Bsquare Corp (BSQR) 2015 Q2 法說會逐字稿

Good day, and welcome to the BSQUARE Corporation second-quarter 2015 financial results conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Jerry Chase, Chief Executive Officer. Please go ahead, sir.

Thank you, and 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. During this call, we will be making forward-looking statements. These statements are based on current expectations and assumptions that are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the cautionary text regarding forward-looking statements contained in our earnings release issued today and in the posted version of these prepared remarks, both of which apply to the content of this call.

All per-share amounts discussed today are fully diluted numbers where applicable. BSQUARE achieved solid results during the second quarter with a $5.8 million increase in revenue, a $1.2 million increase in net income and a $1.3 million increase in adjusted EBITDAS while reducing OpEx by $234,000, all compared to the year-ago quarter.

We have added $5.3 million to our cash and investments balances since the June 30, 2014 balance sheet.

Like to provide a few comments regarding each of our three lines of business, namely third-party software sales, professional engineering services and proprietary software products.

Third-party software sales under the leadership of Scott Caldwell generated 81% of Q2 revenue at 15% gross margin. Engineering services under the leadership of Mark Whiteside drove 18% of our top line in Q2 at 29% gross margin. The increase in gross margin was the result of orders received during the first six months from key customers such as Google, Coca-Cola, Ford and a new Global 100 customer.

We expect gross margins for this business to be in the mid-20s for the balance of the year. Our proprietary software product revenue was $360,000 in Q2 at 64% gross margin.

Turning to DataV, our Internet of Things offering, as mentioned on previous calls we believe our historical expertise in developing intelligence for and connectivity to smart systems and devices positions us well to exploit opportunities in the emerging Internet of Things, or IoT, market. DataV is our IoT software product that extracts business value and delivers positive outcomes from data generated by corporate assets. This is what we are calling the business of IoT.

Our approach to the IoT market has confirmed a few key elements. Consultative selling is key. Businesses want a solution that improves their outcomes and want to be spoken to in their language using their vocabulary. Consequently, when we engage, we lead with the business value of DataV and focus and execute on business use cases.

We are targeting manufacturers and/or operators of capital-intensive, mission-critical equipment. The value proposition of DataV for these types of businesses include asset uptime, predictive failure, reduced service repair time, reduced warranty obligation, improved product tracking, optimized products and business processes, and increased competitive advantage.

As we have stated in previous calls, we believe that our professional engineering services capability will be a powerful differentiator for BSQUARE in this new and important market. We have encouraging customer pipeline for our IoT products and services. We continue to expect revenue from DataV in 2015, and we look forward to reporting DataV progress to you.

Regarding MobileV, we expect additional sales throughout the rest of the year. As customers begin shipping their MobileV-based products, BSQUARE will earn per-device fees from Microsoft, Aava, and BSQUARE licenses. We are also exploring a source code licensing model for MobileV UX. We look forward to reporting progress to you.

Marty Heimbigner, our CFO, will address our financial performance in the second quarter.

Thanks, Jerry. With that business overview, let me recap our financial results, reflecting the continued hard work and talent of the entire BSQUARE team.

We reported total revenue this quarter of $28.9 million, up 25% from $23.1 million in the second quarter of 2014 and up 10% sequentially from $26.3 million in the first quarter of 2015.

Third-party software sales were $23.3 million this quarter, up 37% year over year from $17.0 million. The increase from the prior-year quarter was primarily attributable to strong Microsoft licensing sales, particularly for Windows Mobile licenses.

Third-party software sales were up 18% sequentially from $19.8 million in the first quarter. The quarter-over-quarter increase was again due to strong Microsoft licensing sales offset partially by a decrease in other third-party products.

Service revenue was $5.2 million this quarter, down 8% year over year from $5.6 million, but up 16% quarter over quarter from $4.5 million. Service revenue was down year over year primarily as a result of decreased service revenue in Japan, partially offset by higher revenue in North America as a result of the addition of a key Global 100 customer.

As we previously reported, 2014 second-quarter results included the completion of a large project in Japan that contributed $478,000 of revenue and margin that was not repeated in 2015. The quarter-over-quarter increase was attributed to strong performance from North America, as mentioned above.

Proprietary software revenue was $360,000 this quarter, down 20% year over year from $448,000 and down 82% from $2 million quarter over quarter because Q1 in 2015 included larger-than-expected sales of our legacy software products. As we reported in Q1, revenue from our proprietary software products can fluctuate significantly from one quarter to the next, and investors should not extrapolate first-half results for the remainder of the year.

Next, I will turn to our gross profit and margins. Overall gross profit was $5.2 million this quarter, or 18% of total revenue, compared to $4.3 million, or 19% of revenue, in the year-ago quarter and $5.4 million, or 21% of revenue, in Q1 2015.

Third-party software gross margin was 15% this quarter compared to 13% in the year-ago quarter and 14% in Q1. The improvement year over year was driven primarily by favorable product mix with higher proportion of sales of Windows Mobile, which has a higher gross profit margin, as well as change in customer mix and operational efficiencies this quarter.

Service gross margin was 29% this quarter, 31% in the year-ago quarter and 17% in Q1 2015. The year-over-year decrease is as a result of the completion of a Japanese handset project and the recognition of profit of $478,000 on that contract in Q2 2014 that was not repeated this year. The quarter-over-quarter increase was as a result of improved utilization of existing resources as well as increase in realized rate per hour.

Proprietary software gross margin was 64% this quarter, compared to 58% in the year-ago quarter and 93% in Q1 2015. Fluctuations in proprietary software gross margin is generally given driven by changes in revenue as the cost of sales is relatively fixed. Gross margins from our proprietary software products can fluctuate significantly from one quarter to the next. Investors should not extrapolate first-half results for the remainder of the year.

Moving down the income statement to operating expenses, total operating expenses were $3.4 million this quarter, down approximately 6% year over year and 6% quarter over quarter from $3.6 million. The quarter-over-quarter decrease was primarily as a result of normal seasonal timing of expenses primarily from auditing, fringe benefits and payroll taxes in Q1.

Now I will speak to our bottom-line results. Net income for the second quarter was $1.9 million, or $0.15 per share, compared to net income of $651,000, or $0.06 per share, in the year-ago quarter and net income of $1.8 million, or $0.15 per share, in Q1 2015.

This improvement in net income reflects our continued focus on increasing the efficiency of our core business, resulting in higher revenues and commitment to sustained profitability through focused expense control. We generated adjusted EBITDAS of $2.3 million this quarter, up 109% compared to adjusted EBITDAS of $1.1 million in the year-ago quarter and adjusted EBITDAS of $2.3 million in Q1 2015.

Adjusted EBITDAS is a non-GAAP measure defined as operating income before depreciation, amortization and stock-based compensation. The reconciliation to the comparable GAAP financial measure can be found in our press release and on our website at bsquare.com.

Cash and investments increased to $29.7 million at quarter end from $26.6 million at the beginning of year. Generally, adjusted EBITDAS has been a proxy for our cash flow from our business. However, our working capital changes impact the change in cash and investments as well.

I will now turn the call back to Jerry to provide our outlook for the third quarter and also closing remarks.

Thank you, Marty. We currently have the following expectations for Q3 2015. Total revenue will be in the range of $26 million to $28 million. Third-party software revenue will be lower in the second half of 2015 due to Microsoft fiscal year-end incentives in our second quarter. Gross margin for services will be in the mid-20% range. Operating expenses will increase as we continue to focus on our IoT initiatives.

We expect continued GAAP profitability. And, accounts receivable balance is expected to increase during the third quarter and continue to grow for the balance of 2015, as we have selectively provided extended payment terms to a highly credit-worthy customer. We believe this new arrangement will leverage our strong cash position to improve our third-party gross margins and profitability.

Our accounts receivable balance and our DSO metrics will therefore grow, with a commensurate decrease in cash and/or short-term investments.

Janice, please open the call for questions.

(Operator Instructions). Jim Gentrup, Val Vista Capital Management.

I just wanted you to talk a little bit more about DataV and just the size of the market opportunity a little bit. Can you give us a little more color on what you think you can do there?

The size of the market opportunity in general, of course, I think everybody expects IoT to be a very large market, certainly a subset of big data. We have not given guidance on our participation in the market beyond that we expect to start revenue here in 2015. As we mentioned in our prepared remarks, that we are encouraged by our sales pipeline.

And how are you different from the other products on than the market that are -- can you talk a little bit more about what differentiates you?

I think what we have seen to date is that we do have a product offering. A number of competitors out in the market are still offering custom solutions -- primarily engineering services solutions. I think, also, perhaps some unique insight is that customers aren't really buying IoT solutions, they are buying positive business outcomes. And you have to have a high-touch, consultative approach to selling, as we mentioned in prepared remarks, related to their business use cases.

So, I think those are probably a couple of the items. And then, of course, our ability to wrap engineering services around our products, we believe, is a competitive differentiator.

And did you or have you changed your sales team at all? Have you added a lot of people, or are you selling this through the same channels as you were before? How has that changed?

So far, we have repurposed existing salespeople. We are starting to add incremental salespeople and sales support people to our team.

And that leads to my next -- you made a comment about second-half expenses. Is that where your expenses will be increasing in sales, or will be R&D more or both? Can you give us a little bit more color there? And then how much -- a little more -- quantify it a little bit more would be nice as well.

Yes, so, the expense increases are for our overall investment in the DataV technology and product offering. So it will be in sales and marketing, and we see also increasing expenses over time in our R&D efforts as well.

Okay.

And at this point in time we haven't quantified -- our guidance has been with our revenue, our top-line revenue, but haven't provided guidance of our operating expenses.

Okay. It would be nice to get some -- directionally, obviously, you have given directional guidance, but it would be a little bit nice to have a little more, I guess, idea if you are adding $500,000 for the second half or -- anyway. And just your engineering services was above $5 million the quarter, and you have talked about some new clients. I just wanted to know, do you expect that to grow year over year when you compare the second half of this year to last year's second half?

If you look at our trends, obviously, in Q1 we were at about $4.5 million and then brought it up to over $5 million here in the second quarter. This is an area that we do have fluctuations, and the growth in that area outside of engineering services that we wrap around our DataV product as we make sales in that area, we see that engineering services will be modest, modest increases.

And when you fulfill those types of projects or when you get that lumpiness, do you tend to lean on contractors that you can lay off quickly, or is it all internal employees?

We have a combination of both internal employees and some contractors, and we flex our work force based on the customer demand.

Okay. And then just going back to DataV, you did mention -- do you expect some revenue coming in Q3, Q4 or both or --?

Yes, we have given no guidance on that so far.

And is it licensing revenue or a one-time license, or is it going to be cloud-based or subscription-based?

We are pursuing both perpetual license and subscription revenue, both of which are product sales.

Okay. So you have the ability to do the subscription if the client wants to go that route as well, then?

Yes.

Okay. And then just on MobileV, I was little bit confused. I think it's proprietary, but you classify it as proprietary software. Correct?

MobileV is an offering that combines licenses from ourselves, from Aava, board designs, UX, user interface from us as well as Microsoft licenses.

So, when you report it actually, it doesn't go into the proprietary software bucket; it goes into third-party, then, it looks like?

That is correct. The revenues that we reported for MobileV are in our third-party products line.

Okay. And would that help gross margins in that [line] in?

Yes, that is a higher level of gross margin than our general margins on Microsoft licensing.

But a small impact at this time yet, though?

Yes, the revenue is primarily driven by Microsoft, so that's heavily weighted to Microsoft. The MobileV really doesn't change the overall margin that much.

Okay. I will let somebody else jump in, guys. Thanks.

(Operator Instructions). Ryan Vardeman, Palogic.

Great quarter. The last caller actually had a handful of same questions that I was going to ask. But I think you spoke to it a little bit, but I didn't catch all of it. But as it relates to the extended payment terms going forward, which revenue line item is that or which business line is that associated with?

We haven't disclosed that customer. It is a very strong customer that we do a lot of business with across our lines of business.

Okay. Okay, and then I guess the last question, I guess, is cash. What's the right amount of cash for the Company to hold to achieve all of our growth initiatives going forward?

We are continuing to look at our cash balance. Clearly, we are looking at different ways to make an efficient use of that. Part of this change in our arrangement with a particularly strong credit-worthy customer was to take advantage of our cash position on our balance sheet. And then we are looking at opportunities as we increase our focus on DataV that having substantial cash resources for that.

So, in terms of defining a particular number, we haven't set a target for that.

Is there a point in the future in which you might be able to set something other than a thumb-in-the-air target, some sort of quantitative more so than qualitative target for that?

I am certain that once we are fully operating with our DataV products out in the marketplace, we will have better visibility into what our long-term cash requirements are. We are looking at a three- to five-year business cycle and deployment of this technology. So, we are still early in the rollout of IoT in the market, and obviously BSQUARE's IoT product offerings are still very early in the process.

Thank you. That's very helpful. Good luck, and keep up the good work. Thank you.

(Operator Instructions). Jason Jones, Private Investor.

I have a quick question for you. I am a long-time investor in the Company. You guys are -- quite honestly, you are doing great. As an investor, I think, again, the focus on execution is exactly in the right place.

My question is really around how the Company is positioned from an investor relations perspective. From my vantage point, you have got an amazing story. You are executing. You are doing all the right things. But as an investor, it would be helpful if the story were more available for the public.

And then I say that, I am not looking for some sales job. But we are getting an analyst engagement; we are getting representation on these calls. Where basically the marketplace can understand and appreciate the success that you are delivering today and the direction of the business. Because it's a little bit tough to see such, frankly, just really, really impressive results that are muted by, again, what appears to be a lack of engagement with the Street as well as what I see as very conservative when we talk about guidance, when we talk about where we are headed with the business and the inability to really press-release some of these engagements and some of these clients that you are working with.

So, can you speak to me just a little bit about -- how you can tell the story and get folks to realize what's going on here, because it really is a good story that needs to be told.

Well, thanks. We do agree with you that we do have a good story. Jerry and I and the rest of the team have been primarily focused on execution. We sell to a lot of large companies, and we are only able to disclose what our contractual arrangements allow us to. But we are certainly looking at being able to, as each quarter comes out here in the future, to be able to tell more and more about where we are with our DataV technology and the customer pipeline that Jerry referenced.

Fair enough. One last question. I don't know if you are able to provide any additional insight. Could you describe a little bit the work that is being done with General Electric? I saw some information, some promotional information for their upcoming IoT. And I know that there was some information with respect to a conflict of interest, I think, with one of the former directors. Can you talk a little bit about are they a client? Is this a co-development cooperative that is going on? Can you give some color to that? Because it appears to be -- again, that's not a secret, so to speak.

No, just -- I think maybe what you're picking up on is our participation in the upcoming Minds & Machines conference in San Francisco with GE. And as our tagline says, we are helping GE to scale Predix to resource-constrained devices such as sensors. So, what we are able to do there is reach into very low-cost, simple devices and extend Predix, which is their Internet of Things solution, much deeper into the network by working together.

So, that's probably all I can say about that. To be clear, the head of GE Software is Forell Kadesh, who is a former Board member of ours. So, yes, when he joined GE, he had resigned from here, but that's -- I think that's the conflict that you were mentioning.

Okay. Well, again, I appreciate -- certainly appreciate the good work and the time today. But, again, just to reiterate my earlier comment, you have got a wonderful story. You are executing. I'd love to be able to dial into one of these calls and hear some of the Street-type analysts ask you these questions and learning more about the business. Because, again, you see so many folks that frankly don't have a story to tell. You guys are killing it, and we would like to see, again, a little bit more recognition of that and reward, frankly, for the good work that you guys are doing. Thank you.

All right, Jason. Fair enough. Thank you. Hope you stay interested in us.

Jim Gentrup, Val Vista Capital Management.

Just a couple more for you, if you don't mind. Last year you guys did $39.3 million in revenue from third-party software, and then you have given us some directional guidance sequentially on this call. I'm just curious if we should expect -- or do think you will grow off that $39.3 million base in the second half? And if so, why?

So, in terms of the third-party lines that we have reported, we have had two really good quarters, Q1 and Q2. In our guidance, we're looking at the second half of the year to be a little bit lower in our third-party software line. Part of it is just the timing of when our customers buy.

Also, there were some Microsoft fiscal year-end promotions and incentives that put some sales into the first half of 2015 that will be a different dynamic in the second half of the year.

Did you guys change any salespeople when you made -- when you took over, Jerry, did you make any adjustments in go-to-market with the sales team?

We did. A couple of things, is we consolidated sales and engineering services under Mark Whiteside. And I think Mark correctly led us to a land-and-expand strategy with customers. So we have fewer, more important customers that we are able to call on more effectively. And I give Mark and his team full credit for moving us this past quarter up into the 29% gross margin range as well as mid-20s going forward. So, Mark's leadership there has just been incredible.

Then Scott Caldwell runs our [3PP] revenue business, and we have elevated Scott directly to report to the CEO, me. And Scott runs a very clean, focused business, very lean. And it's a remarkably complex business. If you look at third-party licenses, you might be tempted to think how complicated can it be. Because you buy from one, you sell to the other, but there is actually a lot of very complex nuances in that. Marty has been very involved in that business.

So we think we have taken a couple of extremely bright people in the organization and elevated them to the point where they can quickly call on other resources in the Company to execute against their business.

And aside from execution and new leadership -- and also, I guess, obviously, MobileV has been a bit of a catalyst as well. Right? That has been incremental, too, correct?

MobileV has been incremental, yes.

Okay. And we --.

But it has been modest in 2015. The primary drivers of the revenue have been our third-party licensing with Microsoft, and then the engineering services. We referenced a Global 100 company that we started performing services in the second quarter. Those have been the things that you are seeing drive the revenue increase in 2015.

Thanks for that color. I just want to make sure, am I missing anything else besides those three things in basically execution, MobileV and engineering services? Is there something else that is driving -- helping be a new catalyst here?

No, I think you've got it for the existing business. And, of course, as we mentioned, we are putting a lot of effort into DataV as we go forward.

Okay. And then, just can you speak really quickly about your ability to leverage this income statement yet? In other words, you are making some investments. You are telling us you are going to increase investment in the second half. We are not sure how much. Do you have the ability to manage this such that revenue growth or expense growth will not necessarily exceed gross profit growth? Because I look at it as a gross profit type story. Or do you manage it that way, or is it possible that you'll have lower margins in the second half because you are making big investments? Does that make sense?

As we have been talking to investors, what we have said is that we have been very cautious stewards of the investors' -- of the shareholders' investment of their money. And we would not invest -- our commitment is we would not invest until we saw opportunities related to DataV.

So, what you are seeing so far is modest, prudent investments in the business. We would expect it to be tied to customer visibility. We would also expected that DataV gross margins would be -- once realized, would be higher product-related margins, and so our investments would be very much worthwhile once the sales opportunities are realized.

Okay, guys. Thanks a lot.

That concludes today's question-and-answer session. At this time, I will turn the conference back to management for any additional or closing remarks.

Thank you, Janice. Before concluding the call, on behalf of the entire BSQUARE team I would like to thank our investors and our customers for your interest and for your business. We look forward to reporting back to you next quarter. Thanks for joining us.

This does conclude today's conference. Thank you for your participation.