Socket Mobile, Inc. — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016. Financial statements are unaudited. Socket Mobile develops and sells mobile data-capture products, principally Bluetooth barcode scanners, through distributors. The company phased out its SoMo handheld-computer product line during 2016 and exhausted remaining units in Q3.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $5.10 million | $4.52 million | $15.36 million | $13.01 million |
| Gross profit | $2.63 million | $2.24 million | $7.72 million | $6.16 million |
| Gross margin | 51.5% | 49.5% | Not stated | Not stated |
| Operating income | $718,305 | $601,243 | $1.90 million | $1.10 million |
| Net income | $669,050 | $529,775 | $1.73 million | $859,282 |
| Diluted earnings per share | $0.10 | $0.09 | $0.27 | $0.14 |
| Operating cash flow | Not stated | Not stated | $631,623 | $824,762 |
Q3 revenue rose 13% year over year; nine-month revenue rose 18%. Cordless barcode scanners and accessories generated $4.64 million in Q3, up 15%, and $12.67 million year to date, up 11%. Nine-month mobile handheld-computer, accessories and license-fee revenue increased 88% to $2.33 million, but included a last-time buy and one-time license fees; excluding these, reported sales declined. Service revenue was $67,000 in Q3, down 39%.
Q3 gross margin improved from 49.5% to 51.5%, which management attributed largely to license-fee revenue with no associated cost, as well as manufacturing efficiencies and lower engineering and component costs. Operating expenses increased: R&D was $704,335 in Q3 and $2.10 million year to date; sales and marketing was $694,061 and $2.06 million; general and administrative was $513,114 and $1.65 million. Lower interest expense contributed to improved earnings.
Financial position, liquidity and debt
- At September 30, 2016, cash and cash equivalents were $1.15 million, versus $938,155 at December 31, 2015. Total assets were $10.17 million; current assets were $5.17 million and current liabilities $4.01 million.
- For the first nine months, operating activities provided $632,000, investing activities used $175,000, and financing activities used $249,000. Cash increased $208,000. Operating cash flow was below net income, primarily reflecting working-capital uses, including lower accounts payable and application of a customer deposit to a SoMo last-time buy shipment.
- The company had no bank-line borrowings at quarter end. Its receivables-based facility provides up to $2.5 million, with approximately $1.698 million of borrowing capacity available, subject to eligible receivables, bank discretion and a monthly minimum liquidity ratio covenant of 1.75 to 1. The facility expires February 27, 2018.
- Related-party convertible notes totaled $752,625, classified as current and due September 4, 2017; accrued interest was $354,227. Notes are secured by company assets, bear rates of 8% or 12% (certain notes were previously at 18%), and are convertible at the holder’s option at $1.25 per share. Capital lease liabilities had a present value of $85,707.
- Contractual obligations totaled approximately $5.62 million, including $2.87 million of inventory purchase commitments and $2.66 million of operating lease payments. The Newark facility lease runs through June 2022.
Changes, outlook and commentary
- Management expected Q4 2016 gross margin to be 48%–50%; R&D expense to remain near Q3 levels; sales and marketing expense to be similar to Q3; and G&A expense to increase slightly from Q3.
- Socket Mobile introduced and began shipping DuraScan D750 and D730 products and began shipping its Duracase solution in Q3. The DuraScan D700 was expected in Q4 2016, and Android Duracase variants were in development for an anticipated early-2017 release. Management expected these products to contribute to revenue in 2017.
- The SoMo product family was phased out because key components had become technically obsolete. A substantial part of nine-month SoMo-related revenue reflected a last-time buy and one-time license fees.
- The company repaid $500,000 of related-party short-term credit-line notes in January 2016. Nine-month interest expense fell to $102,380 from $218,152, reflecting reduced debt balances.
- Management was assessing the new revenue-recognition standard and stated it anticipated a cumulative-effect adoption on January 1, 2017; the filing also describes the standard’s later effective date and permitted early adoption.
Risks, contingencies and unusual items
- Revenue is concentrated: Ingram Micro, BlueStar and ScanSource together represented approximately 66% of nine-month 2016 revenue. These distributors are not committed to carry the company’s products, and receivables are also concentrated among a few distributors.
- Two suppliers represented 62% of nine-month inventory purchases, and the top two suppliers represented 28% of accounts payable. Limited-source components create supply and production risks.
- Profitability may not continue. Results depend on product demand, application-developer success, new-product execution, distributor orders and access to working capital. Quarterly results may fluctuate because the company has little backlog and shipments can be concentrated late in a quarter.
- Goodwill was $4.43 million, a significant portion of assets; impairment could materially affect results. The company maintained a full valuation allowance on deferred tax assets, citing negative evidence including its loss history and the SoMo phase-out, despite recent profitability.
- The filing reports no material legal proceedings and no off-balance-sheet arrangements. Customer indemnification provisions may create exposure, although no related claims or liabilities were reported.
- Other disclosed risks include competition and pricing pressure, inventory and returns, foreign-currency exposure, intellectual-property claims, product defects, and the possibility of needing additional capital. Convertible-note conversion and outstanding equity awards could dilute shareholders.
Key facts for investors to verify
- Whether scanner and new-product sales can sustain growth after the SoMo phase-out and after one-time SoMo-related revenue is excluded.
- Whether gross margins remain within management’s Q4 outlook and how operating-expense growth affects profitability.
- Working-capital and cash conversion trends, including distributor collections, supplier payments, inventory commitments and availability under the bank facility.
- Repayment or conversion terms and potential dilution from the $752,625 related-party notes and accrued interest.
- Distributor and supplier concentration, and any developments in goodwill impairment assessment or the revenue-standard adoption plan.