Operator: Welcome to the Socket Mobile Third Quarter 2017 Management Conference call. My name is

Transcription

1 Final Transcript Conference Call hosted by Socket Mobile Call Title: Q3 Management Conference Call Confirmation Number: Host: David Dunlap, CFO Date: October 26, 2017 Time/Time Zone: 4:00 pm Central Time SPEAKERS David Dunlap Chief Financial Officer Kevin Mills President and Chief Executive Officer James Lopez Vice President of Marketing, Sales, and Developers ANALYSTS Will Hamilton Manituck Hill Partners Matthew Galinko Sidoti & Company Al Troy Private Investor Michael Hagerty PRESENTATION Operator: Welcome to the Socket Mobile Third Quarter 2017 Management Conference call. My name is Darryl, and I will be your operator for today s call. 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. 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 Mobile s Third Quarter Management Conference call to review results for its third quarter and nine months ended September 30 th, Presenting today from Socket Mobile are Kevin Mills, President and CEO; James Lopez, Vice President of Marketing, Sales, and Developers; and Dave Dunlap, Chief Financial Officer.

2 Page 2 Socket Mobile distributed its earnings release over the wire service earlier today. The release has also been posted on Socket Mobile s website at 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 Socket s 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 a 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 risks that market acceptance and sales opportunities may not happen as anticipated; the risks 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 risk 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 forwardlooking statements. And now, with that said, I d like to turn over the call to Socket s President and CEO, Kevin Mills. Kevin?

3 Page 3 Kevin Mills: 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 million we reported in Q Our Q3 cordless scanning revenue was $5 million, 11% higher than the $4.6 million we reported for these products in Q 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 100% sure of the cause, we suspect the extreme weather across the U.S. in early September was a 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 $467,000 in other revenue in Q3. This was from licenses from our SoMo 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.

4 Page 4 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 see 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 coverage of the mobile barcode scanner market. VDC has defined the market by form factors: companion scanners, sled/sleeve scanners and ring scanners, and by market segments: retail, commercial services, industrial and manufacturing, transportation and logistics, and healthcare. Moving forward, we will be aligning with VDC s definitions and will be referencing our market segments and solutions in these terms. Socket was proud to be recognized by VDC as a companion scanner of choice worldwide, favored by more than 1 in 3 users. We hope to see our SocketScan 800 series and DuraScan Solution gain similar traction in the 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 sale, are successfully growing our sales in commercial services, industrial, and logistics segments and has shown continuous quarter-over-quarter 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 of reading data from RFID tags or from smartphones leveraging near field communications capabilities, and we see many new and exciting data capture opportunities around RFID Near Field Communications emerging throughout Now, I d like to hand things over to Dave.

5 Page 5 Dave Dunlap: Thank you, James. Total revenue for the third quarter was $5.475 million, a year-overyear increase of 7%. Socket Mobile s cordless barcode scanners generated $5.022 million 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, 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 continued 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 million, up from $1.912 million in the third quarter a year ago, and up from $2.202 million in the previous quarter. We continue to invest in the costs of new product development while maintaining our commitment to operate profitably. Operating income for the third quarter was $775,000, or $0.11 per fully-diluted share. To that balance, we deducted interest expense of $21,000, minimum income taxes currently payable of $28,000, and deferred income taxes of $312,000 to derive net income for the third quarter of $414,000, or $0.06 per fully diluted share. Deferred income taxes are sheltered by our net operating loss carryforwards 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 th, 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 th, 2017 increased to $6.7 million with a current ratio of 3.7.

6 Page 6 Our working capital growth included a combination of operating profitability and the conversion of $1.2 million in convertible notes plus accrued interest that matured on September 4 th, 2017 and converted into common stock. Our stockholders equity at September 30 th, 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 options 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 have 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 and 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: 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 U.S. and we have seen very solid increases from online resellers like Amazon and CDW during the year. We re also seeing stronger 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

7 Page 7 developer partners servicing the local market to design our scanners into 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. We 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. With that said, I d now like to turn the call over to the operator for questions. Operator: Thank you, we will now begin the question-and-answer session. [Operator Instructions]. I m standing by for questions. We do have a question from Will Hamilton. Go ahead with your question. Will Hamilton: Hi, good afternoon guys. Regarding September, Kevin, you made a comment. The second half of the month bounced back to normal trends, is that what you were saying? Kevin Mills: Yes. Will Hamilton: And that s, has that, I know you don t normally provide guidance, but has that continued, linearly, into October? Kevin Mills: Yes. We track, on a weekly basis, our sales out and if it was just one online reseller, then something could have happened. But, when you look at all of our top resellers, that first two weeks of September were strangely quiet across all online outlets. So, essentially, we did typically half of what we

8 Page 8 would normally do in those two weeks and then 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, I would say, 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. Will Hamilton: Okay, so like the sort of, not to put words in your mouth, but the 15%, 20% type growth that you were experiencing before. Kevin Mills: Correct. Will Hamilton: Yes, okay. And then what was the actual scanner unit sales? Kevin Mills: It was 21,500. Will Hamilton: Okay. And you made a comment that there was 20% growth without deployment. I assume the deployments are those to enterprises? Kevin Mills: Yes, so, it was approximately 20%. I think it came out at just under 20%, but yes, if we take out the deployments in both periods, it was about 20% underlying growth. Will Hamilton: So results were heavier on deployments last year. Kevin Mills: Correct. That is true. Will Hamilton: And was that also the case in the fourth quarter?

9 Page 9 Kevin Mills: Yes, last year, we had the benefit of the start of American Greetings in this period, so we had some good deployments during that period. So, yes, I believe that is the case. Will Hamilton: Okay. That s helpful. 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 don t want to be too open. Kevin Mills: If we gave you all the color now, it wouldn t be a surprise when we launch, but 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 we generally launch our new products and people evaluate all the new products in the January/early February timeframe, which is one of the reasons why business tends to be quiet during this period, and then people start purchasing mid- February. We will have, I think, updated versions with good price points to meet or exceed customer expectations in that time frame. Will Hamilton: And then can you just provide, lastly, an update on the DuraCase and how that s performing? James Lopez: Yes, the DuraCase is a complement to our 800 series scanners and it allows the 800 series to be married up with a smart phone 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, it s performing well. It continues to be one of our strongest performers. Will Hamilton: Okay. Thank you, guys.

10 Page 10 Kevin Mills: Thanks, Will. Operator: And our next question comes from Matthew Galinko. You can go ahead with your question. Matthew Galinko: Hi. Good afternoon, guys. So maybe 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 just deferred as a result of natural disasters or whatever 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: Well, first of all, I don t think the business was lost. I think it was delayed, so yes, it comes back over the following quarters, but I think actually,it snaps back probably quicker than that. 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 pick that business up going forward. David Dunlap: And our shipments of orders in October to date are now above $2 million, almost reaching the 40%, approaching that, that we would normally see in September and started to move some of that into the October time period. So, we re expecting that 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. Matthew Galinko: Got it, thanks. 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?

11 Page 11 James Lopez: You know, Matt, this was actually the very first time that VDC has addressed the mobile barcode scanning market as a market in and of itself, so this is the very first report. 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 just 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 that hopefully will bring developers as well. Matthew Galinko: Got you. I know you touched a little bit on developer registration around the near field products, but anything new in terms of the end markets they re touching? James Lopez: You know, they re touching every market. Surprisingly, they re literally touching 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 use cases emerge. So, with our D600 product, we already have a handheld solution that our developers can turn to. Matthew Galinko: Got it. Alright, just one more from me. I guess one of your point of sale application partners, public ones, commented on sort of targeting a move up market. I m curious if you have any

12 Page 12 clearly not much visibility into what they re doing but do you have a sense that you re being pulled up market on the point of sale side at all through the application channel? James Lopez: You know, we do. We draft off of their efforts to move into different markets, so as we saw our partners originally tackle retail boutiques and specialty shops, as we saw them go into other applications like quick-service restaurants and service industries where inventory was big, we saw ourselves get pulled into 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 the enabler is the application being able to service the market and then our products complement that. So we definitely draft off of those opportunities. Matthew Galinko: Got it. Alright. Thanks for the color. James Lopez: Thanks, Matt. Operator: And our next question comes from Al Troy. Al, you can go ahead with your question. Al Troy: Thank you. Hi, Kevin. You mentioned China, Socket s scanners have been approved for sale in China. Do you expect substantial revenue from China? Kevin Mills: Yes, we do, but not instantly. I mean, as we ve pointed out many times, no one s going to write software for products that don t physically exist in their space. So there s a process to it. First, we have to make the product available, which we now have done. It took, as I said, a little longer. There s a lot of regulations in China to get through. The products are now available, which then encourages people to bake them into their solutions, because ultimately they want to sell their software and the hardware they need to support it needs to be available.

13 Page 13 So, yes, we think China is a big market. In looking at the VDC numbers China represents the third largest market after combined Europe. We weren t there and now we ll start to be there. It will take a quarter or two, but yes, we expect to do quite well in China going forward. Al Troy: That sounds good, China could generate a lot of revenues. Do you have any investor conferences planned for the near future to tell your story to investors, mutual funds, etc.? Kevin Mills: At the moment, we don t have a lot of that planned. As you know, we did do the Sidoti conference in New York. We re following up with people based on that. We continue to reach out to people. The Sidoti conference did generate a reasonable amount of interest, but we would like to work through that interest and see how applicable it is before we commit to the next. We re aware there s other conferences that we can sign up for in the fourth quarter, but we haven t signed on the dotted line for any of them at this stage. Al Troy: Okay, is there any chance of issuing any interim information to shareholders? There were no releases between the second and third quarter, new products coming out, anything that s doing, like China was approved and stuff like that. Is anybody letting us know in the meantime without having to wait for the end of the quarter conference calls? Kevin Mills: We could 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, January, as we have new products to launch etc. So I think you will see some more activity in that area between now and the next conference call than you had in the past. Al Troy: Okay, thank you.

14 Page 14 Operator: And our next question comes from Michael Haigety, you can go ahead with your question. Michael Hagerty: Thank you, good afternoon. I have a couple of questions around the stock held in the float. Obviously there s a general concern amongst everybody that the stock appears to be somewhat undervalued and I tend to assume, to some extent, reflecting maybe the possibility of a slower growth on the horizon, which somewhat got seen in this quarter, although for special reasons. I m wondering if you ve considered starting to divert some of the free cash flow that s coming through into share buy-back. That was my first question. My second question, I d like when you mention that we have 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. When I look at the insider trading and see the number of transactions that take place from management, I saw that in the last 18 months, two members of management have traded options 24 times and the total profit of those trades is less than $100,000. It s not a question about how much money they re exercising or bringing in, but I think a casual observer who 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 lack of confidence and concern to potential investors. Those three points please if you may. Kevin Mills: I ll start with the last one, which is the trading of the stock. Most of us have 10b5 s, 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 maybe once every two years, and it gets triggered based on activity in the market, which is outside my control. I believe, I don t know exactly, but I would say over 20 of those 24 trades were triggered by 10b5 plans, so they re based on a blind trust.

15 Page 15 On your point about have we considered dividends or other things. In Q3, I think we finally cleaned up our balance sheet. We converted all our debt, we have no long-term debt. Yes, we will 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 debt. So once we converted that, 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 that are put into the option pool on an annual basis and those are distributed to the employees and management, board of directors, etc. We generally hold a reserve of around 100,000 shares. If we have 7 million shares outstanding at the end of this year the 4% would represent 280,000. Michael Haigety: But there s 2.3 million actually issued at the moment? David Dunlop: Yes. David Dunlop: But they re not all vested. Typically our options vest over a four-year period so there are 1.7 million that are vested, there s another half a million that will vest over the next three or four years. Kevin Mills: The vesting is done on the fair market value of the stock during that time. The employees are able to buy shares today, let s say, worth $4, and you get an option to buy at $4. Obviously the appreciation generates wealth for everybody including the optionee. But it s not like they get the shares for free. Michael Haigety: No, I know about that.

16 Page 16 David Dunlop: And Michael, that is a shareholder approved program and certainly from our experiences it very closely aligns the interests of the employees with the shareholder interest, because everybody s focused on doing the things needed to generate increased value for the company. I also might mention 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 screen for is the sustainability of the company to be able to continue to service the products that they buy. With our positive operating results and cash balances we pass those screenings today. A few years ago we weren t passing them without a lot of explanation. It s true across, our suppliers it s really there to assure our suppliers if we get a large order and want to greatly pick up the pace of ordering, our suppliers don t question our ability to pay when due. There are levels of cash that become very helpful in the operations of a smaller company and at this point we ve appreciated that. Michael Haigety: Sure, I understand. Okay, thank you. Operator: [Operator instructions]. And we have no further questions at this time. Kevin Mills: Okay, 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.