors, resellers, retailers and original equipment manufacturers to sell our products, and our sales would suffer if any of these third parties stops selling our products effectively.

Because we sell our products primarily through distributors, resellers, retailers and original equipment manufacturers, we are subject to risks associated with channel distribution, such as risks related to their inventory levels and support for our products. Our distribution channels may build up inventories in anticipation of growth in their sales. If such growth in their sales does not occur as anticipated, the inventory build up could contribute to higher levels of product returns. The lack of sales by any one significant participant in our distribution channels could result in excess inventories and adversely affect our operating results.

Our agreements with distributors, resellers, retailers and original equipment manufacturers are generally nonexclusive and may be terminated on short notice by them without cause. Our distributors, resellers, retailers and original equipment manufacturers are not within our control, are not obligated to purchase products from us, and may represent competitive lines of products. Our current sales growth expectations are contingent in part on our ability to enter into additional distribution relationships and expand our retail sales channels. We cannot predict whether we will be successful in establishing new distribution relationships, expanding our retail sales channels or maintaining our existing relationships. A failure to enter into new distribution relationships or to expand our retail sales channels could adversely impact our ability to grow our sales.

We allow our distribution channels to return a portion of their inventory to us for full credit against other purchases. We also supply some retailers on a consignment basis, which means we own the inventory until it is sold by the retailer and the inventory can be returned to us at any time. In addition, in the event we reduce our prices, we credit our distributors for the difference between the purchase price of products remaining in their inventory and our reduced price for such products. Actual returns and price protection may adversely affect future operating results, particularly since we seek to continually introduce new and enhanced products and are likely to face increasing price competition.

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Our intellectual property and proprietary rights may be insufficient to protect our competitive position.

Our business depends on our ability to protect our intellectual property. We rely primarily on patent, copyright, trademark, trade secret laws, and other restrictions on disclosure to protect our proprietary technologies. We cannot be sure that these measures will provide meaningful protection for our proprietary technologies and processes. We cannot be sure that any patent issued to us will be sufficient to protect our technology. The failure of any patents to provide protection to our technology would make it easier for our competitors to offer similar products. In connection with our participation in the development of various industry standards, we may be required to license certain of our patents to other parties, including our competitors, that develop products based upon the adopted standards.

We also generally enter into confidentiality agreements with our employees, distributors, and strategic partners, and generally control access to our documentation and other proprietary information. Despite these precautions, it may be possible for a third party to copy or otherwise obtain and use our products, services, or technology without authorization, develop similar technology independently, or design around our patents.

Effective copyright, trademark, and trade secret protection may be unavailable or limited in certain foreign countries. Furthermore, certain of our customers have entered into agreements with us which provide that the customers have the right to use our proprietary technology in the event we default in our contractual obligations, including product supply obligations, and fail to cure the default within a specified period of time.

We may become subject to claims of intellectual property rights infringement, which could result in substantial liability.

In the course of our business, we may receive claims of infringement or otherwise become aware of potentially relevant patents or other intellectual property rights held by other parties. Many of our competitors have large intellectual property portfolios, including patents that may cover technologies that are relevant to our business. In addition, many smaller companies, universities, and individuals have obtained or applied for patents in areas of technology that may relate to our business. The industry is moving towards aggressive assertion, licensing, and litigation of patents and other intellectual property rights.

On June 30, 2003, Khyber Technologies Corporation filed a complaint against us in the United States District Court, Northern District of Ohio, alleging that we had infringed a patent held by Khyber in manufacturing, using and selling our portable bar code scanners. We are currently in the process of analyzing the merits of the complaint.

If we are unable to obtain and maintain licenses on favorable terms for intellectual property rights required for the manufacture, sale, and use of our products, particularly those products which must comply with industry standard protocols and specifications to be commercially viable, our results of operations or financial condition could be adversely impacted.

In addition to disputes relating to the validity or alleged infringement of other parties' rights, we may become involved in disputes relating to our assertion of our intellectual property rights. Whether we are defending the assertion of intellectual property rights against us or asserting our intellectual property rights against others, intellectual property litigation can be complex, costly, protracted, and highly disruptive to business operations by diverting the attention and energies of management and key technical personnel. Plaintiffs in intellectual property cases often seek injunctive relief, and the measures of damages in intellectual property litigation are complex and often subjective or uncertain. Thus, any adverse determinations in this type of litigation could subject us to significant liabilities and costs.

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New industry standards may require us to redesign our products, which could substantially increase our operating expenses.

Standards for the form and functionality of our products are established by standards committees. Separate committees establish standards, which evolve and change over time, for different categories of our products. We must continue to identify and ensure compliance with evolving industry standards so that our products are interoperable and we remain competitive. Unanticipated changes in industry standards could render our products incompatible with products developed by major hardware manufacturers and software developers. Should any unanticipated changes occur, we would be required to invest significant time and resources to redesign our products to ensure compliance with relevant standards. If our products are not in compliance with prevailing industry standards for a significant period of time, we would miss opportunities to have our products specified as standards for new hardware components designed by mobile computer manufacturers and original equipment manufacturers.

Undetected flaws and defects in our products may disrupt product sales and result in expensive and time-consuming remedial action.

Our hardware and software products may contain undetected flaws, which may not be discovered until customers have used the products. From time to time, we may temporarily suspend or delay shipments or divert development resources from other projects to correct a particular product deficiency. Efforts to identify and correct errors and make design changes may be expensive and time consuming. Failure to discover product deficiencies in the future could delay product introductions or shipments, require us to recall previously shipped products to make design modifications, or cause unfavorable publicity, any of which could adversely affect our business and operating results.

Our quarterly operating results may fluctuate in future periods, which could cause our stock price to decline.

We expect to experience quarterly fluctuations in operating results in the future. We generally ship orders as received and as a result typically have little or no backlog. Quarterly revenue and operating results therefore depend on the volume and timing of orders received during the quarter, which are difficult to forecast. Historically, we have often recognized a substantial portion of our revenue in the last month of the quarter. This subjects us to the risk that even modest delays in orders may adversely affect our quarterly operating results. Our operating results may also fluctuate due to factors such as:

• the demand for our products;
  
• the size and timing of customer orders;
  
• unanticipated delays or problems in the introduction of our new products and product enhancements;
  
• the introduction of new products and product enhancements by our competitors;
  
• the timing of the introduction of new products that work with our connection products;
  
• changes in the proportion of revenues attributable to royalties and engineering development services;
  
• product mix;
  
• timing of software enhancements;
  
• changes in the level of operating expenses;
  
• competitive conditions in the industry including competitive pressures resulting in lower average selling prices; and
  
• timing of distributors' shipments to their customers.

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Because we base our staffing and other operating expenses on anticipated revenue, delays in the receipt of orders can cause significant variations in operating results from quarter to quarter. As a result of any of the foregoing factors, our results of operations in any given quarter may be below the expectations of public market analysts or investors, in which case the market price of our Common Stock would be adversely affected.

The loss of one or more of our senior personnel could harm our existing business.

A number of our officers and senior managers have been employed for seven to ten years by us, including our President, Chief Financial Officer, Chief Technical Officer, Vice President of Marketing, and Senior Vice President for Business Development/General Manager Embedded and Industrial Systems Unit. Our future success will depend upon the continued service of key officers and senior managers. Competition for officers and senior managers is intense and there can be no assurance that we will be able to retain our existing senior personnel. The loss of key senior personnel could adversely affect our ability to compete.

If we are unable to attract and retain highly skilled sales and marketing and product development personnel, our ability to develop new products and product enhancements will be adversely affected.

We believe our ability to achieve increased revenues and to develop successful new products and product enhancements will depend in part upon our ability to attract and retain highly skilled sales and marketing and product development personnel. Our products involve a number of new and evolving technologies, and we frequently need to apply these technologies to the unique requirements of mobile connection products. Our personnel must be familiar with both the technologies we support and the unique requirements of the products to which our products connect. Competition for such personnel is intense, and we may not be able to attract and retain such key personnel. In addition, our ability to hire and retain such key personnel will depend upon our ability to raise capital or achieve increased revenue levels to fund the costs associated with such key personnel. Failure to attract and retain such key personnel will adversely affect our ability to develop new products and product enhancements.

We may not be able to collect revenues from customers who experience financial difficulties.

Our accounts receivable are derived primarily from distributors and original equipment manufacturers. We perform ongoing credit evaluations of our customers' financial conditions but generally require no collateral. Reserves are maintained for potential credit losses, and such losses have historically been within such reserves. However, many of our customers may be thinly capitalized and may be prone to failure in adverse market conditions. Although our collection history has been good, from time to time a customer may not pay us because of financial difficulty, bankruptcy or liquidation.

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We may be unable to manufacture our products because we are dependent on a limited number of qualified suppliers for our components.

Several of our component parts, including our serial interface chip, our Ethernet chip, and our bar code scanning modules, are produced by one or a limited number of suppliers. Shortages could occur in these essential materials due to an interruption of supply or increased demand in the industry. If we are unable to procure certain component parts, we could be required to reduce our operations while we seek alternative sources for these components, which could have a material adverse effect on our financial results. To the extent that we acquire extra inventory stocks to protect against possible shortages, we would be exposed to additional risks associated with holding inventory, such as obsolescence, excess quantities, or loss.

Our operating results could be harmed by economic, political, regulatory and other risks associated with export sales.

Export sales (sales to customers outside the United States) accounted for approximately 42 percent of our revenue in 2002 and approximately 40 percent of our revenue in the first six months of 2003. Accordingly, our operating results are subject to the risks inherent in export sales, including:

• longer payment cycles;
  
• unexpected changes in regulatory requirements, import and export restrictions and tariffs;
  
• difficulties in managing foreign operations;
  
• the burdens of complying with a variety of foreign laws;
  
• greater difficulty or delay in accounts receivable collection;
  
• potentially adverse tax consequences; and
  
• political and economic instability.

Our export sales are predominately denominated in United States dollars and in Euros for a portion of our sales to European distributors. Accordingly, an increase in the value of the United States dollar relative to foreign currencies could make our products more expensive and therefore potentially less competitive in foreign markets. Declines in the value of the Euro relative to the United States dollar may result in foreign currency losses relating to collection of Euro denominated receivables.

Our operations are vulnerable to interruption by fire, earthquake, power loss, telecommunications failure, and other events beyond our control.

Our corporate headquarters is located near an earthquake fault. The potential impact of a major earthquake on our facilities, infrastructure, and overall business is unknown. Additionally, we may experience electrical power blackouts or natural disasters that could interrupt our business. We do not have a detailed disaster recovery plan. We do not carry sufficient business interruption insurance to compensate us for losses that may occur. Any losses or damages incurred by us as a result of these events could have a material adverse effect on our business.

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The sale of a substantial number of shares of Common Stock could cause the market price of our Common Stock to decline.

Sales of a substantial number of shares of our Common Stock in the public market could adversely affect the market price for our Common Stock. The market price of our Common Stock could also decline if one or more of our significant stockholders decided for any reason to sell substantial amounts of our Common Stock in the public market.

As of August 5, 2003, we had 27,812,211 shares of Common Stock outstanding. Substantially all of these shares are freely tradable in the public market, either without restriction or subject, in some cases, only to S-3 or S-8/S-3 prospectus delivery requirements and, in some cases, only to manner of sale, volume, and notice requirements of Rule 144 under the Securities Act.

As of August 5, 2003, we had 3,492 shares of Series E redeemable convertible preferred stock outstanding that are convertible into 40,140 shares of Common Stock at $0.87 per share. To the extent the market price of our Common Stock exceeds $0.87 per share, the holder of Series E may decide to convert some or all of the Series E into Common Stock, and such Common Stock would be freely tradable in the public market and subject only to S-3 prospectus delivery requirements.

As of August 5, 2003, we had 199,083 shares of Series F Preferred Stock outstanding that are convertible into 1,990,830 shares of Common Stock at $0.722 per share.

As of August 5, 2003, we had 6,071,674 shares subject to outstanding options under our stock option plans, and 670,088 shares were available for future issuance under the plans. We have registered the shares of Common Stock subject to outstanding options and reserved for issuance under our stock option plans. Accordingly, shares underlying vested options will be eligible for resale in the public market as soon as the options are exercised.

As of August 5, 2003, we had warrants outstanding to purchase a total of 2,591,268 shares of our Common Stock at exercise prices ranging from $0.722 to $2.73. All such warrants may be exercised at any time, and the shares issuable upon exercise may be resold, either without restrictions or subject, in some cases, only to S-3 prospectus delivery requirements, and, in some cases, only to manner of sale, volume, and notice requirements of Rule 144.

Volatility in the trading price of our Common Stock could negatively impact the price of our Common Stock.

During the period from July 1, 2002 through August 5, 2003, our Common Stock price fluctuated between a high of $3.39 and a low of $0.51. The trading price of our Common Stock could be subject to wide fluctuations in response to many factors, some of which are beyond our control, including general economic conditions and the outlook of securities analysts and investors on our industry. In addition, the stock markets in general, and the markets for high technology stocks in particular, have experienced high volatility that has often been unrelated to the operating performance of particular companies. These broad market fluctuations may adversely affect the trading price of our Common Stock.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk.

Our exposure to market risk for changes in interest rates relates primarily to invested cash. Our cash is invested in short-term money market investments backed by U.S. Treasury notes and other investments that mature within one year and whose principal is not subject to market rate fluctuations. Accordingly, interest rate declines would adversely affect our interest income but would not affect the carrying value of our cash investments. Based on a sensitivity analysis of our cash investments during the quarter ended June 30, 2003, a decline of 1% in interest rates would have reduced our quarterly interest income by approximately $4,400.

Our bank credit line facilities of up to $4 million have variable interest rates based upon the lenders index rate plus 0.75% for the domestic line (up to $2.5 million) and the index rate plus 0.5% for the international line (up to $1.5 million). Accordingly, interest rate increases would increase our interest expense on outstanding credit line balances. Based on a sensitivity analysis, an increase of 1% in the interest rate would increase our quarterly borrowing costs by $2,500 for each $1 million of borrowings against our bank credit facility or a maximum of $10,000 per quarter if we utilized our entire credit line.

Foreign Currency Risk.

A substantial majority of our revenue, expense and purchasing activities are transacted in U.S. dollars. However, we allow certain of our European distributors to purchase our products in Euros, we pay the expenses of our European subsidiary in Euros, we pay the expenses of our Japan office in Japanese Yen, and we expect to enter into selected future purchase commitments with foreign suppliers that will be paid for in the local currency of the supplier. To date these balances have been small, and we have not been subject to significant losses from material foreign currency fluctuations. At June 30, 2003, we have payment obligations of approximately 1.0 million Euros as a result of our purchase of Nokia's CompactFlash Bluetooth Card business and related product line technology in March 2002. We have purchased forward purchase contracts for Euros in order to minimize our foreign currency exposure. Based on a sensitivity analysis of our net assets at the beginning, during and at the end of the quarter ended June 30, 2003, an adverse change of 10% in exchange rates would result in an increase in our net loss for the quarter of approximately $33,700. We will continue to monitor and assess the risk associated with these exposures and may at some point in the future take actions to hedge or mitigate these risks.

Item 4. Controls and Procedures

(a) Evaluation of disclosure controls and procedures

Our management evaluated, with the participation of our Chief Executive Officer and our Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

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(b) Changes in internal control over financial reporting

There was no change in our internal control over financial reporting that occurred during the period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 4. Submission of Matters to a Vote of Security Holders

At the Annual Meeting of Stockholders of the Company, held at the Company's Newark, California facilities on June 19, 2003, the stockholders elected seven directors to serve until the next annual meeting of stockholders (proposal one) and ratified the appointment of Ernst & Young LLP to continue as the independent public accountants of the Company for the fiscal year ending December 31, 2003 (proposal two). Total voting shares on the record date of April 21, 2003 consisted of 24,376,984 common shares and 276,269 shares of Series F preferred stock issued and outstanding. Each share of common stock was entitled to one vote, and each share of Series F was entitled to ten votes, for a grand total of 27,139,674 voting shares. A total of 20,462,996 shares or 75.4% of outstanding shares were present or voting by proxy.

Results of the stockholder vote were as follows:

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Item 6. Exhibits and Reports on Form 8-K.

(a) Exhibits

31.1 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(b) Reports on Form 8-K

On June 10, 2003, we reported on Form 8-K that the Company's common stock would be re-listed for trading on the Nasdaq National Market at the opening of trading on June 9, 2003.

On April 23, 2003, we reported on Form 8-K the Company's press release, dated April 23, 2003, announcing first quarter 2003 financial results.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

SOCKET COMMUNICATIONS, INC.
Registrant

 

Date: August 13, 2003		/s/ Kevin J. Mills
		Kevin J. Mills President and Chief Executive Officer
Date: August 13, 2003		/s/ David W. Dunlap
		David W. Dunlap Vice President of Finance and Administration and Chief Financial Officer (Duly Authorized Officer and Principal Financial and Accounting Officer)

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Index to Exhibits

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