Leslie Phillips - Investor Relations Andrew Harries - Executive Chairman Kevin Walsh - Acting CEO Peter Biere - CFO

Ryan Vardeman - Palogic Joe Vidich - Manalapan Oracle Advisers

Please standby, we're about to begin. 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 made 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 over the call over to Andrew Harries, Bsquare Executive Chairman.

Thank you, Leslie, and good afternoon, everyone. As most of you know I've been the Chairman of the Bsquare's Board of Directors for the last five 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 that 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 our 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 refocus strategy for DataV as well as priorities for the remainder of the year. In the fourth quarter of 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 data of DataV pilot conducted during the fourth quarter of 2017. Today, we announced that same customer has signed the associated DataV SaaS agreement. We expect the 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 in 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 three priorities for the remainder of the year. Our number one 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 half are unlikely to proceed within the next 12 months. To our knowledge we do not lose these potential customers to competing IoT solutions. Looking back at on our productivity 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 pilot signed but rather we'll focus 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 deployment. 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. Our key part of this strategy is lowering our customer acquisition costs made possible through collaboration with Amazon Web Services and Microsoft. In the current quarter we made progress to this end and solidify 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. Our breakdown that changes by revenue grouping; third-party software revenue was $16.1 million lower compared to Q4 2017 which reflected heavier customer purchases before year-end. Year-over-year third-party revenue decline 4%. 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 lost 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 we'll 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 on our Itron contract. This value represents two years of the five-year license revenue and we expect to recognize remaining 2 million of this license revenue annually in quarter four over each of the contracts remaining three years. First quarter proprietary software revenue increase sequentially due to the Itron revenue recognition, proprietary software decline $0.8 million compared to Q1 of 2017 as we recognize 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 reach their final delivery points, 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 services 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, primarily driven by shift in our revenue mix. Higher-margin proprietary software revenue was 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 from $1.5 million in quarter one of 2017 and down 235,000 from quarter four of 2017. The increase from the prior year reflects our investment during 2017 and 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 part of our sharpening and 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 one-time 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 quarter 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 total $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 the timing of DataV payments received in quarter four, as well as seasonally driven operating expense payments in quarter one of 2018. Our accounts receivable balance totaled approximately 18 million at March 31, 2018 about $9.1 million which is due from Honeywell. We extend 270 day terms to Honeywell. Net of payments due to Microsoft approximately $7.6 million of those 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 a net loss reflecting moderate investments to grow DataV and one-time realignment costs partially offset by reduced marketing, sales and administrative costs/ Moderator, please open the call for questions.

Thank you. [Operator Instructions] We will take our first question from Ryan Vardeman with Palogic. Please go ahead.

Hi, guys. Thank you for taking my questions. 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 four pilots and then five in Q3 and seven in Q4, so they vary – the vintage of the pilots vary, but that's when they were initiated.

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

Actually we don't have that information. Peter, do you?

Well, I think at our fingertips. I think its vary Ryan, but most of the pilots that are still active with the chance to convert were later in the year.

Okay. That's helpful.

I wouldn't say that's a 100% of them, but most of them were later.

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

I'd say, the one that we converted this quarter is on the larger end.

Okay. I think that does it from me now. Thank you.

Okay. Thank you, Ryan.

Thank you. We'll go next to Joe Vidich with Manalapan Oracle Advisers. Please go ahead.

Yes. Hello guys. I guess question I have is, do you have a number for what you currently your annualized DataV revenues are?

So, let's see how we 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 three major customers we've announced; the PACCAR licenses is perpetual and so it's a one-time 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 the subscription, but because of its nature we recognize that subscription and the chunk every year. And so we had 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 potential to scale, but they are buying perpetual licenses based on the number of machines that they operate in. And so heretofore it's been your 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 a $0.5 million per year. So it at least gives you an idea of the few that we booked what that looks like and we would hope that and believe that most of these licenses that we sell the future will be subscription or SaaS based.

Okay. And I wasn't quite sure if I caught this one 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 forecasts of that. What we said was about half 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're alive. And by the way some of the customers that did not convert we had some successful pilots so there's 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 cost?

Well, they're paid engagements. They pay for the services they consume and they pay for the license while their pilots underway and pilots turn 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 was announced in the prior earnings call or co-funded by either AWS or Microsoft.

Right. Okay, great. I appreciate it and good luck.

Great. Thank you.

Thank you. We'll go next to Jason Jones, who's a Private Investor. Please go ahead.

Yes. Thank you. So, the tally I have 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 hold that over the last couple of years is underwater. So at this stage is there anything positive going on? Is there anything good news?

Let me tackle that Jason. I mean, one we did announced today, a pretty significant SaaS contract with a Fortune 100 firm that is the largest in that segment, so we do that as good news. Regarding the pilots we didn't say they're worthless. We said that roughly half we didn't 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 – you said reduced marketing, but I'm sure more broadly I mean, they 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, this 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 the embedded base. So we view all those as positive indications and are optimistic going forward.

Thank you. We'll take our next question from Steven Libo, he's a Private Investor. Please go ahead.

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

Well, we previously said that we had a services arrangement for this contract which was approaching a $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 or how quickly that take, but we believe it scale, there's a $0.5 million of annual subscription or under the SaaS license.

Yes. So, its $0.5 million of the year, right? Jerry Chase had mentioned early this year that BSQR was expecting a significant contract and he was also asked whether the return on investment on all the DataV investment, would it bear fruit? And he had confidently said that the return on investments would be many times over that investment that were 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 the Fortune 100 Company that was announced today?

Yes. It is that contract.

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 million a year, and looking at all of the losses that you're reporting quarter over quarter losses that's amount to $3 million per quarter. I think, is this a joke? I can't understand this. I mean if you're referring to significant contract and then you're reporting just $0.5 million a year for a SaaS revenue and considering all the cost that's involved, how can it be a profitable contract?

So couple of things keep in mind there. A, if you look at the industry of industrial Internet of things and SaaS offerings and using that is a benchmark, $500,000 a year is quite significant. From a margin standpoint, from a gross margin standpoint, Peter can speak to this more eloquent, but I can't. But there's little of any 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 is 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 has been published by analyst firms that the market while it has great promise has matured more slowly than any of us had hoped for. Just the reality that we have to deal with and its 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 standpoints. So we believe we're getting through that that starting period of customers understanding what they can do with this and are optimistic that that this contract as I said is emblematic of what we'll see in the future.

Thank you. We will take our final question from Ryan Vardeman with Palogic. Please go ahead.

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

Well, so part of what I just talked about is closely uniting ourselves with our key [common] partners and by the way we didn't mentioned this, but I think most people know that almost all of these implementations from any vendor are call based implementation. So I'm being partnered with the two largest classifiers in the world is important for us. So it does reduce a lot of those costs associated with that brings us a better deal flow. The other aspect, I mean, I think we refer to a three or four 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 we're 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 squarely within that you gave 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 precede predictive exercises of one type or another. In IoT device management there's not of that complexity. So we believe that that we can proceed much much more quickly and significantly less expensively from customer engagement into full production.

Thank you.

That concludes 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.