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EX-10.1 - EX-10.1 - BSQUARE CORP /WAbsqr-ex101_54.htm

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

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

For the quarterly period ended September 30, 2016

OR

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

For the transition period from                      to                     

Commission File Number: 000-27687

 

BSQUARE CORPORATION

(Exact name of registrant as specified in its charter)

 

 

Washington

 

91-1650880

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

110 110th Avenue NE, Suite 300,

Bellevue WA

 

98004

(Address of principal executive offices)

 

(Zip Code)

(425) 519-5900

(Registrant’s telephone number, including area code)

 

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes     No  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

 

  

Accelerated filer

 

 

 

 

 

Non-accelerated filer

 

  (Do not check if a smaller reporting company)

  

Smaller reporting company

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes      No  

The number of shares of common stock outstanding as of October 31, 2016: 12,452,144

 

 

 

 

 


BSQUARE CORPORATION

FORM 10-Q

For the Quarterly Period Ended September 30, 2016

TABLE OF CONTENTS

 

 

 

 

 

 

Page

 

 

PART I. FINANCIAL INFORMATION

 

 

 

Item 1

 

Financial Statements

 

 

3

Item 2

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

 

16

Item 3

 

Quantitative and Qualitative Disclosures About Market Risk

 

 

22

Item 4

 

Controls and Procedures

 

 

22

 

 

PART II. OTHER INFORMATION

 

 

 

Item 1A

 

Risk Factors

 

 

23

Item 5

 

Other Information

 

 

23

Item 6

 

Exhibits

 

 

23

 

 

Signatures

 

 

23

 

 

Index to Exhibits

 

 

24

 

 

 

2


PART I. FINANCIAL INFORMATION

 

Item 1.

Financial Statements

BSQUARE CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)

 

 

September 30,

2016

 

 

December 31,

2015

 

 

(Unaudited)

 

 

 

 

 

ASSETS

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

Cash and cash equivalents

$

12,346

 

 

$

16,443

 

Short-term investments

 

19,231

 

 

 

13,280

 

Accounts receivable, net of allowance for doubtful

   accounts of $50 at September 30, 2016

   and $62 December 31, 2015

 

19,808

 

 

 

19,009

 

Prepaid expenses and other current assets

 

459

 

 

 

580

 

Total current assets

 

51,844

 

 

 

49,312

 

Equipment, furniture and leasehold improvements, net

 

1,194

 

 

 

1,167

 

Restricted cash equivalents

 

 

 

 

250

 

Deferred tax assets

 

32

 

 

 

145

 

Intangible assets, net

 

493

 

 

 

594

 

Goodwill

 

3,738

 

 

 

3,738

 

Other non-current assets

 

54

 

 

 

52

 

Total assets

$

57,355

 

 

$

55,258

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

Third-party software fees payable

$

11,068

 

 

$

11,789

 

Accounts payable

 

284

 

 

 

188

 

Accrued compensation

 

1,924

 

 

 

2,390

 

Other accrued expenses

 

741

 

 

 

1,277

 

Deferred rent, current portion

 

315

 

 

 

298

 

Deferred revenue

 

1,170

 

 

 

1,135

 

Total current liabilities

 

15,502

 

 

 

17,077

 

Deferred tax liability

 

85

 

 

 

97

 

Deferred rent

 

937

 

 

 

1,177

 

Deferred revenue

 

2,041

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

 

 

Preferred stock, no par value: 10,000,000 shares

   authorized; no shares issued and outstanding

 

 

 

 

 

Common stock, no par value: 37,500,000 shares

   authorized; 12,415,775 shares issued and

   outstanding at September 30, 2016 and 12,092,598

   shares issued and outstanding at December 31,

   2015

 

135,043

 

 

 

133,331

 

Accumulated other comprehensive loss

 

(907

)

 

 

(869

)

Accumulated deficit

 

(95,346

)

 

 

(95,555

)

Total shareholders’ equity

 

38,790

 

 

 

36,907

 

Total liabilities and shareholders’ equity

$

57,355

 

 

$

55,258

 

 

 

 

See notes to condensed consolidated financial statements.

 

3


 

BSQUARE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

(In thousands, except per share amounts) (Unaudited)

 

 

Three Months Ended

September 30,

 

 

Nine Months Ended

September 30,

 

 

2016

 

 

2015

 

 

2016

 

 

2015

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Software

$

19,216

 

 

$

21,215

 

 

$

58,118

 

 

$

66,679

 

Service

 

3,251

 

 

 

5,220

 

 

 

12,526

 

 

 

14,894

 

Total revenue

 

22,467

 

 

 

26,435

 

 

 

70,644

 

 

 

81,573

 

Cost of revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Software

 

15,281

 

 

 

17,698

 

 

 

47,901

 

 

 

54,732

 

Service

 

3,509

 

 

 

3,864

 

 

 

10,877

 

 

 

11,287

 

Total cost of revenue

 

18,790

 

 

 

21,562

 

 

 

58,778

 

 

 

66,019

 

Gross profit

 

3,677

 

 

 

4,873

 

 

 

11,866

 

 

 

15,554

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Selling, general and administrative

 

3,283

 

 

 

3,174

 

 

 

9,693

 

 

 

9,120

 

Research and development

 

809

 

 

 

312

 

 

 

2,024

 

 

 

1,300

 

Total operating expenses

 

4,092

 

 

 

3,486

 

 

 

11,717

 

 

 

10,420

 

Income (loss) from operations

 

(415

)

 

 

1,387

 

 

 

149

 

 

 

5,134

 

Other income, net

 

128

 

 

 

32

 

 

 

204

 

 

 

124

 

Income (loss) before income taxes

 

(287

)

 

 

1,419

 

 

 

353

 

 

 

5,258

 

Income tax benefit (expense)

 

181

 

 

 

(174

)

 

 

(144

)

 

 

(305

)

Net income (loss)

$

(106

)

 

$

1,245

 

 

$

209

 

 

$

4,953

 

Basic income (loss) per share

$

(0.01

)

 

$

0.10

 

 

$

0.02

 

 

$

0.42

 

Diluted income (loss) per share

$

(0.01

)

 

$

0.10

 

 

$

0.02

 

 

$

0.40

 

Shares used in calculation of income (loss) per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

12,310

 

 

 

11,959

 

 

 

12,189

 

 

 

11,867

 

Diluted

 

12,310

 

 

 

12,466

 

 

 

12,576

 

 

 

12,294

 

Comprehensive income (loss):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

$

(106

)

 

$

1,245

 

 

$

209

 

 

$

4,953

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation, net of tax

 

(78

)

 

 

3

 

 

 

(44

)

 

 

20

 

Change in unrealized gains (losses) on investments, net of tax

 

29

 

 

 

1

 

 

 

6

 

 

 

(3

)

Total other comprehensive income (loss)

 

(49

)

 

 

4

 

 

 

(38

)

 

 

17

 

Comprehensive income (loss)

$

(155

)

 

$

1,249

 

 

$

171

 

 

$

4,970

 

 

 

 

 

 

 

 

 

 

 

 

 

See notes to condensed consolidated financial statements.

 

 

 

4


BSQUARE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands) (Unaudited)

 

 

Nine Months Ended

September 30,

 

 

2016

 

 

2015

 

Cash flows from operating activities:

 

 

 

 

 

 

 

Net income

$

209

 

 

$

4,953

 

Adjustments to reconcile net income to net

   cash provided by operating activities:

 

 

 

 

 

 

 

Depreciation and amortization

 

442

 

 

 

425

 

Stock-based compensation

 

908

 

 

 

1,022

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

Accounts receivable, net

 

(799

)

 

 

(1,934

)

Prepaid expenses and other assets

 

220

 

 

 

203

 

Third-party software fees payable

 

(721

)

 

 

(2,063

)

Accounts payable and accrued expenses

 

(906

)

 

 

224

 

Deferred revenue

 

2,076

 

 

 

(7

)

Deferred rent

 

(223

)

 

 

(203

)

Net cash provided by operating activities

 

1,206

 

 

 

2,620

 

Cash flows from investing activities:

 

 

 

 

 

 

 

Purchases of equipment and furniture

 

(368

)

 

 

(225

)

Proceeds from maturities of short-term investments

 

18,200

 

 

 

14,253

 

Purchases of short-term investments

 

(24,159

)

 

 

(16,906

)

Reduction of restricted cash equivalents

 

250

 

 

 

 

Net cash used in investing activities

 

(6,077

)

 

 

(2,878

)

Cash flows provided by financing activities—proceeds

   from exercise of stock options

 

832

 

 

 

508

 

Effect of exchange rate changes on cash

 

(58

)

 

 

8

 

Net increase (decrease) in cash and cash equivalents

 

(4,097

)

 

 

258

 

Cash and cash equivalents, beginning of period

 

16,443

 

 

 

13,127

 

Cash and cash equivalents, end of period

$

12,346

 

 

$

13,385

 

 

 

 

 

 

 

 

 

 

 

 

See notes to condensed consolidated financial statements.

 

 

 

5


BSQUARE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2016

(Unaudited)

 

1. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of BSQUARE Corporation (“BSQUARE”) have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial reporting and include the accounts of BSQUARE and our wholly owned subsidiaries. Certain information and footnote disclosures normally included in the annual consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed or omitted pursuant to such rules and regulations. In our opinion, the unaudited condensed consolidated financial statements include all material adjustments, all of which are of a normal and recurring nature, necessary to present fairly our financial position as of September 30, 2016, our operating results for the three and nine months ended September 30, 2016 and 2015 and our cash flows for the nine months ended September 30, 2016 and 2015. The accompanying financial information as of December 31, 2015 is derived from audited financial statements. Preparing financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses. Examples include provisions for bad debts and income taxes, estimates of progress on professional engineering service arrangements and bonus accruals. Actual results may differ from these estimates. Interim results are not necessarily indicative of results for a full year. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2015. All intercompany balances have been eliminated.

Recently Issued Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued an Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers,” amending revenue recognition guidance and requiring more detailed disclosures to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The guidance, as amended, is effective for annual and interim reporting periods beginning after December 15, 2017, with early adoption permitted for public companies effective for annual and interim reporting periods beginning after December 15, 2016. We are currently evaluating the impact this ASU will have on our consolidated financial statements and related disclosures.

In November 2015, the FASB issued ASU No. 2015-17, “Balance Sheet Classification of Deferred Taxes,” to simplify the presentation of deferred income taxes. The amendments in this ASU require that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The amendments in this ASU apply to all entities that present a classified statement of financial position. The current requirement that deferred tax liabilities and assets of a tax-paying component of an entity be offset and presented as a single amount is not affected by the amendments in this ASU. We adopted the new guidance retrospectively beginning with the year ended December 31, 2014, and applied such guidance consistently beginning with the year ended December 31, 2015.

In February 2016, the FASB issued ASU No. 2016-2, “Leases,” to make leasing activities more transparent and comparable, requiring most leases be recognized by lessees on their balance sheets as right-of-use assets, along with corresponding lease liabilities. ASU 2016-2 is effective for public business entities for annual periods beginning after December 31, 2018 and interim periods within that year, with early adoption permitted. We are currently evaluating the impact this ASU may have on our consolidated financial statements and related disclosures.

In March 2016, the FASB amended the existing accounting standards for stock-based compensation, ASU 2016-09, “Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting.” The amendments impact several aspects of accounting for share-based payment transactions, including income tax consequences, forfeitures, classification of awards as either equity or liabilities, and classification on the statement of cash flows. We are required to adopt the amendments in the first quarter of 2017, with early adoption permitted. If early adoption is elected, all amendments must be adopted in the same period. The manner of application varies by the various provisions of the guidance, with certain provisions applied on a retrospective or modified retrospective approach, while others are applied prospectively. We are currently evaluating the impact this ASU may have on our consolidated financial statements and related disclosures.

6


In August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows (Topic 230):  Classification of Certain Cash Receipts and Cash Payments,” adding or clarifying guidance on the classification of certain cash receipts and payments in the statement of cash flows. The standard addresses eight specific cash flow issues with the objective of reducing diversity in practice. ASU 2016-15 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017. Early adoption is permitted. We are currently evaluating the impact this ASU may have on our consolidated financial statements and related disclosures.

Income (Loss) Per Share

Basic income (loss) per share is computed using the weighted average number of common shares outstanding during the period, and excludes any dilutive effects of common stock equivalent shares, such as options, restricted stock awards and restricted stock units. Restricted stock awards (“RSAs”) are considered outstanding and included in the computation of basic income or loss per share when underlying restrictions expire and the awards are no longer forfeitable. Restricted stock units (“RSUs”) are considered outstanding and included in the computation of basic income or loss per share only when vested. Diluted income (loss) per share is computed using the weighted average number of common shares outstanding and common stock equivalent shares outstanding during the period using the treasury stock method. Common stock equivalent shares are excluded from the computation if their effect is anti-dilutive.

We excluded an aggregate of 1,545,512 and 627,778 options for the three and nine months ended September 30, 2016, respectively, from diluted income (loss) per share because their effect was anti-dilutive. For the three months ended September 30, 2016, this included common stock equivalent shares of 952,858 calculated using the treasury stock method that would have been included in diluted income (loss) per share had we been in a net income position. In a period where we are in a loss position, diluted loss per share is computed using the basic share count. We excluded an aggregate of 282,276 and 201,091 options for the three and nine months ended September 30, 2015, respectively, from diluted income per share because their effect was anti-dilutive.

2. Cash, Cash Equivalents and Investments

Cash, cash equivalents and short-term investments consisted of the following (in thousands):

 

 

September 30,

2016

 

 

December 31,

2015

 

Cash

$

11,470

 

 

$

7,270

 

Cash equivalents:

 

 

 

 

 

 

 

Money market funds

 

876

 

 

 

1,500

 

Corporate commercial paper

 

 

 

 

5,404

 

Corporate debt securities

 

 

 

 

2,269

 

Total cash equivalents

 

876

 

 

 

9,173

 

Total cash and cash equivalents

 

12,346

 

 

 

16,443

 

Short-term investments:

 

 

 

 

 

 

 

Corporate commercial paper

 

13,701

 

 

 

6,245

 

Treasury bonds

 

 

 

 

1,007

 

Corporate debt securities

 

5,530

 

 

 

6,028

 

Total short-term investments

 

19,231

 

 

 

13,280

 

Restricted cash equivalents—money market fund

 

 

 

 

250

 

Total cash, cash equivalents and short-term investments

$

31,577

 

 

$

29,973

 

Gross unrealized gains and losses on our short-term investments were not material as of September 30, 2016 and December 31, 2015. The balance in restricted cash equivalents at December 31, 2015 related to a letter of credit securing the lease of our corporate headquarters. The restricted cash was released in September 2016.

7


3. Fair Value Measurements

We measure our cash equivalents and short-term investments at fair value. Fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a liability. A three-tier fair value hierarchy is established as a basis for considering such assumptions and for inputs used in the valuation methodologies in measuring fair value:

 

Level 1:

Quoted prices in active markets for identical assets or liabilities.

 

Level 2:

Directly or indirectly observable market-based inputs or unobservable inputs used in models or other valuation methodologies.

 

Level 3:

Unobservable inputs that are not corroborated by market data. The inputs require significant management judgment or estimation.

We classify our cash equivalents and short-term investments within Level 1 or Level 2 because our cash equivalents and short-term investments are valued using quoted market prices or alternative pricing sources and models utilizing market observable inputs.

Assets and liabilities measured at fair value on a recurring basis as of September 30, 2016 and December 31, 2015 are summarized below (in thousands):

 

September 30, 2016

 

 

Quoted Prices in

Active Markets for

Identical Assets

(Level 1)

 

 

Direct or Indirect

Observable

Inputs (Level 2)

 

 

Total

 

Assets

 

 

 

 

 

 

 

 

 

 

 

Cash equivalents:

 

 

 

 

 

 

 

 

 

 

 

Money market funds

$

876

 

 

$

 

 

$

876

 

Total cash equivalents

 

876

 

 

 

 

 

 

876

 

Short-term investments:

 

 

 

 

 

 

 

 

 

 

 

Corporate commercial paper

 

 

 

 

13,701

 

 

 

13,701

 

Corporate debt securities

 

 

 

 

5,530

 

 

 

5,530

 

Total short-term investments

 

 

 

 

19,231

 

 

 

19,231

 

Total assets measured at fair value

$

876

 

 

$

19,231

 

 

$

20,107

 

 

 

December 31, 2015

 

 

Quoted Prices in

Active Markets for

Identical Assets

(Level 1)

 

 

Direct or Indirect

Observable

Inputs (Level 2)

 

 

Total

 

Assets

 

 

 

 

 

 

 

 

 

 

 

Cash equivalents:

 

 

 

 

 

 

 

 

 

 

 

Money market funds

$

5,404

 

 

$

 

 

$

5,404

 

Corporate commercial paper

 

 

 

 

1,500

 

 

 

1,500

 

Corporate debt securities

 

 

 

 

2,269

 

 

 

2,269

 

Total cash equivalents

 

5,404

 

 

 

3,769

 

 

 

9,173

 

Short-term investments:

 

 

 

 

 

 

 

 

 

 

 

Corporate commercial paper

 

 

 

 

6,245

 

 

 

6,245

 

Treasury bonds

 

 

 

 

1,007

 

 

 

1,007

 

Corporate debt securities

 

 

 

 

6,028

 

 

 

6,028

 

Total short-term investments

 

 

 

 

13,280

 

 

 

13,280

 

Restricted cash equivalents—money market fund

 

250

 

 

 

 

 

 

250

 

Total assets measured at fair value

$

5,654

 

 

$

17,049

 

 

$

22,703

 

8


 

4. Goodwill and Intangible Assets

Goodwill relates to the 2011 acquisition of MPC Data, Ltd. (renamed BSQUARE EMEA in 2015), a United Kingdom based provider of embedded software engineering services. The excess of the acquisition consideration over the fair value of net assets acquired was recorded as goodwill. We operate as a single reporting unit, and BSQUARE EMEA falls within that reporting unit. There were no changes in the carrying amount of goodwill during the three and nine months ended September 30, 2016.

Intangible assets relate to customer relationships acquired from TestQuest Inc. in 2008 and from the acquisition of MPC in 2011, the vast majority of which relates to the MPC acquisition.

Information regarding our intangible assets is as follows (in thousands):

 

  

September 30, 2016

 

 

Gross

Carrying

Amount

 

 

Accumulated

Amortization

 

 

Net

Carrying

Value

 

Customer relationships

$

1,275

 

 

$

(782

)

 

$

493

 

 

 

December 31, 2015

 

 

Gross

Carrying

Amount

 

 

Accumulated

Amortization

 

 

Net

Carrying

Value

 

Customer relationships

$

1,275

 

 

$

(681

)

 

$

594

 

Amortization expense was $33,000 and $101,000 for the three and nine months ended September 30, 2016, respectively, and $33,000 and $101,000 for the three and nine months ended September 30, 2015, respectively. Amortization in future periods is expected to be as follows (in thousands):

 

Remainder of 2016

$

30

 

2017

 

98

 

2018

 

98

 

2019

 

98

 

2020

 

98

 

2021

 

71

 

Total

$

493

 

 

5. Credit Agreement

 

Line of Credit

 

On September 22, 2015, we entered into a two-year unsecured line of credit agreement (the “Credit Agreement”) with JPMorgan Chase Bank, N.A. (the “Bank”) in the principal amount of up to $12 million. At our election, advances under the Credit Agreement shall bear interest at either (1) a rate per annum equal to 1.5% below the bank’s applicable prime rate or (2) 1.5% above the Bank’s applicable LIBOR rate, in each case as defined in the Credit Agreement. The Credit Agreement contains customary affirmative and negative covenants, including compliance with financial ratios and metrics, as well as limitations on our ability to pay distributions or dividends while there is an ongoing event of default or to the extent such distribution causes an event of default. We are required to maintain certain minimum interest coverage ratios, liquidity levels and asset coverage ratios as defined in the Credit Agreement. We were in compliance with all such covenants as of September 30, 2016. On September 29, 2016, the Credit Agreement was modified to extend the final due date an additional year to September 22, 2018.

 

There were no amounts outstanding under the Credit Agreement as of September 30, 2016 or December 31, 2015. In September 2016 we entered into a new letter of credit agreement for $250,000 secured by the Credit Agreement in connection with the lease of our corporate headquarters.  Accordingly, the principal amount available under the Credit Agreement has been reduced from $12 million to $11.75 million.

9


6. Shareholders’ Equity

Equity Compensation Plans

We have a stock plan (the “Stock Plan”) and an inducement stock plan for newly hired employees (the “Inducement Plan”) (collectively, the “Plans”). Under the Plans, stock options to purchase shares of our common stock may be granted with a fixed exercise price that is equal to the fair market value of our common stock on the date of grant. These options have a term of up to 10 years and vest over a predetermined period, generally four years. Incentive stock options granted under the Stock Plan may only be granted to our employees. The Plans also allow for awards of non-qualified stock options, stock appreciation rights, RSAs and unrestricted stock awards, and RSUs. Expense is recorded for performance options over the requisite service periods when achievement of related performance targets are considered to be probable.

Stock-Based Compensation

The estimated fair value of stock-based awards is recognized as compensation expense over the vesting period of the award, net of estimated forfeitures. We estimate forfeitures based on historical experience and expected future activity. The fair value of RSUs is determined based on the number of shares granted and the quoted price of our common stock on the date of grant. The fair value of stock option awards is estimated at the grant date based on the fair value of each vesting tranche as calculated by the Black-Scholes-Merton (“BSM”) option-pricing model. The BSM model requires various highly judgmental assumptions including expected volatility and option life. If any of the assumptions used in the BSM model change significantly, stock-based compensation expense may differ materially in the future from that recorded in the current period. The fair values of our stock option grants were estimated with the following weighted average assumptions:

 

 

Three Months Ended

September 30,

 

 

Nine Months Ended

September 30,

 

 

2016

 

 

2015

 

 

2016

 

 

2015

 

Dividend yield

 

0

%

 

 

0

%

 

 

0

%

 

 

0

%

Expected life

3.3 years

 

 

3.3 years

 

 

3.4 years

 

 

3.3 years

 

Expected volatility

 

55

%

 

 

53

%

 

 

55

%

 

 

52

%

Risk-free interest rate

 

1.0

%

 

 

1.3

%

 

 

1.1

%

 

 

1.2

%

The impact on our results of operations from stock-based compensation expense was as follows (in thousands, except per share amounts):

 

 

Three Months Ended

September 30,

 

 

Nine Months Ended

September 30,

 

 

2016

 

 

2015

 

 

2016

 

 

2015

 

Cost of revenue — service

$

(4

)

 

$

133

 

 

$

169

 

 

$

351

 

Selling, general and administrative

 

262

 

 

 

298

 

 

 

618

 

 

 

616

 

Research and development

 

22

 

 

 

23

 

 

 

121

 

 

 

55

 

Total stock-based compensation expense

$

280

 

 

$

454

 

 

$

908

 

 

$

1,022

 

Per diluted share

$

0.02

 

 

$

0.04

 

 

$

0.07

 

 

$

0.08

 

 

10


Stock Option Activity

The following table summarizes stock option activity under the Plans for the nine-month period ended September 30, 2016:

 

Stock Options

 

Number of

Shares

 

 

Weighted

Average

Exercise

Price

 

 

Weighted

Average

Remaining

Contractual

Life

(in years)

 

 

Aggregate

Intrinsic

Value

 

Balance at January 1, 2016

 

 

1,778,697

 

 

$

4.43

 

 

 

 

 

 

 

 

 

Granted

 

 

307,700

 

 

 

5.48

 

 

 

 

 

 

 

 

 

Exercised

 

 

(273,320

)

 

 

3.19

 

 

 

 

 

 

 

 

 

Forfeited

 

 

(380,472

)

 

 

5.31

 

 

 

 

 

 

 

 

 

Expired

 

 

(51,367

)

 

 

6.13

 

 

 

 

 

 

 

 

 

Balance at September 30, 2016

 

 

1,381,238

 

 

$

4.61

 

 

 

7.31

 

 

$

1,176,876

 

Vested and expected to vest at September 30, 2016

 

 

1,305,619

 

 

$

4.55

 

 

 

7.21

 

 

$

1,165,259

 

Exercisable at September 30, 2016

 

 

773,084

 

 

$

4.02

 

 

 

6.24

 

 

$

948,542

 

At September 30, 2016, total compensation cost related to stock options granted but not yet recognized was $731,527, net of estimated forfeitures. This cost will be amortized on the straight-line method over a weighted-average period of approximately 1.32 years. The following table summarizes certain information about stock options:

 

 

Three Months Ended

September 30,

 

 

Nine Months Ended

September 30,

 

 

2016

 

 

2015

 

 

2016

 

 

2015

 

Weighted-average grant-date fair value of option

   grants for the period

$

2.53

 

 

$

3.16

 

 

$

2.83

 

 

$

3.10

 

Options in-the-money at period end

 

766,101

 

 

 

1,762,893

 

 

 

766,101

 

 

 

1,762,893

 

Aggregate intrinsic value of options exercised

$

226,430

 

 

$

265,641

 

 

$

568,516

 

 

$

616,417

 

The aggregate intrinsic value represents the difference between the exercise price of the underlying options and the quoted price of our common stock for the number of options that were in-the-money at period end or that were exercised during the period. We issue new shares of common stock upon exercise of stock options.

Restricted Stock Unit Activity

The following table summarizes RSU activity for the nine-month period ended September 30, 2016:

 

  

Number of

Shares

 

 

Weighted

Average

Grant Date Fair

Value

 

Unvested at January 1, 2016

 

104,463

 

 

$

5.97

 

Granted

 

54,870

 

 

 

5.65

 

Vested

 

(56,081

)

 

 

5.94

 

Forfeited

 

(15,969

)

 

 

5.77

 

Unvested at September 30, 2016

 

87,283

 

 

$

5.83

 

Expected to vest after September 30, 2016

 

78,781

 

 

$

5.81

 

 

At September 30, 2016, total compensation cost related to RSUs granted but not yet recognized was $268,388, net of estimated forfeitures. This cost will be amortized on the straight-line method over a period of approximately 1.02 years.

11


Common Stock Reserved for Future Issuance

The following table summarizes our shares of common stock reserved for future issuance under the Plans as of September 30, 2016:

 

Stock options outstanding

 

1,381,238

 

RSUs outstanding

 

87,283

 

Stock awards available for future grant

 

1,105,715

 

Common stock reserved for future issuance

 

2,574,236

 

 

 

7. Commitments and Contingencies

Lease and rent obligations

Our commitments include obligations outstanding under operating leases, which expire through 2020. We have lease commitments for office space in Bellevue, Washington; San Diego, California; Boston, Massachusetts; Taipei, Taiwan; Tokyo, Japan; and Trowbridge, UK. We also lease office space on a month-to-month basis in Akron, Ohio.

 

In August 2013, we amended the lease agreement for our Bellevue, Washington headquarters, which was initially scheduled to expire in August 2014, and extended the lease term to May 2020. The amendment to the headquarters lease provided that no cash lease payments were to be made for a seven-month period from June 1, 2013 to December 31, 2013. In conjunction with the amended lease agreement, the landlord provided lease incentives totaling $1,128,000 for leasehold improvements and furniture related to new space in the same building, which were capitalized and are reflected in the deferred rent liability. We are amortizing these assets over the shorter of their economic life or the lease term.

 

Rent expense was $262,000 and $781,000 for the three and nine months ended September 30, 2016, respectively, and $268,000 and $789,000 for the three and nine months ended September 30, 2015, respectively.

 

As of December 31, 2015, we had $250,000 pledged as collateral for a bank letter of credit under the terms of our headquarters facility lease. The pledged cash supporting the outstanding letter of credit was classified as restricted cash at December 31, 2015. In September 2016 the restriction on this cash was removed as we entered into a new letter of credit secured by our Credit Agreement with the Bank.

 

Future operating lease commitments are as follows by calendar year (in thousands):

 

Remainder of 2016

$

330

 

2017

 

1,185

 

2018

 

1,094

 

2019

 

1,038

 

2020

 

436

 

Total commitments

$

4,083

 

Loss Contingencies

From time to time, we are subject to legal proceedings, claims, and litigation arising in the ordinary course of business including tax assessments. We defend ourselves vigorously against any such claims. When (i) it is probable that an asset has been impaired or a liability has been incurred and (ii) the amount of the loss can be reasonably estimated, we record the estimated loss. We provide disclosure in the notes to the consolidated financial statements for loss contingencies that do not meet both of these conditions if there is a reasonable possibility that a loss may have been incurred that would be material to the financial statements. Significant judgment is required to determine the probability that a liability has been incurred and whether such liability is reasonably estimable. We base accruals made on the best information available at the time which can be highly subjective. The final outcome of these matters could vary significantly from the amounts included in the accompanying consolidated financial statements.

12


A third-party software vendor invoiced us a total of $934,000 for certain licensed software that was lost in transit by a common carrier during the second quarter of 2014. We accrued a liability of $100,000 in the second quarter of 2014 as an estimate of our potential liability for legal and insurance deductible expenses. During the first quarter of 2015, the vendor credited our account for the full $934,000 as the licenses had been deactivated and there was no indication of counterfeit use. Accordingly, we reversed approximately $85,000 of the accrual after payment of legal expenses in the first quarter of 2015.

Volume Pricing Agreements

In conjunction with our activities under our OEM Distribution Agreements (“ODAs”) with Microsoft Corporation (“Microsoft”), as further described in Note 9, we have entered into OEM Volume Royalty Pricing (“OVRP”) commitments with Microsoft. Under these OVRPs, we are provided with volume pricing on a customer-by-customer basis assuming certain minimum unit volumes are met. The OVRP terms are 12 months. In the event we do not meet the committed minimum unit volumes, we are obligated to pay the difference between the committed per-unit volume rate and the actual per-unit rate we achieved based upon actual units purchased. The OVRP arrangements do not equate to a minimum purchase commitment, but rather, the arrangements are a volume pricing arrangement based upon actual volume purchased. In substantially all significant instances, we have reciprocal agreements with our customers such that we will receive per-unit price adjustments, similar to the amounts we would subsequently owe to Microsoft if such OVRP volumes are not met. However, in the event a customer is unwilling or unable to pay us, we would be negatively impacted. Based upon the credit-worthiness of our customers, our historical OVRP experience with our customers and OVRP arrangements in general, we do not believe we will incur any material liability relating to active agreements, and, therefore, no provision or reserve has been recorded as of September 30, 2016 or December 31, 2015.  

In late 2015, Microsoft implemented significant pricing changes for its embedded products, including ending its design registration pricing discounts and its OVRP and changing the aggregate volume price structure and product royalties for existing embedded Windows products effective January 1, 2016. In December 2015, we renewed the majority of our Microsoft licensing customer agreements for 2016 retaining 2015 pricing. As a result, the price changes implemented by Microsoft may not have a significant impact until 2017.

 

8. Information about Geographic Areas and Operating Segments

Our chief operating decision-makers (i.e., our Chief Executive Officer and certain direct reports) review financial information presented on a consolidated basis, accompanied by disaggregated information for purposes of allocating resources and evaluating financial performance. There are no segment managers who are held accountable by our chief operating decision-makers, or anyone else, for operations, operating results, or planning for levels or components below the consolidated unit level. We operate within a single industry segment of computer software and services. We have two major product lines, software and professional engineering services, each of which we consider to be an operating and reportable segment. Software includes third-party software and proprietary software sales, and professional engineering services includes consulting, programming and software implementation revenue. We do not allocate costs other than direct cost of goods sold to the segments or produce segment income statements. We do not produce asset information by reportable segment and it is not presented here.  

 

 

Three Months Ended

September 30,

 

 

Nine Months Ended

September 30,

 

 

2016

 

 

2015

 

 

2016

 

 

2015

 

Software

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

$

19,216

 

 

$

21,215

 

 

$

58,118

 

 

$

66,679

 

Cost of revenue

 

15,281

 

 

 

17,698

 

 

 

47,901

 

 

 

54,732

 

Gross profit

 

3,935

 

 

 

3,517

 

 

 

10,217

 

 

 

11,947

 

Professional Engineering Services

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

3,251

 

 

 

5,220

 

 

 

12,526

 

 

 

14,894

 

Cost of revenue

 

3,509

 

 

 

3,864

 

 

 

10,877

 

 

 

11,287

 

Gross profit (loss)

 

(258

)

 

 

1,356

 

 

 

1,649

 

 

 

3,607

 

Total gross profit

 

3,677

 

 

 

4,873

 

 

 

11,866

 

 

 

15,554

 

Operating expenses

 

4,092

 

 

 

3,486

 

 

 

11,717

 

 

 

10,420

 

Other income, net

 

128

 

 

 

32

 

 

 

204

 

 

 

124

 

Income tax benefit (expense)

 

181

 

 

 

(174

)

 

 

(144

)

 

 

(305

)

Net income (loss)

$

(106

)

 

$

1,245

 

 

$

209

 

 

$

4,953

 

 

13


 

Revenue by geography is based on the sales region of the customer. The following table sets forth revenue and long-lived assets by geographic area (in thousands):

 

 

Three Months Ended

September 30,

 

 

Nine Months Ended

September 30,

 

 

2016

 

 

2015

 

 

2016

 

 

2015

 

Total revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

North America

$

20,917

 

 

$

23,654

 

 

$

66,275

 

 

$

74,415

 

Asia

 

1,018

 

 

 

1,055

 

 

 

1,847

 

 

 

3,043

 

Europe

 

532

 

 

 

1,726

 

 

 

2,522

 

 

 

4,115

 

Total revenue

$

22,467

 

 

$

26,435

 

 

$

70,644

 

 

$

81,573

 

 

 

 

September 30,

2016