Bsquare Corp (BSQR) 2016 Q3 法說會逐字稿

Good day, ladies and gentlemen and welcome to the Bsquare Corporation third-quarter 2016 financial results conference call. Today's conference is being recorded and at this time, I'd like to turn the conference over to 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 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 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.

During the third quarter, we continued to make strong progress in transitioning Bsquare to a focus on the IoT market with our DataV software offering. We feel confident this is the right strategy for Bsquare. We are proceeding according to plan and DataV is performing very well. The result of this business transformation will be, we believe, an increasing percentage of bookings and greater profitability derived from DataV.

On the customer front, DataV is now operational with a large global Fortune 500 industrial company. Thanks to the success of DataV with this customer and in line with contract milestones, we received a majority of the cash associated with this project during the third quarter despite the fact that revenue will be recognized over a three-year period.

Also, based on the success of DataV, we are currently in discussions with our customer to expand DataV within the division we are currently working with and with other domestic and international divisions. We continue to see a strong customer pipeline and in fact, received a $4.8 million DataV booking from a new customer after the close of the third quarter. We expected this contract in the third quarter, but it was delayed. This project is a Smart Grid initiative expected to cover tens of millions of meters highlighting the scalability aspects of DataV.

In addition, once certain application volume targets have been met, Bsquare will receive per-application royalties on a monthly basis. Given the strength of our DataV customer pipeline, we continue making targeted investments in DataV. These investments will be focused in sales, marketing, service delivery and research and development.

Now let me move to our traditional lines of business. During Q3, third-party software sales again accounted for 81% of top-line revenue and we maintain gross margins at 16%. We are pleased that a significant subset of our DataV pipeline is represented by our existing third-party software customers giving us confidence that our 700-plus third-party software customers represent a rich opportunity for DataV.

As discussed in the Q2 earnings call, during Q3, we undertook restructuring actions within our engineering services business. As part of this restructuring, we transferred certain personnel to our DataV research and development team while reducing the capacity of the remaining engineering services organization. These actions resulted in severance and restructuring costs in our Q3 results of approximately $800,000 with another approximately $200,000 to be recorded in Q4.

We anticipate that this will be mostly completed during the fourth quarter of 2016. We anticipate being able to achieve approximately $2.6 million in annual savings from these actions.

Now let me recap our financial results for the third quarter. We reported total revenue this quarter of $22.5 million, down 15% from $26.4 million and a strong third quarter of 2015. This was due to lower revenue from Microsoft embedded operating systems due to the timing of a significant customer's purchases and lower professional engineering services revenue compared to the prior-year period.

Revenue was down 1% sequentially from $22.7 million in the second quarter of 2016 primarily due to lower engineering services revenue offset partially by a purchase of legacy proprietary software. Third-party software sales were $18.2 million this quarter, down 12% year-over-year from $20.8 million. Third-party software sales were down 1% sequentially from $18.3 million from the second quarter of 2016. Service revenue was $3.3 million this quarter down 38% year-over-year from $5.2 million and down 19% sequentially from $4 million in Q2 2016.

Service revenue was down year-over-year sequentially primarily due to the completion of several large consulting projects early in the year. Proprietary software revenue was $990,000 this quarter, up 133% from $425,000 year-over-year and up 149% from $398,000 quarter-over-quarter. 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 will turn to our gross profit and margins. Overall gross profit was $3.7 million this quarter or 16% of total revenue compared to $4.9 million or 18% of revenue in the year-ago quarter and $3.9 million or 17% of revenue in Q2 2016. Third-party software gross margin was 16% this quarter, up from 15% during Q3 2015 and even with 16% in Q2 2016. As you may recall, at the end of 2015, Microsoft announced changes regarding pricing and distribution for their embedded Windows products. Although we entered into transition agreements with Microsoft and the majority of our customers under substantially the same terms until December 31, 2016, there can be no assurance that our third-party software gross margin will remain at current levels in future periods.

Engineering services gross margin was negative 8% this quarter, 26% in the year-ago quarter and 15% in Q2 2016. The decreases were primarily due to lower revenue, recognition of approximately $800,000 in restructuring expenses in the current quarter, combined with lower utilization of engineering resources this quarter. Non-DataV proprietary software gross margin was 96% this quarter, up from 74% in the year-ago quarter and from 69% in Q2 2016. Fluctuations in non-DataV proprietary software gross margin are generally driven by the product mix sold and by changes in revenue as the cost of sales is relatively fixed.

Next, moving down the income statement to operating expenses. Total operating expenses were $4.1 million this quarter, up from $3.5 million in Q3 2015 and from $4 million in Q2 2016. Compared to the prior-year quarter, research and development expenses increased by approximately $500,000 and SG&A expenses increased by approximately $100,000. The majority of the increase in SG&A expenses was due to investments in DataV sales and marketing and executive severance.

Now, I will speak to bottom-line results. Net loss for the third quarter was $106,000 or $0.01 a share. This is compared to net income of $1.2 million or $0.10 a share in the year-ago quarter and a net loss of $185,000 or $0.02 per share in Q2 of 2016. We generated positive adjusted EBITDAS of $4,000 this quarter, down $2 million compared to $2 million in the year-ago quarter due to lower overall revenue, current period restructuring charges and higher DataV expenses compared to last year and down $278,000 compared to $282,000 in Q2 2016.

Adjusted EBITDA, which is a non-GAAP measure, is 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 www.bsquare.com. We use this non-GAAP measure to monitor our ability to generate cash from the operations of our business. Cash and investments were $31.6 million as of September 30, 2016, an increase of $4.5 million from $27.1 million as of June 30, 2016, and an increase of $1.6 million from $30 million as of December 31, 2015.

I would now like to speak to additional non-GAAP metrics we will be providing on a regular basis to help investors better understand our DataV business. 2016 DataV GAAP revenue recognized through September 30, 2016 was $300,000. 2016 DataV bookings were $4.3 million. Bookings is a non-GAAP measure and is defined as new agreements signed with customers. Cash receipts from DataV contracts were $2.3 million. DataV backlog was $4 million at September 30, 2016. Backlog is a non-GAAP measure and is defined as total DataV bookings less DataV revenue recognized to date.

Total GAAP deferred revenue on our consolidated balance sheet at September 30, 2016 was $3.2 million. This balance included DataV deferred revenue of $2.8 million with $0.8 million classified as current and $2 million classified as long term. The GAAP deferred revenue balances relating to our DataV sales do not represent the total contract value of our DataV agreements. DataV unbilled deferred revenue, which is a non-GAAP measure, was an additional $1.2 million at September 30, 2016. Unbilled deferred revenue represents future contract billings that have not been invoiced and accordingly are not recorded in deferred revenue.

Bookings, backlog and unbilled deferred revenue are non-GAAP measures. These non-GAAP measures have been included because management believes they provide meaningful information related to our new DataV product sales since revenue will often be recognized in periods later than those in which orders have been received or cash has been collected.

We currently have the following expectations for Q4 of 2016. For DataV, we anticipate additional DataV bookings, including an order for $4.8 million that was received in November from a major industrial firm. The first year of that order is valued at $1.9 million with an optional four-year extension valued at $2.9 million. Additionally, Bsquare will be entitled to collect monthly, per-app royalties once certain volume milestones have been achieved. DataV revenue will generally be recognized over the life of the contract.

Operating expenses will continue to reflect targeted increased investment in DataV sales, marketing, service delivery and research and development. This is in an effort to capitalize on a growing customer pipeline. In general, as DataV progresses, we may not announce every order via press release. For example, we may not announce new orders from existing customers. Total revenue for Bsquare will be in the range of $21 million to $24 million. Gross margin percentage for engineering services will continue to be lower than we have historically achieved as a result of our business transition to DataV.

We anticipate a Q4 GAAP net loss with the implementation of our restructuring plan, including approximately $200,000 in estimated severance charges. Additionally, management expects that its commitment to targeted investments in DataV may result in net losses in upcoming quarters as Bsquare transitions to DataV. However, we expect that these investments will be funded by cash flow and investments on hand. We will continue to focus on execution within our traditional businesses and we will continue to accelerate DataV activity in order to capitalize on what we perceive to be a substantial IoT market opportunity. Greg, please open the call for questions.

Absolutely, sir. (Operator Instructions). Dave [Cannon], Cannon Wealth Management.

Good afternoon, guys. First question is in regard to third-party software. I see that, the last couple quarters, it's been declining. Is that a trend that you expect to continue for the foreseeable future? And then I've got another question about DSO and accounts receivable with your Fortune 100 customer. Is there risk at this point of that revenue and profit potentially being reversed and taking a charge for that? Thanks.

So answering the second question first. No, we previously identified that that's Honeywell and that's a very high-quality receivable. We leveraged our balance sheet to win that business. That's a very steady relationship and there's no chance that that's going to be reversed.

And please remind me of the first part of your question. Oh, free (multiple speakers). So Microsoft has renamed the business that we deal with there from embedded to IoT. So Microsoft is transitioning that business to try to connect more closely the Azure Cloud Services to the traditional business so they are trying to proliferate their operating systems. Our relationship with Microsoft continues to be very warm. We've been told by Microsoft that they like what we are doing with DataV and IoT. I think you might have seen a press release last week from us about this Smart Meter opportunity where we announced Azure as our partner. So we would expect that fluctuations in our traditional business could be a little bit softer, but, as you can see that Microsoft is changing and we are certainly changing with them.

Okay. When do you expect to start growing the top line again? Do you think 2017 with your DataV initiative you could see growth overall?

Well, one of the reasons that we are giving non-GAAP measures is that we are under software revenue recognition rules with DataV and the revenue might not -- well, we said in prepared remarks and in the earnings release that revenue will be recognized over the term of the contract. So one of the reasons that we are calling attention to cash collections, to cash growth, to deferred revenue, etc., is because revenue might not necessarily be recognized in the top line. So we will continue to be very forthcoming and transparent on those non-GAAP measures as we move forward.

Understood. Okay, I'm going to drop back into queue and see if anyone else would like to ask questions. I may have a follow-up. Thank you.

(Operator Instructions). Orin Hirschman, AIGH Investment Partners.

Just one question on the Microsoft relationship if you are able to answer. The implication is is that this would continue to be a business that provides some level of cash flow to you for the foreseeable future even in light of the Microsoft changes. Is that a fair summary, or is it not a fair summary?

Yes, we believe that's the case. We continue to run that business very efficiently and we are pleased with the relationship, we are pleased with the financial metrics around that and we will continue to run that business into the foreseeable future.

Okay. And now just on DataV, can you just summarize the large orders -- the other order that you referenced, the one that was recently announced and this is yet another order?

Yes, the $4.8 million is an incremental order.

Is that the third large order?

Second.

I'm sorry, it's second? Can you just go over the details in that order because it sounds like that one was a little bit different than maybe the others you've had before?

It is. Just upfront, DataV is flexible and we can meet our customer's requirements in that regard. It is different than the one that we announced back in May. In this case, as we mentioned, we have $1.9 million in year one. The contract is a five-year contract that, all things going well, we'll automatically renew, although the customer does have the option after year one of not renewing, but the contract language is that it will. That's an additional $2.9 million in years two through five and then once certain volume commitments are made on applications deployed on Smart Meters, Bsquare will start enjoying the benefit of a royalty on each individual application.

In this case, your customer is related to the Smart Meter, it's a municipality? I just want to make sure I understand (inaudible)?

Yes, great question. Our customer is the manufacturer of the Smart Meter. Their customer is the utilities.

And who is the driver here, the Smart Meter guy or the utility?

Well, both, right? The Smart Meter company, our direct customer is trying to fulfill a demand for more intelligent energy consumption at the utility level.

And by way of illustration, what were their other options in this particular case in terms of trying to get some of that additional functionality if it was available for them?

So, in other words, what could they have done with their customer, or what would have been our competition for the deal?

Yes.

Okay. So, as far as we are aware, there's not another competitor that could have fulfilled this need for DataV. We operate in a very constrained environment on utilities themselves and we went through some very rigorous quality and scalability tests as you can imagine when we are talking about tens of millions of devices.

Okay. In terms of how that $1.9 million is recognized, is it ratably over that 12 months?

We are still determining that and, again, these are software revenue recognition rules unrelated to cash collections and some of this is going to depend on eventually the length of the contract. Again, I mentioned there's an automatic renewal provision. That could affect how we recognize revenue, but we will certainly be transparent as we understand that.

And going back to that renewal provision, do they have until the very end of the year to notify you if they are not going to renew, or is there something that triggers earlier if you meet a certain requirement and they are happy that there's automatic triggers in the renewal that could be locked in place before the end of the year?

Yes, they have up until 30 days before the end of the year to notify us.

Okay. And one last question. Is it on one particular meter or it's across a whole multiple line of meters?

That's a great question. Initially it's focused on the electric meters.

Okay. Thank you so much.

(Operator Instructions). Dave Cannon.

Okay. First question, is the $2.6 million in annualized savings, will we realize all of that or is there an offset to the investments in DataV and if so, what's the net savings after the investments in DataV?

Yes, so that's just from the engineering services actions and the restructuring. We haven't offered up the net on the date of the investments, but what you are seeing there, Dave, is the Company is focusing on DataV. We are very pleased. We've taken a number of the engineering services people and have repurposed them to DataV and sized accordingly. But that is a discrete number; that's not a net number.

Okay. You are saying we've taken restructuring actions that are going to save the Company $2.6 million annualized, so the implication is OpEx is going to -- or COGS is going to -- a combination thereof -- is going to drop by that amount and my question is what's the real savings? I'm excited about DataV, but are you going to reinvest potentially all of that back in DataV? Is there any savings? Is there actually a net increase? What kind of guidance can you give me there?

Yes, great question. So the savings from engineering services is just engineering services. We have not given specific guidance on what we are going to be investing in in DataV itself beyond that it's targeted and tied to our expectations of customer pipeline. The other thing that I will caution you on a little bit, because I know you are a quant guy, is that not necessarily -- certainly everything will be in the income statement and on the balance sheet, but because we are under software revenue recognition rules, we may be collecting cash well in advance of actual revenue recognition and the best example I can give is the deal that we announced in May where we collected $2.3 million in Q3, but we are not going to be able to recognize revenue for the life of the contract, which in this case is three years. So we are going to have to be more forthcoming on things like bookings, backlog, etc. to help you guys understand that.

No, I totally understand and you will record a deferred revenue liability; I understand all that. I just want to understand what is the net savings. You went out of your way to highlight that number. Is there an offset there and roughly what is it? Is it a wash or is it an actual savings, or is it an actual increase? I'm just trying to understand that. And then the other thing is on DataV, like I'm sure you guys have internal goals and projections. Two years from now, what type of annual bookings do you think we could see from DataV?

Yes, great questions. I certainly understand the question. We haven't offered guidance on that, but we do expect that DataV will become the primary focus of Bsquare. We are out in the public domain saying that gross margins will be above 70%. We would expect that shareholders, investors and certainly Bsquare will benefit from that. But to be clear, we have not given guidance beyond the next quarter.

Okay. And getting back to the original question though, Jerry, is there a net savings or you have no idea?

Yes, I have an idea, but we haven't given guidance. I certainly understand your question, Dave.

It's just peculiar. You are highlighting $2.6 million in savings, but there may not be any savings after all. I don't mean to criticize you; I'm trying to figure out and model when you get profitable, so it just makes it a little challenging, but it sounds like you have some very good things going on and I wish you the best. Thank you.

Thanks, Dave. Those are great comments and we will -- as you can see, we are trying to offer a lot more guidance, if you will or insight into the business through these non-GAAP measures and certainly as we can, we will continue to be very forthcoming about both GAAP and non-GAAP metrics.

Gary Siperstein, Eliot Rose Wealth Management.

Hi, guys. Jerry, just a few things. So you mentioned that on the engineering services, that's where most of the restructuring took place and the people that stayed moved over to DataV. Do you expect therefore like we've seen year-over-year and sequentially the engineering services revenue figure to go down? Is that ultimately going to go to zero or will there always be some projects involved with the third-party software on the engineering side so it might bottom at $1 million or $2 million, but then it should be steady-state?

Yes. So great question. So, as a reminder, we still are very much engaged with Coca-Cola in our engineering services group. We are still very engaged with Google in our engineering services group and a variety of other customers. So we would expect to continue to service those customers in our engineering services group, but we would also expect to wrap services around our own product in an increasing fashion going forward and we had also indicated in prior reporting periods that we would expect higher gross margins on the engineering services that we provide wrapped around DataV.

Great, great. So that's not going to zero, that will be ongoing and it might bottom and then pick up again as it gets involved more with DataV?

Exactly.

Okay. And then my second question is on the new contract for the Smart Grid, the $1.9 million, not the revenue recognition side, but did you already collect the $1.9 million in advance, or how is that payment going to go? Separate from revenue recognition?

Great question. So, no, we haven't collected it yet. It's going to be a combination of integration work, etc. during this first year, some licenses, etc. that we are going to be completing during the year, but we are just getting going on that.

So what's the cadence? Should we divide the $1.9 million by four quarters, or are you going to get more of it in the first half?

Yes, potentially, we could get up to $0.5 million of that in Q4 and then spread out over the remaining part of a year.

Okay. And then not to parse the English too severely, but you mentioned in the second paragraph of the news release, after the close of the quarter, we secured additional DataV contract wins with an S. So you've announced the grid one, were there any others that were not called out because they are nonmaterial?

Yes. Yes, but I answered too soon. Yes, but I would delete the part about material. In other words, yes, we believe that it's important, but we did not announce it, but it was not an issue of because we didn't think it was material.

So was there some confidentiality around that one?

Potentially, yes, and we are still working with the customer on what we can disclose.

Okay. So I don't know if I'm saying this right, it was not announced not because it was immaterial -- has it been contracted? Is it something you've already won and it's just getting permission from the client on what you can announce to the Street?

Yes, that's correct.

Okay. Prior to last quarter and the quarter before, you only had that one large win where you collected the $2.3 million up front. Were there other wins that did indeed fall below that level either due to materiality or due to other clients not letting you say anything about them?

Yes, that's correct. They're smaller POs that could be characterized as proofs of concept.

All right. So can you give us some -- without talking a dollar value -- can you give us how many wins we've actually had for DataV; different discrete customers?

No, we haven't offered guidance on that. We certainly will as we can, but we have not offered specificity on that yet.

Okay. And then to the cash balance and to the prior gentleman's question, so as he mentioned, you called out cost savings, but you haven't been totally clear to the Street on the extent of the additional investment in DataV, so when we try to model to see if it's going to burn cash or not burn cash. Can you give us some color on that? So in other words, if cash is at $31 million now, I think previously you had said something to the point of you are going to make your investments in DataV from cash flow. So should we at a minimum expect cash to either be flat or grow as you make these investments, or are the investments going to be so significant that they are going to exceed the $2.6 million in cost savings and start to burn into cash?

Yes, what we had said in prepared remarks is that we would fund the investments through cash flow and investments on hand. So I think we've been trying to show for the last periods going back three years, we had made the commitment to the investment community that's interested in Bsquare that we would run the Company leanly for profit and cash until such time as we saw a market opportunity for IoT and that we believe we could serve for DataV.

So we are very prudent with your investment dollars. We match our investments to what we see, where we need -- I think we called out specifically sales, marketing and R&D -- but we haven't offered specific guidance. We certainly understand what you and Dave Cannon before you are asking, but we are being very prudent as we invest and being very targeted in order that we can chase these opportunities. And we do believe that we are on the front end of a pretty exciting market with a great product.

Okay. Thanks for that color. My final question is the receivable with Honeywell, I think in the last conference call or release at that time, you had talked about that receivable would peak in the third quarter that we are in now. So I'm assuming you did not get that cash in by the end of the quarter and receivables were $19 million versus I guess we started the year around $19 million. So as Honeywell starts to pay off and in light of the new Microsoft deal where those third-party sales might be flat to trending down, should we expect going forward a smaller receivable number and that should go to cash?

Yes, that's a very insightful question. Really we believe we've reached status quo with Honeywell. Part of that is going to depend on whether they increase or decrease their purchases of licenses, but right now we believe that we've reached a status quo with that. And then overall on receivables, to some extent, it's going to depend on DataV, but I think your question was more specific about Honeywell.

Okay. It's DataV for the most part though separate from revenue recognition? Aren't you going to -- once the client commits to it -- aren't you going to get most of that cash upfront so it will be a smaller receivable figure going forward?

Well, yes, exactly. But to pick up an earlier conversation about the nature of the contracts, that certainly was the case with the May contract that we announced. We received the majority of the cash in Q3 and then some of these, of course, are going to be deferred over time and we will become very forthcoming about that as we announce these deals. But as we talked about the Honeywell situation, it's a great relationship. We believe that we've achieved status quo. Might be a little up; might be a little bit down, but obviously that's a very high-quality receivable.

Okay, that's all I have. Congratulations and nice progress.

Ladies and gentlemen, that does conclude today's question-and-answer portion of the conference. I'd like to turn the floor back to Jerry Chase for any additional or closing remarks.

Thanks, Greg. 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.

Ladies and gentlemen, that does conclude today's conference. We appreciate your participation. You may now disconnect.