Bsquare Corp (BSQR) 2007 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the BSQUARE Corporation Third Quarter 2007 Earnings Conference. (OPERATOR INSTRUCTIONS) This conference is being recorded today, Thursday, November 8, 2007. I would now like to turn the conference over to Mr. Scott Mahan, Chief Financial Officer of BSQUARE Corporation. 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 listeners' 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," "the quarter" or "Q3" mean the third quarter of 2007, while references to the "second quarter" or "Q2" mean the second quarter of 2007 and references to the "fourth quarter" or "Q4" mean the fourth quarter of 2007.

Let me start by speaking to revenue. We reported total revenue this quarter of $13.6 million, up 18% from $11.5 million in the year-ago quarter and down 10% from $15.1 million in Q2. This quarter represented our eighth straight quarter of year-over-year total revenue increases. We had expected total revenue to be down roughly 4 to 6% sequentially, driven by an anticipated decline in third-party software sales. Third-party software sales did decline from Q2 but did so within expectations, with service revenue accounting for the larger-than-expected sequential decline. We had no 10% customers this quarter. Total revenue for the nine months of 2007 was $43.8 million, up 23% from $35.7 million in 2006, driven by increases in all major revenue components.

Sales of third-party software were $8.1 million this quarter, up 16% from $7.0 million in the year-ago quarter and down 11% from $9.1 million in Q2. Customer base growth and an increase in average sales per customer drove year-over-year increase. As we commented on last quarter's call, we expected third-party software sales to decline roughly 10 to 14% sequentially based on one large sale which benefited Q2, coupled with the fact that Q3 is typically a seasonally soft quarter.

Third-party software sales were $25.4 million for the first nine months of 2007 compared to $22.6 million in 2006, representing an increase of 12%.

Proprietary software revenue was $886,000 this quarter, up 79% compared to $494,000 in the year-ago quarter and down from $1.0 million in Q2. Royalties from certain service contracts drove the year-over-year increase, partially offset by an OEM royalty over-reporting adjustment which negatively impacted this quarter by $151,000 and also accounted for the sequential decline. The impact on any one historical quarter of the over-reporting adjustment was not significant. Proprietary software revenue increased 71% to $2.9 million for the first nine months of 2007, compared to $1.7 million in 2006 due to the service contract royalties. On last quarter's call we commented that we expected proprietary software revenue to be up slightly on a sequential basis. Lacking the effect of the royalty over-reporting adjustment, Q3 proprietary software revenue would have been flat compared to Q2.

We have commented previously regarding royalties impacting proprietary software revenue related to certain 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 $420,000 in royalty revenue from these contracts this quarter as compared to $90,000 in the year-ago quarter and $403,000 in Q2

Service revenue was $4.7 million this quarter, up 18% from $4.0 million in the year-ago quarter and down 4% from $4.9 million in Q2. The year-over-year increase was driven by higher rebillable service revenue and improvement in our realized rate per hour. Rebillable service revenue, predominantly third-party costs passed through to our customers at a small markup, was $385,000 this quarter compared to $95,000 in the year-ago quarter and $295,000 in Q2. Gross margin on this quarter's rebillable revenue was 13%.

Service revenue increased 36% to $15.5 million for the first nine months of 2007, compared to 11.4 million in 2006. This quarter's billable hours were flat year over year and declined 3% sequentially. This quarter's bill rate increased 9% year-over-year and declined 7% sequentially. Year-over-year bill rate increase was driven by strengthening 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. The sequential bill rate decline was driven by decreases in both North America and Asia. In North America we agreed to lower our bill rate for a portion of this quarter on a large project for strategic reasons, whereas the sequential decline in Asia was driven by two projects that began in Q3 in which we were performing engineering services at lower rates in exchange for downstream royalties. Subsequent to quarter-end, the terms of both of these projects were restructured, which Brian will speak to momentarily.

We expected Q3 service revenue to increase roughly 4 to 8% sequentially versus an actual decline of 4%, which translated into weaker-than-expected service revenue in Q3 of roughly $550,000. As we commented in today's press release, the service slowdown that began in Q2 extended further into Q3 than we anticipated, which accounted for most of the shortfall. Further, we were again impacted this quarter by $180,000 in revenue recognition delays at quarter end, which contributed roughly $130,000 of the shortfall.

Turning to gross profit and margins, overall gross profit was $3.5 million this quarter, or 26% of total revenue, as compared to $2.8 million, or 25% of revenue, in the year-ago quarter, and $3.5 million, or 23% of revenue in Q2. Overall gross profit was $11.0 million, or 25% of total revenue for the first nine months of 2007, compared to $8.2 million, or 23% of revenue in 2006.

Third-party software margin was 17% for both Q3 and the year-ago quarter and 14% in Q2. The second quarter third-party software margin was impacted by one large sale with lower-than-average margins.

We continued to maintain a high gross margin on our proprietary software revenue of 97% this quarter.

Service gross margin was 26% this quarter compared to 31% in the year-ago quarter and 26% in Q2. Year-over-year decline was driven by an increase in service cost of sales resulting from headcount additions made toward the end of 2006 in anticipation of higher service demand than we have been experiencing. Consequently our utilization dropped 11% compared to the prior year and our service gross margin declined. While our service gross margin was flat sequentially at 26% despite lower service revenue, we had anticipated a roughly 7 percentage points sequential increase based on an expectation that our service revenue would increase, thereby leveraging our excess delivery capacity. Using actual Q3 bill rates, we had excess service capacity this quarter that could have translated into roughly $550,000 in incremental service revenue, assuming higher demand. This quarter approximately 12% of our service cost of sales was fixed in nature.

Moving down to P&L, operating expenses were $3.2 million for both this quarter and the year-ago quarter and $3.3 million in Q2. Total operating expenses were $9.9 million for the first nine months of 2007, as compared to $9.6 million in 2006.

Now I'll speak to our bottom-line results. We reported net income for the quarter of $359,000 or $0.03 per diluted share, which represented our fourth straight profitable quarter. This compared to a net loss of $235,000, or $0.02 per diluted share in the year-ago quarter and net income of $542,000, or $0.05 per diluted share in Q2. Q2 benefited from a $280,000 gain on sale of a marketable security. For the first nine months of 2007 we reported net income of $1.5 million or $0.15 per diluted share compared to a net loss of $1.2 million or $0.12 per diluted share in 2006.

Our outstanding share count at quarter end was 9.9 million shares, which increased 45,000 shares from Q2 due to stock option exercises, from which we realized proceeds of $81,000. We had $1.9 million options outstanding as of quarter end, with an average strike price of $4.30.

Cash and short-term investments increased $1.0 million to $13.4 million at quarter end, as compared to June 30, representing our fourth straight quarterly increase. $1.1 million of the ending balance is restricted.

Total non-cash expenses were $452,000 and CapEx was $67,000 this quarter. We currently expect fiscal 2007 non-cash expenses to be slightly over $1.5 million and CapEx to be approximately $400,000.

Headcount including contractors is currently 186, compared to 192 as of the date of our last conference call. Engineering services headcount is currently 115, down from 123.

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

Thanks, Scott. Today I will provide additional color on our Q3 results, an update on our business initiatives, and will finish with an outlook for Q4.

Let me start by speaking to our third-party software sales. Third-party sales of $8.1 million came in at the higher end of our expectations, while the margin of 17% was better than expected. Our sales strategy of targeting customers who are in need of technological or engineering assistance, are less cost sensitive and have the potential to purchase other BSQUARE products and services appears to be working. As a result we have been able to maintain margins above our longer term historical run rate for several of our recent quarters while growing year-to-date third-party sales by 12% compared to 2006.

We continue to be positive about our third-party software sales prospects, our relationship with Microsoft is strong, and we are actively talking to existing and new partners about new complementary third-party products that we can sell.

Next I would like to comment on BSQUARE proprietary products. At quarter end we announced the hiring of Rajesh Khera as our new VP of Products. Raj has a great background in technology and mobile devices from his stints at Microsoft and most recently RealNetworks. We are excited to have Raj join our management team. Now that Raj is on board, the products team is focused on fleshing out plans for our next set of reference design and middleware products, which we'll roll out beginning in Q4 and continuing into next year.

Now on to the discussion of specific products and initiatives.

SDIO product revenue came in below our expectations this quarter at $229,000. In the past we have spoken about our belief that SDIO revenue would reach a run rate of $500,000 per quarter by the second half of 2007. We felt this level was achievable based upon the sales of new development kits we made last year and earlier in 2007, and our best estimate of device shipments and shipment volumes by our customers. Given the fact that we have not achieved the revenue levels we expected, we have reexamined our assumptions for shipment volumes and have readjusted our expectation for SDIO revenue to the $200,000 to $300,000 per quarter range in the near term.

We recently announced Version 1.2 of our SDIO technology, which features support for several new processors from TI, Freescale and Qaulcomm as well as other enhancements and performance improvement. We sold several new SDIO development kits during the quarter, and we continue to see interest in the product from prospective customers in North America and Asia.

Now turning to sales of our reference design products. Sales of our DevKit designs and related revenue were $267,000 in the quarter, up from $180,000 in Q2. 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 Board Support Package development product. We expect that the direct revenue we generate from sales of our DevKits and Schema will continue to increase in the future.

More importantly, our sales force continues to use our DevKits and Schema as an entry point for the sale of other BSQUARE products and services. As an example, during the quarter we began work on a new $1.2 million service project for a customer who has hired us to ad CDMA and GSM communications capabilities to our DevKit PXA320 product to enable them to create a wide-area network communications development platform. Last time we talked, I mentioned that we expected to announce a DevKit product based on a new processor architecture during Q3. We have delayed announcement of this product to Q4 at the request of our silicon vendor partner. However, at the end of Q3 we shipped and recognized revenue on our first unit of this product and are excited to fully roll out the product during Q4.

Looking forward we expect to continue to create new DevKit platforms. Some will be general purpose, and some will be targeted at specific verticals. We are also adding new capabilities to our existing DevKit products. For example we are currently working on adding CDMA and GSM capabilities to all our DevKit in conjunction with a partner who builds CDMA and GSM radio modules. The resulting product will make our platforms even more attractive to data collection, point-of-sale, kiosk and industrial automation customers who are looking to add wide-area networking capabilities to their products, functionality that we think will become more prevalent in the future. You should expect detailed announcements of this initiative during Q4.

In past quarter we have 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+ software stack that was originally developed for the BSQUARE Power Handheld device. Subsequent to Q3 we recognized our first royalties from this device as the customer placed an initial order for licenses to initiate a small sales and marketing production run of devices in anticipation of full production. While the Q4 royalty order is small and the initial rollout of the device has been delayed from its original schedule, if our customer continues on their current rollout schedule and the device meets with commercial success, we have the potential to recognize over $1 million of Productivity+ royalties in 2008.

Last time we also talked about a customer building a retail kiosk that has licensed our Media+ product. We expect that this customer will begin shipments of their product in 2008, and over the next couple of years, assuming that the customer meets their schedule and the product meets with commercial success, we have the potential to generate between $1 to $3 million of royalties from this design, although it is not yet clear to us how much of this will fall into 2008.

We are currently working with other customers to license our Productivity+ and Media+ technologies and hope 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 up sequentially based on our pipeline and our expectation that demand would rebound in Q3 as it did in 2006. We did eventually see a rebound in service demand in the quarter. However, it did not come earlier enough for us to show the sequential revenue increase we had expected. From a customer and project perspective, this was a fairly typical quarter for us. We worked on 65 projects in the quarter and as usual our service business was well balanced between Windows CE and Windows Mobile work. During the quarter we worked on projects to create multiple Windows CE and Windows Mobile-based Smartphones, Windows Mobile-based handheld data collection devices, a Windows CE-based tablet device, retail kiosk and several new Board Support packages for Silicon vendors.

Despite the fact that demand didn't rebound as quickly as we would have liked in Q3, we entered Q4 with a near-record backlog of work and sales activity has been strong, to the point that our service capacity in Q4 is almost completely sold out. Based on our backlog and pipeline, we are expecting to see a very healthy sequential increase in service revenue in Q4, which I'll speak to momentarily.

I would also like to spend a moment discussing our outlook for royalty-bearing service contracts. Last time we talked I disclosed that we were working on one new royalty-bearing project and that we were close to starting on two new projects during Q3 that could together be worth roughly $1 to $2 million in 2008 royalties. Subsequent to our call, we did begin work on the two new royalty-bearing projects I just mentioned. Of the three projects we worked on during Q3, two involved software development and quality assurance services for two models of Windows Mobile Smartphones being developed by Asian ODMs for the same North American OEM. Near the end of Q3, the North American OEM decided to take over the software development directly and has contracted with BSQUARE North America under a time-and-materials contract. This will be a very good contract for us, likely worth between $1 and $2 million in service revenue over the next two to three quarters. So even though we will not be receiving the royalties from the Asian customers, the bottom line impact should be net neutral with lower risk to BSQUARE.

Our goal is to continue to grow our royalty revenue through sales of BSQUARE IP into devices and by closing new royalty-bearing service contracts. Looking forward into 2008 we expect to grow our royalty revenue as we should begin to see royalty revenue from Productivity+, Media+ and Schema sales that we made in 2006 and 2007. In addition we have several new potential royalty-bearing service contracts that we are working to close in both North America and Asia.

Next I would like to discuss our activities surrounding acquisitions and partnerships. We have spoken in the past of our desire to grow our revenues and profits through acquisitions. Given our strengthening balance sheet, we have been actively looking at opportunities and expect to announce a small acquisition in the next few weeks. In addition to this opportunity, we have several other opportunities that we find interesting and are in various stages of diligence. We want to emphasize for investors that we do not intend to take on any acquisitions that would push BSQUARE back into a loss position for any extended period of time. And we are determined to use our hard-won balance sheet gains wisely.

Finally I would like to speak to our expectations for the fourth quarter. In Q4, we expect to see overall revenue increase roughly 16% from Q3 driven by improvement in all three of our revenue lines. We expect our service revenue to increase approximately 20% sequentially based on the strength of our service backlog and our sales pipeline. We expect our third-party software revenue to increase approximately 6% from Q3 based on our sales forecast and a strong start to the quarter. We are expecting our proprietary software to increase approximately 80% over Q3. Let me provide a bit more color on the proprietary software increase. First we expect to see a modest sequential increase in our DevKit, Schema and SDIO proprietary software revenue. We also expect continued recognition of royalties from the royalty-bearing service contracts we have discussed previously.

Additionally there are two large items that will positively impact our proprietary software revenue in Q4, one of which is of a non-recurring nature. First we have an OEM customer for our old reference design product called SmartBuild which occasionally places orders for SmartBuild run-time licenses. This customer last ordered licenses in Q1 of 2007 and has placed another order in excess of $250,000 which will positively impact Q4. We expect that this customer will place additional orders in 2008. Second we have spoken in the past of an Asian ODM who was the launch customer for our Media+ product back in 2005. This customer signed a contract at the time which contained among other things guaranteed royalty commitments. Subsequently the customer backed out of that contract. We have been engaged in a legal action against this customer to recover amounts that we felt we were owed under the contract. We have recently settled with this customer for $400,000 and have already received cash payment in full. The majority of this $400,000 settlement will be recorded as proprietary software revenue in Q4. We do not expect to generate additional revenue from this customer in the future.

Based on our revenue expectations for Q4, we expect to end fiscal 2007 on a strong note at the bottom line.

Before I open up the call for questions, let me speak to the recently announced Google phone software. We have had several inquiries as to how this will impact our business both in the short term and long term. Practically speaking it's too early to tell what this will mean to us. Google has not yet released any technical details on the software platform. We know that it's based on the Linux operating system, but that's about all at this point. In the short term we have not seen any of our Windows Mobile customers change their plans based on this announcement. This announcement does not impact our Windows CE or Windows XP embedded customers or our customers who build data collection devices based on Windows Mobile. Windows CE, Windows XP embedded and Windows Mobile data collection customers make up the majority of our revenue today. In the longer term, the Google phone software may represent an incremental opportunity for us to port our SDIO middleware stack. It may also represent an expansion opportunity for our engineering services. There are many possibilities, but it's too early for us to tell where the opportunities and risk lie. We will be keeping close watch on this going forward.

That ends the prepared portion of the call today. I would like to thank investors for their interest in BSQUARE, and we'll now open up the call for questions.

(OPERATOR INSTRUCTIONS) We now have a question from the line of [Brian Roth] with SMH Group. Please go ahead.

Hey, guys.

Hi, Brian.

I guess it's not much of a surprise I guess this quarter going off of what we heard last quarter and knowing that this is a seasonally slow quarter. One thing that I guess concerned me more than anything, because it sounds like the revenue growth will be back again next quarter from what you've said, going on that acquisition idea, I mean, now that we're at the point where we've done four straight quarters of profit and then saying--I don't know if the acquisition specifically you're talking about is the one that you're going to announce in the next few weeks, but maybe ones after that as well when you said that you weren't looking--you didn't think that it would affect your profit for any extended time. Is that something that is sooner than later if you were going to announce that in the next quarter, which sounds like it's going to be so much strong? Is this recent acquisition going to affect this coming quarter, the fourth quarter, or are you looking further down the road? And what exactly is an extended amount of time?

Well, the acquisition that we hope to announce in the next few weeks will not impact our fourth quarter. We've always stated that we always want acquisitions to be accretive, and we never wanted them to push us into the red from where we are, and we want to stay profitable. For us, I mean, we would only consider something--an extended period of time for us would be no more than one or two quarters. And honestly right now we don't have anything in our pipeline that I think would put us there. But that's not to say that if we saw something that we thought had tremendous strategic value to us that we wouldn't go for it.

Okay. And one follow-up with that. As your balance sheet improves and your cash balance improves, are stock buy-backs something that you guys potentially look at also to increase shareholder value?

It's not something that we have contemplated doing any time in the near future.

Okay. All right. Thank you for your time and keep up the good work.

Thank you.

(OPERATOR INSTRUCTIONS) We do have a question from the line of John Porter. Please go ahead with your question.

Brian?

Hello?

This is John Porter calling. I've got a question on this recent partnership you had with InPlay, and you expected in the second quarter of '08 to be going strong or something by that time.

Well, the announcement was InPlay's announcement. We do do work with InPlay.

Yes. You partnered with them. I understand.

Yes. And so I'm going to refer any questions on that partnership to InPlay.

Okay. All right. Thank you.

You're welcome. Operator, any other questions?

We do not have any further questions at this time. Please continue.

Okay. Well, at this point we'll go ahead and terminate the call. Thank you, everybody, for listening and your interest in BSQUARE. We'll talk to you again next quarter.

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation. You may now disconnect.