BSQUARE Corporation
Q4 2015 Earnings Call Transcript

Published: 12 Feb 2016

[Operator:]

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's Chief Executive officer. Please go ahead.

[Jerry Chase:]

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 $216,000 increase in adjusted EBITDAS and increased cash and equivalent balances by over $3.3 million. For the full year of 2015, we increased revenue by $10.7 million or 11% compared with 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 opportunities, 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 would like to move to engineering services, under the leadership of Mark Whiteside, which drove 22% of our topline 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-20s 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.

[Martin Heimbigner:]

Thanks, Jerry. With that business overview, let me recap our financial results reflecting the continued hard work and talents 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 service 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 non-recurring 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

[Jerry Chase:]

Thank you, Marty. We currently have the following expectations for Q1 2016

[Operator:]

[Operator Instructions] And we'll go first to Jim Gentrup with Val Vista Capital Management.

[Jim Gentrup:]

Just looking at the $106 million this year, I guess -- last year, I guess. I believe now we're done with that, right. So what has to happen to 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?

[Jerry Chase:]

So we see the opportunity on the growth side in our IoT DataV product. So what you'll be seeing is that we'll 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.

[Jim Gentrup:]

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

[Jerry Chase:]

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.

[Jim Gentrup:]

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 think you've already said about the lumpiness, I understand that, but can you give us any more kind of, I guess, a little bit of guidance as how that grows out?

[Jerry Chase:]

I think that's fair, Jim. I think you can expect that we will be -- we're 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.

[Jim Gentrup:]

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 the deal size and just how the client is going to take this offer?

[Jerry Chase:]

No, we haven't given any guidance on deal size, but you're exactly right, the way that product DataV is offered, it's tailored to what the customer needs. We can operate in terms of a perpetual license, which means that we would have a lager sale upfront and then support and warranty going forward. And what you're also remembering correctly is that we're offering it as a subscription, which potentially could mean a monthly fee per piece of equipment for the customer.

[Jim Gentrup:]

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

[Jerry Chase:]

Yes, that's correct. That is our target. We're seeing initial discussions with either makers or operators of large capital intensive equipment, so that's 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're exactly correct, that is what we're targeting.

[Jim Gentrup:]

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?

[Jerry Chase:]

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

[Jim Gentrup:]

So a couple of more questions, if I can or I can get back in queue, what do you prefer?

[Jerry Chase:]

No, go ahead, Jim.

[Jim Gentrup:]

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

[Jerry Chase:]

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'll 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'll be able to ask for and receive higher gross margin as a result of those types of engagements.

[Jim Gentrup:]

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

[Martin Heimbigner:]

Yes, you're correct. We grew from 14% to 15% from last year to this year.

[Jim Gentrup:]

On an annual basis, right?

[Martin Heimbigner:]

We improved the gross margin percentage by the 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. 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 embedded distribution model.

[Jim Gentrup:]

But you don't necessarily -- you're not meaning to say that there is going to be a lot degradation there either though?

[Jerry Chase:]

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 we're going to play out in 2015. That was the guidance that we provided in the third quarter and we're reiterating that guidance here.

[Martin Heimbigner:]

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

[Jim Gentrup:]

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 is a descent run rate, even though you're going after this DataV market? But I mean is there 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?

[Martin Heimbigner:]

Our commitment to you and to the rest of investor base is that we're just going to in that 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 sales people as you've asked about few moments ago and why we're adding selectively to our R&D group.

[Operator:]

With nobody in the queue, I'd like to turn the program back over to Mr. Chase for any additional or closing comments. End of Q&A

[Jerry Chase:]

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.

[Operator:]

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