Back to GetFilings.com

Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

[X]      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2002

OR

[   ]      TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period from __________ to ____________ .

Commission File Number: 000-27687

BSQUARE CORPORATION
(Exact name of registrant as specified in its charter)

(425) 519-5900
(Registrant’s telephone number, including area code)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [   ].

     As of November 1, 2002, there were 36,860,280 shares of the registrant’s common stock outstanding.

Table of Contents

BSQUARE CORPORATION

FORM 10-Q

For the Quarterly Period Ended September 30, 2002

TABLE OF CONTENTS

2

Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

BSQUARE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)

See notes to condensed consolidated financial statements.

3

Table of Contents

BSQUARE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)

See notes to condensed consolidated financial statements.

4

Table of Contents

BSQUARE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

See notes to condensed consolidated financial statements.

5

Table of Contents

BSQUARE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2002
(unaudited)

1.

Summary of Significant Accounting Policies.

Basis of Presentation

     The condensed consolidated financial statements have been prepared by BSQUARE Corporation (the “Company” or “BSQUARE”) without audit pursuant to the rules and regulations of the Securities and Exchange Commission for interim financial reporting and include the accounts of the Company and its subsidiaries. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. In the opinion of the Company, the unaudited financial statements reflect all adjustments, consisting only of normal recurring adjustments, as well as the accounting changes resulting from the adoption of Statement of Financial Accounting Standards (SFAS) 142, “Goodwill and Other Intangible Assets,” necessary for a fair presentation, in conformity with U.S. generally accepted accounting principles, of the Company’s financial position at September 30, 2002 and its operating results and cash flows for the three and nine months ended September 30, 2002 and 2001. Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses. Examples include provision for bad debts, valuation of long-lived assets and deferred revenue. Actual results may differ from these estimates. Interim results are not necessarily indicative of results for a full year. The information included in this Form 10-Q should be read in conjunction with the Company’s financial statements and notes thereto contained in the Company’s annual report on Form 10-K for the year ended December 31, 2001 filed with the Securities and Exchange Commission. Certain reclassifications have been made for consistent presentation.

2.

Consolidation of Excess Facilities and Restructuring Charge.

     Due to the economic slowdown in the U.S. and international business environment, as well as the reduction in our business with Microsoft, on January 8, 2002, the Company completed a company-wide reduction in workforce of approximately 100 employees, representing approximately 20% of the Company’s total employees at the time, including the closure of the Company’s 25-person professional service engineering facility in Eden Prairie, Minnesota. A restructuring charge of $2.2 million was recorded in the first quarter of 2002 relating to severance and other benefits costs associated with the headcount reduction, facility closure and consolidation costs, and fixed asset impairment, as well as payments for excess facilities under noncancelable leases.

     On July 17, 2002, to further reduce expenses, the Company announced a company-wide reduction in workforce of approximately 30% of the remaining workforce to be completed by December 31, 2002. Approximately 60 employees were involuntarily terminated in the third quarter of 2002, with 50 more to be involuntarily terminated in the fourth quarter of 2002. These reductions resulted in the curtailment of certain research and development initiatives and reductions in the Company’s engineering services, sales, general and administrative departments. In connection with the July 2002 reduction in force, the Company recorded a restructuring charge of $9.9 million during the third quarter of 2002, which included $1.5 million for severance and other benefits paid by the Company, $6.4 million for excess facilities primarily relating to noncancelable leases and early lease termination fees, and $2.0 million of property and equipment that was disposed of or abandoned.

6

Table of Contents

     The restructuring costs and other related charges are summarized as follows (in thousands):

     Included in the charges recorded in the first and third quarters of 2002 were non-cash adjustments of $401,000 and $707,000, respectively, due to changes in estimates and assumptions related to the impact of subleasing excess facilities and the successful negotiation of an early lease termination. Other related charges recorded in the third quarter of 2002 included $2.0 million of impairment losses related to property and equipment that were disposed of or abandoned. In calculating the impairment loss, the Company evaluated the fair value of the assets located in the facilities to be abandoned by estimating the expected present value of their future cash flows. The net lease expense due to the excess capacity of the Company’s facilities will be paid over the respective lease terms through 2005. The Company continues to market its excess space for sublease.

3.

Acquisitions.

     On March 13, 2002, the Company acquired Infogation Corporation (Infogation) in a purchase transaction valued at approximately $8.7 million. Infogation Corporation, located in San Diego, California, was dedicated to the development of on-board and handheld vehicle navigation systems (telematics). Total consideration included the issuance of approximately 1.2 million shares of BSQUARE common stock valued at $3.55 per share, the market price on the date of closing, and approximately $3.9 million in cash. The Company assumed Infogation’s outstanding vested and unvested employee stock options, which were converted into options to acquire approximately 200,000 shares of the Company’s common stock. The fair value of these vested and unvested options were included in the purchase price and recorded as deferred stock compensation. In addition, $300,000 of cash and 129,762 shares of common stock are being held in escrow subject to the indemnification provisions of the merger agreement. The agreement also contains provision for the payment of up to $3.0 million of additional consideration in cash and/or common stock based upon the attainment of certain revenue targets, as defined in the merger agreement. The cash held in escrow is included in restricted cash at September 30, 2002.

     A summary of the purchase price paid in connection with the acquisition of Infogation is as follows (in thousands):

     The purchase price was allocated as follows:

7

Table of Contents

     The excess of consideration paid over the fair value of the net assets acquired was recorded as goodwill and other intangible assets as developed technology. In accordance with generally accepted accounting principles, the amount allocated to in-process research and development was recorded as a charge to expense in the first quarter of 2002 because its technological feasibility had not been established and it had no alternative future use at the date of acquisition.

     The results of operations of Infogation have been included in the Company’s consolidated results beginning March 14, 2002. The following table presents unaudited pro forma results of operations as if the acquisition of Infogation had occurred at the beginning of the periods presented. The unaudited pro forma information is not necessarily indicative of the combined results that would have occurred had the acquisition taken place at the beginning of the periods presented, nor is it necessarily indicative of future results.

     Due to weaker-than-expected demand for telematics products and services, the Company significantly reduced telematics personnel, most of whom joined the Company as a result of the Infogation acquisition. The Company reduced the headcount in the telematics division from 23 employees in March 2002 to 11 employees at the end of the third quarter of 2002 and had plans to make further reductions over the next three months.

     In connection with a potential acquisition, the Company advanced $1.8 million in January 2002 to the target company as a working capital loan. This amount is included in other non-current assets in the accompanying consolidated balance sheet. The Company terminated negotiations for the acquisition and is seeking repayment of the loan, which was guaranteed by an investor in the target company. The Company expects repayment of the loan, but the guarantor has disputed the conditions of the arrangement and therefore the portion of the loan that will ultimately be recovered is not determinable with certainty at this time.

     The Company has made investments in certain equity securities of both publicly-traded and privately-held companies, which are included in “Investments” in the accompanying balance sheets. These investments are accounted for under the cost method as the Company’s ownership is less than 20% and it does not have significant influence. To the extent that the capital stock held is in a public company and the securities have a quoted market price, the carrying value of the investment is adjusted to reflect market value. The Company’s policy is to regularly review the operating performance in assessing the carrying value of investments in privately-held companies. In the three and nine months ended September 30, 2002, the Company recorded a charge of $1.6 million and $3.4 million, respectively, to reflect the permanent impairment in value of these cost-based investments. At September 30, 2002, the carrying value of these investments was $240,000. In addition, under certain conditions, the Company has certain rights to acquire an aggregate of approximately 791,000 additional shares of these entities for additional consideration.

4.

Goodwill and Other Intangible Assets — Adoption of Statement of Financial Accounting Standards (SFAS) No. 142.

     Effective January 1, 2002, the Company adopted SFAS No. 142, which requires companies to discontinue amortizing goodwill and certain intangible assets with an indefinite useful life. SFAS No. 142 requires that goodwill and indefinite life intangible assets be reviewed for impairment upon adoption of the accounting standard and annually thereafter, or more frequently if impairment indicators arise. During the third quarter of 2002 the Company completed its evaluation of goodwill and other intangible assets acquired in prior years, as required. As a result, the Company recorded a retroactive impairment loss of $14.9 million as of January 1, 2002. In addition, due to weaker-than-expected demand for telematics products and services, the Company significantly reduced telematics personnel, most of whom joined the Company through the Infogation acquisition. As a result, the Company evaluated the carrying value of the goodwill and other intangible assets associated with the purchase of Infogation and recognized a $6.5 million

8

Table of Contents

impairment loss in the third quarter of 2002. In calculating these impairment losses, the Company evaluated the fair value of its reporting units by estimating the expected present value of their future cash flows.

     The 2001 results on a historical basis do not reflect the provisions of SFAS No. 142. Had the Company adopted SFAS No. 142 on January 1, 2001, the historical net loss and basic and diluted net loss per common share would have been changed to the adjusted amounts indicated below (in thousands, except per share amounts):

     The effect of the change on the first and second quarters of 2002 is as follows (in thousands, except per share amounts):

     The Company’s intangible assets and related accumulated amortization consisted of the following (in thousands):

     Amortization expense associated with intangible assets and goodwill for the nine months ended September 30, 2002 and 2001 totaled $1.2 million and $4.3 million, respectively. Based on the current amount of intangible assets subject to amortization, the estimated amortization expense for the fourth quarter of 2002 and the years ending December 31, 2003 and 2004 is $146,000, $583,000 and $266,000, respectively.

5.

Comprehensive Income (Loss).

     Comprehensive income (loss) is defined as the change in equity of a company during a period from transactions and other events and circumstances, excluding transactions resulting from investments by owners and distributions to owners. The difference between net loss and comprehensive loss for BSQUARE results from foreign currency translation adjustments and unrealized gains and losses on available-for-sale securities.

9

Table of Contents

     Components of comprehensive income (loss) consist of the following (in thousands):

6.

Income Taxes.

     The Company recorded a provision for federal, state and international income taxes of $2.1 million for the nine months ended September 30, 2002. In the nine months ended September 30, 2002, the Company recorded an additional valuation allowance against all net deferred tax assets due to uncertainty as to the recoverability of these assets.

     In general, prior to 2002, the Company’s effective tax rate had been positively affected by the tax benefit of interest income earned on tax-exempt and tax-advantaged municipal securities held in short-term investments, but had been negatively affected by the non-deductibility of amortization of intangible assets and foreign losses from international operations.

7.

Recent Accounting Pronouncements.

     In April 2002, the Federal Accounting Standards Board, or FASB, issued SFAS No. 145, which rescinds SFAS No. 4, “Reporting Gains and Losses from Extinguishment of Debt,” and amends SFAS No. 64, “Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements.” This statement also rescinds SFAS No. 44, “Accounting for Intangible Assets of Motor Carriers,” and amends SFAS No. 13, “Accounting for Leases.” The Company has evaluated the impact of these changes and does not expect the pronouncement to have a material impact on its consolidated financial position, results of operations or cash flows.

     In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” This statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” This statement requires that a liability for a cost associated with an exit or disposal activity be recognized at fair value when the liability is incurred. We will adopt the provisions of SFAS 146 no later than January 1, 2003. We are currently assessing the impact of this statement on our results of operations, financial position and cash flows.

8.

Commitments and Contingencies.

     The Company leases its office space under non-cancelable operating leases that expire at various dates through 2005. In September 2002, the Company executed an amendment to the terms of the lease for their corporate offices in Bellevue, Washington, which will allow for the surrender of approximately 56,700 square feet of unused office space by the end of 2002 and the remainder of the space as of December 31, 2004, almost five years earlier than the original termination date. To achieve these terms, the Company agreed to pay $4.3 million, of which $1.8 million was paid in September 2002, and the remaining $2.5 million will be paid in quarterly installments through 2004.

     Minimum rental commitments under non-cancelable operating leases at September 30, 2002 are as follows (in thousands):

     During the third quarter of 2002, the Company pledged $5.6 million to a bank as collateral for letters of credit issued to landlords for deposits against these lease commitments. The pledged cash is recorded as restricted cash in the consolidated balance sheets.

10

Table of Contents

     In summer and early fall of 2001, four purported shareholder class action lawsuits were filed in the United States District Court for the Southern District of New York against the Company, certain of the Company’s current and former officers and directors (the “Individual Defendants”), and the underwriters of our initial public offering. The suits purport to be class actions filed on behalf of purchasers of the Company’s common stock during the period from October 19, 1999 to December 6, 2000. The litigation is being coordinated with over 300 nearly-identical actions filed against other companies. The complaints allege that the underwriter defendants agreed to allocate stock in our initial public offering to certain investors in exchange for excessive and undisclosed commissions and agreements by those investors to make additional purchases of stock in the aftermarket at pre-determined prices. Plaintiffs allege that the prospectus for the Company’s initial public offering was false and misleading in violation of the securities laws because it did not disclose these arrangements. They seek damages in an unspecified amount. The complaints against the Company have been consolidated into a single action, and an amended complaint was filed on April 19, 2002. On October 9, 2002, the Court dismissed the Individual Defendants from the case without prejudice based upon Stipulations of Dismissal filed by the plaintiffs and the Individual Defendants. On July 15, 2002, the Company moved to dismiss all claims against it and the Individual Defendants. The Court has not ruled on this motion. The Company intends to defend this action vigorously. However, due to the inherent uncertainties of litigation, the Company cannot accurately predict the ultimate outcome of the litigation. Any unfavorable outcome of litigation could have an adverse impact on our business, financial condition and results of operations.

9.

Subsequent Events

     On October 1, 2002 the Company elected not to renew a $5 million secured revolving line of credit. The line of credit was secured by substantially all the assets of the Company and carried certain other restrictive terms and conditions, with which the Company was in compliance.

     The Company terminated its 1999 Employee Stock Purchase Plan effective October 14, 2002.

11

Table of Contents

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     From time to time, information provided by us, statements made by our employees or information included in our filings with the Securities and Exchange Commission may contain statements that are “forward-looking statements” involving risks and uncertainties. In particular, statements in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” relating to our revenue, profitability, and sufficiency of capital to meet working capital and capital expenditure requirements may be forward-looking statements. The words “expect,” “anticipate,” “plan,” “believe,” “seek,” “estimate” and similar expressions are intended to identify such forward-looking statements. Such statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that could cause our future results to differ materially from those expressed in any forward-looking statements made by or on behalf of us. Many such factors are beyond our ability to control or predict. Readers are accordingly cautioned not to place undue reliance on forward-looking statements. We disclaim any intent or obligation to update any forward-looking statements, whether in response to new information or future events or otherwise. Important factors that may cause our actual results to differ from such forward-looking statements include, but are not limited to, the factors discussed elsewhere in this report in the section entitled “Factors That May Affect Future Results.”

Results of Operations

Overview

     We are a leading provider of software solutions that enable the creation and deployment of a wide variety of smart devices based on the Microsoft Windows-based operating systems. We work with semiconductor vendors and original equipment manufacturers to provide software products and engineering services for the development of smart devices.

     We enable the rapid and low-cost deployment of smart devices by providing a variety of software products and services for the development, integration and deployment of Windows-based operating systems with industry-specific applications. We also develop software applications that are licensed to OEMs to provide smart devices with additional functionality. Our products and services are marketed and supported on a worldwide basis through a direct sales force augmented by distributors.

     To date, we have derived a significant portion of our revenue from services provided to Microsoft, semiconductor vendors and original equipment manufacturers. We also generate product revenue from software sales and royalty licenses and the distribution of third-party product licenses. We perform our services under both time-and-materials contracts and fixed-fee contracts. We also receive a small portion of service revenue from the provision of contract product support services. We sell our software products through our direct sales force and through indirect channels, such as resellers. In addition, we receive license and royalty payments from original equipment manufacturers in connection with the bundling of our software on their smart devices.

Microsoft Master Development and License Agreement

     For the nine months ended September 30, 2002 and 2001, approximately 20% and 40% of our revenue, respectively, was generated under our master development and license agreement with Microsoft (the Master Agreement). Effective July 1, 2001, we renegotiated the Master Agreement, accepting a 10% bill rate reduction, a scheduled reduction in projects and an expiration date of July 2003. As of September 30, 2001, ninety-two engineers were deployed on several projects subject to the Master Agreement compared to six engineers deployed on one project as of September 30, 2002. We bill Microsoft on a time-and-materials basis, although each project has a maximum dollar cap, and recognize revenue generated under the Master Agreement as the services are rendered. The Master Agreement and specific work plan may be modified or terminated by Microsoft at any time. Although we are unable to predict the magnitude and number of future projects for Microsoft, we are committed to playing an important role in supporting Microsoft and its technologies.

12

Table of Contents

     The following table presents certain financial data as a percentage of total revenue for the three- and nine-month periods ended September 30, 2002 and 2001. Our historical operating results are not necessarily indicative of the results for any future period.