Socket Mobile, Inc. (NASDAQ:SCKT ) Q2 2022 Earnings Conference Call July 28, 2022 5:00 PM ET

Kevin Mills - President and CEO

David Holmes - Chief Business Officer

Steve Swanson - Private Investor

Chris Sakai - Singular Research

Welcome to the 2022 Second Quarter Financial Results for Socket Mobile. My name is Hilda and I will be your operator for today's call.

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 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 material 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 doing so, the risk of 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.

At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] Please note that this conference is being recorded.

On the call with me today, are Kevin Mills, Chief Executive Officer, Dave Holmes, Chief Business Officer, and Lynn Zhao, Chief Financial Officer. I will now turn the call over to Kevin Mills. Mr. Mills, you may begin.

Thank you, operator. Good afternoon, everyone, and thank you for joining us today. In Q2, our revenue increased slightly to $6.05 million over our revenue of $6 million in Q2 2021. Our gross margins were 50.2% compared to 54.7% in Q2 2021.

Our margins were lower as we paid more for components and freight costs were higher due to the ongoing global supply issues. Our earnings per share were $0.01 compared to $0.27 in Q2 2021, which included a tax benefit of $0.20 per share. In Q2, we experienced some strong headwind and our results were impacted by supply chain issues and material shortages that were outside of our control.

Historically, about 55% of our retail business is driven by the deployment of new whole point of sale system where the scanner is sold as a component. The remaining 45% of our retail revenue comes from scanners purchased some plan after the initial deployment, which we refer to as upgrade business.

In Q2, we saw the deployment portrait of our retail business was significantly impacted by a shortage of other hardware components, such as mobile printers and cash drawers. This reduced our app partner's ability to deploy new solutions. As a result, our deployment associated revenue dropped the 38% of our total retail revenue. These shortages were not expected and were outside our control and impacted our business despite the fact, we worked hard to be in a position to deliver.

The upgrade portion of our business for end customers added scanner sometime after they deployed the mobile point of sale system remains strong and the upgrade portion of our business increased to 62% of the total retail business and we were able to deliver without any issue.

In response to these market changes and the unforeseen supply issues, especially while [indiscernible] and pastures, we plan to focus more on the upgrade business for the remainder of the year. In Q2, we announced our SocketScan S720 an upgraded version of our best-selling S700 in replacement with few hours scanning support. As many of you see in your daily life, QR codes have become ubiquitous and are regionally used in payment related activities. We believe many small retailers will need to support this requirement in the coming quarters and the S720 has been designed to serve that requirement. The S720 is aggressively priced at $249 and we 8% higher than the S700.

We also feel it will be a desirable home production for the more than 400,000 S700 end users, especially within an attractive trade program we'll have. We expect to start shipping the S720 in late August, while it's impacting Q3 will be small, we feel it will significantly impact Q4 and enable us to resume our growth regardless of the supply issues in the market. In Q2, we also made significant progress on initiatives that we believe will ensure our long term growth and success.

And I'd now like to hand the call over to Dave Holmes, our Chief Business Officer to provide an update on those initiatives. Dave?

Thank you, Kevin and good afternoon, everyone. Today, I'd like to highlight a couple of the key milestones that we achieved in Q2 as we continue our journey of becoming a more comprehensive data capture company. We made significant strides with our capture SDK software tools. We continue to provide best-in-class development tools for our application partners and we support all of the major development environments in the market today. The SDK team has grown and we are very proud of the work that they have been delivering.

In Q2, we upgraded Capture SDK to include SocketCam C820, our free camera-based scanning software that turns any mobile device into a high performance barcode scanner. Our app developer partners to now begin offering free scanning to their customers. Capture SDK with C820 allows our developer partners to serve all of their end users from price sensitive to performance sensitive with one integration.

Socket Mobile scanners are primarily used in performance sensitive portion of the data capture market, but we have a commanding market share. That said, our application partners have end users with different data capture needs, and they're often not data capture experts. Historically, they typically only add Capture SDK to support socket scanners when their customers ran into performance or productivity issues. The addition of C820 will allow our development partners to bring socket scanning expertise and capabilities to a much wider audience.

Within completion of phase one, by adding free camera scanning to Capture SDK, the team is now working hard to deliver enhanced camera scanning through the SDK in the second half of 2022, which we will offer on a monthly subscription basis. We think this is a critical piece in the data captured journey and it will make us a more complete hardware and software data capture company heading into 2023.

Also, we're seeing positive signs with our NFC business as more developers begin embracing contactless technology. Initial commercial deployments of our S550 NFC reader rider for mobile ticketing, emoney and loyalty applications are resulting in exceptional consumer experiences, happy app development partners, and follow-on projects.

Finally, we introduced SocketScan S370, a universal NFC and QR code mobile wallet reader. This gives our app partners the flexibility to accept multiple formats with one device. With the myriad of credentials types out there S370 also provides our partners with the peace of mind that they can implement one device and not have to worry about choosing the wrong technology. S370 can also read credentials following ISO18013-5. This is the standard being adopted for mobile driver's license or MDL in most states and countries.

We're seeing positive signs all around and we continue to invest in digital ID and NBL space. We feel this is a big opportunity and that Socket Mobile is well positioned to become a significant player in the MDL reader space. This will mark another evolution in the data capture journey. In addition to reading barcodes, to capture data about products and things who will also be reading QR codes and NFC credentials about people in identities.

With that, I'll turn it over to Lynn for more details on our financial results. Lynn?

Thanks, David. Thank you, everyone for joining today's call. Our Q2 result -- Q2 revenue was flat compared to last year at $6 million and decreased by 4% sequentially compared to $6.3 million in Q1. We believe that their slowdown in Q2 was because of our retail customers have been unable to obtain their mobile printers and cash drawers, with switch our scanners pair.

The second quarter's gross margin decreased by 450 basis points compared to prior year quarter, but the increase of 50 basis points compared to the preceding quarter. The decrease in margin versus the prior year quarter was driven by persistent higher component and the freight cost. Q2 operating expenses were $2.85 million increase of 17% over the prior year quarter. We have moved our business to a new location in Fremont, California. The lease agreement we entered was effective May 01, 2022.

Although we are entitled to free rent in the first is three months, the street line rent for May and June was charged to our expenses, which cost the 3% increase of the operating expense. Spend on engineering increased to 15% driven by hiring in our SDK team as to continue commitment to research and development activities, which is essential to provide a new product offering to provide engineering support for key customers and to maintain our existing products.

Increases in sales, marketing and the customer support are 31%, reflecting the cost associated with higher headcount and consulting in the external professional services. General and administrative expenses increased by 4%.

Q2 operating income was $189,000 representing a 3% operating margin. Earnings were $104,000 or $0.01 per fully diluted share compared to $0.27 per fully diluted share for the prior year quarter, which included an income tax benefit of $0.20 per fully diluted share. Adjusted EBITDA in the first quarter was $0.6 million decreased by 46% from prior year quarter of $1.2 million.

In Q2, we generated a free cash flow of $0.6 million and invested $0.4 million in capital assets, including equipment software and the website development. We ended a Q2 with the cash balance of $5.6 million.

As of June 30, our inventory level net off reserve was at $4.9 million compared to $5.2 million at the end of 2021. Increased inventory was related to purchases committed prior to quarter Q2 or even last year. Although the increased inventory helps us navigating the supply chain disruption, we are taking steps to manage the inventory for the remainder of 2022 in the face of the near-term headwinds. We believe our balance sheet and the liquidity continue to be in a healthy position to meet the challenging environment.

This wraps out our prepared remark. Now I will hand the call over to the operator for questions.

Thank you. We will now begin the question-and-answer session. [Operator instructions] We have a question from Charlie Chambers from C3. Please go ahead.

Thank you. Question about the share buyback. Can you shed some light on that? Thank you.

Okay. Yeah. We entered the 10B5 plan in April. So as of today, we have purchased 150 K shares of the common stock from the market and there we will continue the purchasing of another 30 K shares for this quarter. Then our 10B5 plan -- according to our 10B5 plan for the next quarter we'll enter a new purchase after we started the next quarter.

Thank you. The next question comes from Frank [ph] from Prudential Securities. Please go ahead.

Hi, Kevin, Hi Lynn. Frank [ph] here. Well, one of my questions on the buyback was partially answered. My question is, it wasn't going to be my first question, but the criteria that you use, I hear you using shares. Is it predicated on the previous volume of the previous week or previous month on how many shares you can buy back at a certain percentage? That's the first question.

Yeah, according to 10B5 plan, only we purchase their shares, the pursuant to the rule 10B18, which defines their volume, the pricing, in general, it's their average, four weeks volume -- trading volume preceding the 10B5 plan starting date.

Okay. Now the final question is twofold. One example, I recently tried to lease or buy a new car, the dealer, very enthusiastic, and then, as I'm ready to exit the car, he says, oh we are missing a couple chips, but we expect all the chips and everything, this is General Motors by the way, to settle by year end.

And my question is since like locally here, there are houses, well over $500,000 and with the interest rates now going up, most of the companies have had pretty good heads up with Powell telegraphing, the fed's move well in advance, but the housing market, which was booming, now it's subsiding to a point where the builders are reducing locks by some $50,000 houses by $50,000. So the people can qualify for the houses. Now I see you have new products.

Is it possible that you could come up with some new business plan that could denote each product and what your expectations are for them if all the things fell in place, meaning your supply chain and your material shorts. I know it's been tough with the COVID. I know it's been tough with the gyration that they're gone on around the world, but there's a lot of people that, they still have their phones in their hand, the businesses, the world is run by iPhones and, I applaud you for your products.

But the question is I'm a novice in the arena. The question is like each product is -- what is your projection for, if everything was normal to what would each one contribute to the bottom line And, once your costs have abated and you're on street, so that's my question.

All right. So it's a bit of a complicated question. So let me answer it in the following. 70% of our business is driven by activity in the retail space. Primarily we benefit as people deploy iPad-based cash registers in various boutiques and small business.

We have a range of product that allow the end customer to choose at what level of the scanning performance they need. The product we're introducing now the S720 is an entry level product that has the additional benefits of reading, not only the linear barcode, but a QR code also, because we see from our customers that more and more people are coming into their stores with QR code-based coupon, QR code-based payment requirements, etcetera. And therefore the merchant who needs to service this requirement needs to have a scanner that supports that requirement.

And as you are just bought a car, even with General Motors, they do offer, the same car with a two liter engine, a three liter engine, a four liter engine, a diesel option, a petrol option, electric option. We basically have some of the same issues. It's very difficult to just have one car that is going to serve the market because different people, whether they're more fuel conscious, or performance conscious, determines what they need to buy.

And similarly our products fall into a range where we offer variations, just like a General Motors between diesel and petrol and electric and engine size. And then ultimately the consumer finds a fix that meets their requirement. So we get a lot of leverage through this model and the benefits, the short-term interest rates impact our customers because people have less disposable income, but ultimately if you're running a shop and you have a cash register system, even if you have less traffic you do need to scan the items to make sure your inventory is correct, and that your book balance at the end of the period. So that's the answer to your question.

Now as Dave Holmes has pointed out, we have some new areas we're going into and we believe the investment in those areas will open up new opportunities going forward. So, sorry that it's a bit of a circuitous answer, but I think it's the best I can do to kind of cover the question you asked.

Well, I appreciate the answer and believe me, I have tried to understand the company from three years ago when I first got interested in your products and I saw, this growth factor, I did not expect these huge bumps in a road. The larger companies, they've got a big everybody's sign and say, oh, well, so, and so's got $50 billion loose, certain $12 billion loose and all that. I understand you're a small, but I consider you a little gross company and I thank you for the understanding.

Okay. I appreciate it, Frank. Thank you very much.

Thank you. Our next question comes from Steve Swanson, who's a private investor. Please go ahead.

Good afternoon. Hey it looks like you sold about 27,500 scanners in first quarter. What was the count that you had sold for second quarter?

It was 26,537, I believe. About a thousand units left a little bit less, but not all.

Okay, thanks. Are we going to -- is Socket planning on increasing scanner prices going forward to help offset the increased component input prices? And I guess what I'm trying to, what a roundabout way of asking is what's our long term gross margin target going to be, and how are we going to get back to it?

Well we increased gross margin by about 0.5% last quarter. We are comfortable that we have stabilized the prices. We did pay a lot of premiums in the first six to nine -- in the previous nine months that I think we're paying less premiums. And on the component side are comfortable that we have a plan to get back to the 54 point gross margin range without increasing prices.

Obviously we're introducing some new products like the S720, which will help on the margin side, even though the price point is still very attractive. I think in the short term, the biggest impact on the margin is actually overhead allocation, which is really fixed. I think last quarter, because we made a few less units that impact us by as much as a, another quarter to half percent.

So we're comfortable we have a plan to get back to the 54 point gross margin without raising prices. And we don't think raising prices in the short term is the right thing to do either because it makes us much more attractive against the competition, some of whom have raised the prices.

Okay. Thanks for that. Another question sales and marketing costs up 31% in the quarter and 33% for the first half of the year, which is just under a $1 million increase over last year run rate for the full year. Is this more heads? Is this, what are we actually spending this money on? And is it -- is this step chain going to be permanent or is it a first half kind of a thing? And if it's permanent, what do we actually see long term getting out of this extra money we're spending on sales and marketing?

We've spent a lot of money to revamp and upgrade our website to make sure that it is our primary go to market vehicle including launching sites in other countries and other languages. I think that, to be honest we were underspending for quite some time. I think the level is more in line with what we want to do. It's not going to increase much more but in today's, global world a person in Japan, who's buying our product expects to be able to read about the product and buy the product in Japanese.

And we have incurred the cost to do a lot of this work, which is largely a onetime investment. We will have to obviously maintain it, but at the moment there's a bit of a lift particularly as we have in my opinion, upgraded our website significantly over the last six months.

Well, I do agree that your website looks a lot more professional and user friendly than it did in the past. So it sounds like there's $0.5 million or $470,000 increase in sales and marketing for the first half of the year. You're saying that that isn't gonna be the run rate going forward. It'll tail off a bit. There will be some more spend because of maintaining it, but you had a bigger push in the first half of the year to get that upgraded. Is that what I'm understanding?

Yeah, but we're not done yet. If we're honest, I think that we have to push and maintain the higher levels probably for another quarter. Maybe a quarter two, and then it'll level out, but we're still doing a lot of work to include things like product selectors and other things, which we believe will enhance the business going forward. And it's our primary go to market strategy. As you know, we don't actually have feet on the street sales people anymore. So the webpage really is our flow case, our display window, if you will.

Okay. Thanks for that, Kevin. Last question I got is can you provide a little more color around this Q3 upgrade program where I think you're moving people from the S700 to the S720, is that something that they're going to keep their existing scanner and you just upgrade the software at a cost or is this they send you their old scanner, you send them a new scanner kind of, can you help me understand what we're trying to accomplish with this program?

Yeah, so the way that this would work is that you would be able to buy the upgraded scanner and we would then send it to you. You would then return the old units and we would rebate you something in the region of $50 to $100 depending on the unit you returned and whether you allowed us to use the motherboard from the old units in the unit that we upgraded. And so we made it reasonably straightforward.

We do have return centers in most countries. So for a person in Germany if they bought us, they would be returning their scanner to a local people in Germany. So the cost of returning it is quite small. And then they get upgraded and they get the benefit of the new system and they can then support QR codes.

So we'll have a pretty good plan and aggressive plant reach out to the people that already have scanners. We see that the requirements have changed and we want to make them happy customers going forward as well as they've been in the past. So it'll work pretty well and actually going back to your previous question, we've done a lot of work on the web to make this a automated process.

So all of your units are now tracked. You can see them in terms of the upgrade is we automatically check when your unit was manufactured and we can then customize the rebates based on how old it is, etcetera. So we think it'll actually go quite well, but people will get a new or fully refurbished scanner, and it's not a software update, it's a physical upgrade.

Okay. So it'll be if I'm a customer and I opt for this program, I'll send you some money. You'll send me a brand new scanner at 720, where, so I can keep working with my S700, I'll convert to that and send you back the old 700. I think you said there were a 100,000 of these in use currently that might be potentially upgraded over time. Does the return unit just get thrown in the trash or you scabbing that for parts what happens with your return?

Well, when you select how much rebate we would, the motherboard in the return unit is fully usable and can be recycled and we would encourage people to do that. Certainly we don't want to be throwing good units into landfills, etcetera. So the idea would be that we would refurbish and make sure that the return unit is fully functional and meets all respects. And that would be reused in a 720, which we think is the responsible and environmentally friendly thing to do.

Got it. So if I wanted, I guess there'll be some pricing differences. If I wanted a refurbish unit, it'll be a lower cost. And if I wanted a brand new unit for the second one…

So you're going to try to scavenge these parts where you can, so you don't end up throwing these all into a landfill, which is good to hear. I appreciate the feedback on the questions I had. So that's all I have for today. Thanks.

Thank you. Our next question comes from Chris Sakai from Singular Research. Please go ahead.

Hi, Kevin and Lynn. I just had a question on the 50 basis point increase in gross margin. What was the driver -- what were the drivers there? What led to the increase?

Well there was a few things, but I think the main thing that led to the increase is that we compressed the reseller margins at the halfway through the quarter. So we didn't increase our end user price, but we did reduce the discounts we give to certain elements of the channel. And as a result, our effective price into distribution went up in certain categories, and that was part of how we started to reduce the margin.

The other thing that I think that's happening is that the premiums we paid on components during the first half of the year have come down somewhat and therefore the component costs are slightly better. So, we did feel that we could get our margins back into the, mid-fifties and Q2 was kind of the first step on that product, but going forward, I think it'll be primarily based on less premium as opposed to adjustment in the distribution channel.

Okay. All right. Thanks for that. And, your operating expenses increased 17% from year-over-year. Just wanted to get a sense, will these, I know it was 7% increase sequentially, but will we see a decrease in operating expenses back to lower levels?

Well in Q2 you also had about a $100,000 due to this GAAP requirements to straight line our rent. But I hate to answer your question. Our expenses will come down a little bit but we find ourselves in a position where we have what we feel is an enormous opportunity with the free scanning and the enhanced scanning in the camera based stuff, plus we have a lot of early fraction in the NFC world.

So we're not overly inclined to reduce our engineering our sales and marketing expenses. We tighten our belt a little bit, but be a little bit because we think the opportunity we have in front of us is too good not to keep our foot down on the gas if you will, even in these tough times over the next six months.

The next question comes from Charlie Chambers from C3.

Yes. Thank you. Stock buyback, the average strike price for 1Q, 2Q in year-to-date is the first question. I think the total was mentioned as about 150,000. I think 1Q was about 96,000 shares. And then the second question is going to be on the QR code strategy moving forward. Do you see it something like a WeChat and China combined with QR code for access, which is barely used here at the United States. Thank you.

All right, so I'll Lynn answer the first question on the number, the prices we paid, but we do have in the 10B5, when we did the 10B5. We are limited to 1.5% of the outstanding shares in any given quarter, which is about 90,000 shares. I don't know the exact prices. So maybe Lynn could answer that question.

Yes, actually it's a 1.25% of the -- yes it's 1.25% per quarter of the outstanding shares. So in the first quarter, we purchased 91,000 shares at the average price, about 410. And there as of yesterday, Q2, we have bought let's say this one about 68,000 shares at their average price about $3.

Okay. As regard to QR, so I think you're exactly rising your question, in much of Asia and particularly in China, QR codes are used for payments everywhere, which is not have been the case in the US and to a large extent in Europe. However, this is changing. You now, even on an airplane can convert your credit card into a QR code so that they can do the payment using that mechanism instead of having to swipe or inserter half the card.

And we do see that coming as a big wave, especially as QR kind of became the norm during COVID with certifications and other types of identification, etcetera. Many of the merchants that use our product have a reader that was designed for product and it doesn't support QR code, which is why we're doing the upgrades.

So the newer version would just to do everything the S700 does in the one day world, but also support QR codes, as well as another few codes that they may need for the payment activities that we see coming at them. We are not really in charge of the timing of these activities, but we do see a lot of indicators that you will have a weak that equivalent and it can be driven by a PayPal or credit card companies, etcetera going forward. And the merchant has been a position to respond and have a device that we set. So going back, I think that you are exactly right, that issues that have been common in Asia and particularly China will go global based on QR will feel over the next 12 months.

Thank you. We have a question from Frank Frank [ph] from Prudential securities. Please go ahead,

One more question, on the sales force, national and international, I don't see Vietnam example. I had my Japanese friends. I was showing them golf courses in Florida, the cost is too high. We ended up in Hawaii, they ended up selling out. Now their major businesses are in Vietnam. What is our potential for salesman directing the potential customers like all of them -- all the majors to your website? What is your driver as far as, why would they tune into your website versus, like the logic or one of them, the larger content,

Right. So we don't have any Vietnamese website. We have a Japanese website and we sell a significant number of products in Japan. And, our business model follows with the iPad and the iPad is too expensive in a number of countries and Apple products, even though they sell very well in the US and in China, Japan and in Western Europe countries. They don't sell that well in Asian countries because of the price point.

Primarily, we've been focused on being the companion scanners of the Apple. The now this is changing and one of the things we're doing with the free camera scanning is we would be able to service the Android market, which is much bigger and by starting people at a lower price point, we feel we'll be able to support more of the world with these options going forward.

We would not contemplate adding a jeopardy Vietnamese or other websites, unless we already had some business in that area. So it's a little bit further down the track before. We would consider that. Today I think we have six or seven website, including Germany, France, Spain and obviously UK and Ireland, English. We have Japanese, Australian, etcetera, but all that takes maintenance and support.

Okay. And going back to your iPad situation, too expensive abroad, all I can tell you is my grandkids eight and 12 years old, they are up to date. They nagged their mother and father. They have to have that new iPad and of course games, but they're selling like crazy either way whenever they update. Okay. Thank you.

[Operator instructions] At this moment, we show no further questions. I would like to turn the call back to Mr. Mills for final remarks.

Thank you, operator. So in summary, in Q2, we delivered solid results and made significant progress in a very challenging environment. We reveal we are continuing to build a solid foundation that will enable us to grow our revenue and importance over the next two years. And I'd like to thank everyone for your time and interest in Socket Mobile and wish you all a good afternoon.

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