Bsquare Corp (BSQR) 2011 Q1 法說會逐字稿

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the BSQUARE Corporation first-quarter 2011 earnings conference call. (Operator Instructions). This conference is being recorded today, Thursday, May 5, 2011. I would now like to turn the conference over to Scott Mahan, Chief Financial Officer of BSQUARE. Please go ahead, sir.

Good afternoon, everyone.

Before I begin, let me remind you that the 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 in 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 results.

We reported total revenue this quarter of $26.0 million, up 53% from $16.9 million in the year-ago quarter and down 6% from $27.6 million in Q4. An increase in third-party software sales and service revenue accounted for the year-over-year increase, whereas the decline in third-party proprietary software sales accounted for the sequential decline.

Our largest customer, Ford, accounted for 9% of total revenue this quarter, 14% in the year-ago quarter, and 7% in Q4.

Sales of third-party software were $17.3 million this quarter, up 57% from $11.0 million in the year-ago quarter and down 6% from $18.5 million in Q4. The year-over-year growth was driven by a 32% increase in Microsoft General Embedded license sales, primarily due to higher purchasing volumes from our larger customers and a 256% increase in Windows Mobile license sales, driven by an increase in customer count and higher purchasing volumes. One General Embedded licensing customer, in particular, had significantly higher purchasing volume this quarter and represented 8% of total revenue.

The sequential decrease in third-party software sales was driven by a 14% decline in Microsoft General Embedded license sales, due to lower purchasing volumes from our larger customers, despite the significant customer I just mentioned. This decline was partially offset by a 30% sequential increase in Windows Mobile license sales, driven by higher purchasing volumes.

Proprietary software revenue was $1.4 million this quarter, compared to $978,000 in the year-ago quarter and $2.1 million in Q4. The year-over-year growth was primarily driven by increased product support revenue. Texas Instruments, OMAP, and QUALCOMM Snapdragon revenue also contributed to the growth. A significant Q4 TestQuest sale to China Mobile in the amount of $723,000 drove the sequential decline.

Service revenue was $7.3 million this quarter, up 47% compared to $4.9 million in the year-over quarter and up 5% from $6.9 million in Q4. Ford accounted for $2.3 million in service revenue this quarter, flat from the prior year and up from $1.9 million in Q4. Overruns in the now completed main Ford program negatively impacted service revenue in the year-ago quarter.

The year-over-year service revenue growth was driven by Ford, a relatively new customer in North America which contributed $1.3 million in service revenue this quarter, growth in North America outside of Ford and this new customer, and a 341% increase in APAC service revenue. Ford was the primary driver behind this sequential increase.

Turning to gross profit and margins, overall gross profit was $5.3 million this quarter, or 20% of total revenue, as compared to $1.2 million, or 7% of revenue, in the year-ago quarter and $6.5 million, or 24% of revenue, in Q4. Year-over-year gross profit and gross margin increases were primarily driven by the fact that the year-ago quarter was negatively impacted by the Ford overruns, which affected revenue recognition and also resulted in a lost contract accrual.

Third-party software margin was 13% in the quarter, 14% in the year-ago quarter, and 15% in Q4. Proprietary software gross margin was 82% this quarter, 85% in the year-ago quarter, and 93% in Q4. The higher proprietary software gross margin in Q4 was the result of the significant TestQuest sale.

Service gross margin was 24% this quarter, negative 24% in the year-ago quarter as a result of the Ford overruns and 26% in Q4. An increase in fringe benefits and stock compensation expense totaling $348,000 negatively affected this quarter's service margins compared to Q4, without which this quarter's service margin would've been 29%.

Moving down the P&L, operating expenses were $4.8 million for the quarter, compared to $4.0 million in the year-ago quarter and $4.4 million in Q4. The sequential and year-over-year increases were primarily driven by higher sales and marketing expenses resulting from our sales expansion and marketing and rebranding efforts. In total, sales and marketing expenses were up $636,000 year over year and $381,000 sequentially.

While R&D expense was essentially flat year over year and sequentially, if I include the amount of support burden now classified as software cost of sales beginning this quarter, R&D expense was actually up 108 -- $138,000 sequentially, the majority of which related to incremental expense associated with our HCP trial in China.

The increase in sales and marketing expense and OpEx in general was also driven by higher fringe benefits expense of $310,000 and higher stock comp expense of $171,000. Including service cost of sales, fringe benefits expense and stock comp expense increased sequentially by $539,000 and 296 -- $290,000, respectively. Fringe benefits expense increases in the fourth (sic -- see Presentation) quarter of every year as compared to Q4, and then tails off as the year progresses as a percentage of wages.

Now I'll speak to our bottom-line results. We reported net income for the quarter of $184,000, or $0.02 per share, compared to a net loss of $3.4 million, or $0.34 per share, in the year-ago quarter and compared to net income of $4.7 million, or $0.42 per share, in Q4.

The year-ago quarter was negatively affected by the Ford overruns I discussed earlier. The year-ago quarter was also negatively affected by the lost contract accrual on the Ford project and an auction rate security write-down in the combined amount of $0.09 per share.

Q4 benefited by a $2.6 million tax benefit, or $0.23 per share, and also benefited from the TestQuest sale to China Mobile by $0.07 per share. Also, as I mentioned, fringe benefits increased by $539,000, or $0.05 per share, and stock comp expense increased by $290,000, or $0.02 per share, this quarter as compared to Q4, and this quarter was also impacted by the sales, marketing, and HCP investments I spoke to earlier.

We generated EBITDAS of $1.1 million this quarter, or $0.10 per share, compared to negative EBITDAS of $2.5 million, or $0.24 per share, in the year-ago quarter and positive EBITDAS of $2.5 million, or $0.23 per share, in Q4.

Cash and investments decreased $1.7 million to $21.4 million at quarter-end, $1.0 million of which is classified as long-term. A back-loading of sales in the quarter was the primary driver for the cash burn, which caused our Accounts Receivable to increase by $1.7 million and our DSO to increase from 47 days in Q4 to 55 days this quarter. We do currently expect our DSO to improve in Q2 and expect to add approximately $2.5 million of cash to the balance sheet.

CapEx was $120,000 this quarter, and we currently expect FY 2011 CapEx to run approximately $600,000. Headcount, including contractors, is currently 302, compared to 283 as of the date of our last call. Engineering services headcount is currently 192, up from 183.

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 Q1 results, update you on our key initiatives, and then discuss our outlook for Q2.

Overall, I felt that Q1 was a solid quarter. We were profitable and we made progress on our strategic initiatives.

The one area I was disappointed in was our Microsoft Embedded licensing results. While we were up substantially compared to Q1 of 2010, I had expected Microsoft Embedded license sales to be roughly flat from Q4. Yet we actually finished down about $2 million.

Our analysis shows that several of our largest customers slowed their purchasing in the quarter, mostly because they overbought product in previous quarters and still had inventory on hand. We expect that this is a transitory situation, that these customers will work through their inventory, mostly during Q2 and to a lesser extent in Q3, and then will return to their normal ordering volumes.

The sequential decline in Windows Embedded license sales was somewhat offset by stronger-than-expected sales of Windows Mobile licenses, up over $1 million compared to Q4. We saw strong demand from Windows Mobile licenses out of Asia.

Sales of our other third-party products, such as Adobe Flash, were down slightly compared to Q4, but we view this as a typical quarter-on-quarter variation and are more focused on the longer-term trends for sales of other third-party software, which are positive.

Overall, we expect that Q2 will be the low quarter for third-party software sales in 2011 and that third-party sales growth will start back up in Q3. However, because of the large customer inventory issue and also because it took us longer than expected to complete our Europe expansion agreement with Microsoft, some of the third-party revenue growth we were expecting in 2011 is pushing into 2012. And we are reducing our overall third-party growth estimates for 2011 to the $5 million to $10 million range.

Our service and proprietary software results from the quarter were generally in line with our expectations. We were a little service capacity-constrained during the quarter, in that we could've delivered slightly higher service revenue had we been able to hire certain kinds of talent a little more quickly. But this is a good problem to have, and as we ramp our Asia delivery centers further, as I will discuss in a moment, capacity constraints should be less of an issue.

Now let me discuss our strategic initiatives -- growing sales through product and territory expansion, growing our Asia sales and delivery capabilities, and our Handset Certification Platform.

Our strategy to grow software sales is simple. We seek to expand the territories that we can sell our existing products into and we are looking for new products to sell. We were happy to announce in the quarter an agreement with Microsoft that allows us to sell Microsoft Embedded products in Europe, initially focused on selling in the UK and Germany. The market for Microsoft Embedded products in Europe is almost as large as the North American market we already sell into, and we intend to bring the successful sales model we employ in North America to the European market.

To get started, we hired Mr. Morten Iverson to lead our efforts in Europe. Morten is working on filling out his team and building the customer pipeline. In addition to Microsoft Embedded and Windows Mobile products, Morten and his team will be selling the full suite of BSQUARE's offerings in Europe, including our proprietary products like TestQuest and the Handset Certification Platform, our service offerings, and the other third-party products that we sell.

As we have previously stated, we expect that Europe will primarily be an investment for us in 2011. We expect to earn approximately $2 million in revenue in Europe by the end of 2011, but are forward investing ahead of the revenue and do expect that this investment will negatively affect our bottom line by about $500,000 this year. In 2012, we believe that Europe represents up to $10 million in incremental revenue and will be accretive.

Another of our strategic initiatives is sales and engineering expansion in Asia. We are expanding in Asia for two reasons. First, Asia is a large market with a tremendous amount of design activity. By expanding our local sales and engineering presence, we expect we will grow the sales and our products -- the sales of our products and services directly to customers in Asia.

Second, we have discussed in past calls the multiple millions of dollars of lost service revenue in North America because we are not always price competitive delivering services using only North America resources, especially when we compete in deals against larger competitors who have development centers in eastern Europe or India. By expanding our Asia engineering teams, we gain additional capacity and talent to blend higher-cost North America resources with lower-cost Asia resources and deliver services more cost-effectively to our North America customers. And we think we can do this while improving margins.

We made good progress in our Asia expansion initiative during the quarter. We added additional sales personnel in Korea, Japan, and China, and we have been involved in several new significant business opportunities as a result. Our engineering staff in Taiwan grew during the quarter, and we have now hired the leader for our China Development Center.

During the quarter, approximately 26% of the hours for our North America service customers were delivered out of Asia, versus 10% in Q1 of 2010. Our ultimate goal is to deliver around half of our service hours out of Asia, while growing both our North America and Asia service footprints.

While we're on the topic of Asia, let me spend a few minutes discussing the status of our other important strategic initiative, the Handset Certification Platform, as our first customer in Asia is now up and running using our product and we are receiving our first revenues.

By deploying our Handset Certification Platform, a mobile operator can develop, manage, and publish portfolios of automated test cases to multiple smartphone OEMs. The OEMs, in turn, use the platform to pre-certify their devices before submitting them to the network operator for final certification and sale to customers. We believe that by using the Handset Certification Platform that mobile network operators and device OEMs will be able to introduce new devices faster with higher initial quality.

Last quarter, I discussed that we were in trial with a China-based network operator. That trial has completed, and we are now testing production handsets using the automated tests that we developed in conjunction with the operator. We had hoped to do an announcement at the completion of the trial, but unfortunately, the operator wishes to remain confidential, and we will respect their wishes.

Over the past month, we have been performing tests on multiple devices for major handset OEMs and have shown that our product can expose problem areas in handsets that should be remedied before these devices are sold to customers.

We have now signed our first two agreements with handset OEMs and will recognize our first revenues from the Handset Certification program in Q2. While the initial revenue is relatively small, when an OEM is willing to write a check for a product, it is validation that that product provides value and that we are on the right track. We have a pipeline of additional OEMs that we are working to close in 2011 and expect our revenue to grow as new OEMs deliver handsets to our network operator partner.

To remind you of our Handset Certification Platform business model, we partner with a network operator to automate the testing processes for that operator. We do not charge the operator for the product or for the test automation. Once a set of automated tests exists, we charge handset OEMs a yearly per-seat subscription fee to access the product and the automated test developed for a particular network operator.

We believe that the revenue opportunity per network operator is in the $1 million to $3 million per year range. OEMs will be required to subscribe to the product for each network operator we partner with, since the suite of tests will be different and the product may be customized for a particular operator.

Our agreement with the network operator is that we will use a portion of the revenue earned from OEMs to fund continued expansion and development of the test suites, which will serve to keep the product relevant. In addition to the subscription fee, we also offer OEMs bundled support packages and a full range of other BSQUARE products and services.

Obviously, it will take time to ramp up to the full revenue potential for each network operator, as not all handset OEMs will be supplying new handsets to the operator at the same time. For our first operator, we expect that the total revenue opportunity from this installation should exceed $1.5 million between today and the end of 2012, and we are working to bring about half of that revenue in during 2011.

Generally, we expect that margin on the subscription revenue will be in the 80% range and the blended margin on the subscription revenue and support revenue will be in the 65%-plus range. We've identified three other network operators in our immediate pipeline, and we hope to start a trial with one of these operators during Q2.

I will finish our call today with expectations for the second quarter. Overall, we currently expect that revenue in Q2 will be in the $25 million to $27 million range. We expect that our third-party sales will decline from Q1 as we work through the customer inventory issues that I described earlier. We expect services to be up slightly from Q1 and we expect that proprietary product revenue will be up from Q1. Because revenue is shifting toward higher-margin offerings in Q2, we currently expect to be more profitable in Q2 than we were in Q1 and we expect to see an approximate $2.5 million increase in our cash and investments.

Looking past Q2, I'm very excited about how we have positioned our business and our prospects for growth. Last quarter, I warned investors that we were making investments and that our growth could be a little lumpy during the year. I also said that, on an EBITDAS basis, I thought our run rate was in the $0.14 to $0.15 per share range. If you add back the investments we made in Q1 in initiatives like growing Asia and the Handset Certification Platform, we are right on that run rate. We still expect to grow all of our product and service revenue lines this year, and on an EBITDAS basis, we still expect to be more profitable in 2011 than we were in 2010.

With that, I will wrap up by thanking you for attending our call today. This ends the prepared portion of our call, and we will now open the call up for questions.

(Operator Instructions). I am showing that there are no questions in the queue. I will turn it back over to Brian Crowley for any closing remarks.

Thank you, operator. With that, we will end the call. Thank you, everybody, for listening, and we will talk to you next quarter.

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