Bsquare Corp (BSQR) 2009 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen. Thank you for standing by.

Welcome to the BSquare Corporation fourth quarter 2009 earnings conference call.

(Operator Instructions). This conference is being recorded today, Thursday, March 25, 2010.

At this time I'd like to turn the conference over to Scott Mahan, Chief Financial Officer. Please go ahead, sir.

Good afternoon, everyone.

Before I begin, 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'd also like to direct listeners' attention to the Safe Harbor statement contained in our press release issued today, and the Safe Harbor statement posted with these prepared remarks, both of which apply to the content of this call.

During the discussion today references to "this quarter," "the quarter" or"Q4" mean the fourth quarter of '09. References to "third quarter" or "Q3" mean the third quarter of '09, and references to the "first quarter" or "Q1" mean the first quarter of 2010. Further references to "this year", "the year" or the "full year" mean 2009 while references to "last year" mean 2008.

That said, let me recap our financial results.

We reported total revenues this quarter of $15.2 million, down from $17.1 million in the year-ago quarter and $16.4 million in Q3. Decreases in service revenue accounted for both declines. Our largest customer, the Ford Motor Company, accounted for 8% of total revenue this quarter, 24% in the year ago quarter and 20% in Q3. Total revenue for the full year was $64.4 million, down 2% from $65.8 million in 2008.

Sales of third party software were $9.5 million this quarter, up 13% from $8.4 million in the year-ago quarter and up 7% from $8.9 million in Q3. Higher Microsoft licensing sales to our larger customers drove both increases, in particular, one customer accounted for $1.1 million in license purchases this quarter, higher than the normal run rate. Third party software sales were $32.4 million for the full year, compared to $35.4 million in 2008.

Proprietary software revenue was $1.1 million this quarter, up 56% compared to $706,000 in the year-ago quarter, and up 16% from $947,000 in Q3. Proprietary software revenue was $4.2 million for the full year, compared to $3.1 million in 2008. Growth in TestQuest product revenue coming off our November 2008 acquisition drove all increases. TestQuest product and support revenue was $588,000 this quarter, compared to $233,000 in the year-ago quarter, and $273,000 in Q3. TestQuest product and support revenue was $1.8 million for the full year.

Service revenue was $4.7 million this quarter, down 41% compared to $7.9 million in the year-ago quarter, and down 28% from $6.5 million in Q3. A decrease in North American service revenue, primarily revenue associated with our Ford project, accounted for both declines. The Ford project accounted for $1.2 million in service revenue this quarter, down from $4.1 million in the year-ago quarter, and down from $3.3 million in Q3.

As we mentioned in our earnings release, we experienced large overruns on the Ford project, which had the effect of significantly reducing the amount of revenue we recognized on the project this quarter under percentage of completion accounting. Consequently these overruns caused our service revenue to come in well below expectations and contributed significantly to our loss this quarter. Entering the quarter, we expected total service revenue to come in around $6.2 million, and Ford to contribute approximately $2.5 million of that, of which $200,000 would be low-margin rebillable revenue. However after quarter-end, the estimated project hours increased significantly, causing actual Ford revenue to come in at $1.2 million of which $941,000 was low-margin rebillable revenue, representing a $2.0 million miss on nonrebillable Ford service revenue for the quarter.

It's important to remember that this revenue was not lost, but will be recognized in future quarters. Absent any additional funds from Ford on the current program, we have $3.6 million in nonrebillable service revenue to recognize in 2010 and the program is expected to remain a drain on gross profit, margins and the bottom line into Q2.

Service revenue was $27.8 million for the full year, up 2% compared to $27.2 million in 2008. Ford service revenue was $14.9 million for the full year, compared to $6.8 million in 2008.

Turning to gross profit and margins, overall gross profit was $1.2 million this quarter, or 8% of total revenue, as compared to $4.5 million, or 26% of revenue, in the year-ago quarter, and $3.4 million or 21% of revenue in Q3. The year-over-year unsequential total gross profit and gross margin declines were driven by the Ford overruns.

Third party software margin was 15% this quarter, 16% in the year-ago quarter, and 17% in Q3. Q3 benefited from a large flash licensing order which boosted margins.

Proprietary software gross margin was 85% this quarter, 91% in the year-ago quarter and 84% in Q3.

Service gross margin was a negative 25% this quarter, a positive 31% in the year-ago quarter and 17% in Q3. Service margin declines were driven by the Ford overruns, which impacted both Q3 and Q4, but Q4 much more significantly. Service margin was also negatively affected by two other factors. First, low margin rebillable service revenue represented a greater percentage of service revenue this quarter; and, second, a portion of our service cost of sales is fixed in nature and declining revenue levels will negatively affect margins.

Overall gross profit was $13.4 million, or 21% of total revenue, for the full year, compared to $17.2 million, or 26% of revenue in 2008.

Moving down the P&L, operating expenses were $4.3 million for the quarter, compared to $4.6 million in the year-ago quarter and $3.3 million in Q3. Q3 OpEx benefited from the reversal of an accrued legal liability in the amount of $534,000, without which OpEx would have been $3.9 million. Lower R&D spend on our TI initiatives drilled the year-over-year decline. The sequential increase was driven by the legal fee reversal which benefited Q3, higher sales wages and related costs, higher stock comp expense and a few other items, none of which were individually significant. Some of these increases will not continue into Q1 and consequently, we currently expect Q1 OpEx to decline sequentially.

Total operating expenses were $16.3 million for the full year, compared to $15.4 million in 2008. An incremental $2.1 million in TestQuest-related operating expenses drove the full-year increase.

Now let's speak to the bottom line results.

We reported a net loss for the quarter of $3.0 million, or $0.30 per share, compared to a net loss of $370,000 or $0.04 per share in the year-ago quarter, and compared to net income of $71,000, or $0.01 per diluted share in Q3. Year-ago quarter included an investment impairment loss of $377,000, or $0.04 per share, while Q3 benefited from the legal liability reversal of $534,000, or $0.05 per share. For the full year, we reported a net loss of $2.7 million, or $0.27 per share, compared to net income of $2.0 million, or $0.19 per diluted share, in 2008.

TestQuest results negatively affected the bottom line for the quarter in the amount of $211,000, or $0.02 per share, and $1.2 million, or $0.12 per share, for the full year, compared to approximately $250,000, or $0.03 per share, in the year-ago quarter.

Besides TestQuest there were additional items which negatively impacted the bottom line this quarter and/or for the full year. First was the negative economic conditions which impacted us in 2009, primarily in the first half of the year. Second is the investment we made in our TI initiatives, which negatively impacted the bottom line by $170,000 this quarter, and by $700,000 for the full year. Our R&D spend related to TI, which ran $246,000 in Q4, will decline significantly by the end of Q1. The third item is Ford, which contributed significantly to our Q4 loss.

We generated negative EBITDAS of $2.6 million this quarter, compared to positive EBITDAS of $393,000 in the year-ago quarter, and $477,000 in Q3. We generated negative EBITDAS of $1.1 million for the full year, compared to positive EBITDAS of $4.1 million in 2008. We incurred $520,000 of non-cash expenses this quarter and $1.8 million for the full year. We currently expect 2010 noncash expenses to run approximately $1.8 million to $2.0 million.

CapEx was $278,000 for the full year, and we currently expect 2010 CapEx to run in the $400,000 range. Cash and investments increased $2.4 million for the quarter, and $4.7 million for the full year, ending the year at $18.0 million. The year-end balance includes $900,000 of restricted cash and $4.2 million of option rate securities, both classified as long-term.

Headcount, including contractors, is currently 266, compared to 272 as of the date of our last call. Engineering services headcount is currently 178, down from 179.

Now I'd like to turn the call over to Brian Crowley, BSquare's Chief Executive Officer.

Thanks, Scott.

Today I'll provide my perspective on our results from Q4, update you on our key initiatives and then discuss our outlook for Q1.

Let me start with our service results for the quarter. The big driver of our service results as well as our overall Company results, is the Ford program, so I'll start there. We are in the final integration stage of the program. In this stage, BSquare is responsible for assembling, integrating and testing the software written by BSquare and all other program partners into the final system. Examples of software provided by other partners include navigation, voice recognition and the operating system software.

All the pieces have been integrated. The system is operational and we are proceeding through the various testing and remediation stages. As defects or anomalies in system operation are discovered, our development team triages the issues and determines if a fix is need from BSquare or from one of the other program partners. This process continues until we have completed our final test pass and all the specified system functionality is operational. Our current estimate is that we will be finished with this program by the end of the second quarter 2010.

It's safe to say that all the partners in the program, including BSquare, underestimated the amount of time it would take to get through the final integration stage. As a result, we have kept our development and quality assurance teams working on the program longer than we planned, resulting in a meaningful increase in the number of hours estimated to complete the program. Our agreement with Ford is such that if we mis-estimate task, we absorb whatever overage is required to complete that task. However, if we end up investing more time than expected due to bugs or delays from Ford or another partner, then Ford is responsible for covering the cost of the delay.

We have invested significant time in the program helping partners to identify and fix issues with their software, and are currently in discussions with Ford to be paid for that work. We are confident that we will receive additional funds to apply towards the program. However, the ongoing discussions with Ford are sensitive and I'm not going to estimate the level of funds that we might receive.

We are actively working with Ford to scope the next set of programs which can take us through 2010 and into 2011. A key part of the discussion for both BSquare and Ford concerns personnel, process and business model improvements that we both must make in order for our execution to improve in the future. This will be an ongoing process. BSquare has developed a very deep expertise on the Ford platform and we believe that given our expertise and the nature of the follow-on programs, the risk profile of the next set of programs is much reduced when compared to the initial program.

However, we need to be comfortable that we can execute these programs successfully from both a technical and financial standpoint and I am actively taking steps to ensure this outcome.

Let me step back and speak about the importance of this initiative. A few years ago automakers used to upgrade audio systems and add extra speakers as a differentiator in terms of entertainment systems. With the advances in technology, the expectation of universal connectivity and the desire of consumers to access a variety of content and media from anywhere, the bar has been significantly raised. More and more consumers are using MP3s for their music, expecting navigation systems with real-time traffic updates and using Bluetooth to utilize Smartphones as part of a robust entertainment and information system. This trend is accelerating, and automakers are working to one-up each other with sophisticated systems. In our opinion, and in the opinions of many experts, the Ford SYNC system is currently the leading state-of-the-art entertainment and information platform and we are confident that the next-generation Ford My Touch system, when complete and introduced, will extend Ford's lease.

The level of complexity and integration that is required to deliver a state-of-the-art entertainment and information platform is large and growing every year. Because this integration is a complex undertaking, and as a result of our experience with Ford, we think that BSquare is uniquely positioned to win additional business with automakers and Tier 1 automotive suppliers.

Therefore, even though the last few quarters on the Ford program have been difficult, we have learned much through this process, have incorporated what we have learned into our organization and are focused on the automotive segment as a key vertical for BSquare. We have already won new business at Ford and with other automotive suppliers, and are determined to grow our footprint in this vertical.

Outside of Ford, I've been concerned for several quarters that our service backlog and revenues have not grown as expected. Our service bid activity, which is a good forward-looking indicator for future service business, was down slightly sequentially in Q3 but up 40% over the fourth quarter of 2008. Our bid activity has run 7% to 50% higher than the activity in comparable quarters in 2008, and my concern has been around the poor conversion ratio of bids-to-contract awards. Over the past few quarters, we've implemented a number of organizational and programmatic activities to turn the trend around, but I eventually came to the conclusion that it was time for new sales leadership to revitalize our service and product sales efforts. Consequently, we announced in the first quarter that Mark McMillan join BSquare as our new Vice President of Worldwide Sales.

Mark comes to us with extensive experience in the mobile and embedded space and a proven track record of innovation and growth. Mark has only been with us for a few weeks, but is already having a favorable impact on our efforts to return BSquare to solid growth. In conjunction with Mark coming on board, we took the opportunity to reorganize our sales teams and have kicked off efforts to create more vertical offerings for our products and services. I am confident that we have made a very good addition to our executive management team, and we'll report on our efforts in regards to our sales organization and vertical market efforts in future quarters.

Turning to third party software sales. Record soft licensing sales were strong again in the quarter as we saw increased order volumes from nearly all our top customers. First quarter Microsoft licensing sales have also been strong and we are currently expecting a sequential increase in the first quarter. It appears to me that licensing sales bottomed out in the first half of 2009, and I am expecting a year-over-year improvement in 2010.

We announced in the fourth quarter that Microsoft selected BSquare as its first mobile indirect channel distribution partner for Windows Mobile Version 6.5 and earlier. This partnership allows BSquare to sell Windows Mobile to handset manufacturers developing phones and to rugged device manufactures shipping data collection terminals and other vertical devices.

Microsoft retains a direct relationship with a select few Windows Mobile customers and is in the process of transitioning all other customers to BSquare. We expect that the majority of the customers will have transitioned by the end of 2010. In addition to selling Windows Mobile licenses to these customers, BSquare is entering into paid support agreements in order to provide technical support, training and to act as the interface with Microsoft's development team. We view this as a cross-selling opportunity, and are focused on expanding our penetration with these customers in order to sell our full portfolio of products and services.

This partnership is positive for BSquare. We have already closed over $1 million of Windows Mobile license revenue in the first quarter, have closed over a half-dozen paid support agreements and have engaged with over a half-dozen customers who are interested in buying other products or engaging our service organization to help them with their Windows Mobile projects. We believe that we are still on target to close $5 million to $10 million of Windows Mobile license revenues in 2010 at margins comparable to our existing Microsoft embedded licensing revenue.

Now turning to our product initiatives. I'll give you a quick update on our two main product initiatives, TestQuest and our Texas Instruments, or TI, co-investment.

Our TestQuest revenue in the fourth quarter was much improved, more than doubling from the third quarter. The increase was mainly due to better execution by our sales and product teams, as well as closing deals that fell out of the third quarter. Our development teams continue their work to advance both the countdown and TestQuest Pro products based on feedback from our customers, and expect to have new releases of both products in 2010. Based on our sales pipeline, sans any last minute deals dropping out of the quarter, we expect to see another sequential increase in TestQuest revenue in the first quarter.

Overall for 2009, our TestQuest results were disappointing. The combination of sales execution issues, coupled with an economy that was crashing as we closed the TestQuest acquisition, resulted in us falling well short of our goals for the year. The good news is that we believe we have the execution issues understood and behind us, and the economic conditions are improving.

The TestQuest product offerings deliver a good value proposition to our customers and we are working hard to make it easier for our customers to adopt and use the product. We're currently investigating several potentially interesting avenues for TestQuest, including a rental and a service model for the product. I will continue to report on these efforts in future quarters.

Next I will turn to our TI Board Support Package, or BSP, initiatives. You'll remember we have two tracks of partnership with TI. The first is for the co-development of a Windows CE6 BSP and the second is for a Windows Mobile 6.5 BSP.

Our Windows CE BSP development efforts are beginning to wind down. Our BSP has been released to the market and we have been receiving revenue from the BSP for several quarters. In Q4 we recognized two Windows CE BSP design wins and we expect to recognize four to eight design wins in Q1.

Our agreement with TI is such that we receive payments when specific design win criteria are met. The development team is wrapping up work on porting the BSP to a new OMAP3 variant, and once this work completes in the second quarter 2010, we expect our development activities on the Windows CE BSP to be primarily maintenance and bug fixes.

Regarding our Windows Mobile BSP project, we are concluding development work on the Windows Mobile BSP at the end of Q1. Our agreement with TI is such that TI provides the Windows Mobile BSP to their largest partners and we receive royalties from TI as they ship silicon to those partners. For all others who are interested in using our Windows Mobile BSP, BSquare sells the BSP to customers directly and then charges a royalty as those customers ship product based on the BSP. Our BSP sales efforts have largely been focused on vertical device manufacturers and we currently have closed deals with one manufacturer and are very close to closing deals with five others.

Between our Windows CE and Windows Mobile BSP efforts, we believe there is an opportunity for $4 million to $6 million in licensing and royalty revenue from 2010 to 2013 which should run close to 100% margin. On top of this revenue we believe that we will sell additional BSquare products and services.

Based on the mobile indirect channel partnership with Microsoft that I described earlier, we are now able to offer our customers a complete reference solution for Windows Mobile, including a TI reference design, a production quality Windows Mobile BSP and Windows Mobile licenses. This is a unique offering that is unmatched in the market today and will bolster our efforts to drive incremental service and product revenue from our Windows Mobile BSP project.

As 2010 progresses, we expect Windows CE and Windows Mobile BSP revenue to increase, while at the same time we expect our development expenses to decrease to a maintenance level after the second quarter.

I will finish our call today with expectations for the first quarter.

Based on our current outlook we expect total revenue to increase sequentially. We expect third party software sales will be up substantially sequentially, as we see strength in the Microsoft embedded licensing demand continuing and we expect an incremental $1 million plus in new Windows Mobile licensing revenue. We expect service revenue to be up sequentially as we continue to progress on the current Ford program and are able to recognize revenue, including some of which was pushed out of Q4 due to the previously discussed overruns. We expect our proprietary software revenue to be up sequentially driven primarily by an increase in TestQuest license and support revenue and by TI OMAP-related revenues.

Thank you for attending our call today. This ends the prepared portion of our call. We will now open up the call for questions.

Thank you, sir.

(Operator Instructions).

Our first question's from the line of Ryan (inaudible) with PayLogic. Please go ahead.

Hey, guys.

Hey, Ryan.

The deferred revenue balance increase quarter-over-quarter, what's the -- what is that composed of?

Pardon me, Ryan?

Ryan, this is Scott. Would you -- I didn't catch the question.

The deferred revenue increase during the quarter? Am I mistaken? I think the deferred revenue was up a couple million bucks.

It's Ford and TQ, and TestQuest.

It's Ford and TestQuest. Can you give a break out of how much is Ford and how much of it is software sales?

I can follow up with you off-line.

Okay.

I don't have the numbers right in front of me.

Okay.

And AR, there's no past due or late AR?

No significant past dues. We were basically current for as of year-end. There was about $300,000 that was past due. As of right now they are past due to the point of about $1.3 million.

Okay.

The OMAP started shipping, what, last quarter?

Started shipping -- our OMAP BSP, Ryan, started shipping in Q3. And then in Q4 we basically did an update to it. I'm talking about our CE BSP. Our Mobile BSP we have given to customers in data form now for a couple of quarters.

And it's shipping this quarter -- Q1?

Yes. There's customers we have, as I mentioned, we closed one customer already.

TI has closed HTC. That's previously been disclosed as a customer.

We've closed one customer ourselves and we've got about five others in the pipeline that we think will close over the next couple of quarters. It typically takes a customer, once we close them, anywhere from three to nine months,depending on where they are at the design cycle at the time we close them to get their products out to market.

So the way it works is we get an up front fee for selling the BSP a license fee and then we get royalties as they begin to ship products.

Right. Okay. I'm just trying to get a sense for an order of magnitude, what that might mean. Thoughts or ways you can --

Well, the license fee we charge for the BSP tends to be around $25,000 per customer, and then the unit cost really depends on their volume. It could be anywhere from $0.50 to a couple dollars per unit.

Okay. Thanks.

And then do you expect, what kind of margins do you expect this quarter for your -- the services?

For Q1 they still won't be pretty. We are currently thinking that they won't be negative in Q1, but they won't be good.

Some of it, Ryan, I mentioned we were talking to Ford about getting coverage for some of the overages.

Right. Obviously, anything we could pull in there could potentially benefit Q1 as well as Q2.

My numbers, Ryan, assumed no additional funds from Ford at this point. It just assumes we recognize the remaining $3.6 million that I discussed that's left on the current contract without getting any more money.

Okay. What about cash at the end of this quarter?

We are currently thinking on cash that we are going to burn probably around $700,000, if we collect those receivables that I just discussed with Ford, the $1.3 million, and if we don't we will burn about $2 million Does that make sense?

Yes. Thank you, guys, very much. Good luck.

Thanks, Ryan.

Thank you.

(Operator Instructions).

Management, I'm showing no further questions at this time. Please continue with any closing remarks.

Well, we will go ahead and end the call at this point. Thank you all for your interest and for listening and we'll talk to you again next quarter.

Thank you, sir. Ladies and gentlemen, if you'd like to listen to a replay of today's conference please dial 1-800-406-7325, or 303-590-3030, using the access code of 426-5663, followed by the pound key.

This does conclude the BSquare Corporation fourth quarter 2009 earnings conference call. Thank you very much for your participation. You may now disconnect.