Socket Mobile, Inc. Q4 FY2022 Earnings Call

Welcome to the Fourth Quarter and Full Year 2022 Financial Results for Socket Mobile. My name is Darrell, 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 materially from the results anticipated in such forward-looking statements because of a number of factors including but not limited to, the risk that manufacturer 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 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 listen-only mode. Later we will conduct a question-and-answer session. 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. Kevin, you may begin.

Thank you, operator. Good afternoon, everyone and thank you for joining us today. I'll begin with a review of both 2022 and Q4, starting with Q4. Our Q4 revenue was $5.2 million, a 15% decrease compared to the $6.1 million in Q4 of 2021 and a 39% increase compared to the $3.7 million reported in Q3 2022. Our gross margins in Q4 were 49.3% compared to 52.1% in Q4 2021 and 44.4% in Q3 2022. In Q4, we recorded an operating loss of $152,000 compared to an operating income of $693,000 in Q4 of 2021 and an operating loss of $947,000 in Q3 2022. In Q4 EBITDA was $301,000 compared to $1.1 million in Q4 of 2021 and a loss of $506,000 in Q3 2022. Looking at our full year results for 2022, our revenue for 2022 was $21.2 million, compared to $23.2 million in 2021, a decrease of 8%. Our gross margins were 48.8% compared to 53.6% in 2021, with the reduction being driven by supply difficulties. Our operating loss was $446,000 compared to an operating income of $2.7 million in 2021. EBITDA for 2022 was $1.3 million, compared to $4.2 million in 2021. In 2022, our diluted earnings per share was $0.01 compared to diluted earnings per share of $0.48 in 2021, and both years benefited from income tax credits. Overall, 2022 was a strange and challenging year. We saw very strong demand during the first six months of 2022 as distributors and resellers over-purchased due to supply and availability concerns. In the second half of 2022, we saw distributors and resellers reduce their purchases as they rebalanced their inventories. Socket Mobile reports sales into distribution as revenue, which made our 2022 revenue very lumpy. We also measure sales out of distribution to gauge the actual demand. In the first half of 2022, sales out of distribution were a little over $10 million, as of second half, they were a little under $10 million. Demand remained solid throughout the year, with the first half being slightly stronger than the second half. Our application-driven business model does not enable us to impact near-term sales as demand is generated by application sales from our application partners. In 2022, we saw demand remain reasonable even in these difficult and uncertain times. Our focus was on developing new products and solutions that will enable Socket Mobile to achieve long-term growth. I feel against this metric, 2022 was a very positive year for Socket Mobile, as we made significant progress in several areas, which Dave Holmes will discuss in a few minutes. As regards the outlook for 2023, I think market conditions will remain challenging, especially in the first half of the year, as inflation and uncertainty remain key concerns. So we expect we will continue to face some headwinds in the short term. However, we do see a trend of people wanting to return to physical stores, which would be good for Socket Mobile, as there are more scanners needed in physical stores that are required with online shopping; especially, as many of the physical stores are now using iPads as their primary point of sale device. With that said, I'll turn the call over to David Holmes for his comments.

Thank you, Kevin, and good afternoon, everyone. Today, I'd like to highlight a couple of the key milestones that we achieved in 2022, as we continue our journey of becoming a more comprehensive data capture company. We significantly improved Capture SDK, our unified software development toolset that supports our entire data capture portfolio. One integration with Capture SDK is our app provider partners and access to all Socket Mobile data capture solutions. We also expanded our development environment support. We now support Flutter, an open-source framework created by Google, Swift Package Manager, iOS’ native package managing solution for developers, and .NET MAUI, a replacement for Xamarin to create multi-platform apps using a single project. One of the most important achievements we made last year is that Capture SDK now includes camera-based scanning software. App providers typically had to integrate with multiple parties to support all of their end users. Now with one integration with Socket Mobile, we can support all of their needs. Our hardware scanners continue to deliver best-in-class performance and in 2022, we added Socket Cam CA20, a camera-based scanning software to our product portfolio. The CA20 is included in the latest version of Capture SDK and it enables our app providers to provide their end users with free scanning support. App end users have a variety of profiles and requirements. Socket Mobile has traditionally addressed only the high-end users who need the ultimate performance. Our barcode scanners have served this segment well. We have a commanding market share in the space. In 2022, we opened the door for other tiers of end users to also leverage Socket Mobile's data capture expertise. The Socket Cam CA20 enables app end users with free user-friendly barcode and QR code scanning capabilities without having to purchase any additional hardware. This allows end users to experience the capabilities and benefits of barcode scanning without requiring a large initial investment into physical barcode scanner. This is an ideal option for users who are new to scanning, have low scanning volume or simply need to test out their daily scanning needs. App providers that integrate the latest version of Capture SDK can support hardware scanners, free camera scanning and in 2023, this will also enable enhanced camera scanning. Our C860 advanced technology will be available on a subscription basis and it will establish a recurring revenue stream for Socket Mobile for software sales. The app providers will not have to change their code as their end user's needs change. The end users can upgrade from free to subscription, to a hardware scanner seamlessly, since all are supported with the same unified Capture SDK. Our SDK team has done an excellent job in delivering these new capabilities, and we believe this is a critical step in the data capture journey. We'll make this a more complete hardware and software data capture company in 2023. Outside of camera scanning, we are seeing positive signs with our NFC business as more developers begin embracing contactless technology. Initial commercial deployments of our S550 NFC reader writer for mobile ticketing, e-money and loyalty applications are resulting in exceptional customer experiences and follow-on projects. The S550 was chosen as a finalist for the NFC Forum Innovation Award and is outperforming competitive solutions in head-to-head competitions. We continue to be excited about the opportunity that digital ID is presenting and we spent time in 2022 ensuring that we are prepared to meet the opportunity. In addition to launching the S550, we also launched S370, a universal NFC and QR code mobile wallet leader to enable app partners to support e-wallet centric opportunities like mobile driver's licenses and digital health care cards. Our app development partners love the technology flexibility to accept multiple formats with one device that their S370 provides. With the myriad of credential types out there, S370 provides their partners with 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 ISO 18013-5. This is a standard being adopted for mobile driver's licenses or MDL in most states and countries. We're seeing positive signs all around and we continue to invest in digital ID and MDL space. We feel our camera scanning and digital ID products create new opportunities for Socket Mobile. We can reach a large and more diverse set of application providers and their end users. With that, I'll turn it over to Lynn for more details on our financial results.

Thank you, Dave. Good afternoon, everyone. Thank you for joining today's call. 2022 has been a challenging year with macroeconomic headwinds affecting our financial results. Revenue for the full year of 2022 decreased 8% year-over-year to $21.2 million compared to $23.2 million in 2021. Gross margin was 48.8% compared to 53.6% in 2021. Operating expenses were $10.8 million, an increase of 11% from $9.7 million in 2021, as we continue to invest in the business to fuel long-term growth. The diluted earnings per share for 2022 were $0.01, which included a $0.09 per share income tax benefit, primarily related to the adoption of Section 174 of the Tax Cuts and Jobs Act of 2017, compared to diluted earnings per share of $0.48 in the prior year, which included a $0.21 per share income tax benefit. Section 174 eliminates the expensing of R&D costs beginning in 2022, instead requiring the company to capitalize and amortize R&D expenditures, resulting in an income tax benefit and a net increase in our deferred tax assets for 2022. Adjusted EBITDA for 2022 was $1.3 million compared to $4.2 million in 2021, with an adjusted EBITDA margin of 6.2%, compared to 18.2% in 2021. Our Q4 revenue decreased 15% to $5.2 million compared to $6.1 million in the same quarter the previous year; however, it increased sequentially by 39% compared to $3.7 million in Q3 2022. Q4 gross margin was 49.3%, down from 52.1% in the same quarter last year, with the decrease attributed to significant inflation and consistently higher component costs. Compared to Q3, our gross margin improved by 490 basis points, primarily due to more efficient allocation of manufacturing overhead costs across improved production volumes in Q4. Q4 operating expenses were $2.7 million, up 8.4% from the same quarter last year and 3.8% sequentially compared to the prior quarter. Compared to the diluted earnings per share of $0.11 a year ago, we faced a net loss per share of $0.11 in the prior quarter. Q4 diluted earnings per share of $0.06 included an $0.08 per share income tax benefit related to the adoption of Section 174 of the Tax Cuts and Jobs Act of 2017. Turning to our balance sheet, we ended the year with a cash balance of $3.6 million. In Q4, we invested $270,000 in capital expenditures, repurchased 85,000 shares for $176,000, and repaid $125,000 of the loan balance. For the full year of 2022, we invested $1.2 million in capital expenditures, repurchased 266,000 shares for $837,000, and repaid $500,000 of the loan balance. The remaining loan balance of $125,000 was paid off at the end of January 2023. As of December 31, 2022, our inventory level, net of reserves, was $5.6 million compared to $5.2 million a year ago. We managed our inventory levels while maintaining our on-time delivery commitment to our partners. This concludes our prepared remarks. Now I will hand the call over to the operator for questions.

Can you talk about the jump of 5% in gross margin? Is this sustainable? And how do you see this playing out in 2023?

We improved our gross margin due to increased volume that helped cover fixed overhead expenses. In Q3, however, we shipped less, and our gross margin was also affected by the high cost of components. We paid a premium for several components in 2022 because of shortages and concerns over availability. We believe that a gross margin around 50 points, potentially slightly above that, is sustainable moving forward, as our business model relies on it. When shipping volumes are low, we have more overhead to manage, but in the long term, we are confident that margins of 50 points or more are achievable, and that Q3 was an anomaly caused by decreased shipping volume.

Okay. Then can you comment on how is your supply chain looking? Is it improving?

Well, first of all, we didn't really have a great deal of supply problems. I think that we probably panicked a little bit sooner than most, and we took an inventory position to make sure that the supply issues didn't impact our partners. So throughout 2022, we were able to maintain and deliver against a 6-week lead time, which many of our partners appreciated. Our inventory did rise substantially from 2019. So in '20 and '21, we increased our inventory by several million dollars to make sure that there was no impact. Today, inventory is around the $6 million level. Our plan is to start to reduce that. The supply situation has improved, at least it's stabilized, and there is now good availability on certain components. But as you need all components before you really solve the problem, we're not completely out of the woods yet, but I would say the situation is significantly better.

Okay. And then talking about inventory, you say you plan to reduce it from the $6 million level. About where would you say we could expect it in 2023?

Well, I would hope that we would get it down to more like $5 million by the end of the year. Certainly, with higher availability of supply, you don't need to carry as much inventory. So as lead times start to fall, we will reduce our inventory to basically be more in line with that. So I would say $5 million towards the end of this year is reasonable if the supply situation continues to improve as we expect.

Okay. Lastly, how do you anticipate operating expenses will trend in 2023? Will growth be primarily driven by inflation?

Yes. I mean obviously, there is more pressure to increase salaries, which we have done in 2021. So we will see some pressure to increase operating costs. And we also continue to hire in select areas where we feel we need to add more resources. So I think moderate growth in expenses this year, primarily driven by inflation-related salary increases, yes, I think that's reasonable.

I have a two-part question. First, on the buyback, how many shares have you purchased so far? I believe I noticed a figure of 266,000. My question is, since the buyback concludes in May and you allocated $1.8 million for it, how much of that amount has been utilized to date? If it hasn't been fully used, will there be an extension of the buyback period? The second part is regarding supply chain concerns; it appears that many companies rely heavily on one or two suppliers for their core components. Is there a possibility that you might consider acquiring a smaller company to secure a key supplier and potentially reduce costs, thereby strengthening your inventory base?

So let's answer those questions, and then you can ask some more. So maybe Lynn will provide detail of what we've bought back so far and what's remaining. So Lynn, could you answer that question, please?

Yes. So as of today, we have purchased 320,000 shares at the cost of slightly lower than $960,000. So the current repurchase plan will expire at the end of March, and we have about 38,000 shares to go. So after we reported Q1 results, our Board will make a decision to see if we are going to restart a new repurchase plan.

Okay. So hopefully that answers that part of the question for you. On key components, first of all, in very few cases are we singly sourced, so we make sure that we have more than one supplier. The issue with lead times was really a combination of supply-related concerns. People were unable to manufacture because factories were closed, people were unable to go to work, particularly in China, etc. So there were some key components that weren't made. Many people want those components. When there's a shortage, and there's a lot of people who want it, you have to kind of hoard the components, which we did, which is why our inventory went up. Now that the situation is resolving itself, we don't need to purchase any companies to guarantee supply. We need to have multiple sources for each component, which we work hard to do, and the supply costs will come down because the demand is more in line with production. This is no different than the personal situations people faced when COVID started, whether it was for household items or anything else. There was a shortage, and people went crazy to buy and hoard that shortage. It drove prices up, and now they've come down again. We believe we did a good job managing that. We spent a little bit of money and put it in our inventory. But now as the situation resolves, we will reduce our inventory and get back to more competitive pricing. The one thing we did, which I think we received a lot of credit from our partners for is that at no time during 2021 or 2022 were we unable to deliver or did we have to extend our lead times beyond our standard 6 weeks. So a lot of credit is due to our operations team for managing that and making that happen. So that's the current situation regarding key components.

Okay. One final question: as your supply chain reaches capacity, I'm sure your original business plan has changed quite a bit. With your new products coming online, if things return to normal, what percentage do you forecast for when you have a full inventory of all your products and sales are increasing? What can shareholders expect in terms of forecasts for the next two to three years? The good news is that I see your company remaining viable and operating well with products for the next three to five years. My question is how you see that, especially if you're operating at only 70% of the product or components coming in as quickly as you can sell them.

I'm going to give you maybe a slightly different answer than you're expecting, okay? First of all, we didn't have any supply issues. I think what impacted our sales more than anything else was the availability of other components required to deploy a solution. For a person deploying a mobile point-of-sale solution, they need about 5 components. They need an iPad. They need a stand. They need a cash drawer, a printer and a scanner. The availability of printers and cash drawers, and even iPads, was severely impacted in 2022, so that customers who wanted to deploy, and our scanners were available for them to deploy, were unable to do so because they were waiting on printers and cash drawers. The supply of printers and cash drawers has improved. It's not at the level it needs to be, but I think that has retarded our sales in the short term, not because we couldn't supply, but because other people who are key components of the solution couldn't supply. We're monitoring that situation, and we feel it will be better certainly in the second half of 2023, and that will help us to have more sales. Our products are not stand-alone products. They just don't work on their own. They're part of a system. The unavailability of other elements of the system does retard our sales, and we pointed that out on the last call as well.

Okay. Well, the only problem I see is, with the buybacks and with you struggling through and I think succeeding very well as far as all the problems that basically the entire world is going under at this point in time, but the problem still remains that the price of the stock is so way undervalued. And it's just so disappointing sitting here for 3 years, and the company is growing even though it's flatlined, in some cases, just due to COVID and products and so forth. But again, my question is the buyback. I mean, it's there and you're doing it; it's just amazing to me, as a former broker and shareholder of many of the companies that did do buybacks in different related products and so forth, it's just befuddles me to see the price just flatlined at $2 a share. That's it.

Yes. No, we share your frustration. We'll see what we can do to improve the share price as we have better results this year. Overall, it's been a tough two years for everybody, and we got through it reasonably well. Long term, we still have a lot of upside. So yes, we can't do anything about it in the short term. We are buying back shares, as you know, and we'll see how things progress as the year rolls out. Okay. I'd just like to thank everyone for participating in today's call and wish you all a good afternoon. Thank you.

And thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.