Bsquare Corp (BSQR) 2010 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen. Welcome to the BSQUARE Corporation first quarter 2010 earnings conference call. (Operator Instructions). This conference is being recorded today, the 13th of May 2010. I would now like to turn the conference over to our host, Mr. Scott Mahan, Chief Financial Officer of BSQUARE. Please go ahead.

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 would 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.

With that said, let me recap our financial results. We reported total revenue this quarter of $16.9 million, up from $16.7 million in the prior year and $15.2 million in Q4. An increase in third-party software sales accounted for the sequential increase. Our largest customer, Ford, accounted for 14% of total revenue this quarter, 31% in the year-ago quarter and 8% in Q4.

Sales of third-party software were $11.0 million this quarter, up 51% from $7.3 million in the prior year and up 16% from $9.5 million in Q4. This quarter included $1.2 million in Windows Mobile license sales, a new product line for us. Improvement in macro economic conditions and the addition of the Windows Mobile product line accounted for the year-over year increase whereas Windows Mobile sales drove the sequential increase.

Proprietary software revenue was $978,000 this quarter compared to $961,000 in the prior year and $1.1 million in Q4. TestQuest revenue was $557,000 this quarter compared to $277,000 in the prior year and $558,000 in Q4. The year-over-year growth in TestQuest revenue was offset by declines in a number of less significant product lines.

Service revenue was $4.9 million this quarter, down 42% compared to $8.4 million in the prior year and up 4% from $4.7 million in Q4. Ford accounted for $2.3 million in service revenue this quarter, down from $5.2 million in the prior year but up from $1.2 million in Q4. A year-over-year and sequential decline in service revenue at several other historically significant North American customers added to the year-over-year decline in Ford revenue and partially offset the sequential increase in Ford revenue. Service revenue met expectations provided on last quarter's call, despite Ford revenue coming in roughly $600,000 short of forecast. The Ford shortfall was caused by continued overruns which reduced the amount of revenue we recognized, pushing that revenue into future quarters. We still have $2.2 million left to recognize on the original program, the vast majority of which is expected to be recognized in Q2 along with whatever other revenue we might recognize from Ford in the form of changes of scope, new programs or overrun compensation.

Turning to gross profit and margins. Overall gross profit was $1.2 million this quarter, or 7% of total revenue, as compared to $4.4 million, or 27% of revenue, in the prior year and $1.2 million, or 8% of revenue, in Q4. The year-over-year gross profit and gross margin declines were driven by the Ford overruns. Third party software margin was 14% this quarter, 16% of the prior year, and 15% in Q4. Proprietary software gross margin was 85% this quarter, 87% in the prior year and 85% in Q4. Service gross margin was a negative 24% this quarter, a positive 29% in the prior year and a negative 25% in Q4. This quarter's negative service margin and the year-over-year decline were driven by Ford overruns. As a result of the Ford overruns and the lack of any definitive agreement with Ford as to overrun compensation, our estimate of the remaining costs on the program exceeded the amount of revenue left to recognize at quarter-end, which resulted in us booking a loss contract accrual in the quarter in the amount of $390,000 and reduced service margin by eight percentage points.

Moving down the P&L. Operating expenses were $4.0 million for the quarter compared to $4.7 million in the prior year and $4.3 million in Q4. The year-over-year decrease was primarily due to a reduction in R&D investment on both the TestQuest and TI-OMAP product efforts. The sequential decline was driven by a number of items with the most notable being a decrease in sales commissions and bonuses. Our fringe benefits expense, which increases in the first quarter of every year as compared to Q4, and then tails off as the year progresses, was up almost $200,000 sequentially on a Company-wide basis.

Now, I'll speak to our bottom line results. We reported a net loss for the quarter of $3.4 million, or $0.34 per share, compared to a net loss of $90,000, or $0.01 per share, in the prior year and compared to a net loss of $3.0 million, or $0.30 per share, in Q4. This quarter's results included a $510,000, or $0.05 per share, unrealized loss on our Auction Rate Securities portfolio and the loss contract accrual of $390,000, or $0.04 per share. TestQuest results negatively affected the bottom line for the quarter in the amount of $363,000, or $0.04 per share, compared to $454,000, or $0.05 per share in the prior year and $211,000, or $0.02 per share, in Q4.

The TI program negatively affected the bottom line by $97,000, or $0.01 per share, this quarter compared to $234,000, or $0.02 per share, in the prior year and $157,000, or $0.02 per share, in Q4. The TI program should become accretive in Q2 as a good portion of our development work was completed this quarter. Lastly, the Ford program, including the effect of the loss contract accrual, was the primary driver in our significant loss this quarter, as well as in Q4. We generated negative EBITDA of $2.5 million this quarter, compared to positive EBITDA of $227,000 in the prior year and negative EBITDA of $2.6 million in Q4. CapEx was $38,000 this quarter although we still expect full year CapEx to run in the $400,000 range.

Cash and investments, both short and long-term, decreased $2.2 million, ending the quarter at $15.8 million. On last quarter's call we commented that if Ford paid us what was owed at the time, we would burn roughly $700,000 in cash and if they did not, we would burn $2.0 million. Ford did not pay us during the quarter and that fact, coupled with an increase in our Auction Rate Securities valuation reserve of roughly $200,000, accounted for the majority of the decrease in cash and investments. Ford did pay us all past due amounts after quarter-end

The quarter-end cash and investments balance includes $875,000 of restricted cash and $4.0 million of ARS. As of quarter-end, there was an $888,000 valuation reserve recorded against our ARS. One of the primary drivers behind the increase in the reserve this quarter, and the $510,000 unrealized loss which negatively affected the bottom line, was a recent decision to pursue a claim against the firm that sold us the ARS. This decision was made for a variety of reasons including the fact that the firm recently settled several state lawsuits regarding their ARS activity and neither of the settlements benefited corporate clients as have similar settlements agreed to by other firms in the past. While the claim isn't expected to be resolved for some time, roughly 12 to 14 months, the decision to file the claim means we will liquidate our ARS. We sold our first ARS subsequent to quarter-end, a $500,000 par value security on which we realized proceeds of $471,000.

Because we have begun the liquidation process, we relied more heavily on secondary market data for our ARS valuation at quarter-end which had the effect of increasing the reserve. Additionally, we are now considering 100% of the valuation reserve to be other-than-temporary which resulted in the negative impact on operating results. We plan on an orderly liquidation of our ARS and will utilize the time between now and the arbitration hearing to maximize the amount we receive. Headcount, including contractors, is currently 266 while engineering services headcount is currently 179. Both amounts are essentially flat compared to the last call. Now, I would like to turn the call over to Brian Crowley, BSQUARE's Chief Executive Officer.

Thanks Scott. Today I will provide my perspective on our results from Q1, update you on our key initiatives and then discuss our outlook for Q2. Let me start with our service results for the quarter. The big driver of our service results as well as our overall Company results continues to be the Ford program. Since we last talked just over a month ago, we have made substantial progress towards completing the original development and integration programs. All the various software and hardware components have been integrated. The system is operational and we are proceeding through the final testing and remediation of defects. This process will continue until we have completed our final test pass and all the specified system functionality is operational. We remain on track to complete this program during the second quarter.

On our last earnings call, I mentioned that we had initiated discussions with Ford to obtain additional funds to cover the unplanned time that we have spent completing the program. These discussions have advanced considerably since our last call and we are targeting to wrap them up before the end of May. Because of the sensitive nature of these discussions, I am not able to provide any additional details at this time. Additional funds that we receive from Ford that cover past overruns will likely benefit Q2 from a revenue perspective.

We have completed the initial scope definition for the next set of Ford programs which will take us through 2010 and into 2011. More importantly, working together with Ford we have defined the outline of a business model that we believe works for both Ford and BSQUARE. We are currently in the process of fleshing out that model with details including financials, staffing and the ramp up of various programs. We expect to have all this substantially agreed to by the end of May and we expect to get started on the next set of programs in June.

The last two quarters have been very difficult for our employees and our shareholders. However, we have tried to maintain a long-term outlook that allowed us to work through the current difficulties with Ford and to build a relationship that provides long-term benefits for BSQUARE.

We have developed very deep expertise on the Ford platform and given this expertise and the nature of the follow-on programs, we think that our forward risk profile on future programs is much reduced when compared to the initial program. It's not often that a company the size of BSQUARE is given the opportunity to enter a new market segment alongside a premiere customer on a leading platform, but that is what has happened here. So, despite the pain that we are experiencing right now, I am excited about the additional capabilities and proprietary IP that we have built or will build in the future to serve the automotive market. Over the long term I believe that this is a positive move for BSQUARE.

Beyond Ford, we are actively working with two other automotive-related customers, and have additional automotive opportunities in our sales pipeline. I mentioned last time that we had started an internal reorganization such that automotive is a key vertical business segment for BSQUARE. That reorganization is now complete and our team is in the process of researching and defining new solutions for the automotive market. We expect that these solutions will encompass all that BSQUARE has to offer, including our services, proprietary IP and third party IP.

We think this is a very good time to be in the automotive segment as automotive OEM's are using in-vehicle offerings such as connectivity, entertainment, and access to internet-based applications in order to differentiate their offerings. Based on our experiences with Ford and on our own market reconnaissance, we believe that we can grow our services revenue in the automotive segment to somewhere between a $20 million and $30 million dollar per year run-rate within the next three to five years, with an opportunity to grow larger as we determine how to penetrate Asian automakers. We believe that there is an opportunity to sell our other products alongside these services, although we have not sized that market potential yet.

Outside the automotive segment I talked last time of my concerns that our service backlog and revenues have been flat to declining for several quarters. Our service bid activity, which is a good forward-looking indicator for future service business, was up slightly over Q4. Over the past year our bid activity has consistently run higher than it did in the comparable periods in 2008. My concern has been that we have done a poor job of converting those bids to contract awards. This was one driver behind the hiring in January of Mark McMillan as our new VP of Worldwide Sales and the overall reorganization of our sales force.

Mark has hit the ground running, has reorganized the sales force, upgraded key positions and worked on improving our sales processes and reporting systems. Realistically it always takes a couple of quarters for these types of changes to take hold but I'm very happy with the job that Mark has done so far and expect that these changes coupled with an overall improvement in economic conditions bode well for our business in the coming quarters. In fact we entered the second quarter with slightly higher service backlog than we entered the first quarter and this is the first time in more than a year that our service backlog has grown in sequential quarters.

Turning to software sales, third party software sales were up again sequentially for the third straight quarter. Not only did we see another sequential increase in Microsoft embedded licensing but we had a good first full quarter of Windows Mobile licensing and had another solid -- another quarter of solid results for the other third party software we sell such as Adobe Flash and McAfee Solidcore.

In Q4 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. Since we started selling Windows Mobile licenses we have concluded agreements with 13 customers and actually shipped licenses to seven of those customers including two that are brand new Window Mobile licensees who were not previously able to obtain a Windows Mobile license directly from Microsoft. These customers have all purchased support agreements from BSQUARE and we have quoted other products and services to nine of these customers. Selling Windows Mobile has been very positive for BSQUARE. We believe that we are still on target to close between $5 million to $10 million of Windows Mobile license revenue in 2010 at margins comparable to our existing Microsoft embedded licensing revenue.

Now I will give you a quick update on our two main product initiatives, TestQuest and our Texas Instruments co-investment. Our TestQuest revenue was flat from the fourth quarter which was a disappointment. We had expected to see sequential improvement but some expected business slipped into the second quarter. We are currently forecasting a sequential improvement in TestQuest revenue in the second quarter. Our development team released version 3.0 of the Countdown product in the quarter which includes usability improvements and expanded support for the Android platform which should help the sales process. Frankly, I am tired of reporting inconsistent results on TestQuest. Under Mark's leadership, we have reorganized the way we sell the product.

A piece of feedback we have received from our customers is that the learning curve for the product is steep, so we are working on ways we can make the product more customer friendly out of the box. We are actively exploring the possibility of offering the product under alternate business models, including a subscription or hosted model in order to enhance the return on investment for our customers. We bought TestQuest because we know that testing is a big problem for our customers and we believe that TestQuest can help solve that problem. A top priority for me and the organization is to drive our TestQuest results where they need to be.

Regarding our TI Board Support Package, or BSP, initiatives. You'll remember that we have two tracks of partnership with TI. The first is for the co-development of a Windows CE 6 BSP and the second is for a Windows Mobile 6.5 BSP. Our Windows CE BSP efforts are moving to a support status. In Q1, we recognized two additional Windows CE BSP design wins, which is lower than the four to six we had expected to recognize. The difference is timing-related and we expect to claim at least two of these design wins in Q2.

Regarding our Windows Mobile BSP project, we concluded development work on the Windows Mobile BSP and ramped the development team down at quarter-end. Our sales efforts have been focused on vertical device manufacturers and we currently have closed deals with three manufacturers, are very close to closing one additional manufacturer and have several more in our pipeline. The business model for the Windows Mobile BSP is different from the Windows CE BSP. We license the Windows Mobile BSP for a fee to our customers and then receive royalties as devices ship. Between our Windows CE and Windows Mobile BSP efforts, we still believe that there is an opportunity for $4 million to $6 million in licensing and royalty revenue, assuming our customers' devices are successful, between 2010 and 2013. On top of this revenue, we believe that we will sell additional BSQUARE products and services, and in fact we have already booked additional service revenue based on our BSP sales efforts.

I will finish our call today with expectations for the second quarter. Based on our current outlook, we expect total revenue to increase sequentially. We expect third-party software sales will be up sequentially as strength in Microsoft embedded licensing continues and we ship Windows Mobile licenses to additional OEMs. We expect service revenue to be up sequentially as we wrap up the Ford program, recognize the remaining Ford revenue and start work on the next set of Ford projects. We expect our proprietary software revenue to be up sequentially driven primarily by an increase in TestQuest license and support revenue. In fact, if the current sales forecasts hold true, this will be a record revenue quarter for BSQUARE by a substantial margin. I'll look forward to the day that I can make that report to you.

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

(Operator Instructions) And our first question comes from the line of [Ryan Bartman] of [Pelagic]. Please go ahead.

Hi, guys.

Hey, Ryan.

What sort of legal expenses do you expect going forward as it relates to the ARS litigation?

Ryan, this is Scott. If we get all the way to the hearing and there is no settlement prior to that, we would spend about $50,000 out of pocket.

Okay. And then some of the accounts payable was up a little bit as were some of the other accrued expenses. What is that related to?

That's the Microsoft licensing stuff. Microsoft licensing activities. We've always got -- basically at any one point in time we have two months' worth of royalties outstanding on our balance sheet to Microsoft. One month is sitting in accounts payable. One month is sitting in accrued expenses. Sales of Microsoft licensing were up this quarter thus you're seeing that rise on that side of the balance sheet.

Okay. Perfect. And then what about gross margins as it relates to services assuming that you don't get any of the back Ford revenue? How can we think about gross margins in the services business kind of doing forward?

Well, there's two ways to answer that question. There's what should you think about them in terms of Q2 and what should you think of them longer term. I'll answer both of those. In Q2 you asked me the same question last quarter and I said that, you know, based on what I told you, you should have zeroed in on about a 0% margin last quarter and obviously it came in a lot lower than that due to both the loss contract accrual we booked on Ford and the fact that we had some more overruns. So we're projecting service margin to be in the low double digits for Q2 right now and, again, assuming we have no more overruns in the Ford program and that assumes we don't book any overrun compensation in the quarter. On a longer term basis obviously the goal is to drive our service margins back up into the high 20%, low 30% range.

Okay. Very good. And then kind of cash balance at the end of Q2?

Right now we are thinking it's going to be -- it's primarily based on some negative working capital movement. Probably about a $600,000 burn in the quarter.

Okay. Great. Thank you all very much.

Thank you and, Mr. Crowley, at this time there are no further questions.

Okay. We'll go ahead and close the call up. Thank you for attending today and we'll talk to you again next quarter.

Ladies and gentlemen, this concludes the BSQUARE Corporation's first quarter 2010 earnings conference call. I would like to thank you for your participation. You may now disconnect.