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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, 1999
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 18, 2000 was approximately
$263.5 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 32,569,125 shares of common stock, no
par value, outstanding at February 18, 2000.
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
May 2, 2000 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
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PART I......................................................................................12
Item 1. Business...................................................................12
Item 2. Properties.................................................................24
Item 3. Legal Proceedings..........................................................24
Item 4. Submission of Matters to a Vote of Security Holders........................24
PART II.....................................................................................24
Item 5. Market for Registrant's Common Equity and Related Shareholder Matters......24
Item 6. Selected Financial Data....................................................26
Item 7. Management's Discussion and Analysis of Results of Operations and
Financial Condition........................................................26
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.................31
Item 8. Financial Statements and Supplementary Data................................32
Item 9. Changes in and Disagreements with Accountants on Auditing and Financial
Disclosure.................................................................49
PART III....................................................................................49
Item 10. Directors and Executive Officers of the Registrant........................49
Item 11. Executive Compensation....................................................49
Item 12. Security Ownership of Certain Beneficial Owners and Management............49
Item 13. Certain Relationships and Related Transactions............................50
PART IV.....................................................................................50
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K...........50
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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 limited operating
history, 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 us and our business 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 whom a
substantial portion of our revenue is generated and on whom 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;
- increased competition and changes in our pricing as a result of
increased competitive pressure;
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- 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.
SUBSTANTIALLY ALL OF OUR REVENUE, INCLUDING 88% OF OUR TOTAL REVENUE FOR THE
YEAR ENDED DECEMBER 31, 1999, IS GENERATED FROM OUR RELATIONSHIP WITH MICROSOFT,
WHICH CAN BE MODIFIED OR TERMINATED BY MICROSOFT AT ANY TIME.
For the years ended, December 31, 1997, 1998 and 1999 approximately 39%,
79% and 88% of our revenue, respectively, was generated under our master
development and license agreement with Microsoft. The master agreement, the
current renewable term of which concludes in July 2000, 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. 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
200 of our 300 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 all of our revenue through 1999 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. In addition, Microsoft has
developed a version of its Windows NT operating system for
intelligent computing devices and could decide to shift its support
to this operating system to the detriment of Windows CE;
- the ability of the Windows CE operating system to compete against
existing and emerging operating systems for the intelligent computing
device market including: VxWorks from WindRiver Systems Inc., pSOS
from Integrated 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
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faces intense competition from PalmOS used on 3Com Corporation's Palm
devices 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 between
several of the largest manufacturers of cellular phones, which
recently announced it has agreed to discuss cross-licensing its
technology with the Palm Computing unit of 3Com. 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 CE-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
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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. Many of our original equipment manufacturer
customers are referred to us by Microsoft. 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 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.
THE FIXED-FEE ARRANGEMENTS WE HAVE WITH MANY OF OUR CUSTOMERS EXPOSE US TO THE
RISK THAT WE MAY UNDERESTIMATE OUR COSTS FOR PROJECTS, WHICH COULD LOWER OUR
PROFIT MARGINS.
In addition to the capped-fee arrangements we have with Microsoft, we
provide our services to many of our customers under fixed-fee arrangements. In
1998 and 1999, approximately 12% and 8%, respectively, of our total revenue was
derived from fixed-fee contracts. In the event that we underestimate the scope
or work effort required for a customer's project, we may be required to complete
the project at a loss or at a significantly reduced gross margin. If we
underestimate the fees for a series of projects and/or a very large project, our
gross margins for a fiscal period may decline. In addition, revenue from these
contracts is recognized on the percentage-of-completion method, measured by the
cost incurred to date relative to the estimated total cost for the contract. If
we underestimate the time necessary to complete these projects, we may be
required to recognize revenue at a later time than we had anticipated, which
would have a negative impact on our financial condition and cause our quarterly
results to fluctuate.
IF WE FAIL TO SECURE CONTRACTS ON SUFFICIENTLY PROFITABLE TERMS, OR AT ALL, WITH
THE LIMITED NUMBER OF MARKET-LEADING ORIGINAL EQUIPMENT MANUFACTURERS OUR
REVENUE AND PROFIT MARGINS WOULD SUFFER.
Currently substantially all of our non-Microsoft revenue is generated
from sales to original equipment manufacturers. For the year ended December 31,
1999, approximately 11% of our revenue was from sales to original equipment
manufacturer customers. There are a limited number of original equipment
manufacturer customers that are capable of building and shipping large
quantities of intelligent computing devices. In some market segments, one or two
original equipment manufacturers account for a majority of all unit sales.
Competition for the business of these original equipment manufacturers is
intense. If we fail to secure and maintain service and licensing contracts with
the limited number of original equipment manufacturers in these markets we may
not be able to participate in those market segments. In addition, as a result of
their strong market position, these companies are typically able to secure
favorable terms, including favorable pricing, in their technology licensing and
service agreements. Further, many of these potential original equipment
manufacturer customers have the capability to replace our services and products
by utilizing internal resources. For these reasons, there is no guarantee that
we will
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be able to secure contracts on profitable terms, or at all, with the
market-leading original equipment manufacturers, which could harm our business.
OUR MARKET IS BECOMING INCREASINGLY COMPETITIVE, WHICH MAY RESULT IN PRICE
REDUCTIONS, LOWER GROSS MARGINS AND LOSS OF MARKET SHARE.
The market for Windows CE-based software products and services is
becoming increasingly competitive. 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;
- large professional engineering services firms that may enter the
market;
- established intelligent computing device software and tools
manufacturers;
- small- and medium-size engineering services companies; 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, with respect to system
integration. 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.
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 three 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,
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
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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 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 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 software 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.
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OUR FIVE-YEAR OPERATING HISTORY MAKES IT DIFFICULT TO EVALUATE OUR FUTURE
PROSPECTS, AND WE CANNOT ASSURE YOU THAT OUR REVENUE GROWTH RATE WILL NOT
DECLINE OR THAT WE WILL BE ABLE TO SUSTAIN OR INCREASE OUR PROFITABILITY.
We were founded in July 1994, generated our first revenue in October
1994 and shipped our first product in November 1996. Accordingly, we have a
limited operating history and you should not rely on our past results to predict
our future performance. The rate of growth of our revenue over the prior year
was 245% from 1996 to 1997, 71% from 1997 to 1998, and 62% from 1998 to 1999.
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 1999, we grew from 21 employees to 379
employees, and we expect this 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.
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, 1999, less than 1% 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.
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IF WE CONDUCT FUTURE ACQUISITIONS, THEY COULD PROVE DIFFICULT TO INTEGRATE,
DISRUPT OUR BUSINESS, DILUTE SHAREHOLDER VALUE AND ADVERSELY AFFECT OUR
OPERATING RESULTS.
Although we currently have no specific understandings, commitments or
agreements for any acquisition, we may make investments in complementary
companies, services and technologies in the future. If we fail to properly
evaluate and execute acquisitions and investments, they may seriously harm our
business and prospects. 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 or our management may be distracted from our day-to-day operations. In
addition, if we conduct acquisitions using debt or equity securities, existing
shareholders may be diluted, 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.
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
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- 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.
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 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, as of this year's annual meeting of
shareholders, our board of directors will be divided into three classes. The
directors in each class will 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 antitakeover provisions could limit the price that investors
might be willing to pay in the future for shares of our common stock.
IMPACT OF THE YEAR 2000
Even though we have not experienced any immediate adverse impact from
the transition to the year 2000, it is possible that other dates in the year
2000, may further affect computer software and systems. While we believe that
all of our systems are year 2000 compliant, we may discover problems during 2000
that may require expenditures in order for our computer and software systems to
be upgraded, modified or replaced. In addition, we do not currently have any
information concerning the year 2000 compliance status of our clients or other
parties with whom we do business. It is possible that some of the internal
systems of our clients or other parties with whom we do business have already
been or will be negatively affected by the year 2000 date change. We currently
have no contingency plan to manage any year 2000 issues that may arise.
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PART I
ITEM 1. BUSINESS.
OVERVIEW
We provide a broad range of software products and services that both
facilitate the integration of Microsoft Windows operating systems into a variety
of devices we call intelligent computing devices (ICDs) and enhance the
functionality of those devices. Original equipment manufacturers, semiconductor
vendors and software developers rely on our products and services to help bring
customized intelligent computing devices and intelligent computing device
applications to market in a timely fashion. We have been providing Windows
CE-based software services since before the commercial release of Windows CE in
September 1996, and therefore we believe that we offer a greater breadth and
depth of Windows CE expertise than any of our current competitors. 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, the
acquisition of Blue Water Systems broadened our product line for developers of
ICDs based on additional Windows operating systems including Windows 98, Windows
2000, Windows NT and Windows NT Embedded.
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" such as kiosk
terminals and navigational devices used in cars and trucks; and Windows-based
terminals. Compared to traditional computers, intelligent computing devices are
often less expensive and more adaptable in terms of their size, weight and
shape, while still providing sophisticated computing and communications
capabilities, including Internet connectivity. Increasingly, intelligent
computing devices are able to connect directly to the Internet, either through
wired or wireless telecommunications systems. As businesses and consumers
increasingly use the Internet to transact business and as demand for smaller and
more mobile devices grows, original equipment manufacturers are developing new
intelligent computing devices to better meet the needs of end users. Because of
space constraints and other design and resource limitations inherent in the
intelligent computing device environment, original equipment manufacturers
require a computer operating system that is both scalable and highly
customizable, with lower system requirements than traditional PC operating
systems. There are several different operating systems that can be used in
intelligent computing devices. Windows CE, a versatile and highly adaptable
operating system modeled after Microsoft Windows, is gaining market acceptance
among original equipment manufacturers as an operating system that meets these
requirements. As increased use of the Internet by consumers and businesses helps
fuel the growth of the intelligent computing device market, we believe that the
market for Windows CE will in turn benefit. In addition, the Windows NT Embedded
(NTE) operating system is used for "computerizing" larger, more complex devices
with a need for real time functionality. Examples of devices for which NTE is
targeted include Windows-based terminals, office machine equipment such as
printers, and telecommunications equipment.
We develop products and provide services that facilitate the development
of Windows-based intelligent computing devices. We generate revenue in three
distinct ways. First, we provide software code-writing and related engineering
services to Microsoft and semiconductor vendors to adapt Windows CE to different
microprocessors and to enhance Windows CE's user-specific features and
functions. Second, we offer a comprehensive set of software products and
services that help enable original equipment manufacturers to cost-effectively
integrate Windows CE, NTE and other Windows operating systems into their
intelligent computing devices. These offerings include original equipment
manufacturer adaptation kits, software development products, test programs and
Microsoft Windows CE licensing, along with engineering, quality assurance
services and training. Our service and product offerings are designed to ensure
that Windows works properly with the original equipment manufacturer's computer
boards, which are the internal hardware constituting the core of their
intelligent computing devices. We also offer software engineering services for
the integration of Window NT Embedded into ICDs, and for other Windows-based
operating systems we offer the BlueWater Systems software development products.
Third, we license a wide range of Windows CE-based software applications to both
original equipment manufacturers and intelligent computing device consumers to
provide additional functions to Windows CE-based intelligent computing devices,
such as printing and faxing capabilities.
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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. According to a November 1998 report by Forrester Research entitled
"Re-sizing On-line Business Trade," U.S.-based Internet commerce between
businesses is expected to grow from $43 billion in 1998 to $1.3 trillion in
2003.
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;
- 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 and vehicle navigational
devices. 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 we received in August 1999 from International Data Corporation, a
provider of information technology data and industry analysis, the market for
consumer information appliances, a subset of the overall intelligent computing
device market, is expected to grow from $2.2 billion in 1998 to $18.7 billion in
2003.
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
estimates in a December 1998 report entitled
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"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.
To take advantage of the multiple benefits of these Windows operating
systems, many original equipment manufacturers and semiconductor vendors require
the services of a software product and service provider with the breadth of
experience and depth of capabilities to fully support the Windows CE and Window
NT Embedded operating systems and related applications across different
semiconductors and intelligent computing devices. 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.
OUR BUSINESS
We provide a variety of software products and services that facilitate
the integration of Microsoft operating systems into a wide range of intelligent
computing devices and enhance the functionality of those devices. Original
equipment manufacturers, semiconductor vendors and Windows CE software
developers rely on our products and services to help bring customized
intelligent computing devices and intelligent computing device applications to
market in a timely fashion. Key elements of our solutions include:
A BROAD SET OF END-TO-END SOFTWARE DEVELOPMENT PRODUCTS AND SERVICES TO
SUPPORT A DIVERSE RANGE OF INTELLIGENT COMPUTING DEVICE HARDWARE, SYSTEMS AND
APPLICATIONS DEVELOPMENT REQUIREMENTS:
- Software development. We provide software development, testing and
program management 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. Software
development tools are software packages that help engineers develop
new software applications. 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.
- Hardware support. We provide software products and services to
original equipment manufacturers that support a variety of
microprocessors and other intelligent computing device computer
hardware. For example, our CE Xpress Kits provide pre-configured
software packages that enable original equipment manufacturers to
integrate Windows CE into their intelligent computing devices.
- System validation. We provide software products and services to
assist original equipment manufacturers in the validation and
verification of their hardware and software executing Windows CE and
Windows NT Embedded, including services designed to help original
equipment manufacturers develop testing programs to validate the
performance and reliability of their intelligent computing devices.
- Applications software. We provide software packages that facilitate
the third-party development of Windows CE-based intelligent computing
device user interfaces. We also license software applications to both
original equipment manufacturers and intelligent computing device end
users that enhance the functionality of their intelligent computing
devices.
PRODUCTS AND SERVICES THAT USE EXISTING MICROSOFT TECHNOLOGIES AND
STANDARDS. Our Windows-based products and services use existing Microsoft
technologies and standards to enable semiconductor vendors and original
equipment manufacturers to deliver highly customizable and cost-efficient
intelligent computing devices to their end users. These technologies enable
original equipment manufacturers to efficiently utilize the existing pool
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of programmers familiar with the Windows operating system to develop
differentiating applications for intelligent computing devices based upon the
Windows family of operating systems. Our use of common programming standards
also allows intelligent computing devices designed with our development products
and services to integrate with existing information systems, as well as with
other Microsoft technologies and applications. By enabling original equipment
manufacturers to standardize on a given software platform, our products and
services help original equipment manufacturers more rapidly deploy new hardware
technologies without having to re-implement their software investments across
multiple platforms.
CAPITALIZING ON OUR DEPTH OF EXPERIENCE IN DEVELOPING WINDOWS-BASED
SOFTWARE PRODUCTS AND SERVICES AND OUR VARIETY OF STRATEGIC RELATIONSHIPS TO
DELIVER TANGIBLE BENEFITS TO WINDOWS-BASED 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 and software
developers. Such benefits include:
- REDUCED TIME-TO-MARKET. By using our software services and
pre-configured software components, 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 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 software solutions for the
development of ICDs is very fragmented. Our strategy is to become one of the
primary providers of software products and services for facilitating the
integration of operating systems into 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. Specifically for Windows CE-based
solutions, because we have been providing Windows CE-based software services
since prior to the commercial release of Windows CE in September 1996, we
believe that we offer a greater breadth and depth of Windows CE expertise than
our current
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competitors. We intend to continue to utilize this 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 CE as an embedded operating system, and
our in-depth experience with Windows NT provide a foundation of technical and
engineering process expertise to offer our Windows NT Embedded software service
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 CE, Windows NT Embedded and other Windows-based operating systems where
applicable. We provide software products and services that enable manufacturers
of microprocessors, computer boards and other components to develop hardware
designs compatible with Windows CE. We have also entered into licensing
arrangements with software developers to provide connectivity technologies for
products that interface with Windows CE. 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 new Porting Partners Program, for which we will provide
software engineering services to microprocessor vendors seeking compatibility
with Windows CE. Currently, we provide software code-writing and related
engineering services to Microsoft for a number of different Windows CE projects
and we intend to continue this relationship in the future. We believe that our
success is related to the overall adoption of Windows-based as an operating
system on ICD platforms, and therefore we intend to continue to work with
Microsoft to promote the Windows family of operating systems as the systems of
choice for ICDs.
Utilize our extensive Windows CE expertise to develop additional
software applications. We believe that as Windows CE is widely adopted in the
marketplace, there will be an increasing demand for complete, end-user software
applications that enhance the capabilities of Windows CE-based intelligent
computing devices. We intend to use our Windows CE expertise, our alliances with
original equipment manufacturers and our relationship with Microsoft to develop
a leading position in the market for Windows CE-based software applications. We
currently offer a variety of personal productivity software applications,
including calendar, address book and task-list functions, as well as utility and
communications software for Windows CE-based intelligent computing devices. We
intend to continue to make use of our Windows CE expertise to develop additional
applications to address the evolving requirements of this market.
Expand our international presence. We intend to continue to expand
internationally in order to enhance our profile and market reach. We believe
that Windows CE is gaining acceptance in the Asian and European markets. These
markets are attractive to us because of their high concentration of OEM
customers focusing on the development of intelligent computing devices. 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.
SOFTWARE SERVICES AND PRODUCTS
We develop, market and support a wide variety of Windows-based software
products and services for the development and integration of the Windows family
of operating systems across a diverse selection of intelligent computing
devices.
Operating system development and accompanying tools
We provide software code-writing 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;
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- the utility of the Microsoft Visual Tools series, a set of software
development tools for use with the Windows CE operating system; and
- the integration of Windows CE with multiple microprocessors.
The services we provide these customers include software development,
software testing and program management. We provide these services both as a
comprehensive solution and on a point basis to address specific needs depending
upon individual customer requirements.
The following table summarizes the key features and benefits of the
services we offer to Microsoft and semiconductor vendors:
BSQUARE SERVICE DESCRIPTION BENEFIT
--------------- ----------- -------
Software development - We aid Microsoft in the - The Visual Tools are
services to Microsoft development of its Visual necessary for the adaptation
Tools series of development of Windows CE to new
tools for Windows CE intelligent computing devices
and for the development of
Windows CE software
applications
Software engineering - We assist Microsoft and - Allows semiconductor vendors
consulting services to semiconductor vendors in to make their products
Microsoft and the development of available for use in Windows
semiconductor vendors system-level software that CE-based intelligent
enables Windows CE to computing devices in a timely
control the functions on a and cost-effective manner
particular microprocessor
Integration of Windows CE and Windows NT Embedded with intelligent computing
devices
We offer software products and services that are used by original
equipment manufacturers to integrate Windows operating systems with intelligent
computing devices. We offer a comprehensive set of software products and
services that enable original equipment manufacturers to cost-effectively
integrate Windows CE or Windows NT Embedded with intelligent computing devices,
thus reducing time-to-market and decreasing the risk of project failure.
Products -- The following table summarizes the key features and
benefits of the products we offer to original equipment manufacturers for the
integration of Windows CE with intelligent computing devices.
BSQUARE PRODUCT DESCRIPTION BENEFIT
--------------- ----------- -------
CE Xpress Adaptation Kits - A set of pre-developed and - Designed to save original
tested code for low-level equipment manufacturers time
support of hardware in a developing low-level software
Windows CE-based device support, reducing time-to-market
- Available for a broad range - Pre-tested components increase
of chip sets including those reliability of target device
manufactured by AMD, Cyrix,
Hitachi, Intel and Motorola
- Sold in source code format
to allow customer
modifications
CE Xpress Binary Kits - Includes same functionality - Enables original equipment
as CE Xpress Adaptation Kit manufacturers to rapidly
without access to source code evaluate Windows CE on a
specific reference board with
minimal investment
- Enables original equipment
manufacturers to bring reference
board-compatible products to
market with no porting or
low-level customization
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BSQUARE PRODUCT DESCRIPTION BENEFIT
--------------- ----------- -------
CE Xpress Single Board - A development kit that works - Provides a foundation for
Computer Kits in conjunction with single original equipment
board computers to quickly manufacturers to begin
install and run Windows CE immediate development of
for the development of Windows CE-based intelligent
intelligent computing devices computing devices
- Provides all of the
infrastructure normally
needed for development of
applications and
customizations based on
industry-standard expansion
bus (or "plug-in")
architectures
CE Xpress86 Kit - A development kit that - Eliminates need to wait for
allows original equipment hardware development before
manufacturers to run Windows beginning software
CE on a standard PC-based development, enabling faster
platform time-to-market
- Runs Windows CE without DOS - Reduces the cost of PC-based
Windows CE systems by
eliminating the DOS license
requirement
CE Xpress OnDemand - An online subscription - Enables CE Xpress Kit
service for portable device customers to access the latest
drivers for CE Xpress Kit drivers and driver updates
customers online
CEValidator - A quality assurance and - Designed to save original
testing technology for the equipment manufacturers
validation of Windows CE testing costs Enables original
integration with intelligent equipment manufacturers to
computing devices test software throughout the
- A client/server-based test
design process program of
more than 1,000 individual
test cases for testing
compliance and reliability
- Extendable architecture for
incorporating additional and
custom test programs
CE Interface Composer - A fully customizable desktop - Gives original equipment
building utility manufacturers the ability to
create a device-specific
- Includes a set of
pre-developed components for - graphical user interface
creating a custom desktop
- Helps enable original
- Contains customizable equipment manufacturers to
security and interface rapidly and easily create
features for commercial design prototypes and complete
applications the implementation of
graphical user interfaces
To augment our own Windows-based 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 Windows CE software products and services. We are currently a
licensed distributor of Windows CE-based software from Communications
Intelligence Corporation, Datalight, Intrinsyc and Microsoft.
Services -- We also provide 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 such as kiosk
terminals and navigational devices in cars and trucks, and Windows-based
terminals. Our software engineering services use our existing products, such as
our CE Xpress Adaptation Kit, CE Interface Composer and CE Validator, to
implement the hardware and software specifications of our customers' intelligent
computing device 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
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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 our original
equipment manufacturer customers to complete intelligent computing device
development and reduce time-to-market.
The following table summarizes the key features and benefits of the
services we offer to our original equipment manufacturer customers:
BSQUARE PRODUCT DESCRIPTION BENEFIT
--------------- ----------- -------
Systems consulting - We provide Windows CE and - Without our software
services to original Windows NT Embedded engineering consulting
equipment manufacturers integration services to services, original equipment
developing intelligent original equipment manufacturers would need to
computing devices manufacturers developing increase their development
intelligent computing devices costs and extend their project
along with custom adaptations schedules to provide the
of Windows CE training and materials
required to complete the
- We provide software projects in-house
engineering consulting
services to write the - Allows original equipment
software code that enables manufacturers to move quickly
Windows CE and Windows NT past the traditionally time
Embedded to integrate with consuming early stage of
intelligent computing device integrating Windows-based
hardware operating systems with their
existing hardware and software
Applications consulting - We provide software - Allows original equipment
services to original applications development manufacturers to avoid the
equipment manufacturers according to customer time and cost of developing
developing intelligent specifications in-house expertise in
computing devices applications development for
Windows CE
Quality assurance - We provide complete quality - Allows early discovery of
consulting services to assurance services on every design problems, a more rapid
original equipment project to ensure the highest development process and higher
manufacturers developing quality quality products for end users
intelligent computing
devices
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 market our consumer
software applications through standard retail and electronic commerce channels
and also license these products to original equipment manufacturers in formats
suitable for bundling with their own products. Our current consumer software
application product offerings include:
PRODUCT DESCRIPTION BENEFIT
------- ----------- -------
bFAX - A product family that - Provides a practical and
provides faxing capabilities comprehensive faxing solution
for intelligent computing for Windows CE-based devices
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 SpreadSheet - A spreadsheet application for - Provides independent
palm-size PCs functionality while
maintaining Pocket Excel
compatibility
bUSEFUL Utilities Pak - Utility suite for handheld - Provides utility applications
and palm-size PCs that which enhance the performance
contains 12 different utility and functionality of Windows
applications CE-based devices
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TECHNOLOGY
We have developed a set of technologies incorporated in the software
products described under "-- Integration of Windows CE and Windows NT Embedded
with intelligent computing devices -- Products" that are used by original
equipment manufacturers to integrate Windows CE with their computer boards, the
internal hardware constituting the core of their intelligent computing devices.
The technology contained in our CE Xpress Kits, including the Original Equipment
Manufacturer Adaptation Layer, the CE Platform Layer and the Device Driver
Library, provides the interface between Windows CE and the computer board
contained within the intelligent computing device. The basic features and
functions of these technologies are described below.
Original Equipment Manufacturer Adaptation Layer Library
The Original Equipment Manufacturer Adaptation Layer provides a standard
interface between the Windows CE operating system and the core components of an
intelligent computing device's computer board. A new board-specific Original
Equipment Manufacturer Adaptation Layer must be implemented for each computer
board that will be using Windows CE.
We maintain a library of Original Equipment Manufacturer Adaptation
Layers for several of the computer boards used in Windows CE-based intelligent
computing device products. These Original Equipment Manufacturer Adaptation
Layers are distributed to our customers in our CE Xpress Kits and are also used
by our engineers when we are contracted to create custom solutions. In addition,
our Original Equipment Manufacturer Adaptation Layer library serves as a
starting point for the creation of new Original Equipment Manufacturer
Adaptation Layer implementations.
Device Driver Library
Device drivers provide the interface by which the Windows CE operating
system controls any peripheral devices, including keyboards, display screens and
computer network interface cards, that may be connected to an intelligent
computing device's computer board. A separate device driver must be implemented
for each peripheral device connected to a Windows CE-enabled computer board.
We have created a library of device drivers for inclusion in our CE
Xpress Kits and for use in the custom software products and services we provide
to our customers. The existing set of drivers also provides starting points for
the creation of new device drivers.
CE Platform Layer
A peripheral device normally requires a different device driver for each
model of computer board to which it is to be connected. A device driver for one
model of computer board will not generally work with a different model of
computer board.
Our CE Platform Layer technology allows our engineers and third-party
hardware manufacturers to develop a single driver for a peripheral device that
may then be used on many different models of computer boards. This increases the
value and flexibility of each computer board by increasing the number of readily
available peripheral devices that can be used.
Our CE Platform Layer technology is included in our CE Xpress Kits and
is used for the implementation of the majority of our device drivers.
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CEValidator
Our CEValidator product is a quality assurance and testing tool which we
originally developed for in-house use. We believe that it is important to test
devices early in the design process and to continue testing at a high frequency
throughout the development cycle. We have designed our CEValidator to support
such a testing pattern. CEValidator is based on two primary components:
- a broad suite of over 1,000 tests which evaluate the various
subsystems of Windows CE. These tests have been developed by our
engineers in the course of our own software development efforts. In
addition, CEValidator allows original equipment manufacturers to add
their own test suites to evaluate specific features of their
intelligent computing devices.
- a test control system. This system manages the execution of the tests
suite and the recording of test results. CEValidator provides
communication features which control testing over network
connections, a graphical user interface for displaying user controls
and test results, and simultaneous testing capabilities for multiple
systems.
CUSTOMERS
Microsoft is our largest customer, representing approximately 39%, 79%
and 88% of our total revenue in 1997, 1998 and 1999, respectively. Our other
target customers include semiconductor vendors and original equipment
manufacturers seeking to leverage the numerous benefits of Windows CE in order
to develop high quality, full-feature products that meet the complex and
evolving requirements of numerous end-markets.
Semiconductor Vendors
Through late 1997, we provided services directly to semiconductor
vendors. In late 1997, Microsoft decided to contract with us to provide services
to the semiconductor vendors with whom we had previously contracted directly. In
1996 and 1997 we provided in excess of $1.0 million of services to each of the
following semiconductor vendors:
ARM
Hitachi Semiconductor (America)
Motorola Computer Group
NEC
From late 1997 to early 2000, we provided software products and services
to these and other semiconductor vendors under our master agreement with
Microsoft. In January 2000, we signed a new agreement with Microsoft entitled
the Porting Partners Agreement, in which we were named the exclusive provider of
software engineering services to semiconductor vendors seeking Windows CE
software support for their products. Under this new agreement, we will again
provide services directly to semiconductor vendors new to the Windows CE
operating system.
OEM Customers
The following is a representative list of our original equipment
manufacturer customers in 1999:
AT&T Philips Mobile Computing Group
Boundless Technologies Sainco
Casio Sharp Electronics
Cedar Systems Symbol Technologies
Data General Takaoka Electric
Development Concepts Televideo
Ericsson Telxon
Hewlett-Packard Total Control Products
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IGEL AG Touchstar Technologies
Lexicon Two Technologies
LG Electronics WebTV
NEC Electronics
Philips Electronics
Due to customer confidentiality requirements, some customers are not
disclosed. For 1999, per-customer revenue for all customers varied from less
than $5,000 to approximately $596,000.
MICROSOFT RELATIONSHIP
We maintain strategic relationships with Microsoft to promote its
Windows CE operating system 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 200 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 are the exclusive partner of Microsoft for providing
software engineering services to semiconductor manufacturers seeking Windows CE
software support 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.
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 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 different semiconductor vendors through our
direct sales force. We market our software tools products and related services
that help original equipment manufacturers integrate Windows CE into their
intelligent computing devices through our direct sales force, as well as through
third-party representatives and distributors. We market our Windows CE-based
software applications either bundled by original equipment
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manufacturers onto particular intelligent computing devices or purchased
directly by consumers for their intelligent computing devices through our direct
sales force, third-party representatives, distributors, or other consumer retail
channels. We have direct sales offices in the United States, Germany and Japan.
As of December 31, 1999, we had 35 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
CE-based intelligent computing devices.
RESEARCH AND DEVELOPMENT
As of December 31, 1999, we had 302 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.
A substantial majority of our research and development 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 five
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.
The remainder of our research and development engineers provide services
and develop Windows CE software for both end-user markets and
product/application developers. The software engineers in this team are
responsible for the development of commercial applications that provide added
breadth and functionality for Windows CE-based intelligent computing devices as
well as standard products used in the development and testing of new products
utilizing the Windows CE operating system. Our engineers have significant
experience in creating products for Windows CE, 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;
- large professional engineering services firms;
- established intelligent computing device software and tools
manufacturers;
- small- and medium-size engineering services; and
- software and component distributors.
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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 three pending U.S. patent applications. We do not have
any issued patents. BSQUARE, bFAX and BSQUARE View are our registered
trademarks. Additionally, bTRACK, bREADY, bFIND, bPRINT, bMOBILE, bUSEFUL,
bTASK, bPRODUCTIVE, bSTART and CEValidator are our trademarks. We will continue
to pursue registration of these and other marks. This prospectus also contains
trademarks and tradenames of other companies.
EMPLOYEES
As of December 31, 1999, we had 379 employees, excluding independent
contractors and other temporary employees, including 302 employees in software
engineering services and product development, 35 employees in sales and
marketing and 42 employees in general and administrative services (including
executive officers). Of these employees, 369 are located in the United States,
three are located in Germany and seven 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.
ITEM 2. PROPERTIES.
We lease approximately 126,000 square feet of space in a single location
in Bellevue, Washington, pursuant to a lease that expires in 2009, with the
option to renew for up to an additional 20 years. We also lease office space in
Munich, Germany and Tokyo, Japan. We believe that our facilities will be
adequate to meet our needs 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.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.
MARKET PRICES AND DIVIDENDS ON COMMON STOCK
Our common stock is traded on The Nasdaq National Market under the
symbol "BSQR." The following table sets forth the high and low sales prices of
our common stock as reported on The Nasdaq National Market since October 20,
1999, the date our common stock commenced public trading.
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Quarter Ended High Low
----------------- ------ ------
December 31, 1999 $56.50 $15.00
The closing price of our common stock as reported by The Nasdaq National
market on February 18, 2000 was $36.00 per share. We estimate that at February
18, 2000 there were approximately 134 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."
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
1995 1996 1997 1998 1999
-------- -------- -------- -------- --------
(unaudited)
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenue .................................................. $ 1,573 $ 4,179 $ 14,405 $ 24,612 $ 39,938
Gross profit ............................................. 778 2,775 8,761 13,407 20,644
Income from operations ................................... 692 1,964 4,564 3,170 1,881
Net income ............................................... $ 693 $ 1,971 $ 3,806 $ 2,300 $ 1,691
======== ======== ======== ======== ========
Basic earnings per share ................................. $ 0.03 $ 0.09 $ 0.18 $ 0.12 $ 0.06
======== ======== ======== ======== ========
Shares used in computation of basic earnings per
share .................................................... 21,000 22,106 21,400 18,372 27,858
======== ======== ======== ======== ========
Diluted earnings per share ............................... $ 0.03 $ 0.09 $ 0.17 $ 0.08 $ 0.06
======== ======== ======== ======== ========
Shares used in computation of diluted earnings per
share .................................................... 21,000 22,106 21,781 27,475 30,539
======== ======== ======== ======== ========
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and short-term investments ........ $ 103 $ 187 $ 2,286 $ 6,906 $ 82,397
Working capital .......................................... 236 658 2,918 10,280 81,178
Total assets ............................................. 514 1,057 6,453 16,158 95,624
Long-term obligations, net of current portion ............ -- -- 1,743 289 --
Mandatorily redeemable convertible preferred stock ....... -- -- -- 14,417 --
Shareholders' equity (deficit) ........................... 261 924 2,330 (1,298) 88,538
- --------------------
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
development and proliferation of a wide variety of intelligent computing devices
based on the Microsoft Windows-based operating systems. Intelligent computing
devices, or ICDs, are a class of non-personal computer devices that offer
electronic connectivity. 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-powered operating systems
with industry-specific applications. We also develop software applications that
are licensed to end users 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 $14.4 million in 1997, $24.6 million in 1998 and
$39.9 million in 1999. We generated net income of $3.8 million in 1997, $2.3
million in 1998 and $1.7 million in 1999.
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To date, we have derived substantially all 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 standard retail
channels, 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.
MICROSOFT MASTER DEVELOPMENT AND LICENSE AGREEMENT
In 1997, 1998 and 1999, approximately 39%, 79% and 88% of our revenue,
respectively, was generated under our master development and license agreement
with Microsoft. The master agreement, the current renewable term of which
concludes in July 2000, 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.
In addition, under a non-competition provision contained in the master
agreement, we must obtain written permission from Microsoft in order to design
or develop products, or provide services in connection with products, which
compete with Windows, or related products in existence as of October 1, 1998 or
which Microsoft is developing or intends to develop or acquire. In January 2000,
Microsoft eliminated this non-competition provision in conjunction with the
execution of a new Porting Partners agreement.
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,
--------------------------------
1997 1998 1999
------ ------ ------
CONSOLIDATED STATEMENT OF OPERATIONS DATA
Revenue:
Service ................................................ 97% 95% 95%
Product ................................................ 3 5 5
------ ------ ------
Total revenue ..................................... 100 100 100
------ ------ ------
Cost of revenue:
Service ................................................ 39 46 47
Product ................................................ -- -- 1
------ ------ ------
Total cost of revenue ............................. 39 46 48
------ ------ ------
Gross margin .............................................. 61 54 52
Operating expenses:
Research and development ............................... 10 14 17
Selling, general and administrative .................... 19 26 29
Amortization of deferred stock option compensation ..... -- 1 1
------ ------ ------
Total operating expenses .......................... 29 41 47
------ ------ ------
Income from operations .................................... 32 13 5
Interest income, net ...................................... -- 1 2
------ ------ ------
Income before income taxes ................................ 32 14 7
Provision for income taxes ................................ 6 5 3
------ ------ ------
Net income ................................................ 26% 9% 4%
====== ====== ======
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COMPARISON OF YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
Revenue
Total revenue increased 71% from $14.4 million in 1997 to $24.6 million
in 1998, and an additional 62% to $39.9 million in 1999. Microsoft accounted for
39%, 79% and 88% of total revenue in 1997, 1998 and 1999, respectively. Revenue
outside of North America totaled $4.3 million in 1997, $954,000 in 1998 and $1.2
million in 1999. The decrease in international revenue from 1997 to 1998
correlates with the corresponding increase in Microsoft revenue resulting from
the shift from working directly with semiconductor vendors to working with
Microsoft for the benefit of those customers during this period. 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.
Service revenue. Service revenue increased 67% from $14.0 million in
1997 to $23.4 million in 1998, and an additional 63% to $38.1 million in 1999.
The increases in service revenue for all periods were due to the increasing
number and size of service projects and related hiring of engineering personnel
to fulfill project requirements. As a percentage of total revenue, service
revenue did not change materially.
Product revenue. Product revenue increased 217% from $384,000 in 1997 to
$1.2 million in 1998, and an additional 52% to $1.9 million in 1999. The
increases in product revenue from 1997 to 1999 resulted from the expansion of
product offerings from software applications for handheld PCs to intelligent
computing device integration tool kits and CE Validator quality assurance test
suites. As a percentage of total revenue, product revenue did not change
materially.
Cost of Revenue
Cost of service revenue. Cost of service revenue increased 98% from $5.6
million in 1997 to $11.0 million in 1998, and an additional 70% to $18.8 million
in 1999. These increases resulted from the hiring and training of additional
employees to support our growing customer base. At December 31, 1997, 1998 and
1999, we had 87, 152 and 222 employees, respectively, engaged in engineering
consulting. Cost of service revenue as a percentage of related service revenue
was 40% in 1997, 47% in 1998 and 49% in 1999. 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 area, as well as higher facilities and depreciation costs
associated with expansion.
Cost of product rev