Good day, ladies and gentlemen, and thank you for standing by. Welcome to BSQUARE Corporation’s Q1 2013 Earnings Call. (Operator instructions.) I would now like to turn the conference over to Scott Mahan, Chief Financial Officer. Go ahead, sir.
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. We provided color in our earnings release on significant year-over-year trends and therefore the focus today will be on quarter-over-quarter trends. With that said, let me recap our results.
We reported total revenue this quarter of $20.9 million, down 18% year-over-year from $25.5 million and down 19% quarter-over-quarter from $25.9 million. Third-party software sales were $15.5 million this quarter, down 9% year-over-year from $17.1 million and down 17% quarter-over-quarter from $18.7 million. The quarter-over-quarter decline resulted from a $3.7 million drop in Windows Mobile sales.
As we mentioned on last quarter’s call we had several customers take large orders in Q4 and therefore we expected Q1 to be soft. Further, Korea contributed $1.6 million of Windows Mobile sales in Q4 and as we also mentioned on last quarter’s call, our rights to distribute there ended on October 31.
Proprietary software revenue was $1.0 million this quarter, down 10% year-over-year from $1.1 million and down 33% quarter-over-quarter from $1.5 million. The quarter-over-quarter decline was driven by lower TestQuest revenue as several large deals benefited Q4, and HCP revenue declined as customers transitioned to competitive solutions or have not yet renewed.
Service revenue was $4.4 million this quarter, down 41% year-over-year from $7.3 million and down 23% quarter-over-quarter from $5.7 million. The quarter-over-quarter decrease was driven by roughly equal declines in Japan and North America. In the case of Japan, the drop was driven by project transitions and we do expect increased activity in Q2.
In the case of North America, the drop was driven by overall softness as the number of projects was relatively consistent with average project revenue declining by 20%. The MY4 touch program accounted for $1.3 million of service revenue this quarter, $1.8 million in the year-ago quarter, and $1.3 million in Q4.
Turning to gross profit margins, overall gross profit was $3.3 million this quarter or 16% of total revenue compared to $4.8 million or 19% of revenue in the year-ago quarter and $5.0 million or 19% of revenue in Q4. The quarter-over-quarter decrease in total gross profit was driven by declines of proprietary software and service revenue and service margin.
Third-party software gross margin was 16% this quarter, in the year-ago quarter and in Q4. Proprietary software gross margin was 83% this quarter, 78% in the year-ago quarter and 86% in Q4. Service gross margin was 0% this quarter, 16% in the year-ago quarter and 15% in Q4.
As mentioned on our last call we took steps in Q4 to partially address excess service capacity that we expect to reduce service cost of sales by a net $300,000 in Q1 compared to Q4. Actual Q1 service cost of sales was down $457,000 sequentially. Despite the reductions, service margin declined sequentially driven by the revenue drop and a decision to retain excess capacity even though utilization dropped an additional three points sequentially, causing our cost per billable hour to increase by 13%.
Moving down the P&L, total OPEX was $4.3 million this quarter, down 15% year-over-year from $5.1 million and down 2% quarter-over-quarter from $4.4 million. At the bottom line we reported a net loss for the quarter of $862,000 or $0.08 per share compared to net loss of $188,000 or $0.02 per share in the year-ago quarter, and compared to net income of $696,000 or $0.06 per share in Q4. The quarter-over-quarter decrease was driven by the revenue and service margin declines which negatively impacted gross profit by $1.7 million.
We generated negative adjusted EBITDA of $485,000 this quarter compared to positive adjusted EBITDA of $448,000 in the year-ago quarter and positive adjusted EBITDA of $1.1 million in Q4. Cash and investments declined $307,000 to $20.3 million at quarter end from December 31, $875,000 of which is classified as long term. CAPEX was $18,000 this quarter. Cash and investments are expected to be flat to down slightly at June 30 compared to March 31.
Headcount including contractors is currently 247 compared to 258 as of our last call. Engineering services headcount is currently 152 down from 160. Now I’d like to turn the call over to Brian Crowley, BSQUARE’s Chief Executive Officer.
Thanks, Scott. Before I give you an update on our initiatives I would like to talk for a few minutes about the current state of our business and where we are in our efforts to drive improved results. Our efforts take on three forms – retooling our sales force, controlling expenses, adding new products and services for revenue expansion.
As I discussed on the last call, we went through a major transition in our sales leadership last year, starting with the exit of our previous Worldwide Sales Leader in early summer 2012 and then the subsequent hiring of Mike Stipe to lead our sales efforts last October. Mike comes with deep experience in the mobile and embedded industry, having had good success leading product and service sales efforts at both Wind River and at Symphony Teleca.
Mike has exerted positive leadership since he joined, he has driven an assessment of his team’s skills, looked at our sales and marketing strategy and has developed an action plan to improve results. As a result of Mike’s efforts we determined that in certain territories new skills and personnel were required in order to drive the results we expect. We have already made most of these personnel changes with only a couple still in process.
For example, in January we brought in new sales leadership for North America and in March, April and May we brought in new sales personnel in several US territories and in China. All the people we have hired have a background of selling products and services into the mobile and embedded industry; therefore we think that they will ramp fairly quickly, typically one to two quarters.
We’ve also revised our sales compensation and account plans to further focus the team on building products and services pipelines for future growth, booking longer-term business for stability, working more closely with our strategic partners for leverage and selling wider and deeper into our key existing customers. With the turnover in our sales leadership last year we clearly lost some momentum over the second half of 2012 and this is reflected in our Q1 results.
We believe that the market opportunity for our products and services is strong and our issue is one of execution. With new leadership and sales personnel in place, coupled with the efforts I’ve just described, we’ve more than doubled our raw sales pipeline since the beginning of the year, and given our typical six- to nine-month sales cycle for larger opportunities we are beginning to see improved deal activity and are expecting improved results in Q2, especially in services.
Last year we reduced our operating costs to bring them more in line with revenue and gross profit. You’ll remember that during 2011 we ramped operating expenses to $20.5 million for the full year as we made investments that we anticipated would generate additional growth during 2012. When it became clear that some of the investments were not going to have the ROI we wanted we took action to reduce expenses so that as of Q1 we are on an operating expense run rate of approximately $17 million although we do expect that to increase somewhat in Q2 and Q3 as our recent sales hires take hold.
The one area in which we did not completely reduce expenses to match revenue was on our services delivery team. We chose to hold onto more delivery capacity than required because we felt that in light of the growing sales pipeline it would be short sighted not to maintain the key talent needed to grow revenue once we fixed our sales issues. In the interim, we’ve put these engineers to work developing new skills around leading technologies such as Qualcomm application processors, Windows 8 and Windows Phone 8. We’ve built our application development porting service and we’ve built out solutions and demos to aide our sales efforts into key vertical markets.
We made the right choice as our delivery team utilization looks to have bottomed out in February and has been climbing every month since. In fact, in certain practice areas we are looking to obtain additional delivery capacity most likely through contracts for now due to demand. This is the driver behind our forecast that service revenue will improve in Q2 and why we have a positive outlook for the remainder of 2013.
Now let me give you an update on our initiatives. As I’ve discussed in the past, our HTML5 initiative is designed to take us into an important new market that brings us into the opportunity to sell our products and services around the creation of rich user interfaces on devices using the HTML5 standard. We believe that this is important for BSQUARE because of the interest we see in HTML5 development across our customer base.
Based on our market research we think that there are thousands of embedded project starts each year that are potential customers for HTML5 products and services especially in the automotive, retail, and industrial automation verticals. To date, our relatively modest HTML5 investment has driven well over $4 million in cumulative product and service revenue. In Q1, our solution won a Microsoft Technical Excellence Award, and Microsoft is referring Windows CE and Windows Embedded Compact customers who are looking for HTML5 support to BSQUARE.
Our 2013 plans include sales and marketing efforts to bolster our customer pipeline and development efforts to expand the scope of our solution. We expect to add specific functionality to our solution that will be attractive to the automotive, gaming, retail display, and point of sale segments. Our current plans support this roadmap without any increase in overall R&D spend.
Another of our initiatives is to build an application development porting service which is designed to make it very efficient and easy for companies and developers to get their applications imported to Windows 8 and Windows Phone 8. We are focused on Android and IOS application ports, however we can port from other operating systems such as Blackberry or Windows Mobile 6.5.
We now have six projects underway or completed and a pipeline of over a dozen more. We have become a Microsoft Application Porting Partner and are working with the Microsoft Sales Channel to identify and close additional opportunities. Through the end of Q2 we expect that our application porting team will have delivered over $400,000 of cumulative incremental revenue. As I have said in the past, our goal is to grow this into a multi-million dollar services practice that enables not only porting and delivery but would become a bridge to new service offerings around the connected cloud.
The rugged device segment of the industrial automation vertical has been an important source for steady and profitable revenue to us over the past years and we have earned tens of millions of dollars selling our products, services, and third-party software to the makers of rugged mobile devices.
Microsoft Windows Embedded Handheld 6.5 operating system has long been the standard operating system used in the rugged device market. However, Microsoft released the last update for this operating system in 2010 and has been slow to announce a new roadmap. This has caused customers to slow their development efforts or try to develop products and alternative operating systems which has impacted both our third-party product and service results.
In Q4 2012, Microsoft finally announced the successor to Windows Embedded Handheld 6.5 called Windows Embedded 8 Handheld, which is based on the modern Windows Phone 8 platform. Microsoft also announced the initial wave of OEMs who will be given access to Windows Embedded 8 Handheld and this list includes longtime BSQUARE customers Honeywell, Motorola Solutions, Intermec, and Bloomberg as well as a new customer, Ingenico.
As the initial Windows Embedded 8 Handheld Systems Integration Partner, BSQUARE has been working closely with Microsoft and these OEMs to deliver training and architectural consulting and we also invested in training our own engineers in the new technology.
Windows Embedded 8 Handheld is a significant change from the old platform and we’ve seen opportunities to win several million-dollar plus projects during 2013 to assist OEMs in developing their Windows Embedded 8 Handheld devices. We have begun providing initial design services to OEMs as they plan their device projects and are now in the process of providing formal quotations for the larger development programs.
We continue to work with Qualcomm around their Hexagon digital signal processor, or DSP. The Hexagon DSP is integrated into the Qualcomm Snapdragon platform and provides OEMs the ability to differentiate the multimedia features of their devices. In mid-2012 Qualcomm announced that BSQUARE was one of the early access companies participating as an Ecosystem Partner in the Hexagon program.
Over the past two quarters we have invested in training our engineers on the Hexagon DSP technology in preparation for OEM referrals from Qualcomm. We now have our first two Hexagon porting customers and through Qualcomm we have built a pipeline of over a dozen additional customers.
Finally, we are often asked about the status of the teams working on the MY4 touch program through Microsoft. I can report that our team has been extended through the end of 2013 and we are in discussion for a further extension. However, it looks like we will see a 10% to 20% reduction in team size sometime during the second half of 2013.
Now to wrap up, I expect that Q2 revenue will be up sequentially in the $21 million to $23 million range. Our products revenue line is expected to be approximately flat from Q1. Our services and third-party product revenue are both expected to be up sequentially, with service revenue finally reversing its four-quarter downward trend and returning to growth.
With that I wish to thank you for your interest in our company and will now end the prepared portion of our call, and ask the operator to open up the call for questions.
Thank you, sir, we will now begin the question-and-answer session. (Operator instructions.) And I’m showing no questions in the queue, please continue.
Thank you, Operator. So with that we’ll end the call. Thanks for the interest in BSQUARE and we will talk to you again next quarter.
Ladies and gentlemen, this does conclude our conference for today. Thank you for your participation, you may now disconnect.
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