Bsquare Corp (BSQR) 2018 Q1 法說會逐字稿

Good day, and welcome to the Bsquare Corporation First Quarter 2018 Financial Results call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Leslie Phillips, Investor Relations. Please go ahead.

Thank you, and good afternoon, everyone.

Before we begin, we'd like to 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 Bsquare's 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 Bsquare's 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.

Now I'd like to turn the call over to Andrew Harries, Bsquare Executive Chairman.

Thank you, Lesley, and good afternoon, everyone.

As most of you know, I've been the Chairman of Bsquare's Board of Directors for the last 5 years. As a board, we have been and continue to be fully committed to building sustainable shareholder value. Several years ago, we decided to pursue the emerging Industrial Internet of Things market with a proprietary software product DataV. We continue to believe that the industrial IoT market is going to be very large. In fact, Gartner projects 2.7 billion business and industrial IoT endpoints by the year 2021, roughly 500 million of which are in industries we directly address. We also continue to believe that with DataV, Bsquare has the potential to become a significant player in this market.

However, it has been well-documented that the rate of adoption across the industry has been slower than many anticipated, and we have been similarly impacted. Thus far, progress in our DataV business has not met our expectations in terms of the rate of conversions and broader customer adoption. That is why the board, in conjunction with their CEO, Jerry Chase, agreed that it was the right time to change leadership.

As we announced last week, Jerry has stepped down and I have stepped up my level of involvement with the company to Executive Chairman. Kevin Walsh, our Head of Marketing and Product Management, has assumed the role of acting CEO. I would like to thank Jerry for his role in leading the development of our new strategy, and welcome Kevin into his new position. We have a great deal of confidence in Kevin and the leadership team and their ability to refine the company's strategy and meet our goal of scaling DataV.

With that, I will turn it over to Kevin to review our first quarter 2018 results.

Thank you, Andrew.

I'd like to start out today by providing a brief overview of our first quarter 2018 activities. And then I'll discuss our refocused strategy for DataV as well as priorities for the remainder of the year.

In the fourth quarter last year, we announced a major DataV subscription renewal with Itron, a global provider of smart energy distribution systems. Itron has integrated DataV into their OpenWay Riva system to provide a software distribution layer that allows utilities to dynamically and securely download apps to targeted populations of smart meters.

Pursuant to this renewal, in the first quarter of 2018, we successfully delivered the associated engineering services work to reach customer acceptance, allowing us to recognize $1.9 million revenue. Peter will provide more detail on revenue recognition for the remainder of the contract.

During the first quarter, we also entered into a DataV engineering services contract with a Fortune 100 firm, valued at just under $1 million. That work was a result of DataV pilot conducted during the fourth quarter of 2017.

Today, we announced that, that same customer has signed the associated DataV SaaS agreement. We expected SaaS value to approach $0.5 million per year once the customer is fully deployed. With this contract, the customer will use DataV to on board, manage, update and ensure compliance across tens of thousands of devices in North America and Europe. This deployment leverages a number of IoT-specific services provided by Amazon Web services. This customer is the largest in their segment, and our agreement represents a significant validation of our DataV IoT device management strategy.

Building on Andrew's remarks, while DataV had some early successes, the pace of converting pilots to deployments and overall customer acquisition over the past year has not met our expectations. We still have confidence in the product, and believe that wider customer adoption is an achievable goal. We believe now is the appropriate time to revamp our go-to-market approach and refine our focus in rolling out DataV, which brings me to our 3 priorities for the remainder of the year. Our #1 priority is to delight our customers across all areas of our business. Toward that end, we are realigning our structure to more effectively deliver customer needs.

Our second priority is to accelerate the pace of DataV customer acquisition and conversion. In 2017, we closed 19 new DataV pilots across an array of customer types and industries. Since reporting our 2017 results, we have reevaluated the likelihood of these pilot customers moving forward with production deployments and determined that roughly 1/2 are unlikely to proceed within the next 12 months. To our knowledge, we did not lose these potential customers to competing IoT solutions.

Looking back at -- on our pilot activity in 2017, we did not adequately qualify those opportunities to ensure their capacity for production deployment, following completion of an evaluation period. And this is something we intend to correct going forward. We will no longer focus purely on the number of pilots signed, but rather, we'll focus more on engaging customers who have clear and funded plans to move from pilot to production deployment. We did not close new pilots in the first quarter, but several of the pilots initiated in 2017 still have potential to move forward towards production deployments.

This brings me to our third priority, which is improving Bsquare's overall financial performance.

Beginning in the current quarter, we are reducing our annualized marketing, sales and administrative costs by an estimated $5 million as part of sharpening our DataV product and go-to-market strategy. A key part of this strategy is lowering our customer acquisition costs made possible through a collaboration with Amazon Web Services and Microsoft.

In the current quarter, we made progress to this end and solidified our collaboration with AWS in the IoT Device Management segment. We believe these changes are appropriate, given our current position and our goals for DataV.

Now I would like to turn the call over to our CFO, Peter Biere, to address our financial performance in the first quarter.

Thank you, Kevin.

First, let's review our revenue for the first quarter. Total revenue was $20.7 million, which includes $1.9 million of revenue recognized under our Itron contract. Excluding Itron, our total revenue was $18.8 million, coming in at the upper end of the $17.5 million and $19 million range we announced in our Q4 earnings call. Compared to the prior year quarter, total revenue was down 9% from $22.8 million and up 6% from $19.5 million sequentially.

I'll break down the changes by revenue grouping. Third-party software revenue was $16.1 million, lower compared to Q4 of 2017, which reflected heavier customer purchases before year-end. Year-over-year, third-party revenue declined 4% percent.

Over the past few quarters, we stated that we believe we've seen the bulk of any competitive fallout due to changes in Microsoft contract terms, but that there might be variability in this revenue line.

Late in the first quarter, we participated in a competitive auction for Honeywell's EMEA business. We were unwilling to match the winning bid at the expense of gross margin, and as such, we will no longer be selling to this Honeywell division starting in the second quarter. We expect this customer loss to impact quarterly revenue by approximately $1.2 million to $1.5 million going forward.

While we've had some success in winning back business that had been previously lost and will continue to push to win new opportunities, we do expect that third-party software revenue could fluctuate moderately.

Proprietary software revenue was $1.8 million and included $1.4 million of revenue recognized under Itron contract. This value represents 2 years of the 5-year license revenue, and we expect to recognize remaining $2 million of this license revenue annually in quarter 4 over each of the contract's remaining 3 years.

First quarter proprietary software revenue increased sequentially due to the Itron revenue recognition. Proprietary software decline $0.8 million compared to Q1 of 2017 as we recognized the entire value of the PACCAR license revenue in that quarter.

Professional engineering service revenue, which include our DataV and traditional service contracts, was $2.8 million this quarter, down 17% year-over-year and up 45% from the sequential quarter.

During 2017, a number of traditional service contracts reached their final delivery point, which explains the year-over-year decline. The sequential increase was primarily due to services revenue recognized upon customer acceptance from Itron in the first quarter.

During the first quarter of 2018, we recorded approximately $2.6 million in total DataV revenue between, both proprietary software and professional engineering service segments.

Now I'll turn to our gross profit and margins in the first quarter. Gross profit totaled $5.2 million or 25.1% of revenue, which included $1.6 million of gross profit recognized under our Itron contract. Excluding the impact from the Itron transaction, total gross profit was $3.6 million or 19.1% of revenue, slightly exceeding our guidance range of 17% to 19%, due primarily to some end-of-life buying for a non-Microsoft product. Gross margin slightly decreased from the prior year period, primarily driven by a shift in our revenue mix. Higher-margin proprietary software revenue was comprised -- comprised the lower portion of the overall total revenue.

Total gross profit was down $1.1 million from the year-ago quarter primarily due to lower revenue levels in our third-party software business and proprietary software. The sequential increase in both gross margin and gross profit was driven primarily by higher proprietary software revenue.

Next, I'll speak to operating expenses and our bottom line results in the first quarter. Total operating expenses were $7.7 million, up $1.5 million from quarter 1 of 2017 and down $235,000 from quarter 4 of 2017. The increase from the prior year period reflects our investment during 2017 in product development sales, marketing and customer support teams to scale DataV. The decrease from the sequential quarter was primarily due to lower overall sales and marketing costs.

As Kevin mentioned earlier, as part of our sharpening of focus with DataV, we are reducing annualized marketing, sales and administrative costs by approximately $5 million. This will begin in the second quarter but will be partly offset by onetime costs associated with severance payments. We expect the full impact of cost reductions to materialize in the third quarter of 2018.

We recorded a net loss of approximately $2.4 million or $0.19 per share for the first quarter of 2018 compared to net income of $202,000 or $0.02 per share in the year-ago quarter and a net loss of $4.2 million or $0.33 per share for the fourth quarter of 2017.

Adjusted EBITDAS, a non-GAAP measure defined as operating income before depreciation, amortization and stock-based compensation, was negative $2 million for the first quarter of 2018 compared with positive $0.6 million in the year-ago quarter, primarily due to lower third-party software and proprietary software revenue, combined with higher DataV expenses incurred compared to the prior year.

Moving to the balance sheet. Cash and total -- and investments totaled $21.4 million as of March 31, 2018, down $3.3 million sequentially. Cash usage for the quarter was $1.3 million higher sequentially, due primarily to timing of DataV payments received in quarter 4 as well as seasonally driven operating expense payments in quarter 1 of 2018.

Our accounts receivable balance totaled approximately $18 million at March 31, 2018, about $9.1 million of which is due from Honeywell. We extended 270-day terms to Honeywell net of payments, due to Microsoft approximately $7.6 million of this receivable will convert to cash.

Related to the loss of Honeywell's EMEA business, we expect approximately $4 million of cash conversion during the balance of 2018.

I'll now turn the call back to Kevin to provide an outlook for the second quarter and closing remarks.

Thank you, Peter.

As noted in today's press release, we currently have the following expectations for Q2 2018: revenue in the range of $16 million to $18 million, reflecting a reduction in third-party software sales to Honeywell, which we expect will impact revenue by $1.2 million to $1.5 million per quarter. Blended gross margin will be in the 17% to 19% range, and the net loss reflecting moderated investments to grow DataV and onetime realignment costs, partially offset by reduced marketing, sales and administrative costs.

Moderator, please open the call for questions.

(Operator Instructions) We will take our first question from Ryan Vardeman with Palogic.

Of the pilots that are remaining that you think are perhaps possible to convert, what are the vintages of those pilots from last year?

Well, we signed up, as you may know, beginning in Q2, 4 pilots and then 5 in Q3 and 7 in Q4. So they vary -- the vintages of the pilots vary, but that's when they were initiated.

I guess, of the 1/2 that are unlikely to proceed in the next 12 months, can you kind of let us know what buckets of those 3 quarters they would come out of?

I think -- actually, we don't have that information, Peter, do you?

Well, I think -- at our fingertips. I think it's vary, Ryan. But most of the pilots that are still active with a chance to convert were later in the year. I wouldn't say that's a 100% of them. But most of them were later.

And do see that the rest of these pilots are of similar magnitude in size as the one that converted this quarter?

I'd say the one that we converted this quarter is on a [medium-to-larger] end (corrected by company after the call).

We'll go next to Joe Vidich with Manalapan Oracle Advisors.

I guess, the question I have is, do you have a number for what you -- currently your annualized DataV revenues are?

So let's see how I can answer that question. We're just embarking on our very first SaaS license, which is more accurately reportable on either monthly recurring, or in our case, probably annual-recurring basis. The licenses we've signed so far with the 3 major customers that we've announced, the PACCAR licenses is perpetual. And so it's a onetime license fee with a 15% ongoing annual maintenance and support agreement. The Itron license, which we just announced recognizing a couple of years of the revenue, is a subscription. But because of its nature, we recognize that subscription in a chunk every year. And so we have $1.4 million, roughly $700,000 a year would be the annual run rate for the Itron license. That also carries some maintenance and support payments. The third customer, the name of which we have not announced is smaller and it has a potential to scale, but they're buying perpetual licenses based on the number of machines that they operate in. And so heretofore, it's been reasonably small. And again, it has a chance to grow quite a bit. The announcement we just made today, Kevin mentioned at scale, that could become $0.5 million per year. So it at least gives you an idea of the few that we've booked, what that looks like. And we would hope that and believe that most of these licenses that we sell in the future will be subscription or SaaS-based.

Okay. And I wasn't quite sure if I caught this or not. Did you mention how many trials you have now that you feel are likely to convert within the next 18 months?

We didn't make a forecast of that. What we said was about 1/2 of the pilots that we signed last year are still in motion. And just like we felt last year when we were signing these up, we were optimistic that we could do a good job for the customer and that every customer would convert. That's proving to be too optimistic. But I'd say, we have a chance to record more than a handful of the licenses that are left, and we continue to work with each. So I think as long as they are alive -- and by the way, some of the customers that did not convert, we had some successful pilots. So there is still opportunity for us to go back to those folks. I think our comment was, we didn't rightly expect it in the next year, but you never know.

Okay. And just, I guess, one last question is, do you run those pilots on like a -- so you actually breakeven on them or do you -- how does that work in terms of revenue or costs?

Well, they're paid engagements. They pay for the services they consume and they pay for the license while their pilot is underway, and pilots tend to be 90 to 120 days in duration. And we expect not to lose money on those pilots. Many of the pilots, by the way, as was announced in the prior earnings call, are co-funded by either AWS or Microsoft.

We'll go next to Jason Jones, who's a private investor.

So the tally I have is that we've lost the CEO, we've lost the piece of Honeywell business. One half of the POCs, which were used as a gauge for DataV uptake, were now understanding to be worthless. We're reducing marketing spend, which is going to impact, at least, in every business I've ever seen. It impacts negatively the ability to attract new business and to bring on new customers. And I guess that everybody who's bought a share of this and still holds it over the last couple of years is underwater. So at this stage, is there anything positive going on? Is there anything -- are there any good news?

Let me tackle that, Jason. I mean, one, we did announce today a pretty significant SaaS contract with a Fortune 100 firm that is the largest in their segment. So we view that as a good news. Regarding the pilots, it's -- we didn't say they're worthless. We said that roughly 1/2, we didn't think would materialize within the next 12 months, so we're not going to focus on those quite as much. The other half roughly are still in flight. And those are still a variety of companies and a variety of industries that potentially have value. And regarding the reduced, well, you said, reduced marketing but I'm sure, more broadly, you mean the reduced customer acquisition costs. And as we mentioned, we are taking steps to more closely align ourselves with AWS and Microsoft. And that's from a selling and marketing standpoint. It's from a demand-generation standpoint. We believe we can do that because we believe we have something that adds value to their solution and allows us to draft off of their own very, very significant demand-generation efforts as well as embedded base. We view all those as positive indications and are optimistic going forward.

We'll take our next question from Steven [Libol], he's a private investor.

I would like to know how much contribution would we get from today's announced contract?

Well, so we previously said that we had a services arrangement for this contract which was approaching $1 million. And that gets worked until the contract goes into production. And then, once they're in production, we believe, at scale, which -- no projection of how quickly that takes, but we believe, at scale, there is a $0.5 million of annual subscription or under the SaaS license.

So it's $0.5 million every year, right? Jerry Chase has mentioned earlier this year that Bsquare was expecting a significant contract. And he was also asked whether the return on investment on all the DataV investments, would it bear fruit? And he had confidently said that the return on investments would be many times over the investments that have been made on DataV. So first question is this, the significant contract that Jerry Chase was referring to earlier this year, was it this particular contract with a Fortune 100 company that was announced today?

Yes, yes. This is the contract...

But -- okay. And would you say that's a significant amount, $0.5 million a year? Is that something that the investor should be all excited about? $0.5 a year, and looking at all of the losses that you're reporting quarter-over-quarter, losses that amount to $3 million per quarter, I think -- is this a joke? I mean, I kind of understand that -- I mean, if you're referring to a significant contract, and then you're reporting just $0.5 million a year for a SaaS revenue, and considering all the costs that's involved, how can it be a profitable contract?

So a couple of things to keep in mind there. I mean, A, if you look at the industry of Industrial Internet of Things and SaaS offerings and using that as a benchmark, $500,000 a year is quite significant. From a margin standpoint, from a gross margin standpoint, Peter can speak to this more eloquently than I can. But there's little, if any -- excuse me, it's probably in the 80% to 90% gross margin range on that business as opposed to the type of business we've done in the past. So from that standpoint, it's very significant.

It's also -- and probably more importantly, it's emblematic of where the industry is going. As Andrew said at the outset, it's broadly understood and it's been published by analyst firms that said, that the market while it has great promise has matured more slowly than any of us had hoped for. That's just a reality that we have to deal with. And it's partly due to the fact that all of these implementations are relatively complex undertakings by large industrial corporations, not only from a technology standpoint but from a business process standpoint. So we're -- we believe we're getting through that starting period of customers understanding what they can do with this and are optimistic that this contract, as I said, is emblematic of what we'll see in the future.

We will take our final question from Ryan Vardeman with Palogic.

Thanks for taking the follow-up. If we're cutting sales and marketing and the paid pilots were a go-to-market strategy before, how would you characterize the new go-to-market strategy? And how we're pushing sales going forward?

Well, so part of what I just talked about is closely aligning ourselves with our key contract partners. And by the way, we didn't mention this, but I think most people know that almost all of these implementations from any vendor are cloud-based implementations. So being partnered with the two largest cloud suppliers in the world is important for us. So it does reduce a lot of those costs associated with that and brings us better deal flow. The other aspect, I mean, I think we referred to 3 or 4 times during the call, and the other release that was issued today point to IoT device management as a key use case that's foundational to a lot of IoT undertakings. And one of the reasons that were enthused about IoT device management as a use case is not only the fact that a number of our customers already Itron, for instance, fits clearly within that use case category. In many cases, we believe it's not required that the customer enter into pilot agreements before they proceed to full production. Pilot agreements tend to be used when there's a lot of data science work that will proceed predictive exercises of one type or another. In IoT device management, there's none of that complexity. So we believe that we can proceed much, much more quickly and significantly less expensively from customer engagement into full production.

That concludes the question-and-answer portion of today's presentation. I'd like to turn the call back over to management for any closing or additional remarks.

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 your business. We look forward to reporting back to you next quarter. Thank you for joining us.

Ladies and gentlemen, this does conclude today's conference. Thank you for your participation, and you may now disconnect.