BSQUARE CORPORATION The following discussion should be read in conjunction with our condensed consolidated financial statements and related notes. Some statements and information contained in this discussion are not historical facts but are forward-looking statements within the meaning of Section 27A of the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). In some cases, readers can identify forward- looking statements by terms such as "may," "will," "should," "expect," "plan," "intend," "forecast," "anticipate," "believe," "estimate," "predict," "potential," "continue," or the negative of these terms or other comparable terminology, which when used are meant to signify the statement as forward-looking. These forward-looking statements include, but are not limited to, statements about our plans, objectives, expectations and intentions and other statements that are not historical facts. These forward-looking statements are not guarantees of future performance and involve known and unknown risks, uncertainties and situations that are difficult to predict and that may cause our own, or our industry's actual results, to be materially different from the future results that are expressed or implied by these statements. Accordingly, actual results may differ materially from those anticipated or expressed in such statements as a result of a variety of factors, including those discussed in the sections entitled "Risk Factors" in this Quarterly Report on Form 10-Q and in in Item 1A of Part I of our Annual Report on Form 10-K for the year endedDecember 31, 2021 as well as similar discussions contained in our periodic reports, and other documents or filings and documents that we may from time to time file or furnish with theSEC . Readers are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date made. Except as required by law, we undertake no obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise. Overview Bsquare develops and deploys technologies for the makers and operators of connected devices. These fleets of business-oriented devices, often called the Internet of Things ("IoT"), offer a powerful means to connect organizations, people, information, and ideas. Hundreds of millions of connected devices have already been deployed and it is estimated that billions more will be. Despite their growing prevalence, these devices and the systems in which they operate remain a significant source of complexity, unplanned and often uncontrolled expense, and operational risk. Our customers are undergoing a massive change in their business practices and Bsquare provides technology that helps them capture the value of connected devices and reduces the cost and risk of doing so. Since our founding in 1994, Bsquare has helped embedded device manufacturers ("Original Equipment Manufacturers" or "OEMs") design and build cost-effective products. For most of our history, we operated at the intersection of hardware and software, helping our customers select, develop, and configure system software for a variety of purpose-built devices, from mobile computing to point-of-sale systems to healthcare equipment to hospitality, gaming, and more. Our expertise in hardware, device configuration, and operating systems became essential to our customers' design cycles and purchasing decisions. As our customers deployed ever-larger fleets of devices, our understanding of the requirements for large-scale device operations increased. More recently, our expertise and business prospects have shifted to cloud-connected devices that have been connected to create intelligent systems. This shift coincides with the overall growth of IoT technologies and with our customers' recognition that connected intelligent devices create significant business opportunities. Device makers have increasingly specified their products not only to be connection-ready, but also to be enhanced by the breadth and depth of functionality that connection creates. We have taken to market a portfolio of products and services that we believe meets the needs of connected device makers. This portfolio captures our experience and our expertise can enable our customers to be more productive, flexible, and financially successful. And, in turn, our customers can then help make people and organizations more productive, improve quality of life, and reduce demands on the limited resources of our planet. Key Highlights Partner Solutions revenue was lower than anticipated in the third quarter as our customers continue to face supply chain issues. In addition, a few Microsoft products reached end of life and our customers did not elect to continue their product programs with new versions of Windows. The decrease also reflects lower sales inAsia . We believe our Partner Solutions revenue is affected by other Microsoft distributors offering deep discounts on Windows IoT OS software as part of hardware/software bundles. We expect this market trend may continue in future quarters. We are working to retain and attract customers with superior service and technical support, pricing that rewards loyalty, and a path to IoT operations. In our Edge to Cloud segment, we continue to focus our efforts on a relatively small number of key customers that help us gain credibility as a reliable technology partner. For example, we support Itron, Inc. with its intelligent utility grid. We believe our experience serving Itron and our other large IoT customers positions us to improve our IoT software and services in 2022 and beyond.
Our focus on expense discipline has continued. Our selling, general and
administrative expenses for the nine-month period ended
Throughout 2021 and through the third quarter of 2022, we invested in the development of new product offerings for our customers. We recently updated our SquareOne product to include two pricing packages. SquareOne Essentials is an entry-level package available to those customers who do not require the full-suite of connected services, but still want to take advantage of SquareOne's core functions. Devices that are enabled with SquareOne Essentials can be recovered in the event of a security breach or system failure and an in-place upgrade of the OS can be easily performed. SquareOne Premier is the full-suite, configurable IoT device management solution designed to remotely manage device fleets at scale. This multi-OS, end-to-end solution can be configured to securely monitor key device telemetry, set alerts, diagnose issues and deploy fixes-all remotely and in real-time. In the first nine months of 2022, our product development investment totaled over$1.2 million , of which$0.4 million was capitalized on the balance sheet as internally developed software and the remainder is captured on the statement of operations as research and development expense. During the quarter, we invested$22.1 million in treasury bills to take advantage of rising interest rates. Approximately$11.4 million of the investment had a maturity of less than 90 days as ofSeptember 30, 2022 and is classified as a cash equivalent on the balance sheet. The remaining investment of$10.7 million had a maturity of just over 90 days and is classified as a short-term investment. Cash, cash equivalents, restricted cash and short-term investments totaled$37.1 million onSeptember 30, 2022 , a decrease of$3.0 million sinceDecember 31, 2021 . 13
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Table of Contents Critical Accounting Estimates Revenue recognition Our revenue recognition accounting methodology contains uncertainties because it requires us to make significant estimates and assumptions, and to apply judgment. For example, for arrangements that have multiple performance obligations, we must exercise judgment and use estimates in order to (1) determine whether performance obligations are distinct and should be accounted for separately; (2) determine the standalone selling price of each performance obligation; (3) allocate the transaction price among the various performance obligations on a relative standalone selling price basis; and (4) determine whether revenue for each performance obligation should be recognized at a point in time or over time. Triggered by a contract modification, inJune 2022 , we updated the standalone selling price estimates for the identified performance obligations of a contract within our Edge to Cloud segment. We have not made any other material changes to the significant estimates utilized to determine the total transaction price and stand-alone selling prices at contract inception. Our customer contracts that involve perpetual licenses are less sensitive to changes in estimates than contracts involving SaaS as those arrangements require us to estimate customer usage. Changes to our customer usage estimates could have a material impact on the total transaction price.
In addition, we exercise judgment in certain transactions when determining whether we should recognize revenue based on the gross amount billed to a customer (as a principal) or the net amount retained (as an agent). These judgments are based on our determination of whether or not we control the service before it is transferred to the customer.
Taxes As part of the process of preparing our consolidated financial statements, we are required to estimate income taxes in each of the countries and other jurisdictions in which we operate. This process involves estimating our current tax expense together with assessing temporary differences resulting from the differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities. Net operating losses and tax credits, to the extent not already utilized to offset taxable income or income taxes, also give rise to deferred tax assets. We must then assess the likelihood that any deferred tax assets will be realized from future taxable income, and, to the extent we believe that recovery is not likely, we must establish a valuation allowance. We are required to use judgment as to the appropriate weighting of all available evidence when assessing the need for the establishment or the release of valuation allowances. As part of this analysis, we examine all available evidence on a jurisdiction-by-jurisdiction basis and weigh the positive and negative information when determining the need for full or partial valuation allowances. The evidence considered for each jurisdiction includes, among other items, (i) the historical levels of income or loss over a range of time periods that extends beyond the two years presented, (ii) the historical sources of income and losses, (iii) the expectations and risk associated with underlying estimates of future taxable income, (iv) the expectations and risk associated with new product offerings and uncertainties with the timing of future taxable income, and (v) prudent and feasible tax planning strategies. Significant judgment is required in determining our provision for income taxes, deferred tax assets and liabilities and any valuation allowance recorded against our deferred tax assets. We estimate the valuation allowance related to our deferred tax assets on a quarterly basis. Our sales may be subject to other taxes, particularly withholding taxes, due to our sales to customers in countries other thanthe United States . The tax regulations governing withholding taxes are complex, causing us to have to make assumptions about the appropriate tax treatment. Further, we make sales in many jurisdictions acrossthe United States , where tax regulations are varied and complex. We must therefore continue to analyze our state tax exposure and determine what the appropriate tax treatments are, and make estimates for sales, franchise, income and other state taxes. The Inflation Reduction Act of 2022 (the "Act") was signed intoU.S. law onAugust 16, 2022 . The Act includes various tax provisions, including an excise tax on stock repurchases, expanded tax credits for clean energy incentives, and a corporate alternative minimum tax that generally applies toU.S. corporations with average adjusted financial statement income over a three year period in excess of$1 billion . We do not expect the Act to have a material impact on our consolidated financial statements. Results of Operations
The following table presents our summarized results of operations for the periods indicated. Our historical operating results are not necessarily indicative of the results for any future period.
Three Months Ended September 30, Nine Months Ended September 30,
(In thousands,
except
percentages) 2022 2021 $ Change % Change 2022 2021 $ Change % Change
Total revenue $ 8,406 $ 10,646 $ (2,240 ) (21 ) $ 28,532 $ 31,289 $ (2,757 ) (9 )
Total cost of
revenue 7,271 9,318 (2,047 ) (22 ) 24,315 27,176 (2,861 ) (11 )
Gross profit 1,135 1,328 (193 ) (15 ) 4,217 4,113 104 3
Operating
expenses 2,289 2,194 95 4 6,971 7,150 (179 ) (3 )
Loss from
operations (1,154 ) (866 ) (288 ) 33 (2,754 ) (3,037 ) 282 (9 )
Other income,
net 29 (29 ) 58 (200 ) 116 1,575 (1,459 ) (93 )
(Loss) income
before income
taxes (1,125 ) (895 ) (230 ) 26 (2,638 ) (1,462 ) (1,176 ) 80
Income taxes - - - - - - - -
Net (loss)
income $ (1,125 ) $ (895 ) $ (230 ) 26 $ (2,638 ) $ (1,462 ) $ (1,176 ) 80
Revenue
We generate revenue from the sale of software, both embedded operating system software that we resell and our own proprietary software, and related professional services.
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Total revenue for the three months ended
the Edge to Cloud segment. Total revenue for the nine months endedSeptember 30, 2022 decreased compared to the same period in 2021 due to decreased sales in our Partner Solutions segment inAsia and a decrease in the Edge to Cloud segment.
Additional revenue details are as follows:
Three Months Ended September 30, Nine Months Ended September 30,
(In thousands,
except
percentages) 2022 2021 $ Change % Change 2022 2021 $ Change % Change
Revenue
Partner
Solutions $ 7,557 $ 9,638 $ (2,081 ) (22 ) $ 26,042 $ 28,393 $ (2,351 ) (8 )
Edge to Cloud 849 1,008 (159 ) (16 ) 2,490 2,896 (406 ) (14 )
Total revenue $ 8,406 $ 10,646 $ (2,240 ) (21 ) $ 28,532 $ 31,289 $ (2,757 ) (9 )
As a percentage
of total
revenue:
Partner
Solutions 90 % 91 % 91 % 91 %
Edge to Cloud 10 % 9 % 9 % 9 %
Partner Solutions revenue
Partner Solutions revenue decreased $2.1 million or 22% for the three
months ended September 30, 2022 compared to the same period in 2021. Partner
Solutions revenue decreased $2.4 million or 8% for the nine months ended
September 30, 2022 compared to the same period in 2021. The decrease in revenue
for both periods is primarily attributable to lower sales in Asia . It also
reflects that our customers continue to face supply chain issues, have not
continued with new versions of Microsoft products that have reached end of life,
and discounted pricing structures by various Microsoft distributors.
Edge to Cloud revenue
Edge to Cloud revenue decreased $0.2 million or 16% for the three months ended
September 30, 2022 compared to the same period in 2021. The decrease is
primarily due to non-recurring professional services revenue recognized in the
third quarter of 2021.
Edge to Cloud revenue decreased $0.4 million or 14% for the nine months ended
September 30, 2022 compared to the same period in 2021. The
year-over-year decrease is driven by the conclusion of our relationships with
several smaller customers as we have strategically shifted our focus to larger
customers and product development opportunities, partially offset by a large,
one-time revenue recognition event that occurred in June 2022 .
Gross profit and gross margin
Cost of revenue for the Partner Solutions segment consists primarily of embedded
operating system software product costs payable to third-party vendors, net of
rebate credits earned through Microsoft's distributor incentive program. Cost of
revenue for the Edge to Cloud segment consists primarily of salaries, benefits
and re-billable expenses. Gross profit and gross margin were as follows:
Three Months Ended September 30, Nine Months Ended September 30,
(In thousands,
except
percentages) 2022 2021 $ Change % Change 2022 2021 $ Change % Change
Partner
Solutions $ 983 $ 1,147 $ (164 ) (14 )% $ 3,810 $ 3,865 $ (55 ) (1 )%
Partner
Solutions gross
margin 13 % 12 % 1.0 15 % 14 % 1.0
Edge to Cloud $ 152 $ 181 $ (29 ) (16 )% $ 407 $ 248 $ 159 64 %
Edge to Cloud
gross margin 18 % 18 % - 16 % 9 % 8.0
Total gross
profit $ 1,135 $ 1,328 $ (193 ) (15 )% $ 4,217 $ 4,113 $ 104 3 %
Total gross
margin 14 % 13 % 1.0 15 % 13 % 2.0
Partner Solutions gross profit and gross margin
Partner Solutions gross margin rate increased for the three and nine months endedSeptember 30, 2022 compared to the same period in 2021 primarily due to customer and product mix. Partner Solutions gross profit dollars decreased in both the three and nine month periods, commensurate with the revenue decreases in those periods. Partner Solutions gross profit is impacted by rebate credits earned through Microsoft's distributor incentives program. In accordance with program rules, we allocate 50% of the incentive earnings to reduce Partner Solutions cost of revenue with the remaining 50% utilized to offset qualified marketing expenses in the period the expenditures are approved. See Footnote 9 - Significant Risk Concentrations for further information about these rebates.
Edge to Cloud gross profit and gross margin
Edge to Cloud gross profit dollars and gross margin rate for the three months endedSeptember 30, 2022 were essentially flat compared to the same period in 2021. Edge to Cloud gross profit dollars and gross margin rate increased for the nine months endedSeptember 30, 2022 compared to the same period in 2021 driven primarily by decreased costs of revenue. The prior period included amortization expense related to intangible assets that were fully amortized as ofDecember 31, 2021 . 15
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Operating expenses
The following table presents our operating expenses for the periods indicated:
Three Months Ended September 30, Nine Months Ended September 30,
(In thousands,
except
percentages) 2022 2021 $ Change % Change 2022 2021 $ Change % Change
Operating
expenses:
Selling, general
and
administrative $ 2,030 $ 1,786 $ 244 14
259 408 (149 ) (37 ) 776 941 (165 ) (18 )
Total operating
expenses $ 2,289 $ 2,194 $ 95 4 $ 6,971 $ 7,150 $ (179 ) (3 )
As a percentage
of total
revenue:
Selling, general
and
administrative 24 % 17 % 22 % 20 %
Research and
development 3 % 4 % 3 % 3 %
Selling, general and administrative
Selling, general and administrative ("SG&A") expenses consist primarily of
salaries and related benefits, commissions and bonuses for our sales, marketing
and administrative personnel, facilities and depreciation costs, as well as
professional services fees (e.g., consulting, legal, audit and tax). SG&A
expenses for the three months ended September 30, 2022 increased compared to the
same period in 2021 driven by increased marketing costs. SG&A expenses for the
nine months ended September 30, 2022 were essentially flat to the same period in
2021.
Research and development
Research and development ("R&D") expenses consist primarily of salaries and
related benefits for software development and quality assurance personnel,
contractor and consultant costs. R&D expenses decreased for the three and nine
months ended September 30, 2022 compared to the same periods in 2021 primarily
due to increased capitalization of personnel costs partially offset by new
product amortization expense.
Other income (expense), net
Other income (expense), net consists primarily of interest income on our cash
and investments, gains and losses we may recognize on our investments, and gains
and losses on foreign exchange transactions and other items. Other income
(expense), net was essentially flat for the three months ended September 30,
2022 compared to the same period in 2021. The year-over-year decrease for the
nine months ended September 30, 2022 compared to the same period in 2021 is due
to the forgiveness of our Paycheck Protection Program ("PPP") loan in the second
quarter of 2021, which was accounted for as a $1.6 million gain from
extinguishment that did not reoccur in 2022.
Income taxes
Income taxes were not recorded for the quarterly and year-to-date periods ended
Liquidity and Capital Resources
As ofSeptember 30, 2022 , we had$37.1 million of cash, cash equivalents, restricted cash, and short-term investments, reflecting a decrease of$3.0 million fromDecember 31, 2021 . We generally invest our excess cash in high quality marketable investments. These investments typically include corporate notes and bonds, commercial paper, and money market funds, although specific holdings can vary from period to period depending upon our cash requirements. Cash equivalent investments held atSeptember 30, 2022 totaled$11.4 million . We believe that our existing cash and cash equivalents will be sufficient to meet our needs for working capital and capital expenditures for at least the next 12 months.
Cash Flows from Operating Activities
Operating activities used cash of approximately$2.5 million for the nine months endedSeptember 30, 2022 . The operating cash use was driven by the period's net loss of$2.6 million , increased by non-cash adjustments of$0.6 million , and reduced by$0.5 million of changes in working capital items. The largest working capital change was a decrease of deferred revenue, reflecting revenue recognition for which payment had been received in a prior period. Additionally, accounts receivable decreased, reflecting a source of cash for the period. Accounts receivable changes are largely driven by the timing of customer payments.
Cash Flows from Investing Activities
Investing activities used cash of approximately$11.1 million for the nine months endedSeptember 30, 2022 . During the quarter, we invested$10.7 million in treasuries with a maturity date ofDecember 31, 2022 . These are reflected as short-term investments on the balance sheet. The remaining cash used in investing activities relates to additions to our property, plant and equipment in the form of internally-developed software.
Cash Flows from Financing Activities
Financing activities used cash of approximately$0.1 million for the nine months endedSeptember 30, 2022 . Cash use was due to the PSU cash settlement, partially offset by proceeds from the exercise of stock options. 16
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Material cash requirements and sources of liquidity
Cash requirements arising from contractual obligations relate to our office leases. See Footnote 5 - Leases for further information. Other significant cash requirements include software royalties, which become a liability at the point we sell third-party software to our customers, and salary and benefit expenditures related to our personnel. Our sources of liquidity include cash and cash equivalents currently on-hand, short-term investments, and cash generated from operations. We believe that our existing cash, cash equivalents and short-term investments are sufficient to meet our cash requirements for the foreseeable future.
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