SOCKET MOBILE, INC. quarterly report, Q2 FY2017

Socket Mobile, Inc. — Q2 2017 Form 10-Q

Business context and period: The company designs mobile data-capture products, principally cordless barcode scanners, for business applications. This unaudited report covers the three and six months ended June 30, 2017; comparisons are with the same 2016 periods.

Financial performance

MetricQ2 2017Q2 2016Six months 2017Six months 2016
Revenue$5.81 million$5.21 million$11.43 million$10.26 million
Gross profit / margin$3.11 million / 53.6%$2.58 million / 49.5%$6.02 million / 52.7%$5.09 million / 49.6%
Operating income$908,000$579,000$1.58 million$1.18 million
Net income$490,000$517,000$876,000$1.07 million
Diluted EPS$0.07$0.07$0.12$0.16
Operating cash flowNot separately statedNot separately stated$702,000$457,000
  • Revenue increased 11% in both the quarter and first half. Cordless barcode scanners and accessories generated $5.69 million in Q2, up 41%, and $11.24 million in the first half, up 40%. These products represented about 98% of Q2 revenue.
  • Gross margin improvement reflected supplier component-cost reductions at higher volumes and a product mix weighted more toward scanners. Operating expenses rose: first-half R&D was up 18%, sales and marketing up 10%, and general and administrative expense up 13%.
  • Net income declined despite higher operating income, principally amid a much larger income-tax provision: $387,000 in Q2 and $640,000 for the first half, versus $33,000 and $41,000, respectively, in 2016. The 2017 first-half provision included $614,000 of deferred tax expense.
  • Cash and cash equivalents were $2.13 million at June 30, 2017, versus $1.32 million at year-end 2016. Current assets were $8.17 million and current liabilities $3.49 million. Total liabilities were $3.83 million; stockholders’ equity was $17.97 million.
  • First-half operating cash flow was $702,000, investing cash outflow $88,000, and financing cash inflow $201,000, primarily from exercised stock options. Inventory increased to $2.23 million from $1.54 million at year-end, partly reflecting preparation for higher sales.

Material changes and unusual items

  • Effective January 1, 2017, the company changed distributor revenue recognition: it recognizes sales when shipment is completed and title transfers, net of estimated returns, rather than generally deferring revenue until distributors sell products onward. The transition produced a one-time $503,000 net improvement in retained deficit after tax effects. This accounting change affects comparisons with prior periods.
  • The company released its full deferred-tax valuation allowance at December 31, 2016, citing three consecutive years of increasing net income and expectations of continued profitability. Deferred tax assets were $8.64 million at June 30, 2017; realization depends on future taxable income.
  • Mobile handheld computers were phased out in 2016 due to component obsolescence. Their revenue fell sharply; scanner growth more than offset the decline.
  • Related-party convertible notes of $753,000, plus approximately $441,000 accrued interest, were outstanding. The notes mature September 4, 2017, are secured by company assets, and are convertible at the holder’s option at $1.25 per share. The bank line had no borrowings; stated available capacity was approximately $1.96 million.

Outlook, risks and contingencies

  • Management expected the D600 contactless reader-writer to be delivered in Q3 2017. R&D expense was expected to remain flat with Q2 levels for the rest of 2017; sales and marketing expense was expected to increase moderately, while G&A was expected to remain flat. The filing provides no numerical revenue or earnings guidance.
  • The bank facility permits up to $2.5 million subject to qualified receivables, bank discretion, and a minimum liquidity ratio of 1.75 to 1. The domestic line was extended to February 2019; the international line expires February 2018.
  • Contractual obligations included $3.25 million of inventory purchase commitments, $2.35 million of operating lease payments, and approximately $67,000 of capital lease payments. The office lease runs through June 2022. No material legal proceedings or off-balance-sheet arrangements were reported.
  • Key risks include reliance on a small group of distributors and suppliers, application-developer adoption and customer deployments, product development and component availability, distributor returns and inventory levels, and the ability to sustain profitability. The three largest distributors represented about 75% of first-half 2017 revenue; Ingram Micro alone accounted for 39%. The top two suppliers represented 58% of Q2 inventory purchases.
  • A 10% adverse currency move was estimated to reduce Q2 net income by approximately $33,200 if unhedged. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.

Important facts for investors to verify

  1. Whether the scanner-led revenue and margin gains continue, and how distributor sell-through and returns develop under the new revenue-recognition policy.
  2. How the September 2017 related-party note maturity and accrued interest were resolved, including any repayment, extension, or conversion and resulting dilution.
  3. Whether the deferred-tax assets can be realized through future taxable profits and whether future ownership changes could restrict use of net operating losses.
  4. Whether the D600 launched on schedule and whether demand, component supply, and distributor concentration support the company’s growth expectations.
  5. Whether working-capital needs, inventory purchase commitments, and facility covenants remain manageable as sales expand.