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 handheld computers and other mobile computing devices, growth in demand for our products, expansion of the markets that we serve, expansion of the distribution channels for our products, adoption of our embedded products by third-party manufacturers of electronic devices, 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, management's beliefs, and assumptions made by management. These forward-looking statements are not guarantees of future performance and are subject to certain risks, uncertainties, and assumptions that are difficult to predict; 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, but are not limited to: continued weakness in the U.S. and world economy generally and in the markets we serve in particular; 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 announced third-party handheld computer 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 handheld computers and barcode scanners; market acceptance of emerging standards such as Bluetooth and wireless LAN and of our related connection, data collection and mobile handheld computer products; the ability of our strategic relationships to benefit our business as expected; our ability to enter into additional distribution relationships; or other factors described in this Form 10-Q including "Item 1A. Risk Factors" and recent Form 8-K and Form 10-K reports filed with the
Securities 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 in the form 10/K, and other information contained in other reports and documents filed from time to time with the Securities and Exchange Commission. 13 -- Index The Company We are a producer of mobile cordless barcode scanners and handheld computers for the business mobility markets. Our markets for our barcode scanning products as defined by Venture Development Corporation(a leading technology market research firm) include retail, commercial services and healthcare. Our products are designed for a mobile worker using applications running on mobile devices while walking or standing. We offer easy-to-use software developer kits to application developers that enable the integration of our barcode scanning software into mobile applications running on Smartphones, tablets and mobile computers. These devices use operating systems from Apple® (iOS), Google™ (Android™) and Microsoft® (Windows®/Windows Mobile™). We focus on serving the needs of application developers as our barcode scanner sales are application driven. Once we are built into an application, our products become an ingredient of their solutions and marketing programs. Our registered developer program for barcode scanning has grown to over 900 developers which include developers of third party applications such as retail point of sale software licensed to customers and developers building in-house commercial services programs for business entities. Our mobile handheld computers are used in many hospitality and healthcare applications. We have more than 100 registered developers for our handheld computer. We design our own products and then subcontract the manufacturing to independent third-party contract manufacturers located in North America, Taiwanand other Asian countries that have the equipment, know-how and capacity to manufacture products to our specifications. We perform final product assembly and testing, and package and distribute our products at and from our Newark, Californiafacility. Our data collection products and mobile handheld computers are sold through a worldwide network of distributors and resellers, vertical industry partners, and value added resellers. Our OEM products are sold directly to the original equipment manufacturers. 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, building a growing demand for our products. Our barcode scanning and mobile handheld computer products address the growing need for speed and accuracy by today's mobile workers, thereby enhancing their productivity and allowing them to exploit time sensitive opportunities and improve customer satisfaction.
Liquidity and Going Concern
We were unprofitable in the quarter ended
March 31, 2014. We were profitable in each of the first two quarters in 2013, but unprofitable in the third and fourth quarters, and unprofitable in total for fiscal 2013 in the amount of $620,000. As of March 31, 2014, we have an accumulated deficit of $61.2 million. Our cash balances at March 31, 2014were $0.7 million, including $0.8 millionadvanced on our bank lines of credit. At March 31, 2014, we had additional unused borrowing capacity of approximately $284,000on our bank lines of credit. Our balance sheet at March 31, 2014has a current ratio (current assets divided by current liabilities) of 0.4 to 1.0, and a working capital deficit of $4,200,000(current assets less current liabilities). These circumstances raise substantial doubt about our ability to continue as a going concern. 14 -- Index
In the last three years we have taken actions to reduce our expenses and to align our cost structure with economic conditions. We have the ability to further reduce expenses if necessary. Steps taken by us to reduce operating losses and achieve profitability include reduction of headcount to manage payroll costs, the introduction of new products, and continued close support of our distributors and application development partners as they establish their mobile applications in key vertical markets. We believe we will be able to further improve our liquidity and secure additional sources of financing by managing our working capital balances, use of our bank lines of credit, and raising additional capital as needed including development funding from development partners and the issuance of additional equity securities. However, there can be no assurance that additional capital will be available on acceptable terms, if at all, and any such terms may be dilutive to existing stockholders. Our bank lines of credit may be terminated by the bank or by us at any time. If we cannot maintain profitability, we will not be able to support our operations from positive cash flows, and would use its existing cash to support operating losses. If we are unable to secure the necessary capital for its business, it may need to suspend some or all of our current operations.
If we can maintain revenue growth and attain ongoing profitability, we anticipate requirements for cash will include funding of higher receivable and inventory balances, and increased expenses, including an increase of costs relating to new employees to support our growth and increases in salaries, benefits, and related support costs for employees.
The accompanying financial statements have been prepared assuming that we will continue as a going concern, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. These financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from our inability to continue as a going concern.
We classify our primary products into two broad product families:
· Cordless barcode scanning products and related accessories and service;
· Mobile handheld computer products and related accessories and service;
Cordless barcode scanners We offer a family of cordless barcode scanning products that connect over Bluetooth with smartphones, tablets and mobile computers running operating systems from Apple (iOS), Google (Android), and Microsoft (Windows/Windows Mobile). Our cordless barcode scanners include two dimensional (2D) and linear (1D) barcode scanners in both durable and colorful cases. Our Series-7 models are lightweight and ergonomically designed as a standalone handheld barcode scanner and are widely used with tablet computers. Our Series-8 models can be used stand-alone or attach to a Smartphone to enable one-handed barcode scanning. We also offer wearable cordless ring scanners for hands free barcode scanning. Extended warranty programs are available for all of our barcode scanning products. Mobile handheld computers
We offer a family of SoMo® ("Socket® Mobile") handheld computer products in standard or antimicrobial cases running the Windows Embedded Handheld System 6.5 operating system. Handheld computer accessories include plug-in 1D and 2D barcode scanners, cradles, radio frequency identification (RFID) readers and magnetic stripe readers. Our handheld computers are designed with wireless LAN (802.11 b/g/n) and Bluetooth connectivity for use with applications that do not require phones. We also offer handheld computers without wireless connectivity for secure environments. Our newest family of handheld computers,
SoMo Model655, commenced sales in June 2012, replacing the SoMo650 introduced in 2007. We offer extended warranty programs for our mobile handheld computer products.
15 -- Index Service Our products are warranted for one year and we offer SocketCare extended warranty programs for up to three years including repair or replacement due to accidental breakage. We will also service products that are beyond their warranty period. Service revenues are included in the revenue totals for data collection products and handheld computer and data collection products as described in the table that follows further below.
Other products include customized versions of our products we make available to original equipment manufacturers ("OEMs"), and upon request we also supply small quantities of discontinued legacy products when available.
Total revenues for the three months ended
March 31, 2014were $3.8 million, a decrease of 11% from revenues of $4.3 millionin the comparable period one year ago. Our revenues are classified into two primary product families. Additionally, we sell OEM embedded products to third parties, and we continue to carry legacy plug-in connectivity products. Our product revenues and the corresponding increase or decrease in revenues for the comparable periods are shown in the following table: (revenues in thousands) Three months ended March 31, 2014 2013 Increase Product family: Amount % Amount % (Decrease) Cordless barcode scanning and related products and service $ 2,91277 % $ 2,43057 % 20 % Mobile handheld computer and related products and service 848 22 % 1,448 34 % (41 %) Other 35 1 % 387 9 % (91 %) Total $ 3,795100 % $ 4,265100 % (11 %)
Our cordless barcode scanning and related products and service revenues in the first quarter of 2014 were
$2.9 million, an increase of $0.5 million, or 20%, compared to revenues of $2.4 millionin the first quarter of 2013. Combined revenue increases totaling $0.5 millionwere from increased sales volumes of our Apple certified Series-7 high performance 1D cordless handheld barcode scanner and from increased sales volumes of our Series-8 cordless scanner optimized for use with smartphones and tablets. Slight revenue increases in sales of our barcode scanning related accessories and services were offset by slight declines in sales of our Apple certified entry level and imager based cordless handheld scanners. Although sales of our Apple certified entry level scanner declined slightly in the first quarter 2014 compared to the same period one year ago, the first quarter of 2013 included the sale of $0.5 millionto a single customer. 16 -- Index Our mobile handheld computer and related products and service revenues in the first quarter of 2014 were $0.8 million, a decrease of $0.6 million, or 41%, compared to revenues of $1.4 millionin the first quarter of 2013. Mobile handheld computer revenues (excluding revenues from the related plug-in products, accessories, and services) declined by $0.5 millionreflecting lower overall sales volumes compared to the same period one year ago. Remaining declines in the first quarter 2014 were primarily from declines in sales of our companion plug-in data collection products due primarily to lower sales volumes of CompactFlash plug-in barcode scanners, and from declines in sales of related mobile handheld computer accessories and services, also reflective of the overall lower unit sales volumes of our mobile handheld computers in the first quarter 2014 compared to the same period one year ago. Sales of our mobile computer models have been affected by the uncertainty surrounding Microsoft's support of the Windows Embedded Handheld 6.5 operating system, which they clarified in mid 2013 by their announced commitment to this operating system until early 2020. Additionally, sales of standard handheld computing devices such as our mobile handheld computer have been declining due to the increased popularity of alternative tablet and smartphone devices. Service revenues were 5% and 4% of our total revenues in the three months ended March 31, 2014and 2013, respectively. Increases in service revenues in the first quarter 2014 reflect increases in revenues related to out-of-warranty repair services, partially offset by declines in our SocketCare services reflecting the lower unit sales of our mobile handheld computers in the first quarter 2014 compared to the same quarter one year ago, as described previously. The majority of our SocketCare service contracts are purchased by our customers in conjunction with the purchase of mobile handheld computers. Service revenues have been allocated to the respective products serviced in the table above. Other revenues in the first quarter of 2014 were $35,000, a decrease of 91% compared to revenues of $387,000in the first quarter of 2013. Revenue decreases reflect diminishing sales of legacy products and sales to OEM customers in the first quarter 2014 compared to the same quarter one year ago.
Our gross margins for the first quarter of 2014 were 43% compared to 40% in the comparable period one year ago. We generally price our products as a markup from our cost, and we offer discount pricing for higher volume purchases. Improvements in overall margins in the first quarter of 2014 are due primarily to a change in mix of products sold favoring a greater proportion of sales of our cordless handheld barcode scanner models which overall have slightly higher than average margins, and a lower proportion of sales of our mobile handheld computers which have slightly lower than average margins.
Research and Development Expense
Research and development expense in the first quarter of 2014 was
$554,000, an increase of 6% compared to $525,000in the first quarter of 2013. Increases in the level of research and development expense were primarily due to higher personnel costs compared to personnel costs a year ago which reflected compensation expense savings programs initiated in late 2012 and in effect through the first quarter of 2013. Partially offsetting this increase was a decrease in equipment costs in the first quarter 2014 compared to the same period a year ago. Research and development expense in the second quarter of 2014 is expected to moderately increase from first quarter levels. 17 -- Index Sales and Marketing Expense Sales and marketing expense in the first quarter of 2014 was $476,000, a decrease of 15% compared to $559,000in the first quarter of 2013. Decreases in sales and marketing expense were due primarily to declines in personnel costs due to lower overall comparable headcount. Additional declines were from reductions in travel related expenses partially offset by increases in outside services expense. Sales and marketing expense in the second quarter of 2014 is expected to moderately increase from first quarter levels.
General and Administrative Expense
General and administrative expense in the first quarter of 2014 was
$521,000, an increase of 13% compared to $461,000in the first quarter of 2013. Increases in the level of general and administrative expense were primarily due to higher personnel costs compared to personnel costs a year ago which reflected compensation expense savings programs initiated in late 2012 and in effect through the first quarter 2013. General and administrative expense is expected to moderately decline in the second quarter of 2014 from first quarter levels due to the absence of professional fees and other expenses related to the costs of our annual audit which are expensed primarily in the first quarter.
Interest Expense and Other, Net of Interest Income and Other
Interest expense and other, net of interest income and other, was
$136,000in the first quarter of 2014 compared to $80,000in the first quarter of 2013. Interest expense in each of the comparable first quarters was related primarily to interest on our notes payable, interest on our convertible notes payable issued in 2012 and reissued in September of 2013, and interest on amounts drawn on our bank lines of credit (see "NOTE 4 - Related Party Convertible Notes Payable" and "NOTE 5 - Related Partyand Other Short Term Notes Payable" for more information). Additionally, interest expense in each of the comparable first quarters includes interest on equipment lease financing obligations. Higher interest expense in the first quarter 2014 reflects higher overall note balances in effect for the full duration of the quarter compared to the same quarter last year. Interest income and other reflects interest earned on cash balances. Interest income was nominal in each of the comparable first quarters, reflecting low average cash balances combined with low average rates of return. Other income and expense includes foreign currency transaction gains and losses, which were nominal in each of the periods presented.
Deferred tax expense in the first quarter of 2014 and 2013 and the corresponding deferred tax liability shown on our balance sheet, is related entirely to the deferred tax liability on the portion of our goodwill amortized for tax purposes. Due to the indefinite characteristic of this deferred tax liability, it cannot be offset against deferred tax assets. We maintain a full valuation allowance for all other components of deferred tax assets. There can be no assurance that the deferred tax assets subject to the valuation allowance will be realized. We have not generated taxable income in any periods in any jurisdiction, foreign or domestic. 18 -- Index
Cash Flows and Contractual Obligations
As reflected in our Statements of Cash Flows, net cash provided by operating activities was
$27,000in the first quarter 2014, compared to net cash used in operating activities of $267,000in the comparable period a year ago. We calculate net cash provided by or used in operating activities by increasing our net income, or reducing our net loss ( $71,000net loss in the first quarter of 2014, and $75,000net income in the first quarter of 2013) by those expenses that did not require the use of cash, and reversing gains or losses that did not generate or use cash. These items consist of stock based compensation expense, depreciation, amortization of intangible assets, and deferred tax expense. These amounts totaled $140,000and $168,000in the first quarter of 2014 and 2013, 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 quarter of 2014 changes in operating assets and liabilities resulted in a net use of cash of $42,000and were primarily from increases in accounts receivable due to the timing of customer shipments later in the first quarter compared to the previous fourth quarter, declines in stocking levels in our distribution channel reflecting normal fluctuations in distributor stocking, increases in prepaid expenses related to service and insurance renewals, and declines in accrued payroll expenses. These uses of cash were partially offset by reductions in inventory levels related to our scanning and mobile handheld computer product lines, and increases in accounts payable due to the timing of vendor payments. In the first quarter of 2013 changes in operating assets and liabilities resulted in a net use of cash of $0.5 millionand were primarily from net increases in accounts receivable due to higher overall shipments to our distributors in the first quarter of 2013 compared to the fourth quarter of the prior year, increases in prepaid expenses and other current assets due primarily to advance payments required by suppliers, and reductions in the inventory levels in our distribution channel. These were partially offset by increases in accounts payable.
Investing activities in the first quarter of 2014 was related primarily to expenditures on tooling related to our scanning product line. There were no uses of cash in investing activities in the first quarter of 2013.
Cash provided by financing activities was
$46,000in the first quarter of 2014 compared to cash provided by financing activities of $515,000in the first quarter of 2013. Financing activities in the first quarter of 2014 consisted primarily of net amounts advanced on our bank lines of credit. The proceeds from and repayments of borrowings in the first quarter 2014 as shown on our Condensed Statement of Cash Flows excludes $752,000related to the amounts outstanding under the credit line with our former bank which was transferred to our new bank on March 7, 2014(see "NOTE 6 - Bank Financing Arrangements" for more information). Financing activities in the first quarter of 2013 consisted primarily of proceeds from the issuance of related party and other short term notes payable, and net amounts advanced on our bank lines of credit, partially offset by repayment of a short term note originally advanced on August 31, 2012with final repayment completed in January 2013. 19 -- Index Our contractual cash obligations at March 31, 2014are 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 $ 2,081,000 $ 2,081,000$ - $ - $ - Operating leases 3,645,000 382,000 810,000 876,000 1,577,000 Short term notes payable 650,000 650,000 - - - Capital leases 53,000 23,000 30,000 - - Total contractual obligations $ 6,429,000 $ 3,136,000 $ 840,000 $ 876,000 $ 1,577,000
We have outstanding amounts borrowed under our lines of credit with
Bridge Bankat March 31, 2014of approximately $815,000. Accrued interest related to the amounts outstanding at March 31, 2014was approximately $3,000. The credit facility agreement expires on February 27, 2016unless renewed. The agreement may be terminated by us or by the Bank at any time. Upon such termination, the Bank would no longer make advances under the credit agreement and outstanding advances would be repaid as receivables are collected. All advances are at the Bank's discretion and the Bank is not obligated to make advances. Additionally, at March 31, 2013we had outstanding a total of $778,000in subordinated convertible notes issued to select officers and directors of the Company. $381,000of these notes have a term of four years that accrue interest at 8% per annum compounded quarterly, mature on September 4, 2017, and have a note holder call provision that becomes effective on September 4, 2014. $372,000of the notes have a term of four years that accrue interest at 18% per annum compounded quarterly, mature on September 4, 2017, and do not have a call provision. The remaining $25,000of notes at March 31, 2014accrued interest at 8% per annum and were repaid in April 2014including $3,420of accrued interest. Accrued interest for all convertible notes is payable upon redemption. The notes are convertible into common stock at the option of the holder at $2.44per share as long as warrants issued on November 19, 2010are outstanding, or at $1.25per share for the four-year notes, if these warrants are no longer outstanding. The warrants issued on November 19, 2012expire on May 20, 2016. Accrued interest expense at March 31, 2014for all convertible notes outstanding was approximately $63,000. The notes are secured by all of the assets of the Company and are subordinated to amounts outstanding under the Company's working capital bank line of credit with Bridge Bank.
Off-Balance Sheet Arrangements
20 -- Index