Bsquare Corp (BSQR) 2006 Q2 法說會逐字稿

Good day, everyone and welcome to the BSquare Corporation Second Quarter 2006 Financial Results Conference Call. As a reminder, today's conference is being recorded. At this time, all participants have been placed in a listen-only mode. The floor will be open for your questions following the presentation.

It now my pleasure to turn to conference over to Scott Mahan, Chief Financial Officer. Please, go ahead, sir.

Good afternoon and welcome to BSquare Second Quarter 2006 Conference Call. With me, today is Brian Crowley, our CEO. Let me remind you that this call is being recorded and broadcast live over the Internet and that a recording of this call, as well as the text of our prepared remarks, will be available in the Investor Relations section of our website at BSquare.com. I would also like to direct listeners' attention to the Safe Harbor statement contained in our earnings press release issued earlier today which applies to the comments and content of this call.

With that said, I'll provide a recap of our performance for the quarter and first half of '06. During the discussions, references to this quarter or the quarter mean the second quarter of '06. References to the first quarter mean the first quarter of '06, while references to the third quarter mean the third quarter of '06.

Let me start by speaking to revenue. BSquare reported total revenue this quarter of 12.6 million, a 22% increase from 10.3 million in the year-ago quarter and a 9% increase from 11.6 million in the first quarter. Total revenue for the first half of '06 increased to 24.2 million, up 20% from 20.1 million in the prior year. Total quarterly revenue came in at the high end of the expected range, as provided on last quarter's call, with better than expected growth in software sales, partially offset by lower than expected service revenue.

Sales to third party software, most notably Microsoft embedded operating systems, were 8.2 million this quarter, a 19% increase from 6.9 million in the year-ago quarter and an 11% increase from 7.4 million in the first quarter.

Contribution from a marketing referral arrangement entered into in the fourth quarter of 2005 drove the sales growth. We sold Microsoft embedded operating systems to a record 377 customers this quarter, up 27% year over year and 5% sequentially. We achieved modest cross-selling expense for our engineering services and proprietary products to these customers during the quarter, a statistic we hope to improve on as the portfolio of our software products targeting the general embedded market in North America expands in 2006 and beyond.

Proprietary software revenue was 810,000 this quarter, a 16% decrease from 970,000 in the year-ago quarter but an 85% increase from 439,000 in the first quarter. Proprietary software revenue came in well above the 30% to 50% sequential increase outlook provided on the first quarter call. Sales of the Company's reference designs and related software products increased 167,000 this quarter, as compared to the year-ago quarter and 127,000 sequentially, driven by the introduction of our new IDP 270 reference design, contribution from products acquired from Vibrant in June 2005 and royalties generated from older reference designs.

The year-over-year increase in reference design revenue was offset by a decline in other proprietary software revenue related to 300,000 in previously unreported OEM royalties recognized in the year-ago quarter. As mentioned on the first quarter call, we expected to benefit from the closing of an SDIO Now run time royalty order in the second quarter which positively affected this quarter's results by 350,000. Brian will speak to the outlook of our software products momentarily.

Service revenue was 3.6 million this quarter, up 44% from 2.5 million in the year-ago quarter and down 3% from 3.7 million in the first quarter. The year-over-year increase was driven by improved market strength and sales execution. Billable hours increased 59% year over year, offset by a 9% decrease in realized rate per hour.

This quarter's service revenue was positively impacted by 187,000 in net service revenue, delayed from the first quarter, due to contract signing delays. Offsetting this effect was the impact of several Asia Pacific contracts where we are providing services at relatively low rates, in exchange for royalty payments in the future. These contracts - not all of which are completed - provide for minimum guaranteed royalty payments of 2.2 million which should begin to impact revenue in the third quarter in a relatively modest manner, with the bulk of the guaranteed royalties expected to impact fiscal 20007, given current timing expectations, completion of the underlying contracts, and our belief that these customers will fulfill their contractual obligations.

Service revenue fell below our expectations this quarter, dampening what could have been a stronger quarter at both the top and bottom lines. We had expected 5% to 10% sequential growth in service revenue versus the modest decline that did occur. The expectation shortfall was driven by the unexpected movement of service projects and opportunities into the second half of the year. However, our service backlog continues to improve for the third quarter and the rest of 2006, although the early part of the third quarter was impacted by the slowness experienced this quarter.

Turing to gross margins, overall gross profit was 3.0 million this quarter or 23.8% of total revenue, as compared to 2.5 million or 24.5% of total revenue in the year-ago quarter and 2.3 million or 20.0% of total revenue in the first quarter. Overall gross profit was 5.3 million or 22.0% of total revenue in the first half of '06, compared to 4.4 million or 22.0% of total revenue in the prior year. The 30% sequential increase in gross profit dollars this quarter highlights potential leverage in our operating model when our proprietary software revenue attains higher levels. Had service revenue performed to our expectations this quarter, we would have posted a gross profit in excess of 3.2 million, surpassing the fourth quarter of 2005, which represented a gross profit level not seen by the Company for several years.

Third-party software margin was slightly over 15% this quarter, due to some positive rebate adjustments. We expect third-party software margins to fall back to the roughly 14% level we have experienced recently in the third quarter. We continued to maintain a high gross margin level for our proprietary software during the quarter of 90.9% which includes the impact of 48,000 in amortization relating to our 2005 Vibrant acquisition. This amortization expense will end in the second quarter of 2007.

Service gross margin increased to 28.3% this quarter, compared to 23.3% in the year-ago quarter and 25.2% in the first quarter. The year-over-year increase was driven by higher revenue levels and increased utilization. Service gross margin was positively impacted this quarter by the 187,000 in net revenue recognized on work performed in the first quarter, plus the sequential decline in service cost for sales of 211,000. Seventy thousand of the sequential decline was fringe benefit-related, while the rest related to lower contract from wage costs. Though possible and appropriate, service cost to sales was managed down this quarter, in light of lower activity levels.

We do expect service cost to sales to increase some in the third quarter, as we ramp headcount, in light of increasing demand but expect service margins to improve sequentially, based on current service revenue expectations for that same timeframe.

Moving down to PNL, operating expenses were 3.2 million this quarter, compared to 2.6 million in the year-ago quarter and 3.3 million in the first quarter. Total operating expenses were 6.4 million for the first half of '06, compared to 5.1 million in the prior year. SG&A expenses increased 380,000 year over year and were flat sequentially. The year-over-year increase was driven primarily by 115,000 in stock comp expense, not present in 2005, and sales investments made both domestically and internationally.

R&D expenses were 672,000 this quarter, compared to 447,000 in the year-ago quarter and 741,000 in the first quarter. The year-over-year increase was driven by investments made to support our increased focus on proprietary products. To reiterate comments made on the first quarter call, based on existing plans, we currently expect our third quarter operating expenses to be similar to this quarter's levels, other than the potential impact Sarbanes-Oxley compliance. In fact, total operating expenses were down slightly on a sequential basis this quarter.

Including the impact on cost to service, total stock comp expense was 175,000 this quarter, compared to none in the year-ago quarter and 154,000 in the first quarter. Including stock comp expense, depreciation and amortization, our total non-cash expenses were 307,000 this quarter. Our company-wide fringe benefit expense declined 109,000 from the first quarter, which saw a 250,000 sequential increase from the fourth quarter of 2005. We expect fringe benefit expense to decline some for the remainder of 2006.

Now, I'll speak to our bottom line results. The Company reported a net loss for the quarter of 88,000, including 175,000 in stock comp expense or $0.01 per diluted share, which compared to a net loss of 37,000 or $0.00 per diluted share in the year-ago quarter, which included no stock comp expense.

In the first quarter, we reported a net loss of 849,000, including 154,000 of stock comp expense or $0.09 per diluted share. For the first half of '06, the Company reported a net loss of 937,000 or $0.10 per share, compared to a net loss of 582,000 or $0.06 per share in the prior year.

The first half of 2006 included stock comp expense of 329,000, as compared to none in the prior year and also included 1.4 million of R&D expense which increased 580,000 over the prior year.

The Company split adjusted outstanding share account remained relatively constant for the periods mentioned. Headcount, including contractors, is currently 170, compared to 163 at the end of the first quarter. Professional engineering services headcount is currently 97, up five from the end of the first quarter.

Before I end my remarks, I would like to comment on two matters. The first item is Sarbanes-Oxley compliance. Given our size, we will not be required to comply with Section 404 of Sarbox until December 31, 2007. The SEC [unintelligible] have recently issued communication and guidance on Sarbox compliance, some of which is intended to reduce the cost of compliance efforts, particularly for smaller companies. At this point, some form of compliance by us, at the end of 2007, appears inevitable. The timing of our compliance activities is currently under review. The impact of compliance activities could have an expense impact on the second half of '06 and most assuredly on 2007.

Lastly, I would like to comment on our previously discussed foreign tax withholding exposure on SDIO Now sales in Taiwan. During the quarter, we were successful in obtaining all remaining exemptions for which we were seeking approval at March 31, 2006, thereby eliminating the 273,000 in exposure present as of that date. However, modifications to the scope of the exemptions by the Taiwan tax authority means we will have to continue to apply for exemptions to eliminate withholding tax and/or allow us to repay trade funds from Taiwan related to future SDIO sales.

Now, I'd like to turn the call over to Brian.

Thanks, Scott. Today, I will provide additional color on our Q2 results, an update of our business initiative and we'll finish by providing revenue guidance for Q3.

Generally, with the exception of service revenue falling below our expectations and lack of a portable media player reference design sale, I was pleased with our second quarter results. Our Q2 sales of third-party software were strong and reflect both continued adoption of Microsoft's embedded operating systems by OEMs and our sales approach that emphasizes BSquare's embedded systems technical expertise, as well as our ability to provide follow-on product support, integration services and complementary products.

This is our one revenue line that has, at times, shown some bumpiness in the third quarter as sales can slow in the month of July and August, followed by a typically strong September. In fact, we are off to a slow July in sales of third-party software. Therefore, while we expect to continue to grow our third-party revenue into the future, in line with Microsoft overall market growth rates, we are not expecting any significant sequential revenue growth in the third quarter.

I was disappointed in service revenue results in the quarter. Based on the backlog and sales pipeline at the time of our last quarterly call, we forecasted a 5% to 10% sequential increase in revenue. After our second quarter call, several of our engineering projects did not ramp and several pipeline opportunities did not mature as quickly as expected. By mid July, many of these projects were back on track and we have closed several new, large projects and demand for our services has grown to the point that we are, again, expanding our service capacity in order to meet this demand.

I am optimistic on the overall prospects for our engineering services revenue through the remainder of the year. Our service revenue backlog is currently at its highest level in 2006 and we have won a good mix of long-term projects with our Tier I OEM customers.

To give you a flavor for the types of service projects in which we are currently engaged, we are working with several well known OEMs and silicon vendors on projects to develop next generation Windows mobile-based smart phones. We have a long-term contract with a major defense contractor for a Windows CE-based smart device and during the quarter, we highlighted our success in helping our customer PFC scanning to bring their Falcon 4400 Windows mobile data collection device to market. We provided quality assurance consulting and testing services which supported PSC through the Windows mobile logo test kit certification process.

Examples of new projects that we have recently won include a project with a large silicon vendor to create Windows mobile board support packages and provide quality assurance services for their Next Generation applications processors, projects with two vendors of handheld data collection terminals for Windows mobile development and testing and a project with a large Asian ODM to create a new Windows mobile smart phone. I am pleased to report that, during the quarter, BSquare was named as Microsoft Windows Embedded Systems Integrator of the Year. This award validates BSquare's expertise in embedded Windows technology and highlights the value that we bring to our customers. I am very proud of our services team for their hard work and dedication that led to this achievement.

Our proprietary software products had a good quarter. We recognized run time royalties from a number of product lines, including SDIO, the scheme of the SP product acquired last year from Vibrant Technologies and from BSquare's older PXA255 smart build reference design. We also recognized our first revenues from initial sales of our debt kit IDP270 reference design.

During the quarter, we released a new version of our SDO technology - SDIO HX or high performance. To review, SDIO or secured digital IO is a standard space method for connecting peripherals such as cameras, Wi-Fi cards and memory cards to smart devices. BSquare's SDO technology is the software component that interfaces these peripheral devices to the Windows CE or Windows mobile operating system.

Early, in 2006, we released version 2.2 of our SDIO technology. Version 2.2 established new performance and functionality benchmarks, compared to our earlier version and most notably, added dual slot support that allows to connect multiple SDIO peripherals using a single SDIO host controller with [unintelligible] performance.

After the release of SDIO version 2.2, our customers requested higher SDIO performance in order to support a new generation of applications that are very date intensive. Examples of these applications, including voice-over-IP, IPTV, and other multi-media applications where large amounts of data need to be transferred over a Wi-Fi network or from an SP memory card.

In response to these requests, BSquare developed and released SDIO HX which offers three times the performance improvement, compared to our version 2.2 For example, using SDIO HX, we have measured Wi-Fi performance in the 12 megabit to 16 megabit per second range and even as high as 20 megabits per second. This compares to the 4 megabit to 6 megabit per second performance typically seen using our older version 2.2 technology.

Our customers have a choice when deciding how to support SDIO in their devices. They can use the SDIO technology that is built into the latest versions of Windows CE or Windows mobile, they can attempt to create the technology on their own, or they can adopt BSquare's latest SDIO technology. In addition to the functionality and performance features I had discussed earlier, BSquare has developed a strong SDIO product roadmap that includes support for the upcoming of smart SD cards and support for the Multimedia Card Association or MMCA memory cards, as well as the new MMCA security standard. We believe that our overall SDIO technology and roadmap creates a compelling reason for customers to adopt BSquare's SDIO technology.

We have already had several large OEMs agree to design our SDIO HX technology into their devices and we are continuing to see strong interest from new customers. Based on this, we believe that our SDIO revenues will continue at their current run rate, averaging 300,000 per quarter for the last four quarters and have the potential to grow to a 500,000 per quarter run rate by the middle of 2007, as more of our customers begin shipping their devices.

Looking at our reference design efforts, I am happy to report that we released both our portable media player, software reference design, now called Media Plus and our IDP270 reference design during the quarter. As we have described in the past, our Media Plus reference design is aimed at OEMs and ODMs who are creating handheld portable media players or who are looking to add media capabilities to their existing devices. In the latter category, we continue to see interest from OEMs who have created GPS solutions and from OEMs who are creating retail devices, such as tablets and kiosks that they wish to enhance with multimedia capabilities.

Our Media Plus reference design is built on top of the Windows CE core operating system which allows us to create a solution that leverages Microsoft's direct show architecture, the place for sharer rights management infrastructure, and give their customers an extremely rich solution for content storage and playback that is compatible out of the box with a wide variety of media and download services.

I'm disappointed to report that we have not yet closed a new Media Plus customer at this time. We continue to see good interest in the products and are currently engaged in multiple discussions with OEMs and ODMs worldwide. In Korea, alone, for example, we are aware of over 20 companies who are currently evaluating or building portable media player solutions. I believe that we will sign additional Media Plus customers in 2006. Although, given the business model of Media Plus, a small amount of [NRE] followed by royalties as a device [to ship], Media Plus is not likely to impact our revenues in any meaningful way until 2007, as customers who adopt our solution this year get their devices to market.

Also, during the quarter, we released our DevKit IDP 270 reference design. Our IDP 270 reference design is aimed at the general embedded market and is a good solution for customers building a wide variety of devices, including handheld data collection devices, wireless terminals, medical devices and other automation solutions. The business model for IDP 270 is an upfront purchase of a design kit which can range in price from $5,000 to $50,000, followed by run time royalties in the $3.00 to $15.00 range, depending upon volume, as customers shift their devices. We also expect and have seen that some customers will hire our engineering services organization to customer their reference design for a particular application.

We successfully closed our first IDP 270 customers in Q2 and while the product was too late in the quarter to meaningfully contribute to product revenue, we continued to see good interest in our IDP 270 reference solution. During the quarter, we continued to work on our next reference design, based on Intel's Next Generation X Scale application processor, codename, Monahans. Intel is expecting to release several versions of the Monahans processor in the consumer smart phone and general embedded applications. We expect to release our Monahans reference design in Q3, roughly at the same time Intel begins releasing production Monahans chips and we expect to eventually have multiple variations of our Monahans reference design and in the both general embedded and consumer mobile markets.

I want to provide a few comments on the announced and impending sale of Intel's PXA application processor family, including the PXA 270, which is the basis for our IDP 270 and the Monahans processor family to [Marvel]. We expect that customers who are in the early processor selection stage will be evaluating alternatives as they try to understand what level of support they can expect to receive from Marvel in the future.

Based on our conversations with both Intel and Marvel, we expect that Marvel will continue to enthusiastically support the PXA processor family into the embedded market. It is difficult for us to predict, at this point, what the short-term and long-term impact of this sale will be on our IDP 270 in Monahans reference design. We continue to see interest in our reference designs and we are working to build our IDP 270 lead file and we have closed additional IDP 270 sales in July. As we learn more of Marvel's plans for the PXA processor line, we will adjust our strategy accordingly.

Also, during the quarter, we announced our agreement with Arrow Electronics whereby Arrow will re-sell our IDP 270 reference design. Although this relationship is just beginning, we are excited that Arrow has decided to work with BSquare and believe this relationship will have a meaningful in our revenue, starting in Q4.

Arrow has a broad sales channel and are often aware of new design opportunities that BSquare is never exposed to. We have not yet quantified the full revenue impact this relationship will have, however, from a customer standpoint, we believe this relationship will expose us to 20 to 30 additional customers per quarter in that we will make IDP 270 sales to some percentage of these customers. We also believe that some of these customer engagements will lead to additional service revenue opportunities.

As we have discussed on past calls, we will continue to expand the depth and breadth of our reference design offerings by supporting new application processors as they become available from our semiconductor partners and by adding additional software functionality to our reference design, such as expanded board support functionality, using our schema software product, middleware functionality that expands on our SDIO technology and additional applications for specific technology or market verticals.

Now, to provide some revenue guidance for Q3. For the third quarter, we are expecting our revenues to be flat to up slightly, sequentially, and up approximately 25%, compared to the quarter of 2005. We expect our total software revenue to be flat with proprietary software revenues down sequentially in the 15% range due mainly to the large SDIO order taken in Q2 and our expectation that none of our similar-sized SDIO opportunities will close in the third quarter. We expect this sequential proprietary software decline to be offset, in large part, by a small, sequential increase in third-party software revenue. But as I noted earlier, this quarter can be challenging because it's a historically slow month for third-party software sales in July and August.

We expect our service revenue to increase approximately 5% sequentially, as the projects delayed for Q2 begins to ramp. That ends the prepared portion of our call today. I would like to thank everyone for their time today and continued interest in BSquare. We will now open the call up for questions.

Thank you. [OPERATOR INSTRUCTIONS] And it appears there are no questions at this time. I'd like to turn the conference back over to you.

Okay, thank you very much. Once again, thank you for interest in BSquare and we look forward to talking to you again, next quarter.

Thank you, everyone. That does conclude today's conference. You may now disconnect.