Bsquare Corp (BSQR) 2007 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the BSQUARE Corporation Second Quarter 2007 Conference. [OPERATOR INSTRUCTIONS]

I would now like to turn the conference over to Mr. Scott Mahan, BSQUARE's chief financial officer. Please go ahead, sir.

Good afternoon. With me today is Brian Crowley, our CEO.

Let me remind you that this call is being broadcast over the Internet and that a recording of the call and the text of our prepared remarks will be available on our website.

I would also like to direct listener's attention to the safe harbor statement contained in our earnings release issued today, which applies to the content of this call.

With that said, let me recap our financial results. During the discussion, references to this quarter or the quarter mean the second quarter of 2007, while references to the first quarter means the first quarter of 2007 and the third quarter means the third quarter of 2007.

Let me start by speaking to revenue. We reported total revenue this quarter of $15.1 million, up 20% from $12.6 million in the year ago quarter and flat as compared to the first quarter. We had expected total revenue to be down roughly 4% to 6% on a sequential basis due to softness in service revenue. While service revenue was off sequentially, a record quarter in sales of third-party software compensated for the service revenue decline.

We had no 10% customers this quarter. The customer which accounted for 12% of total revenue in the first quarter accounted for just 4% of total revenue this quarter.

Total revenue for the first half of 2007 was $30.2 million, up 25% from $24.2 million in 2006, driven by increases in all major revenue components. Sales of third-party software were $9.1 million this quarter, up 11% from $8.2 million in both the year ago and first quarters. The increases were primarily driven by one large sale this quarter at lower than average margin.

Third-party software sales were $17.4 million for the first half of 2007, up 11% from $15.7 million in 2006.

Proprietary software revenue was $1.0 million this quarter, compared to $810,000 in the year ago quarter and $970,000 in the first quarter. Royalties from certain Asia-Pac service contracts drove the year-over-year increase whereas the sequential increase was driven by higher SDIO revenue, offset by the lack of a large reference design royalty order similar to the $195,000 order that benefited the first quarter.

Proprietary software revenue increased 67% to $2.0 million for the first half of 2007, compared to $1.2 million in 2006.

On last quarter's call we commented that we expected total software revenue to be up slightly on a sequential basis, whereas the actual increase was 13%, driven by unexpected strength in third-party software sales primarily due to the one large sale previously mentioned.

We have commented previously regarding royalties impacting proprietary software revenue related to certain Asia-Pac service contracts. In these contracts, we typically accept a lower than average bill rate on our engineering services in exchange for downstream royalties, some of which may be guaranteed. We recognized $403,000 in royalty revenue from these contracts this quarter as compared to an immaterial amount in the year ago quarter and $355,000 in the first quarter. Total guaranteed royalties under these contracts is $2.2 million, of which $863,000 has been recognized. We still expect guaranteed royalties under these contracts to be roughly $1.4 million for all of 2007, assuming these customers report only their guaranteed minimums and honor their contractual obligations. We expect to enter into more of these contracts in the future and did so subsequent to quarter end.

Service revenue was $4.9 million this quarter, up 36% from $3.6 million in the year ago quarter and down 17% from $5.9 million in the first quarter. The year-over-year increase was driven by strength in North America, whereas the sequential decrease was largely driven by a drop in rebillable service revenue we spoke to on last quarter's call. Rebillable revenue -- predominantly third-party costs passed through to our customers at a small markup -- was $295,000 this quarter compared to $187,000 in the year ago quarter and $921,000 in the first quarter. Gross margin on this quarter's rebillable revenue was 12%.

Service revenue increased 48% to $10.8 million for the first half of 2007, compared to $7.3 million in 2006. This quarter's billable hours increased 31% year-over-year and declined 9% sequentially. The year-over-year increase was driven by strength in North America, whereas the sequential decrease was due to softness in both North America and Asia-Pac. This quarter's bill rate increased 5% year-over-year and 2% sequentially, driven by an increase in our Asia-Pac bill rate stemming from several large low-margin contracts which impacted 2006 but did so to a much lesser extent in 2007.

We expected this quarter's service revenue to decline roughly 14% on a sequential basis, with 80% of the decline driven by lower rebillable revenue. The actual decline was 17%, with 63% of the decline driven by lower rebillable revenue. The 3 percentage point sequential miss translates in $165,000 of revenue which was driven by abnormally high revenue recognition delays and write-offs which affected the quarter.

We experienced a certain amount of revenue recognition delays and write-offs almost every quarter. This quarter there was $156,000 in service revenue we could not recognize under our policies, and we experienced $169,000 in write-offs, some of which occurred for strategic reasons. These figures cumulatively ran about $230,000 higher than our norm, and $182,000 higher than the first quarter, which also experienced a somewhat higher than usual level of write-offs. We expect the service revenue not recognized in this quarter to positively impact the third quarter.

Turning to gross profit and margins, overall gross profit was $3.5 million this quarter, or 23% of total revenue, as compared to $3.0 million, or 24% of revenue, in the year ago quarter, and $4.0 million, or 26% of revenue in the first quarter. Overall gross profit was $7.5 million, or 25% of total revenue for the first half of 2007, compared to $5.3 million, or 22% of revenue in 2006.

Third-party software margin was 14% this quarter, as compared to 15% in the year ago quarter and 18% percent in the first quarter. One large sale this quarter with lower than average margin drove the year-over-year in sequential declines. Additionally, on last quarter's call we commented that the first quarter's third-party software margin was unusually high and we did not expect to maintain that margin level into this quarter.

We continued to maintain a high gross margin on our proprietary software revenue, 91% this quarter. Proprietary software costs of revenue included $48,000 in amortization which ended this quarter.

Service gross margin was 26% this quarter compared to 28% in both the year ago and first quarters. The sequential and year-over-year declines were driven largely by the revenue recognition delays and write-offs mentioned previously. As we mentioned in our press release, an incremental $130,000 in service revenue would have brought us in on par with the 28% service margin we saw in the year ago and first quarters and the expectation we said on last quarter's call for this quarter.

We have commented previously that we should realize service margin leverage as service revenue increases due to the fact that a certain component of our service cost of sales is relatively fixed. This quarter, approximately 11% of our service costs were fixed, excluding rebillable expenses. We are currently not seeing this leverage due to our service revenue running below what we anticipated when we expanded our engineering head count in the second half of 2006. Consequently, we are currently running under our target utilization. At our target bill rate assumptions, we had excess service capacity that could have translated into roughly $650,000 in incremental service revenue this quarter.

Moving down the P&L, operating expenses were $3.3 million this quarter compared to $3.2 million in the year ago quarter and $3.4 million in the first quarter. We provided commentary on the year-over-year increase in today's earnings release; therefore I would like to focus on the sequential decline.

SG&A expense declined $194,000, whereas R&D expense increased $53,000, resulting in a net sequential decline of $141,000. On last quarter's call, we commented that there were a number of items affecting first quarter SG&A expense which we didn't expect to reoccur this quarter and had estimated the sequential drop at $150,000, whereas the actual came in at $194,000. The decline was driven by a number of items, most notably bonuses and professional fees.

Total operating expenses were $6.7 million for the first half of 2007, as compared to $6.4 million in 2006, with the increase driven by SG&A expense.

Now I'll speak to our bottom line results. We reported a net income for the quarter of $542,000 or $.05 per diluted share, which compared to a net loss of $88,000, or $.01 per diluted share in the year ago quarter and net income of $638,000, or $.06 per diluted share in the first quarter. This quarter represented our third straight profitable quarter.

Our outstanding share count at quarter end was 9.9 million shares, which increased 106,000 shares compared to March 31 due to stock option exercises, from which we realized proceeds of $337,000. We had $1.9 million options outstanding as of quarter end, with an average strike price of roughly $4.25.

Total cash, cash equivalents and short-term investments increased $339,000 to $12.4 million at quarter end, as compared to March 31, representing the third straight quarter of increases in our cash and short-term investments. $1.1 million of the ending balance is restricted.

Total non-cash expenses were $389,000 and CAPEX was $171,000 this quarter. We currently expect fiscal 2007 non cash expenses to be roughly $1.4 million and CAPEX to be approximately $430,000.

On previous calls we commented on the recognition of a previously written off equity investment and planned liquidation. We did liquidate this investment this quarter, resulting in other income of $287,000.

Head count including contractors is currently 192, compared to 196 as of the date of our last call. Engineering services head count is currently 123, down from 125 as of the date of our last call.

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

Thanks, Scott.

Today I'll provide additional color on our Q2 results, an update on our business initiatives, and will finish with our outlook for Q3.

Let me start by speaking to third-party software sales. Third-party sales of $9.1 million came in above our expectations, while the resulting gross margin of 14% was in line with our expectations. One large low-margin sale drove third-party revenue above our expectations.

For the past several quarters, we have focused our third-party sales efforts on customers which need technical or engineering assistance and had the potential to purchase other BSQUARE products and services. Our belief is that these customers exhibit less price sensitivity than customers who purchase large quantities of licenses and that by focusing on this customer set, we can maintain our gross margins at their current level and increase the cross sales of other BSQUARE products and services.

Next, I'd like to comment on the sales of BSQUARE proprietary products. Our SDIO revenue rebounded as expected this quarter to $325,000. SDIO revenue in the quarter came from two sources -- sales of our development tool kits to new customers and royalties from customers shipping devices utilizing our SDIO technology.

During the quarter we announced Version 1.1 of our SDIO technology, and our SDIO team is hard at work on the next version -- Version 1.2 -- that will feature support for several new processors from TI, 3scale and QUALCOMM as well as other enhancements. We expect to ship Version 1.2 during Q3. In order to keep our SDIO technology relevant to our customers, it's important that we continue to invest in supporting new processors, the latest operating systems from Microsoft, and revisions to the SD specification.

In past calls, we spoke to our expectation to achieve a $500,000 per quarter SDIO revenue run rate by the second half of 2007. We made progress towards that goal this quarter, and we still believe that our SDIO revenue line has room to grow. Since the beginning of 2006, we have sold well over 20 new SDIO development kits to companies located in the U.S., Taiwan and Japan who are building smart phones, portable navigation devices and handheld data collection devices. We estimate that it typically takes 6 to 12 months from the sale of an SDIO development kit to achieve a shipping device. Therefore, based on past sales and our expectations that new devices using our technology will begin shipping in the second half of 2007, we still believe that our $500,000 per quarter run rate goal is achievable by the second half of 2007.

As we mentioned last quarter, we are continuing to work on new middleware products that we believe our customers will license for inclusion into their devices. Current products that we are either working on or considering include ultra-wideband and specifically wireless USB, which is a new specification designed to replace hardwired USB cables and enable seamless content interchange between devices.

We are also looking to support existing and emerging mass storage specifications for embedded devices, as well as other wireless connectivity options for devices such as WiMAX and digital video broadcast. We expect that the business model for these products will be similar to our SDIO model of licensing the technology in the form of development kits and collecting royalties as devices ship. We expect that the first of these new products will be available towards the end of 2007 or the beginning of 2008. As we get closer to having marketable products, we will describe these efforts and their prospects in more detail.

Now turning to sales of our DevKit reference designs, overall sales of our DevKit reference designs and related revenue -- not including our older, SmartBuild design -- were $180,000 in the quarter, up from $143,000 in Q1. The increase was driven by sales of our DevKit design for the Marvell PXA320 processor, as well as royalties resulting from past sales of our Schema development product. We expect that the direct revenue we generate from sales of our DevKits in Schema will continue to increase in the future.

More importantly, our sales force will continue to use DevKits and Schema as an entry point for the sale of other BSQUARE products and services. For example, we are wrapping up a project for a customer that initially purchased our DevKit design for the PXA270 processor, and the subsequently hired our professional services organization to engineer a fully customized device based on our DevKit design. This customer also licensed both our Schema and SDIO technology for use in their device, and purchased their Microsoft Windows CE-embedded operating system licenses from us. Total revenue from this customer has exceeded $3 million, with the potential for additional royalty and licensing revenue in the future. We have started similar projects using our DevKit reference designs with new customers, and going forward we expect that a number of these customers will subsequently purchase other products and services.

We are currently working on a new DevKit reference design which will support a processor family offered by a major Silicon vendor other than Marvell. We expect to fully announce this product during Q3, with initial shipments taking place in Q4 of this year.

I would also like to comment on new customer sales of two BSQUARE products that we have not discussed for the last few quarters.

First, just after quarter end we closed a deal to license portions of our Media-plus software stack to a North America kiosk vendor. This vendor chose BSQUARE's Media-plus technology for its ability to rapidly enable the Windows CE user interface to be reskinned to a new look and feel which will give our customer's product great field versatility. Our services organization is currently working with the customer to implement our Media-plus technology into their product, which is expected to enter production in early to mid-2008. Assuming that our customer rolls their product out as planned and meets with commercial success, we currently expect that we will generate anywhere from $1 million to $3 million of Media-plus royalties during 2008 and 2009.

In past quarters we have also made reference to a service project we are involved with to create a secure phone for homeland-security type applications. As part of this project, our customer licensed our Productivity-plus software stack that was originally developed for the BSQUARE power handheld device. We expect that this customer will begin shipping this device in early 2008, and assuming the device meets with commercial success, we currently expect to generate $1 million to $2 million of Productivity-plus royalties during 2008. Given the expected lifetime of this design, we could potentially see additional royalties in subsequent years.

We are currently working with other customers to license our Productivity-plus and Media-plus technologies and expect to win new designs before the end of 2007.

Next I would like to discuss our service revenue. During last quarter's call, I indicated that we expected service revenue to be down sequentially approximately 14%, whereas we were actually down 17% due to lower rebillable revenue, revenue recognition delays, and write-offs that Scott spoke to earlier. I also said on the last earnings call that we expected the second quarter to be challenging due to declining business levels at one of our struggling North America handset OEM customers, as well as the completion of a very large service contract without a similar sized contract ready to immediately start.

The quarter played out pretty much as we predicted, and we are not particularly happy with Q2 service results. We have been focusing our attention on refilling our sales pipeline and backlog and feel we have made solid progress on both fronts during the quarter, as I will discuss in a moment.

From a customer and project perspective, this was a fairly typical quarter for us. We worked on 58 projects in the quarter and while the absolute number of projects was down from 73 in Q2 of the previous year, the average project revenue was up by 71% over the previous year. I view this as a positive trend. About half of our service revenue came from Windows CE-based projects and half from Windows Mobile-based projects. During the quarter we worked on projects to create Windows CE and Windows Mobile-based smart phones, handheld data collection devices, new board support packages for Silicon vendors, and retail kiosks.

Looking into the remainder of 2007, we believe that we will see sequential increases in service revenue in both Q3 and Q4 due to the number and size of service deals in our pipeline that either have closed subsequent to quarter end or that we expect to close in the near term. We have won or we believe we will win new substantial projects from several Silicon vendor partners in North America and Taiwan, a U.S. government agency, Microsoft and several Asian and North American device OEMs. In fact, we had more deals with revenue potential greater than $1 million in our pipeline than at any time in the last three years.

I would also like to spend a moment discussing our outlook for royalty-bearing service contracts. We did not close any new royalty-bearing service contracts during the second quarter. However, we closed one new royalty-bearing service project subsequent to quarter end and expect to close two more during Q3. Royalties from the project that we just closed are expected to be somewhere around $800,000 in 2008, and the two new projects that we expect to close in the near future are together expected to bear $1 million to $2 million of royalties in 2008.

Of course, all this is predicated on project completion, our customers actually shipping their devices, market acceptance of those devices, and customers paying for royalties owed.

As you can see, between the new royalty-bearing service engagements that we are either working on or are expecting to close, as well as royalties expected from our current and planned proprietary products, we expect to grow our royalty revenue in the future potentially significantly.

I would like to talk for a moment on our efforts to expand our sales in Asia. I am pleased to announce that we have recently hired a new country manager to run our Japan subsidiary, BSQUARE K.K. Our new country manager is a Japanese national who has been selling into the embedded and mobile markets in Japan for the past several years and has extensive experience with Microsoft Windows CE and Windows Mobile. We expect to have our Japanese subsidiary back up and running by Q4 of 2007 and expect to see our subsidiary begin to meaningfully contribute to our revenue in 2008.

Finally, I would like to speak to our expectations for the third quarter. In Q3, we expect to see overall revenue down 4% to 6% from Q2, primarily due to a decline in third-party software sales. Q2 was a record quarter for third-party sales, and Q3 has historically been a seasonally slow quarter for us. Therefore we do not expect that we can repeat the third-party sales performance of Q2 in the third quarter.

We expect total software revenue to be down 10% to 14% from Q2 as a result. We expect proprietary software revenue to be up slightly from Q2. We expect our service revenue to be up 4% to 8% based sequentially based upon the strength of our sales pipeline and the effect of the revenue recognition delays from Q2. We expect to be profitable again in Q3.

That ends the prepared portion of our call today. I would like to thank investors for their interest in BSQUARE. We will now open up the call for questions.

Thank you, sir. Ladies and gentlemen, at this time we will begin the question-and-answer session. [OPERATOR INSTRUCTIONS]

Management, at this time we have no questions. Please continue with any further remarks that you would like to make.

Okay. Well at this time, I guess, if there's no questions, we'll go ahead and end the call. Thank you for listening today, and we'll talk to you again next quarter.

Ladies and gentlemen, this concludes the BSQUARE Corporation Second Quarter 2007 Conference. We thank you for your participation. You may now disconnect.