Bsquare Corp (BSQR) 2015 Q4 法說會逐字稿

Good day, everyone, and welcome to the BSQUARE Corporation's fourth-quarter and full-year 2015 financial results conference call. Today's conference is being recorded.

And at this time, I'd like to turn the conference over to Mr. Jerry Chase, BSQUARE Chief Executive Officer. Please go ahead.

Thank you and good afternoon, everyone. Before I begin, let me remind you that this call is being webcast 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 and 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.

Throughout 2015, our primary focus was on execution within our core businesses, while at the same time laying the groundwork for DataV, our new Internet of Things software offering. As a result, we were able to deliver profits in each quarter and more than double our year-over-year earnings per share.

Our results during the fourth quarter were solid, if slightly lower than Q3. Net income was $1.1 million or $0.09 per share compared to $1.4 million or $0.12 per share for the year-earlier period. However, as compared to the year-earlier period, we increased gross profits by $152,000, achieved a $260,000 increase in adjusted EBITDAS, and increased cash and equivalent balances by over $3.3 million.

For the full year 2015, we increased revenue by $10.7 million or 11% compared to the prior year. Net income for 2015 was $6.1 million or $0.49 per share compared with $2.3 million or $0.20 per share for the prior year. We believe growing revenue and more than doubling earnings reflects our success implementing the strategy we adopted in 2013 to return BSQUARE to sustained profitability.

With regard to DataV, we are fully committed to this product initiative and are encouraged by the level of activity we see in our sales channel. Toward that end, during the fourth quarter, we engaged in multiple paid commercial trials of DataV. To date, these trials have been successful and represent a required first step in almost all commercial IoT deployments. We are also encouraged by the breadth of industry verticals and business use cases in which DataV can be applied.

I'd also like to point out that our professional engineering services gives us an important competitive differentiator in the IoT market. As we address IoT opportunity, there is invariably a requirement to provide systems integration capabilities in addition to licensed software, an area in which BSQUARE has a long and successful track record.

Our view is that the IoT market is potentially large, yet still in its infancy. We continue to monitor the market closely, both with our customers and with industry analysts, and feel that we are very well positioned both from the standpoint of solution differentiation and market timing.

Moving on to third-party software sales under the leadership of Scott Caldwell. This business generated 76% of our Q4 revenue at 15% gross margin. For all of 2015, third-party software sales were very strong, up $9 million or 12%.

As we reported on our third-quarter call, Microsoft has implemented significant pricing changes for its embedded products effective January 1, 2016. To help ameliorate this impact, during 2015, we entered into transition agreements with Microsoft and a majority of our customers through 2016 under substantially the same terms.

I am confident that we will continue to remain competitive and serve our customers with the same skill we have demonstrated in the past. We continue to believe that many organizations within our large embedded software customer base are well suited to adopt DataV. During 2016, we will attempt to further tap into our embedded software customer base for DataV opportunities.

Next, I'd like to move to engineering services under the leadership of Mark Whiteside, which drove 22% of our top line in Q4 at 29% gross margin. As a reminder, this line of business provides engineering support to Fortune 500 customers such as Google, Coca-Cola, Hewlett-Packard, and Ford. We expect gross margins for engineering services will continue in the mid-20%s for the near term. Finally, our proprietary software product revenue was $558,000 in Q4 at 80% gross margin.

Next, Marty Heimbigner, our CFO, will address our financial performance in the fourth quarter and 2015.

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 $25.0 million, down 2% from $25.6 million in the fourth quarter of 2014 and down 5% sequentially from $26.4 million in the third quarter of 2015, primarily due to lower third-party software sales. For the year 2015, total revenue was $106.6 million, up 11% compared to $95.9 million for the year of 2014, primarily due to strong third-party software sales and proprietary software sales in the first half of 2015.

Third-party software sales were $19.0 million this quarter, down 5% year over year from $20.1 million. Compared with the prior-year quarter, our Microsoft licensing revenues were essentially flat and the overall third-party software decrease was primarily attributable to $1.0 million MobileV sales in the fourth quarter of 2014 that did not occur in Q4 2015.

Third-party software sales were down 9% sequentially from $20.8 million in the third quarter of 2015 as the fourth quarter, contrary to typical seasonal patterns, was the lowest of the four quarters in 2015. This was in part due to strong sales to our largest Microsoft licensing customer in Q1 and Q2 that were lower in both Q3 and Q4. Third-party software sales were $82.9 million for the full year 2015, up 12% as compared to $73.9 million in 2014, primarily due to increased Windows Mobile sales to our largest Microsoft licensing customer.

Service revenue was $5.5 million this quarter, up 10% year over year from $5.0 million and up 5% sequentially from $5.2 million. Service revenue was up year over year, primarily due to stronger surface revenue in North America as a result of the addition of Hewlett-Packard as a key global 100 customer, partially offset by lower revenue in Japan as a result of a nonrecurring large handset project completed in the 2014 period.

Service revenue was up 4% to $20.4 million for the full year 2015 compared to $19.7 million in 2014. Proprietary software revenue was $558,000 this quarter, essentially flat year over year and up 31% from $425,000 quarter over quarter. Proprietary software revenue was $3.3 million for the full year 2015, up 44% as compared to $2.3 million in 2014 due to larger-than-expected sales that occurred in Q1.

As we have previously noted, revenue and gross margin from our proprietary software products can fluctuate significantly from one quarter to the next. And investors should not extrapolate individual quarterly results for future periods.

Next, I'll turn to our gross profit and margins. Overall gross profit was $4.9 million this quarter or 20% of total revenue compared to $4.8 million or 19% of revenue in the year-ago quarter and $4.9 million or 18% of revenue in Q3 2015. Overall gross profit was $20.5 million or 19% for 2015 compared to $16.5 million or 17% for 2014.

This substantial increase in gross profit was due to one: a $9 million or 12% increase in third-party licensing revenue at an overall gross margin 1% higher than the prior year. Two: $1 million higher proprietary software revenue at an 85% gross margin. And three: $700,000 increase in engineering services, with higher utilization of our engineering resources. All three of these factors contributed to the increased profitability in 2015.

Third-party software gross margin was 15% this quarter compared to 14% in the year-ago quarter and 15% in Q3 2015. The improvement year over year was driven primarily by changes in product and customer mix, operational efficiencies this quarter compared to the prior-year period, and stronger sales to our largest customer with extended payment terms.

Third-party software gross margin was 15% for 2015 compared to 14% in 2014 for the same reasons as the quarter-over-quarter changes. The improvement in third-party software margin during the past year is not expected to continue in 2016 due to recently announced changes regarding pricing and distribution for embedded Microsoft Windows products. Although we have entered into transition agreements with Microsoft and the majority of our customers under substantially same terms until December 2016, there can be no assurances that our third-party software gross margins will remain at the level achieved in 2015.

Service gross margin was 29% this quarter, 29% in the year-ago quarter, and 26% in Q3 2015. Year over year, it was essentially flat as a result of the completion of a Japanese handset project and a recognition of $598,000 of profit on that contract in Q4 2014 that was a one-time impact in the prior-year period. The quarter-over-quarter increase was due to improved utilization of engineering resources.

For the annual period, service gross margin improved to 25% in 2015 from 24% in 2014. The change was again driven by improved utilization of engineering resources due to strong customer demand, primarily after the first quarter of 2015.

Proprietary gross margin was 80% this quarter as compared to 85% the year-ago quarter and up from 74% in Q3 2015. Proprietary software gross margin was 85% in 2015 as compared to 75% in 2014. This increase was due primarily to larger-than-expected sales of proprietary software in the first quarter of 2015.

Fluctuations in proprietary software gross margin are generally driven by changes in revenue, as the cost of sales is relatively fixed. Revenue and gross margin from our proprietary software products can fluctuate significantly from one quarter to the next and investors should not extrapolate quarterly or year-to-date results for future periods.

Moving down the income statement to operating expenses. Total operating expenses were $3.6 million this quarter, up approximately 4% year over year and quarter over quarter from $3.5 million. Operating expenses were $14 million in 2015, essentially flat from 2014.

Note that non-cash expense for stock-based compensation was approximately $137,000 and $263,000 higher in Q4 and for the year, respectively. The quarter-over-quarter and year-over-year increases were primarily as a result of seasonal timing of expenses as well as increased spending in support of DataV, both in product development and marketing.

Now I'll speak to our bottom-line results. Net income for the fourth quarter was $1.1 million or $0.09 per share compared to net income of $1.4 million or $0.12 per share in the year-ago quarter and net income of $1.2 million or $0.10 per share in Q3 2015.

The year-over-year change was driven primarily by the timing of revenues in our third-party software business and a profit recognition of $598,000 from a large handset project in Japan that was not repeated in Q4 2015. We believe that our solid results in Q4 reflect our continued focus on increasing the efficiency of our core business and commitment to sustained profitability through focused expense control.

Net income for the full year 2015 was $6.1 million or $0.49 per share compared to $2.3 million or $0.20 per share in 2014. Our performance in 2015 reflected substantial revenue growth in our third-party software business, over $1 million of additional proprietary software sales, improved utilization of our engineering resources, and focused expense control while laying the groundwork for our DataV technology.

We generated adjusted EBITDAS of $1.9 million this quarter, up 13% compared to $1.7 million in the year-ago quarter and down 2% compared to $2 million in Q3 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. We use this non-GAAP measure to monitor our ability to generate cash from the operations of our business and a demonstrated consistency in all four quarters.

For the full year, we generated $8.5 million in adjusted EBITDAS, up 108% from $4.1 million in 2014. Cash and investments increased to $30 million at December 31, an increase of $3.4 million from $26.6 million at December 31, 2014.

Generally, adjusted EBITDAS, which was $8.5 million in 2015, has been a proxy for cash flow from our business. However, working capital changes impact the change in cash and investments as well. During 2015, due to the extended payment terms we provided to a highly credit-worthy customer, our accounts receivable balance grew by $5.4 million, which was a working capital change that had a negative effect on our cash balance as of year end.

As we indicated last quarter, our accounts receivable balance is expected to continue to increase into early 2016. At end of the first quarter of 2016, we expect that the working capital changes will begin to reverse and make a positive contribution to the growth of our cash balance.

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

Thank you, Marty. We currently have the following expectations for Q1 2016: total revenue will be in the range of $23 million to $25 million; gross margin for services will continue in the mid-20% range; increased bookings and revenue from DataV; continued GAAP profitability. And as previously noted, we expect our accounts receivable balance will continue to increase during the first few months of 2016 due to extended payment terms granted to a highly credit-worthy customer.

Robbie, please open the call for questions.

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

Just looking at the $106 million this year -- I guess last year -- I guess now we're done with that, right? So what has to happen for you guys to grow that $106 million and change number? What has to go right for you and where do you see your opportunity on the growth side?

So we see the opportunity on the growth side in our IoT DataV product. So what you will be seeing is that we will be looking to grow that. We've not offered guidance, but as a portion of our business, we would expect that to increase. And we would expect that would be at higher gross margins than our traditional businesses.

And the IoT, can you expand on that a little more? Did you give a number on what you did last year on IoT then?

No, we didn't. We indicated during prepared remarks that we engaged in a number of paid trials for DataV and that we expect that those paid trials will lead to greater sales opportunities.

Okay. Is this something that will be weighted more towards the backend of the year? Just because of the nature of getting these sales cycle or -- I know I think you already said about the lumpiness. I understand that. But can you give us anymore kind of I guess a little bit of guidance as how that grows out?

I think that's fair, Jim. I think you can expect that we are on a curve. And we haven't offered guidance specifically about what that will look like, but I think your comment is fair. That as the year unfolds we would expect to be growing in subsequent quarters.

And just the deal size that we're talking about in general, are these -- I think before you said that some of these are going to be subscription and some of these will still be the old premise-based licensing. Can you just talk to that a little bit about deal size and just how the client is going to take the software?

We haven't given any guidance on deal size, but you are exactly right. The way the product -- DataV -- is offered, it's tailored to what the customer needs. We offer it in terms of a perpetual license, which means that we would have a larger sale up front and then support and warranty going forward. And what you are also remembering correctly is that we are offering it as a subscription, which potentially could mean a monthly fee per piece of equipment for the customer.

But it is going to fairly large enterprises? Isn't that your target market: the same people you kind of deal with?

Yes, that's correct. That is our target. We're seeing initial discussions with either makers or operators of large capital intensive equipment, that it is very painful for them when the equipment goes down. So uptime, warranty improvement, supply chain engagement -- those sorts of things.

But certainly when we say that we're pleased with the POCs and the visibility that we have on the pipeline and engaging with our traditional portfolio of customers, you are exactly correct. That is who we are targeting.

And I think I may have asked this before, but just who is selling this? Is it the same sales force or have you greatly changed that?

We are selling it through our existing sales force. And we have started to hire additional people whose sole responsibility is for selling DataV.

Okay. So a couple more questions, if I can, or I can get back in queue. What do you prefer?

Go ahead, Jim.

Okay. Just on the service side, you grew a little bit year over year on the annual basis, but you also had 10% growth in the service side. Where can we kind of expect that to go? Is that a 10% a year growth or what should be kind of the expectations there?

So what we're pursuing there under Mark Whiteside's leadership is land and expand. So we're very pleased with the customers that we have there: Google, Coca-Cola being two obvious noteworthy examples. So we'll be looking to expand within existing customers.

We feel like that fits our business model. But uniquely, we will also be looking to wrap our engineering services around our DataV product. We believe that that's a competitive differentiator and we believe that we will be able to ask for and receive higher gross margins as a result of those types of engagements.

Okay. And then just to go back to -- well, in the prepared remarks, I think you basically said I don't expect more margin -- or any margin expansion for the third-party software. I think you made that clear. Because you did have some growth. Wasn't 13% versus 12%, if I remember correctly. Is that what you said?

You're correct. We grew from 14% to 15% from last year to this year.

That was on an annual basis, right?

We improved the gross margin percentage by 1 percentage point. And that was due to our product mix, our customer mix, operational efficiency, and our largest customer. All of those things added to that 1% improvement in margin.

But you're not -- go ahead. I'm sorry.

So what we're saying is that we're not expecting that type of growth in 2016, given the changes that Microsoft has done to the embedded distribution model.

But you don't necessarily -- you are not meaning to say that there's going to be a lot of degradation there either, though?

We are saying that the business model is being impacted by the changes that Microsoft has put in place, that we don't know exactly how they are going to play out in 2015. That was the guidance that we provided in the third quarter and we are reiterating that guidance here.

And Jim, our assumptions in there are embedded in our guidance for Q1 at $23 million to $25 million. And certainly, the remarks or the question that you asked earlier about what we're expecting with DataV is also embedded in that guidance.

Okay. And then just one final question. Given your hirings -- and it looks like you guys have done a wonderful job on the operating expense line. And your SG&A did creep up by about $170,000 year over year this quarter. Is this a decent run rate, even though you are going after this DataV market? But is this something or should we see that SG&A line -- the selling expenses, especially -- should we see that tick up as you continue to go after this?

Our commitment to you and to the rest of the investor base is we are just going to invest, whether it's in sales or R&D, at the rate that we see activity in the market. Clearly we're enthusiastic about the market opportunity. We believe it's in its infancy. We believe that we're investing appropriately.

And again, our commitment to you and the investor base is we will invest prudently as we see opportunity. And that's why we are growing our dedicated salespeople, as you asked about a few moments ago, and why we're adding selectively to our R&D group.

All right. Thanks, guys. I'll let somebody else jump in.

Thanks for your questions, Jim.

(Operator Instructions) With nobody in the queue, I'd like to turn the program back over to Mr. Chase for any additional or closing comments.

Thanks, Robbie. Before concluding the call, on behalf of the entire BSQUARE team, I'd 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. Thank you for joining us.

That does conclude today's call. Thank you for your participation.