Bsquare - Q4 2022

Transcript

Operator (participant)

Ladies and gentlemen, greetings and welcome to the Bsquare Corporation Fourth Quarter 2022 earnings conference call. At this time, all participant lines are in a listen only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce you to Ralph C. Derrickson, President and CEO. Please go ahead.

Ralph Derrickson (President and CEO)

Thank you. Good afternoon, investors, and welcome to the Q4 2022 Bsquare quarterly earnings call. Joining me today for the first time is Cheryl Wynn, Bsquare's Chief Financial Officer. Though this is the first time you'll actually hear from Cheryl, you have heard her words as she's played a significant role in drafting our prepared remarks in prior periods. Cheryl joined us as our Senior Director of Finance and Controller in November 2020.

Since joining, Cheryl has significantly improved our accounting systems as well as our internal reporting and analysis. Chris's departure and her transition to this new role has been natural and without any issues. I look forward to working closely with Cheryl as we strive for break-even operations in 2023.

Cheryl and I appreciate your interest in Bsquare and thank you for taking the time to be with us this afternoon. Before we go any further, 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 the Bsquare website. During today's call, we'll 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.

In our commentary, we may also refer to GAAP and non-GAAP financial measures. Please refer to the cautionary text regarding forward-looking statements contained in Bsquare's earnings release issued today and on our website at www.bsquare.com under Investors. All per share amounts discussed today are fully diluted numbers where applicable.

We will be taking questions after our prepared remarks. For anyone who would like to arrange a follow-up conversation with us, please send an email to [email protected]. You will get a response within one business day. With that out of the way, let's get started. Q4 was really a mixed bag. Partner Solutions revenue was down.

SquareOne revenue did not materialize as we had hoped. On the plus side, higher than expected margins and interest income from our investments helped to reduce our net loss. Those were offset by the one-time restructuring charges associated with the workforce reduction we implemented in December of 2022. The 20% workforce reduction in December, while difficult, was an important part of our preparation to achieve break-even operations in 2023.

I will talk more about our plans for 2023 after Cheryl takes us through the fourth quarter results. Cheryl, over to you.

Cheryl Wynn (CFO)

Thank you, Ralph, and good afternoon, investors. Today, I'll be providing an overview of our financial results for the fourth quarter of 2022. Most of my comparisons will be to the third quarter. I'll let you know when I'm comparing to other periods. I'll start with a review of our income statement and then move to a discussion of our balance sheet.

Total revenue for the fourth quarter was approximately $8 million, which was a decrease of $500,000 or 5% from the third quarter. The Partner Solutions segment drove the decrease as revenue from the Edge to Cloud segment was up slightly quarter-over-quarter. Despite the revenue decrease, total gross profit was up $100,000 as compared to the previous quarter, driven by gross margin rate improvement in both segments.

Let's take a look at our revenue and gross profit results at a segment level, starting first with Partner Solutions. Partner Solutions revenue decreased $500,000 or 6% quarter-over-quarter. Continued supply chain disruptions and other macroeconomic factors affected the ordering patterns of this segment's customers. In spite of the revenue decrease, gross profit dollars in this segment increased just over $60,000, driven by a 180 basis point improvement in gross margin rate.

This rate improvement was primarily due to higher quarter-over-quarter recognition of rebates stemming from Microsoft's distributor incentive program. A portion of these rebates are recorded as a reduction of cost of goods sold and accordingly impact our gross margin rate in the Partner Solutions segment. In the Edge to Cloud segment, revenue was up very slightly, $29,000 or 3%.

This increase was driven by the timing of feature completion for one of our key customers. Cost of revenue in this segment is relatively fixed and accordingly was essentially flat quarter-over-quarter. The increase in revenue drove an increase in gross profit dollars. Turning our attention now to expenses. As we've noted before, our cost structure is stable and well managed.

There is some seasonality to our expenses which causes fluctuations quarter to quarter. We saw this in our fourth quarter selling, general, and administrative or SG&A expenses, which were $250,000 higher than the third quarter. A portion of the increase was due to professional fees related to Q4 activities, specifically the once a year expenses that we incur related to our annual shareholder meeting.

The rest of the SG&A increase was driven by marketing spend primarily related to an overhaul and upgrade of our website. We knew this was a critical investment to make and are pleased with the changes. Research and development expenses, which consist primarily of labor and benefits, were flat quarter-over-quarter.

As Ralph noted earlier, during the fourth quarter, we executed a reduction in force as part of broader efforts to align our cost base with our 2023 strategic priorities, which include break-even operations. We reduced our headcount by nearly 20% and recorded expenses of $200,000 related to the one-time termination benefits provided to impacted employees. These restructuring charges are presented as a separate line item within operating expenses on our income statement.

As you may recall, during the third quarter, we implemented an investment strategy intended to take advantage of rising interest rates while maintaining a focus on liquidity. Our Q4 results include $300,000 of interest income, reflecting a full quarter of strategy execution. We intend to continue investing our cash reserves for the foreseeable future until there is an alternative use of the reserves that will produce a higher return.

We are utilizing a laddered investment strategy, staggering maturity dates so that portions of our portfolio mature at regular intervals. This strategy ensures that our liquidity is readily accessible and available to fund strategic growth investments. Overall loss from operations for the quarter was $1.5 million compared to the third quarter loss from operations of $1.2 million.

About half of this deterioration was driven by the one-time restructuring charges. The other half was driven by the increased SG&A expenses. Net loss for the quarter was $1.2 million or $0.06 per diluted share compared to a net loss of $1.1 million or $0.05 per diluted share in the third quarter of 2022. The quarter-over-quarter decline was driven by loss from operations, partially offset by an improvement in interest income.

Turning now to the balance sheet. In total, cash equivalents, restricted cash, and short-term investments totaled $35.6 million at year-end. This reflects a net cash use of $4.5 million during 2022, which was primarily driven by loss from operations. A small portion of our cash use, however, did relate to the share repurchase program that we announced in November.

As a reminder, we announced a plan to repurchase up to $5 million worth of our common stock. The plan is intended to return value to our shareholders without compromising our ability to pursue organic growth or strategic alternatives. During the fourth quarter, we repurchased nearly 180,000 shares for approximately $200,000. Despite the cash decrease during 2022, we continue to have a strong financial position with healthy reserves, current receivables, and no debt. I'll turn it back to Ralph now for more color on our operations and plans for 2023.

Ralph Derrickson (President and CEO)

Thank you, Cheryl. The decline in Partner Solutions revenue was a continuation of what we have experienced since the onset of the COVID pandemic. While we continue to add new customers with new product designs, the reality is new customers are generally buying lower-priced licenses, and their order activity typically starts small and increases over time.

In 2022, the wins simply didn't grow fast enough to make up for the decay of revenue from existing customers whose product lines were reaching the end of life or were disrupted by supply chain issues. Total revenue from our top 20 customers didn't change much between 2021 and 2022. Where we saw the decay was in the middle of our book of business. At the same time, the SquareOne launch didn't go as we had hoped.

Our 2022 plan assumed that we would acquire some customers with existing fleets of devices that would ramp revenue in the second half of the year. That didn't happen. We encountered 2 problems. Potential customers had a solution that was, in their words, "good enough" or that SquareOne didn't provide a specific feature they required. Where we did find opportunity was with new Partner Solutions customers.

Again, they are early in their life cycle, and their per-device revenue potential is low initially. For 2023, we knew we had to make some changes. We knew it would be unwise to assume revenue growth. We did our planning based on flat Partner Solutions revenue, predictable revenue from our edge-to-cloud customers, and a very small amount of revenue from SquareOne or related projects.

With those assumptions, we knew we would need to reduce expenses. In early December, we implemented a reduction in the team. The timing wasn't ideal. We didn't like the idea of not telling our team what was happening, and in hindsight, I'm glad we did it ahead of the onslaught of tech industry layoffs that occurred in January and February. For 2023, we established three initiatives that drove our planning and budgeting.

Our first initiative is to achieve break-even operations. The first step towards this was the reduction I discussed earlier. We also eliminated in our 2023 budget any spending that wasn't generating revenue or wasn't vital to our other initiatives. Achieving break-even operations also requires us to maximize the existing business assets for reinvestment in revenue growth, which is our second 2023 initiative.

To do this, we are changing how we're going to market and managing our business assets. In Partner Solutions, we will emphasize our reputation as the premium provider of technical support and business services. In an effort to improve our ability to attract new customers, we have simplified and repackaged our OS consulting services, creating a starter bundle of services for customers with new product designs.

Early experience with this approach has been positive. We believe the repackaging has the potential to increase the initial value of a new customer and improve our ability to upsell our OS consulting services. It also gives us visibility into the nature of their business model and the potential opportunity for Square 1, our device operations and management solution. If their business model is simply to sell devices to their customers, Square 1 isn't likely relevant.

If their business model is to charge their customers a monthly fee for the service provided by the device, some form of digital transformation, then SquareOne could be highly relevant. I'll say more about SquareOne in a moment, but I wanna call out the importance of being able to understand how and if companies are evolving their business models to a recurring revenue model. It would be easy to assume the Partner Solutions segment is just a low margin commodity business, and for a portion of it, that is true. For the portion that is evolving their business model, it has the potential to provide valuable information that could inform our product and strategic decisions.

Maximizing business in the Edge to Cloud segment means continuing to provide great service while we look for opportunities to expand our relationships with those customers and, when possible, replicating the success we've had using SquareOne as a solution accelerant. For SquareOne, maximizing the business means dialing back heavy investment in general marketing and instead working closely with our customers and technology partners to understand where there is opportunity and where development is needed.

We are modularizing the SquareOne design, making it easier to configure or plug in new capabilities that support our customer requirements and/or potential business partners. In 2022, we positioned SquareOne as a complete solution. In 2023, we are positioning it as a solution accelerant that can be valuable to customers and other players in the IoT ecosystem.

We see potential selling partnerships with our customers and other technology players, especially in the building and facilities management, healthcare, point of sale, and energy verticals. We believe this approach has the potential for generating revenue, albeit at a much slower pace than we assumed in 2022, and it can provide valuable inputs into our third initiative.

Our last initiative is to identify and pursue strategic opportunities with the potential for high growth revenue and margin. This effort will be informed by the first two initiatives as well as other efforts to find strategic opportunities. To summarize, we are entering 2023 with an operating plan and a cost structure that aligns with reality. We will seek every avenue for organic growth within our means, but we will only invest in repeatable success.

We are running and will continue to run the business as efficiently as possible while we aggressively consider a range of strategic options. We believe our understanding of our business assets, our operating discipline, and our cash reserves provide a strong foundation for building value for our shareholders in 2023 and beyond.

Before we close out the call, I want to remind shareholders that we are planning to put forth a plan to declassify the board of directors in a phased manner over three years, ultimately resulting in one-year terms for all directors. We intend to present this plan at the annual shareholder meeting that will take place in June of this year, which is back on our historical cadence. Declassification of the board will bring us in line with governance best practices and reflects the input of several of our shareholders.

Okay, with that, operator, please open the line for questions. We don't often get many questions on our call, I will remind you that if you would like to arrange a follow-up conversation, please send an email to [email protected]. Operator, please open the line.

Operator (participant)

Thank you. Ladies and gentlemen, at this time, we will be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Ladies and gentlemen, we will wait for a moment while we poll for questions. Our first question comes from the line of Jacobson Beetle, an individual investor. Please go ahead.

Jacobson Beetle (Shareholder)

Yeah, hi. good afternoon. Can you hear me?

Ralph Derrickson (President and CEO)

Yes, we can. Thank you.

Jacobson Beetle (Shareholder)

Well, thank you. I was wondering, given the declining revenue and the increasing expenses, has the company given any consideration to simply spinning the company down and paying the cash out to the investors?

Ralph Derrickson (President and CEO)

Great question. I will tell you that the board and I have looked at and will continue to consider all strategic options.

Jacobson Beetle (Shareholder)

Okay. Have you specifically considered this option, this one option?

Ralph Derrickson (President and CEO)

We are always looking at the right thing to do for building shareholder value, and so that, among others, is something that we'd absolutely, have looked at.

Jacobson Beetle (Shareholder)

Okay. You know, just speaking for myself as an individual investor here, what I'm seeing is a declining balance sheet, a declining revenue and, you know, not a great situation. The company does have cash assets, and it does have intellectual property and so forth. I would urge the board of directors to consider this as an option, please.

Ralph Derrickson (President and CEO)

Yeah, I appreciate your question. I appreciate your point of view and, absolutely understand, and thank you.

Jacobson Beetle (Shareholder)

Thank you.

Operator (participant)

Thank you. Our next question comes from the line of Steve Bailey from an individual investor. Please go ahead.

Steve Bailey (Shareholder)

Hey, Ralph. Well, first off, I would completely disagree with what the last caller just asked you. I, you know, I don't think you guys are nearly at that point, but that's obviously you guys to decide. What I really would like to know, obviously the hot button right now is artificial intelligence. You know, it's been around forever or at least a long time, as has Internet of Things. Is there a potentially a correlation between the two that could create some added additional revenue for you guys?

Ralph Derrickson (President and CEO)

That's a great question, Steve, and that's actually something that we've looked at. As you know, artificial intelligence, machine learning, and the models of that are absolutely part of the things that we get involved in with our customers with SquareOne, some of the larger edge-to-cloud customers. Yeah, we do see there's opportunity for that.

I think, you know, ChatGPT is getting a lot of buzz right now, and that's really in, you know, AI and putting together words and phrases and, you know, sort of answering questions. Absolutely, the use of AI, machine learning, and those kinds of models are things that we're involved in, and we'll continue to look for ways to take advantage of that. That isn't lost on us, and that's a great point. Steve, thanks.

It's great to get a question, especially from you. You know, I wanna kind of address your point about we're not at that point and what the other caller had said is that, you know, we're constantly looking at ways to evaluate and to create value. You know, I think we've shown that discipline in using our cash and, you know, we're transparent with things. We're gonna look at everything. Sometimes those options are more appealing than others, but we are not gonna stop looking for ways to build value and appreciate your support.

Steve Bailey (Shareholder)

Good. I appreciate. Well, that's kinda what I wanna hear because you guys aren't exactly burning cash like a biotech or as the joke is always in my household, like my daughters and wife would if I left them. You know, that would seem to me like a desperate move from a company that doesn't, you know, is not doing, you know, $24 million in revenue and hemorrhaging, which you guys are not.

To me, there's just too much, you know, potential, you know, particularly now. You know, things. We're in a recession, you know? It's a tough one because expenses are going up for everybody as revenue is stagnant or declining. It's not just you guys. You know, it's a tough environment. As we all know, it's not gonna stay that way forever.

You know, with crisis, it's gonna become opportunity. As I said to you before, you know, those that have the cash at the end are gonna win. You might be able to buy somebody, you know, that you can implement what they have into what you have for pennies on the dollar. I guess that's always the dream with B Square. Anyway, I'm glad that that's still alive and, you know, I say if there is an opportunity you guys will pull the trigger at some point.

Ralph Derrickson (President and CEO)

Yeah. I'll just, you know, close by saying that, you know, our plan for 2023 is we've got an expense structure that works within the revenue that we planned. We're gonna maximize the assets of our business. We've got a history of easing to expense, and we're gonna continue to look for ways to use our assets to create opportunities for us. That's our commitment, we'll continue that into 2023.

Steve Bailey (Shareholder)

Cool. Thanks, Ralph.

Ralph Derrickson (President and CEO)

Thank you.

Operator (participant)

Thank you. Ladies and gentlemen, if you wish to ask a question, please press star one. Our next question comes from the line of Jacobson Peter, an individual investor. Please go ahead.

Jacobson Beetle (Shareholder)

Yeah, thank you. Yeah, just a follow-up question. I understand the realignment of the cost structure. Does that mean that you expect to be a cash flow positive or EBITDA positive or anything like that in the next coming quarters? Or when do you expect to see this break even?

Ralph Derrickson (President and CEO)

Yeah, that's great. I'll field this, and I'll turn it over to Cheryl for more color. Getting to break even won't happen immediately. We believe that it'll happen... Things will improve in the first quarter, but the big improvement will come second quarter and then the second half of the year. It would take a certain amount of time for the adjustments that we've made to flow through and take full advantage of those, and that won't be realized until the second half. Cheryl, is there anything you wanna add to that?

Cheryl Wynn (CFO)

Just that also we have some revenue recognition that will occur more in the second half of the year based on the pattern of how our customers utilize our software. When we talk about break-even operations, it's a, it's a 2023 in its entirety goal, and we look forward to reporting out on it each quarter, but it won't be till the end of 2023 that we'll really be able to say we're at break-even operations.

Jacobson Beetle (Shareholder)

Yeah, I appreciate that. I mean, I don't have access to the backlog, so I don't have an understanding of the backlog, of course. I just, again, wanna urge you to look at all alternatives. To the former caller's point, you know, I appreciate that there's opportunities out there, but at the end of the day, our job is to maximize our return on the investment. I appreciate what you guys are doing. I'm just asking you to take a good look, and if you do not expect that you can return to profitability, you know, in a timely manner, then, you know, I would urge the board of directors to consider an alternative plan. Thank you.

Ralph Derrickson (President and CEO)

Thank you for that. I appreciate that input, and we'll be sure to relay that to our board.

Operator (participant)

Thank you. Ladies and gentlemen, if you wish to ask a question, please press star one. Ladies and gentlemen, a reminder, if you wish to ask a question, please press star one. Since there are no further questions, I would like to turn the conference over to Ralph C. Derrickson, President and CEO, for closing comments.

Ralph Derrickson (President and CEO)

Thank you. Thank you, investors. I really appreciate the questions and the dialogue. Thank you for taking the time for participating with us today. We appreciate your interest in B Square. Have a nice day.

Operator (participant)

Thank you, sir. The conference of Bsquare Corporation has now concluded. Thank you for your participation. You may now disconnect your line.