Bsquare Corp (BSQR) 2004 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the BSQUARE second quarter 2004 conference call. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded today, Thursday, July 29 of 2004. I would now like to turn the conference over to Scott Mahan, Chief Financial Officer. Please go ahead, sir.

Good afternoon and welcome to our second quarter 2004 conference call. With me today is Brian Crowley, our President and CEO, and Don Bibeault, our Chairman.

I will begin the call by giving you an overview of the financial results for the quarter, and then Brian will offer additional views on our results as well as discuss overall business trends and outlook before we open up the call for questions.

Before we begin, let me remind you that this call is being recorded and broadcast live over the Internet. And that a recording of this call will be archived on our website at www.BSQUARE.com.

Let me also remind you that, except for historical statements and information contained herein, the matters discussed in this call, including any revenue and net income expectations and comments regarding our go forward product strategy, are forward-looking statements that involve risks and uncertainties.

Factors that could cause actual results to differ materially include, but are not limited to, a decline in the market for Windows-based or other Smart devices, or the failure of such markets to develop as anticipated, adverse changes in macroeconomic conditions, a decline in the market for our products, technology licenses and services, our ability to successfully implement, execute and make adjustments in our business strategy, business model or product offering, lack of customer acceptance of our new products or initiatives, risks associated with the effects of our restructuring, our ability to successfully support our operations, competition, and lastly, intellectual property risks.

A more detailed description of certain factors that could affect actual results include, but are not limited to, those discussed in BSQUARE's annual report on Form 10-K for the year ended December 31, 2003 in the section entitled, Risk Factors, and in our subsequent quarterly report on Form 10-Q.

Listeners are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the day 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.

Let me preface the financial results overview with a note that our Power Handheld business unit has been accounted for as a discontinued operation. Consequently, the results of the Power Handheld unit, including all revenues and expenses, have been presented in our financial results as one line item entitled, Loss From Discontinued Operations.

Total revenue for the quarter was $8.8 million compared to 9.4 million in the second quarter of 2003 and 10.6 million in the first quarter of 2004. We provided detail on the revenue components and trends in our earnings release, so I would like to focus on a few of the more notable items in this call.

First, the decrease in total revenue from the first quarter of this year was primarily attributable to a 1.7 million decrease in sales of Microsoft embedded operating systems. Lower revenue in 2 major accounts during the quarter, largely contributed to the decrease. We do expect embedded licensing sales to pick up in the second half of the year due to improvements in major accounts volumes, as well as volume from other customers seated with embedded toolkits in the second quarter, which is a forward indicator of embedded license sales. Sales of embedded toolkits were up 57 percent over the first quarter of 2004.

Second, we experienced a record quarter for sales of our SDIO Now! product. Revenue for the SDIO product was $580,000 in the second quarter of 2004 as compared to $260,000 in the preceding quarter. Brian will speak to the future of SDIO Now! later in the call.

Lastly, although service revenue was roughly flat sequentially we did demonstrate that the first quarter operational improvements are sustainable. Additionally we worked on 2 significant international service projects during the quarter which offset some softness in the U.S. service market.

We expect U.S. service revenue to pick up in the second half of the year based on the addition of sales capacity in the second quarter and the strengthening of our pipeline. Compared to the second quarter of last year, service revenue was down slightly from 3.0 million to $2.8 million, but service revenue in the year ago quarter included $260,000 of revenue deferred from the previous quarter.

Turning to gross margin, combined gross margin was 25 percent in this quarter versus 23 percent in the first quarter of 2004 and 24 percent in the second quarter of 2003. The increase in combined margins in the first quarter was largely attributable to an increase in software margin from 21 to 25 percent due to our higher margin proprietary software products comprising a larger percentage of software revenue. Service margin was down to 24 percent from 28 percent in the first quarter, but the decline was not significant in absolute dollars.

Moving down the P&L, operating expenses related to research and development and sales, general and administrative activities were $2.9 million in the second quarter of 2004 compared to $3.8 million in the second quarter of 2003 and $2.6 million in the first quarter of 2004.

As noted in our earnings release, second quarter operating expenses included costs of $310,000 relating to the Company's settlement of a royalty dispute with Microsoft. Excluding the impact of the Microsoft settlement, operating expenses for Q2 were in line with the first quarter of 2004 and down substantially from the second quarter of last year, stemming from savings in facilities head count and other costs generated through our turnaround initiatives.

One item of note is the total amount of operating expense associated with our research and development efforts. In our previously published financial results, total research and development expense was much higher since it included expense related to our Power Handheld efforts. Research and development expense associated with the Power Handheld is now presented within discontinued operations, which has resulted in lower R&D OpEx in our continuing results. Brian will speak to our current and increasing investment in proprietary products later in the call.

While we do not expect a significant decrease in operating expenses on a go forward basis, we will continue to watch expenses closely and identify savings where possible, especially now that the Power Handheld unit is no longer part of the overall BSQUARE overhead structure.

As readers of our 10-Q and 10-K have noted over the last 2 quarters, we have been undergoing an audit by Microsoft and their representatives relating to our distribution of Microsoft's embedded software licenses. This is standard practice for Microsoft, but was the first time BSQUARE has been audited by Microsoft in the Company's history.

The audit began in the fourth quarter of last year and was recently concluded. The audit focused on both the correct reporting of royalties on recorded sales, as well as our accounting for Microsoft license inventory, and covered a period of almost 5 years. Microsoft found that BSQUARE had correctly reported royalties during the audit period, but that BSQUARE could not account for all inventory that the Company had received from Microsoft authorized replicators. Most of the unaccounted for licensed inventory related to products which have not been sold by BSQUARE for several years.

While the Company believes that the unaccounted for licensing inventory relates to undocumented inventory returns, and disagrees with the audit findings, the Company ultimately chose to settle the dispute, which was causing substantial internal burden and distraction as well as external costs.

Total settlement costs in the second quarter were $310,000, including audit costs of $140,000. The settlement amount will largely be paid to Microsoft in the first quarter of 2005. As part of our ongoing efforts to improve systems, processes and controls surrounding all aspects of our business, we have strengthened the processes and controls related to our handling and sale of Microsoft embedded systems -- operating system licenses substantially since the beginning of the year.

The loss from continuing operations for the quarter was $660,000, including the $310,000 in Microsoft audit settlement costs mentioned previously. This compares to income from continuing operations of 1.3 million in the second quarter of 2003, which included a net restructuring gain of 2.8 million, and a loss from continuing operations of $200,000 in the first quarter of 2004.

Excluding the impact of the Microsoft settlement cost, the loss from continuing operations was up slightly from the first quarter on substantially lower revenue. As noted earlier, the Power Handheld business unit was accounted for as a discontinued operation in our financial results. For the quarter, the loss from the Power Handheld unit was $4.5 million, which included a $3.3 million charge related to asset impairment and restructuring costs. This loss compares to 2.0 million in both the second quarter of 2003 and the first quarter of 2004.

In addition to the impairment charge, the Power Handheld business unit incurred operating losses of 1.2 million in the second quarter of 2004. Power Handheld revenue for the quarter was $370,000 on 510 units shipped as compared to revenue of $520,000 in the first quarter of 2004 on 701 units shipped.

The second quarter 2004 discontinued operations loss included non-cash depreciation and amortization charges of $300,000. As a result of restructuring efforts implemented late in the first quarter of 2004, we were able to reduce the second quarter operating costs of the Power Handheld unit as we continued exploration of strategic financing alternatives.

Additionally, because we had already purchased a significant amount of inventory in 2003, there was no cash costs for Power Handheld units shipped during the quarter. These factors and other working capital impact meant that the cash burn of the Power Handheld business unit was approximately $300,000 in the second quarter, one of the primary factors considered by our Board of Directors in continuing exploration of possible strategic financing options into this quarter. Brian will speak more to our strategic financing efforts later in the call.

As a result of the decision to discontinue manufacturing of the Power Handheld device, and restructure the business unit, 12 employees and contractors were terminated or have been given notice. 8 employees previously involved with the Power Handheld unit were reassigned into our Professional and Engineering Services Group or our proprietary product initiative.

The net loss for the second quarter of 2004 was $5.1 million, or 14 cents per diluted share, including the loss from the discontinued Power Handheld business of 4.5 million. This compares to a net loss of $740,000 or 2 cents per diluted share in the second quarter of 2003 and a net loss of 2.2 million or 6 cents per diluted share in the first quarter of 2004.

Now let me turn to our cash flows. The Company used $1.4 million in cash during the quarter. Significant cash uses included approximately $300,000 related to the Power Handheld business, $300,000 in lease restructuring payments, and $360,000 in capital expenditures, largely related to the Company's new headquarters. For comparison we used 2.4 million in cash in the first quarter of this year.

The $300,000 in quarterly lease restructuring payments will continue for the next two quarters at which point the Company's obligations will be satisfied. At June 30, 2004 BSQUARE had 14 million in cash and cash equivalents, restricted cash and short-term investments compared with 15.4 million at the end of the first quarter of 2004.

As of June 30, 2.6 million of our 14 million in cash and investments was restricted under letters of credit backing our headquarter's facility lease. The portion of our cash and investments that is restricted will decline to approximately 1.2 million by year end.

Now I'll turn the call over to Brian who will provide additional perspective on our results, discuss our go forward strategy, and our business outlook for the second half of the year.

First, let me address the decision to cease manufacturing of the Power Handheld. We were disappointed to have to take this action. By doing so we are exiting the hardware manufacturing business into which BSQUARE has invested a great deal of time and money. However, it became clear that the time and resources needed to fund the Power Handheld were not sustainable by BSQUARE. In addition, the current Power Handheld design was nearing the end of its life cycle, and extending this life would have required substantial additional investment.

Over the past month we have conducted an exhaustive search for a financial alternative to fund the Power Handheld business. We engaged the services of an outside banker to help us with the process. And we talked to over 60 companies about either investing in or purchasing the Power Handheld unit. While we had several promising leads and were in discussions with potential partners up through the end of June, we ultimately were not able to find an outside financing partner, leading to the recommendation by management, which was endorsed by the Board of Directors, to end the Power Handheld manufacturing and focus all of our efforts on the continuing software and service business.

Ultimately the hardware oriented nature of the Power Handheld took us away from our core competency of providing software and services to Smart Device makers. As we pursued sales opportunities with current and potential Power Handheld customers, we learned that many were interested in the system and application software that powered the Power Handheld and not in the hardware, which they viewed as a commodity, not as BSQUARE's core competency. We believe that there is an opportunity to leverage this software, and I will talk more about this later.

Now to talk about the continuing aspects of our business, including some key achievements during the quarter. We significantly grew sales in our Taiwanese operation. We believe that there are other untapped opportunities for BSQUARE in Taiwan. And we intend to continue to make investments in our sales and engineering capabilities in the Taiwan operations.

During the quarter we began a significant Windows mobile service project for a large Japanese OEM, demonstrating that the combination of BSQUARE expertise, combined with our lower Taiwan cost base, should allow us to win additional projects in this cost sensitive part of the world.

We had record SDIO Now! software sales in the quarter. We now have a total of 65 SDIO Now! licensees in our program. Some examples of SDIO Now! licensees in Q2, including market leading consumer electronics manufacturers such as Panasonic, Renases (ph) Technology, and BenQ Corporation. These partners joined our SDIO Now! program because BSQUARE represents the industry standard for SDIO interoperability for Windows embedded and Windows mobile devices.

Earlier today we announced Version 2.0 of our SDIO technology, which includes key features requested by licensees such as support for the SD Card Association's soon to be released SDIO 1.1 specification, Intel's CXA-270 native controller -- native SDIO controller, substantial performance enhancements, support for Windows CE 50 and Microsoft Next Generation Windows mobile platform.

Moving on to our Microsoft Windows embedded licensing business. Although our licensing revenue was sequentially down this quarter, we expect to see revenue pick up as the year progresses. Sales of developmental kits were strong in the quarter. Our customers purchased toolkits during the development process, therefore strong toolkits are one leading indicator to sales of embedded licenses.

Second, Microsoft announced Windows CE Version 5.0, as well as Windows XP Embedded service pack 2 during the quarter. New operating system versions typically generate additional interest from OEMs and can be a precursor to stronger sales.

Showcasing our momentum with XP Embedded -- with the XP Embedded operating system, we experienced a 200 percent increase over the prior quarter in the delivery of XP Embedded JumpStart service packages. BSQUARE ports applications to XP Embedded and delivers a componentized image to its OEM customers enabling them to get to market rapidly with an optimized product, often leading to additional XP Embedded licensing sales by BSQUARE.

During the quarter we were selected by Sygate as their value added provider of M-Point Security for OEM manufacturers and Windows XP Embedded retailers. We will resell the new Sygate security agent for Microsoft Windows XP Embedded and provide customized system integration services, consulting and technical support. BSQUARE is currently engaged with leading thin client and point-of-sale OEMs for evaluation of this security solution.

In the past we have talked about our goal of creating synergies between the various products and services that we sell, so that each time we touch a customer we are able to offer multiple relevant products that solve that customer's problems. Sygate, combined with our packaged security solutions, is a good example of this strategy in action.

By creating solution bundles containing XP Embedded licenses, Sygate licenses, and a fixed service package, we create differentiation for BSQUARE, and believe that we will be able to increase the average sale price for our products and services, as well as protect, if not increase, our margins.

In our service business we completed 21 service engagements during the quarter. We continue to see strong demand for BSQUARE services in both the general embedded and the Windows mobile area of our businesses. We showed consistency in our service business, reporting 2.8 million in revenues, and generally holding the positive improvements in our service margins when compared to the prior quarter.

With the discontinuation of Power Handheld manufacturing, I would like to spend a few minutes talking about our plans with regard to go forward research and development investment. Over the past 2 years the bulk of BSQUARE's R&D investment has gone towards the Power Handheld. While the hardware aspect of this investment ultimately was not successful, we think that we've created a set a valuable software IT, including power management, radio communications, user interface and information management software that we believe enable important functionality for OEMs who do not have the expertise or time to develop it for themselves.

Smart Device makers such as NEC America and Hop and Vessel (ph) have previously licensed this software technology for integration into their Windows CE-based devices, and others have expressed interest. We intend to dedicate resources to further development of the Power Handheld software IT and to offer these solutions to the market.

In addition to our investment in the Power Handheld software, we intend to continue to reinvest in our SDIO technology. We have stated in the past that we expect the SDIO market window to close this year because our agreement with Microsoft required us to provide a source snapshot our SDIO code for inclusion into Microsoft's Windows CE operating -- CE 5.0 operating system.

To the contrary, we have seen continued strength in SDIO revenues for 2 primary reasons. First, delays in Microsoft Microsoft's release of Windows CE 5.0 encouraged OEMs to come to BSQUARE for early access to this space technology. And second, SDIO adoption by OEMs, ODMs, silicon vendors and peripheral device makers has been stronger than expected. While we do not expect to have a repeat of our record Q2 for SDIO Now!, we are forecasting steady SDIO Now! business for the remainder of this year as the royalty stream from current SDIO licensees offset the expected decline in new licensees.

As we indicated earlier, we're releasing the next version of our SDIO technology later in this quarter. While we are fully compatible with CE 500, our new technology contains functionality and performance improvements that differentiate us from the base SDIO functionality contained in Windows CE 5.0. We believe that this alone will extend the market window for SDIO Now! well into 2005. We're also making additional investments in SDIO technology and we will announce these products as they are closer to availability.

Let me end our commentary by reinforcing our goal of moving our core business to profitability on a quarterly basis this year. As we recapped in our earnings release and earlier in the call, our loss from continuing operations after the impact of the Microsoft settlement was not far from breakeven on a disappointing topline quarter. We will continue to watch expenses closely and look for additional savings.

We are expecting revenues for the second half of the year to be between 20 and $22 million. We expect growth in revenues as compared to our second-quarter results to come from a rebound in our sale of Microsoft embedded system -- operating systems, as well as an increase in U.S. service revenues. Last quarter we made incremental investments in increasing our sales capacity, and we expect to start seeing a payoff in the second half of this year.

These facts, coupled with continued pickup of the market share of Windows embedded and Windows mobile operating systems and an overall improving market for OEMs creating Smart devices, gives us confidence that we will be able to grow our sales in the second half of 2004.

What that we would be happy to take your questions.

(OPERATOR INSTRUCTIONS). Sean Matthews with Alchemist (ph) Capital Management.

When you wrote down the inventory for the Power Handheld, how much was the actual write-down on inventory? Did you give that number?

We didn't particularly disclose that number, but it was a significant number.

And do you expect that inventory to be sold at some point in the future, or is that just been written down and that's it?

It's been written down, but obviously we are in process currently of kind of looking at the inventory, which is located in China, and finding the best solution for its disposal. Obviously looking to maximize the proceeds we will get from that inventory.

Sure. So when you're talking about a profitable quarter is that on a continuing operations basis or is that with some sort of boost from the inventory sell?

No, that is profit from continuing operations in Q4. And we don't expect much, if any, tail so to speak from the Power Handheld unit in Q4.

And on the finance side, do you guys expect to have to go to the Capital Markets or do you have enough cash going forward?

At this point we have enough cash in the bank today. We ended the quarter with $14 million. Obviously we're not projecting to get to profitability of the core business until Q4. And as I mentioned in the earnings release, there are still a couple of nonoperational cash commitments such as our lease restructuring payments.

Those are fairly small compared to your actual cash size?

Correct. We have $300,000 a quarter in the case of our lease restructuring payment. But yes, our singular goal right now is to get to profitability. We should get there with a strong balance sheet, obviously we have no debt, and without the need for additional cash.

Did you guys -- or will you guys start to give a utilization rate as far as your bench goes on your consultants, or is that trending higher at least, can you give us that?

That's a metric, Sean, which I don't think we are going to disclose publicly. It, in some ways -- while I wouldn't call it competitive information, it is sensitive information.

Let me ask you this on those at least. Are the ASP's on those -- on the consultants holding steady or going up? Can you give us at least a little granularity on that?

Our ASPs at consultants generally have been going up.

Good job, guys. Keep up the good work.

(OPERATOR INSTRUCTIONS). Gentlemen, there are no further questions at this time.

Okay. We would like to thank everybody for being on the call, and we look forward to talking to you again next quarter.

Ladies and gentlemen, this concludes the BSQUARE second quarter 2004 conference call. If you'd like to listen to a replay of today's conference, you may dial 303-590-3000 or 800-405-2236 followed by access number 11000247.

Once again, thank you for your participation. Have a pleasant evening. And at this time you may disconnect.