Socket Mobile, Inc. (SCKT) Q4 2018 Earnings Report, Transcript and Summary

Hello, and welcome to the Q4 2018 Socket Mobile Management Conference Call. My name is Johnny Perkins, and I will be your operator for today's call. [Operator Instructions]. Please note that this conference is being recorded. I will now turn the call over to David Dunlap, Chief Financial Officer. David, you may begin.

Thank you, Operator. Good afternoon, everybody, and welcome to Socket Mobile's conference call today to review financial results for its fourth quarter and year ended December 31, 2018. On the call with me today from Socket Mobile is Kevin Mills, President and Chief Executive Officer, to answer your questions. Socket Mobile distributed its earnings release over the wire service earlier today. The release has also been posted on Socket's website at socketmobile.com. In addition, a replay of today's call will be available shortly after the call's completion through the company's website, socketmobile.com, and a transcript of this call will be posted on the Socket website within a few days. Before we begin, I'd 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 Exchange Act of 1934, as amended. Such forward-looking statements include, but are not limited to, statements regarding mobile data collection and mobile data collection products, including details on timing, distribution and market acceptance of products and statements predicting the trends, sales and market conditions and opportunities in the markets in which Socket Mobile sells its products. Such statements involve risks and uncertainties, and actual results could differ materially from the results anticipated in such forward-looking statements because of a number of factors including, but not limited to, the risk that manufacture of Socket's products may be delayed or not rolled out as predicted due to technological, market or financial factors, including the availability of product components and necessary working capital; the risk that market acceptance and sales opportunities may not happen as anticipated; the risk that Socket's application partners and current distribution channels may choose not to distribute the products or may not be successful in doing so; the risk that acceptance of 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 such forward-looking statements. Now with that said, I'd like to turn the call over to Socket's President and Chief Executive Officer, Kevin Mills. Kevin?

Thanks, Dave. Good afternoon, everyone, and thank you for joining us today. Our revenue in 2018 was a very disappointing $16.5 million, a decrease of 23% over 2017 revenue of $21.3 million. We reported a loss of $571,000 or $0.09 per share compared to the loss of $1.6 million or $0.23 per share in 2017. First, I'd like to spend a little time outlining why our 2018 sales results were so poor, and then outline why we believe 2019 will be significantly better. In 2018, we had 2 significant transitions to accomplish. We completed both by the end of the year, but one of them significantly impacted our sales revenue during the year. We needed to transition our customers from our legacy products over to our new and improved SocketScan family of products. We needed to do this to continue to be able to support long-term requirements of the rapidly changing mobile environment. Our legacy products were designed years ago and lacked the internal resources to meet newer requirements, so they continued to work extremely well in many situations. Unfortunately, this transition didn't go smoothly. First, we were late delivering our new products for which we must take responsibility, and we delayed our customers' qualification process. Secondly, and more importantly, our customers remained very happy with the reliability, quality and pricing of our legacy products and were not motivated to do the work associated with the upgrade. Even though, in our opinion, that work was pretty minor. Our new and improved SocketScan products are 100% compatible with all existing software applications. So we only needed them to complete their testing and update their marketing material with the new and improved SKU information. Regardless of this, the reality is that the clear majority of our application partners did not complete the work until late Q4 when we finally discontinued our legacy products. The slow transition caused confusion and resulted in us losing sales momentum, which impacted our results. We are happy to report that most of our customers have successfully transitioned their marketing material and customer outreach over to the newer versions, and we are, again, seeing good momentum in the business. Socket's products are sold via our application-driven design win process, which is a long sales process followed by a long revenue stream. We sold our legacy products without transition for well over 5 years, and we expect the new and improved versions to also be selling for a minimum of 4 to 5 years. Why we underestimated how difficult the transition would be? We don't expect to run into this issue again for a long time and expect to handle it better when we do. This silver lining, if there is one, is that it demonstrates the strength of the relationship between the applications and our scanners and shows how difficult it is to change or modify us. Socket spent most of 2018 trying to complete this transition with better, in some cases, cheaper versions that were 100% software-compatible. So you can imagine how difficult it is for our competitors to displace us with noncompatible products, especially if we don't mess up. The second transition, which was equally important, but not as impactful on our revenue, was the transition from our old SDK to our new Capture SDK. This transition went reasonably well, and a good number of our customers have already transitioned. With the new Capture SDK, we are able to better support existing customers, accommodate many new requirements and also expand the number of developer environments we can support. A tremendous amount of work went into this new and improved Capture SDK that delights us with a positive response we have received from our developer community. So we began 2019 in a significantly stronger position with all our new products having been tested, proven and deployed by our application partners and with our new and improved Capture SDK launched and receiving positive feedback. In addition, there were several additional things, we believe, will help grow our revenue in 2019. In the point-of-sale market where we remain very strong, there are new markets and some government-driven initiatives that will help expand the point-of-sale markets. They're government programs to both encourage small merchants to switch from a traditional Casio-style cash register to a computerized point-of-sale system, and some penalties for those who don't. We believe this will increase the number of small businesses that switch to iPad-based point-of-sale systems and will increase our revenues. In Japan, there is both a large incentive and depending sales tax change, which will encourage small merchants to switch to a new point-of-sale system in 2019. In addition, there is a strong -- there is strong government support for tax-free shopping for all visitors during the 2020 Olympics, requiring merchants to scan visitor passports. Socket is very well positioned with the leading iPad-based point-of-sale providers, and we expect to see incremental sales in Japan this year. In France, there are new antifraud laws require all small merchants to upgrade to an NF525-compliant point-of-sale system. Again, we are well positioned with NF525-compliant iOS-based point-of-sales system providers and expect to benefit from these changes. There are also new point-of-sale markets like cannabis, which are ideally suited to iPad-based point-of-sale solutions for accounting and regulatory compliance and where we already have well-established partnerships. This month, we will finally deliver an iPhone DuraCase solution. We have had customers -- we've had customer requests for this solution for at least 2 years. But we've been unable to provide it. Our DuraCase solution, enabling single-handed scanning and combined charging and a protective case, will now support the iPhone 6, 7 and 8 and iPhone Pluses 6, 7 and 8. We'll deliver our first units to customers later this month. Our DuraCase business has grown steadily over the past 2 years, but the lack of iPhone support was a gaping hole in our portfolio. We are happy to complete our product portfolio, and believe these products will be a significant addition to our revenue in 2019. We are also seeing more applications in the commercial services category reaching the market, with the inspection and auto-type applications leading the way. The commercial services applications tend to be more corporate-driven and tend to have a more predictable rollout schedule. Finally, we are seeing existing customers increasing their percent of 2D scanner -- scanning in response to both our recent price changes and market forces, which will increase our revenue during 2019. Our developer community remains healthy. We have done a number of things to better support our application developers in addition to migrating them to our Capture SDK. We have enabled developer company accounts, so members of a team working for a company can have a better experience, share resources more effectively and better manage field role process. We have over 1,100 companies that are registered members of our community. We are also seeing a growing number of applications with native support for our scanners in the app store, which bodes well for the long-term health of our business. So in summary, 2018 revenues were impacted by our SocketScan transition, which is now behind us. We believe that we will be much stronger this year based on a combination of a stronger and more stable point-of-sale business, new markets like cannabis, and increased demand from Japan and France, particularly in Q2 and Q3. We are also likely to benefit from new products like our DuraCase for the iPhone series. We look forward to reporting substantially better numbers in 2019. With that said, I'll turn the call over to Dave for his comments.

Thank you, Kevin. 2018 was a challenging year for the company, following 4 solid years of profitable revenue growth. That growth was driven by cordless barcode scanning applications on smartphones and tablets, focused on the under-served small business retail point-of-sale market. Annual growth and barcode scanning revenue was 40% in 2014, 16% in 2015 and 2016, and 15% in 2017 with growing profitability year-over-year. We successfully transitioned our DuraScan product line in 2016 and 2017 to new IP54 water- and dust-rated products, and we built a wide range of other improvements into our SocketScan line of products in 2017 for release in early 2018. In the second half of 2017, we were identified by Venture Development Corporation as the worldwide leader in companion barcode scanning, a position that we retained today. And since that review, we've entered into the sled and the sleeve category of data capture products with our growing DuraCase product line. As Kevin has noted, a several month delay in the launch of the SocketScan line from January through April 2018, triggered a slowdown in 2018 sales that persisted throughout the year. We recently discontinued selling our old SocketScan line of products, and the pace of selling activity of the new products has been accelerating. As a result, sales of $16.5 million in 2018 were flat from quarter-to-quarter during 2018 and were down over the previous year by 21% in cordless barcode scanning and 23% overall, with a 2% reduction in margin contribution. We held operating expenses flat for the year, but elected to continue our active product development program despite the lower revenues. Our net loss for the year was $571,000 or $0.09 per share, including a loss in the fourth quarter of $163,000 or $0.03 per share. For the year and fourth quarter, we achieved positive EBITDA results and positive free cash flow. As a result, we entered 2019 with the SocketScan product transition behind us with state-of-the-art developer tools to serve our growing base of application developers across a widening range of mobile market opportunities and with new products in hand that are fully compatible with the older products that we've replaced. Our balance sheet remains liquid with an end-of-year current balance sheet ratio of 1.42 and over $1 million of cash on hand. We are positioned for and prepared for the return to profitable growth that we see immediately before us. Now let me turn the call over to the operator for your questions. Operator? Again, let me turn the call over to our operator, Johnny Perkins. Johnny?

Hello, it is the operator.

Yes, Johnny, we're ready for you to moderate questions.

[Operator Instructions]. And it looks like we do have a question. You may ask your question now.

The question I got is with the kerfuffle we had with the rollout last year of scanners and the SDK switchovers, our R&D was running about $3.5 million per year in the last two years to support both those initiatives. I am wondering what are we going to bring the R&D costs down during 2019 as part of the plan going forward.

I will start with the -- he didn't provide us an introduction, so we don't know who we're speaking with. So would you mind just introducing yourself?

Yes, I'm sorry, I'd said. This was Steve Swanson, a private investor.

Okay, Steve. So we don't really have a plan to reduce the R&D. We spend a lot of money just in current with the ever-changing world of mobile computing world. Obviously, both Apple and Android and Windows are constantly upgrading, changing, improving all of their products. And as a result, we need to also maintain a high level of activity, just to stay current. I think one other things that we did in 2018 by moving to the Capture SDK is to allow us to better service the market going forward as well as to expand into new markets. So the vast majority of our money is actually spent, and we'll continue to invest in new products. So there is no plan to reduce R&D in 2019.

In fact, Steve, even last year, even though we held our overall operating expenses flat, we did allow an increase, not a large one, but we went from $35 million to $36.5 million in research and development because of the desire to maintain a priority in that category. And we were able to bring down alternate other expenses in G&A as an example. So we do expect that, that pattern will continue, but we were closely watching our expenses to ensure that we're spending what we need to, to accomplish our goals. But ideally, we are keeping in line with the revenue growth picture this year that will allow bottom line profitability to grow as well.

And just maybe one last thing to add, Steve, is that our R&D investment is probably two years out of sync with our revenue from that investment because of the process we go through. So again, as Apple and [indiscernible], in 2018, their launch of Android Ace changed a lot of things as it relates to Bluetooth, all of which we were able to mask from our customers by having the work done in advance to make sure that those changes didn't impact their applications.

Okay. Well, one of the things that I was unaware of was this development of this token that you guys did a press release on, which, in my mind, is kind of a new product. Can you share anything -- are there any other new products you are working on in development that has the potential to come out in 2019? Or are you sitting kind of where you are for now, and you're just maintaining -- using the R&D to maintain as the software companies make their changes?

So first to address the token. We have been working for at least the last 2 years to be in a position so when token exchange and electronic token exchange hits the markets, we'll be in a position to catch those tokens and transfer them. We do have a product in the market called the D600, which is a token exchange product. And we've worked with a number of developers to get this up and going. The S500 product is more designed for what's happening with Apple and Android full related, especially as Apple opens up the RFID world and allow you to use the RFID on your phone for more than just payment. And we currently have that hard work, I would say, 90% complete. We're working with a number of large developers so they can utilize this, and our plan is then to ship this product towards the end of -- the middle to end of 2019. So we will continue to work. One of the other things we've done with our token exchange product is that we service it with the same Capture SDK that we have talked about so that our customers can support both 1D, 2D barcode scanning and token exchange with one development and allow them to mix and match, depending on what their customers want to do. And we get to reuse a lot of the work we did from our point of view, whether we are capturing a barcode or capturing an RFID token. We transport that payload the same. So we get to reuse a lot of the work we have done. And we do have some other variations on our products that will come out during the year, but they won't be substantial. We will expand our product lines into, I think, a few new areas, particularly as it relates to reading passports, which was already announced because there's a greater requirement to how some identification, whether it be from passports or travel cards in a number of our environments, particularly at the retail level because people need access to kind of the shops that require ID and over 21. Governments are trying to encourage duty-free shopping within their country, but require passport reading. But I don't think there'll be any substantial thing. I think you will see that the token exchange adding to revenue, I would say, in the latter part of this year.

Okay. Thanks for that. I guess, the other last question I would have is, I understand kind of where things are with expenses. But maybe you can help me on the revenue side then. Are we doing anything different in 2019 relative to 2018 to help drive revenue and to make it grow over what it was in 2018?

Yes, we're doing a number of things. I think that, obviously, we have modified our organizational structure to be a little bit more on top of the end customers' requirements. We have launched a few new initiatives, and we've been much more aggressive in our outreach to the smaller point-of-sale guys. We've made our products much more available than they were in a number of outlets, including through our own websites or to Amazon. So I think that we took a stock of kind of where we were, and we have made some adjustments that we are confident will help our revenue in 2019.

Also Steve, we're not needing to do transitioning in 2019. That had a tremendous slowdown effect in 2018. For example, we saw several million dollars' worth of larger corporate deployments in 2017 that were not recurring in 2018 and the large part because of timing and because of the transitioning effects, where people really needed to test the new products and make sure they were going to fit under a going-forward plan. And so -- the catch-up things like our commercial services are a reflection of the DuraScan products that we upgraded in 2016 and '17, but it takes a while for those applications to develop and to be tested and deployed. And we're now starting to see much more of that occurring as well. So the combination of being past the transition and just the time needed for larger -- for applications, particularly in the corporate world, to be developed, both of those work to our benefit in 2019.

[Operator Instructions]. At this time, we do not have any further questions.

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

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.