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

NOTE 1 — Basis of Presentation

The accompanying unaudited condensed financial statements of Socket Mobile, Inc. (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 8 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 condensed financial statements should be read in conjunction with the audited financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011. The financial statements in the Company’s annual report on Form 10-K were prepared on a going concern basis.

Liquidity and Going Concern

During the nine months ended September 30, 2012, and the year ended December 31, 2011, the Company incurred net losses of $2,609,997 and $2,422,361, respectively. As of September 30, 2012, the Company has an accumulated deficit of $59,814,096. The Company’s cash balance at September 30, 2012 was $407,211. At September 30, 2012, the Company had additional unused borrowing capacity of approximately $161,000 on its bank lines of credit (approximately $90,000 and $71,000, respectively, on the domestic and international credit lines). The Company’s balance sheet at September 30, 2012 has a current ratio (current assets divided by current liabilities) of 0.5 to 1.0, and a working capital deficit of $3,503,307 (current assets less current liabilities). These circumstances raise doubt about the Company's ability to continue as a going concern.

In the last three years the Company has taken actions to reduce its expenses and to align its cost structure with economic conditions. The Company has the ability to further reduce expenses if necessary. Steps by management intended to reduce operating losses and achieve profitability include reduction of headcount to manage payroll costs, the introduction of new products, and continued close support of the Company’s distributors and its application development partners as they establish their mobile applications in key vertical markets. The Company has commitments for additional financing (see “NOTE 14 — Subsequent Event” for more information). The Company is also investigating the possibility of development funding from a development partner. Management believes that it will be able to further improve the Company's liquidity and secure additional sources of financing by managing its working capital balances, use of its bank lines of credit, and raising additional capital as needed including development funding from development partners and the issuance of additional equity securities. However, there can be no assurance that additional capital will be available on acceptable terms, if at all, and any such terms may be dilutive to existing stockholders. If the Company cannot attain profitability, the Company will not be able to support its operations from positive cash flows, and the Company would use its existing cash to support operating losses. If the Company is unable to secure the necessary capital for its business, the Company may need to suspend some or all of its current operations.

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

If the Company can return to revenue growth and attain profitability, the Company anticipates requirements for cash will include funding of higher receivable and inventory balances, and increased expenses, including an increase of costs relating to new employees to support the Company’s growth and increases in salaries, benefits, and related support costs for employees.

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. These financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the Company’s inability to continue as a going concern.

NOTE 2 — Summary of Significant Accounting Policies

Use of Estimates

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, the disclosure of contingent assets and liabilities at the date of the financial statements, and 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.

Cash Equivalents and Fair Value of Financial Instruments

The Company considers all highly liquid investments purchased with an original maturity date of 90 days or less at date of purchase to be cash equivalents. At September 30, 2012 and December 31, 2011, all of the Company’s cash and cash equivalents consisted of amounts held in demand and money market deposits in banks. The carrying value of the Company’s cash and cash equivalents, accounts receivable, accounts payable, debt and foreign exchange contracts approximate fair value due to the relatively short period of time to maturity.

NOTE 3 — Goodwill and Other Intangible Assets Review

Goodwill is tested for impairment annually as of September 30th or more frequently when events or circumstances indicate that the carrying value of the Company's single reporting unit more likely than not exceeds its fair value.

The Company performed its annual goodwill impairment analysis as of September 30, 2012. The Company used the two-step test as required to assess goodwill for impairment. The first step of the goodwill impairment test consisted of comparing the carrying value of the reporting unit to its fair value. Management estimated the fair value of the Company's reporting unit using various methods and compared the fair value to the carrying amount (net book value) to ascertain if potential goodwill impairment existed. The Company utilized methods that focused on its ability to produce income ("Income Approach") and the estimated consideration it would receive if there were a sale of the Company ("Market Approach"). Key assumptions utilized in the determination of fair value in step one of the test included the following: the Company's market capitalization; revenue and expense forecasts used in the evaluation were based on trends of historical performance and management's estimate of future performance; cash flows utilized in the discounted cash flow analysis were estimated using a weighted average cost of capital determined to be appropriate for the Company. The fair value of the Company's reporting unit exceeded its carrying value and as a result, goodwill is considered not impaired as of September 30, 2012.

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

NOTE 4 — 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 5 — Short-Term Note Payable

On August 31, 2012, the Company issued a promissory note to a lender for $400,000. The promissory note matures on January 31, 2013 and has an implied monthly compounded interest rate of 9.7%. The Company is required to pay a total of $528,000 principal and interest on the promissory note in weekly installments of approximately $25,000. The note is secured by substantially all the Company’s assets including intangible assets. This promissory note is subordinated to the bank financing arrangement as described in Note 7. During the three months ended September 30, 2012 the Company made principal payments of $36,160 and interest payments of $38,841 on this promissory note. As of September 30, 2012, the outstanding balance on this note payable is $363,840.

NOTE 6 — Convertible Note Payable

On August 1, 2012, the Company issued to select officers and directors of the Company $400,000 in convertible subordinated notes. The net proceeds of $400,000 are being used for working capital purposes. The notes have a term of two years that accrue interest at 8% per annum and mature on August 1, 2014. Accrued interest is payable upon redemption. The notes and accrued interest may be redeemed after six months. The notes are convertible into common stock at the option of the holder at $2.44 per share as long as warrants previously issued to Hudson Bay Capital Master Fund are outstanding, or at $2.00 per share if the Hudson Bay warrants are no longer outstanding. The Hudson Bay Capital Master Fund warrants expire on May 20, 2016. Accrued interest expense at September 30, 2012 was $5,348. The notes are secured by all of the assets of the Company and are subordinated to amounts outstanding under the Company’s working capital bank line of credit with Silicon Valley Bank.

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

During 2011 and prior to the Company entering into the credit agreement as described above, the Company had a senior convertible note outstanding (see “NOTE 9 — Senior Convertible Note” for more information).

NOTE 7 — Bank Financing Arrangements

On October 12, 2011, the Company entered into a new credit facility agreement with Silicon Valley Bank (the “Bank”). This credit facility allows the Company to borrow up to $2,500,000 based on the level of qualified domestic and international receivables, up to a maximum of $1,500,000 and $1,000,000, respectively. Advances against the domestic line are calculated at 80% of qualified receivables except for receivables from distributors which are calculated at 60%. Advances against the international line are calculated at 90% against qualified hedged receivables and 70% against qualified non-hedged receivables and receivables from distributors. Borrowings under the lines bear an annual interest rate equal to the greater of (i) the Bank’s prime rate plus 1%, or (ii) 5%. The rate in effect has been 5% to date. There is also a collateral handling fee of 0.25% per month of the financed receivable balance outstanding. The applicable interest and fees are calculated based on the full amount of the accounts receivable provided as collateral for the actual amounts borrowed. The credit facility agreement expires on October 12, 2013 unless renewed. The agreement may be terminated by the Company or by the Bank at any time. Upon such termination, the Bank would no longer make advances under the credit agreement and outstanding advances would be repaid as receivables are collected. All advances are at the Bank’s discretion and the Bank is not obligated to make advances. In addition, the Company must maintain a minimum liquidity ratio calculated at the end of each month of quick assets (unrestricted cash equivalents at the Bank plus net eligible accounts receivable) to outstanding obligations to the Bank of not less than 2.0 to 1.0. The outstanding amounts borrowed under the domestic and international lines at September 30, 2012 were $406,914 and $247,833, respectively, and the full amounts of accounts receivable provided as collateral were $674,616, and $351,282, respectively. The outstanding amounts borrowed under the domestic and international lines at December 31, 2011 were $921,621 and $187,979, respectively, and the full amounts of accounts receivable provided as collateral were $1,481,039, and $266,006, respectively. Interest expense on the amounts drawn during the three and nine months ended September 30, 2012 were $23,717 and $79,176, respectively. Accrued interest related to the amounts outstanding at September 30, 2012 and December 31, 2011 was $3,451 and $10,477, respectively.

NOTE 8 — Common Stock Financing

On February 23, 2011, the Company issued 282,485 shares of its common stock to settle trade payables due to AboCom Systems. The shares were priced at a closing bid price of $1.77 per share as reported on February 23, 2011 for a total of $499,998.

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

NOTE 9 — Senior Convertible Note

On November 19, 2010, the Company issued a senior secured convertible note having a principal amount of $1,000,000 in a private placement financing. The convertible note was recorded on the Company’s balance sheet net of the associated debt discount. On August 3, 2011, the Company gave notice to call its senior convertible note with a redemption date of September 6, 2011. The unconverted note principal at the notice date was $700,394. The note holder completed a full conversion of the note to common stock by the redemption date. Amortization of the related debt discount during the three and nine months ended September 30, 2011, totaled $475,395 and $944,351, respectively, which is classified as interest expense in the Company’s Condensed Statement of Operations. Interest expense on the note principal for the three and nine months ended September 30, 2011 was $12,488 and $56,107, respectively. In accordance with the terms of the convertible note, a premium was attached to the conversion upon redemption. This resulted in the additional interest expense recognized in the three and nine month periods ended September 30, 2011 of $89,387. An aggregate of 721,009 shares of common stock was issued during the nine months ended September 30, 2011 to satisfy the conversion of the entire principal amount of $1,000,000 plus $16,732 of accrued interest and $89,387 of additional interest expense.

NOTE 10 — Segment Information and Concentrations

Segment Information

The Company operates in one segment—mobile systems solutions for businesses. Mobile systems solutions typically consist of a handheld computer or other mobile device such as a smartphone or tablet, some with data collection peripherals, and third-party vertical applications software. The Company markets its products in the United States and foreign countries through its sales personnel and distributors. Revenues for the geographic areas were as follows:

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

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

Major Customers

Customers who accounted for at least 10% of the Company’s total revenues in the three and nine month periods ended September 30, 2012 and 2011 were as follows:

_____________

* Customer accounted for less than 10% of total revenues for the period

Concentration of Credit Risk

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash, cash equivalents and accounts receivable. The Company invests its cash in demand and money market deposit accounts in banks. To the extent of the amounts recorded on the balance sheet, cash is concentrated at the Company’s bank to the extent needed to comply with the minimum liquidity ratio of the bank line agreement. To date, the Company has not experienced losses on these investments. The Company’s trade accounts receivables are primarily with distributors and OEMs. The Company performs ongoing credit evaluations of its customers’ financial conditions but the Company generally requires no collateral. Reserves are maintained for potential credit losses, and such losses have been within management’s expectations. Customers who accounted for at least 10% of the Company’s accounts receivable balances at September 30, 2012 and December 31, 2011 were as follows:

_____________

* Customer accounted for less than 10% of total accounts receivable for the period

Concentration of Suppliers

Several of the Company’s component parts are produced by a sole or limited number of suppliers. Shortages could occur in these essential materials due to increased demand, or to an interruption of supply such as the Company experienced in the fourth quarter 2010 and to a progressively lesser extent over the first, second, and third quarters of 2011 with the delays in availability of LCD touch screens used in the manufacture of the Company’s mobile handheld computer. Suppliers may choose to restrict credit terms or require advance payments causing delays in the procurement of essential materials. If the Company were unable to procure certain of such materials, it would be required to reduce its operations, which could have a material adverse effect upon its results. At September 30, 2012 and December 31, 2011, 36% and 56%, respectively, of the Company’s accounts payable balances were concentrated in a single supplier. For the three and nine months ended September 30, 2012, this and another supplier accounted for 67% and 64%, respectively, of the inventory purchases.

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

NOTE 11 — Stock-Based Compensation

The Company recognizes stock-based compensation in the financial statements for all share-based awards to employees, including grants of employee stock options, based on their fair values. The Company uses a binomial lattice valuation model to estimate the fair value of stock option grants. The binomial lattice model incorporates calculations for expected volatility, risk-free interest rates, employee exercise patterns and post-vesting employment termination behavior, and these factors affect the estimate of the fair value of the Company's stock option grants. Total stock-based compensation expense for the three and nine months ended September 30, 2012 was $105,657 and $469,117, respectively. Total stock-based compensation expense for the three and nine months ended September 30, 2011 was $188,677 and $548,838, respectively. In the three and nine months ended September 30, 2012, 32,000 and 247,300 stock options were granted, respectively, at weighted average per share fair values estimated at $0.71 and $1.22, respectively.

NOTE 12 — Net Loss Per Share Applicable to Common Stockholders

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

For the three and nine months ended September 30, 2012 and 2011, the diluted net loss per share is equal to the basic net loss per share because the Company experienced losses in these periods. Thus no potential common shares underlying stock options and warrants have been included in the net loss per share calculation, as their effect is anti-dilutive. Options and warrants to purchase 2,137,113 shares and 2,051,730 shares of common stock at September 30, 2012, and 2011, respectively, have been omitted from the net loss per share calculation.

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

NOTE 13 — Taxes

Income tax expense during the three and nine months ended September 30, 2012 and 2011, and the deferred income tax amounts shown on the Company’s Condensed Balance Sheets, is related entirely to the deferred tax liability on the portion of the Company’s goodwill amortized for tax purposes. Due to the indefinite characteristic of this deferred tax liability, it cannot be offset against deferred tax assets. As a result, the Company recognized deferred tax expense of $7,985 and $23,955 in each of the three and nine month periods ended September 30, 2012 and 2011.

At December 31, 2011, the Company has an unrecognized tax benefit of approximately $635,000, which did not change significantly during the three and nine months ended September 30, 2012. Future changes in the unrecognized tax benefit are unlikely to have an impact on the effective tax rate due to the full valuation allowance recorded on the Company’s deferred tax assets, as realization of the deferred tax assets is dependent upon future taxable income.

NOTE 14 — Subsequent Event

On November 5, 2012, the Company’s Board of Directors approved the issuance of up to $350,000 in convertible subordinated notes to its Chairman to be used for working capital purposes. The notes will be issued from time to time as funds are needed by the Company. The notes are identical to the Notes issued on August 1, 2012 (see “NOTE 5 — Convertible Note Payable” for more information). The notes are two-year notes that accrue interest at 8% and mature on August 1, 2014. Accrued interest is payable upon redemption. The notes and accrued interest may be redeemed after six months. The notes are convertible into common stock at the option of the holder at $2.44 per share as long as warrants previously issued to Hudson Bay Capital Master Fund are outstanding, or at the fair market value per share at the time each note is converted if the Hudson Bay Warrants are no longer outstanding. The Hudson Bay Capital Master Fund warrants expire on May 20, 2016. The notes are secured by all of the assets of the Company and are subordinated to amounts outstanding under the Company’s working capital bank line of credit with Silicon Valley Bank.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements include statements forecasting our future financial condition and results, our future operating activities, market acceptance of our products, expectations for general market growth of handheld computers and other mobile computing devices, growth in demand for our products, expansion of the markets that we serve, expansion of the distribution channels for our products, adoption of our embedded products by third-party manufacturers of electronic devices, and the timing of the introduction and availability of new products, as well as other forecasts discussed under “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Words such as “may,” “will,” “predicts,” “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” variations of such words, and similar expressions are intended to identify such forward-looking statements. Such forward-looking statements are based on current expectations, estimates, and projections about our industry, management’s beliefs, and assumptions made by management. These forward-looking statements are not guarantees of future performance and are subject to certain risks, uncertainties, and assumptions that are difficult to predict; therefore, actual results and outcomes may differ materially from what is expressed or forecasted in any such forward looking statements. Factors that could cause actual results and outcomes to differ materially include, but are not limited to: continued weakness in the U.S. and world economy generally and in the markets we serve in particular; the risk of delays in the availability of our products due to technological, market or financial factors including the availability of product components and necessary working capital; our ability to successfully develop, introduce and market future products; our ability to effectively manage and contain our operating costs; the availability of announced third-party handheld computer hardware and software that our products are intended to work with; product delays associated with new model introductions and product changeovers by the makers of products that our products are intended to work with; continued growth in demand for handheld computers and barcode scanners; market acceptance of emerging standards such as Bluetooth and wireless LAN and of our related connection, data collection and mobile handheld computer products; the ability of our strategic relationships to benefit our business as expected; our ability to enter into additional distribution relationships; or other factors described in this Form 10-Q including “Item 1A. Risk Factors” and recent Form 8-K and Form 10-K reports filed with the Securities and Exchange Commission. 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 financial statements and notes included elsewhere in this report, the Company’s annual financial statements in the form 10/K, and other information contained in other reports and documents filed from time to time with the Securities and Exchange Commission.

The Company

We are a producer of mobile handheld computers and data collection products serving the business mobility markets and designed for the mobile worker. We offer a family of general purpose handheld computer products running the Windows Mobile operating system and a wide range of data collection products including two dimensional (2D) and linear (1D) bar code scanners, Radio Frequency Identification (RFID) readers, and magnetic stripe readers. We also offer wearable ring scanners, customized versions of our handheld computers, embedded wireless LAN cards and Bluetooth modules as OEM products to third party companies. Our companion plug-in data collection products work with our handheld computers and our cordless handheld barcode scanners work with many third-party mobile handheld devices including smartphones, tablet computers, ultra-mobile personal computers (UMPCs), notebooks and desktop systems, adding data collection capabilities to these devices. Our products are designed to run or enhance mobile applications that enable the accessing, collection and processing of data by workers while mobile. Our 2D (imager) and 1D (linear) barcode scanners are designed to work with a wide range of Smartphones and tablets running Apple iOS, Google Android, RIM BlackBerry and Microsoft Windows/Windows Mobile operating systems. Our mobile computing products utilize popular Bluetooth and wireless LAN connection technologies using management software we developed for ease of use.

We work closely with software application developers offering or developing software applications for use with our Windows Mobile handheld computers. Healthcare and hospitality are two of the primary areas of focus for software application developers who have developed applications for use on our mobile handheld computers, and a significant portion of our mobile handheld computer sales now come from organizations within these two market segments. Other vertical markets benefiting from mobile solutions include retail merchandising, automotive, government and education. These mobile solutions are designed to improve the productivity of business enterprises and service providers by automating manual tasks, improving the quality of information collected, and enhancing mobile productivity by processing and transferring information from remote locations and mobile devices to the business or medical enterprise, and then if required, back to the remote locations and mobile devices. We also closely support software application developers offering or developing software applications for use with our companion plug-in data collection devices and our cordless handheld barcode scanners. We offer software developer kits to enable developers to easily integrate bar code scanning with our products into their applications.

We believe growth in the mobile workforce along with technical advances and cost reductions in mobile devices and networking technologies along with the pervasive use of the Internet are driving broader adoption of mobile computing and barcode scanning solutions. Our products are designed to address the growing need for mobile computing and barcode scanning by today’s mobile workforce by enabling them to run or enhance mobile applications that allow access to business data files, or collect and process data while mobile, thereby enhancing their productivity and allowing them to exploit time sensitive opportunities and improve customer satisfaction. Overall, our hardware products enable mobile third-party applications to become part of complete mobile systems solutions.

We also make available to original equipment manufacturers (“OEMs”) customized versions of our handheld computers and companion plug-in data collection products, our cordless hand scanners, our wearable ring scanners, and component Bluetooth and wireless LAN technologies. We customize these products and components for our use in our own products and leverage that investment through the sale of modified versions or modules and plug-in cards to OEM manufacturers to embed into their products, including driver and device management software that is designed to simplify the ability of mobile employees to get and stay connected with Wi-Fi as well as with Bluetooth.

We subcontract the manufacturing of all of our products to independent third-party contract manufacturers located in the U.S., China and Taiwan who have the equipment, know-how and capacity to manufacture products to our specifications. Our mobile handheld computers and related companion plug-in data collection products, and our cordless handheld barcode scanners are sold through a worldwide network of distributors and resellers, vertical industry partners, and value added resellers (VARs). Our OEM products are sold directly to the original equipment manufacturers. The geographic regions we serve include the Americas, Europe, the Middle East, Africa and Asia Pacific.

Liquidity and Going Concern

During the nine months ended September 30, 2012, and the year ended December 31, 2011, we incurred net losses of $2.6 million and $2.4 million, respectively. As of September 30, 2012, we have an accumulated deficit of $59.8 million. Our cash balance at September 30, 2012 was $0.4 million. At September 30, 2012, we had additional unused borrowing capacity of approximately $0.2 million on our bank lines of credit. Our balance sheet at September 30, 2012 has a current ratio (current assets divided by current liabilities) of 0.5 to 1.0, and a working capital deficit of $3.5 million (current assets less current liabilities). These circumstances raise doubt about our ability to continue as a going concern.

In the last three years we have taken actions to reduce our expenses and to align our cost structure with economic conditions. We have the ability to further reduce expenses if necessary. Steps by us intended to reduce operating losses and achieve profitability include reduction of headcount to manage payroll costs, the introduction of new products, and continued close support of our distributors and our application development partners as they establish their mobile applications in key vertical markets. We have commitments for additional financing (see “NOTE 14 — Subsequent Event” for more information). We are also investigating the possibility of development funding from a development partner. We believe that we will be able to further improve our liquidity and secure additional sources of financing by managing our working capital balances, use of our bank lines of credit, and raising additional capital as needed including development funding from development partners and the issuance of additional equity securities. However, there can be no assurance that additional capital will be available on acceptable terms, if at all, and any such terms may be dilutive to existing stockholders. If we cannot attain 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. If we are unable to secure the necessary capital for our business, we may need to suspend some or all of our current operations.

If we can return to revenue growth and attain profitability, we anticipate requirements for cash will include funding of higher receivable and inventory balances, and increased expenses, including an increase of costs relating to new employees to support our growth and increases in salaries, benefits, and related support costs for employees.

The accompanying financial statements have been prepared assuming that we will continue as a going concern, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. These financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from our inability to continue as a going concern.

Revenues

Total revenues for the three and nine months ended September 30, 2012 were $2,796,000 and $10,788,000, respectively, a decrease of 40% and 17% from revenues of $4,681,000 and $13,073,000, respectively, in the comparable periods one year ago. In 2012 we began classifying our revenues into two broad product families:

In the table that follows, revenues in the comparable three and nine months of 2011 have been reclassified to conform to the current quarter presentation.

Our mobile handheld computer and related products include our SoMo^® series mobile handheld computers (SoMo is derived from Socket Mobile), and the related peripheral plug-in data collection products and other accessories. Our SoMo series and related peripherals are designed to be durable, lightweight and dependable devices which meet the requirements of the healthcare, hospitality and other markets we serve. Our initial model, the SoMo 650, was introduced in June 2007 with initial volume shipments in September 2007, and features the Microsoft Windows Mobile operating system (currently Version 6.1). Windows Mobile is an industry standard OS for mobile applications thereby ensuring that the SoMo series is compatible with a large number of business applications, giving workers and businesses a familiar computing environment. Our mobile handheld computers are easy to customize for a particular application with peripherals such as our plug-in data collection devices and accessories, and are designed with an expected product life cycle of three to five years which meets the needs of our customers who are deploying mobile solutions. The SoMo 650’s other features include wireless LAN and Bluetooth, a fast processor, a large, bright screen display enabling its use outdoors, large amounts of SDRAM and flash memory, an extended battery, a durable case, multiple language support, reinforced CompactFlash and SDIO card slots, and programmable action buttons to activate peripheral devices such as our companion plug-in data collection products. Our plug-in data collection products are of CompactFlash form factor, are used primarily with our SoMo series mobile handheld computers, and are designed to extend the functionality of the SoMo series of mobile handheld computers to enable the electronic collection of data from barcodes, radio frequency identification (RFID) tags or magnetic stripes. These plug-in data collection products have been designed to complement our SoMo series of handheld computers and are similarly durable devices for commercial use enabling a wide variety of accurate and rapid scans over a full work shift, and come with SocketScan software that allows data to be edited when scanned and provides an easy-to-use interface for developers to build barcode scanning into their applications. The SoMo 650 was specifically designed without an integrated mobile phone to serve the market for business mobility applications that are not mobile phone centric such as medication dispensing in the healthcare market or tableside ordering in the hospitality market, most of which use Bluetooth or wireless LAN connections for data communications.

In late 2008, we introduced the SoMo 650 Rx Model made with antimicrobial materials added to the case plastics to provide an extra layer of protection to the device to aid against the multiplication and spread of potentially harmful bacteria and microbes found in healthcare environments. We expanded the use of this material and began offering antimicrobial versions of the SoMo related peripheral plug-in data collection devices. We also introduced a SoMo 650 DX Model without Bluetooth or wireless LAN for high security environments. We have also developed accessory products such as a back pack to enable direct connections to mobile phone networks using network phone cards and a durable case to provide additional protection in the event the computer is dropped. In addition, we work with third-party accessory providers who have qualified to make a number of accessory products that work with the SoMo family of products including headsets, battery chargers, keyboards, printers and smartcard readers.

In January 2012 we announced the SoMo 655 as an improved version of the SoMo 650, to be available in the second quarter of 2012, with expanded wireless LAN (802.11b/g/n in the SoMo 655 vs. 802.11b/g in the SoMo 650), more memory (4 GB vs. 1 GB), an upgraded Windows Mobile operating system to Windows Embedded Handheld 6.5 (formerly known as Windows Mobile 6.5), micro SD and CompactFlash expansion card slots, and improvements in durability and other features. In June 2012 we began shipping the SoMo 655 in standard and antimicrobial (Rx) models, and plan to release the no wireless LAN (DX) model as current models of the SoMo 650DX are exhausted. The SoMo 655 models are expected to be available for five years. Stocks of SoMo 650 standard and antimicrobial models were exhausted during September 2012.

Our cordless handheld barcode scanning products use Bluetooth technology as the connection interface. The scanners are ergonomically designed for ease of use and accurate repetitive rapid scanning over a full work shift, are durable, lightweight and compact. These scanners are available with 2D (imager) and 1D (linear) scanning engines, and are available in standard or antimicrobial cases. Our cordless handheld barcode scanners come with our SocketScan software which enables the use of these scanners with a wide variety of smartphones and tablets using operating systems from Apple (iOS), Google (Android), Research in Motion (Blackberry) and Microsoft Windows/Windows Mobile devices. We offer a software developer’s kit which enables developers to add commercial-grade barcode scanning capabilities to their applications, and we began offering Apple certified versions of our 2D scanner in both standard and antimicrobial versions beginning in late 2011 and, beginning in the second quarter of 2012, began shipping Apple certified versions of our 1D scanner.

Our SocketCare services provide extended warranty and accidental breakage coverage for selected products including our SoMo series of mobile handheld computers, our cordless handheld barcode scanners, and our CompactFlash plug-in data collection products. Service purchased at the time of product purchase provides for coverage in two-year and three-year terms. We additionally offer comprehensive coverage and program term extensions. We will also repair products that are out of warranty for a fee. Service revenues related to our SocketCare program and out-of-warranty services represented approximately 6% of our revenues in each of the three and nine month periods ended September 30, 2012, compared to 5% and 6% in the comparable periods one year ago. Service revenues are included within the related product revenues in the table that follows.

Other revenues include our OEM and embedded products, and our connectivity products. Our OEM and embedded products consist of our Bluetooth and wireless LAN plug-in cards used primarily by Original Equipment Manufacturers (OEMs) of electronic products to build wireless connection functions into their products using the Bluetooth and wireless LAN standards for wireless connectivity, and our cordless ring scanner which is an industrial strength barcode scanner that is worn on the index finger and connects via Bluetooth to mobile or fixed data collection computing devices. The cordless ring scanner enables a worker to scan while having two hands available and is designed for applications such as warehousing and pick-and-pack operations. Our connectivity products consist of our legacy products including our modems and accessory products including our Mobile Power Pack, adapters and cables. Other revenues represented approximately 6% and 5% of our revenues in the three and nine month periods ended September 30, 2012, respectively, compared to 17% in each of the comparable periods one year ago.

Our revenues by product family for the three and nine months ended September 30, 2012 and 2011, and the corresponding increase or decrease in revenues for the comparable periods are shown in the following table:

Our mobile handheld computer and related product and service revenues in the three and nine months ended September 30, 2012 were $1.4 million and $5.9 million, a decrease of 49% and 26% compared to revenues of $2.8 million and $8.1 million in the corresponding periods one year ago. Mobile handheld computer revenues (excluding revenues from the related plug-in products and services) declined by $0.9 million and $0.6 million, respectively, in the three and nine month periods ended September 30, 2012 compared to the same period one year ago reflecting lower sales volumes, primarily, and price discounts in effect during the second and third quarters of 2012 to incentivize sales of our older SoMo 650 models as we began the transition of the product line to the next generation SoMo 655 models which we commenced shipping into our distribution channel in June 2012. Product transitions such as this tend to slow customer deployments because of the time needed by customers and integrators to evaluate and qualify the new models with their applications. Additional declines in the three and nine month periods ended September 30, 2012 of $0.4 million and $1.5 million, respectively, were primarily from declines in sales of our companion plug-in data collection products due primarily to lower sales volumes of customized versions of our CompactFlash plug-in barcode scanners compared to the corresponding periods one year ago.

Our cordless handheld barcode scanning product revenues in the three and nine months ended September 30, 2012 were $1.2 million and $4.3 million, an increase of 8% and 53% compared to revenues of $1.1 million and $2.8 million in the comparable periods one year ago. Revenue increases in the three and nine month periods of $0.4 million and $0.8 million were from increased sales volumes of our new entry level Apple certified cordless handheld scanning product which began shipping in the fourth quarter of 2011. Additional revenue increases of $0.7 million in the nine month comparable periods were from increased sales volumes of our imager based cordless handheld scanners including our Apple certified cordless handheld scanner. Partially offsetting the revenue increases in the comparable three month periods were declines in sales volumes of our imager based Apple certified cordless handheld scanner as customers could now opt for our lower cost entry level cordless hand scanner where appropriate for their Apple based solutions.

Service revenues were $0.2 million or 6% of our revenues in the third quarter 2012 compared to $0.3 million or 5% of our revenue in same quarter one year ago. Service revenues were $0.6 million or 6% of our revenues in the first nine months of 2012 compared to $0.8 million or 6% of our revenue in same period one year ago. Decreases in service revenues in the comparable three and nine month periods were due mostly to decreases in out-of-warranty related services. Service revenues have been allocated to the respective products serviced in the table above.

Other revenues in the three months ended September 30, 2012 were $0.2 million, a decrease of 80% compared to revenues of $0.8 million in the same quarter one year ago. Other revenues in the nine months ended September 30, 2012 were $0.5 million, a decrease of 76% compared to revenues of $2.2 million in the same period one year ago. Revenue declines of $0.5 million and $0.7 million in the comparable three and nine month periods were from reduced sales volumes of our Bluetooth and wireless LAN plug-in cards used primarily by OEM customers. Additional declines in the three month comparable periods were from reduced sales volume of our Cordless Ring Scanner. Additional revenue declines in the nine month comparable periods were from declines of $0.7 million from reduced sales volumes of our Cordless Ring Scanner, and $0.3 million from reduced sales volumes of our legacy connectivity products.

Gross Margins

Our gross margins in the three and nine months ended September 30, 2012 were 35% and 37%, compared to margins of 43% and 41%, in the corresponding periods one year ago. We generally price our products as a markup from our cost, and we offer discount pricing for higher volume purchases. Declines in overall margins in the three and nine months ended September 30, 2012 were due primarily to the reduction of inventory in our distribution channel, primarily in the stocking levels of our SoMo 650 models, and lower overall sales in the comparable periods which resulted in the absorption of a greater portion of fixed overhead costs in the current periods compared to the corresponding periods one year ago.

Research and Development Expense

Research and development expense in the three months ended September 30, 2012 was $0.6 million, a decline of 10% compared to $0.7 million in the corresponding period one year ago. Research and development expense for the nine months ended September 30, 2012 was $2.2 million, an increase of 7% compared to research and development expense of $2.0 million in the corresponding period one year ago. Changes in the levels of research and development expense in the three and nine month periods were primarily from development activities related to the development of our next generation SoMo series of mobile handheld computers, the majority of which was conducted over the period beginning mid 2011 and concluding with initial customer shipments in June 2012. Research and development expense in the fourth quarter of 2012 is expected to decline from third quarter levels.

Sales and Marketing Expense

Sales and marketing expense for the three months ended September 30, 2012 was $0.8 million, a decline of 14% compared to sales and marketing expense of $0.9 million in the corresponding period one year ago. Sales and marketing expense for the nine month period ended September 30, 2012 was $2.7 million, an increase of 5% compared to sales and marketing expense of $2.6 million in the corresponding period one year ago. Decreased sales and marketing expense in the comparable three month periods was due primarily to declines in personnel costs due to lower overall comparable headcount and declines in the use of outside services. Partially offsetting these declines were increases in advertising costs in the comparable periods. Increased sales and marketing expense in the comparable nine month period was due primarily to increases in advertising and travel costs partially offset by declines in the use of outside services in the comparable periods. Sales and marketing expense in the fourth quarter of 2012 is expected to decline from the preceding third quarter level.

General and Administrative Expense

General and administrative expense for the three months ended September 30, 2012 was $454,000, a decrease of 10% compared to general and administrative expense of $504,000 in the corresponding period one year ago. General and administrative expense for the nine month period ended September 30, 2012 was $1,564,000, a decrease of 4% compared to general and administrative expense of $1,632,000 in the corresponding period one year ago. Declines in the comparable three and nine month periods were primarily from reductions in personnel costs related to lower stock compensation expense and declines in outside services expense. Partially offsetting these declines were increases in legal expense in each of the comparable periods.

Interest Income and Expense

Interest income reflects interest earned on cash balances. Interest income in the three and nine months ended September 30, 2012 and 2011 was nominal in each of the periods, reflecting low average rates of return on cash balances.

Interest expense in the three and nine months ended September 30, 2012 was $70,000 and $126,000, compared to interest expense of $578,000 and $1,091,000 in the same periods one year ago. Interest expense in the three and nine months ended September 30, 2012 was related primarily to interest on amounts drawn on our bank lines of credit, interest on our short term loan advanced on August 31, 2012, and interest on our convertible note payable issued on August 31, 2012. Interest expense in the three and nine months ended September 30, 2011 was related primarily to our senior convertible note including the amortization of the related debt discount and interest on the principal outstanding during the three and nine month periods (see “NOTE 9 — Senior Convertible Note” for more information). Amortization of debt discount in 2011 was a non-cash expense. Additionally, interest expense in each of the quarters presented includes interest on equipment lease financing obligations.

Income Taxes

Deferred tax expense in the first nine months of 2012 and 2011 and the corresponding deferred tax liability shown on our balance sheet, is related entirely to the deferred tax liability on the portion of our goodwill amortized for tax purposes. Due to the indefinite characteristic of this deferred tax liability, it cannot be offset against deferred tax assets. We maintain a full valuation allowance for all other components of deferred tax assets. There can be no assurance that the deferred tax assets subject to the valuation allowance will be realized. We have not generated taxable income in any periods in any jurisdiction, foreign or domestic.

Cash Flows and Contractual Obligations

As reflected in our Statements of Cash Flows, net cash used in operating activities was $0.7 million in the first nine months 2012, compared to cash used in operating activities of $0.2 million in the comparable period a year ago. We calculate net cash provided by or used in operating activities by reducing our net loss ($2.6 million and $2.0 million in the first nine months of 2012 and 2011, respectively) by those expenses that did not require the use of cash, and reversing gains or losses that did not generate or use cash. These items consist of stock based compensation expense, depreciation, amortization of intangible assets, deferred tax expense, and in 2011, the amortization of debt discount and non cash interest expense related to the conversion of our senior convertible note payable. These amounts totaled $0.7 million in the first nine months of 2012 and $1.9 million in the first nine months of 2011. In addition, we report increases in assets and reductions in liabilities as uses of cash and decreases in assets and increases in liabilities as sources of cash, together referred to as changes in operating assets and liabilities. In the first nine months of 2012 changes in operating assets and liabilities resulted in a net source of cash of $1.2 million and were primarily from reductions in accounts receivables due to lower overall shipments to our distributors in the third quarter of 2012 compared to the fourth quarter of last year, and reductions in inventory due primarily to reduced stocking levels of our SoMo 650 mobile handheld computers as we transitioned to the next generation SoMo 655 models. These were partially offset by declines in accounts payable as the result of reduced overall inventory purchases as a result of lower shipping levels in the third quarter 2012 previously mentioned. In the first nine months of 2011 changes in operating assets and liabilities resulted in a net use of cash of $0.1 million and were primarily from increases in accounts receivable due to higher overall shipments to our customers timed late in the third quarter compared to the fourth quarter of last year, partially offset by increases in accounts payable due to the receipt of supplies timed late in the third quarter to meet the higher levels of shipments, increased stocking levels in our distribution channel as a result of the overall increased shipments timed late in the quarter, and reductions in inventory as a result of increased shipments to our customers previously mentioned.

Cash used in investing activities was $0.2 million in the first nine months of 2012 compared to $0.1 million in the first nine months of 2011. Increases in investing activities in the first nine months of 2012 is related primarily to expenditures on tooling for our next generation mobile handheld computer which we began shipping into our distribution channel in June 2012.

Cash provided by financing activities was $0.3 million in the first nine months of 2012 compared to cash provided of $0.8 million in the first nine months of 2011. Financing activities in the first nine months of 2012 consisted primarily of proceeds from the issuance of convertible notes payable, net proceeds from the advance of a short term loan, and proceeds from stock option and warrant exercises. These were partially offset by net amounts paid on our bank lines of credit. Financing activities in the first nine months of 2011 consisted primarily of a reduction in the amount of cash required to collateralize our senior convertible note payable. Overall increases in qualified accounts receivable beginning in the first quarter 2011 were sufficient to fully collateralize the note thereby eliminating the requirement to restrict cash as noted on our balance sheets at the end of the first and second quarters of 2011. In September 2011 the note holder fully completed the conversion of the note to common stock thereby terminating the requirement to collateralize the note (see “NOTE 9 — Senior Convertible Note” for more information).

Our contractual cash obligations at September 30, 2012 are outlined in the table below: