SOCKET MOBILE, INC. This Quarterly Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements include statements forecasting our future financial condition and results, our future operating activities, market acceptance of our products, expectations for general market growth of mobile computing devices, growth in demand for our data capture products, expansion of the markets that we serve, expansion of the distribution channels for our products, and the timing of the introduction and availability of new products, as well as other forecasts discussed under "Management's Discussion and Analysis of Financial Condition and Results of Operations." Words such as "may," "will," "predicts," "anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates," variations of such words, and similar expressions are intended to identify such forward-looking statements. Such forward-looking statements are based on current expectations, estimates and projections about our industry, and management's beliefs and assumptions. These forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties; therefore, actual results and outcomes may differ materially from what is expressed or forecasted in any such forward-looking statements. Factors that could cause actual results and outcomes to differ materially include,1 but are not limited to: volatility in the world economy generally and in the markets we serve in particular, including the impact of the COVID-19 pandemic; the risk of delays in the availability of our products due to technological, market or financial factors including the availability of product components and necessary working capital; our ability to successfully develop, introduce and market future products; our ability to effectively manage and contain our operating costs; the availability of third-party hardware and software that our products are intended to work with; product delays associated with new model introductions and product changeovers by the makers of products that our products are intended to work with; continued growth in demand for barcode scanners; market acceptance of emerging standards such asRFID/Near Field Communications and of our related data capture products; the ability of our strategic relationships to benefit our business as expected; our ability to enter into additional distribution relationships; and other factors described in this Form 10-Q including under "Risk Factors" and those discussed in other documents we filed with theSecurities and Exchange Commission . We assume no obligation to update such forward-looking statements or to update the reasons why actual results could differ materially from those anticipated in such forward-looking statements. You should read the following discussion in conjunction with the interim condensed financial statements and notes included elsewhere in this report, the Company's annual financial statements included in its Annual Report on Form 10-K, and other information contained in other reports and documents filed from time to time with theSecurities and Exchange Commission .
The Company and its Products
We are a leading innovator of data capture and delivery solutions for enhanced productivity in workforce mobilization. Our products are incorporated into mobile applications used in point of sale (POS), commercial services (field workers), asset tracking, manufacturing process and quality control, transportation and logistics (goods tracking and movement), event management (ticketing, entry, access control, and identification), medical and education. Our primary products are cordless data capture devices incorporating barcode scanning orRFID/Near Field Communications (NFC) technologies that connect over Bluetooth. All products work with applications running on smartphones, mobile computers and tablets using operating systems from Apple® (iOS), Google™ (Android™) and Microsoft® (Windows®). We offer an easy-to-use software developer kit (Capture SDK) to application developers, which enables them to provide their users with our advanced barcode scanning features. Our products are integrated in their application solutions and are marketed by the application developers or the resellers of their applications. The number of our registered developers for data capture applications continues to grow. 16 Index Companion SocketScan family. Our Companion SocketScan family consists of the ergonomic and independent 700 series, including 1D Linear Imaging (S700), 1D Laser (S730), and 1D/2D Universal Barcode (S740), available in multiple vivid colors: blue, green, red, white, yellow and black. Companion DuraScan Family. Our DuraScan® 700 Series Linear Barcode Scanner (D700), Laser Barcode Scanner (D730) and Universal Barcode Scanner (D740, D745, D750, D755, D760), are designed to be durable barcode scanners with IP54-rated outer casing to withstand tougher environments. Universal Barcode Scanners (D740, D745, D750, D755, D760) read all common 1D, stacked, 2D and postal codes. D740 is priced competitively with a 1D barcode scanner, making D740 the affordable 2D option available in the market. D760 includes MRZ (machine-readable zone) support, making it capable of scanning passports, visas and other travel documents. D745 and D755 are medical-grade, universal scanners. Attachable Family. Our attachable scanners include DuraSled and SocketScan 800 Series scanners. DuraSled is a barcode scanning sled designed for durability. It combines a phone with a scanner to create a one-handed solution. DuraSled protects phones from impact damage and provides a robust charging solution for all environments. It is easy-to-use and ideal for delivery services, stock counting, ticketing and other application-driven mobile solutions. The DuraSled series are compatible with Apple, Samsung and Windows devices. SocketScan 800 Series cordless barcode scanners, 1D linear imaging (S800) and 2D (S840, S860) are attachable to smartphones, tablets and other mobile devices with an easily detachable clip or DuraCase, creating a one-handed solution. S860 includes MRZ (machine-readable zone) support, making it capable of scanning passports, visas and other travel documents in addition to barcodes. SocketScan 800 Series scanners may be used stand-alone as well. Contactless RFID/NFC reader writer. Our contactless product line includes D600 and S550. The D600, an ergonomically handheld model with IP54-rated outer casing, can read and write many different types of electronic SmartTags or transfer data with near field communication. The S550, a contactless membership card reader/writer, is designed to facilitate tap-and-go smart card and NFC applications. It combines the latest 13.56 MHz contactless technology with Bluetooth LE connectivity. Software Developer Kit (Capture SDK). Our Software Developer Kit (Capture SDK) supports all our data capture devices with a single integration, making it easier for a developer to integrate our data capture capabilities into their application. With the installation of our data capture software, the developers' customers can choose any of our products that work best for them. Our Capture SDK enables the developer to modify captured data, control the placement of the barcoded or RFID data in their application, and control the feedback to the user that the transaction and transmission was successfully completed. Our Capture SDK also supports the built-in camera in a customer's smartphone or tablet to be used for occasional or lower volume data collection requirements. The Capture SDK uses tools integrated with software building environments such as CocoaPods, Maven and NuGet, adds support for high level frameworks such asXamarin , Cordova and Java, and adds other features to make it easier for developers to integrate our data capture software into their applications. 17 Index We design our own products and are responsible for all associated test equipment. We use third party contract manufacturers to make many components. We perform final product assembly, test and packaging at, and distribute our products from ourNewark, California facility. We offer our products worldwide through two-tier distribution enabling customers to purchase from large numbers of on-line resellers around the world including application developers who resell their own solutions along with our data capture products. We believe growth in mobile applications and the mobile workforce are resulting from technical advances in mobile technologies, cost reductions in mobile devices and the growing adoption by businesses of mobile applications for smartphones and tablets, building a growing demand for our products. Our data capture products address the need for speed and accuracy by today's mobile workers and by the systems supporting those workers, thereby enhancing their productivity and allowing them to exploit time sensitive opportunities and improve customer
satisfaction. Results of Operations Revenues
Total revenues for the three and nine months endedSeptember 30, 2021 , were approximately$6.3 million and$17.1 million , respectively, an increase of 54% and 55%, respectively, from revenues of approximately$4.1 million and$11 million , respectively, in the comparable periods one year ago. The increases in revenues were from both the run rate business through the distribution channel and the large customers, driven by the deployment of business applications, particularly in retail as the economy re-opens. Gross Margins Our gross profit margins on sales for the three and nine months endedSeptember 30, 2021 were both 54.2%, compared to gross margins of 55.3% and 53.0% for the corresponding periods a year ago. The margin decrease in three months endedSeptember 30, 2021 compared with the same period last year was primarily due to higher component costs and higher shipping costs. The improvement in nine-month margins compared to the corresponding period from last year primarily attributed to higher revenues and the absorption of fixed manufacturing overhead.
Research and Development Expense
Research and development expense in the three and nine months endedSeptember 30, 2021 were approximately$1.0 million and$2.9 million , respectively, an increase of 49% and 21% compared to expenses of approximately$0.7 million and$2.4 million in the corresponding periods a year ago. 18 Index The increases were primarily attributable to an increase in personnel expenses, (as we had realized a benefit in 2020 from our short-term cost reduction initiatives in this area), higher employee incentive-based compensation expense associated with improved financial performance, the inclusion of amortization and depreciation expenses of newly acquired intangible assets and equipment, and increased fees paid for contractors and consultants assisting with product development. We believe a continued commitment to research and development activities is essential to maintain or achieve a leadership position for our existing products, provide innovative new product offerings, and provide engineering support for key customers. In addition, we consider our ability to accelerate time to market for new products to be critical to our revenue growth. Therefore, we expect to continue to make significant research and development investments as our revenue grows. Sales and Marketing Expense Sales and marketing expense in the three and nine months endedSeptember 30, 2021 were approximately$788,000 and$2,182,000 , respectively, an increase of 20% and 2% compared to expense of approximately$658,000 and$2,148,000 in the corresponding periods a year ago. The increase in expense quarter over quarter was primarily attributed to the development of a new Return Merchandise Authorization portal. The increase in expense quarter over quarter was primarily due to the hiring of additional employee and also due to the benefit realized in the third quarter of 2020 from our short-term cost reduction initiatives. The increase in expense during the first nine months of 2021 was primarily due to increased fees paid for contractors and consultants assisting with website development and upgrades. We expect that sales and marketing expenses will increase for the rest of the year as we continue improving our website and increasing brand and product awareness and customer base outside retail.
General and Administrative Expense
General and administrative expense in the three and nine months endedSeptember 30, 2021 were approximately$667,000 and$2,142,000 , respectively, an increase of 37% and 23% compared to expense of approximately$485,000 and$1,741,000 in the corresponding periods a year ago. The increase was due to the benefit realized in 2020 from our short-term cost reduction initiatives and higher employee incentive-based compensation expense associated with improved financial performance. The increase in expense during the first nine months of 2021 was also due to higher professional fees associated with the filing of a shelf registration statement, higher proxy distribution costs resulting from a greatly increased number of beneficial owners of the Company's stock and increased insurance costs.
Interest Expense, Net of Interest Income
Interest expense, net of interest income, in the three and nine months endedSeptember 30, 2021 was approximately$50,000 and$150,000 , respectively, compared to approximately$23,900 and$51,500 , respectively, in the same periods one year ago. Interest expense in the three and nine months endedSeptember 30, 2021 was related to interest on the secured subordinated convertible notes payable (see "NOTE 6 - Secured Subordinated Convertible Notes Payable" of the notes to consolidated financial statements for more information) and on the CalCap Loan. Our credit lines had no outstanding balances during the three and nine months endedSeptember 30, 2021 . Interest expense in 2020 was primarily related to interest on credit line facilities, secured subordinated convertible notes payable and bank term loan. 19 Index
Interest income reflects interest earned on cash balances. Interest income was nominal in each of the comparable first quarters, reflecting low average rates of return. Income Taxes In the three months endedSeptember 30, 2021 , we recorded an income tax expense of$260,000 . In the nine months endedSeptember 30, 2021 , we recorded an income tax benefit of$1.6 million primarily attributable to the tax deduction resulting from the disqualified disposition of incentive stock options. We recorded no deferred tax benefit for the loss in the three and nine months endedSeptember 30, 2020 . Our deferred tax asset, primarily representing future income tax savings from the application of net operating loss carry forwards, was valued at$7.1million as ofSeptember 30, 2021 . We have determined that utilization of existing net operating losses against future taxable income is not limited by Section 382 of the Internal Revenue Code. Future ownership changes, however, may limit our ability to fully utilize the existing net operating loss carryforwards against any future taxable income. We will continue to monitor the likelihood to realize the value of deferred
tax assets in the future.
Liquidity and Capital Resources
As reflected in our Statements of Cash Flows, net cash provided by operating activities was approximately$1,179,000 in the first nine months of 2021, compared to net cash provided of approximately$387,000 in the comparable period a year ago. We calculate net cash used in or provided by operating activities by increasing our net income (approximately$3,474,000 in the nine months of 2021) or by decreasing our net loss (approximately$4,861,000 in the first nine months of 2020) by the expenses, such as stock-based compensation expense, depreciation, amortization, and deferred tax expense, that did not require the use of cash. These amounts totaled approximately ($554,000 ) and$5.26 million in the first nine months of 2021 and 2020, respectively. In addition, we report increases in assets and reductions in liabilities as uses of cash and decreases in assets and increases in liabilities as sources of cash, together referred to as changes in operating assets and liabilities. In the first nine months of 2021, changes in operating assets and liabilities resulted in net cash used in operating activities of approximately$1.7 million which was primarily from increasing our inventory levels in order to cope with supply chain disruptions as demand increased with the reopening of the economy, increased accounts receivable driven by higher shipment levels in the third quarter of 2021 and increased prepaid expenses. The uses of cash were partially offset by increases in accrued payroll and related expenses, primarily employee incentive-based compensation associated with improved financial performance, and by increases in accounts payable driven primarily by increased inventory purchases. In the first nine months of 2020, changes in operating assets and liabilities resulted in net cash used in operating activities of approximately$9,000 which was primarily due to decreases in accounts receivable resulting from the lower shipments in the third quarter of 2020. 20 Index In the first nine months of 2021 and 2020, we invested approximately$558,000 and$375,000 , respectively, in manufacturing tooling costs and computer software development costs.
Net cash provided by financing activities was approximately$2.6 million in the first nine months of 2021, compared to net cash provided by financing activities of approximately$804,000 in the comparable period a year ago. Financing activities in 2021 consisted primarily of$1.86 million in proceeds from the exercise of employee stock options and of a net borrowing of$750,000 on the CalCap Loan. Financing activities in the first nine months of 2020 consisted of proceeds of a loan of$1.06 million under the Paycheck Protection Program ("PPP") of the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") and a loan of$150,000 from the SBA under its Economic Injury Disaster ("EIDL") assistance program, offset by an approximately$1.41 million net payment of borrowings under our bank lines of credit, an approximately$333,000 repayment on our term loan and a$150,000 repayment on the SBA loan. The subordinated convertible note financing added approximately$1,433,000 to net cash in the first nine months of 2020. Critical Accounting Estimates Our significant accounting policies are described in "Note 2 - Summary of Significant Accounting Policies" in the notes to condensed financial statements. The application of these policies requires us to make estimates and judgments that affect the reported amount of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We base our estimates on a combination of historical experience and reasonable judgment applied to other facts. Actual results may differ from these estimates, and such differences may be material to the financial statements. In addition, the use of different assumptions or judgments may result in different estimates. We believe our critical accounting policies that are subject to these estimates are: Revenue Recognition and Accounts Receivable Reserves, Inventory Valuation, Stock-Based Compensation, Income Taxes and Valuation ofGoodwill .
A complete description of our critical accounting policies and estimates is
contained in our Annual Report on Form 10-K for the fiscal year ended
Contractual Obligations Our contractual cash obligations atSeptember 30, 2021 are outlined in the table below: Payments Due by Period Less than 1 to 3 4 to 5 More than Contractual Obligations Total 1 year years years 5 years Unconditional purchase obligations with contract manufacturers$ 9,697,000 $ 9,619,000 $ 78,000 $ - $ - Operating lease 394,000 394,000 - - - Total contractual obligations$ 10,091,000 $ 10,013,000 $ 78,000 $ - $ - 21 Index
Off-Balance Sheet Arrangements
As of
22 Index
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