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EARNINGS CALL TRANSCRIPT
EARNINGS CALL TRANSCRIPT 2017 - Q3
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Executive

David Dunlap - CFO Kevin Mills - President and CEO James Lopez - VP, Marketing, Sales and Developer Programs.

Analyst:.

Operator

Welcome to the Socket Mobile Third Quarter 2017 Management Conference Call. My name is Daryl and I will be your operator for today's call. [Operator Instructions], Please note this conference is being recorded. I will now turn the call over to David Dunlap. David, you may begin..

David Dunlap

Thank you, operator. Good afternoon, everyone, and welcome to Socket's Mobile's Third Quarter Management Conference Call to review results for its third quarter and nine months ended September 30, 2017.

Presenting today from Socket Mobile are Kevin Mills, President and CEO; James Lopez, Vice President of Marketing, Sales and Developer 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 Mobile's website at www.socketmobile.com.

In addition, a replay of today's call can be accessed on Socket’s website by selecting About Us, Investor Relations/Conference Calls/ Events. A transcript of this call will also 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 and Exchange Act of 1934, as amended.

Such forward-looking statements include, but are not limited to, statements regarding mobile data collection 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 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 as a result of the number of factors, including, but not limited to, the risk that manufacture of Socket Mobile'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 Mobile'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 Mobile 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. And now with that said, I'd like to turn the call over to Socket's President and CEO, Kevin Mills. Kevin..

Kevin Mills President, Chief Executive Officer & Director

Thanks, Dave. Good afternoon, everyone, and thank you for joining us today. We are pleased to report another profitable and solid revenue quarter. Our Q3 revenue was 5.5 million, a 7% increase over the 5.1 we reported in Q3 2016. Our Q3 cordless scanning revenue was 5 million, 11% higher than the 4.6 million we reported for these products in Q3 2016.

Our operating income was $775,000, up slightly compared to the 718,000 operating income we reported in the same quarter a year ago. Even though our Q3 results were positive and allowed us to maintain our history of improving operating results, I also have to say that Q3, as a quarter, was a little bit strange.

Typically we see modest sales in July and August and very robust sales in September. Typically September represents about 40% of Q3 sales. However, this was not the case this year.

We saw solid sales out in July and August, followed by a soft September The first two weeks of September were off significantly, with sales out returning to normal levels in the latter portion of the month. While we are not a 100% sure of the cause, we suspect the extreme weather across the US in early September was the strong factor.

It is also worth noting that in September the Labor Bureau jobs report highlighted high job losses in the hospitality sector. So it felt like a 12 week quarter, rather than the usual 13 weeks.

Despite this, we did see our year-over-year cordless scanning run rate business grow by approximately 20%, when you exclude deployments from both periods, reflecting the continued strength of our application driven business model. We also had 467 in other revenue in Q3.

This was from licenses from our server products, sales of legacy products and engineering services. Because of the design win nature of our business and our long standing relationships with customers, we are happy to accommodate these opportunities when we can. We will continue to have some revenue in this category going forward.

I will now turn the call over to James Lopez, our Vice President of sales, marketing and developers to provide a bit more color on the markets and how we them evolving going forward. James. .

James Lopez

Thank you Kevin. In Q3, VDC Research who broadly covers the auto identification and data capture industry started the coverage of the mobile barcodes scanner market.

VDC has designed the market by form factors, companion scanners, sled and sleeve scanners and ring scanners and by market segments, retail, commercial services, industrial manufacturing, transportation and logistics and healthcare.

Moving forward, we will be aligning with VDC’s definition and will be referencing our market segments and solutions in these terms.

Socket was proud to be recognized by VDC as the companion scanner of choice worldwide favored by more than one in three users and hope to see our Socket Scan 800 series and DuraScan solution in similar traction in this sled and sleeve market. Socket does not participate in the ring scanner market.

Our 800 series scanners continued to perform well in Q3, as did our DuraScan 700 series scanners.

Our DuraScan scanners which were primarily designed to address the durability needs of market segments outside of mobile point of sales are successfully growing our sales and commercial services, industrial and logistics segments, and have shown continuous quarter-over-quarter of growth since launch.

Lastly, Q3 also demonstrated a lot of early but strong interest in the DuraScan D600 from developers representing every segment.

The D600 is our first handheld capable reading data from RFID tags or from smartphones leveraging near-field communications capabilities and we’ve seen many new and exciting data capture opportunities around RFID/NFC emerging throughout 2018. Now I’d like to hand things over to Dave. .

David Dunlap

Thank you James. So total revenue for the third quarter was $5,475,000, a year-over-year increase of 7%. Socket Mobile’s cordless barcode scanners generated $5,022,000 in revenue from the quarterly worldwide sale of 21,500 barcode scanners, a year-over-year revenue increase of 8%.

The additional revenue of 453,000 was primarily from non-recurring revenue sources including the sale of legacy products, service revenue or license fees and engineering services. The total in this category in the third quarter last year was $467,000. Revenue for the nine months of 2017 was 16.3 million, a year-over-year increase of 28%.

Our gross margins continue to benefit from product component cost reductions. Total margins for the third quarter increased to 55.5%. Total margins from cordless barcode scanning sales were 53.6%. Operating expenses were at $2,271,000, up from $1,912,000 in the third quarter a year ago, and up from $2, 202,000 in the previous quarter.

We continue to invest in the cost of new product development, while maintaining our commitment to operate profitably. Operating income for the third quarter $775,000 or $0.11 per fully diluted share.

To that balance, we deducted interest expenses of 21,000, minimum income taxes currently payable of 28,000 and deferred income taxes of 312,000, to derived net income for the third quarter of $408,000 or $0.06 per fully diluted share. Deferred income taxes are sheltered by our net operating loss carry forwards and do not require the use of cash.

Our balance sheet continues to benefit from our profitable operating results and from the sheltering of our deferred income taxes. Cash and equivalents at September 30, 2017 increased to 2.9 million, up from 2.1 million at the end of the second quarter and up from 1.3 million at the end of last year.

We also have an available unused receivables based bank line of credit of up to $2.5 million. Working capital at September 30, 2017 increased to 6.7 million with a current ratio of 3.7.

Our working capital growth included a combination of operating profitability and the conversion of 1.2 million in convertible notes plus crude interest that matured on September 4, 2017 and converted in to common stock. Our stockholders equity at September 30, 2017 has grown to 19.8 million, up from 16.2 million at the beginning of the year.

Today we have approximately 7 million common shares outstanding. In addition, we have reserved 2.3 million shares for future issue, as stock option outstanding are exercised. Future stock option exercises will generate nearly $5 million in cash and additional equity.

Socket has made considerable financial progress over the past three years and the financial trends continue to be positive. Cordless barcode scanning revenue has more than doubled over the past three years, and represented 92% of our revenue in the most recent quarter.

We’ve improved our operating margins over the past three years from the 40% level to more than 50% through a combination of product cost reductions and manufacturing efficiencies. We’ve increased our operating expenses on our headcount this year, which increased by about 10% to support growth and an active and expanded product development program.

Our commitment is to continue to grow and to operate profitably. Now I’d like to turn the call back to Kevin. .

Kevin Mills President, Chief Executive Officer & Director

Thank you Dave. So in summary, our cordless scanning revenue growth continues to be strong, and we feel very positive about the future. Our application driven business model continues to be validated by the strong results in the US and we have seen very solid increases from online resellers like Amazon and CDW during the year.

We’re also seeing strong run rate business in Europe and Japan. Our products are just becoming available in China, which took longer than expected, and we expect their availability to allow our developer buyers servicing the local market to designer scanners in to their applications.

This will take time, but product availability is the first major milestone in the design win process and that has now been achieved.

We believe 2018 will be a big year for Socket Mobile, who expect to launch newer versions of our products with attractive price points and new features which we feel will both solidify our market leadership position and enhance our growth and profitability. That said, I’d now like to turn the call over to the operator for questions. .

Operator

[Operator Instructions] And we do have a question from [Will Hamilton]. Go ahead with your question..

Unidentified Analyst

Regarding September, so Kevin you need to comment it. So the second half of the month bounced back to normal trends is that what you were saying. .

Kevin Mills President, Chief Executive Officer & Director

Yes..

Unidentified Analyst

I know you don’t know (inaudible) provide but is it that sort of continued literally in to October?.

Kevin Mills President, Chief Executive Officer & Director

Yes. So we track on a weekly basis our sales out. So it was just one online reseller and it would be – something could have happened. But when you look at all of our top resellers, that first two weeks of September were strangely quite across all our line outlets.

So we did a typically half of what we would normally do in those two weeks, and that it’s come back and been completely normal since. So we don’t exactly know, but I think the fall-off in sales coincides with hurricanes Harvey and Irma and all the activities that were going on in the US in the first two weeks.

So in that respect, I think the quarter turned out to be a little bit softer than we expected, and certainly we were surprised by that. But things have all returned to normal since. .

Unidentified Analyst

So like they’re sort of - not to put – working around, but that 15% to 20% type growth that you are experiencing before. .

Kevin Mills President, Chief Executive Officer & Director

Correct..

Unidentified Analyst

And then what was the actual unit, scanner unit sales?.

Kevin Mills President, Chief Executive Officer & Director

It was 21,500..

Unidentified Analyst

And you made a comment that there was 20% growth without the deployments of those two enterprises..

Kevin Mills President, Chief Executive Officer & Director

Yeah, it was approximately 20. I think it came out just under 20, but if we take the deployments in both periods, it was about 20% underlying growth. .

Unidentified Analyst

So they were heavier, not in deployment last year. .

Kevin Mills President, Chief Executive Officer & Director

Correct. That is true..

Unidentified Analyst

And was that also the case in the fourth quarter?.

Kevin Mills President, Chief Executive Officer & Director

Yes. I believe that is. Last year we had the benefit of the start of American Greeting in this period, I believe. So we had some deployments and during that period. So I believe that is the case. .

Unidentified Analyst

Just one last question as it relates to your comments on 2018. You mentioned some new versions coming out at some competitive pricing. Can you give any more color around that? I know you want do to. .

Kevin Mills President, Chief Executive Officer & Director

If we gave you all the color now, it wouldn’t be a surprise. I think that we’ve been working hard to make sure that we’re in a better position for next year and in the beginning of the year, particularly as it relates to shows like NRF.

This is where you generally launch your new products and people evaluate all the new products in the January or February timeframe which is one of the reasons why business tends to be quite during this period, and then people start purchasing in mid-February.

And we will have updated versions with good price points to meet or exceed that customer expectation in that timeframe. .

Unidentified Analyst

And can you just broadly lastly update on the DuraCase and how that’s performing?.

Kevin Mills President, Chief Executive Officer & Director

The DuraCase is a complement to our 800 series scanners and it allows the 800 series to be married up with the smartphone or an iPod touch as a single handed solution, and it’s doing great. The 800 series has shown a lot of growth quarter-over-quarter, and right now its performing well.

I mean nothing other than saying quarter-over-quarter it continues to be one of our strongest performers. .

Operator

And our first question comes from Matthew [Kolenko]. You can go ahead with your question..

Unidentified Analyst

Just one more question on the Q3 order flow. Do you think that perhaps demand is going to snap back in any way and was deferred as a result of natural disasters or whatever, kind of triggered the slow spending.

So do you think it plays catch-up over a couple of quarters and then back to normal or is it just sort of an anomaly that never really comes back..

Kevin Mills President, Chief Executive Officer & Director

First of all, I don’t think the business was lost. It was delayed, so yes it comes back over the following quarters. But I think actually it snaps back probably quicker than this. As we’ve pointed out many times, we have a run rate business and we have large resellers like Amazon and CDW.

We can’t obviously see the individual purchases, but you can see the trends. And those two weeks were abnormally low, but we don’t believe the business was lost, it was just delayed. So to answer your question, yes we would expect to think that business up going forward. .

David Dunlap

In our ship of orders Matt in October, to-date or now above $2 million almost takes the 40% (inaudible) app that you saw back – we normally see in September and started to move some of that in to the October time period.

So we’re expecting if the delay is probably short term for at least a good portion of that and we’ll know more as we go through the quarter..

Unidentified Analyst

Regarding the VDC report, does that tend to – I guess it’s been a little while since their last report.

Does that have any influence on inbound interest for deployments in the business or does it have any influence in the market for you?.

Kevin Mills President, Chief Executive Officer & Director

Matt this was actually the very first time that VDC has addressed the mobile barcodes scanning market as a market in and of itself. So this is the very first report. So I think what they’ve done is shined a light on an emerging market and presented it as something that is adding to the user base that used to be represented only by the AIDC market.

So for us it’s a real validation of what we’ve been chasing for the last few years and how the applications on mobile devices are opening up applications of barcode scanning and near field scanning moving forward.

So it’s been a great validation of the market that we’re participating in and it gives us a frame of reference now to, as I mentioned start defining our markets with and to start positioning our products within.

And I think that there are people who are going to be seeing the report and seeing the validation there, and hopefully will bring developers as well. .

Unidentified Analyst

I know you touched on a little bit on developer registration around the near field products. But just anything new in terms of the end markets they are touching. .

Kevin Mills President, Chief Executive Officer & Director

They’re touching every market, surprisingly literally every market. And one of the interesting things is a lot of the old developers that were barcode scanning developers are coming back and looking at the near field products, including some of our mobile point of sale partners.

So across the board there’s a lot of interest in what can happen there, and I think as applications for near field emerge with companies like Apple promoting the near field capabilities of their devices and how that near field capability is available to application developers, you’re going to see new used cases emerge.

And so with our D600 product, we are ready to have a handheld solution that our developers can turn to. .

Unidentified Analyst

Just one more from me, one of your point of sale application partners, public ones, commented on sort of targeting at a move up market. I’m curious if you can have any clearly normal feasibility in to what they are doing but do you have a sense that you are being pulled up market on the point of sale side at all through the application channel. .

Kevin Mills President, Chief Executive Officer & Director

We do. We draft off of their efforts to move in to different markets. So as we saw our partners originally [Calico] retail, boutiques and specialty shops. As we saw them go in to other applications like quick service restaurants and service industries where inventory was big, we saw ourselves get pulled in to new inventory opportunities.

And so in the same way as they address new markets, we see ourselves also being able to address those markets. And we certainly have the products to address the markets. So enabler is the application dealing with the service to market and then our product confluence that. So we definitely dropped off of those opportunities. .

Operator

And then our next question comes from [Al Troy]. Al you can go ahead with your questions. .

Unidentified Analyst

Kevin you mentioned that China Socket scanners have improved sales in China.

Do you expect substantial revenue from China?.

Kevin Mills President, Chief Executive Officer & Director

Yeah, we do, but not instantly. As we’ve pointed out many times and no ones’ going to write software for products that don’t physically exist in their space. And there is a process to it. First we have to make the product available which we know it took as I said a bit longer and there’s a lot of regulations in China to get through.

But the products are now available, which then encourages people to bake them in to their solutions, because ultimately they want to sell their software and the hardware they need to support it to be available. So, yes we think China is a very big market, and looking at the VDC numbers, China I think represents the second largest market for us.

But the third largest market after combined Europe, and now we’ll start to be there. It will take a quarter or two, but yes, we expect that to do quite well in China going forward. .

Unidentified Analyst

That sounds good, if China could generate a lot of revenues.

Do you have any investment conferences planned for the near future to tell your story to investors, mutual fund, etcetera?.

Kevin Mills President, Chief Executive Officer & Director

At the moment we don’t have a lot plans. As you know we did do the Sidoti Conference in New York. So we’re following on people based on that and we continue to reach out to people.

The Sidoti Conference did generate a reasonable amount of interest, but we would like to kind of work through that interest and see how applicable it is before commit to the next. We are aware of those other conferences that we can sign up from the fourth quarter, but we haven’t signed on the dotted line for any of them at this stage. .

Unidentified Analyst

Is there any change of like issuing any interim information to shareholders like there was no releases between the second and third quarter. So like the new products coming out or anything that’s doing like China was approved or stuff like that.

Is there any way of letting us know in the mean time without having to wait for the end of the quarter conference calls?.

Kevin Mills President, Chief Executive Officer & Director

Yeah, we can certainly look at that. I think we’ll have some new products to announce, particularly a time that’s busy for us would be towards the end of the year or January as we have new products to launch etcetera. So I think you will see some more activity in that area between now and the next conference call that you had in the past. .

Operator

And our next question comes from [Michael Haggerty]. You can go ahead with your question..

Unidentified Analyst

I have a couple of questions around the stock holding the float.

And obviously there’s a general concern amongst everybody that the stock appears to be somewhat undervalued, and I tend to assume that to some extent reflecting maybe possibility of the slower growth in the horizon which somewhat got seen in this quarter, although for some special reasons.

I’m wondering if you’ve considered starting to divert some of the free cash flow that’s coming through in to share buyback. That was my first question. My second question is, when you mentioned that we’ve got 2.3 million options currently outstanding, I’d like to know how many options are issued each year.

And then a third point is, I’d just like to make a statement really, it’s not intended to be a criticism.

But when I look at the insider trading and see the number of transactions that take place for management, I saw that in the last 18 months two members of management have traded options 24 times, and the total revenue or the total profit of those trades is less than a $100,000.

It’s not a question about how much money they are exercising or bringing in. But I think a casual observer looks at the insider trading and sees senior level management exercising options 24 times in 18 months that’s two people. I think that can send a signal of a lack of confidence and concern to potential investors.

So those three points please, if you may..

Kevin Mills President, Chief Executive Officer & Director

I’ll start with the last one, which is the trading of the stock. Most of us have 10b-5 which is a vehicle that we use, where we make a plan. I can speak for myself, I make a plan once every year or once every two years and it gets triggered based on activity in the markets, which is outside my control.

And I believe, I don’t know exactly but I would say over 20 of those 24 trades were triggered by 10b-5 plans so they are based on a blind trust. On your point about, have we considered dividends or other things. In Q3, I think we finally cleaned up our balance sheet. We converted debts, we have no long term debts.

Yes we’ll have to look at a plan for the cash, but we don’t have such a plan right now. To me any plan to buy back shares or do other things was premature, based on the fact that we had still outstanding convertible debts. So once we converted debt, I think now is the time to look at it and we will look at it.

Lastly, on your question about stock options, we do have a shareholder approved stock option plan that generates 4% of outstanding shares put in to the option pull on manual basis. And those are distributed to the employees and management, Board of Directors etcetera and we generally hold a reserve of around 100,000 to 150,000 shares.

So if we have 7 million shares outstanding at the end of this year, the 4% would represent 280,000. .

Unidentified Analyst

So there’s 2.3 million actually issued at the moment?.

David Dunlap

Yes. But they are not all vested. Typically our options vest over a four year period. So there is 1.7 million that are vested, there’s another 0.5 million that we’ll vest over the next three or four years. .

Kevin Mills President, Chief Executive Officer & Director

And the vesting is done based on the fair market value of the stock during that time. So the employees are able to buy shares today let’s say worth $4 and you get an option. You get an option to buy shares at $4, obviously the appreciation generates wealth for everybody including the option [piece], but it’s not like we get the shares for free. .

David Dunlap

And Michael that is a shareholder approved program and it’s certainly from our experiences it very closely aligns the interest of the employees with the shareholder interest, because everybody is focused on doing the things needed to generate increased value for the company.

I also Mike mentioned that from a perspective on cash, we find cash from an operating standpoint to be very helpful in our relationships with all our stakeholders.

Larger organizations that are considering buying our products, one of the things that they will scream for is the sustainability of the company to be able to continue to service the products that they buy. And with our positive operating results and cash balances, we pass those screenings today.

A few years ago we weren’t passing them with (inaudible) acceleration. And it’s true across our suppliers, it’s really there to assure our suppliers if we get a large order and one that greatly picks up the pace of ordering, our suppliers don’t question our ability to pay when due.

So there are levels of cash that become very helpful in the operations of a smaller company and at this point we’ve appreciated that. .

Operator

[Operator Instructions] And we have no further questions at this time. .

Kevin Mills President, Chief Executive Officer & Director

So I would like to close by just thanking everyone for participating in today’s call and wish you all a good afternoon. Thank you..

Operator

Thank you ladies and gentlemen. This concludes today’s conference. Thank you for participating. You may now disconnect. Speakers’ standby for your post-conference..

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