Bsquare Corp (BSQR) 2011 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the BSQUARE Corporation third-quarter 2011 earnings conference call. During today's presentation, all parties will be in a listen-only mode and following the presentation the conference will be open for questions. (Operator Instructions) This conference is being recorded today, Thursday, November 10, 2011, and I would now like to turn the conference over to Mr. Scott Mahan, Chief Financial Officer. 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 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. We provided color on the release issued today on significant year-over-year trends. Given this and the relative lack of seasonality in our business, the focus of my discussion will be on quarter-over-quarter trends. With that said, let me recap our results.

We reported total revenue this quarter of $24.0 million, down 5% year-over-year from $25.4 million and up 3% quarter-over-quarter from $23.4 million. An increase in service revenue accounted for the quarter-over-quarter increase. Our largest customer, Ford, accounted for roughly 10% of total revenue this quarter, in the year-ago quarter and in Q1. Total revenue for the nine months was $73.5 million, up 6% from $69.2 million in 2010. Higher proprietary and third-party software revenue drove the nine months increase.

As previously disclosed, we acquired the outstanding shares of MPC Data, Limited, a UK -based engineering services company, on September 11. MPC contributed $333,000 of revenue in Q3, significantly all of which was engineering service revenue. Third-party software sales were $15.6 million this quarter. Down 14% year-over-year from $18.0 million, and up 2% quarter-over-quarter from $15.3 million. The quarter-over-quarter increase was driven by a 12% increase in Microsoft General Embedded license sales.

We have discussed previously that a number of our larger Microsoft General Embedded customers overbought in prior quarters and we expected order volumes to start to return to normal levels in Q3, which was the case. Third-party software sales were $48.3 million for the nine months, up 6% from $45.4 million in 2010. Proprietary software revenue was $1.4 million this quarter, up 31% year-over-year from $1.1 million, but down 17% quarter-over-quarter from $1.7 million.

The sequential decline was due to lower OMAP Royalty revenue, offset in part by lower margin in BSQUARE WebKit sales. Proprietary software revenue was $4.6 million for the nine months, up 51% from $3.0 million in 2010. BSQUARE WebKit sales accounted for $844,000 of the nine-month increase.

Service revenue was $7.0 million this quarter, up 13% year-over-year from $6.2 million and up 10% quarter-over-quarter from $6.4 million. Ford accounted for $2.5 million in service revenue this quarter, and in the year-ago quarter, and $2.4 million in Q2. MPC accounted for $330,000 of the sequential increase and growth in Asia primarily accounted for the remainder. We generated our first meaningful service revenue out of the Korea and China [GOs] in the quarter.

Service revenue declined 1% to $20.6 million for the nine months from $20.8 million in 2010. Ford contributed $7.2 million in service revenue for the first nine months, compared to $11.0 million in 2010. The $3.8 million nine-month decline in Ford revenue was offset primarily by growth in North America outside of Ford, as well as growth in Asia and the contribution from MPC.

Turning to gross profit margins, overall gross profit was $4.8 million this quarter, or 24% of total revenue, as compared to $5.0 million or 20% of revenue in the year-ago quarter and $5.1 million or 22% of revenue in Q2. Third-party software gross profit was down $288,000 sequentially and proprietary software gross profit was down $498,000, offset partially by a $483,000 increase in service gross profit. Third-party software margin was 15% this quarter, 15% in the year-ago quarter, and 17% in Q2.

The sequential decline of third-party software margin was due to increased sales of higher-margin Adobe Flash products in Q2. Proprietary software gross margin was 63% this quarter, 83% in the year-ago quarter and 80% in Q2. The sequential decline of proprietary software margin was due to a product mix shift towards lower margin BSQUARE WebKits. Service gross margin was 23% this quarter, 24% in the year-ago quarter and 18% in Q2.

The sequential service parts and improvement were primarily due to the project overruns which negatively affected Q2. However, service margin is still running below where we would like, something Brian will speak to later. Total gross profit was $15.2 million or 21% of total revenue for the nine months, compared to $14.0 million or 20% of total revenue in 2010.

Moving down the P&L, OpEx was $5.3 million for the quarter, up 31% year-over-year from $4.0 million and up 4% quarter-over-quarter from $5.1 million. The sequential increase was driven by $152,000 of acquisition transaction cost and $66,000 of MPC-related OpEx for the short period in September. Total OpEx was $15.2 million for the nine months, compared to $11.9 million in 2010. Year-over-year increase was due in part to the MPC-related items, but was primarily driven by the investments we have made, which Brian will speak to later.

Now I'll speak to our bottom-line results. We reported a net loss for the quarter of $166,000 or $0.02 per share, compared to a net income of $936,000 or $0.09 per share in the year-ago quarter, and compared to net income of $21,000 or $0.00 per share in Q2. MPC contributed $118,000 or $0.01 per share to the bottom line for the quarter, excluding transaction expenses which negatively impacted the quarter by $152,000 or $0.01 per share.

For the nine months we reported net income of $39,000 or $0.00 per share, compared to net income of $1.5 million or $0.14 per share in 2010. We generated EBITDA of $297,000 or $0.03 per share this quarter, compared to EBITDA of $1.5 million or $0.14 in the year-ago quarter and EBITDA of $809,000 or $0.07 per share in Q2. For the nine months, we generated EBITDA of $2.2 million or $0.19 per share compared to $3.4 million or $0.33 per share in 2010.

Cash and investment decreased $5.5 million to $17.7 million at quarter end, a million of which is classified as long-term. $4.8 million in cash was paid to the former owners of MPC during the quarter. We had anticipated cash to be flat to up slightly this quarter without the effect of MPC. Cash came in slightly lower than anticipated due to some large accounts receivables not being collected by quarter end.

Consequently DSOs were net 59 this quarter, excluding the affect of MPC, compared to 52 in Q2. However, all of these accounts reflect that just after quarter end and as such we expect cash and investments to increase roughly $1.0 million, inclusive of an additional $1.4 million in purchase price paid to the former owners of MPC in Q4. We sold our last auction rate security after quarter end, which will result in a gain of $85,000 in Q4.

CapEx was $189,000 this quarter and has run $528,000 for the nine months. We currently expect FY '11 CapEx to come in about $100,000 higher than the $600,000 forecast previously provided due to expansion of our facilities in both Taipei and Beijing and improvements to our Belleview facility.

Headcount, including contractors, is currently 363, compared to 281 at the date of our last call. Engineering services headcount is currently 242, up from 170. The MPC acquisition had the effect of adding 55 total headcount, of which 47 are in engineering services.

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

Thanks, Scott. I'll start off with my perspective on Q3 results. Then I will provide you with an update on a few of our initiatives. Finally I will discuss our outlook for Q4.

While I'm not pleased with our Q3 financial results, I am pleased with the progress we are making in transitioning BSQUARE from a small company focused exclusively on providing Windows CE and Windows Mobile products and services primarily to customers in North America, into a supplier of cross-platform products and services to some of the largest and most respected ODMs, OEMs, silicon vendors and mobile network operators worldwide.

Over the past year, we have made investments designed to expand our customer base, diversify our engineering capabilities, and expand our geographic footprint. These investments have been made in some cases at the expense of short-term profits, and some are just beginning to show results. We think these are important investments for us to make now in order to secure future growth.

Now let me discuss third-party software sales for the quarter. As expected, demand for Microsoft Embedded products improved in the quarter by over $1.2 million as compared to Q2. As Scott mentioned earlier, we had a situation where some of our larger customers took too much inventory late last year and earlier this year, which resulted in reduced order volumes last quarter as they worked through that excess inventory.

We currently expect that order volumes will improve again in Q4. The increase in Microsoft Embedded product revenue was offset by a $759,000 drop in Adobe Flash licensing compared to Q2. Adobe Flash revenue tends to be quite variable from quarter to quarter so this drop is not unexpected. We are currently forecasting an increase in Adobe Flash revenue in the fourth quarter.

Many of you have probably seen Adobe's announcement that they are discontinuing development of Flash for mobile devices and you might wonder what this means to BSQUARE. It's really too early to tell. We don't expect a big impact over the next two quarters, as there are many customers who have devices incorporating Adobe Flash technologies in the pipeline that will go to completion.

There is a tremendous amount of Flash-based content on the Internet that is not going away anytime soon. Device makers will still need a way to render Flash content on their devices. So it's clear that there still be demand for Adobe Flash technologies in the near term.

But beyond the next few quarters, it's too early to speculate how quickly the shift to alternate technologies will be made. For perspective, we did about $400,000 in Flash licensing and $214,000 in Flash-related services in Q3 and we are forecasting an increase in Flash licensing revenue in Q4.

It's been obvious to us for a while that the future of user interface and content rendering on mobile devices has been moving towards HTML5. We've invested heavily in training our engineering staff in HTML5 technology. We have invested in R&B dollars towards building a licensable high-performance version of the industry-standard WebKit, HTML5 rendering engine, for Windows CE and Windows Mobile devices. Therefore, even after the shift away from Adobe technologies is complete, BSQUARE will still be a player in this important segment of the market.

Next I would like to talk about our acquisition of MPC Data. We acquired MPC Data in September in order to accomplish several objectives. Most obvious, MPC Data helped us profitably grow our service revenue. MPC Data has a long history of running a profitable service business and we expect that profitability to continue under BSQUARE.

Second, when Microsoft awarded us the right to sell Windows Embedded products in Europe earlier this year, we knew that in order to successfully differentiate ourselves from other Windows Embedded distributors, we would need a European service capability. The MPC Data team fills that need, provides us with a solid base of operations in Europe and allows us to expand our service reach into Europe.

Since closing the acquisition, we have been delighted with the MPC team, their capabilities and their enthusiasm. The two companies have a lot in common and we could not be any happier to have the MPC Data team on board. We have been busy with integration activities, which are going well. We've transitioned employees, gotten a good start on integrating systems and have worked hard to maintain the great customer relationships that MPC Data built over the years.

As Scott mentioned earlier, MPC Data was accretive for us in the third quarter. And we only expect that contribution to improve in the upcoming quarters as we finalize integration activities and recognize the full synergies of the combination.

Back on the topic of investments, we have been investing heavily into our services organization over the past year. On top of our MPC Data acquisition, we now have over 60 employees in Taiwan. We have opened a development office in Beijing, hired a senior manager to run the Beijing office and have been staffing engineers at that office.

We have invested in staff training around Android development and we are working to formalize our ISO certifications for software project delivery. We've invested in new project management software to allow us to more efficiently manage our resources and projects across multiple locations. All these investments have allowed us to win projects beyond our traditional Windows CE and Windows Mobile base.

In 2010, Ford and Coke, our two largest service customers, together accounted for 56% of our overall service revenue. Year-to-date, in 2011, they represent only 41% of our overall service revenue, while our service revenue has been flat compared to the same period in 2010. We have filled that revenue GAAP with new customers, including significant wins at companies such as Nokia, LG Electronics, Mitsubishi Electronics, Fujitsu, [Waway] and others working on Android, Windows phones, automotive, Adobe Flash and HTML5 projects.

Of course, the downside to these investments is that they add expense up front that we have to grow our way into. It takes time for new engineers to become billable. Opening new offices and adding new leadership loads additional overhead on our service organization which, in turn, puts pressure on our service margins.

The additional sales resources we have put into place in Asia and Europe are just now starting to fully become fully productive and deliver incremental sales. However, as our engineering utilization improves and our sales revenue grow, our service margins will improve, too. Service margins decreased from 18% in Q2 to 23% in Q3 and over the upcoming quarters we are projecting steady improvements in our service margin as the additional overhead we have added is spread across a larger team.

Today we are in a somewhat awkward position of no longer being a small boutique service player focused only on Microsoft technologies. But neither have we completed our transition to a larger multi-platform service organization with a significant offshore back-end delivery capability. We expect this transition will be ongoing during 2012. And we'll ultimately not be satisfied until we have our service margin solidly in the low- to mid-30% range.

While I am on the topic of services, let me address the status of our Ford service team. As many of you know, we have a team of approximately 40 engineers working on the My Touch program. Our contract with Ford is up at the end of 2011, and we are currently in discussions with various program players on renewing the team.

The discussions are very sensitive, which limits how much I can say; however, I can tell you that we have been told that there is an overall level of satisfaction with the performance of our team over the past year. And there is a desire to renew our agreement. I cannot yet discuss at what level or for how long we might renew as this is very preliminary information. Normally I would not even comment this early in the process, except for the fact that so many shareholders ask us about the status of this program.

Finally, let me update you on the status of our other important initiative, the handset certification platform or HCP. We announced last quarter that our first HCP installation is up and running at China Mobile, the world's largest mobile operator. We are working with China Mobile Smartphone OEM partners who need to certify subsidized Smartphones for sale and use on China Mobile's network.

We have been performing tests designed to primarily access to assess the stability of Smartphones before China Mobile offers these phones to their customers. We have shown both China Mobile and our OEM customers that the HCP is able to expose problem areas that should be remedied before these phones are put into the hands of China Mobile customers. Our sales team is working to sell HCP subscription licenses to new OEMs who are preparing to certify their phones with China Mobile.

The team is also selling additional HCP licenses to OEMs who bought licenses from us previously and want to expand their installation. During Q3 we bought sold HCP licenses to three new OEMs and are currently engaged with six additional OEMs who would be new licensees of HCP if we are able to close them in Q4.

Overall, we have not been happy with the pace of revenue coming from our China Mobile HCP installation. Our licenses of our current OEM customers will be up for renewal during the first quarter of 2012 and we will be looking to modify our business model with the OEMs and with China Mobile to improve our revenue flow next year.

We are also working to begin a production trial with a second operator located in North America. You'll remember that we disclosed that we had completed a successful proof of concept with this operator last quarter and have started discussions around moving to a production trial eventually leading to a full production deployment. I don't have a lot of new information to report on this other than the discussions and planning for the trial are ongoing and the operator remains extremely interested in our solution.

Handset quality, the time it takes to get new handsets to market, processing returns and the resulting customer satisfaction issues are big problems to the industry and this particular operator has shared numbers with us that certainly reinforce this. As we move through this process, we are realistic that large mobile operators move very methodically and despite our efforts to push the trial along, the operator is going to dictate the pace. We are hopeful to move to the next step with this operator during the fourth quarter.

Overall, I remain bullish on our handset certification platform. We overcame many difficulties during the process of bringing our product online at China Mobile. We took what we learned, improved our products and our processes, and those learnings have helped us tremendously as we went through the proof of concept process at what we hope will become our second HCP customer. As we have engaged with the second operator, we are learning about the particular needs and making adjustments to our approach and business model as appropriate.

I will finish our call today with expectations for the fourth quarter. I currently expect revenue in Q4 will be up from Q3 in the $24 million to $26 million range. I expect that our third-party sales will increase slightly from Q3. I expect services to be up substantially from Q3, based on backlog and the full quarter contribution from MPC data. I expect that proprietary product revenue will be flat from Q3.

Let me speak for a minute about operating expenses. In support of the investments I have just discussed, we increased our operating expenses substantially in 2011 as compared to 2010. After consideration of how long it is taking some of these investments to mature, we made the difficult decision to decrease our operating expense run rate by approximately $1.7 million per year through staff and other reductions. Reductions are being made immediately and will have a small impact on our Q4 run rate, but will have full effect in 2012.

Based on revenue and operating expense expectations I just outlined, I currently expect profitability and EBITDA to sequentially improve in Q4. Overall, I feel we are making good investments for the future. We are monitoring the results of these investments closely and adjusting course as needed. With that, I will wrap up today by thanking you for attending our call. This ends the prepared portion of our call. We will now open up the call for questions.

Thank you, sir, we will now begin the question-and-answer session. (Operator Instructions). One moment, please, for our first question. (Operator Instructions). At this time, we have no questions. I would like to turn the call back to Mr. Mahan for closing remarks.

Thank you, operator, and thank you very much for attending our call and we will talk to you again next quarter. You can disconnect now, operator.

Ladies and gentlemen, that does conclude the BSQUARE Corporation third quarter 2011 earnings conference call. This conference will be available for replay. You may access the replay system at any time by dialing 1-877-870-5176. We'd like to thank you for your participation. You may now disconnect.