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NOTE 1 Summary of Significant Accounting Policies
 12 Months Ended
Dec. 31, 2011
Notes to Financial Statements  
Summary of Significant Accounting Policies

NOTE 1 — Summary of Significant Accounting Policies

 

Organization and Business

Socket Mobile, Inc. (the “Company”), produces mobile handheld computers and data collection products serving the business mobility market and designed for the mobile worker. The Company offers a family of general purpose handheld computer products running the Windows Mobile operating system and a wide range of data collection products including two dimensional (2D) and linear (1D) bar code scanners, Radio Frequency Identification (RFID) readers, and magnetic stripe readers. The Company also offers wearable ring scanners, customized versions of its handheld computers, embedded wireless LAN cards and Bluetooth modules as OEM products to third-party companies. The Company’s data collection products work with the Company’s handheld computers and the Company’s cordless hand scanners work with many third-party mobile handheld devices including smartphones, tablet computers, ultra-mobile personal computers (UMPCs), notebooks and desktop systems, adding data collection capabilities to these devices. For a complete description of the Company’s products see “Products” in “Item 1. Business.” The Company works closely with software application developers offering or developing software applications for use with the Company’s mobile handheld computers and barcode scanners. The Company offers software developers kits to enable developers to easily integrate the Company’s barcode scanning products into their applications. The Company’s family of barcode scanners are designed to work with a wide range of smartphones and tablets running Apple iOS4, Google Android, RIM BlackBerry and Microsoft Windows/Windows Mobile operating systems. Healthcare and hospitality are two of the primary areas of focus for software application developers who have developed applications for use on the Company’s handheld computers, and a significant portion of the Company’s handheld computer sales now come from organizations within these two market segments. Other vertical markets benefiting from mobile solutions include retail merchandising, automotive, government and education. These mobile application solutions are designed to improve the productivity of business enterprises and service providers.

 

The Company subcontracts the manufacturing of substantially all of its products to independent third-party contract manufacturers who are located in the U.S., China and Taiwan and who have the equipment, know-how and capacity to manufacture products to the Company’s specifications. The Company markets its products through a worldwide network of distributors and resellers, as well as through original equipment manufacturers and value added resellers. The geographic regions served by the Company include the Americas, Europe, the Middle East, Africa and Asia Pacific. The Company’s total employee headcount on December 31, 2011 was 66 people.

 

The Company was founded in March 1992 as Socket Communications, Inc. and reincorporated in Delaware in 1995 prior to the Company’s initial public offering in June 1995. The Company began doing business as Socket Mobile, Inc. in January 2007 to better reflect its market focus on the mobile business market, and changed its legal name to Socket Mobile, Inc. in April 2008. The Company’s common stock trades on the NASDAQ Capital Market under the symbol “SCKT.” The Company’s principal executive offices are located at 39700 Eureka Drive, Newark, CA 94560.

 

Liquidity

During the years ended December 31, 2011, 2010, and 2009, the Company incurred net losses of $2,422,361, $3,975,837, and $7,888,804, respectively. As of December 31, 2011, the Company has an accumulated deficit of $57,204,099. The Company’s cash balances at December 31, 2011 were $957,022 including $1,109,600 advanced on its bank lines of credit. At December 31, 2011 the Company had additional unused borrowing capacity of approximately $901,000 on its bank lines of credit (approximately $248,000 and $653,000, respectively, on the domestic and international credit lines). The Company’s balance sheet at December 31, 2011 has a current ratio (current assets divided by current liabilities) of 0.79 to 1.0, and a working capital deficit of $1,449,862 (current assets less current liabilities), and no material long term debt.

 

Beginning in the fourth quarter of 2008, the Company took actions to reduce its expenses and to align its cost structure with economic conditions in response to the slow-down in business spending resulting from the economic downturn beginning in late 2008. The Company took additional actions during 2009 to reduce expenses, and the Company reduced overall expenses further in 2010 and 2011. The Company has the ability to further reduce expenses if necessary. Additional steps by management intended to reduce operating losses and achieve profitability include the introduction of new products, continued close support of the Company’s distributors and its application partners as they establish their mobile applications in key vertical markets. Management believes its existing cash, plus its ability to reduce costs and manage its working capital balances, and its bank lines of credit will be sufficient to meet its funding requirements at least through December 31, 2012.

 

If the Company can return to revenue growth and attain profitability, the Company anticipates 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 the Company’s growth and increases in salaries, benefits, and related support costs for employees. If the Company cannot attain profitability, the Company will not be able to support its operations from positive cash flows, and the Company would use its existing cash to support operating losses. The Company may also find it necessary to raise additional capital to fund its operations, 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. If the Company is unable to secure the necessary capital for its business, the Company may need to suspend some or all of its current operations.

 

Use of Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported amounts of revenue and expense during the reporting period. Actual results could differ from those estimates, and such differences may be material to the financial statements.

 

Cash Equivalents

The Company considers all highly liquid investments purchased with a maturity date of 90 days or less at date of purchase to be cash equivalents. As of December 31, 2011 and 2010, all of the Company’s cash and cash equivalents consisted of demand and money market deposits held in banks.

 

Restricted Cash

There was no restricted cash at December 31, 2011. At December 31, 2010, all of the Company’s restricted cash consisted of amounts held in demand deposits in banks under the terms of its senior convertible note issued in November 2010. Under the terms of the note the Company was required at all times to maintain collateralization of the convertible note with an amount equivalent to the unconverted principal plus accrued interest. Collateral consisted of qualified accounts receivable of the Company, plus cash to the extent qualified accounts receivables were less than the unconverted principal plus accrued interest.

 

Fair Value of Financial Instruments

The carrying value of the Company’s cash and cash equivalents, accounts receivable, accounts payable, debt and foreign exchange contracts approximate fair value due to the relatively short period of time to maturity.

 

Fair Value Measurements

The Company’s estimates of fair value for assets and liabilities is based on a framework that establishes a hierarchy of the inputs used in valuation and gives the highest priority to quoted prices in active markets and requires that observable inputs be used in the valuations when available. The disclosure of fair value estimates is based on whether the significant inputs into the valuation are observable. In determining the level of the hierarchy in which the estimate is disclosed, the highest priority is given to unadjusted quoted prices in active markets and the lowest priority to unobservable inputs that reflect management’s significant market assumptions. The three levels of the hierarchy are as follows:

 

Level 1: Unadjusted quoted market prices for identical assets or liabilities in active markets that we have the ability to access.
Level 2: Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets in inactive markets; or valuations based on models where the significant inputs are observable (e.g., interest rates, yield curves, default rates, etc.) or can be corroborated by observable market data.
Level 3: Valuations based on models where significant inputs are not observable. The unobservable inputs reflect management’s assumptions about the assumptions that market participants would use.

 

 

There were no significant fair value measurements for the years ended December 31, 2011 and 2010. The significant fair value measurements for the year ended December 31, 2009 were on a nonrecurring basis and related to the Company’s goodwill impairment assessment as described below under “Goodwill and Other Intangible Assets Review.” The Company performed an impairment test of its goodwill as of December 31, 2009 using Level 3 inputs and recorded estimated goodwill impairment charges of $5.4 million as of December 31, 2009.

 

 

Derivative Financial Instruments

The Company's primary objective for holding derivative financial instruments is to manage foreign currency risks. The Company's derivative financial instruments are recorded at fair value and are included in other current assets, other assets, other accrued liabilities or long-term debt depending on the contractual maturity and whether the Company has a gain or loss. The Company's accounting policies for these instruments are based on whether they meet the Company's criteria for designation as hedging transactions, either as cash flow or fair value hedges. A hedge of the exposure to variability in the cash flows of an asset or a liability, or of a forecasted transaction, is referred to as a cash flow hedge. A hedge of the exposure to changes in fair value of an asset or a liability, or of an unrecognized firm commitment, is referred to as a fair value hedge. The criteria for designating a derivative as a hedge include the instrument's effectiveness in risk reduction and, in most cases, a one-to-one matching of the derivative instrument to its underlying transaction. Gains and losses on derivatives that are not designated as hedges for accounting purposes are recognized currently in earnings. The Company regularly enters into forward foreign currency contracts to reduce exposures related to rate changes in certain foreign currencies.

 

The Company's forward foreign currency contracts are recorded at fair value at December 31, 2011. At December 31, 2011, these derivative instruments were not designated as hedges, and accordingly, changes in the fair value of the forward foreign currency contracts were recorded in earnings. At December 31, 2011, contracts with a notional amount of $323,000 to hedge Euros and $277,000 to hedge Yen had fair values of an immaterial amount for each currency based on quotations from financial institutions, and had maturity dates in January 2012. At December 31, 2010, contracts with a notional amount of $132,900 to hedge Euros had a fair value of an immaterial amount based on quotations from financial institutions, and had maturity dates in January 2011.

 

Accounts Receivable Allowances

The Company estimates the amount of uncollectible accounts receivable at the end of each reporting period based on the aging of the receivable balance, current and historical customer trends, and communications with its customers. Amounts are written off only after considerable collection efforts have been made and the amounts are determined to be uncollectible. The following describes activity in the allowance for doubtful accounts for the years ended December 31, 2011, 2010, and 2009:

 

Year Balance at
Beginning of Year		  Charged to
Costs and
Expenses		  Amounts
Written Off		  Balance at
End of
Year
2011 $89,058  $—  $—  $89,058
2010 $121,713  $—  $32,655  $89,058
2009 $118,651  $3,062  $—  $121,713

 

 

 

Inventories

Inventories consist principally of raw materials and sub-assemblies stated at the lower of standard cost, which approximates actual costs (first-in, first-out method), or market. Market is defined as replacement cost, but not in excess of estimated net realizable value or less than estimated net realizable value less a normal margin. At the end of each reporting period, the Company compares its inventory on hand to its forecasted requirements for the next nine month period and the Company writes-off the cost of any inventory that is surplus, less any amounts that the Company believes it can recover from the disposal of goods that it specifically believes will be saleable past a nine month horizon. The Company’s sales forecasts are based upon historical trends, communications from customers, and marketing data regarding market trends and dynamics. Changes in the amounts recorded for surplus or obsolete inventory are included in cost of revenue. Inventory components at year-end, net of write-downs, are presented in the following table:

 

 

 

  December 31,
  2011  2010
Raw materials and sub-assemblies $1,432,696  $1,608,469
Finished goods  28,356   90,181
  $1,461,052  $1,698,650
        

 

 

Property and Equipment

Property and equipment are stated at cost. Depreciation and amortization are computed using the straight-line method, over the estimated useful lives of the assets ranging from one to five years. Assets under capital leases are amortized in a manner consistent with the Company’s normal depreciation policy for owned assets, or the remaining lease term as applicable.

 

Goodwill

Goodwill is tested for impairment annually as of September 30th or more frequently when events or circumstances indicate that the carrying value of the Company’s single reporting unit more likely than not exceeds its fair value. No impairment of goodwill was recorded in 2011 and 2010.

 

Subsequent to the annual impairment test at September 30, 2009, indicators of impairment existed which resulted in the Company performing additional impairment testing with the assistance of a third-party valuation specialist as of December 31, 2009. The Company used the two step test as required to assess goodwill for impairment. The first step of the goodwill impairment test consisted of comparing the carrying value of the reporting unit to its fair value. Management estimated the fair value of the Company using various methods and compared the fair value to the carrying amount (net book value) to ascertain if potential goodwill impairment existed. The Company utilized methods that focused on its ability to produce income (“Income Approach”) and the estimated consideration it would receive if there were a sale of the Company (“Market Approach”). Key assumptions utilized in the determination of fair value in step one of the test included the following: the Company’s market capitalization; market multiples of comparable companies within its industry; revenue and expense forecasts used in the evaluation were based on trends of historical performance and management’s estimate of future performance; cash flows utilized in the discounted cash flow analysis were estimated using a weighted average cost of capital determined to be appropriate for the Company.

 

Based on the fair value estimated in step one, the Company determined a step one failure occurred which indicated a goodwill impairment may exist. The Company performed a step two analyses which included estimating the fair value of its assets and liabilities, including previously unrecognized intangible assets. The Income Approach was utilized to value the Company’s identified intangible assets, including developed technology, trade name, patents, and internally developed software. As a result, the Company recorded an estimated $5,370,946 goodwill impairment as of December 31, 2009.

 

Deferred Rent

The Company operates its headquarters under a non-cancelable operating lease. The Company recognizes rent expense under its lease on a straight line basis measured over the term of the lease. The excess of accumulated rental expense measured on a straight lined basis over actual accumulated rent paid is capitalized as a liability on the Company’s balance sheet in its short and long term components. The short term and long term components of deferred rent at December 31, 2011 were $3,853 and $179,527, respectively. The short term and long term components of deferred rent at December 31, 2010 were $14,008 and $183,379, respectively. 

 

Concentration of Credit Risk

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash, cash equivalents and accounts receivable. The Company invests its cash in demand and money market deposit accounts in banks. To the extent of the amounts recorded on the balance sheet, cash is concentrated at the Company’s bank to the extent needed to comply with the minimum liquidity ratio of the bank line agreement. To date, the Company has not experienced losses on these investments. The Company’s trade accounts receivables are primarily with distributors and OEMs. The Company performs ongoing credit evaluations of its customers’ financial conditions but the Company generally requires no collateral. Reserves are maintained for potential credit losses, and such losses have been within management’s expectations. At December 31, 2011, there were three customers with material amounts outstanding totaling 54% of the Company’s accounts receivable balances. At December 31, 2010, there were five customers with material amounts outstanding totaling 62% of the Company’s accounts receivable balances.

 

Concentration of Suppliers

Several of the Company’s component parts are produced by a sole or limited number of suppliers. Shortages could occur in these essential materials due to an interruption of supply or increased demand in the industry, such as the Company experienced in the fourth quarter 2010 and to a progressively lesser extent over the first, second, and third quarters of 2011 with the delays in availability of LCD touch screens used in the manufacture of the Company’s mobile handheld computer. If the Company were unable to procure certain of such materials, it would be required to reduce its operations, which could have a material adverse effect upon its results. At December 31, 2011 and 2010, 56% and 32%, respectively, of the Company’s accounts payable balances were concentrated in a single supplier. For the years ended December 31, 2011, 2010, and 2009, two suppliers accounted for 70%, 63%, and 63%, respectively, of the inventory purchases in each of these years.

 

Revenue Recognition and Deferred Income

Revenue on sales to customers other than distributors is recognized upon shipment provided that persuasive evidence of a sales arrangement exists, the price is fixed or determinable, title has transferred, collection of resulting receivables is reasonably assured, there are no customer acceptance requirements, and there are no remaining significant obligations. Revenue on sales to distributors where a right of return exists is recognized upon “sell-through,” when products are shipped from the distributor to the distributor’s customer. Revenue related to those products in the Company’s distribution channel at the end of each reporting period which has not sold-through is deferred. The amount of deferred revenue net of related cost of revenue is classified as deferred income on shipments to distributors on the Company’s balance sheet. At December 31, 2011 and 2010, deferred income on shipments to distributors represented deferred revenues totaling $3,448,021 and $1,400,155, respectively, net of related costs of those revenues of $1,876,477 and $726,671, respectively.

 

 

The Company also earns revenue from its SocketCare Extended Warranty service program which offers extended warranty coverage of up to three years in duration on select products. Revenues from the SocketCare Extended Warranty service program are recognized ratably over the life of the extended warranty contract. The amount of unrecognized warranty service revenue is classified as deferred service revenue and presented on the Company’s balance sheet in its short and long term components. The Company also earns revenue from services performed in connection with consulting arrangements. For those contracts that include contract milestones or acceptance criteria the Company recognizes revenue as such milestones are achieved or as such acceptance occurs. In some instances the acceptance criteria in the contract requires acceptance after all services are complete and all other elements have been delivered. Revenue recognition is deferred until those requirements are met. Revenues related to these services in the years presented were not material.

 

Research and Development

Research and development expenditures are charged to operations as incurred. The major components of research and development costs include salaries and employee benefits, stock-based compensation expense, third party development costs including consultants and outside services, and allocations of overhead and occupancy costs.

 

The accounting for the costs of computer software to be sold, leased or otherwise marketed, requires the capitalization of certain software development costs subsequent to the establishment of technological feasibility. Based on the Company’s product development process, technological feasibility is established upon the completion of a working model. Costs incurred by the Company between the completion of the working model and the point at which the product is ready for general release have been insignificant. Accordingly, the Company has charged all such costs to research and development expenses in the accompanying statements of operations.

 

Advertising Costs

Advertising costs are charged to sales and marketing as incurred. The Company incurred $296,346, $188,600, and $426,923, in advertising costs during 2011, 2010, and 2009, respectively.

 

Income Taxes

The Company uses the asset and liability method to account for income taxes. Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using enacted tax rates and laws that will be in effect when the differences are expected to reverse. The Company records a valuation allowance against deferred tax assets when it is more likely than not that such assets will not be realized. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

 

The Company recognizes the tax benefit from uncertain tax positions if it is more likely than not that the tax positions will be sustained on examination by the tax authorities, based on the technical merits of the position. The tax benefit is measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement.

 

Shipping and handling costs

Shipping and handling costs are included in the cost of revenues in the statement of operations.

 

 

Net Loss Per Share

The following table sets forth the computation of basic and diluted net loss per share:

 

   Years Ended December 31,
  2011  2010  2009 
Numerator:         
  Net loss $(2,422,361) $(3,975,837) $(7,888,804)
 
Denominator:		            
  Weighted average common shares outstanding used in computing net loss per share:            
         Basic and diluted  4,360,217   3,795,673   3,562,080 
  Net loss per share applicable to common stockholders:            
         Basic and diluted $(0.56) $(1.05) $(2.21)

 

 

For the 2011, 2010, and 2009 periods presented, the diluted net loss per share is equivalent to the basic net loss per share because the Company experienced losses in these years and thus no potential common shares underlying stock options or warrants have been included in the net loss per share calculation. Options and warrants to purchase 2,034,532, 1,829,375, and 1,298,501 shares of common stock in 2011, 2010, and 2009, respectively, have been omitted from the loss per share calculation as their effect is anti-dilutive.

 

Stock-Based Compensation

The Company accounts for stock-based compensation of stock options granted to employees and directors and of employee stock purchase plan shares by estimating the fair value of stock-based awards using the binomial lattice model. The fair value is amortized as compensation expense over the requisite service period of the award on a straight-line basis. The binomial lattice model incorporates calculations for expected volatility, risk-free interest rates, employee exercise patterns and post-vesting employment termination behavior, and these factors affect the estimate of the fair value of the Company's stock option grants.

 

The weighted average assumptions and grant date fair values for options granted are as follows:

 

  Years Ended December 31,
  2011  2010  2009
Risk-free interest rate (%)  3.30%   3.03%   3.05%
Dividend yield  —   —   —
Volatility factor  0.6   0.9   1.0
Expected option life (years)  5.7   4.0   3.9
Weighted average grant date fair value $1.08  $1.92  $1.64

 

 

Stock-based compensation expenses included in the Company’s statement of operations is as follows:

 

  Years Ended December 31,
Income Statement Classification 2011  2010  2009
 Cost of revenues $61,994  $55,607  $62,320
 Research and development  165,028   151,978   161,406
 Sales and marketing  177,065   196,368   263,428
 General and administrative  319,112   272,601   227,932
  $723,199  $676,554  $715,086

 

 

At December 31, 2011, the fair value of unamortized stock-based compensation expense was $687,336, and will be amortized over a weighted average period of 1.78 years.

 

Segment Information

Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief executive officer in deciding how to allocate resources and in assessing performance. The Company operates in one segment—mobile systems solutions for businesses. Mobile systems solutions typically consist of a handheld computer, data collection and connectivity peripherals, and third-party vertical applications software. The Company markets its products in the United States and foreign countries through its sales personnel and distributors.

 

Revenues for the geographic areas for the years ended December 31, 2011, 2010, and 2009 are as follows:

  Years Ended December 31,
Revenues: (in thousands) 2011  2010  2009
  United States $11,624  $10,205  $9,930
  Europe  4,092   2,742   5,386
  Asia and rest of world  1,795   551   1,811
  $17,511  $13,498  $17,127

 

Export revenues are attributable to countries based on the location of the customers.

 

Information regarding product families for the years ended December 31, 2011, 2010, and 2009 is as follows:

  Years Ended December 31,
Revenues: (in thousands) 2011  2010  2009
         
 Mobile handheld computer products $8,748  $6,622  $6,467
 Data collection products  7,613   4,956   5,632
 OEM embedded products  672   1,414   3,318
            
 Other:           
     Connectivity (legacy)  478   506   815
     Serial interface *  —   —   895
  $17,511  $13,498  $17,127

 

*Note: On September 30, 2009, the Company sold its serial product line assets to Quatech, Inc. (see “Note 8 – Sale of Product Line Assets” for more information).

 

 

Major Customers

Customers who accounted for at least 10% of total revenues for the years ended December 31, 2011, 2010, and 2009 were as follows:

  Years Ended December 31,
  2011  2010  2009
Ingram Micro Inc.  13%   14%   18%
Scansource, Inc.  16%   *   *
Tech Data Corporation  *   13%   17%
Epocal, Inc.  11%   10%   *
BlueStar, Inc.  *   11%   *
* Customer accounted for less than 10% of total revenues for the period

 

 

Reclassifications and Other Adjustments

Adjustments have been made to properly reflect Restricted cash in Net cash provided by (used in) financing activities and Net increase (decrease) in cash and cash equivalents in the Statements of Cash Flows for the year ended December 31, 2010. Reclassification of Amortization of intangible assets in the Statements of Operations for the years ended December 31, 2010 and 2009, have been made to include these charges within Research and development expense to conform to the current year presentation.