Bsquare Corp (BSQR) 2002 Q3 法說會逐字稿

My name is Tracease and I will be your conference facilitator today. At this time, I also would like to welcome everyone to the BSquare 2002 earnings conference call, hosted by Mr. Jim Ladd, Senior Vice President and Chief Officer of BSquare. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer period. If you would like to ask a question during that time, simply press"*", then the number"1"on your telephone keypad. If you would like to withdraw your question, press the "#" key. Thank you. Mr. Ladd you may begin your conference.

Thank you. Good afternoon and thank you for participating in our third quarter conference call. I am James Ladd, and to clarify I am Chief Financial Officer of BSquare. Today's call will be divided into two sections. First, I'll provide a financial overview for the quarter ended September 30th, 2002. And then Bill Baxter, our President and CEO, will briefly address the developments since June 30th and provide a business and financial outlook. We will then open the call for questions. But first let me start with the necessary Safe Harbor Statement. Except for the historical statements and information contained herein, the matters discussed in this call, including the revenue and net income expectations, are forward-looking statements that involve risks and uncertainties. Factors that could cause actual results to differ materially include, but are not limited to the decline in the market for Windows based or other smart devices or the failure of such market to develop as anticipated, adverse changes in macro-economic conditions, the failure of these were to attract microprocessor vendors into secured contracts in sufficiently profitable terms, factors that may affect these possibilities to complete work under contract, competition, and intellectual property risks. More detailed description of risk factors that could affect actual results include, but are not limited to, those discussed in BSquare's annual report and Form 10-K for the year ended December 31, 2001 in the section entitled risk factors, and those described in BSquare's subsequent quarterly filings on Form 10-Q with section entitled factors that may affect future results. Listeners are cautioned not to place undue reliance on these forward-looking statements, which speak only as to the date of this conference call. BSquare undertakes no obligation to update publicly any forward-looking statements to reflect new information, events, or circumstances after the date of this call, or to reflect the occurrence of unanticipated events.

Now through the financial results. Revenue for the third quarter was $10 million up 5% from $9.5 million in the second quarter. The increase was due primarily to additional sales of Microsoft licenses, which helped to boost product sales to $5.6 million or 56% of the revenue, up [audiobreak] second quarter and well above our target range. About 85% of third quarter product revenue came from the distribution of Microsoft licenses and other third party products. Despite the high percentage of third party product sales, the increase in total product revenue is encouraging. As we stated at the end of the second quarter, the sale of third party products has enabled us to expand our customer base. We intend to aggressively market BSquare's own product and services with this new customer base. Going forward, we expect sales of BSquare's own products to continue to increase in dollar value, and to improve our margins as we introduce new products to the market and gain increasing visibility and acceptance, within the industries we serve and target. In contrast to our increasing product sales, service revenue declined from $5.1 million in Q2 to $4.4 million in Q3, to 44% of total revenue, reflecting a decrease in revenue from three of our largest customers offset, by increases in revenue from other customers. OEM revenue rose to 84% of total revenue, an increase from 78% in Q2 while as expected, revenue from Microsoft declined to 17% of the total, compared to 20% in Q2. And revenue from semiconductor vendors was 5% of total, down from 8% in the second quarter.

Moving down the income statement, gross profit for the quarter was $968,000 or 10% of revenue, compared to $1.8 million or 19% of revenue in second quarter, reflecting the growth in low margin Microsoft licensing revenue, reduced billing rates with services declines in this tough economy, and excess capacity in our professional engineering services department for the quarter. As we begin sales of new BSquare products, we expect our gross margins to increase in the future. In addition, we believe we can increase the utilization of our professional services consultants in conjunction with our new products and through tighter management.

Turning to other expenses, as we announced in July, due to the continuing weak demand for our technology products and services, management made the strategic decision to reduce company-wide headcount by 30% by the end of 2002. In connection with these actions, we recorded a third quarter restructuring charge of $9.9 million for severance and other cost associated with the headcount reduction, as well as for the cost of excess facilities under non cancelable leases. As of today, the company has 301 employees down from about 400 in July. An additionally offset of plans and have been announced as certain projects are completed. Looking forward, we expect to realize annual savings of $13-15 million from these cost reduction measures. We will continue to manage our service capacity and overhead expenses while meeting market demands. R&D expenses for the quarter were $3.6 million or 36% of total revenues down from, $5 million or 53% in the second quarter. Our decision to continue investing in R&D stems from our belief that it is vitally important to maintain our market lead in products and services. Bill Baxter will discuss our three major product initiatives and the recent and upcoming launches later in the call. For the third quarter of 2002, our pro forma loss was 20 cents per diluted share, compared to 28 cents on a same basis in the prior quarter. Our GAAP based net loss was 69 cents per diluted share, including $9.9 million of restructuring and other related charges and $6.5 million impairment charge, compared to a net loss of 35 cents per diluted share in the prior quarter on a same basis. The reconciliation of diluted earnings per share to diluted pro forma net loss per share is contained in our press release.

Now I'll touch on two key sections of our balance sheet. First cash. Our cash, cash equivalents, restricted cash, and short-term investment balance was $43.8 million at September 30th 2002, compared to $53.5 million at June 30th 2002, reflecting the use of $9.7 million of cash during the quarter, including $6.7 million used for operations and $3 million used for other purposes. As we've stated at the end of the last quarter, we had expected cash used in operations to be in the range of $8-9million for the third quarter, not including payment of one-time restructuring and similar charges. So we did better than expected in that regard. The other charges consist primarily of restructuring and the lease termination costs. The layoffs announced in July resulted in severance and related payments of about $1 million in the quarter. And in September, we executed an amendment to the terms of the lease for our corporate offices in Bellevue Washington, which will allow us to surrender about 56,700 square feet of unused office space by the end of 2002, and the remainder of our current space as of 31st December 2004, almost five years earlier than the original termination date. To achieve these terms, we agreed to pay $4.3 million, of which $1.8 million was paid in September and the balance of $2.5 million is due in quarterly installments through 2004. We estimate that the early termination of this lease will enable us to save about $14 million for the remaining term of the original lease after considering the cost of replacement space. Considering all these factors we expect to use $7-8 million in cash for operations in the fourth quarter of 2002 not including delayed payments of restructuring the lease termination or similar charges. Including those charges we expect to use $9-10 million in total. We obviously cannot continue to spend at these levels. Management and the Board Of Directors are committed to bring cash-based operations to breakeven within the next year. Moving to accounts receivable, our accounts receivable at September 30th, 2002 totaled $6.5 million, a reduction of 26% from the total of 8 million at June 30th, 2002 as we continue to emphasize function of receivables. As we look ahead to the fourth quarter, our biggest challenge is clearly to grow our top-line revenue and increase our gross margins. At the same time we will continue to focus on reducing our operating expenses and maintaining the strength of our balance sheet, by cutting our cash use rate. We expect the factors that contributed to declining revenues through 2001 and early 2002 will continue to put pressure on our near term sales. Consequently, we have set a target range of $8-9 million in revenue for the fourth quarter with the pro forma loss of 20-26 cents per share. I will now turn the call over to Bill Baxter, President and CEO, who'll comment on recent operational changes and current strategic initiatives.

Thanks Jim. As Jim has already said, product revenue increased to more than 50% of total sales during the quarter for the first time in the company's history. And new customers have expanded our market share, and created new opportunities to sell additional products and services. This is in keeping with our long held objective of reducing our reliance on service revenue under our massive agreement with Microsoft. While we had anticipated that our total revenue under the agreement would decline further during 2002, we had hoped and expected that other projects from Microsoft and other interesting customers would offset that decrease. Unfortunately, we had not realized our goals for new business although, we have made great progress. We believe we can continue to leverage our technology, expertise, and a leading market position to expand our market share and generate revenue from other sources. To accomplish this we're continuing to align our organization and resources to support key growth initiatives from the mobile, vertical, and embedded software markets. Specifically, we are targeting these three markets with three BSquare products. Our Power Handheld reference design, software quality management, and SmartBuild product design packages. We choose from these key, smart device markets because first the market for handheld devices is opening to opportunities for higher end products with color screen and faster processers. Second, Carriers are searching for ways to support the more complex devices on their network and third, transactional devices currently used by vertical markets are right per placement because they are expensive and limited in functionality. Our first initiative in the mobile device market is BSquare Power Handheld reference design, which incorporates our technology in every step from the advanced board design to the optimized user interface. Power Handheld is a new class of device, which represents the next generation of wireless handheld. It enables email on the road, enhances productivity, and improves the overall user experience providing greater power and performance for mobile professionals and enterprise clients. The potential for Power Handheld to enhance revenue per unit, increase high value customer acquisition, and support rapid customization, makes it especially attractive to OEM and wireless carriers who represent our primary target market for this product. We've successfully deployed devices for evaluation with two European carriers and anticipate signing at least one in the first quarter of 2003. Our software quality management services will provide wireless carriers and device OEM with a group of services to increase their capability to remotely manage and repair smart device software over any IP-based network. This total quality management solution for mobile devices, calls on BSquare's expertise in industry leading quality assurance and development engineering to provide a host of service business model reducing device recall and enhancing manufacturer's ability to meet launched deadlines, with less cost and minimized risks. Optimized for wireless communication network and over the air upgrades, this group of services allows smooth migration during device deployment and help to ensure easy-to-use maintenance free end user experiences. The overall market for this type of service is expected to grow rapidly in 2003. The potential for the total unit supported to reach approximately 5 million. BSquare has won 3-5 companies lined for business in this state. We're planning on initiating trials of our service within the fourth quarter of 2002 with both U.S. and European carriers. In the vertical market, our product initiative is turnkey solution and profiling likely solution-oriented customers. An example is the SmartBuild Solutions group. Last quarter we introduced this complete development solution for Windows CE-based smart devices including reference hardware, system, and software application with remote management capability. SmartBuild directly addresses our customers need to compress their development time scales and feel an increasing number of new products per year. Utilizing SmartBuild and BSquare's customized services, OEM can shorten their product development cycle. In addition, SmartBuild can reduce risks, lower development costs, and help our customers get to market faster. As we announced earlier in the quarter, Motorola was the first to start the SmartBuild Solutions group and is currently using it to develop software components for the new handheld color touch screen tablet. Ten customers are also using it in handheld and home smart device market open only for consumer, enterprise, and military use. Look for more customer announcements demonstrating SmartBuild attraction in the coming month. The vertical market at which these services are targeted is forecast in 2003 to reach a volume of between 11 and 17 million unit shift. The last of our three initiatives is embedded software. We are aggressive in our plan to convert licensing sales to other business. We are trying to up sell from Windows Classic and DOS to Windows CE and up sell from licenses to other BSquare products and services that carry a higher margin. Industry analysts estimate that the possible market revenue for embedded software in 2003 is over $1 billion. Since BSquare currently represents less than 2% of this licensing market we believe there is a significant upside in revenue potential in this market as well. We believe these initiatives will help drive sales growth to build our customer base and increase the dollar value and marketability of our customer engagement. In addition to the steps I just announced, we will continue to build strategic relationships with existing introspective channel partners and to develop third party relationships for deploy our products and services across multiple market segments. As we are no longer dependant on Microsoft, it is important that we solidify and expand other customer relationships. As we look out over the next year, we're encouraged by several factors that we believe will help to drive our growth and lead to return to profitability. New products in which we had invested heavily over the past year, will continue to enter the market over the next several quarters creating the potential for revenue growth and improved product margin. The growth of our customer base for third party products represent a new and potentially significant market for the sales of our other products and services. Realignment of our sales and marketing teams has enabled us to identify and focus our efforts and resources on those geographic areas and market segments that have the greatest potential for new business. And finally, our emphasis on cost controls and operational discipline is reflected in improving fundamentals, which we believe will continue to improve over the next several quarters. In closing, we believe we are well positioned for steady growth and a return to profitability with a focused strategy of sound business plan, innovative technology, expanding markets, excellent partners, a healthy cash position, no debt, and most importantly, talented, productive, and dedicated employees. As the result of the challenges we have faced during the past year; I believe BSquare is a stronger company with a more promising future than anytime in our history and we are committed to deliver on our potential. Now we would like to turn the call over to questions.

At this time, I would like to remind everyone, in order to ask a question, please press "*" then the number "1" on your telephone keypad. And your first question comes from Jeff Macy from Needham & Co.

Good afternoon.

Hi Jeff.

Hi, few questions. First of all, for the next quarter, can you give maybe a rough estimate of what you expect the breakdown between service and product would be?

We do expect that the trend towards products would increase. So we will have a higher percentage of product revenue than we had in this quarter.

Right, so, it sounds like a lot of the business from Microsoft accounts is dropped off so, that's going to be weighing heavily on that?

Yeah, you know, we do anticipate, maybe some slight growth in the product side, but at this time, we have no commitments from Microsoft to follow on services, but we do have in proposals with Microsoft for new business going forward.

Okay, and you mentioned that you had a lot of excess capacity as far as in the professional engineering services going down, are we looking to try to or maybe cut some costs there possibly?

Yeah, as we had indicated in the call script, as these projects ramp down, we are terminating certain employees. That process is continuing through this quarter.

Okay, so we would expect to see the cost of sales in the service area begin to drop somewhat then in next quarter.

Yes.

Okay, and kind of hitting again on the related third party sales which you have been doing, you know, you've mentioned about, you know, expanding your customization and kind of up selling them through other products or services which you have. Can you name any specific instances where that's occurred yet?

Not anything material at this point in time. We have some tax tools that was associated with distribution. We do have, in the pipeline though, quite a few opportunities that we've been working since the integration of that distribution business and we hope that within the quarter, we'll have something to announce.

Okay. And you mentioned as far as the new Handheld -- the Power Handheld, you, I didn't quite get you said there were two European carriers that are currently...

Evaluating the product and we hope to be generating revenue through that product with at least of those carriers in Q1.

And I am assuming you're in more negotiations in just about two year....

No, those were ones where we have active use of the device within the carrier characterizing on their network, that sort of stuff.

Okay, and can you extend a little bit more on what you're trying to do with the embedded software area, which you've mentioned?

Yes, you know, our origin is to provide horizontal tools and technologies to enable customers to go after a broader way of market. Not really pinning our hopes on any given device market, and SmartBuild is an incarnation of that. With SmartBuild we've been able to penetrate military, industrial enterprise, and consumer markets. And so our strategy around that is to provide a platform that has the flexibility to enable us, as new money flows into the markets to be able to go after those market opportunities. Right now, given the government's investment in homeland defense, defense contractors are looking to see on all sorts of new devices and there is plenty of money out there to be had and so the ability for us to go after these new market opportunities with a flexible platform is what helps us to keep this deals.

Okay.

Now, going back to your Power Handheld, in addition to the carriers we are also targeting OEMs to customize or to take the Power Handheld reference design in to the market under their own brand, and those conversations and negotiations have been going very well as well. So you want to see coming out of the carrier, you will potentially see it coming out of a major OEM name brand.

Okay, and one last question about SmartBuild, I think, I remember right you said that last quarter you had like six customers, and now it was like there is ten, is that correct?

Yes.

Okay, and four additional customers, can you talk a little a bit about, you know, what areas those customers are in, what source of things?

Well I know one of them is military, you know, probably a couple of the others are consumer handhelds, and probably one of them is an industrial handheld, but, you know, I can give you a better idea probably off line.

Okay, great thanks a lot.

Okay.

At this time you have no questions.

Okay, well, thank you very much. We appreciate your time on this business call and your continued interest in BSquare. Our year-end earnings conference call is scheduled for the fourth Thursday of January 2003. Thank you very much.

This concludes today's conference, you may all disconnect.