Socket Mobile, Inc. (SCKT) Q2 2016 Earnings Report, Transcript and Summary

Greetings and welcome to Socket Mobile's Second Quarter 2016 Management Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to Jim Byers, at MKR Group. Thank you, Jim. You may begin.

Thank you, operator. Good afternoon and welcome to Socket's conference call today to review financial results for its second quarter and six months ended June 30, 2016. On the call today from Socket are Kevin Mills, President and CEO; James Lopez, Vice President of Marketing; and Dave Dunlap, Chief Financial Officer. Socket Mobile distributed its earnings release over the wire service earlier today. The release has also been posted on Socket's website at www.socketmobile.com. In addition, a replay of today's call will be available at vcall.com shortly after the call's completion and a transcript of this call will be posted on the Socket website within a few days. We've also posted replay numbers in today's press release for those wishing to replay this call by phone. The phone replays will be available for one week. And before we begin, I would like to remind everyone that this conference call may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 as amended, and Section 21E of the Securities and Exchange Act of 1934 as amended. Such forward-looking statements include but are not limited to statements regarding mobile computer data collection and handheld computer products, including details on timing, distribution and market acceptance of products; and statements predicting trends of sales and market conditions and opportunities in the markets in which Socket sells its products. Such statements involve risks and uncertainties, and actual results could differ materially from the results anticipated in such forward-looking statements, as a result of a number of factors including but not limited to the risk that manufacture of Socket's products may be delayed or not rolled out as predicted, due to technological market or financial factors, including the availability of product components and necessary working capital; the risk that market acceptance and sales opportunities may not happen as anticipated; the risk that Socket's application partners and current distribution channels may choose not to distribute the products or may not be successful in doing so; the risks that acceptance of Socket's products in vertical application markets may not happen as anticipated; as well as other risks described in Socket's most recent Form 10-K and 10-Q reports filed with the Securities and Exchange Commission. Socket does not undertake any obligation to update any forward-looking statements. Now, with that said, I would like to turn the call over to Socket's President and CEO, Kevin Mills.

Thanks, Jim. Good afternoon, everyone and thank you for joining us today. We are pleased to report second quarter results that include solid revenue growth year-over-year and improved profitability. The second quarter was very much in line with the expectations we outlined in our previous earnings call and we remain on track with our objectives for 2016. Our second quarter revenue was $5.2 million, an increase of 16% over Q2 last year. Our higher revenue coupled with our improved gross margins and modest expense growth in Q2 resulted in net income for the quarter of $517,000, or $0.09 per share, which is up 29% year-over-year. This solid improvement also represents our fifth consecutive quarter of profitability. Our Q2 results reflect the ongoing success of our strong application-driven business model, which has been our focus now for the past few years. Q2 also benefited from final sales of our legacy SoMo product. We completed delivery of a SoMo order from last year, which contributed $1.1 million to Q2 revenue. This represents the very last SoMo sale, and SoMo will no longer contribute to our sales going forward. As we have noted before, we have been phasing out this legacy business over the past 12 months, while supporting our many loyal customer and without any negative financial impact. Over the past ten years, we sold over 85,000 SoMo unites, which helped us tremendously in understanding many of the unique dynamics in the mobile market, and we've applied what we learned to our growing data-capture business. Going forward, Socket Mobile is now a pure data-capture-centric company. As you many know, under our unique application-driven business model, our scanners are a secondary purchase to an application sale. The mobile point of sale market provides a good example of how our model works and continues to be the primary driver of our business. The customer's primary purchase is the mobile point-of-sale application. Once the purchase has been made, the customer must then choose from among a limited number of hardware peripherals supported by the application provider. Socket's success with this process is largely due to our excellent SDK, our application-centric focus and our Apple-certified barcode scanners, so that the decision to purchase a Socket Mobile scanner is primarily determined by the customer's scanning needs, which vary based on items being sold. As most of these individual customers have been advised by their application that Socket Mobile is the only recommended or supported scanner for that particular application, they purchase it via a price-competitive and convenient option which is why Amazon is our number one reseller. The decision to design the scanner into the application is often made many months, quarters, even years earlier by the application development team. But Socket Mobile's revenue only happens when the customer has finally deployed the complete solution. While this model does not enable us to motivate or control sales in the short term, it does provide a steady and growing revenue stream, which we refer to as our run rate business. This portion of our business grew about 10% year-over-year and the primary driver of our scanning run rate business continues to be the small retail locations. Mobile point of sale is currently our largest underserved market and is a huge driver of our business. Mobile point-of-sale applications allow small merchants to replace their old Casio-style cash registers with an application running on an iPad or Android device and get the same level of business analytics as much larger companies. In addition, the monthly Software-as-a-Service, or SaaS, application model makes the transition possible without major capital expenditure. This market requirement probably existed for years, but lacked an efficient and profitable way to service. The combination of the app store that delivers applications and online stores like Amazon, coupled with an increasing end-user knowledge has made it possible to serve this market effectively. These underserved markets have been and will continue to be Socket's bread and butter, as we have optimized our business model to serve them. While this application-driven model has been most successful in the mobile point-of-sale market, we are seeing other underserved markets starting to be served in a similar way. Today, our application-driven model is much stronger in the U.S. than internationally, as more U.S. applications are available, largely due to VC investments. In addition, U.S. customers seem to be more comfortable with both business applications and online purchasing. However, we are now seeing signs that the international markets are becoming more comfortable with this approach. We are also continuing to see a large number of asset tracking, inventory and other non-mobile point-of-sale applications being developed that we believe will broaden our market opportunities, once these applications gain some market traction. In addition to our steady run rate revenue, our cordless barcode scanning revenue also comes from project-based business, which typically comes from companies who want to deploy a larger number of scanners at one time. These larger deals are often driven by a corporate reseller who does much of the coordination work for the company and are common in the AIDC industry. While they have been a smaller percent of our overall business in the past few years, we are seeing an increasing interest from larger companies that are revaluating their mobile deployment plans for their workforces and increasingly considering mobile applications as a viable alternative. While the process of writing and deploying applications is never quick, and we don't expect to see an instant impact on our revenue, we do see a change in attitude and a lot more resources being devoted to this possibility. In fact, it is interesting to note that last week SalesForce.com announced that they will be limiting mobile support to iPhones and to Android devices from Nexus and Samsung. A decision like this has a large ripple effect, as it limits the choices corporations that are dependent on this software can deploy. This also highlights the fact that we are headed to the point where the application is becoming more important than the hardware. The application will dictate the hardware you buy, not the other way around. As a result, we are seeing the market coming our way and seeing a bigger market opportunity. In summary, we continue to see our markets evolving and maturing and believe we are well positioned to capitalize on these favorable market trends with our application-driven business model and existing and new products that will enable us to support a greater range of mobile deployment. Looking ahead to Q3, we expect to see continued solid growth in our data-capture category. While we will feel some impact in the near term from the absence of our SoMo revenue, our primary objective for Q3 is to grow our data-capture revenue and remain profitable. Overall, we expect the second half of the year to be strong, with our mobile point-of-sale-driven portion of the business being strongest in September and October, as it has been for the past three years. While the timing is very difficult to determine, we are confident the underlying trend is very strong. In addition, we expect to see benefits from our newest product introductions, particularly the DuraScan 750 that began shipping in Q2 and is now in the hands of potential customers. We also expect to ship the D730 and D700s in Q3, which completes shipments of our new DuraScan family of products. And we expect to ship our Apple-certified DuraCase in Q3, which we believe will enable us to support the many customers who want to deploy inventory applications that need a one-handed solution. This project has taken longer than expected, but we are excited about the potential of this opportunity, and we will be delighted to deliver the DuraCase into our customers' hands. With that said, I will now turn the call over to Dave for a review of the financials. Dave.

Thank you, Kevin. We are pleased to report a second quarter profit of $517,000, or $0.09 per share, adding to a profitable first quarter of $548,000, or $0.10 per share. The second quarter was Socket's fifth consecutive quarter of profitability and brings net income for the six months and the June, 30, 2016, to $1.065 million, or $0.19 per share, compared to net income for the first six months of 2015 or $329,000, or $0.06 per share. The second quarter and six-month results reflected improving revenues from higher unit sales of our cordless barcode scanners, higher margins on sales, completion of shipments of a major OEM order announced last year for components of our handheld computer product family, and planned increases in operating expenses while growing the bottom line. Our balance sheet continued to benefit from ongoing profitability with stockholders equity increasing from $3.3 million at the end of last year to $4.2 million at March 31, 2016, and increasing to $4.8 million at June 30, 2016. Stockholders equity balances in excess of 4 million that were reached during the first quarter enabled us to reapply for a listing on the NASDAQ Capital Markets, and we began trading as a NASDAQ company on June 22, 2016, under our common stock trading symbol, SCKT. Total cash flow from operations has remained positive. We reported cash balances at June 30, 2016, of $1.054 million. During the second quarter, we paid down our revolving bank line, from $350,000 at the end of March to zero. Our unused bank line draw capacity, as of the end of June, was approximately $1.6 million in cash. The liquidity provided by our own cash resources and by our revolving bank line of credit will ensure that we have the working capital to fund future growth from within our own resources. Sales of cordless barcode scanners represented 77%, or $4 million of our second quarter revenue of $5.2 million. During this second quarter, we shipped $640,000 in components of our SoMo handheld computers used by another equipment manufacturer as a controller device, increasing the revenue from our handheld computer products to $1 million for the quarter, or 20% of total second quarter revenue. Service represented 3% of our revenue. Second quarter margins on sales of 49.5% were similar to first quarter margins of 49.7% and up from second quarter margins a year ago of 47.2%, and reflected ongoing product cost reductions and manufacturing efficiencies. Our operating expenses in the second quarter were $2 million, or 38% of revenue, and included higher planned expenditures for new product development, the effect of annual salary increases for our employees, a one-time NASDAQ listing application fee of $50,000, and higher income tax expense, reflecting our estimate of alternative minimum taxes payable. Our net income continues to be sheltered for tax purposes by our net operating loss carry-forwards. Engineering development costs peaked in the second quarter. As Kevin has noted, we are now shipping our new DuraScan durable barcode 2D scanner Model 750, and are completing the release of the companion models, Model 730 for laser and Model 700 for linear imaging barcode scanning, all of which are expected to be volume shipping by the end of the current quarter. The DuraScan products have an IP 54 dust and water rating, which is one of the best in the industry. We expect operating expenses for the balance of 2016 to not significantly increase. Our new DuraScan products enable one-handed barcode scanning by combining our attachable barcode scanner and selected smart phones in a durable case designed for both products to be used and charged together as an integrated unit. The product development for the DuraCase unit has been completed and we are finalizing certifications and gearing up for production, with product release expected later this quarter. We are also developing future data-capture products that use near field communications technology that should be ready for the markets early next year. One of Socket's features that is most attractive to mobile software developers is the ability for developers to easily install our software developer's kit, which enables a sophisticated use of all of our barcode scanning products with a single installation. Our software team keeps the SDK current, ensuring that our products remain compatible with new Apple, Google, or Microsoft smart phones and tablets and changes they make to their underlying systems. Much of our revenue today continues to be generated from the sale or licensing by software developers of mobile point-of-sale software to the underserved small retailer community, with our products either recommended or included in the hardware package for those who need barcode scanning. Smaller retailers can now install, for a very reasonable price, a combination of hardware updates, including a tablet as a cash register, and the analytics that capture for the retailer information critical to managing the business. To the extent that the retailer needs barcode scanning for transaction processing or inventory management, the use of our products for barcode scanning is built into the application software, and we become part of the end user's solution. Many mobile point-of-sale application developers were financed several years ago by Venture Capital funding, and were able to move quickly to develop and deploy their products. We are now seeing business software addressing other mobile categories entering the market, including asset management, manufacturing and transportation. Our new DuraScan and DuraCase cordless barcode scanning products becoming available this quarter are ideally designed to service these non-mobile point-of-sale markets. Commencing with the third quarter, we have completed the major portion of the planned phase-out of our SoMo handheld computers, due to the technological obsolescence of some of its key components. Whereas our growth in cordless barcode scanning has been partially masked in prior years, by declines in handheld computer sales, going forward, our revenues will fully reflect our data-capture business, which today is primarily cordless barcode scanning, and is growing. Our growth reflects the increasing number of developer applications for mobile platforms becoming available to end users, and the increasing deployment of mobile applications by businesses, including deployments in traditional, non-mobile environments such as manufacturing. Our expectations are to remain profitable going forward. Now I'd like to turn the call over to the operator for your questions. Operator?

Thank you. At this time, we'll be conducting a question-and-answer session. [Operator Instructions] Our first question is from the line of Tomar Cohen with Fivros Capital. Please proceed with your question.

Hey guys, congratulations on a great quarter. My first question is on the competitive environment in the mobile point-of-sale arena. Are you seeing any new entrants or any changes in that environment?

No, not really, it's the same entrants; it's the same kind of environment. There's kind of a long lead time to developing the application, so a lot of the activity that you're starting to see productized today started awhile back. We see different participation in different markets, but we don't see new competitors showing up yet. We'll -- I'll keep you tuned for how that kind of emerges, but today it's the same set of providers and developers.

Okay, great. And then, looking at the growth of the business, excluding SoMo, for just the data-capture business, it seems like you're going to grow year-over-year in the low single digits which is smaller than it's been in the past and also lower than how much the mobile point-of-sale guys have been growing. So I'm curious if you can give us any color on the flow down there and why that's happened?

Well, I think that's -- there's not a direct correlation in the growth of the mobile point-of-sales and ourselves because a lot of the mobile point-of-sale growth at this stage has been in bars and restaurants that are not good candidates for barcode scanning because there's no transaction. So you always have to be a little bit careful because, in certain applications, the scanning is not used as a point of sale. We do see potential longer term in those bars and restaurants as inventory applications get baked into the solution. But overall, we were reasonably happy with the growth and we didn't have any what we'd call larger deals, compared to this time last year. I think our underlying trend of growth was around 10%. And then a lot depends on how things fall, in terms of where Easter or Passover or other holidays are. A one- or two-week difference can make a big difference to our numbers because our numbers are still relatively small.

Okay, that's helpful. And then on the new products that you launched or that you're planning to launch the second half of this year, can you give me a sense for how much you had to invest to get those products ready?

Sorry, could you repeat the question, the last part of it?

Sure. The question is how much did you have to invest in the new products that you're planning to launch in the second half of this year to get those products ready?

Well, our investment is an ongoing thing. I mean, I think that there was probably, I mean, in terms of the engineering work and the design, I would say, probably in the $400,000 to $500,000 per quarter. We do see increases in our investment briefly as we get ready to go to market because we have to pay for all the agency certifications, etc., which is a one-time hit. So I think maybe to answer your question, we probably had an incremental $100,000 in getting certifications and other one-time events ready to get these products into the markets. But we've been consistent in probably doing about $600,000 of R&D per quarter. And then as products come to market, you have those additional costs.

And you can see that increase the second quarter. Our research and development expense was $741,000; in the first quarter, it was $657,000. Although overall our spending in research and development this year is up anywhere from $150,000 to this last quarter maybe closer to $200,000, because of the fact that three major product families are finishing up or well along in development and our engineering team is pretty well focused on those products. But we do expect that from this point forward, our research and development, at least this year, will stay in line with our second quarter, perhaps even a little bit below that, just based on the timing of what has to be done to get the products into market.

And just wanting to expand, it's taken -- about how long has it taken to get these products to market? I mean, $400,000 a quarter; how many quarters did it take to get here?

Well, again, I would say four would be a good -- and again, I would say -- yes, four quarters. So I would say you're talking about $1.5 million to get these products in the market between that and $2 million. And then, also, we're doing this as a second, third, fourth iteration. So we already are starting. So there is a lot of improvements that have been designed in. but it does take time to get this right and to make them easy to use. We spend a lot of time trying to make complicated things as simple as possible.

That's an understatement.

That's helpful. Well, I'll jump back in the line.

Thank you.

Thank you. [Operator Instructions] Our next question is from the line of Paul Hart with Management [ph]. Please proceed with your questions.

Yes, good afternoon. I have a couple of big picture questions in regards to the NPOS market that you're involved with. Currently, what percent of your business is U.S. versus non-U.S.? And when you look at the non-U.S. market, are there additional challenges in resources that you face in order for you to capture market share in the non-U.S. as you are doing in the U.S. markets?

Okay. Well, to answer your question, I would say that probably 80% of our business in mobile point of sale is U.S. at the moment. Maybe 75% to 80%. I think that the U.S. is further ahead in this market than the international community primarily because the selling process is -- tends to be a little more straightforward in the U.S., and secondly the U.S. benefited from the fact that there was a lot of VC money put into these markets, I would say in 2012 and 2013. So they have an advantage. We see a lot of smaller companies doing well overseas, but they're further back in the process; maybe 18 months behind. They have some different challenges, a lot to do with tax and value-added tax and local customs. They have a much more complicated payment system. Right? So, I would say we're seeing a similar pattern but the U.S., I think, has a lead of at least 12 months over the rest of the world. And I think with payment facilities like Apply Pay and other touch pays; it will be easier for the international crowd to catch up. And then we do now see a lot of what we call homegrown mobile point-of-sale people. The larger U.S. companies, I think, had planned, a lot of them, to go overseas and replicate what they had done in the U.S. -- you know, France and Germany, etc., thinking that the language was the only barrier to entry. But I think that the reality is that the sales customs, the taxes, the reporting requirements, are a lot more difficult than they imagined. So as a result, we've seen a lot more small, homegrown applications now coming to the market. Did that answer your question?

Yes, but, given what you just stated, is that over time, obviously, the non-U.S. will catch up to the U.S. As you said, there's a lag in other issues. Does that potentially preclude you from participating in the non-U.S. to the extent that you're participating in the U.S. market?

Absolutely not. We're a secondary purchase and we have a lot of international guys who have designed us in. It's just that they don't have the momentum we see in the U.S. yet. But they'll get there.

Okay. And then the second question that I had, big picture, is regards to what you're doing in the NPOS market and the inventory management that you mentioned up front. I'm not sure if that's linked right now but, in my mind, that would be a huge market. As you do a point of sale with your barcode, you automatically update your inventory, etc. Can you state where you're at in that area now and what you see the future and the potential market in that area?

Okay, so first of all it's not our application. So I guess the first thing to understand is we are the enabler. So in response to the first question, I mentioned that in bars and restaurants, there is no transaction -- barcode-driven transaction as and when you buy a pint of beer, it doesn't come with a barcode.

I understand.

However, what we do see happening is that people want to, once a month, do a cycle count or year-end inventory or other things, and that their mobile point-of-sale partners are being asked to extend the mobile point-of-sale software to allow them to include an inventory. Which I think would then change the number of barcode scanners that will be in the market. Right? Most of the point-of-sale systems today -- and again, we would be very strong in what we call fashion or specialty stores, where they're selling high-end shoes, or jackets or something like this. They will have an inventory and they will decrement that inventory as they sell. And that's fine, but then -- and those are the people that are using scanners, right? So we are encouraging them. Some of the solutions we're bringing out like our DuraCase, which allows a single-handed solution for inventory, cycle counting and other inventory-related actions. I think we'll help accelerate that market, but we can't make it go faster. All we can do is enable the software guys with the right hardware to make -- and the software components -- to make the overall workflow much better.

Right, but it's a market potentially you could participate in.

Absolutely.

Our partners are all looking at adding inventory components to their solution, which opens up an opportunity for us to sell the data-capture tool. So we are excited about that.

Right, intuitively, it makes sense, even if they're a small business, to know what your inventories at and control it through a point-of-sale system.

Exactly. And, again, a lot of these people came from -- they had a Casio cash register and Excel spreadsheets. Now they've lost the Casio cash register. Some of them might still have the Excel spreadsheets and be doing a cycle count, but then you have to do double entry to enter that into your system to do adjustments, you need it to reconcile with your QuickBooks. So, the requirements are the same for a small company as a big company, but the tools haven't been there. But people are building them now.

And the service industry or the boutiques that -- they can take advantage of it because now they can take business management software to the background. And that's where there's a scanning opportunity for us in those service industries.

Exactly. And then when inventory's low, they can automatically order through their systems, with you as a partner and your partners.

Exactly or even inventory balancing, when you happen to grow beyond one location. Right? So knowing where your inventory is across all locations becomes very important.

Yes, it becomes more important. Exactly. Okay, thank you.

Thank you, Paul. The next question is a follow up from Tomar Cohen from Fivros Capital. Please go with your question.

I was hoping you could give us an update on the number of registered developers. And also, if you see any change in what portion of registered developers are getting through to a completed app?

We are. The number of registered developers continues to grow; we end up getting a couple a day on average. The applications that we see, we have about 500 applications in the Apple store. And those are the ones that are the most visible to us because they go through MFI certification. But what -- the trend we're actually seeing is that we're seeing more and more privately made available applications which means there is a lot of in-source application development happening in our development community. So we don't have a lot of visibility directly to what those are, but a lot of our developers are spending more and more time on upgrading apps for business use. So we continue to track that. I can't put numbers to it, but I can tell you that the numbers are increasing based on how our developers are telling us they're making apps available.

The thing, maybe, to add is that we've been building some better onboarding systems to help us manage the developers and we can tell you that we are now better able to track how many developers come and actually end up signing up, etc. It's early days. If you know a little bit of our history, we were struggling 18 months ago when we had all these developers come to us. We've had to build new websites and new back-end infrastructure. So I think we'll be in a better position moving forward to explain the impact of these developers. And while we continue to acquire our large developers, it's -- for us it's a lot about how predictive our developers are and how productive our partners are being. And so one of the things that we're doing is also attracting the activity of our developers so that we can help them better.

Thanks. Is it too early to disclose how many developers you have on the platform?

Well, I mean we did previously disclose that we'd over 1,400. Sam, we think that we're really interested in sorting that number out to make it a better reflection of how many people are active on the platform. And I think it's too early too, I mean the number -- people want to correlate the developers direct to our revenue and that -- we're not at the stage yet but we hope to be in the next quarter or two where we can tell people how many active developers and where they are. The number itself, I don't think has enough meaning right now to be thrown around. So I know it's a bit of a roundabout answer but I think that's more appropriate.

If I remembered enterprise certified applications is probably indicative of the potentials in the actual number of developers?

Yes, we probably added over -- I would say -- we probably added between 60 and 80 new applications this quarter.

Okay, that's helpful. And then I guess last question, you mentioned that your run rate was growing at 10% or you had 10% growth, I'm curious if you can tell me what portion of your revenues you counted the run rate business?

Well, I would say in Q2, it was probably 90% plus. So we sold approximately 16,000 scanners. In Q2 15,000 were in the -- what we call run rate, the ones -- we had one deal for thousand. If you go back a year, we sold -- I don't know, probably close to the same number of scanners but within that we only had about 13 something that were run rate so we had approximately 2,500 that were identified deals, not associated with what we're doing. So that's where that number comes from.

Great, appreciate it. Thanks.

The next question is from the line of Al Troy [ph], private investor. Please proceed with your question.

Congratulations Kevin and while the people at Socket on getting listed on NASDAQ. I also have a five consecutive profitable quarters. My question is now that you're on NASDAQ, what steps you're taking to increase investors and institutions interest in the company and the great story that you have to tell?

Well, we're going to -- we've signed up for conferences like Cloud etcetera that's in September and we'll continue to do a little bit more outreach. I don't that we're kind of -- we're still, I would say onboarding to the NASDAQ process and I think the biggest problem has been that by not being on NASDAQ, the access to investors in general is somewhat curtailed because many of the applications people used to check stock and buy and trade stock don't connect to you unless you're on NASDAQ. So we do have plans to continue to tell the story. You will notice that our stock is up over 70% this year already. So we continue the good work and we're not going to -- I would say, do big roadshows but we are -- we do have systematic plans to get out there and make it more and more obvious to people that we have good story going here.

Yes, you do have a good story. I think the more conferences you go to and the more exposure I think will be beneficial to the stock price for sure.

We concur.

Okay, thank you. Good job.

Thanks.

At this time I will turn the floor back to management for closing remarks.

Thank you, operator. So we just like to thank everyone for participating in today's call and wish you all a good afternoon. Thank you.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.