Bsquare Corp (BSQR) 2010 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the BSQUARE Corporation fourth-quarter 2010 earnings conference call. During today's presentation all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions.

(Operator Instructions)

This conference is be recorded today, Thursday, March 3, 2011. I would now like to turn the conference over to Scott Mahan, CFO of BSQUARE. Please go ahead.

Good afternoon, everyone. Before I begin, let -- 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 your attention to the safe harbor statement contained and our press release issued today and the safe harbor statement which will be posted with these prepared remarks both of which apply to the content of this call. All per share amounts discussed today are fully diluted numbers. With that said, let me recap our financial results. We generated record total revenue this quarter of $27.6 million, up to 82% from $15.2 million in the year-ago quarter and up 9% from $25.3 million in Q3. A significant increase in third-party software sales accounted for the majority of the year-over-year increase whereas increases in all revenue components drove the quarter-over-quarter increase.

Total revenue for the year was a record $96.8 million, up 50% from $64.4 million in '09. Sales of third-party software were $18.5 million this quarter, up 96% from $9.5 million in the year-ago quarter and up 3% from $18.0 million in Q3. The year-over-year increase was driven by a 59% increase in Microsoft General Embedded operated system sales and was also driven by $3.4 million in Window -- Windows Mobile sales compared to none in the year-ago quarter and $3.1 million in Q3. The increase in General Embedded sales was driven by higher average producing volumes. Third-party software sales were $63.9 million for the year, compared to $32.4 million in 2009; $10.2 million in Windows Mobile sales compared to none in 2009; and higher General Embedded operating system sales drove the full year increase. Proprietary software revenue was $2.1 million this quarter, up 91% compared to $1.1 million in the year ago quarter and in Q3. A significant sale of our TestQuest product to China Mobile this quarter in the amount of $723,000 and an increase of Texas Instruments OMAP related revenue drove the increases. Proprietary software revenue was $5.2 million for the year compared to $4.2 million in 2009.

Service revenue was $6.9 million this quarter, up 47% compared to $4.7 million in year-ago quarter and up 11% from six -- $6.2 million in Q3. Ford-related service revenue was $1.9 million this quarter compared to $1.2 million in the year-ago quarter and $2.5 million in Q3. The year-over-year improvement was driven by Ford, 160% increase in APAC service revenue, and a relatively new North American customer which accounted for $1.4 million of the increase. The sequential increase was driven by the new North American customer, offset by the Fort decline. Subsequent to quarter end, we announced a new amendment with Ford, which should generate $9.3 million of service revenue in 2011. Total service revenue was $27.7 million for the year compared to $27.8 million in 2009. Ford-related service revenue was $12.9 million for the year compared to $14.9 million in '09.

Turning to gross profit and margins, overall gross profit was $6.5 million this quarter for 24% of total revenue compared to $1.2 million or 8% of revenue in the year-ago quarter and $5.0 million or 20% of revenue in Q3. The year-over-year increase in overall gross profit was driven by increases in all of our gross profit components and, in particular, service gross profit which increased $2.9 million. The quarter-over-quarter increase in overall gross profit was driven primarily by a $1.1 million increase in proprietary is software gross profit. Third party software margin was 15% for the quarter compared to 15% in the year-ago quarter and in Q3. Proprietary software margin was 93% this quarter compared to 85% in the year-ago quarter and 83% in Q3. Service margin was 26% for the quarter compared to a negative 25% in the year ago quarter and 24% in Q3. Year-over-year improvement in service margin was due to project overruns on the main Ford program which negatively affected the year-ago quarter. The quarter-over-quarter increase in service margin was driven by higher service revenue. Overall gross profit was $20.5 million or 21% of total revenue for the year compared to $13.4 million or 21% of revenue in 2009.

Moving down to P&L, operating expenses were $4.4 million for the quarter compared to $4.3 million in the year-ago quarter and $4.0 million in Q3. The sequential increase was driven by higher incentive competition costs, costs associated with our Asia sales expansion, and additional bad debt expense. Total OpEx was $16.2 million for the year compared to $16.3 million in '09. Now I'll speak to our bottom-line results. We generated net income for the quarter of $2.1 million or $0.19 per share, up from a loss of $3.0 million or $0.30 per share in the year-ago quarter and up from net income of $936,000 or $0.09 per share in Q3. The current quarter benefited from a TestQuest sale in the amount of $723,000 or $0.07 per share whereas the year-ago quarter was negatively affected by the Ford overruns I mentioned earlier.

For the year, we generated net -- net income of $3.5 million or $0.32 per share compared to a net loss of $2.7 million or $0.27 per share in '09. Auction rate security losses negatively affected 2010 by $580,000 or $0.05 per share while a legal accrual reversal benefited '09 by $534,000 or $0.05 per share. We generated EBITDAS of $2.5 million this quarter, or $0.23 per share, compared to negative EBITDAS of $2.6 million or $0.26 per share in the year-ago quarter, and positive EBITDAS of $1.5 million or $0.14 per share in Q3. We generated EBITDAS of $5.9 million or $0.54 per share for the year compared to negative EBITDAS of $1.1 million or $0.10 per share in 2009. Cash investments increased $1.6 million to $23.1 million in quarter end, $1.0 million of which is classified as long-term. During the quarter, we sold auction rate securities with a par value of the $850,000 for $682,000, on which we realized a loss of $23,000. We currently have one ARS on the books with a fair value of $122,000. CapEx was $98,000 this quarter and $218,000 for the full year. We currently expect FY11 CapEx to run $500,000 to $600,000.

Headcount, including contractors, is currently 283 compared to 263 as of the date of our last call. Engineering services headcount is currently 183, up from 171. As I mentioned in our press release today, financial results discussed today are preliminary. Our form 10-K filing will be delayed but not beyond the filing deadline as result of correspondence with the SEC regarding the normal periodic review of our 2009 form 10-K filings. While we don't anticipate that the SEC's review will impact financial amounts discussed today, subsequent events could arise which may. Further, we are examining our accounting for income taxes, particularly the 100% valuation allowance currently provided for on our deferred tax assets. Any modifications to income taxes would impact the net income and earnings per share amounts discussed today but not impact the EBITDAS and the EBITDAS per share amounts. Now I'd like to turn the call over to Brian Crowley, BSQUARE's Chief Executive Officer.

Thanks, Scott. Today I will provide my perspective on our Q4 results, update you on our key initiatives, and then discuss our -- our outlook for Q1 in 2011. Overall, I was very pleased with the results for the fourth quarter and the full year. Many of you will remember that we had a rough start to the year, with a large loss in the first quarter as result of our project with Ford. The team rallied and we put together three successive solid quarters to finish the year with record revenue and solid profits. Just as important, we defined several new growth initiatives during the year, including our handset certification platform, our international expansion strategy, and our blended service delivery strategy. We have made good progress against all these initiatives and I will discuss all three in more detail at various points in today's call.

Now turning to service activity in Q4, we delivered strong service performance which drove a sequential increase in service revenue, which I expect to occur again in Q1. We announced in early February an agreement with Ford to extend and expand our Telematics Competency Center through December of 2011. We are excited to continue our work with Ford and to continue development of the MyFord Touch platform. I remain grateful to the BSQUARE team who, through their hard work and dedication, made this extension possible. One of our key service initiatives is to expand our Taiwan engineering team and to build out an engineering team in mainland China. To remind you, we believe it is important to expand our service delivery capabilities in Asia for two reasons. First, we believe there is a substantial opportunity to win additional business from Asia customers. However, a more substantial local engineering presence is required in order to win this incremental business.

Second, we believe that if we can successfully deliver work to our North America customers at lower rates than we have charged in the past, there is a substantial opportunity to grow our North America service revenue as a result. We intend to lower our rates by using a blend of engineering resources in North America mixed with the lower-cost resources located in Asia. We believe that this blending of resources will deliver better value to our customers and improved service margins to BSQUARE. During the quarter, we increased our Taiwan engineering headcount and continue to -- and will continue to do so in Q1 and -- and we had been hiring in mainland China in support of a handset certification platform trial and expect that hiring to continue in Q1 and Q2 as we build out our China Development Center. We are now successfully delivering several US projects using a blend of North American and Taiwan resources and our objective is to increase the percentage of blended projects we deliver as the year progresses.

Another key service initiative, which has been ongoing for several quarters is the expansion of our applications and user interface development practice. Given the explosion of applications on all types of smart connected devices, we view applications and user interface development as a key growth area for a service revenue. This is a highly competitive market area and, to be successful, we must continually improve the depth and breadth of our skill set and gain additional projects experience, both of which are underway. Our results to date on this initiative are fairly dramatic. We are growing our applications and user interface practice revenue over 300% year-over-year and 65% sequentially from Q3. In 2011, we expect to focus more of our attention towards delivering application and user interface services on the Android and Windows Phone 7 operating systems, which both look like solid growth opportunities. We view the Microsoft-Nokia partnership as very positive for BSQUARE and we are actively pursuing several opportunities to deliver services into this partnership. Finally, we are on the lookout for companies that we can acquire that bring application and user interface experience for product technologies that complement and add to our existing capabilities.

Next I would discuss our proprietary product results. We saw a substantial sequential increase in propriety revenue driven primarily by a large TestQuest product sale to China Mobile. China Mobile intends to use TestQuest to monitor application and network performance throughout their network. Note that this is a standard TestQuest product sale, one in conjunction with two partners in China, not a handset certification platform sale. While we are keenly focused on the success of our handset certification platform initiative, we will continue to sell TestQuest to our traditional OEM and enterprise customer base and hope to close more sales like the China Mobile network monitoring sale, although sales of this size and complexity are difficult to forecast.

Our Texas Instrument OMAP Windows CE OCI in Windows Mobile board support package, or BSP, related revenue was up sequentially from Q3. As I mentioned last quarter, we've effectively ended the engineering investment in the OMAP BSPs and have moved both products into harvest mode. We expect that OMAP-related revenue will continue to grow as more devices shift using our BSPs and we earn royalties from those devices. We also continue to earn revenue from a variety of other sources, including our legacy SDIO and Schema products, as well as sales of Qualcomm's Snapdragon Mobile Development Platform. We expect that Snapdragon revenue will increase over the year and sales of our -- of our other legacy products will generally remain at current levels for the remainder of the year.

Finally, we turned in an overall sequential increase in third-party software sales. Breaking down the revenue components that make up this increase, Microsoft Embedded sales were roughly flat sequentially, while our Windows Mobile sales were up 12%. Outside of Microsoft products, sales of the other third-party products including Adobe Flash Lite, McAfee Solidcore, and Datalight were up sequentially as well. We enjoyed tremendous growth in our third-party product sales in 2010. The bulk of this growth was driven by our largest Microsoft Embedded customers increasing their order volume coupled with the addition of Windows Mobile license sales. Looking forward, we currently believe our larger customers have hit their run rates in order volume at least for the next few quarters. And therefore, additional third-party growth in 2011 will come primarily from our third-party growth initiative which I will discuss next.

Our growth strategy around third-party products is quite straightforward. We are working with our partners to expand the territories in which we are able to sell their products and we are looking for additional products to sell. For example, today we are authorized to sell the Microsoft Embedded products only in North America but we would like to sell these products worldwide. I am happy to say that we are the final stages of negotiating an agreement with Microsoft that will authorize BSQUARE to sell Microsoft embedded products in Europe, initially focused on the UK and Germany. Europe is the second largest market for Microsoft Embedded products behind North America.

Even better from our perspective is that the market for Embedded products in Europe is expected to grow by over 20% in Microsoft's next fiscal year and the average margins run higher there than in the US market. Microsoft is looking to add another distribution partner in Europe due to consolidation that has taken place among existing distribution partners. We have already start to build our team in Europe and have identified a very experienced managing director for Europe who will be filling up the rest of his team in Q2. Overall, we expect that Europe will bring in incremental $2 million to $4 million of revenue in 2011 and up to $10 million of incremental revenue in 2012. However, we are forward investing in Europe and expect that this investment will negatively infect -- negatively affect the bottom-line by roughly $500,000 or $0.05 per share in 2011, but will be accretive in 2012.

Finally, let me update you on our TestQuest handset certification platform efforts. The handset certification platform, or HCP, allows a mobile operator to develop, manage, and publish portfolios of test cases to multiple smartphone OEMs and enables OEMs to pre-certify devices before they are submitted to the mobile operator for final certification. The complete cycle from test, development, distribution, testing, and mobile operator certification is automated, secure, and auditable. We believe that this product will give both mobile operators and smartphone OEMs a valuable tool to ensure incoming device quality and reducing the cycle time to bring new devices to market.

Last quarter, I said that I'd hoped we could sign and announce our first HCP Customer before the end of 2010. I was very disappointed that we did not accomplish this objective. However, I believe that we are very close, as we have been in trial with the a major Chinese mobile network operator since December. The trial is expected to be complete by the end of March. The trial has been successful in demonstrating the value of the HCP product to the operator and to the OEMs who have participated. The trial has also allowed us to identify and improve several areas of our products which we believe will enhance our value proposition when we go to production with current and future HCP customers.

Once the trial is complete and we have signed -- we have a signed agreement with our customer, the real work begins. We will begin the production deployment of the HCP platform and we must sign agreements with many different handset vendors for their use of the HCP platform. For example, our first customer has identified over 50 OEMs that will use the HCP once it goes into production. The first time an OEM is ready to use the HCP to deliver a handset, that OEM must sign an agreement with us and work with us to ensure that their device works properly with the platform. These agreements will be structured as yearly access subscriptions and we also expect that some percentage of OEMs will need our help to get the devices through certification and therefore will purchase additional support contracts from us.

We expect that the total revenue opportunity from just this HCP installation should easily exceed $1.5 million between today and the end of 2012. Generally we expect that margin on the subscription revenue will be in the 80% range and the blended margin of the subscription revenue and support revenue will be in the 65% range. Because not all OEMs will deliver handset to the operator at the same time, we want to caution investors that revenue from this program should ramp as the year progresses. We are bringing on additional resources in China to support this opportunity and some of those resources are being brought on ahead of OEM revenue, meaning that there is some forward investing taking place to make sure our first HCP deployment is successful. We still have two other customers interested in our HCP product. However, we have chosen to hold off pursuing those customers in the short-term, in order to focus all our resources on making our first customer successful.

I will finish our call today with expectations for the first quarter and our overall outlook for 2011. Let me start with 2011. We are expecting to grow all three of our revenue streams for the full year as compared to the full year 2010, building on top of the progress that we made in 2010. We expect to be more profitable in fiscal 2011 than we were in fiscal 2010. We expect to add additional operating expenses during the year, primarily in support of the handset certification platform, expansion into new territories, and an extensive marketing initiative that we have undertaken in Q1 to refresh our brand and our external website. For Q1, based on our current outlook, we expect total revenue to be roughly flat compared to Q4. We expect overall third-party software sales to be flat from Q4. We do not expect our largest Microsoft Embedded customers to increase their purchasing volumes compared to Q4 and therefore, we expect Microsoft Embedded revenue to be roughly flat sequentially. Microsoft has brought onto Windows Mobile distributors in Asia, which we expect will have a slightly negative impact on Windows Mobile revenue as compared to Q4. However we expect the Windows Mobile decrease to be offset by a slight increase in all of the other third-party products that we sell.

We expect our proprietary product revenue to be down from Q4 as we do not expect that Q1 will -- will include another large TestQuest product sale like the China Mobile network monitoring sale that we closed in Q4. We do not expect to recognize any substantial handset certification platform revenue in Q1. Rather we believe that this revenue will ramp through the year as we sign [HTP] OEM contracts and bring additional OEMs online. We do expect our service revenue to be up sequentially driven by the Ford Competency Center renewal I discussed earlier. We expect that our total gross margin will decline due to the drop in proprietary software revenue and an increase in service cost of sales due to higher fringe benefits expense and other costs. We expect to be profitable in Q1, however our profitability will decline compared to Q4 due to the reasons I just mentioned. Obviously, these expectations are based on our current forecasts, which are subject to change and as we mentioned in a press release, our revenue is a little more backloaded this quarter than it has been for the past couple of quarters.

On the Q3 call, I said that our revenue run rate that we generated in Q2 and Q3 and the resulting profitability therefrom should represent a new baseline from which we expect it to grow. As a reminder, we generated earnings per share of $0.11 in Q2, after normalizing for the effects of the Ford adjustments which benefited the quarter, and $0.09 per share in Q3. We also generated normalized EBITDAS of $0.14 per share in Q2 and $0.14 in Q3 as well. As you heard today, we generated earnings per share of $0.19 in Q4 and EBITDAS per share of $0.23. However, the quarter benefited from the China Mobile TestQuest sale in the amount of $0.07 per share and Q4 also benefited from being -- from the fact that fringe benefit expense is the lowest of the year. As we look out over the full year 2011, I still believe that the normalized Q2 and Q3 run rates will be our baseline. But investors should expect some quarter-to-quarter lumpiness as we make some Ford investments and bring new revenue streams online.For example in Q1, we are making Ford investments in Europe, marketing, and the handset certification platform -- investments that I believe will pay handsomely. I view Q1 as a quarter where we are investing and gathering ourselves to launch into our next growth phase.

One other point. Scott mentioned earlier that we are reviewing our accounting for our deferred tax assets, which are all currently 100% reserved for, and to the extent that we do record a deferred tax asset as of 12/31/2010, our income tax expense will increase in 2011, as compared to current run rates and would likely approximate something more in line with statutory effective rates which will negatively affect the bottom line in EPS but will have no effect on EBITDAS and EBITDAS per share. With that, I will wrap up by saying I remain very enthusiastic about our business and the opportunities ahead of us. 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)

One moment please. And our first question is from the line of Sarkis Sherbetchyan with B. Riley & Company, please go ahead.

Hello Brian, hello Scott, how are you guys doing?

Good, how are you?

Good, thank you. Nice quarter there.

Thank you very much.

Can you give us some additional color on the new customer that you'd mentioned that contributed $1.4 million to revenues?

It's a -- it is a -- obviously a service customer. And what's interesting about this customer is we're doing, tying back in with Brian's comments on the growth in our application area of our practice, this is -- I believe 100% application work.All application and -- and UI type work.Across, yes, many different platforms. So this customer has an application that runs on -- on tablets and smart phones and desktops and we're helping them with all that cross-platform development.

Okay. And what -- what region was this customer in? Was it a APAC customer or -- or something else, North America?

It's a -- a North America customer but this is actually one of the customers that we're doing blended delivery with so the work is being done here at North America as well as in Asia.

Okay. Nice. And you also mentioned that two additional customers were interested in your HCP, but you kind of wanted to delay that. Can you maybe give us some color as to the size and the -- the region of that interested carrier or carriers?

Sure. Sure.One of them is a North America carrier and the other is a European. And when I say delay, I mean I'm talking about a delay in the order of maybe 30 to 45 days before we really go after them in earnest. You know, the -- the first time you go through one of these large deployments, you learn a lot. And we -- we are choosing to do that learning with -- in this trial that we're in with our -- our Asia customer. And we think that's going to benefit us quite a bit when we go after these next two.

Now when you say 30 to 45 day delay, is that a trial or is that signing the contract and hopefully bringing some -- some of those OEMs online as soon as you signed a contract?

No, that would be delay in us potentially getting started with them in some sort of trial. So, we're just -- we're just at -- in the beginning part of the sales process with -- with the other two guys.

Okay. And then, you also mentioned you were on the look out for acquisitions on the application in UI side or product technologies that complement your capabilities. Do you mind maybe giving us some color as to the size of -- of the acquisition you're looking for?

Well, I guess obviously the -- the top end of something like that would be somewhat dictated by our market cap and how much cash we wanted to use. But generally we look for acquisitions that are in the $5 million to $15 million range. It is sort of a sweet spot for us, for acquisition. We would pick up something smaller if it was a nice technology, for example. And we would potentially do something larger if there was something that was super synergistic and involved more of a, I guess a merger rather than acquisition. We would consider that as well if -- if what we saw at the other side was -- would give us scale and mass to go after the market even harder.

Okay and then just kind of looking at your R&D expenses, do we expect the -- the current quarterly run rate to kind of carry through fiscal year '11 or do we expect some incremental investments there as well?

It will increase. And one of the things Brian referred to earlier is -- is we are bringing on folks, for example, and almost -- almost exclusively relative to the HCP program with our -- with our trial customer in Asia so there will be some -- some increase in R&D in 2011, with almost all of that increase focused around the handset certification program.

Okay, and maybe, maybe, I'm sorry --

I mean to put it in perspective, I mean, we're -- we're not planning on doubling R&D. I mean, our -- our increases will be, we -- we tend to increase R&D at a reasonable rate.

Okay, thank you for the -- for that color. And -- and with respect to the tax rate going forward when you say normalized statutory rate, would -- if we were to model somewhere around 35% or so, would that be reasonable within your expectations?

Yes, I think from a modeling perspective, you should consider our all-in US effective rate to be here over 36% when you include federal and state and then tack on -- tack on a little bit more than that for international.

All right, thank you. I will get back into queue.

The next question is from the line of Aaron Martin with AIGH Investment Partners. Please go ahead.

Hello?

Mr. Martin, your line is open.

Guess he got his questions answered.

We will move onto the next question which is from the line of David Mau with Montgomery Street Research. Please go ahead.

Hello, good afternoon Brian and Scott. Nice quarter.

Thank you very much.

I just had a quick modeling question and then I have another question regarding the potential for the Nokia switch to Windows Mobile. But you -- you have a comment that the next quarter is going to backend loaded and I'm curious if you could give some more color to that. Is this just a -- a seasonality thing?

I wouldn't call it a seasonality thing. I mean, typically our quarters are -- are not exactly linear. But for whatever reason this quarter, just the sales are just loaded more into the backend than we typically see. And, so we just wanted to put that color out there for investors. We -- we always work hard to bring the quarter in where we -- where we -- within the -- the guidance that we've given. But this quarter is just a little bit riskier than previous quarters have been from a -- a loading perspective.

Okay, thank you. And then obviously, there, a -- a big announcement for Nokia was their move to Windows-based technologies and Windows Mobile and I'm curious as to what you guys think that means for you?

Well, it -- it's really early to know for sure, but we think it means good things for us. We -- we have been a partner with -- with Microsoft as -- as you know for years. And certainly Nokia trying to switch thousands and thousands of engineers over from Symbian and Linux MeeGo technologies to Windows phone technology, even a company with Microsoft scale is going to need some help. And so we are actively pursuing opportunities inside of Microsoft and Nokia to -- to help them in that transition and -- and potentially take on some of that work ourselves. It's primarily a services opportunity for us at this point. We haven't identified really any opportunities for third-party products for our own proprietary products enough to say that we won't but it's still very early and -- and inside of Nokia I think decisions are still being made as to -- as to how things are going to shake out.

I'd add to that, that from where we sit today, there's only upside for us.

Very good. Well, congratulations again on the quarter and keep up the good work.

Thank you.

(Operator Instructions)

The next question is from the line of Bill Frazier with Greenhill Capital, please go ahead.

Good afternoon gentlemen.

Good afternoon.

(inaudible) something -- I have a -- a question on your -- your business model. When you do professional services for a company like Ford is there a back-end royalty stream that comes along with the contract?

In -- in the case of Ford and we've -- we've said this previously, in the case of Ford in particular, to use your example, we did sell them some third-party software on top of our engineering services and there is a high likelihood downstream that we will get some runtime royalties as a -- as a additional runtime royalty form of (inaudible). They did by a fairly large [traunch] for one time royalties for the particular third party software that we sold them back in Q3 of '09 -- but to answer, I think, your broader question, there are definitely instances where we're in with a customer and we're -- we're selling them a variety of different software offerings that we deliver including engineering services, our own proprietary software and there can be runtime royalties associated with those design wins. I would say today, in the case of engineering services, that is -- that is, the majority don't include the runtime royalties but there are definitely significant design wins out there that do have backend royalties, some of which we will benefit from in the future.

Very good, gentlemen. Thanks for -- thank you for the -- the clarification. Thank you.

And I'm showing no further questions at this time. I will turn it back over to Management for any closing remarks.

Okay. Well, thank you very much for attending our call today. And we will talk to you again next quarter.

Ladies and gentlemen, this concludes the conference call. You may now disconnect and thank you for your participation.