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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
COMMISSION FILE NUMBER 000-27687
BSQUARE CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
WASHINGTON 91-1650880
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
3150 -- 139TH AVENUE NE, SUITE 500
BELLEVUE, WASHINGTON 98005-4081
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(425) 519-5900
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, NO PAR VALUE
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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of voting stock of the registrant held by
non-affiliates of the registrant as of February 28, 2001 was approximately
$142.7 million based on the closing sales price of the registrant's common stock
as reported on The Nasdaq National Market. For the purposes of this response,
executive officers, directors and persons who own 5% or more of the outstanding
shares of common stock are deemed to be affiliates of the registrant. This
determination of affiliate status is not necessarily a conclusive determination
for any other purpose. The registrant had 34,019,063 shares of common stock, no
par value, outstanding at February 28, 2001.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive proxy statement to be delivered to shareholders
in connection with the annual meeting of shareholders to be held on April 30,
2001 are incorporated by reference into Part III of this Form 10-K.
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BSQUARE CORPORATION
FORM 10-K
TABLE OF CONTENTS
PAGE
----
PART I.................................................................... 3
Item 1. Business.................................................... 3
Item 2. Properties.................................................. 24
Item 3. Legal Proceedings........................................... 24
Item 4. Submission of Matters to a Vote of Security Holders......... 24
PART II................................................................... 25
Item 5. Market for Registrant's Common Equity and Related
Shareholder Matters......................................... 25
Item 6. Selected Financial Data..................................... 26
Item 7. Management's Discussion and Analysis of Results of
Operations and Financial Condition.......................... 27
Item Quantitative and Qualitative Disclosures About Market
7A. Risk........................................................ 33
Item 8. Financial Statements and Supplementary Data................. 35
Item 9. Changes in and Disagreements with Accountants on Auditing
and Financial Disclosure.................................... 57
PART III.................................................................. 57
Item Directors and Executive Officers of the Registrant.......... 57
10.
Item Executive Compensation...................................... 57
11.
Item Security Ownership of Certain Beneficial Owners and
12. Management.................................................. 57
Item Certain Relationships and Related Transactions.............. 57
13.
PART IV................................................................... 58
Item Exhibits, Financial Statement Schedules and Reports on Form
14. 8-K......................................................... 58
............................................................ 60
Signatures
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PART I
ITEM 1. BUSINESS
FORWARD-LOOKING STATEMENTS
This Form 10-K and the documents incorporated herein by reference contain
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934 based on
current expectations, estimates and projections about our industry and our
management's beliefs and assumptions. When used in this Form 10-K and elsewhere,
the words "believes," "plans," "estimates," "intends," "anticipates," "seeks"
and "expects" and similar expressions are intended to identify forward-looking
statements. 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 are subject to certain risks and
uncertainties that are difficult to predict. Accordingly, actual results may
differ materially from those anticipated or expressed in such statements.
Particular attention should be paid to the cautionary statements contained in
this Form 10-K under "Risk Factors" involving potential fluctuations in our
quarterly operating results, our reliance on Microsoft, uncertainty about the
Windows CE market, unpredictability of future revenue, the intensely competitive
nature of our industry, our ability to protect our intellectual property rights,
management of growth, the integration of any future acquisitions and our
reliance on third parties, manufacturers, distributors and suppliers. 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. Readers, however, should carefully
review the factors set forth in this and other reports or documents that we file
from time to time with the Securities and Exchange Commission.
RISK FACTORS
In addition to other information in this Form 10-K report, investors
evaluating our business and us should carefully consider the following risk
factors. These risks may impair our operating results and business prospects and
the market price of our stock. The risks set forth below and elsewhere in this
Form 10-K report could cause actual results to differ materially from those
projected.
UNANTICIPATED FLUCTUATIONS IN OUR QUARTERLY OPERATING RESULTS DUE TO FACTORS
SUCH AS ADVERSE CHANGES IN OUR RELATIONSHIP WITH MICROSOFT OR A DECLINE IN THE
MARKET FOR WINDOWS-BASED INTELLIGENT COMPUTING DEVICES COULD CAUSE OUR STOCK
PRICE TO DECLINE SIGNIFICANTLY.
Our operating results have fluctuated in the past, and we expect that they
will continue to do so. We believe that period-to-period comparisons of our
operating results are not meaningful, and you should not rely on such
comparisons to predict our future performance. If our operating results fall
below the expectations of stock analysts and investors, the price of our common
stock may fall. Factors that may cause our quarterly operating results to
fluctuate include:
- the failure or perceived failure of Windows CE, the operating system upon
which demand for the majority of our products and services is dependent,
to achieve widespread market acceptance;
- the failure of the intelligent computing device market to develop;
- adverse changes in our relationship with Microsoft, from which a
substantial portion of our revenue is generated and on which we rely to
continue to develop and promote Windows CE;
- our inability to develop and market new and enhanced products and
services on a timely basis;
- unanticipated delays, or announcement of delays, by Microsoft of Windows
product releases, which could cause us to delay our product introductions
and adversely affect our customer relationships;
- changes in demand for our products and services;
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- increased competition and changes in our pricing as a result of increased
competitive pressure;
- our ability to control our expenses, a large portion of which are
relatively fixed and which are budgeted based on anticipated revenue
trends, in the event that customer projects, particularly Microsoft
projects, are delayed, curtailed or discontinued;
- changes in the mix of our services and product revenue, which have
different gross margins;
- underestimates by us of the costs to be incurred in significant fixed-fee
service projects; and
- varying customer buying patterns which are often influenced by year-end
budgetary pressures.
In addition, our stock price may fluctuate due to conditions unrelated to
our operating performance, including general economic conditions in the software
industry and the market for technology stocks.
THE MAJORITY OF OUR REVENUE, INCLUDING 58% OF OUR TOTAL REVENUE FOR THE YEAR
ENDED DECEMBER 31, 2000, IS GENERATED FROM OUR RELATIONSHIP WITH MICROSOFT,
WHICH CAN BE MODIFIED OR TERMINATED BY MICROSOFT AT ANY TIME.
For the years ended December 31, 1999 and 2000, approximately 85% and 58%
of our revenue, respectively, was generated under our master development and
license agreement with Microsoft. The master agreement, the current term of
which concludes in July 2001, includes a number of project-specific work plans.
We anticipate that the agreement will be extended. We bill Microsoft on a
time-and-materials basis, although each project has a maximum dollar cap. We
expect the revenue generated from work plans with Microsoft will continue to
comprise the majority of our revenue for the next several years. We presently
have dedicated approximately 126 of our 397 engineers to these projects.
However, the master agreement and each of the individual work plans may be
terminated or modified by Microsoft at any time. In addition, there is no
guarantee that Microsoft will continue to enter into additional work plans with
us. In the past, Microsoft has modified the timing and scope of certain
projects, requesting that our engineers be moved from one project to another.
For example, in late 1997 Microsoft decided to contract with us to provide
Windows CE support services to semiconductor vendors with whom we had previously
contracted directly. As a result, from late 1997 through late 1998 our revenue
shifted from being generated by a variety of semiconductor vendors to being
generated primarily by Microsoft. We do not believe that we could replace the
Microsoft revenue in the short- or medium-term if existing work plans were
canceled or curtailed, and such cancellations or curtailments would
substantially reduce our revenue. Microsoft is a publicly traded company that
files financial reports and information with the Securities and Exchange
Commission. These reports are publicly available under Microsoft's Exchange Act
filing number, 000-14278.
IF THE MARKET FOR THE WINDOWS CE OPERATING SYSTEM FAILS TO DEVELOP FULLY OR
DEVELOPS MORE SLOWLY THAN WE EXPECT, OUR BUSINESS AND OPERATING RESULTS WILL BE
MATERIALLY HARMED.
Windows CE is one of many operating systems developed for the intelligent
computing device market and the extent of its future acceptance is uncertain.
Because the majority of our revenue for 1999 and 2000 has been generated by
software products and services dependent on the Windows CE operating system, if
the market for Windows CE fails to develop fully or develops more slowly than we
expect, our business and operating results will be significantly harmed. Market
acceptance of Windows CE will depend on many factors, including:
- Microsoft's development and support of the Windows CE market. As the
developer and primary promoter of Windows CE, if Microsoft were to decide
to discontinue or lessen its support of the Windows CE operating system,
potential customers could select competing operating systems, which would
reduce the demand for our Windows CE-based software products and
services;
- the ability of the Windows CE operating system to compete against
existing and emerging operating systems for the intelligent computing
device market including: VxWorks and pSOS from WindRiver Systems Inc.,
VRTX from Mentor Graphics Corporation, JavaOS from Sun Microsystems, Inc.
and Linux. In particular, in the market for palm-size devices, Windows CE
faces intense competition from
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PalmOS from Palm Incorporated, and to date has had limited success in
this market. In the market for cellular phones, Windows CE faces intense
competition from the EPOC operating system from Symbian, a joint venture
among several of the largest manufacturers of cellular phones. Windows CE
may be unsuccessful in capturing a significant share of these two
segments of the intelligent computing device market, or in maintaining
its market share in those other segments of the intelligent computing
device market on which our business currently focuses, including the
markets for Internet-enabled television set-top boxes, handheld
industrial devices, consumer Internet appliances such as kiosk terminals
and vehicle navigational devices, and Windows-based terminals;
- the acceptance by original equipment manufacturers and consumers of the
mix of features and functions offered by Windows CE; and
- the willingness of software developers to continue to develop and expand
the applications that run on Windows CE. To the extent that software
developers write applications for competing operating systems that are
more attractive to intelligent computing device end users than those
available on Windows CE, potential purchasers could select competing
operating systems over Windows CE.
IF THE MARKET FOR INTELLIGENT COMPUTING DEVICES FAILS TO DEVELOP FULLY OR
DEVELOPS MORE SLOWLY THAN WE EXPECT, OUR REVENUE WILL NOT GROW AS FAST AS
ANTICIPATED, IF AT ALL.
The market for intelligent computing devices is emerging and the potential
size of this market and the timing of its development are not known. As a
result, our profit potential is uncertain and our revenue may not grow as fast
as we anticipate, if at all. We are dependent upon the broad acceptance by
businesses and consumers of a wide variety of Windows-based intelligent
computing devices, which will depend on many factors, including:
- the development of content and applications for intelligent computing
devices;
- the willingness of large numbers of businesses and consumers to use
devices such as handheld and palm-size PCs and handheld industrial data
collectors to perform functions currently carried out manually or by
traditional PCs, including inputting and sharing data, communicating
among users and connecting to the Internet; and
- the evolution of industry standards that facilitate the distribution of
content over the Internet to these devices via wired and wireless
telecommunications systems, satellite or cable.
IF MICROSOFT ADDS FEATURES TO ITS WINDOWS OPERATING SYSTEM THAT DIRECTLY COMPETE
WITH SOFTWARE PRODUCTS AND SERVICES WE PROVIDE, OUR REVENUE COULD BE REDUCED AND
OUR PROFIT MARGINS COULD SUFFER.
As the developer of Windows, Microsoft could add features to its operating
system that directly compete with the software products and services we provide
to our customers. Such features could include, for example, faxing,
hardware-support packages and quality-assurance tools. The ability of our
customers or potential customers to obtain software products and services
directly from Microsoft that compete with our software products and services
could harm our business. Even if the standard features of future Microsoft
operating system software were more limited than our offerings, a significant
number of our customers and potential customers might elect to accept more
limited functionality in lieu of purchasing additional software. Moreover, the
resulting competitive pressures could lead to price reductions for our products
and reduce our profit margins.
IF WE DO NOT MAINTAIN OUR FAVORABLE RELATIONSHIP WITH MICROSOFT, WE WILL HAVE
DIFFICULTY MARKETING OUR SOFTWARE PRODUCTS AND SERVICES AND MAY NOT RECEIVE
DEVELOPER RELEASES OF WINDOWS CE, AND OUR REVENUE AND OPERATING MARGINS WILL
SUFFER.
In the event that our relationship with Microsoft were to deteriorate, then
our efforts to market and sell our software products and services to original
equipment manufacturers could be adversely affected and our business would be
harmed. Microsoft has great influence over the development plans and buying
decisions of original equipment manufacturers utilizing Windows CE for
intelligent computing devices. Microsoft refers
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many of our original equipment manufacturer customers to us. Moreover, Microsoft
controls the marketing campaigns related to its operating systems, including
Windows CE. Microsoft's marketing activities, including trade shows, direct mail
campaigns and print advertising, are important to the continued promotion and
market acceptance of Windows CE and, consequently, of our Windows CE-based
software products and services. We must maintain mutually successful
relationships with Microsoft so that we may continue to participate in joint
marketing activities with Microsoft, including participating in "partner
pavilions" at trade shows and listing our services on Microsoft's website, and
to receive referrals from Microsoft. In the event that we are unable to continue
our joint marketing efforts with Microsoft or fail to receive referrals from
Microsoft, we would be required to devote significant additional resources and
incur additional expenses to market our software products and services directly
to potential customers. In addition, we depend on receiving from Microsoft
developer releases of new versions of and upgrades to Windows CE and related
Microsoft software in order to timely develop and ship our products and provide
services. If we are unable to receive these developer releases, our revenue and
operating margins would suffer.
UNANTICIPATED DELAYS, OR ANNOUNCEMENT OF DELAYS, BY MICROSOFT OF WINDOWS CE
PRODUCT RELEASES COULD ADVERSELY AFFECT OUR SALES.
Unanticipated delays, or announcement of delays, in Microsoft's delivery
schedule for new versions of its Windows CE operating system could cause us to
delay our product introductions and impede our ability to complete customer
projects on a timely basis. These delays or announcements by Microsoft of delays
could also cause our customers to delay or cancel their project development
activities or product introductions. Any resulting delays in, or cancellations
of, our planned product introductions or in our ability to commence or complete
customer projects may adversely affect our revenue and could cause our quarterly
operating results to fluctuate. For example, in 1998 Microsoft delayed the
release of a version of its Windows CE Platform Builder, which delayed our
introduction of a complementary product for an original equipment manufacturer
customer.
OUR MARKET IS BECOMING INCREASINGLY COMPETITIVE, WHICH MAY RESULT IN PRICE
REDUCTIONS, LOWER GROSS MARGINS AND LOSS OF MARKET SHARE.
The market for Windows-based software products and services is becoming
increasingly competitive. In addition, competition is intense for the business
of the limited number of original equipment manufacturer customers that are
capable of building and shipping large quantities of intelligent computing
devices. Increased competition may result in price reductions, lower gross
margins and loss of market share, which would harm our business. We face
competition from:
- our current and potential customers' internal research and development
departments that may seek to develop their own proprietary solutions;
- professional engineering services firms;
- established intelligent computing device software and tools vendors; and
- software and component distributors.
As we develop new products, particularly products focused on specific
industries, we may begin competing with companies with whom we have not
previously competed. It is also possible that new competitors will enter the
market or that our competitors will form alliances, including alliances with
Microsoft, that may enable them to rapidly increase their market share.
Microsoft has not agreed to any exclusive arrangement with us nor has it agreed
not to compete with us. The barrier to entering the market as a provider of
Windows-based intelligent computing device software and services is low. In
addition, Microsoft has created a marketing program to encourage systems
integrators to work on Windows. These systems integrators are given the same
access by Microsoft to the Windows technology as we are. New competitors may
have lower overhead than us and may therefore be able to offer advantageous
pricing. We expect that competition will increase as other established and
emerging companies enter the Windows-based intelligent computing device market
and as new products and technologies are introduced.
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IF WE FAIL TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, COMPETITORS
MAY BE ABLE TO USE OUR TECHNOLOGY OR TRADEMARKS, WHICH COULD WEAKEN OUR
COMPETITIVE POSITION, REDUCE OUR REVENUE AND INCREASE OUR COSTS.
If we fail to adequately protect our intellectual property, our competitive
position could be weakened and our revenue adversely affected. We rely primarily
on a combination of patent, copyright, trade secret and trademark laws,
confidentiality procedures and contractual provisions to protect our
intellectual property. These laws and procedures provide only limited
protection. We have applied for a number of patents relating to our engineering
work. These patents, if issued, may not provide sufficiently broad protection or
they may not prove to be enforceable against alleged infringers. There can be no
assurance that any of our pending patents will be granted. Even if granted,
these patents may be circumvented or challenged and, if challenged, may be
invalidated. Any patents obtained may provide limited or no competitive
advantage to us. It is also possible that another party could obtain patents
that block our use of some, or all, of our products and services. If that
occurred, we would need to obtain a license from the patent holder or design
around their patent. The patent holder may or may not choose to make a license
available to us at all or on acceptable terms. Similarly, it may not be possible
to design around such a blocking patent.
In general, there can be no assurance that our efforts to protect our
intellectual property rights through patent, copyright, trade secret and
trademark laws will be effective to prevent misappropriation of our technology,
or to prevent the development and design by others of products or technologies
similar to or competitive with those developed by us. We frequently license the
source code of our products and the source code results of our services to
customers. There can be no assurance that customers with access to our source
code will comply with the license terms or that we will discover any violations
of the license terms or, in the event of discovery of violations, that we will
be able to successfully enforce the license terms and/or recover the economic
value lost from such violations. To license many of our software products, we
rely in part on "shrinkwrap" and "clickwrap" licenses that are not signed by the
end user and, therefore, may be unenforceable under the laws of certain
jurisdictions. As with other software products, our products are susceptible to
unauthorized copying and uses that may go undetected, and policing such
unauthorized use is difficult.
A significant portion of our marks include the word "BSQUARE" or the
preface "b." Other companies use forms of "BSQUARE" or the preface "b" in their
marks alone or in combination with other words, and we cannot prevent all such
third-party uses. We license certain trademark rights to third parties. Such
licensees may not abide by our compliance and quality control guidelines with
respect to such trademark rights and may take actions that would harm our
business.
The computer software market is characterized by frequent and substantial
intellectual property litigation, which is often complex and expensive, and
involves a significant diversion of resources and uncertainty of outcome.
Litigation may be necessary in the future to enforce our intellectual property
or to defend against a claim of infringement or invalidity. Litigation could
result in substantial costs and the diversion of resources and could harm our
business and operating results.
THIRD PARTIES COULD ASSERT THAT OUR SOFTWARE PRODUCTS AND SERVICES INFRINGE
THEIR INTELLECTUAL PROPERTY RIGHTS, WHICH COULD EXPOSE US TO ADDITIONAL COSTS
AND LITIGATION.
Third parties may claim that our current or future software products and
services infringe their proprietary rights, and these claims, regardless of
their merit, could increase our costs and harm our business. We have not
conducted patent searches to determine whether the technology used in our
products infringes patents held by third parties. In addition, it is difficult
to determine whether our software products and services infringe third-party
intellectual property rights, particularly in a rapidly evolving technological
environment in which there may be numerous patent applications pending, many of
which are confidential when filed, with regard to similar technologies. If we
were to discover that one of our software products violated a third party's
proprietary rights, we may not be able to obtain a license on commercially
reasonable terms, or at all, to continue offering that software product.
Moreover, any indemnification we obtain against claims that the technology we
license from third parties infringes the proprietary rights of others may not
always be available
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or may be limited in scope or amount. Even if we receive broad third-party
indemnification, these indemnitors may not have the financial capability to
indemnify us in the event of infringement. In addition, in some circumstances we
could be required to indemnify our customers for claims made against them that
are based on our solutions.
There can be no assurance that infringement or invalidity claims related to
the software products and services we provide or arising from the incorporation
by us of third-party technology, and claims for indemnification from our
customers resulting from such claims, will not be asserted or prosecuted against
us. We expect that software product developers will be increasingly subject to
infringement claims, as the number of products and competitors in the software
industry grows and the functionality of products in different industry segments
overlaps. Such claims, even if not meritorious, could result in the expenditure
of significant financial and managerial resources in addition to potential
product redevelopment costs and delays.
IF WE DO NOT RESPOND ON A TIMELY BASIS TO TECHNOLOGICAL ADVANCES AND EVOLVING
INDUSTRY STANDARDS, OUR FUTURE PRODUCT SALES COULD BE NEGATIVELY IMPACTED.
The market for Windows-based embedded products and services is new and
evolving. As a result, the life cycles of our products are difficult to
estimate. To be successful, we must continue to enhance our current product line
and develop new products. We have experienced delays in enhancements and new
product release dates in the past and may be unable to introduce enhancements or
new products successfully or in a timely manner in the future. Our business may
be harmed if we must delay releases of our products and product enhancements or
if these products and product enhancements fail to achieve market acceptance
when released. In addition, our customers may defer or forego purchases of our
products if we, Microsoft, our competitors or major hardware, systems or
software vendors introduce or announce new products or product enhancements.
Such deferrals or failures to purchase would decrease our revenue.
WE CANNOT ASSURE YOU THAT OUR REVENUE GROWTH RATE WILL NOT DECLINE OR THAT WE
WILL BE ABLE TO SUSTAIN OR INCREASE OUR PROFITABILITY.
The rate of growth of our revenue over the prior year was 63% from 1997 to
1998, 60% from 1998 to 1999, and 53% from 1999 to 2000. The rate of growth of
our revenue over prior periods may continue to decline. We anticipate that our
expenses will increase substantially in the foreseeable future as we continue to
develop our technology and expand our product and service offerings. These
efforts may prove more expensive than we currently anticipate, and we may not
succeed in increasing our revenue sufficiently to offset these higher expenses.
If we fail to increase our revenue to keep pace with our expenses, we may
experience losses.
IF WE ARE UNABLE TO MANAGE OUR GROWTH OUR BUSINESS WILL SUFFER.
Our rapid growth has placed, and is expected to continue to place, a
significant strain on our managerial, technical, operational and financial
resources. From August 1996 to December 31, 2000, we grew from 21 employees to
501 employees, and we expect rapid growth to continue for the foreseeable
future. To manage our growth, we must implement additional management
information systems, further develop our operational, administrative and
financial systems and expand, train and manage our work force. We will also need
to manage an increasing number of complex relationships with customers,
marketing partners and other third parties. We cannot guarantee that our
systems, procedures or controls will be adequate to support our current or
future operations or that our management will be able to effectively manage our
expansion. Our failure to do so could seriously harm our ability to deliver
products and services in a timely fashion, fulfill existing customer commitments
and attract and retain new customers.
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OUR INTERNATIONAL OPERATIONS EXPOSE US TO GREATER INTELLECTUAL PROPERTY,
MANAGEMENT, COLLECTIONS, REGULATORY AND OTHER RISKS.
In late 1998 we opened offices in Munich, Germany and Tokyo, Japan. For the
year ended December 31, 2000, approximately 3% of our total revenue was
generated by our international offices. Our international operations expose us
to a number of risks, including the following:
- greater difficulty in protecting intellectual property due to less
stringent foreign intellectual property laws and enforcement policies;
- greater difficulty in managing foreign operations due to the lack of
proximity between our home office and our foreign operations;
- longer collection cycles in Japan than we typically experience in the
U.S.;
- unfavorable changes in regulatory practices and tariffs;
- adverse changes in tax laws;
- seasonal European sales declines in the summer months;
- the impact of fluctuating exchange rates between the U.S. dollar and
foreign currencies; and
- general economic and political conditions in Asian and European markets.
These risks could have a material adverse effect on the financial and
managerial resources required to operate our foreign offices, as well as on our
future international revenue, which could harm our business.
RECENT AND FUTURE ACQUISITIONS COULD PROVE DIFFICULT TO INTEGRATE, DISRUPT OUR
BUSINESS, DILUTE SHAREHOLDER VALUE AND ADVERSELY AFFECT OUR OPERATING RESULTS.
During the year ended December 31, 2000, we acquired BlueWater Systems,
Inc. and Mainbrace Corporation, among others, and we may acquire or make
investments in complementary companies, services and technologies in the future.
If we fail to properly evaluate, execute and integrate acquisitions and
investments, including these recent acquisitions, our business and prospects may
be seriously harmed. To successfully complete an acquisition, we must properly
evaluate the technology, accurately forecast the financial impact of the
transaction, including accounting charges and transaction expenses, integrate
and retain personnel, combine potentially different corporate cultures and
effectively integrate products and research and development, sales, marketing
and support operations. If we fail to do any of these, we may suffer losses and
impair relationships with our employees, customers and strategic partners, and
our management may be distracted from our day-to-day operations. We also may be
unable to maintain uniform standards, controls, procedures and policies, and
significant demands may be placed on our management and our operations,
information services and financial, legal and marketing resources. Finally,
acquired businesses sometimes result in unexpected liabilities and contingencies
which could be significant. In addition, acquisitions using debt or equity
securities dilute the ownership of existing shareholders, which could affect the
market price of our stock.
IF WE ARE UNABLE TO LICENSE KEY SOFTWARE FROM THIRD PARTIES OUR BUSINESS COULD
BE HARMED.
We often integrate third-party software with our internally developed
software to provide software products and services for our original equipment
manufacturer customers. If our relationships with our third-party vendors were
to deteriorate, we might be unable to obtain licenses on commercially reasonable
terms, if at all, for newer versions of their software required to maintain
compatibility. In the event that we are unable to obtain additional licenses, we
would be required to develop this technology internally, which could delay or
limit our ability to introduce enhancements or new products or to continue to
sell existing products.
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OUR SOFTWARE PRODUCTS OR THE THIRD-PARTY HARDWARE OR SOFTWARE INTEGRATED WITH
OUR SOFTWARE PRODUCTS AND SERVICES MAY SUFFER FROM DEFECTS OR ERRORS THAT COULD
IMPAIR OUR ABILITY TO SELL OUR SOFTWARE PRODUCTS AND SERVICES.
Software and hardware components as complex as those needed for intelligent
computing devices frequently contain errors or defects, especially when first
introduced or when new versions are released. We have had to delay commercial
release of certain versions of our software products until software problems
were corrected, and in some cases have provided product enhancements to correct
errors in released products. Some of our contracts require us to repair or
replace products that fail to work. To the extent that we repair or replace
products our expenses may increase, resulting in a decline in our gross margins.
In addition, it is possible that by the time defects are fixed the market
opportunity may have been missed which may result in lost revenue. Moreover,
errors that are discovered after commercial release could result in loss of
revenue or delay in market acceptance, diversion of development resources,
damage to our reputation or increased service and warranty costs, all of which
could harm our business.
WE MAY BE SUBJECT TO PRODUCT LIABILITY CLAIMS THAT COULD RESULT IN SIGNIFICANT
COSTS.
Our license agreements with our customers typically contain provisions
designed to limit our exposure to potential product liability claims. It is
possible, however, that these provisions may be ineffective under the laws of
certain jurisdictions. Although we have not experienced any product liability
claims to date, the sale and support of our software products and services
entail the risk of such claims and we may be subject to such claims in the
future. A product liability claim brought against us, whether successful or not,
could harm our business and operating results.
THE LENGTHY SALES CYCLE OF OUR PRODUCTS AND SERVICES MAKES OUR REVENUE
SUSCEPTIBLE TO FLUCTUATIONS.
Our sales cycle is typically three to six months because the expense and
complexity of our products and services generally require a lengthy customer
approval process, and may be subject to a number of significant risks over which
we have little or no control, including:
- customers' budgetary constraints and internal acceptance review
procedures;
- the timing of budget cycles; and
- the timing of customers' competitive evaluation processes.
In addition, to successfully sell our products and services, we frequently
must educate our potential customers about the full benefits of our products and
services, which can require significant time. If our sales cycle lengthens
unexpectedly, it could adversely affect the timing of our revenue which could
cause our quarterly results to fluctuate.
THE VOLATILITY OF THE STOCK MARKETS COULD ADVERSELY AFFECT OUR STOCK PRICE.
Stock markets are subject to significant price and volume fluctuations
which may be unrelated to the operating performance of particular companies, and
the market price of our common stock may therefore frequently change. The market
price of our common stock could also fluctuate substantially due to a variety of
other factors, including quarterly fluctuations in our results of operations,
our ability to meet analysts' expectations, adverse circumstances affecting the
introduction and market acceptance of new products and services offered by us,
announcements of new products and services by competitors, changes in the
information technology environment, changes in earnings estimates by analysts,
changes in accounting principles, sales of our common stock by existing holders
and the loss of key personnel.
A SMALL NUMBER OF OUR EXISTING SHAREHOLDERS CAN EXERT CONTROL OVER US.
Our executive officers, directors and principal shareholders holding more
than 5% of our common stock together control a majority of our outstanding
common stock. As a result, these shareholders, if they act together, could
control our management and affairs of the company and all matters requiring
shareholder
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approval, including the election of directors and approval of significant
corporate transactions. This concentration of ownership may have the effect of
delaying or preventing a change in control of us and might affect the market
price of our common stock.
IT MIGHT BE DIFFICULT FOR A THIRD PARTY TO ACQUIRE US EVEN IF DOING SO WOULD BE
BENEFICIAL TO OUR SHAREHOLDERS.
Certain provisions of our amended and restated articles of incorporation,
bylaws and Washington law may discourage, delay or prevent a change in the
control of us or a change in our management even if doing so would be beneficial
to our shareholders. Our board of directors has the authority under our amended
and restated articles of incorporation to issue preferred stock with rights
superior to the rights of the holders of common stock. As a result, preferred
stock could be issued quickly and easily with terms calculated to delay or
prevent a change in control of our company or make removal of our management
more difficult. In addition, our board of directors is divided into three
classes. The directors in each class serve for three-year terms, one class being
elected each year by our shareholders. This system of electing and removing
directors may tend to discourage a third party from making a tender offer or
otherwise attempting to obtain control of our company because it generally makes
it more difficult for shareholders to replace a majority of our directors.
In addition, Chapter 19 of the Washington Business Corporation Act
generally prohibits a "target corporation" from engaging in certain significant
business transactions with a defined "acquiring person" for a period of five
years after the acquisition, unless the transaction or acquisition of shares is
approved by a majority of the members of the target corporation's board of
directors prior to the time of acquisition. This provision may have the effect
of delaying, deterring or preventing a change in control of our company. The
existence of these anti-takeover provisions could limit the price that investors
might be willing to pay in the future for shares of our common stock.
BUSINESS
We provide a broad range of products and services that facilitate the
creation and deployment of a class of devices we call Intelligent Computing
Devices (ICDs). Original Equipment Manufacturers (OEMs), semiconductor vendors,
original design manufacturers, software developers, value-added resellers,
Internet service providers and network service providers rely on our products
and services to help bring customized intelligent computing devices and their
applications to market quickly at lower cost and with higher quality. We believe
customers are attracted to our products and services because we cost-effectively
apply our in-depth understanding of operating systems, compilers and debuggers,
and platform software tools to solving customer needs. We have supplied
Windows-based software services and products for over six years, enabling us to
become one of the leading providers of comprehensive solutions for intelligent
computing devices.
Intelligent computing devices are an emerging class of products with
sophisticated processing power that are designed for specific computing and
communications applications. Examples of intelligent computing devices include
television "set-top boxes," which sit on top of television sets and provide
users with interactive cable TV services, sophisticated video gaming features
and Internet access; handheld and palm-size PCs; gaming systems; handheld
industrial data collectors; consumer "Internet appliances," kiosk terminals, and
navigational devices used in cars and trucks; and Windows-based terminals,
Webpads, E-books and Pocket PCs used both in the workplace and at home. Compared
to traditional computers, intelligent computing devices are often less expensive
and more adaptable in terms of size, weight, shape and mobility, while still
providing sophisticated computing and communications capabilities, including
Internet connectivity.
Intelligent Computing Devices are at the root of emerging markets,
delivering access to data at the point of use in a wide variety of scenarios,
from the factory floor to the mobile workforce to the home. Supermarkets deploy
intelligent computing devices as mobile, wireless barcode scanners facilitating
inventory control. Factories use intelligent computing devices as remote
equipment monitors or sophisticated man-machine interfaces. Fleet managers use
intelligent computing devices to efficiently dispatch and track trucks and
drivers over a wide territory through least cost, wireless communication. Cable
operators deploy and manage sophisticated intelligent computing devices such as
Webpads and set-top boxes, offering advanced services for the home.
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The successful development and deployment of intelligent computing devices
present many challenges: rapidly advancing technology, such as new
microprocessors and chipsets, connectivity issues, interface design and
usability, remote device management and in-field support, security, the
pervasive influence of the World Wide Web, evolving business models, and time to
market, a paramount concern. We offer a strategic set of products and services
to address these challenges.
Increasingly, Internet technologies and communications demands are driving
the design of intelligent computing devices. Original equipment manufacturers
are developing new intelligent computing devices to help businesses and
consumers use the Internet to transact business, through wired and wireless
telecommunications systems. The growth of wireless communications is expanding
through the development of many new technologies, including Bluetooth, 3G, and
802.11 standards. We combine our own advanced wireless expertise with strategic
partnerships to enable the adoption of these technologies.
We have been providing Windows CE-based software services since before the
commercial release of Windows CE in September 1996. In addition, in late 1999,
we began offering Windows NT Embedded integration services, thus expanding the
breadth of our service offerings, and in January 2000, our acquisition of
BlueWater Systems broadened our product line for developers of intelligent
computing devices based on additional Windows operating systems including
Windows 98, Windows 2000, Windows NT and Windows NT Embedded. Our acquisition of
Mainbrace Corporation in May 2000 enables us to provide standard manufacturable
designs of popular intelligent computing devices such as Webpads, Web-phones,
Pocket PCs, E-books and portable data tablets, which together with our other
products and services offer customers a broad range of solutions to rapidly
bring products to market.
We generate revenue in four distinct ways. First, we create software
development tools and provide related engineering services to Microsoft and
semiconductor vendors, adapting Windows CE to different microprocessors and
enhancing the operating system and its tools. Second, we offer a comprehensive
set of software products and services that enable original equipment
manufacturers to cost-effectively develop and deploy intelligent computing
devices. These offerings include OEM adaptation kits, software development
products, test programs and Microsoft Windows licensing, along with engineering
and quality assurance services and training. Third, we license a wide range of
Windows-based software applications to OEMs, value added resellers, Internet
service providers, network service providers and ICD consumers to provide
additional functions to intelligent computing devices, such as printing and
faxing capabilities, voice-over internet protocol, remote device management and
wireless connectivity. Fourth, we license standard manufacturing design of
intelligent computing devices for use in such devices as Webpads, Web-phones,
Pocket PCs, E-books and portable data tablets and bundle our products and
integration services for our customers.
INDUSTRY BACKGROUND
The increasingly widespread use of electronic communications, including the
Internet, is enabling networks of businesses and consumers to collaborate,
access information and conduct business and personal interactions more
effectively. As the number of Internet users grows, so does the diversity of
content, services and applications available via the Internet. While the
Internet is already having a significant and highly visible impact on
business-to-consumer and consumer-to-consumer relationships, the market for
business-to-business Internet transactions is expected to expand at a greater
rate.
As more businesses and consumers access the Internet, new ways of
conducting business electronically are emerging. Examples of users who are
leveraging this ability to communicate electronically include:
- businesses that use mobile computing devices to permit their employees to
access server-based network applications and the Internet from remote
sites;
- retail businesses that use handheld point-of-sale terminals to provide
real-time inventory tracking, automate their procurement processes and
publish information instantly to both internal and external users via the
Internet;
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- healthcare professionals who use mobile computing devices to record and
access patient information that can then be shared via the Internet among
a broader group of professionals responsible for providing medical care;
and
- consumers who use Internet-enabled television set-top boxes, smart
cellular phones, gaming systems and other devices to access Internet
content, communicate and conduct transactions online.
The increasing need for connectivity among both business and consumer users
is driving demand for easy-to-use, cost-effective and customizable methods of
electronic communication. Although the PC has been the traditional means of
electronically connecting suppliers, partners and customers, a new class is
emerging. This includes Internet-enabled television "set-top boxes," handheld
and palm-size PCs, gaming systems, handheld industrial data collectors, and
consumer "Internet appliances" such as kiosk terminals, Internet-enabled
television "set-top", vehicle navigational devices, Webpads, E-books and Pocket
PCs. These intelligent computing devices are particularly attractive to business
and consumer users because they are often less expensive than traditional
computers; have adaptable configurations, including size, weight and shape; and
are able to support a variety of customized applications and user interfaces
that can be designed for particular tasks. In addition, these devices are
typically compatible with existing business information systems. According to
information received in November 2000 from eTForecasts, a market research firm
specializing in the personal computer and information appliance industry, the
worldwide information appliance market is projected to grow from 3.3 million
devices in 2000 to approximately 65 million units by 2005. The respective
worldwide revenue in 2000 from the sale of information appliances was $760
million and is projected to grow to $14.6 billion by 2005.
Because intelligent computing devices can be used for a number of purposes,
from consumer information to industrial automation, and can be designed for a
range of unique applications, the intelligent computing device industry is
characterized by a wide variety of hardware configurations and end-user
applications, each often designed for a specific market. To accommodate these
diverse characteristics in a cost-effective manner, semiconductor vendors and
original equipment manufacturers require operating systems that can be
integrated with a number of different intelligent computing devices and can
support an expanding range of industry-specific content and applications. The
Microsoft Windows family of operating systems, specifically Windows CE and
Windows NT Embedded, helps satisfy these requirements because it leverages the
existing industry-wide base of Microsoft Windows developers and technology
standards; can be customized to operate across a variety of intelligent
computing devices and integrate with existing information systems; offers
Internet connectivity; and reduces systems requirements compared to traditional
PC operating systems. Because of these characteristics, we believe Windows CE
and Windows NT Embedded are emerging as operating systems of choice for many
hardware and software applications vendors. Venture Development Corporation
estimated in a December 1998 report entitled "Windows CE and the Future of
Embedded Systems Development" that the number of intelligent computing devices
utilizing Windows CE will increase from just under one million units in 1999 to
more than 14 million units by 2003. IDC subsequently reported that in 1999
Microsoft captured 8% of the $525 million embedded operating system market.
To take advantage of the multiple benefits of these Windows operating
systems, many original equipment manufacturers and semiconductor vendors require
software products and services from a provider with the breadth of experience
and depth of capabilities to fully support the Windows CE and Windows NT
Embedded. These products and services should encompass the full cycle of the
intelligent computing device development process, including hardware support,
software development products and services, system validation and end-user
software applications. In addition, these products and services should use
existing Microsoft and other industry technologies and standards to promote
rapid low-cost development, reduced time-to-market and integration with existing
enterprise software applications. These products and services should also be
designed to accommodate the varying industry-specific needs of semiconductor,
equipment and software developers without compromising functionality and
performance.
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GENERAL
We provide a broad range of products and services facilitating the creation
and deployment of intelligent computing devices. Original equipment
manufacturers, semiconductor vendors, original design manufacturers, software
developers, value added resellers, internet service providers and network
service providers rely on our products and services to help bring customized
intelligent computing devices and their applications to market quickly, at lower
cost and with higher quality. Key elements of our solutions include:
A BROAD SET OF END-TO-END DEVELOPMENT PRODUCTS, SOFTWARE APPLICATIONS,
MANUFACTURING DESIGNS, AND SOFTWARE SERVICES TO SUPPORT A DIVERSE RANGE OF
INTELLIGENT COMPUTING DEVICE HARDWARE, SYSTEMS AND APPLICATIONS:
- Development products. We provide software products that facilitate the
integration of new hardware and peripherals into Windows operating
systems; a family of testing and verification tools for quality
assurance; sets of related communications protocols, or stacks for
Bluetooth and Universal Serial Bus (USB); and user interface design and
development tools.
- Software applications. We license software applications packages that
provide high-level functionality for intelligent computing devices such
as faxing, printing, least-cost routing and remote device management. We
also integrate, enhance and license third-party applications.
- Intelligent computing device designs. We provide standard product designs
for intelligent computing devices such as Webpads, Web-phones, Pocket
PCs, E-books and portable data tablets. We license these designs and
bundle them with our software products and services to provide rapid
development and deployment for a variety of customers.
- Software services. We provide professional engineering services to a
diverse customer base, including custom development services, product
adaptations and system quality assurance services. We also provide
software development and testing services to Microsoft in connection with
its ongoing development and modification of the Windows CE operating
system. We also provide these services to both Microsoft and
semiconductor vendors to assist with the creation of software development
tools sold in conjunction with Windows CE and the integration of Windows
CE with various microprocessors. By using our services, Microsoft can
draw on our extensive expertise and experience with Windows CE and can
devote its internal resources to other projects.
CAPITALIZING ON OUR DEPTH OF EXPERIENCE IN DEVELOPING WINDOWS-BASED PRODUCTS AND
SERVICES AND OUR VARIETY OF STRATEGIC RELATIONSHIPS TO DELIVER TANGIBLE BENEFITS
TO INTELLIGENT COMPUTING DEVICE DEVELOPERS.
We have been providing Windows CE-based services for the development,
integration and deployment of the Windows CE operating system and
industry-specific applications since prior to the commercial release of Windows
CE in September 1996. In addition, we have developed strategic relationships
with Microsoft, including our master development and license agreement and our
distributor agreement with Microsoft, and through other arrangements.
Specifically, we are a provider of software services to Microsoft under our
master agreement, a Microsoft-sanctioned Windows CE systems integrator, as
indicated on Microsoft's website, a licensed distributor of Windows CE under our
distribution agreement and a developer of Windows CE-based software
applications. Moreover, we have worked with several semiconductor vendors to
integrate Windows CE with their proprietary microprocessors. This depth and
breadth of experience enable us to bring tangible benefits to Microsoft and to a
variety of original equipment manufacturers, semiconductor vendors software
developers, value added resellers, internet service providers and network
service providers. Such benefits include:
- Reduced time-to-market. By using our software services, pre-configured
software components and intelligent computing device designs, our
customers can take advantage of our experience with the Windows-based
platforms to help bring quality intelligent computing devices to market
faster than if they had chosen to develop their hardware, operating
systems and software applications internally.
- Lower development costs and reduced risks. By using our extensive library
of software tools for developing Windows CE-based intelligent computing
devices, instead of developing these tools
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internally, our customers can reduce the implementation and training time
required for their engineers and lower their intelligent computing device
development costs. Our software components are thoroughly tested for
performance and reliability, reducing the risk of project failure.
- Rapidly customizable graphical user interfaces. A graphical user
interface is the set of visual images through which the user interacts
with the intelligent computing device. Our software development
solutions help enable our customers to more rapidly design user- and
industry-specific graphical user interfaces to meet the specific needs
of intelligent computing device users across a variety of markets.
- Enhanced intelligent computing device functionality. Our
pre-developed software components help enable original equipment
manufacturer customers to quickly add new and differentiating
application features to their existing intelligent computing device
hardware components, which can help extend product life cycles.
STRATEGY
Currently, the market for providing solutions for the development of
intelligent computing devices is very fragmented. Our strategy is to become one
of the primary providers of products and services for facilitating the rapid and
cost efficient development and deployment of intelligent computing devices. Key
elements of our strategy include:
Continue to enhance our position as a provider of Windows-based integration
services. We intend to enhance our leadership position in the development and
provision of Windows-based integration services to support a wide variety of
intelligent computing devices. We intend to continue to utilize our expertise by
maintaining strong, quality-focused engineering groups, developing
market-focused products and services, and undertaking sales and marketing
activities that highlight key design wins, product awards and other third-party
endorsements. In addition, we believe that our experience with Windows as an
embedded operating system provides a foundation of technical and engineering
process expertise to offer our customers.
Expand our strategic relationships with hardware and software vendors. We
intend to continue to strengthen and extend our relationships with third-party
hardware and software vendors that are designing products based on Windows. We
believe that the use of our products and services by a broad group of industry
leaders is important in increasing market awareness and generating new business
opportunities.
Continue to build on our relationship with Microsoft. We have developed a
close working relationship with Microsoft and under the terms of our master
agreement are a "preferred Microsoft vendor" for the development of the Windows
CE operating system and accompanying tools. We are also Microsoft's exclusive
partner in their Porting Partners Program, for which we will provide software
engineering services to microprocessor vendors seeking compatibility with
Windows CE. Currently, we create software development tools and provide related
engineering services to Microsoft for a number of different Windows CE projects
and we intend to continue this relationship in the future.
Utilize our extensive Windows expertise to develop additional software
applications. We believe that as the intelligent computing device market grows,
there will be an increasing demand for complete, end-to-end software
applications that enhance the capabilities of intelligent computing devices. We
intend to use our embedded systems expertise, alliances with original equipment
manufacturers and our relationship with Microsoft to develop a leading position
in the market. We currently offer a variety of personal productivity software
applications for intelligent computing devices. We intend to continue to make
use of our Windows expertise to develop additional applications to address the
evolving requirements of this market.
Provide a comprehensive solution capability for rapid development and
deployment of intelligent computing devices. Our breadth of products including
software development tools, quality assurance tools, applications for
connectivity, device management, transaction development, user application and
intelligent computing device designs provides a broad portfolio of capabilities
needed by the market. The development and deployment of intelligent computing
devices has expanded beyond traditional customers such as OEMs and software
developers and includes new types of customers such as value added resellers,
original design manufacturers, Internet service providers and network service
providers. The capabilities of these customers
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range from sophisticated engineering teams capable of building full solutions
internally to companies without engineering capability seeking to outsource
development of fully functioning devices. We intend to support this growing base
of customers through a comprehensive solution capability.
Expand our international presence. We intend to continue to expand
internationally in order to enhance our profile and market reach. We believe
that intelligent computing devices are experiencing growing acceptance in the
Asian and European markets. These markets are attractive to us because of their
high concentration of OEM and original design manufacturer customers. During
late 1998, we established sales offices in Tokyo, Japan and Munich, Germany;
during 1999 we negotiated relationships with distributors throughout fourteen
European countries, Taiwan, Singapore and China. In 2000, we expanded our
presence in Japan through the acquisition of one of our distributors, ToolCraft
KK.
ACQUISITIONS
BLUEWATER SYSTEMS, INC.
On January 5, 2000, we acquired all of the issued and outstanding shares of
BlueWater Systems, Inc., a privately held designer of software development tools
for the creation of Windows-based intelligent computing devices. The transaction
was effected through the exchange of 261,391 shares of our common stock and
options to purchase an additional 21,793 shares of our common stock for all of
the issued and outstanding shares and options to purchase shares of BlueWater.
The merger was accounted for as a pooling of interests.
MAINBRACE CORPORATION
On May 24, 2000, we acquired all of the issued and outstanding shares of
Mainbrace Corporation, an intellectual property licensing and enabling software
firm. We paid an aggregate of $10.8 million cash and issued 627,334 shares of
our common stock and options to purchase an additional 172,629 shares of our
common stock in exchange for all of the outstanding shares and options to
purchase shares of Mainbrace. The acquisition was accounted for under the
purchase method of accounting.
Additionally during 2000, we acquired two smaller companies, Embedded
Technologies, Inc. and ToolCraftKK, for total cash and stock consideration of
approximately $5.0 million. Both of these acquisitions were accounted for using
the purchase method of accounting, and the purchase prices were allocated to the
fair value of the acquired assets.
SERVICES AND PRODUCTS
We develop, market and support a wide variety of Windows-based software
products, intelligent computing device designs and services for the development
and deployment of a diverse selection of intelligent computing devices.
SERVICES
We provide professional engineering services to a diverse customer base,
including custom development services, product adaptations, and system quality
assurance services. We focus on providing integration and support services to
original equipment manufacturers developing Windows CE- and Windows NT Embedded-
based intelligent computing devices. For example, we provide implementation
services for companies developing Internet-enabled television set-top boxes,
gaming systems, handheld industrial devices, consumer Internet appliances, kiosk
terminals, navigational devices in cars and trucks, and Windows-based terminals.
Our software engineering services use our existing products, such as our
Bluetooth stack, iWin, Remote Device Administrator, CE Xpress Adaptation Kit,
and the CEValidator family of products. We often retain a license or other
proprietary rights in the resulting work product. At times, we provide new
applications or system software development on behalf of original equipment
manufacturers. We believe that original equipment manufacturer customers in need
of complex adaptations can save time and resources by outsourcing this work to
us. In addition, to support our original equipment manufacturer customers, we
often "bundle" support services with our software products and other services.
These support services help enable
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our original equipment manufacturer customers to complete intelligent computing
device development and reduce time-to-market.
OPERATING SYSTEM DEVELOPMENT AND ACCOMPANYING TOOLS
We provide software development tools and related engineering services to
Microsoft and numerous semiconductor vendors to support and enhance the
following:
- the continued development of the Windows CE operating system;
- the continued development of the Microsoft Visual Tools series, a set of
software development tools for use with the Windows CE operating system.
These tools include compilers, linkers, runtime libraries, debuggers, and
customizations to Platform Builder for Windows CE; and
- the integration of Windows CE with multiple microprocessors.
The services we provide these customers include software development and
software testing. We provide these services both as a comprehensive solution and
on a point basis to address specific needs depending upon individual customer
requirements.
PRODUCTS
The following table summarizes the key features and benefits of the
products we offer to original equipment manufacturers for the creation and
deployment of intelligent computing devices.
Product for developing applications and interfaces for intelligent
computing devices:
iWin(TM) Internet Appliance
Kit iWin is a User Interface technology that allows
customers such as OEMs, VARs , ISVs to create
unique and captivating high value interfaces
for intelligent computing devices that greatly
enhance marketability of the devices. It gives
customers the power to control all aspects of
their device and its usage through standard web
based technologies such as HTML and Jscript.
This makes the devices ideal for deploying
customized intelligent computing devices for
specific markets, such as home portals, kiosks,
set top boxes, and webpads. iWin is designed to
work with Windows CE 3.0, Windows NT, Windows
2000, and Windows NT Embedded.
Product for deploying and managing intelligent computing devices:
Remote Device Administrator Remote Device Administrator, or RDA, is a
full-feature client server system that allows
administrators to control and maintain large
numbers of deployed intelligent computing
devices over a network. RDA allows the
administrators to view and configure settings,
replace files and even completely replace the
operating system of remote devices from one
central location. RDA provides the tools needed
to solve the configuration and maintenance
problems inherent in wide area deployments,
such as enterprise thin-clients, consumer
webpads and cable set-top boxes. It is based on
non-proprietary or open standards and can be
integrated into other server-based solutions.
RDA supports mixed deployments of Windows CE
and Windows NT Embedded devices simultaneously.
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Complete intelligent device design solutions:
SmartBuild Product Design
Packages SmartBuild Product Design Packages provide
complete hardware and software solutions for
developing Windows CE-based products. There are
six design solutions:
- Data Collection Tablet
- Portable Data Terminal
- Web Phone
- eBook
- Pocket PC
- Web Pad
SmartBuild Product Design packages enable
original equipment manufacturers and
value-added resellers to develop products
quickly and cost-effectively by reducing time
to market, lowering development risks, and
reducing the overall cost of products.
Products for controlling intelligent computing device hardware:
WinDK(TM) WinDK is a complete Windows device driver
development tool suite that enables engineers
to quickly and efficiently develop high quality
device drivers for Windows 2000, Window NT 4.0,
Windows NT Embedded, Windows 98, and Windows
ME. The suite includes a powerful wizard that
automatically generates a driver's framework.
WinDK was named as one of the top embedded
development tools of 2000 by EDN.
WinRT(TM) WinRT is an innovative development toolkit that
allows developers to control hardware devices
directly without having to write device drivers
for the hardware. The toolkit enables rapid
prototyping of new hardware systems such as
factory floor controls and data collection.
WinRT supports Windows 2000, Windows NT,
Windows NT Embedded, Windows 98, and Windows
95.
WinRT-VB(TM) WinRT-VB brings the power and convenience of
the WinRT toolkit to Visual Basic developers.
WinRT-VB gives developers the power to quickly
create scriptable interfaces to low level
devices without having to write complex driver
code. WinRT-VB supports Windows NT, Windows 98,
and Windows 95.
Products for intelligent computing device communication:
WinDK(TM) Extension for
Bluetooth The WinDK Extension for Bluetooth toolkit
enables developers to rapidly integrate
Bluetooth wireless technology into their
Microsoft Windows platform. It is a fully
qualified Bluetooth development suite that
leverages the Digianswer Bluetooth stack. The
toolkit supports Bluetooth hardware on Windows
2000, Windows NT, Windows NT Embedded, and
Windows CE.
WinRT-USB(TM) WinRT-USB allows developers to control
Universal Serial Bus hardware directly from
Windows applications without the complexity of
having to write USB drivers. WinRT-USB supports
Windows 98 and Windows 2000.
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USB Extension for WinDK(TM) USB Extension for WinDK extends the power of
the WinDK toolkit to enable developers to
quickly generate high quality drivers for USB
hardware.
Quality assurance and verification testing tools for intelligent computing
devices:
CEValidator PassPORT(TM)
Platform Tester PassPORT Platform Tester is a comprehensive set
of test tools that provides automated
validation of Windows CE integration with
target platforms such as intelligent computing
devices. PassPORT Platform Tester includes a
client/server-based test program of more than
9,600 individual test cases for testing
compliance and reliability, with an extendable
architecture for incorporating additional and
custom test programs.
PassPORT Platform Tester is designed to save
original equipment manufacturers time and
expense by automating the quality assurance
process for testing a port of Windows CE to
their target platform.
CEValidator PassCODE(TM)
Application Tester PassCODE Application Tester provides automatic
functional and regression testing for embedded
Windows applications for Windows CE. Designed
to shorten time to market for Windows CE
applications for intelligent computing devices,
PassCODE Application Tester provides a fast and
easy way to create automated test scripts
without programming.
CEValidator PassPOINT(TM)
Platform Verifier PassPOINT Platform Verifier is a set of
functional "sniff test" tools that enables an
original equipment manufacturer to identify
initial Windows CE platform adaptation
problems. A client/server-based test program of
more than 9,600 individual test cases for
testing compliance and reliability, PassPOINT
Platform Verifier is designed to facilitate
identification and elimination of software bugs
during development.
PassPOINT Platform Verifier offers performance
verification during the initial stages of the
development process, providing a practical and
economical means of automating testing at the
earliest stages of engineering.
To augment our own software products and services, we occasionally enter
into license and distribution agreements with third-party software vendors to
provide our customers with additional features and functionality. Our ability to
license these third-party software products to original equipment manufacturers,
in conjunction with our own software products and services, provides our
original equipment manufacturer customers with a single source for software
products and services for intelligent computing devices. We are currently a
licensed distributor of software from Communications Intelligence Corporation,
Datalight, Intrinsyc and Microsoft.
CONSUMER SOFTWARE APPLICATIONS
We provide a wide range of commercially available personal productivity,
utility and communications software to enhance the functionality and usefulness
of Windows CE-based intelligent computing devices. We
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market our consumer software applications directly to OEMs and original design
manufacturers for bundling with their own products. Our current consumer
software application product offerings include:
PRODUCT DESCRIPTION BENEFIT
------- ----------- -------
bFAX - A product family that provides - Provides a practical and
faxing capabilities for comprehensive faxing solution
intelligent computing devices for Windows CE-based devices
- bFAX Pro provides send and
receive capability for handheld
PCs
- bFAX Express provides send-only
capability for handheld and
palm-size PCs
bPRINT - Print management software for - Users can spool jobs for batch
handheld and palm-size PCs printing
- Increases the variety of
printers compatible with Windows
CE-based devices
BSQUARE A spreadsheet application for palm- Provides independent functionality
SpreadSheet size PCs while maintaining Pocket Excel
compatibility
bUSEFUL Utilities Pak - Utility suite for handheld and - Provides utility applications
palm- size PCs that contains 12 which enhance the performance
different utility applications and functionality of Windows
CE-based devices
CUSTOMERS
Microsoft is our largest customer, representing approximately 75%, 85% and
58% of our total revenue in 1998, 1999 and 2000, respectively. Our other target
customers include semiconductor vendors and original equipment manufacturers
seeking to leverage the numerous benefits of Windows-based operation systems in
order to develop high quality, full-feature products that meet the complex and
evolving requirements of numerous end-markets.
We maintain strategic relationships with Microsoft to promote its
Windows-based operating systems across a broad range of industries and
applications. Our relationship with Microsoft extends to the following:
Development partner. Under the terms of our master agreement, we are a
"preferred Microsoft vendor" for Windows CE. Approximately 126 of our software
engineers work on a number of different Windows CE-based projects for Microsoft
and on the development of Windows CE-related software tools under various work
plans. These software tools are then provided by Microsoft under the Microsoft
name to semiconductor vendors and various original equipment manufacturers
utilizing Windows CE. We bill Microsoft on a time-and-materials basis, although
each project has a maximum dollar cap. A separate work plan is generated for
each project, which can then be modified or terminated by Microsoft at any time.
Porting Partner. We were the exclusive partner of Microsoft for providing
software engineering services to semiconductor manufacturers, such as
Mitsubishi, Matsushita and Infineon, seeking Windows CE software porting
services for the year 2000. Microsoft may expand this program to other companies
in the future.
Systems integrator. We are a Microsoft-sanctioned systems integrator for
Windows CE, as indicated on the "Embedded Windows CE" portion of Microsoft's
website. In this capacity, we provide training, consulting and software
engineering services and products to original equipment manufacturers that are
building Windows CE-based intelligent computing devices. We actively participate
in the Microsoft systems integrator program, including participating with
Microsoft in "partner pavilions" at trade shows and listing our services and
posting our product announcements on the "Embedded Windows CE" portion of
Microsoft's website. In addition, Microsoft has periodically utilized our
services when an original equipment manufacturer has required additional
software engineering services.
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Windows CE distributor. We are a licensed distributor of the Windows CE
operating system. We sub-license Windows CE by reselling the right to bundle
this operating system in intelligent computing devices. Microsoft actively
assists and manages its distributors to secure additional licensing
opportunities for Windows CE. We are promoted on the "Embedded Windows CE"
portion of Microsoft's website as a distributor, and Microsoft shares with us
leads generated from Web inquiries and tradeshows.
Windows CE training partner. BSQUARE is one of the few companies authorized
by Microsoft to provide Windows CE training. This five-day intensive course
draws new customers to us and we have the opportunity to leverage those initial
relationships.
Windows CE independent software vendor. Microsoft actively encourages
third-party application development through its Developer Relations Group and
Windows CE logo program, which allows third-party applications to receive
Windows CE compatibility logos. We develop several software applications for a
wide variety of Windows CE-based intelligent computing devices, which we market
under our brand names, including bFAX and bPRINT. We also participate in
marketing opportunities offered by Microsoft for third-party developers to
promote our software applications. In addition, Microsoft has from time to time
demonstrated our applications in connection with demonstrations to third parties
of its Windows CE operating system.
SALES AND MARKETING
We market our services to semiconductor vendors through our direct sales
force. We market our software products and related services through our direct
sales force, as well as through third-party representatives and distributors. We
market our software applications either bundled by original equipment
manufacturers onto particular intelligent computing devices or integrated with
our intelligent computing device designs. We have direct sales offices in the
United States, Germany and Japan. As of December 31, 2000, we had 41 employees
in our sales and marketing department. Key elements of our sales and marketing
strategy include direct advertising, event marketing, an active public relations
program, channel marketing programs, customer and strategic alliance partner
co-marketing programs and a comprehensive website.
We are currently developing new sales channels, including value-added
resellers and systems integrators. We believe that these additional channels
will further increase the brand awareness of our software products and services
and will further promote the development of software infrastructures for Windows
based Intelligent Computing Devices.
RESEARCH AND DEVELOPMENT
As of December 31, 2000, we had 397 engineers engaged in software
engineering services and research and development. Our research and development
teams are responsible for the design, development and release of our products.
Members of our research and development staff work closely with our sales and
marketing department, as well as with our customers and potential customers, to
better understand market needs and requirements.
Approximately 126 of our 397 engineers are involved in the development of
the Windows CE operating system and accompanying tools for Microsoft. These
responsibilities require significant expertise due to the radically different
nature of the microprocessors and other hardware components used in Windows
CE-based intelligent computing devices. This team has accumulated detailed
knowledge of the Windows CE environment over the past six years, allowing us to
continue to develop software products and services that enable the expanding
capability and compatibility of Windows CE-based intelligent computing devices.
To ensure that compatibility goals are met and that a high level of product
quality is achieved, quality assurance groups within this team subject our
products to tens of thousands of individual tests in multiple test
configurations before the products are released to our customers. Due to the
broad variety of hardware that hosts Windows CE, the quality assurance groups
have had to develop a special expertise in managing and extending the test tools
used to validate the tool kits for these diverse operating environments.
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The remainder of our engineers provide services and develop Windows-based
software and manufacturing ready designs for intelligent computing devices. The
software engineers in these teams are responsible for the development of
commercial applications that provide added breadth and functionality for
Windows-based intelligent computing devices as well as standard products used in
the development and testing of new products utilizing the Windows-based
operating system. Our engineers have significant experience in creating products
for Windows, which enables us to bring products to market in a timely manner.
COMPETITION
We face competition from:
- our current and potential customers' internal research and development
departments that may seek to develop their own proprietary products and
solutions;
- professional engineering services firms;
- established intelligent computing device software and tools
manufacturers; and
- software and component distributors.
As we develop new products, particularly products focused on specific
industries, we may begin competing with companies with whom we have not
previously competed. We compete principally on the basis of the breadth of
software products and services offered, the experience of the providers, the
quality of the software products and services, the time-to-market and price. We
believe we compete favorably in each of these areas.
INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS
Intellectual property is critical to our success. In general, we attempt to
protect our intellectual property rights through patent, copyright, trademark
and trade secret laws and contractual arrangements. There can, however, be no
assurance that our efforts will be effective to prevent misappropriation of our
technology, or to prevent the development and design by others of products or
technologies similar to or competitive with those developed by us.
We currently have a number of pending U.S. patent applications. We have one
issued patent. BSQUARE, bFAX and BSQUARE View are our registered trademarks.
Additionally, we have a number of registered trademarks, including BSQUARE. We
will continue to pursue registration of these and other marks. This report also
contains trademarks and tradenames of other companies.
EMPLOYEES
As of December 31, 2000, we had 501 employees, excluding independent
contractors and other temporary employees, including 397 employees in software
engineering services and research and product development, 41 employees in sales
and marketing and 63 employees in general and administrative services (including
executive officers). Of these employees, 467 are located in the United States,
six are located in Germany and 28 are located in Japan. In addition, from time
to time, we employ temporary employees and consultants. None of our employees is
represented by a labor union, and we consider our relations with our employees
to be good.
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DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information with respect to our
directors and executive officers.
NAME AGE POSITION
---- --- --------
William T. Baxter........... 38 Chairman of the Board and Chief Executive
Officer
Brian V. Turner............. 41 President, Chief Operating Officer and
Secretary
Albert T. Dosser............ 43 Senior Vice President, Director
Jeffrey T. Chambers......... 45 Director
Scot E. Land................ 46 Director
William L. Larson........... 44 Director
Thomas A. Schild............ 37 Senior Vice President, Worldwide Sales and
International Operations
Donald L. Whitt............. 54 General Manager
William T. Baxter co-founded BSQUARE in July 1994 and currently serves as
our Chief Executive Officer and Chairman of the Board. From our inception until
December 2000, Mr. Baxter served as our President, Chief Executive Officer and
Chairman of the Board. From June 1993 to October 1994, Mr. Baxter served as
Principal Engineer at Digital Equipment Corporation, a manufacturer of business
and networking computer systems. Between February 1990 and May 1993, Mr. Baxter
served as Manager of Compiler Development at Intergraph Corporation, a developer
and manufacturer of interactive computer graphics systems. Mr. Baxter holds a
B.S. and M.S. in computer science from the University of Wyoming.
Brian V. Turner has been our President, Chief Operating Officer and
Secretary since December 2000. From April 1999 to December 2000, Mr. Turner
served as our Senior Vice President and Chief Financial Officer. From September
1995 to April 1999, Mr. Turner was the Chief Financial Officer at RadiSys
Corporation, a manufacturer and designer of computers. Between July 1982 and
September 1995, Mr. Turner was with PricewaterhouseCoopers LLP, an accounting
firm, most recently as a director in Corporate Finance. Mr. Turner holds a B.A.
in international political science and a B.B.A. in accounting from the
University of Washington.
Albert T. Dosser co-founded BSQUARE in July 1994 and has served as a Senior
Vice President and a director since our inception. From June 1992 to October
1994, Mr. Dosser served as a software engineer at Digital Equipment Corporation.
Between August 1984 and June 1992, Mr. Dosser served as a software engineer at
Telesoft, a software firm developing Ada compilers and related products, and
from July 1982 to August 1984, he served as a sales support analyst and as
assistant to the national product manager for the OEM Systems Division at NCR, a
manufacturer of business and networking computer systems. Mr. Dosser holds a
B.S. in information science, with a minor in mathematics, from East Tennessee
State University.
Jeffrey T. Chambers has been a director of BSQUARE since February 1998. Mr.
Chambers was elected to our board of directors in connection with the purchase
of shares of our preferred stock by affiliates of TA Associates, Inc., a venture
capital firm. Mr. Chambers has been employed by TA Associates or its predecessor
since 1980, where he currently serves as a managing director. In addition to
BSQUARE, Mr. Chambers currently serves as a director of several privately held
companies.
Scot E. Land has been a director of BSQUARE since February 1998. Mr. Land
was elected to our board of directors in connection with the purchase of shares
of our preferred stock by affiliates of Encompass Group, a venture capital firm.
Mr. Land is currently a managing director of Encompass Ventures, an affiliate of
Encompass Group, a position he has held since September 1997. Prior to joining
Encompass, Mr. Land was a Senior Technology Analyst and Strategic Planning
Consultant with Microsoft from June 1995 to September 1997, and a technology
research analyst and investment banker for First Marathon Securities, a Canadian
investment bank, from September 1993 to April 1995. From October 1988 to
February 1993, Mr. Land was the President and Chief Executive Officer of
InVision Technologies, a publicly traded company founded by Mr. Land in October
1988 that designs and manufacturers high-speed computer-aided topography systems
for automatic explosives detection for aviation security. Prior to founding
InVision Technologies, Mr. Land served as a principal in the international
consulting practice of Ernst and Young LLP, a public accounting firm, from April
1984 to October 1988.
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William L. Larson has been a director of BSQUARE since September 1998. From
September 1993 to January 2001, Mr. Larson served as the Chief Executive Officer
of Network Associates, Inc., a software company, where he also served as
President and a director since October 1993 and as Chairman of the Board since
April 1995. Mr. Larson also served as Chairman of the Board of McAfee.com
Corporation a software company, from October 1998 to January 2001. From August
1988 to September 1993, Mr. Larson served as a Vice President of SunSoft, Inc.,
a systems software subsidiary of Sun Microsystems, where he was responsible for
worldwide sales and marketing. Prior to that, Mr. Larson held various executive
positions at Apple Computer, Inc. and Spinnaker Software and was a consultant
with Bain & Company. Mr. Larson holds degrees from Stanford Law School and the
Wharton School of Finance and Commerce. Mr. Larson is a member of the California
Bar Association and serves on the boards of several technology companies.
Thomas A. Schild has been a Senior Vice President of Worldwide Sales and
International Operations at BSQUARE since February 1999, and from January 1998
to February 1999, Mr. Schild held the positions of Vice President of Marketing
and Director of Business Development. From June 1995 to January of 1998, Mr.
Schild was a Product Line Manager at Digital Equipment Corporation, a supplier
of computing systems. Prior to that, Mr. Schild held marketing and business
development positions at VLSI Technology Inc, a firm that designs, manufactures
and markets integrated chips, and Motorola Corporation, a provider of integrated
communications and embedded electronic products, including an international
assignment in Munich, Germany. Mr. Schild holds a B.S. in Electrical Engineering
from Purdue University and has completed MBA class work at the University of
Phoenix.
Donald L. Whitt has been a General Manager at BSQUARE since April 1998, and
from May 1997 to April 1998, Mr. Whitt held various other positions with us.
From October 1993 to May 1997, Mr. Whitt was a program manager at Secure
Computing Corporation, an Internet security company, and from May 1970 to May
1993, he served in management positions at Control Data Corporation, a computer
manufacturer. Mr. Whitt holds a B.S. in mathematics from California State
University at Fresno.
ITEM 2. PROPERTIES.
Our corporate headquarters are located in approximately 126,000 square feet
of space in a single location in Bellevue, Washington, pursuant to leases which
expire in 2009, and which have the option to renew for up to an additional 20
years. We lease approximately 20,000 square feet in Sunnyvale, California for a
research and development and service facility, under an agreement, which expires
in December 2005. In addition, we lease office space domestically in Eden
Prairie, Minnesota, and internationally for sales offices in Munich, Germany and
Tokyo, Japan. The annual cost of these leases aggregates approximately $5.7
million, subject to annual adjustments. We believe that our facilities will be
adequate to meet our anticipated growth in our operations, infrastructure, and
personnel for at least the next twelve months.
ITEM 3. LEGAL PROCEEDINGS.
We are not currently involved in any material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of shareholders during the fourth
quarter ended December 31, 2000.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.
MARKET PRICES OF COMMON STOCK
Our common stock has been traded on the Nasdaq National Market under the
symbol "BSQR" since October 19, 1999, the date of our initial public offering.
Prior to that time, there was no public market for our common stock. The
following table sets forth, for the periods indicated the high and low sales
prices for our common stock as reported by the Nasdaq National Market.
These quotations represent prices between dealers and do not include retail
markups, markdowns, or commissions and may not necessarily represent actual
transactions.
HIGH LOW
------ ------
FISCAL YEAR ENDED DECEMBER 31, 1999:
Fourth Quarter (from October 19, 1999)................... $56.50 $15.00
FISCAL YEAR ENDING DECEMBER 31, 2000:
First Quarter............................................ $53.50 $20.81
Second Quarter........................................... $26.00 $12.00
Third Quarter............................................ $25.25 $14.38
Fourth Quarter........................................... $18.13 $ 5.38
The closing price of our common stock as reported by The Nasdaq National
market on February 28, 2001 was $9.50 per share. We estimate that at February
28, 2001 there were approximately 172 record owners of our common stock.
DIVIDENDS
We have never paid cash dividends on our common stock other than the
distribution of S corporation earnings prior to October 1997, when we converted
to a C corporation. We currently intend to retain any future earnings to fund
the development and growth of our business. Therefore, we do not currently
anticipate paying any cash dividends in the foreseeable future. In addition, the
terms of our current credit facility prohibit us from paying dividends without
our lender's consent.
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ITEM 6. SELECTED FINANCIAL DATA.
The following selected consolidated financial data should be read in
conjunction with our consolidated financial statements and related notes and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations." Additionally, on January 5, 2000 we acquired BlueWater Systems,
Inc. in a transaction accounted for as a pooling of interests. All of our
financial data presented in the consolidated financial statements and results of
operations have been restated to include the historical financial information of
BlueWater Systems, Inc. as if it had always been a part of BSQUARE.
YEAR ENDED DECEMBER 31,
-----------------------------------------------
1996 1997 1998 1999 2000
------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
CONSOLIDATED INCOME STATEMENT DATA:
Revenue.......................................... $ 5,026 $15,914 $25,937 $41,406 $63,502
Cost of revenue.................................. 1,480 5,815 11,363 19,509 29,786
------- ------- ------- ------- -------
Gross profit..................................... 3,546 10,099 14,574 21,897 33,716
Operating expenses:
Research and development....................... 771 2,086 4,438 7,506 9,259
Selling, general and administrative............ 773 3,117 6,825 11,935 16,675
Acquired in-process research and development... -- -- -- -- 4,100
Amortization of intangible assets.............. -- -- -- -- 2,920
Amortization of deferred stock option
compensation................................ -- 81 171 583 554
------- ------- ------- ------- -------
Total operating expenses............... 1,544 5,284 11,434 20,024 33,508
------- ------- ------- ------- -------
Income from operations........................... 2,002 4,815 3,140 1,873 208
Investment income (expense), net................. 3 (8) 326 926 3,282
Acquisition related expense...................... -- -- -- -- (620)
------- ------- ------- ------- -------
Income before income taxes....................... 2,005 4,807 3,466 2,799 2,870
Provision for income taxes....................... -- 804 1,166 1,104 2,136
------- ------- ------- ------- -------
Net income....................................... $ 2,005 $ 4,003 $ 2,300 $ 1,695 $ 734
======= ======= ======= ======= =======
Basic earnings per share......................... $ 0.09 $ 0.18 $ 0.12 $ 0.08 $ 0.02
======= ======= ======= ======= =======
Weighted average shares used to compute basic
earnings per share(1).......................... 22,367 21,661 18,633 21,430 33,275
======= ======= ======= ======= =======
Diluted earnings per share....................... $ 0.09 $ 0.18 $ 0.08 $ 0.06 $ 0.02
======= ======= ======= ======= =======
Weighted average shares used in computation of
diluted earnings per share..................... 22,367 22,042 27,736 30,800 35,932
======= ======= ======= ======= =======
DECEMBER 31,
----------------------------------------------
1996 1997 1998 1999 2000
------ ------ ------- ------- --------
(IN THOUSANDS)
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and short-term
investments..................................... $ 223 $2,528 $ 7,056 $82,972 $ 72,351
Working capital................................... 775 3,161 10,527 81,675 76,560
Total assets...................................... 1,155 6,921 16,448 96,642 122,262
Long-term obligations, net of current portion..... -- 1,743 289 -- 353
Mandatorily redeemable convertible preferred
stock........................................... -- -- 14,417 -- --
Shareholders' equity (deficit).................... 1,060 2,663 (965) 89,125 108,347
- ---------------
(1) See Note 14 to the Consolidated Financial Statements for a reconciliation of
the numerators and denominators used in computing basic and diluted earnings
per share.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION.
The following Management's Discussion and Analysis of Financial Condition
and Results of Operations should be read in conjunction with our consolidated
financial statements and related notes.
OVERVIEW
We are a leading provider of software solutions that enable the creation
and deployment of a wide variety of intelligent computing 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 intelligent computing devices.
We enable the rapid and low-cost deployment of intelligent computing
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 OEM's to provide intelligent computing devices with additional
functionality. Our products and services are marketed and supported on a
worldwide basis through a direct sales force augmented by distributors.
Our revenue totaled $25.9 million in 1998, $41.4 million in 1999 and $63.5
million in 2000. We generated net income of $2.3 million in 1998, $1.7 million
in 1999 and $734,000 in 2000.
To date, we have derived the majority of our revenue from the provision of
services to Microsoft, semiconductor vendors and original equipment
manufacturers. We also generate product revenue from software sales and royalty
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 support services upon the purchase of our software
products. We sell our packaged software products through our direct sales force
and through indirect channels, such as resellers. In addition, we receive
royalty payments from original equipment manufacturers related to the bundling
of our software on their intelligent computing devices and, more recently, from
the license to them of software products contained in our intelligent computing
device integration tool kits.
On January 5, 2000, we acquired BlueWater Systems, Inc., a privately held
designer of software development tools for the creation of Windows-based
intelligent computing devices. The transaction was accounted for using the
pooling-of-interests method of accounting. All of our financial data presented
in the consolidated financial statements and results of operations have been
restated to include the historical financial information of BlueWater Systems,
Inc. as if it had always been a part of BSQUARE.
On May 24, 2000, we acquired Mainbrace Corporation in a transaction
accounted for as a purchase. Mainbrace Corporation, located in Sunnyvale,
California, is an intellectual property-licensing and enabling software firm
delivering products and services to high-volume market segments including
set-top boxes, web-enabled phones, wireless thin clients and electronic book
readers. The financial data presented in the consolidated financial statements
include the results of operations of Mainbrace Corporation beginning on May 25,
2000.
MICROSOFT MASTER DEVELOPMENT AND LICENSE AGREEMENT
For the years ended December 31, 1998, 1999 and 2000, approximately 75%,
85% and 58% of our revenue, respectively, was generated under our master
development and license agreement with Microsoft. The master agreement, the
current term of which concludes in July 2001, includes a number of project-
specific work plans. 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 each of
the individual work plans may be modified or terminated by Microsoft at any
time. While we anticipate that our relationship with Microsoft will remain
strong, we are unable to predict the magnitude and number of future projects for
Microsoft.
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HISTORICAL RESULTS OF OPERATIONS
The following table presents certain financial data as a percentage of
total revenue for the periods indicated. Our historical operating results are
not necessarily indicative of the results for any future period.
AS A PERCENTAGE OF TOTAL
REVENUE
YEAR ENDED DECEMBER 31,
-------------------------
1998 1999 2000
----- ----- -----
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenue:
Service................................................... 91% 94% 90%
Product................................................... 9 6 10
--- --- ---
Total revenue..................................... 100 100 100
--- --- ---
Cost of revenue:
Service................................................... 43 46 44
Product................................................... 1 1 3
--- --- ---
Total cost of revenue............................. 44 47 47
--- --- ---
Gross margin................................................ 56 53 53
Operating expenses:
Research and development.................................. 17 18 15
Selling, general and administrative....................... 26 29 26
Acquired in-process research and development(1)........... -- -- 6
Amortization of intangible assets(2)...................... -- -- 5
Amortization of deferred stock option compensation........ 1 1 1
--- --- ---
Total operating expenses.......................... 44 48 53
--- --- ---
Income from operations...................................... 12 5 --
Investment income, net...................................... 1 2 5
Acquisition related expense(2).............................. -- -- (1)
--- --- ---
Income before income taxes.................................. 13 7 4
Provision for income taxes.................................. 4 3 3
--- --- ---
Net income.................................................. 9% 4% 1%
=== === ===
- ---------------
(1) The consolidated statements of operations for the year ended December 31,
2000 includes a $4.1 million (6% of total revenue) charge for acquired
in-process research and development costs associated with our purchase of
Mainbrace Corporation in May 2000.
(2) The consolidated statements of operations for the year ended December 31,
2000 include charges of $2.9 million (5% of total revenue) in amortization
of intangible assets, as well as $620,000 (1% of revenue), of acquisition
related expenses associated with a pooling of interests transaction
occurring during 2000.
COMPARISON OF THE YEARS ENDED DECEMBER 31, 1998, 1999 AND 2000
Revenue
Revenue consists of service and product revenue, which includes software
license fees and royalties. Total revenue increased 60% from $25.9 million in
1998 to $41.4 million in 1999, and an additional 53% to $63.5 million in 2000.
Microsoft accounted for 75%, 85% and 58% of total revenue in 1998, 1999 and
2000, respectively. The decrease in the percentage of revenue derived from
Microsoft in 2000 over 1999 is due to the signing of silicon vendors under the
Porting Partner Agreement and the growth in services provided to OEM customers.
We expect that in future periods, the percentage of revenue derived from
Microsoft will continue to decline.
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Revenue outside of North America totaled $1.2 million in 1998, $1.5 million
in 1999 and $13.5 million in 2000. The increase in international revenue from
1998 to 1999 is the result of an increase in the number and size of software
integration service and product contracts with OEMs in Asia Pacific and Europe.
The increase in international revenue from 1999 to 2000 is due to an increase in
both services and products sold to international porting partners and OEM
customers located in Asia Pacific. We expect international sales will continue
to represent a significant portion of revenue, although its percentage of total
revenue may fluctuate from period to period.
Service revenue. Service revenue increased 64% from $23.7 million in 1998
to $38.8 million in 1999, and an additional 47% to $57.2 million in 2000. The
increase in service revenue for all periods was due to the increasing number and
size of software consulting projects. As a percentage of total revenue, service
revenue increased between 1998 and 1999 due to an increase in the growth of the
number and size of software integration contracts. As a percentage of total
revenue, service revenue decreased between 1999 and 2000 due to product sales
increasing at a faster rate than service revenue.
Product revenue. Product revenue increased 15% from $2.2 million in 1998 to
$2.6 million in 1999 and an additional 144% to $6.3 million in 2000. The
increase in product revenue for all periods is due to the expansion of product
offerings and increased sales of intelligent computing device integration tool
kits and CE Validator quality assurance test suites as well as royalties
received from OEM's from the license of our software. As a percentage of total
revenue, product revenue decreased from 9% in 1998 to 6% in 1999 due the service
revenue growth rate increasing at a faster rate than products, resulting from
increases in the number and size of software integration contracts. As a
percentage of total revenue, product revenue increased to 10% 2000 from 6% in
1999 due to expanded product offerings and sales.
Cost of Revenue
Cost of service revenue. Cost of service revenue consists primarily of
salaries and benefits for software developers and quality assurance personnel,
plus an allocation of facilities and depreciation costs. Cost of service revenue
increased 72% from $11.0 million in 1998 to $19.0 million in 1999 and an
additional 49% to $28.2 million in 2000. These increases resulted from the
hiring and training of additional employees to support our growing customer
base. At December 31, 1998, 1999 and 2000, we had 160, 231 and 311 employees,
respectively, engaged in software engineering consulting. Cost of service
revenue as a percentage of related service revenue was 47% in 1998, 49% in 1999
and 49% in 2000. The increases in cost of service revenue as a percentage of
related service revenue reflect higher personnel costs related to the
competitive employee recruiting and retention pressures in the greater-Seattle
and Silicon Valley areas, as well as higher facilities and depreciation costs
associated with expansion into multiple locations in the United States through
our acquisitions. Although cost of service revenue as a percentage of the
related service revenue remained relatively constant for 2000 over 1999, cost of
service revenue may increase in future periods due to continued competition in
employee recruiting and retention pressures, and as we continue to expand our
facilities in Silicon Valley and Eden Prairie, Minnesota.
Cost of product revenue. Cost of product revenue consists of license fees
and royalties for third-party software, product media, product duplication and
manuals. Cost of product revenue increased 62% from $326,000 in 1998 to $529,000
in 1999, and an additional 201% to $1.6 million in 2000. Cost of product revenue
as a percentage of related product revenue was 15% in 1998, 20% in 1999 and 25%
in 2000. The increase in cost of product revenue as a percentage of related
product revenue from 1998 to 1999 relates to a change in mix of product sales
from royalties received from original equipment manufacturers for licenses of
applications in 1998 to a higher proportion of pre-packaged BSQUARE and
third-party applications in 1999. The increase in cost of product revenue as a
percentage of related product revenue from 1999 to 2000 relates to an increase
in sales of third-party products in 2000 over the same period in 1999.
Operating Expenses
Research and development. Research and development expenses consist
primarily of salaries and benefits for software developers, quality assurance
personnel, program managers and an allocation of our
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facilities and depreciation costs. Research and development expenses increased
69% from $4.4 million in 1998 to $7.5 million in 1999, and an additional 23% to
$9.3 million in 2000. These increases relate primarily to the increase in the
number of software developers and quality assurance personnel hired to expand
our product offerings and to support our product development and testing
activities. Research and development expenses represented 17% of our total
revenue in 1998, 18% in 1999 and 15% in 2000. The increase in research and
development expense as a percentage of total revenue between 1998 and 1999
primarily reflects the more rapid investment in our research and development
activities compared to the growth of our revenue during this period. The
decrease in research and development expense as a percentage of total revenue
between 1999 and 2000 primarily reflects the strong growth of our product
revenue compared to the investment in research and development during this
period. We anticipate that research and development expenses will continue to
increase in absolute dollars in future periods.
Selling, general and administrative. Selling, general and administrative
expenses increased 75% from $6.8 million in 1998 to $11.9 million in 1999, and
an additional 40% to $16.7 million in 2000. These increases resulted primarily
from our investment in finance, executive, administration, sales and marketing
infrastructure, both domestically and internationally, which included
significant personnel-related expenses, travel expenses and related facility and
equipment costs, as well as increased marketing activities, including trade
shows, public relations and other promotional expenses. Selling, general and
administrative expenses represented 26% of our total revenue in 1998, 29% in
1999 and 26% in 2000. The increase in selling, general and administrative
expenses as a percentage of total revenue between 1998 and 1999 primarily
reflects the more rapid investment in our administrative and sales and marketing
infrastructure compared to the growth of our revenue during this period. The
decrease in selling, general and administrative expenses as a percentage of
total revenue between 1999 and 2000 primarily reflects the larger percentage
increase in revenue compared to the growth of selling, general and
administrative expenses. During the fourth quarter of 1998, we opened sales
offices in Munich, Germany and Tokyo, Japan. To establish and operate these
offices, we invested $502,000 in 1998, $1.9 million in 1999, and $2.4 million in
2000, which are included in the expense amounts above. We anticipate that
selling, general and administrative expenses will continue to increase in
absolute dollars in future periods as we expand our sales and marketing staff
both internationally and domestically.
Acquisition of in-process research and development and amortization of
intangible assets. On May 24, 2000, we acquired Mainbrace Corporation, an
IP-licensing and enabling software firm delivering product solutions to high
volume market segments including set-top boxes, Web-enabled phones, wireless
thin clients, and electronic book readers. The acquisition was accounted for
using the purchase method of accounting and, accordingly, the results of
Mainbrace's operations are included in our consolidated financial statements
since the date of acquisition.
The purchase price was allocated to the fair value of the acquired assets
and assumed liabilities based on their fair market values at the date of the
acquisition. Of the total purchase price, we allocated $4.1 million to acquired
in-process research and development, $19.7 million to goodwill and other
intangible assets and $1.0 million to working capital and tangible assets. The
amount allocated to in-process research and development was determined by an
independent valuation and has been recorded as a charge to expense because its
technological feasibility had not been established and it had no alternative
future use at the date of acquisition. Goodwill and other intangible assets are
amortized over their estimated future lives, two to seven years.
Additionally during 2000, we acquired two smaller companies, Embedded
Technologies Inc. and ToolCraft KK, for total cash and stock consideration of
approximately $5.0 million. These acquisitions were accounted for using the
purchase method of accounting. The purchase prices were allocated to the fair
value of the acquired assets. In connection with these acquisitions, we recorded
$4.1 million of goodwill and other intangible assets, which is amortized over
their useful lives, two to seven years.
We anticipate that future amortization of intangible assets will
approximate $6.0 million per year.
Amortization of deferred stock option compensation. We recorded
amortization of deferred stock option compensation of $171,000 in 1998, $583,000
in 1999 and $554,000 in 2000. These charges resulted from stock
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option grants at prices below the deemed fair market value of our common stock
when we were a private company. Deferred stock option compensation is amortized
over the vesting periods of the options.
Other Income (Expense), Net
Investment income, net was $326,000 in 1998, $926,000 in 1999 and $3.3
million in 2000. These increases resulted from higher average cash, cash
equivalent and short-term investment balances over the prior year.
In January 2000, the Company acquired BlueWater Systems, Inc. in a
transaction accounted for as a pooling of interests. In connection with the
acquisition, we incurred $620,000 of acquisition-related costs, which were
charged to operations during the year ended December 31, 2000.
Provision for Income Taxes
Our provision for federal, state and international income taxes was $1.2
million for 1998, $1.1 million for 1999 and $2.1 million for 2000, yielding an
effective rate of 33.6%, 39.4% and 74.4% in 1998, 1999 and 2000, respectively.
The increase in the effective tax rate in 1999 over 1998 was due primarily to
the effect of the non-deductibility of losses from our international operations.
The effective rate in 2000 was positively affected by the tax benefit of
interest income earned on tax-advantaged municipal securities held in our
short-term investment portfolio, and was negatively affected by the
non-deductibility of in-process research and development and amortization of
intangible assets.
Pro Forma Cash Basis Net Income
Pro forma cash basis net income, which excludes deferred stock option
compensation, acquired in-process research and development, amortization
intangible assets, and acquisition-related costs, is as follows:
YEAR ENDED DECEMBER 31,
-----------------------------
1998 1999 2000
------- ------- -------
(IN THOUSANDS)
Net income............................................ $ 2,300 $ 1,695 $ 734
Acquired in-process research and development........ -- -- 4,100
Amortization of intangible assets, net of tax
effect........................................... -- -- 2,628
Amortization of deferred stock option compensation,
net of tax effect................................ 111 379 361
Acquisition related expense, net of tax effect...... -- -- 515
------- ------- -------
Cash basis net income................................. $ 2,411 $ 2,074 $ 8,338
======= ======= =======
Diluted earnings per share............................ $ 0.08 $ 0.07 $ 0.23
======= ======= =======
Weighted average shares outstanding to compute diluted
earnings per share.................................. $27,736 $30,800 $35,932
======= ======= =======
The pro forma results are presented for informational purposes only and are
not prepared in accordance with generally accepted accounting principles.
LIQUIDITY AND CAPITAL RESOURCES
Since our inception, we financed our operations and capital expenditures
primarily through cash flow from operations. As of December 31, 2000, we had
$72.4 million of cash, cash equivalents and short-term investments. In October
1999, we completed an initial public offering of 4,000,000 shares of common
stock and raised $54.4 million, net of offering costs. In addition, in September
1999, we sold 1,518,378 shares of our common stock to Vulcan Ventures for
approximately $18.7 million. In January 1998, we issued mandatorily redeemable
convertible preferred stock from which we received net proceeds of approximately
$14.3 million. Concurrent with this transaction, we repurchased 3,333,333 shares
of our common stock for an aggregate of $6.0 million. Our working capital at
December 31, 2000 was $76.6 million compared to $81.7 million at December 31,
1999.
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Our operating activities resulted in net cash inflows of $129,000 in 1998,
$10.0 million in 1999 and $10.9 million in 2000. Cash provided by operating
activities resulted primarily from income from operations (excluding acquired
in-process research and development, amortization of intangible assets and the
tax benefit from the exercise of stock options in 2000) and increases in
deferred revenue, accounts payable and accrued liabilities, partially offset by
increases in accounts receivable.
Investing activities used cash of $3.7 million in 1998, $32.8 million in
1999 and $30.0 million in 2000. Investing activities for 1998 were primarily
purchases of capital equipment. Investing activities in 1999 included $25.8
million in purchases of short-term investments and $7.0 million in purchases of
leasehold improvements and capital equipment primarily associated with the move
to our corporate headquarters in Bellevue, Washington. Investing activities in
2000 included $14.3 million in net cash used in connection with the acquisition
of Mainbrace Corporation, $8.5 million of cash used for the acquisition of
smaller-scale companies and the purchase of strategic investments and $1.8
million of capital equipment purchases.
Financing activities generated $6.5 million in 1998, primarily through the
issuance of mandatorily convertible preferred stock, partially offset by
repayment of shareholder loans and the $6.0 million repurchase of shares of
common stock. Financing activities in 1999 generated $72.9 million due to the
net proceeds from the initial public offering and from the sale of common stock
to Vulcan Ventures. Financing activities generated $3.3 million in 2000 due to
proceeds from the issuance of shares under our employee stock purchase plan, the
exercise of stock options and the exercise of warrants by former BlueWater
Systems, Inc. shareholders.
We have a working capital revolving line of credit with Imperial Bank that
is secured by our accounts receivable. This facility allows us to borrow up to
the lesser of 80% of our eligible accounts receivable or $3.0 million and bears
interest at the bank's prime rate, which was 9.0% at January 4, 2001. The
facility expires in July 2001. The agreement, under which the line of credit was
established contains certain covenants, including a provision requiring us to
maintain specified financial ratios. We were in compliance with these covenants
at December 31, 2000, and at that time there were no borrowings outstanding
under this credit facility.
As of December 31, 2000, our principal commitments consisted of obligations
outstanding under operating leases. We lease approximately 126,000 square feet
in a single facility located in Bellevue, Washington pursuant to a lease, which
expires in 2009. In September 2000, we signed a lease for approximately 20,000
square feet in Sunnyvale, California, which expires in December 2005.
Additionally, we have lease commitments for office space in Eden Prairie,
Minnesota, Tokyo, Japan, and Munich, Germany. The annual cost of these leases is
an aggregate of approximately $5.7 million, subject to annual adjustments.
Although we have no other material commitments, we anticipate an increase in our
capital expenditures and lease commitments consistent with our anticipated
growth in our operations, infrastructure and personnel.
The rate of growth of our revenue over the prior year was 63% from 1997 to
1998, 60% from 1998 to 1999, and 53% from 1999 to 2000. The rate of growth of
our revenue over prior periods may continue to decline. We currently anticipate
that we will continue to experience significant increases in our operating
expenses for the foreseeable future as we enter new markets for our products and
services, increase research and development activities and sales and marketing
activities, develop new distribution channels and broaden our professional
service capabilities. These efforts may prove more expensive than we currently
anticipate, and we may not succeed in increasing our revenue sufficiently to
offset these higher expenses. If we fail to increase our revenue to keep pace
with our expenses, we may experience losses.
We believe that our existing cash and cash equivalents and available bank
borrowings will be sufficient to meet our anticipated cash needs for working
capital and capital expenditures for at least the next 12 months. We believe
that we will be able to meet our anticipated cash needs after that time from
cash generated from operations and do not currently anticipate the need to raise
additional capital. If we do seek to raise additional capital, there can be no
assurance that additional financing will be available on acceptable terms, if at
all. We may use a portion of our available cash to acquire additional
businesses, products and technologies or to establish joint ventures that we
believe will complement our current or future business. Pending such uses, we
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will invest our surplus cash in government securities and other short-term,
investment grade, interest-bearing instruments.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for
Derivative Instruments and Hedging Activities." This statement requires that all
derivative instruments be recorded on the balance sheet at their fair value.
Changes in the fair value of derivatives are recorded each period in current
earnings or other comprehensive income, depending on whether a derivative is
designated as a part of a hedge transaction and, if it is the type of hedge
transaction. Subsequent to the issuance of SFAS No. 133, the FASB received
multiple requests for clarification of certain implementation issues. In June
2000, the FASB issued SFAS No. 138, responding to those requests by amending
certain provisions of SFAS No. 133.
These amendments include allowing foreign currency denominated assets and
liabilities to qualify for hedge accounting, permitting the offsetting of
certain inter-entity foreign currency exposures that reduce the need for
third-party derivatives and redefining the nature of interest rate risk to avoid
sources of ineffectiveness. The Company will adopt SFAS No. 133 effective
January 1, 2001. The Company does not expect that the effect of adoption of this
statement will have a material impact on our financial position or results of
operations. The impact of this statement is on future periods in unknown, but
could result in increased volatility in our earnings and other comprehensive
income.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Interest Rate Risk. We do not hold derivative financial instruments or
equity securities in our short-term investment portfolio. Our cash equivalents
consist of high-quality securities, as specified in our investment policy
guidelines. The policy limits the amount of credit exposure to any one issue to
a maximum 15% and any one issuer to a maximum of 10% of the total portfolio with
the exception of treasury securities, commercial paper and money market funds,
which are exempt from size limitation. The policy limits all short-term
investments to mature in two years or less, with the average maturity being one
year or less. These securities are subject to interest rate risk and will
decrease in value if interest rates increase.
The following table presents the amounts of our cash equivalents and
short-term investments that are subject to market risk by range of expected
maturity and weighted average interest rates as of December 31, 2000 and 1999.
This table does not include money market funds, as those funds are not subject
to market risk.
MATURING IN
--------------------------------------------------------------
THREE MONTHS THREE MONTHS GREATER THAN FAIR
OR LESS TO ONE YEAR ONE YEAR TOTAL VALUE
------------ ------------ ------------ ------- -------
(IN THOUSANDS)
DECEMBER 31, 2000
Included in cash and cash equivalents... $36,108 -- -- $36,108 $35,821
Weighted average interest rate........ 4.9% -- --
Included in short-term investments...... 1,346 $20,354 11,084 $32,784 $32,281
Weighted average interest rate........ 5.1% 4.9% 5.8%
DECEMBER 31, 1999
Included in cash and cash equivalents... $53,394 -- -- $53,394 $53,100
Weighted average interest rate........ 4.5% -- --
Included in short-term investments...... -- $ 5,033 15,824 $20,857 $20,626
Weighted average interest rate........ -- 4.7% 4.5%
Foreign Currency Risk. Currently, the majority of our sales and expenses
are denominated in U.S. dollars and, as a result, we have not experienced
significant foreign exchange gains and losses to date. While we have conducted
some transactions in foreign currencies and expect to continue to do so, we do
not
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anticipate that foreign exchange gains or losses will be significant. We have
not engaged in foreign currency hedging to date, although we may do so in the
future.
Investment Risk. We have investments in voting capital stock of technology
companies for business and strategic purposes. These investments are included in
other assets and are accounted for under the cost method when our ownership is
less than 20% and we do 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, then the investment is marked to market. Our policy is to
regularly review the operating performance in assessing the carrying value of
the investment.
We periodically review our short-term and long-term investments, for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
BSQUARE CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Public Accountants.................... 36
Consolidated Balance Sheets................................. 37
Consolidated Statement of Income and Comprehensive Income... 38
Consolidated Statements of Shareholders' Equity............. 39
Consolidated Statements of Cash Flows....................... 40
Notes to Consolidated Financial Statements.................. 41
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36
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To BSQUARE Corporation:
We have audited the accompanying consolidated balance sheets of BSQUARE
Corporation and subsidiaries as of December 31, 2000 and 1999, and the related
consolidated statements of income and comprehensive income, shareholders' equity
and cash flows for each of the three years in the period ended December 31,
2000. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of BSQUARE Corporation and
subsidiaries as of December 31, 2000 and 1999, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2000, in conformity with accounting principles generally accepted
in the United States.
ARTHUR ANDERSEN LLP
Seattle, Washington,
January 19, 2001
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BSQUARE CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
ASSETS
DECEMBER 31,
-------------------
1999 2000
------- --------
Current assets:
Cash and cash equivalents................................. $55,604 $ 39,566
Short-term investments.................................... 27,368 32,785
Accounts receivable, net of allowance for doubtful
accounts of $142 in 1999 and $502 in 2000.............. 4,302 12,617
Income taxes receivable................................... 274 1,814
Prepaid expenses and other current assets................. 609 1,395
Deferred income tax asset................................. 1,035 1,945
------- --------
Total current assets.............................. 89,192 90,122
Furniture, equipment and leasehold improvements, net........ 7,238 5,640
Investments................................................. -- 4,628
Goodwill and other intangible assets, net................... -- 20,956
Deposits and other assets................................... 212 916
------- --------
Total assets...................................... $96,642 $122,262
======= ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 654 $ 725
Accrued compensation...................................... 2,352 3,596
Accrued expenses.......................................... 3,381 4,511
Deferred income taxes..................................... -- 1,078
Deferred revenue.......................................... 1,130 3,652
------- --------
Total current liabilities......................... 7,517 13,562
Long-term obligations, net of current portion............... -- 353
------- --------
Total liabilities................................. 7,517 13,915
------- --------
Commitments and contingencies (Note 7)
Shareholders' equity:
Series A preferred stock, no par value: authorized
10,000,000; no shares issued and outstanding........... -- --
Blue Water Systems, Inc. Series A Preferred stock, no par
value: authorized 500,000 shares; 46,246 shares issued
and outstanding in 1999; no shares outstanding in
2000................................................... 250 --
Common stock, no par value: authorized 50,000,000 shares,
issued and outstanding, 32,509,978 shares in 1999,
33,975,187 shares in 2000.............................. 90,845 109,268
Deferred stock option compensation........................ (868) (314)
Cumulative foreign currency translation adjustment........ (15) (254)
Accumulated deficit....................................... (1,087) (353)
------- --------
Total shareholders' equity........................ 89,125 108,347
------- --------
Total liabilities and shareholders' equity........ $96,642 $122,262
======= ========
See notes to Consolidated Financial Statements.
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BSQUARE CORPORATION
CONSOLIDATED STATEMENT OF INCOME AND COMPREHENSIVE INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31,
-----------------------------
1998 1999 2000
------- ------- -------
Revenue:
Service................................................... $23,695 $38,823 $57,196
Product................................................... 2,242 2,583 6,306
------- ------- -------
Total revenue..................................... 25,937 41,406 63,502
------- ------- -------
Cost of revenue:
Service................................................... 11,037 18,980 28,195
Product................................................... 326 529 1,591
------- ------- -------
Total cost of revenue............................. 11,363 19,509 29,786
------- ------- -------
Gross profit...................................... 14,574 21,897 33,716
------- ------- -------
Operating expenses:
Research and development.................................. 4,438 7,506 9,259
Selling, general and administrative....................... 6,825 11,935 16,675
Acquired in-process research and development.............. -- -- 4,100
Amortization of intangible assets......................... -- -- 2,920
Amortization of deferred stock option compensation........ 171 583 554
------- ------- -------
Total operating expenses.......................... 11,434 20,024 33,508
------- ------- -------
Income from operations............................ 3,140 1,873 208
------- ------- -------
Other income (expense), net:
Investment income, net.................................... 326 926 3,282
Acquisition related expense............................... -- -- (620)
------- ------- -------
Total other income (expense)...................... 326 926 2,662
------- ------- -------
Income before income taxes.................................. 3,466 2,799 2,870
Provision for income taxes.................................. 1,166 1,104 2,136
------- ------- -------
Net income........................................ $ 2,300 $ 1,695 $ 734
======= ======= =======
Foreign currency translation................................ 5 (20) (239)
------- ------- -------
Comprehensive income........................................ $ 2,305 $ 1,675 $ 495
======= ======= =======
Basic earnings per share.................................... $ 0.12 $ 0.08 $ 0.02
======= ======= =======
Weighted average shares outstanding used to compute basic
earnings per share........................................ 18,633 21,430 33,275
======= ======= =======
Diluted earnings per share.................................. $ 0.08 $ 0.06 $ 0.02
======= ======= =======
Weighted average shares outstanding to compute diluted
earnings per share........................................ 27,736 30,800 35,932
======= ======= =======
See notes to Consolidated Financial Statements.
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BSQUARE CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
CUMULATIVE
FOREIGN RETAINED TOTAL
PREFERRED STOCK COMMON STOCK DEFERRED CURRENCY EARNINGS SHAREHOLDERS'
---------------- --------------------- STOCK OPTION TRANSLATION (ACCUMULATED EQUITY
SHARES AMOUNT SHARES AMOUNT COMPENSATION ADJUSTMENT DEFICIT) (DEFICIT)
------- ------ ---------- -------- ------------ ----------- ------------ -------------
Balance, December 31,
1997..................... -- $ -- 21,590,145 $ 2,769 $ (572) $ -- $ 466 $ 2,663
Repurchase of common
stock.................... (3,333,333) (649) -- -- (5,351) (6,000)
Exercise of stock
options.................. 119,938 6 -- -- -- 6
Compensation attributable
to stock option
vesting.................. -- -- -- -- 171 -- -- 171
Foreign currency
translation adjustment... -- -- -- -- -- 5 -- 5
Accretion on mandatorily
redeemable convertible
preferred stock.......... -- -- -- -- -- -- (110) (110)
Net income................. -- -- -- -- -- -- 2,300 2,300
------- ----- ---------- -------- ------- ----- ------- --------
Balance, December 31,
1998..................... -- -- 18,376,750 2,126 (401) 5 (2,695) (965)
Exercise of stock
options.................. -- -- 281,517 77 -- -- -- 77
Issuance of compensatory
stock options............ -- -- -- 1,050 (1,050) -- -- --
Compensation attributable
to stock option
vesting.................. -- -- -- -- 583 -- -- 583
Foreign currency
translation adjustment... -- -- -- -- -- (20) -- (20)
Accretion on mandatorily
redeemable convertible
Preferred stock.......... -- -- -- -- -- -- (87) (87)
Issuance of BlueWater
Systems Series A
Preferred Stock.......... 46,246 250 -- -- -- -- -- 250
Issuance of common stock
(net of offering costs of
$13)..................... -- -- 1,518,378 18,689 -- -- -- 18,689
Issuance of common stock in
connection with the
initial public offering
(net of offering costs of
$5,601).................. -- -- 4,000,000 54,399 -- -- -- 54,399
Conversion of mandatorily
redeemable convertible
preferred stock into
shares of common stock... -- -- 8,333,333 14,504 -- -- -- 14,504
Net income................. -- -- -- -- -- -- 1,695 1,695
------- ----- ---------- -------- ------- ----- ------- --------
Balance, December 31,
1999..................... 46,246 250 32,509,978 90,845 (868) (15) (1,087) 89,125
Exercise of stock options,
warrants and employee
stock purchase plan...... -- -- 712,680 3,350 -- -- -- 3,350
Compensation attributable
to stock option
vesting.................. -- -- -- -- 554 -- -- 554
Foreign currency
translation adjustment... -- -- -- -- -- (239) -- (239)
Conversion of preferred
stock into common
stock.................... (46,246) (250) 46,246 250 -- -- -- --
Issuance of common stock
upon acquisition of
Mainbrace Corporation.... -- -- 627,334 9,650 -- -- -- 9,650
Issuance of common stock
upon acquisition of
company.................. -- -- 78,949 1,441 -- -- -- 1,441
Tax benefit from exercise
of stock options......... -- -- -- 3,732 -- -- -- 3,732
Net income................. -- -- -- -- -- -- 734 734
------- ----- ---------- -------- ------- ----- ------- --------
Balance, December 31,
2000..................... -- $ -- 33,975,187 $109,268 $ (314) $(254) $ (353) $108,347
======= ===== ========== ======== ======= ===== ======= ========
See notes to Consolidated Financial Statements.
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BSQUARE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1999 2000
------- -------- --------
Cash flows from operating activities:
Net income.................................................. $ 2,300 $ 1,695 $ 734
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization............................. 995 2,264 5,422
In-process research and development....................... -- -- 4,100
Other..................................................... -- -- 250
Deferred income taxes..................................... (397) (925) 168
Tax benefit from exercise of stock options................ -- -- 3,732
Stock and stock option compensation....................... 171 583 554
Amortization of deferred financing costs.................. 14 13 10
Changes in operating assets and liabilities, net of effects
of acquisition:
Accounts receivable, net.................................. (2,795) 1,309 (7,113)
Prepaid expenses and other current assets................. (116) (123) (784)
Deposits and other assets................................. (117) (19) (534)
Accounts payable and accrued expenses..................... 1,050 4,387 3,450
Income taxes.............................................. (389) (144) (1,539)
Deferred revenue.......................................... (587) 952 2,461
------- -------- --------
Net cash provided by operating activities......... 129 9,992 10,911
------- -------- --------
Cash flows from investing activities:
Purchases of furniture equipment and leasehold
improvements........................................... (2,149) (7,035) (1,757)
Purchase of short-term investments, net................... (1,582) (25,785) (5,415)
Purchase of Mainbrace Corporation, net of cash acquired... -- -- (14,294)
Acquisition of companies, net of cash acquired............ -- -- (3,633)
Purchase of investments................................... -- -- (4,878)
------- -------- --------
Net cash used in investing activities............. (3,731) (32,820) (29,977)
------- -------- --------
Cash flows from financing activities:
Repayment of shareholder notes payable.................... (1,743) -- --
Payments on long-term obligations......................... (27) (453) (66)
Repurchase of common stock................................ (6,000) -- --
Deferred financing costs.................................. (2) (25) (8)
Proceeds from exercise of stock options, warrants and
employee stock purchase plan........................... 6 77 3,350
Net proceeds from issuance of mandatorily redeemable
Series A Preferred Stock............................... 14,307 -- --
Net proceeds from issuance of BlueWater Systems Series A
Preferred Stock........................................ -- 250 --
Net proceeds from sale of common stock.................... -- 18,689 --
Proceeds from sale of initial public offering............. -- 54,399 --
------- -------- --------
Net cash provided by financing activities......... 6,541 72,937 3,276
------- -------- --------
Effect of exchange rate changes on cash..................... 7 21 (248)
------- -------- --------
Net increase (decrease) in cash and cash
equivalents..................................... 2,946 50,130 (16,038)
Cash and cash equivalents, beginning of period.............. 2,528 5,474 55,604
------- -------- --------
Cash and cash equivalents, end of period.................... $ 5,474 $ 55,604 $ 39,566
======= ======== ========
See notes to Consolidated Financial Statements.
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BSQUARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
BSQUARE Corporation, a Washington corporation, and its subsidiaries
(collectively the Company) provides a variety of software products and services
that enable the creation and deployment of a wide variety of intelligent
computing devices based on Microsoft Windows-based operating systems. The
Company works with semiconductor vendors and original equipment manufacturers to
provide software products and engineering services for the development of
intelligent computing devices.
The Company helps enable the rapid and low-cost development of intelligent
computing devices by providing a variety of software products and services for
the design, integration and deployment of Windows-based operating systems with
industry-specific applications. The Company also develops software applications
that are licensed to original equipment manufacturers (OEMs) and end users to
provide intelligent computing devices with additional functionality. The Company
markets and supports its products and provides services on a worldwide basis
through a direct sales force augmented by distributors.
CERTAIN SIGNIFICANT RISKS AND UNCERTAINTIES
The Company operates in the software industry, and accordingly, can be
affected by a variety of factors. For example, management of the Company
believes that any of the following factors could have a significant negative
effect on the Company's future financial position, results of operations and
cash flows: unanticipated fluctuations in quarterly operating results; failure
of the market for Windows CE operating system to develop fully; failure of the
market for intelligent computing devices to develop fully; adverse changes in
the Company's relationship with Microsoft; failure to secure contracts with
market-leading original equipment manufacturers; intense competition; failure to
attract and retain key personnel; failure to protect intellectual property;
risks associated with international operations; inability to manage growth; and
litigation or other claims against the Company.
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries. Significant intercompany accounts and
transactions have been eliminated. Accounts denominated in foreign currencies
have been re-measured to the U.S. dollar from the functional currency.
On January 5, 2000, the Company acquired BlueWater Systems, Inc. in a
transaction accounted for as a pooling of interests. The consolidated financial
statements and notes thereto have been restated for all periods presented to
include the accounts and operations of BlueWater Systems, Inc. as if it had
always been a part of BSQUARE.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.
EARNINGS PER SHARE
In accordance with Statement of Financial Accounting Standards (SFAS) No.
128, "Computation of Earnings Per Share," basic earnings per share is computed
by dividing net income available to common
41
42
BSQUARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
shareholders (net income less accretion of mandatorily redeemable convertible
preferred stock) by the weighted average number of shares of common stock
outstanding during the period. Dilutive earnings per share is computed by
dividing net income by the weighted average number of common and dilutive common
equivalent shares outstanding during the period. Common equivalent shares
consist of the shares of common stock issuable upon the conversion of the
mandatorily redeemable convertible preferred stock (using the if-converted
method) and shares issuable upon the exercise of stock options and warrants
(using the treasury stock method); common equivalent shares are excluded from
the calculation if their effect is antidilutive. The Company has not had any
issuances or grants for nominal consideration as defined under Staff Accounting
Bulletin 98.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include demand deposits, money market accounts
and all highly liquid debt instruments with a purchased maturity date of three
months or less.
SHORT-TERM INVESTMENTS
The Company's short-term investments consist primarily of investment-grade
marketable securities, which are classified as held to maturity and recorded at
amortized cost. Due to the short- term nature of these investments, changes in
market interest rates would not have a significant impact on the fair value of
these securities that are carried at amortized cost, which approximates fair
value.
At December 31, 1999 and 2000, all short-term investments had a contractual
maturity of two years or less.
FINANCIAL INSTRUMENTS AND CONCENTRATIONS OF CREDIT RISK
The Company has the following financial instruments: cash and cash
equivalents, short-term investments, accounts receivable, accounts payable,
accrued liabilities, bank lines of credit and standby letters of credit. The
carrying value of cash and cash equivalents, short-term investments, accounts
receivable, accounts payable, and accrued liabilities approximate fair value
based on the liquidity of these financial instruments or based on their short
term nature. The carrying value of notes payable, bank lines of credit, and
standby letters of credit approximates fair value based on the market interest
rates available to the Company for debt of similar risk and maturities.
The Company performs initial and ongoing evaluations of its customers'
financial position, and generally extends credit on open account, requiring
collateral as deemed necessary. The Company maintains allowances for potential
credit losses.
FURNITURE, EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Furniture, equipment and leasehold improvements are stated at cost less
accumulated depreciation. Depreciation is provided on the straight-line method
over the estimated useful lives, as follows: office furniture and
equipment -- four years; computer equipment -- three years. Leasehold
improvements are amortized over the shorter of the lease term or the estimated
useful life. Maintenance and repairs are expensed as incurred. When properties
are retired or otherwise disposed, gains or losses are reflected in the income
statement. When facts and circumstances indicate that the cost of long-lived
assets may be impaired, an evaluation of recoverability is performed by
comparing the carrying value of the asset to projected future cash flows. Upon
indication that the carrying value of such assets may not be recoverable, the
Company would recognize an impairment loss by a charge against current
operations.
42
43
BSQUARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill represents the excess of the purchase price over the fair value of
indentifiable tangible and intangible assets acquired and liabilities assumed in
a business combination accounted for under the purchase accounting method.
Goodwill and other intangible assets are amortized over their deemed useful
lives, ranging from two to seven years.
SOFTWARE DEVELOPMENT COSTS
Under the criteria set forth in Statement of Financial Accounting Standards
No. 86, "Accounting for the Costs of Computer Software to Be Sold, Leased, or
Otherwise Marketed," capitalization of software development costs begins upon
the establishment of technological feasibility of the product, which the Company
has defined as the completion of beta testing of a working product. The
establishment of technological feasibility and the ongoing assessment of the
recoverability of these costs require considerable judgment by management with
respect to certain external factors, including, but not limited to, anticipated
future gross product revenue, estimated economic life and changes in software
and hardware technology. Amounts that could have been capitalized under this
statement after consideration of the above factors were immaterial and,
therefore, no software development costs have been capitalized by the Company to
date.
RESEARCH AND DEVELOPMENT
Research and development costs are expensed as incurred.
INCOME TAXES
The Company computes income taxes using the asset and liability method,
under which deferred income taxes are provided for the temporary differences
between the financial reporting basis and the tax basis of the Company's assets
and liabilities. Deferred tax assets and liabilities are measured using
currently enacted tax rates that are expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. A valuation allowance is established when necessary to reduce deferred
tax assets to the amounts expected to be realized.
FOREIGN CURRENCY TRANSLATION
The functional currency of foreign subsidiaries is the local currency.
Accordingly, assets and liabilities are translated into U.S. Dollars at exchange
rates in effect at the balance sheet date and income and expense accounts at the
average exchange rates during the year. Resulting translation adjustments are
recorded as a separate component of shareholders' equity. The net gains and
losses resulting from foreign currency transactions are recorded in the
consolidated statements of income in the period incurred and were not
significant for any of the periods presented.
REVENUE RECOGNITION
The Company's revenue recognition policy is in compliance with the
provisions of the American Institute of Certified Public Accountants' Statement
of Position 97-2, "Software Revenue Recognition." Service revenue is derived
from software porting and development contracts. Product revenue consists of
licensing fees from software application products and operating system and
software development tool products. The Company's customers consist of software
companies, original equipment manufacturers, distributors and end users.
In December 1999, the SEC issued Staff Accounting Bulletin ("SAB") 101,
"Revenue Recognition," which outlines the basic criteria that must be met to
recognize revenue and provides guidance for presentation
43
44
BSQUARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
of revenue and for disclosure related to revenue recognition policies in
financial statements filed with the SEC. The Company believes that it is in
compliance with the provisions of SAB 101.
Service revenue is derived from fees from professional services, porting
and development contracts, software maintenance and support contracts, and
customer training. Service revenue is recognized as follows:
- Time and Material Consulting Contracts. The Company recognizes revenue as
services are rendered.
- Fixed-Price Consulting Contracts. Service revenue from fixed-price
contracts is recognized on the percentage-of-completion method, measured
by the cost incurred to date to the estimated total cost for the
contract. This method is used as management considers expended costs to
be the best available measure of contract performance. Contract costs
include all direct labor, material and any other costs related to
contract performance. Selling, general and administrative costs are
charged to expense as incurred. Provisions for estimated losses on
uncompleted contracts are made in the period in which such losses are
determined. Changes in job performance, job conditions and estimated
profitability may result in revisions in the estimate of total costs. Any
required adjustments due to these changes are recognized in the period in
which such revisions are determined.
- Software Maintenance Contracts. Software maintenance and support fees are
recognized ratably over the contract period.
- Customer Training. Service revenue from training is recognized when the
services are provided.
Product revenue consists of licensing fees from software development tool
products and operating system licenses and royalty fees from embedded system
run-time licenses. Product licensing fees, including advanced production royalty
payments, are generally recognized when a customer license agreement has been
executed, the software has been shipped, remaining obligations are insignificant
and collection of the resulting account receivable is probable. The Company
recognizes license royalty income as the reseller reports when it ships its
product to distributors.
Deferred revenue consists of deposits received from customers for service
contracts and unamortized service contract revenue.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the current
year presentation.
44
45
BSQUARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
2. CASH AND SHORT-TERM INVESTMENTS
The Company's cash, cash equivalents and short-term investments consist of
the following:
DECEMBER 31,
------------------
1999 2000
------- -------
Cash and equivalents:
Cash................................................... $ 665 $ 1,737
Money market funds..................................... 8,056 1,721
Municipal certificates................................. 46,883 29,200
Commercial Paper....................................... -- 1,899
Corporates............................................. -- 5,009
------- -------
$55,604 $39,566
======= =======
Short-term investments:
Commercial paper....................................... $ 3,064 $ 145
Corporate notes and bonds.............................. 12,580 10,781
Municipal securities................................... 11,724 21,859
------- -------
$27,368 $32,785
======= =======
3. FURNITURE, EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Major classifications of furniture, equipment and leasehold improvements
consist of the following:
DECEMBER 31,
------------------
1999 2000
------- -------
Computer equipment and system software................... $ 3,707 $ 4,992
Office furniture and equipment........................... 1,282 1,460
Leasehold improvements................................... 4,443 3,570
Construction in progress................................. -- 98
------- -------
9,432 10,120
Less: accumulated depreciation and amortization.......... (2,194) (4,480)
------- -------
$ 7,238 $ 5,640
======= =======
4. GOODWILL AND OTHER INTANGIBLE ASSETS
Major classifications of goodwill and other intangible assets consist of
the following:
DECEMBER 31,
---------------
1999 2000
---- -------
Goodwill................................................... $-- $17,395
Non-compete agreements..................................... -- 4,581
Developed technology....................................... -- 1,600
Assembled workforce........................................ -- 300
--- -------
$-- 23,876
Less: accumulated depreciation and amortization............ -- (2,920)
--- -------
$-- $20,956
=== =======
45
46
BSQUARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
5. INCOME TAXES
The Company was a Subchapter S Corporation for income tax purposes from
inception to October 15, 1997. Effective October 16, 1997, the Company converted
to a C Corporation and was thereafter responsible for U.S. federal income taxes.
A net deferred tax liability of $445, primarily related to the required
conversion for income tax purposes from the cash basis method to the accrual
basis method of accounting, was recorded at the conversion date to reflect the
Company's net taxable temporary differences.
The provision for income taxes consists of the following:
YEAR ENDED DECEMBER 31,
--------------------------
1998 1999 2000
------ ------ ------
Current:
U.S. Current................................... $1,536 $2,001 $2,378
International.................................. 27 28 27
U.S. Deferred.................................. (397) (925) (269)
------ ------ ------
Total tax provision.................... $1,166 $1,104 $2,136
====== ====== ======
The components of net deferred tax assets (liabilities) consist of the
following:
DECEMBER 31,
-----------------
1999 2000
------ -------
Deferred income tax asset:
Depreciation and amortization........................... $ 88 $ 101
Accrued compensation and benefits....................... 472 772
Deferred revenue........................................ 213 255
Cash to accrual basis conversion........................ (111) --
Allowance for doubtful accounts......................... 48 174
Acquired net operating losses........................... -- 327
Other, net.............................................. 325 316
------ -------
$1,035 $ 1,945
====== =======
Deferred income tax liability:
Acquired intangible assets.............................. $ -- $ (955)
Other, net.............................................. -- (123)
------ -------
$ -- $(1,078)
====== =======
46
47
BSQUARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
The provision for income taxes differs from the amount of income tax
determined by applying the applicable U.S. statutory federal income tax rate to
pre-tax income, as a result of the following:
YEAR ENDED DECEMBER 31,
------------------------
1998 1999 2000
----- ----- ------
Taxes at the U.S. statutory rate...................... 34.0% 34.0% 34.0%
Increase (decrease) in income taxes resulting from:
Research and development tax credit................. (6.2) (7.2) (16.5)
International operations............................ 4.5 14.3 19.7
Tax exempt interest................................. -- (5.5) (32.3)
Acquisition expenses................................ -- -- 3.9
Acquired in-process research and development........ -- -- 50.0
Amortization of intangible assets................... -- -- 19.7
Other, net.......................................... 1.3 3.8 (4.1)
---- ---- -----
33.6% 39.4% 74.4%
==== ==== =====
6. BANK LINE OF CREDIT
At December 31, 2000, the Company had available a $3.0 million secured
domestic revolving line of credit, with interest accruing at the bank's prime
rate. Restrictive terms of the lines require, among other requirements, that the
Company maintain a minimum quick ratio, tangible net worth and debt service
ratio, and limits the Company's ability to pay dividends without the lender's
consent. The line of credit is secured by substantially all of the assets of the
Company. As of December 31, 2000 the Company had $1.2 million in standby letters
of credit issued and outstanding under the domestic revolving line of credit.
7. COMMITMENTS AND CONTINGENCIES
The Company leases its office space under non-cancelable operating leases
that expire at various dates through 2009. During the years ending December 31,
1998, 1999 and 2000, rental expense was $980, $3,347, and $4,654, respectively.
Minimum rental commitments under non-cancelable operating leases at December 31,
2000 are as follows:
2001........................................................ $ 5,720
2002........................................................ 5,688
2003........................................................ 5,805
2004........................................................ 5,693
2005........................................................ 3,186
Thereafter.................................................. 18,479
-------
$44,571
=======
The Company's corporate headquarters are located in a single location in
Bellevue, Washington. The Company has the option to extend the lease for four
additional periods of five years each. The Company has provided a $1.2 million
stand-by letter of credit as security for this lease, which may be reduced
annually by specified amounts in the lease agreement upon the Company's
achieving certain economic goals.
47
48
BSQUARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
8. SHAREHOLDERS' EQUITY
INITIAL PUBLIC OFFERING
On October 20, 1999, the Company issued 4,000,000 shares of its common
stock at an initial public offering price of $15.00 per share. Also sold in this
offering were 600,000 shares held by selling shareholders upon exercise of the
underwriters' overallotment option. The net proceeds to the Company from the
offering, net of offering costs of approximately $5.6 million, were
approximately $54.4 million. Concurrent with the initial public offering, each
outstanding share of the Company's mandatorily redeemable preferred stock was
automatically converted into common stock.
STOCK PURCHASE AGREEMENT
On August 18, 1999, the Company entered into a stock purchase agreement to
sell 1,518,378 shares of common stock to Vulcan Ventures for approximately $18.7
million.
COMMON STOCK RESERVED FOR FUTURE ISSUANCE
At December 31, 2000, the Company had reserved the following shares of
common stock for future issuance:
BSQUARE Employee Stock Purchase Plan........................ 1,317,038
BSQUARE Stock Option Plans.................................. 2,393,016
9. EMPLOYEE BENEFIT PLANS
STOCK OPTIONS
In May 1997, the Company adopted the Amended and Restated Stock Option Plan
(the Plan). Under the Plan, the Board of Directors may grant nonqualified stock
options at a price determined by the Board, not to be less than 85% of the fair
market value of the common stock. Options have a term of up to 10 years and vest
over a schedule determined by the Board of Directors, generally four years.
Incentive stock options granted under this program may only be granted to
employees of the Company, have a term of up to 10 years, and shall be granted at
a price equal to the fair market value of the Company's stock.
The Company has assumed certain options granted to employees of acquired
companies, referred to as acquired options. These options were assumed by the
Company outside of its stock option plans, and are administered as if issued
under their original plans. All of the acquired options have been adjusted to
reflect the price conversion under the terms of the agreements between the
Company and the companies acquired. The acquired options generally become
exercisable over a four-year period and generally expire ten years from the date
of grant. No additional options will be granted under any of the acquired
companies' plans.
48
49
BSQUARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
A summary of stock option activity follows:
PRICE PER SHARE
-------------------------------
NUMBER OF AVAILABLE WEIGHTED
OPTIONS FOR AVERAGE
OUTSTANDING ISSUANCE EXERCISE PRICE RANGE
----------- ---------- -------------- --------------
Balance, December 31, 1997.................... 1,680,800 819,200 $ 0.08 $0.05 - $ 1.00
Authorized.................................. -- 1,125,000 -- --
Granted..................................... 1,108,150 (1,108,150) $ 1.15 $1.00 - $ 1.80
Exercised................................... (119,938) -- $ 0.05 $0.05 - $ 0.05
Canceled.................................... (128,850) 128,850 $ 0.34 $0.05 - $ 1.00
--------- ---------- ------ --------------
Balance, December 31, 1998.................... 2,540,162 964,900 $ 0.54 $0.05 - $ 1.80
Authorized.................................. -- 2,000,000 -- --
Granted..................................... 1,345,795 (1,345,795) $ 7.24 $1.44 - $45.06
Exercised................................... (281,517) -- $ 0.36 $0.05 - $ 1.00
Canceled.................................... (154,875) 154,875 $ 0.82 $0.05 - $10.00
--------- ---------- ------ --------------
Balance, December 31, 1999.................... 3,449,565 1,773,980 $ 3.15 $0.05 - $45.06
Authorized.................................. -- 1,771,786 -- --
Assumption of acquired company options...... 194,422 (194,422) $ 1.92 $0.07 - $ 3.11
Granted..................................... 1,512,124 (1,512,124) $19.05 $6.00 - $49.69
Exercised................................... (529,718) -- $ 0.86 $0.05 - $11.64
Canceled.................................... (553,796) 553,796 $10.55 $0.05 - $45.06
--------- ---------- ------ --------------
Balance, December 31, 2000.................... 4,072,597 2,393,016 $ 8.58 $0.05 - $49.69
========= ========== ====== ==============
The following table summarizes information concerning currently outstanding
and exercisable options at December 31, 2000:
OUTSTANDING EXERCISABLE
------------------------- ---------------------
WEIGHTED
AVERAGE WEIGHTED
REMAINING AVERAGE
NUMBER OF CONTRACTUAL NUMBER OF EXERCISE
OPTIONS LIFE (YEARS) OPTIONS PRICE
--------- ------------ --------- --------
Range of exercise price:
$ 0.05 - $10.00.............................. 2,469,347 7.1 1,304,231 $ 1.44
$12.00 - $20.00.............................. 1,394,500 9.3 51,325 12.00
$ 2.25 - $39.99.............................. 55,650 9.3 1,500 35.39
$40.00 - $49.69.............................. 153,100 9.0 1,250 43.53
--------- --- --------- ------
4,072,597 8.2 1,358,306 $ 1.93
========= === ========= ======
49
50
BSQUARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
Had compensation expense been recognized on stock options issued based on
the fair value of the options at the date of the grant and recognized over the
vesting period, the Company's net income would have been reduced to the pro
forma amounts presented below:
YEAR ENDED DECEMBER 31,
----------------------------
1998 1999 2000
------ ------- -------
Net income, as reported........................ $2,300 $ 1,695 $ 734
Incremental pro forma compensation expense
under SFAS 123............................... (82) (1,351) (3,342)
------ ------- -------
Pro forma net income (loss).................... $2,218 $ 344 $(2,608)
====== ======= =======
Pro forma basic earnings (loss) per share...... $ 0.12 $ 0.01 $ (0.08)
====== ======= =======
Pro forma diluted earnings (loss) per share.... $ 0.08 $ 0.01 $ (0.08)
====== ======= =======
The fair value of options granted in 1998, 1999 and 2000 of $0.25, $4.89
and $3.58, respectively, has been estimated at the date of grant using the
Black-Scholes method with the following weighted-average assumptions:
YEAR ENDED DECEMBER 31,
-----------------------------
1998 1999 2000
------- ------- -------
Dividend yield.................................. 0% 0% 0%
Expected life................................... 5 years 5 years 5 years
Expected volatility............................. 0% 57% 70%
Risk-free interest rate......................... 5.5% 6.6% 5.7%
The effects on pro forma disclosures of applying SFAS No. 123 are not
likely to be representative of the effects on pro forma disclosures of future
years.
1999 EMPLOYEE STOCK PURCHASE PLAN
On July 21, 1999, the Board of Directors approved the adoption of the
Company's 1999 Employee Stock Purchase (the "1999 Purchase Plan"). Under the
1999 Purchase Plan, the Company is authorized to sell up to 1,500,000 shares of
common stock in a series of eighteen month offerings. The 1999 Purchase Plan
permits eligible employees to acquire shares of the Company's common stock
through periodic payroll deductions of up to 10% of base cash compensation. The
price at which the common stock may be purchased is 85% of the lesser of 1) the
fair market value of the Company's common stock on the first day of the
applicable offering period or 2) the fair market value of the shares on the
purchase date. The initial offering period commenced on the effectiveness of the
initial public offering. During the twelve months ended December 31, 2000, the
Company issued 182,962 shares under the plan.
PROFIT SHARING AND DEFERRED COMPENSATION PLAN
The Company has a Profit Sharing and Deferred Compensation Plan (Profit
Sharing Plan) under Section 401(k) of the Internal Revenue Code of 1986, as
amended. Substantially all full-time employees are eligible to participate. The
Company, at its discretion, may elect to match the participants' contributions
to the Profit Sharing Plan. Participants will receive their share of the value
of their investments upon retirement or termination, subject to a vesting
schedule. The Company made no matching contributions to the Profit Sharing Plan
during 1998. During the years ended December 31, 1999 and 2000, the Company made
matching contributions to the Profit Sharing Plan of $514 and $760 respectively.
50
51
BSQUARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
DEFERRED STOCK OPTION COMPENSATION
In connection with the grant of certain stock options to employees and
consultants during 1999, the Company recorded deferred stock option compensation
of $1.1 million, representing the difference between the estimated fair value of
the common stock for accounting purposes and the option exercise price of such
options at the date of grant. Such amount is presented as a reduction of
shareholders' equity and amortized, in accordance with FASB Interpretation No.
28, on an accelerated basis over the vesting period of the applicable options
(generally four years). During the years ended December 31, 1998, 1999, and
2000, the Company expensed approximately $171, $583, and $554, respectively. The
balance will be expensed over the period the options vest. Compensation expense
is decreased in the period of forfeiture for any accrued but unvested
compensation arising from the early termination of an option holder's services.
Included in the expensed amounts noted above for the year ended December
31, 1999 is $30 related to options granted to a consultant for services
rendered. As of December 31, 1999, the consultant had earned 20,833 options to
acquire common stock at $1 per share. The Company has recorded the fair value of
the options as of the date the options were earned based on a Black-Scholes
model utilizing a 50% volatility factor and an expected life of 2 years. The
agreement was terminated in 1999.
10. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
YEAR ENDED DECEMBER 31,
-------------------------
1998 1999 2000
------ ------ -------
Issuance of notes payable for equipment............. $ 473 $ -- $ --
Cash paid for interest.............................. 57 68 38
Cash paid for income taxes.......................... 2,170 2,520 1,050
Common stock issued for acquisition of BlueWater
Systems, Inc...................................... -- -- 11,044
Common stock issued for acquisition of Mainbrace
Corporation....................................... -- -- 9,650
Common stock issued for acquisition................. -- -- 1,441
All significant non-cash financing activities are listed elsewhere in the
financial statements or the notes thereto.
11. SIGNIFICANT CUSTOMERS
For the years ended December 31, 1998, 1999 and 2000, approximately 75%,
85% and 58% of our revenue, respectively, was generated under our master
development and license agreement with Microsoft. The master agreement, the
current term of which concludes in July 2001, includes a number of project-
specific work plans. As of December 31, 1998, 1999 and 2000 Microsoft
represented 84%, 82%, and 52% of total accounts receivable, respectively.
51
52
BSQUARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
12. GEOGRAPHIC AND SEGMENT INFORMATION
The Company follows the requirements of Statement of Financial Accounting
Standards No. 131 (SFAS 131), Disclosures About Segments of an Enterprise and
Related Information. As defined in SFAS No. 131, the Company operates in two
reportable segments, Service and Products for Windows-based operating systems.
The following table summarizes total revenue and long-lived assets attributed to
significant countries:
YEAR ENDED DECEMBER 31,
-----------------------------
1998 1999 2000
------- ------- -------
Total revenue:
United States............................... $24,698 $39,876 $49,989
Japan....................................... 480 671 8,272
Other Foreign............................... 759 859 5,241
------- ------- -------
Total revenue(1).................... $25,937 $41,406 $63,502
======= ======= =======
Long-lived assets:
United States............................... $ 2,886 $ 7,036 $ 5,681
Japan....................................... 239 257 793
Germany..................................... 205 157 82
------- ------- -------
Total long-lived assets(2).......... $ 3,330 $ 7,450 $ 6,556
======= ======= =======
- ---------------
(1) Revenue is attributed to countries based on location of customer invoiced.
(2) Long-lived assets do not include acquired intangible assets and goodwill.
BSQUARE has two operating segments, Service and Product. The Service
segment includes design and development of integration tools for the
semiconductor vendors and the original equipment manufacturer market. The
Product segment derives revenue from licensing of software products to original
equipment manufactures and distributing product through resellers. The
accounting policies of the segments are the same as those described in the
summary of significant accounting policies.
The Company does not track assets or operating expenses by operating
segments. Consequently, it is not practicable to show assets or operating
expenses by operating segments.
52
53
BSQUARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
13. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Summarized quarterly financial information for 1999 and 2000 are as
follows:
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
--------- -------- ------------- ------------
1999 QUARTER ENDED
Revenue...................................... $ 9,167 $10,094 $10,449 $11,696
Gross profit................................. 4,982 5,400 5,461 6,054
Income (loss) from operations................ 719 731 460 (37)
Net income................................... $ 429 $ 442 $ 378 $ 446
======= ======= ======= =======
Earnings per share, basic.................... $ 0.02 $ 0.02 $ 0.02 $ 0.01
======= ======= ======= =======
Weighted average shares outstanding used to
compute basic earnings per share........... 18,458 18,476 18,844 31,655
======= ======= ======= =======
Earnings per share, diluted.................. $ 0.02 $ 0.02 $ 0.01 $ 0.01
======= ======= ======= =======
Weighted average shares outstanding used to
compute diluted earnings per share......... 28,468 29,145 29,800 32,800
======= ======= ======= =======
2000 QUARTER ENDED
Revenue...................................... $13,292 $15,700 $16,641 $17,869
Gross profit................................. 6,943 8,279 8,850 9,644
Income (loss) from operations................ 1,208 (2,873) 822 1,051
Net income (loss)............................ $ 995 $(2,475) $ 1,252 $ 962
======= ======= ======= =======
Earnings (loss) per share, basic............. $ 0.03 $ (0.07) $ 0.04 $ 0.03
======= ======= ======= =======
Weighted average shares outstanding used to
compute basic earnings (loss) per share.... 32,566 33,076 33,605 33,847
======= ======= ======= =======
Earnings per share, diluted.................. $ 0.03 $ (0.07) $ 0.03 $ 0.03
======= ======= ======= =======
Weighted average shares outstanding used to
compute diluted earnings per share......... 35,628 33,076 36,222 35,946
======= ======= ======= =======
53
54
BSQUARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
14. EARNINGS PER SHARE
The following is a reconciliation of the numerators and denominators used
in computing basic and diluted earnings per share:
YEAR ENDED DECEMBER 31,
-----------------------------
1998 1999 2000
------- ------- -------
Net income (numerator diluted).............................. $ 2,300 $ 1,695 $ 734
Less: Accretion of mandatorily redeemable convertible
preferred stock........................................... (110) (87) --
------- ------- -------
Net income available to common shareholders (numerator
basic).................................................... $ 2,190 $ 1,608 $ 734
======= ======= =======
Shares (denominator basic):
Weighted average common shares outstanding................ 18,633 21,430 33,275
======= ======= =======
Basic earnings per share.................................... $ 0.12 $ 0.08 $ 0.02
======= ======= =======
Shares (denominator diluted):
Weighted average common shares outstanding(1)............. 18,633 21,430 33,275
Mandatorily redeemable convertible preferred stock........ 7,648 6,689 --
Common stock equivalents.................................. 1,455 2,681 2,657
------- ------- -------
Shares used in computation (denominator diluted).......... 27,736 30,800 35,932
======= ======= =======
Diluted earnings per share.................................. $ 0.08 $ 0.06 $ 0.02
======= ======= =======
- ---------------
(1) Share amounts presented for 1998 to 1999 give effect to the issuance of
261,391 shares to the former shareholders of BlueWater Systems to effect its
acquisition by BSQUARE. The transaction was accounted for as a pooling of
interests.
15. ACQUISITIONS
BLUEWATER SYSTEMS, INC.
On January 5, 2000, the Company acquired BlueWater Systems, Inc. in a
transaction accounted for as a pooling of interests. BlueWater Systems, formerly
located in Edmonds, Washington, is dedicated to the design of software
development tool kits and system integration services for the creation of
Windows-based intelligent computing devices. The transaction was effected
through the exchange of 261,391 shares of BSQUARE common stock for all of the
issued and outstanding common shares of BlueWater Systems. The consolidated
financial statements of BSQUARE have been restated for all periods prior to the
merger to include the accounts and operations of BlueWater Systems, Inc. In
connection with the acquisition, the Company incurred $620 ($515 after taxes, or
$0.01 per diluted share) of acquisition-related costs which were charged to
operations during the three months ended March 31, 2000.
54
55
BSQUARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
The following table presents a reconciliation of revenue and net income
previously reported by BSQUARE to those presented in the accompanying condensed
consolidated financial statements:
YEAR ENDED DECEMBER 31,
------------------------
1998 1999
--------- ---------
Revenue:
BSQUARE Corporation.................................. $24,612 $39,938
BlueWater Systems, Inc. ............................. 1,325 1,468
------- -------
Combined.......................................... $25,937 $41,406
======= =======
Net income:
BSQUARE Corporation.................................. $ 2,300 $ 1,691
BlueWater Systems, Inc. ............................. -- 4
------- -------
Combined.......................................... $ 2,300 $ 1,695
======= =======
MAINBRACE CORPORATION
On May 24, 2000, the Company acquired Mainbrace Corporation in a
transaction accounted for as a purchase. Mainbrace Corporation, located in
Sunnyvale, California, is a leading IP-licensing and enabling software firm
delivering product solutions to high volume market segments including set-top
boxes, Web-enabled phones, wireless thin clients, and electronic book readers.
Total consideration included the issuance of 627,334 shares of BSQUARE common
stock, and approximately $10,800 in cash. Additionally, the Company assumed
Mainbrace's outstanding vested and unvested employee stock options, which were
converted into the right to acquire an additional 172,629 shares of the
Company's common stock. Such assumption of Mainbrace's options by the Company
had a fair market value of approximately $552.
A summary of the purchase price for the acquisition is as follows:
Cash........................................................ $10,800
Stock and stock options..................................... 9,650
Direct acquisition costs.................................... 347
Other acquisition costs..................................... 2,840
Net deferred tax liability.................................. 319
Assumed debt................................................ 900
-------
Total............................................. $24,856
=======
The purchase price was allocated as follows:
Working capital acquired.................................... $ 871
Equipment................................................... 160
Goodwill.................................................... 16,885
Intangible assets........................................... 2,840
In-process research and development......................... 4,100
-------
Total............................................. $24,856
=======
The excess of consideration paid over the fair value of the net assets
acquired was recorded as goodwill and other intangible assets and is amortized
over periods ranging from two to seven years.
In accordance with generally accepted accounting principles, the amount
allocated to in-process research and development, which was determined by an
independent valuation, has been recorded as a charge to
55
56
BSQUARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
expense in the second quarter of 2000 because its technological feasibility had
not been established and it had no alternative future use at the date of
acquisition.
The following table presents unaudited pro forma results of operations as
if the acquisition of Mainbrace had occurred at the beginning of each 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.
YEAR ENDED DECEMBER 31,
------------------------
1999 2000
--------- ---------
(UNAUDITED)
Revenue................................................ $44,540 $65,290
======= =======
Net loss............................................... $(4,070) $(2,023)
======= =======
Net loss per share (basic and diluted)................. $ (0.19) $ (0.06)
======= =======
During 2000, the Company acquired two smaller companies, Embedded
Technologies, Inc. and ToolCraftKK, for total cash and stock consideration of
approximately $5.0 million. Both of these acquisitions were accounted for using
the purchase method of accounting, and the purchase prices were allocated to the
fair value of the acquired assets.
Additionally, the Company made several strategic investments during the
year ended December 31, 2000 totaling $4.9 million, which are reflected in
"Investments" in the accompanying balance sheets. These investments are included
in other assets and are accounted for under the cost method as our ownership is
less than 20% and we do 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, then the investment is marked to market. Our policy is to
regularly review the operating performance in assessing the carrying value of
the investment. Pursuant to the terms of these agreements, the Company has
certain rights to acquire approximately 791,000 shares of these entities under
certain conditions for additional consideration. We expect to continue to make
additional investments in the future.
56
57
ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON AUDITING AND FINANCIAL
DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required in this Item regarding our directors and executive
officers is set forth in Part I of this Annual Report under the heading
"Directors and Executive Officers of the Registrant," which information is
incorporated herein by reference.
The information required by this Item regarding our compliance with Section
16(a) is included in our definitive proxy statement for our 2001 annual meeting
of shareholders to be filed with the SEC under the caption "Section 16(a)
Beneficial Ownership Reporting Compliance" and is incorporated herein by this
reference.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this Item is included in our definitive proxy
statement for our 2001 annual meeting of shareholders to be filed with the SEC
under the caption "Information Regarding Executive Officer Compensation" and is
incorporated herein by this reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this Item is included in our definitive proxy
statement for our 2001 annual meeting of shareholders to be filed with the SEC
under the caption "Information Regarding Beneficial Ownership of Principal
Shareholders, Directors and Management" and is incorporated herein by this
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this Item is included in our definitive proxy
statement for our 2001 annual meeting of shareholders to be filed with the SEC
under the caption "Certain Relationships and Related Transactions" and is
incorporated herein by this reference.
57
58
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
FINANCIAL STATEMENTS AND SCHEDULES
1. Financial Statements.
A. Consolidated Balance Sheets at December 31, 1999 and 2000.
B. Consolidated Statements of Income for the Years Ended December 31,
1998, 1999 and 2000.
C. Consolidated Statements of Shareholders' Equity (Deficit).
D. Consolidated Statements of Cash Flows for the Years Ended December
31, 1998, 1999 and 2000.
2. Financial Statement Schedules.
A. Schedule II -- Valuation and Qualifying Accounts.
Financial statement schedules not included herein have been omitted because
they are either not required, not applicable, or the information is otherwise
included herein.
REPORTS ON FORM 8-K
No reports on Form 8-K were filed during the last quarter of fiscal 2001.
EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
---------- -----------
3.1# Amended and Restated Articles of Incorporation.
3.1(a)+ Articles of Amendment to Amended and Restated Articles of
Incorporation.
3.2# Bylaws and all amendments thereto.
4.1 See Exhibits 3.1, 3.1(a) and 3.2 for provisions defining the
rights of the holders of common stock.
10.1# Amended and Restated Stock Option Plan.
10.1(a)++ 1998 Mainbrace Stock Option Plan.
10.2# Employee Stock Purchase Plan
10.3# 401(k) Plan.
10.4# Form of Indemnification Agreement.
10.5# Loan and Security Agreement by and between Imperial Bank and
BSQUARE Corporation dated February 11, 1998.
10.5(a)# Amended and Restated Loan Agreement between Imperial Bank
and BSQUARE Corporation.
10.6# Office Lease Agreement between Seattle Office Associates,
LLC and BSQUARE Corporation dated March 24, 1997 (for Suite
100).
10.7# Sunset North Corporate Campus Lease Agreement between WRC
Sunset North and BSQUARE Corporation.
10.8## First Amendment to Office Lease Agreement between WRC Sunset
North LLC and BSQUARE.
10.9*# Master Development & License Agreement between Microsoft
Corporation and BSQUARE Corporation dated effective as of
October 1, 1998.
10.10# Stock Purchase and Shareholders Agreement dated as of
January 30, 1998.
10.11# Stock Purchase Agreement dated August 18, 1999 by and
between BSQUARE Corporation and Vulcan Ventures
Incorporated.
10.12### Agreement and Plan of Merger among BSQUARE, Bluewater
Systems, Inc. and H2O Merger Corporation dated as of January
5, 2000.
58
59
EXHIBIT
NUMBER DESCRIPTION
---------- -----------
10.13#### Agreement and Plan of Merger among BSQUARE Corporation,
Mainbrace Corporation and Mainbrace Acquisition Inc. dated
as of May 10, 2000.
10.14##### Single-Tenant Commercial Space Lease among One South Park
Investors, Paul Enterprises and FKLM as Landlord and BSQUARE
as Tenant.
10.15 Single-Tenant Commercial Space Lease (NNN), dated as of
August 30, 2000, by and between One South Park Investors,
Partnership and BSQUARE Corporation.
21.1 ##### Subsidiaries of the registrant.
23.1 Consent of Arthur Andersen LLP, Independent Public
Accountants.
24.1 Power of Attorney (See Page 60).
- ---------------
* Subject to confidential treatment.
+ Incorporated by reference to the registrant's quarterly report on Form
10-Q filed with the Securities and Exchange Commission on August 7,
2000.
++ Incorporated by reference to the registrant's registration statement on
Form S-8 (File No. 333-44306) filed with the Securities and Exchange
Commission on August 23, 2000.
# Incorporated by reference to the registrant's registration statement on
Form S-1 (File No. 333-85351) filed with the Securities and Exchange
Commission on October 19, 1999.
## Incorporated by reference to the registrant's annual report on Form 10-K
filed with the Securities and Exchange Commission on March 2, 2000.
### Incorporated by reference to the registrant's Current Report on Form 8-K
filed with the Securities and Exchange Commission on January 18, 2000.
#### Incorporated by reference to the registrant's Current Report on Form 8-K
filed with the Securities and Exchange Commission on May 23, 2000.
##### Incorporated by reference to the registrant's registration statement on
Form S-1 (File No. 333-45506) filed with the Securities and Exchange
Commission on September 14, 2000.
59
60
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized on March 26, 2001.
BSQUARE CORPORATION
By: /s/ BRIAN V. TURNER
------------------------------------
Brian V. Turner
President, and Chief Operating
Officer and Secretary
By: /s/ LEILA L. KIRSKE
------------------------------------
Leila L. Kirske
Vice President Finance and
Administration
(Principal Financial and Accounting
Officer)
POWER OF ATTORNEY
Each person whose individual signature appears below hereby authorizes and
appoints William T. Baxter and Brian V. Turner, and each of them, with full
power of substitution and resubstitution and full power to act without the
other, as his true and lawful attorney-in-fact and agent to act in his name,
place and stead and to execute in the name and on behalf of each person,
individually and in each capacity stated below, and to file, any and all
amendments to this registration statement, including any and all post-effective
amendments thereto and any registration statement relating to the same offering
as this Form 10-K, and to file the same, with all exhibits thereto, and other
documents in connection therewith, with the Securities and Exchange Commission,
granting unto said attorneys-in fact and agents, and each of them, full power
and authority to do and perform each and every act and thing, ratifying and
confirming all that said attorneys-in-fact and agents or any of them or their or
his substitute or substitutes may lawfully do or cause to be done by virtue
thereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on March 26, 2001 on
behalf of the registrant and in the capacities indicated.
SIGNATURE TITLE
--------- -----
/s/ WILLIAM T. BAXTER Chairman of the Board, and Chief Executive
- ----------------------------------------------------- Officer (Principal Executive Officer)
William T. Baxter
/s/ ALBERT T. DOSSER Director
- -----------------------------------------------------
Albert T. Dosser
/s/ SCOT E. LAND Director
- -----------------------------------------------------
Scot E. Land
60
61
SIGNATURE TITLE
--------- -----
/s/ JEFFREY. T. CHAMBERS Director
- -----------------------------------------------------
Jeffrey T. Chambers
/s/ WILLIAM L. LARSON Director
- -----------------------------------------------------
William L. Larson
61
62
REPORT OF INDEPENDENT ACCOUNTANTS ON SCHEDULE
To BSQUARE Corporation:
We have audited in accordance with generally accepted auditing standards in
the United States, the financial statements of BSQUARE Corporation and
subsidiaries included in this Form 10-K, and have issued our report thereon
dated January 19, 2001. Our audits were made for the purpose of forming an
opinion on those statements taken as a whole. The accompanying schedule is
presented for purposes of complying with the Securities and Exchange
Commission's rules and is not part of the basic financial statements. This
schedule has been subjected to the auditing procedures applied in the audits of
the basic financial statements and, in our opinion, fairly states in all
material respects the financial data required to be set forth therein relation
to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Seattle, Washington,
January 19, 2001
62
63
BSQUARE CORPORATION
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
-------- ---------- --------------------------- ------------- -------------
BALANCE AT CHARGED TO
BEGINNING COSTS AND CHARGED TO BALANCE AT
DESCRIPTION OF PERIOD EXPENSES OTHER ACCOUNTS DEDUCTIONS -- END OF PERIOD
----------- ---------- ---------- -------------- ------------- -------------
For the year ended December 31, 1998:
Allowance for doubtful accounts.... $ 10 $ 60 $-- $ 3 $ 67
For the year ended December 31, 1999:
Allowance for doubtful accounts.... $ 67 $ 75 $-- $-- $142
For the year ended December 31, 2000:
Allowance for doubtful accounts.... $142 $453 $-- $143 $502
63