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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

For the fiscal year ended December 31, 2019

OR

For the transition period from           to           

Commission file number: 000-27687

BSQUARE CORPORATION

(Exact name of registrant as specified in its charter)

 

110 110^th Avenue NE, Suite 300, Bellevue, Washington 98004

(Address of principal executive offices, including zip code)

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

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(b) of the Exchange Act:

 

 

Securities registered pursuant to Section 12(g) of the Act: NONE

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☑

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes ☐ No ☑

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 every Interactive Data File required to be submitted 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 such files). Yes ☑ No ☐

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

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

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

The aggregate market value of common stock held by non-affiliates of the registrant on June 30, 2019 was approximately $11.8 million and was determined using the closing price of our common stock on that same date per the NASDAQ Stock Market ($1.16). The number of shares of common stock outstanding as of January 31, 2020: 13,042,293

 

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive proxy statement to be delivered to shareholders in connection with the 2020 annual meeting of shareholders are incorporated by reference into Part III of this Annual Report on Form 10-K.

 

 

 

 

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BSQUARE CORPORATION

FORM 10-K

TABLE OF CONTENTS

 

 

 

 

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Certain statements contained in this Annual Report on this Form 10-K (“Form 10-K”) are not purely historical statements, discuss future expectations, contain projections of results of operations or financial condition, or state other forward-looking information. Those statements are subject to known and unknown risks, uncertainties, and other factors that could cause the actual results to differ materially from those contemplated by the statements. The “forward-looking” information is based on various factors and was derived using numerous assumptions. In some cases, you can identify these so-called forward-looking statements by words like “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” “seeks” or “continue” or the negative of those words and other comparable words. You should be aware that those statements only reflect our predictions and are subject to risks and uncertainties. Actual events or results may differ substantially. Important factors that could cause our actual results to be materially different from the forward-looking statements include (but are not limited to) the following:

This discussion is not exhaustive but is designed to highlight important factors that may impact our forward-looking statements. Because the factors referred to above, as well as the statements included under the heading “Risk Factors” in this Form 10-K, including documents incorporated by reference therein and herein, could cause actual results or outcomes to differ materially from those expressed in any forward-looking statement made by us or on our behalf, you should not place undue reliance on any forward-looking statements.

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. We are under no duty to update any of the forward-looking statements after the date of this Form 10-K to conform such statements to actual results.

All forward-looking statements, express or implied, included in this report and the documents we incorporate by reference and that are attributable to Bsquare Corporation and its subsidiaries (collectively, “we,” “us,” “Bsquare,” or the “Company”) are expressly qualified in their entirety by this cautionary statement. This cautionary statement should also be considered in connection with any subsequent written or oral forward-looking statements that the Company or any persons acting on our behalf may issue.

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PART I

Overview

We believe the promise of Internet of Things (“IoT”) will be realized through the development of intelligent devices and systems that are cloud-enabled, contribute critical data, facilitate distributed control and decision making, and operate securely at scale. The opportunity to help companies transform their businesses and operations through these intelligent systems is enormous, and Bsquare offers a unique combination of expertise in device-level solutions, embedded operating systems, and IoT software and services. Since our founding in 1994, Bsquare has been at the intersection of hardware and software. Today that intersection is the “edge” where cloud-enabled devices connect to create intelligent systems that share data, facilitate distributed control and machine learning, and operate securely at scale. From device hardware, to the operating system, to IoT software solutions, and cloud services that make intelligent systems possible, Bsquare’s expertise, products and services are at the center of digital transformation.

While 2019 was a year of transition for Bsquare, we expect 2020 to be a year of focus and discipline as we seek to accelerate the recovery we started in 2019. With an entrepreneurial leadership team in place we anticipate a return to revenue growth and predictability. In 2019 we established a foundation that will allow Bsquare to more readily take advantage of growth opportunities as they become apparent.

Our Partner Solutions business segment is a strong source of both cash and important partner and customer relationships. We are uniquely positioned as a software-only Microsoft distributor. Because we sell operating system (“OS”) software decoupled from hardware, we can partner with a wide range of customers, especially those who are concerned about procuring their software from a potential hardware competitor. Nearly every customer that has been buying OS software is now contemplating their IoT strategy and our longstanding relationship allows us to cross sell our Edge to Cloud products and services.

The distribution market is also changing dramatically. Our customers’ products, essentially hardware and associated software, cannot be sold, installed, and then forgotten. Today, our customers constantly seek to maintain and optimize the operating system, firmware, and software in their products. Further, these devices are increasingly becoming a part of complex networks, what is often referred to as IoT, and what we call intelligent systems. This evolution is creating new opportunities for our business. Our software and edge expertise combined with our position as a supply chain partner makes us uniquely suited to address these complex requirements.

In our Edge to Cloud business segment, we plan to expand on the valuable experience we gained serving our large customers in 2019 building and operating their IoT solutions at scale. Our B2IQ software and consulting suite and our improved engineering methodologies create a foundation upon which we can build and grow this business segment. We plan to continue to invest in creating an agile and quality-oriented customer service function that will become an integral part of our customers’ IoT operations, allowing our customers to rely on Bsquare to ensure that their products are well designed and can operate in a fully connected IoT-enabled world.

In pursuing revenue growth in both segments, we seek to exploit what we believe to be the obvious synergy between our two core businesses.

We were incorporated in the State of Washington in July 1994. Our principal office is located at 110 110th Avenue NE, Suite 300, Bellevue, Washington 98004, and our telephone number is (425) 519-5900. Our website address is www.bsquare.com. Information contained on or that can be accessed through our website is not a part of this Form 10-K.

Partner Solutions Business Segment

Customers engage us because of our long history as a Microsoft OS distribution and technology partner and our industry leading technical expertise in OS image development, device software development and testing, and embedded and mobile operating systems design. We believe that engaging us on a new device design typically results in shorter development cycles and reduced time-to-market, lower overall costs to complete projects, and enhanced product robustness and features, which a customer may otherwise have been unable to achieve.

Market

Our target market includes makers of connected, intelligent computing devices such as point-of-sale terminals, kiosks, tablets and handheld data collection devices, smart vending machines, ATM machines, essential equipment in buildings and facilities environments, digital signs and in-vehicle telematics and entertainment devices. These devices utilize various operating system software including Microsoft Windows IoT, Android, Linux, or QNX, and are typically connected to a network via a wired or wireless connection. Our customers, for these smart devices, include world-class original equipment manufacturers (“OEMs”), original design manufacturers (“ODMs”), corporate enterprises (“Enterprises”), silicon vendors (“SVs”) and peripheral vendors.

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Software Distribution

We have distribution agreements with multiple third-party software vendors. Our ability to resell these third-party software products, whether as stand-alone products or in conjunction with our own proprietary software and engineering service offerings, provides our customers with a comprehensive solution source for their device project needs. Our primary third-party software offerings include the following:

The majority of our revenue continues to be derived from reselling Microsoft Windows operating system software to device makers. The sale of Microsoft operating systems has accounted for substantially all of our third-party software revenue historically, including approximately 98% of third-party software revenue in 2019 and 97% in 2018.

Software Products

We offer the following software products (B2IQ OS Utilities) and anticipate developing additional products during the year to compliment the offerings of our partners and address the evolving needs of our customers:

Service Products

Bsquare offers a full suite of professional services to assist our customers with the design, development, and deployment of devices and systems that make use of the software we resell. Typically, our professional services are provided on a time and materials consulting basis, although the Jumpstart service is offered as a package. Our professional services include the following:

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Relationship with Microsoft

We have a long-standing relationship with Microsoft and this relationship is important to the continuing success of our business. Our credentials as a Microsoft partner include:

See Item 1A, “Risk Factors,” for more information regarding our relationship with Microsoft.

Competition

Microsoft controls who can distribute its OS software. Authorized distributors that we complete with include the following:

Our competition is not limited to the Microsoft-authorized distributors. We compete with other consulting firms for services related to device design and development, system software development, and engineering firms that offer similar services.

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Edge to Cloud Business Segment

Customers engage us because of our extensive experience in the areas of device software development and testing, our experience with Microsoft Azure and Amazon Web Service cloud development and operation, our modular suite of IoT development components (B2IQ Suite), our experience serving large IoT customers at scale, and our focus on understanding the return on investment (“ROI”) for their IoT projects. We believe that engaging us typically results in shorter development cycles and reduced time-to-market, lower overall costs to complete projects, and enhanced product robustness and features, and a clear ROI for their system.

Market

The IoT market continues to emerge and evolve. This market includes business and industrial segments. It encompasses services, software, hardware, connectivity and cloud providers as well as systems integrators. The IoT marketplace is currently being influenced by the following factors:

Software Products

We offer the following software products and anticipate developing additional products during the year to compliment the offerings of our partners and address the evolving needs of our customers:

Service Products

Bsquare offers a full suite of professional services to assist our customers with the design, development, deployment and operation of their IoT system.

Typically, our professional services are provided on a time and materials consulting basis.

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We have developed, deployed, and operated IoT systems for businesses of all sizes, from global Fortune 500 companies to small private organizations. Our professional services include the following:

Competition

Our competitors in the Edge to Cloud segment, or companies against which we anticipate vying for opportunities, include:

The market for device software and engineering services is competitive. We face competition from the following:

Some of our competitors have greater financial and other resources than we do. They may also focus on only one aspect of our business or offer complementary products that can be integrated with our products. As we develop and bring to market new software products and service offerings, we may begin competing with companies with which we have not previously competed. Further, as we expand the geographic markets into which we sell our services and software solutions, or increase our penetration therein, we may expect to increasingly compete with companies with which we have not previously competed. It is also likely that new competitors will enter the market or that our competitors will form alliances, including alliances with AWS or Microsoft, that may enable them to rapidly increase their market share. New competitors may have lower overhead than we do and may be able to undercut our pricing. We expect that competition will increase as other established and emerging companies enter the connected device market, and as new products and technologies are introduced.

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Neither AWS nor Microsoft has agreed to an exclusive arrangement with us, nor has either agreed not to compete against us. Amazon may decide to focus on providing products or services that compete directly with our products and services or partnering with other solution providers that compete with us. Microsoft may decide to bring in-house more of the core-embedded development services and expertise that we currently provide, possibly resulting in reduced software and service revenue opportunities for us. The barrier to entering the market as a provider of Microsoft-based smart connected systems software and services is relatively low. In addition, Microsoft has created marketing programs to encourage systems integrators to work on Windows operating system software and services, including in the evolving IoT market. These systems integrators may be given substantially the same access by Microsoft to Microsoft technology as we are.

Sales and Marketing

We market our products and professional engineering services utilizing a direct sales model. We have sales personnel in the United States and in the United Kingdom. Historically, we have not made significant use of resellers, channel partners, representative agents or other indirect channels. Key elements of our sales and marketing strategy include direct marketing, digital marketing, content marketing, trade shows, event marketing, public relations, analyst relations, social media properties, customer and strategic alliance partner co-marketing programs and a comprehensive website.

International Operations

Our international operations outside of North America are conducted through our offices in Trowbridge, England. In the fourth quarter of 2019 we made the decision to close our operation in Taipei, Taiwan. Because our OEM Distribution Agreement with Microsoft for the sale of Microsoft Windows IoT operating systems was previously restricted to North America, the majority of our revenue continues to be generated from North America. Revenue generated from customers located outside of North America was approximately 15% and 6% of total revenue in 2019 and 2018 respectively. Our distribution rights for Microsoft Windows IoT products in the E.U., the European Free Trade Association, Turkey and Africa expired on June 30, 2019.

See Item 1A, “Risk Factors,” and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” for more information regarding our international operations.

Personnel

We had total headcount of 75 at December 31, 2019; including 48 located in North America, 26 in the United Kingdom, and 1 in Taiwan. As conditions necessitate, professional engineering service employees may perform research and development activities and vice versa.

Intellectual Property and Other Proprietary Rights

We strive to protect our intellectual property rights through patent, copyright, trademark and trade secret laws and through contractual arrangements. While we cannot be certain that our efforts will be effective to prevent the misappropriation of our intellectual property, or to prevent the development and design by others of products or technologies similar to, or competitive with, those developed by us, we plan to continue to pursue appropriate protections for our intellectual property.

Additionally, because a significant portion of our revenue relates to the sale of third-party software products, we also rely on our partners, particularly Microsoft, to appropriately protect their own intellectual property.

See Item 1A, “Risk Factors,” for more information regarding our intellectual property and other proprietary rights.

Available Information

We electronically file with or furnish to the Securities and Exchange Commission (“SEC”) our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. We make available on our website at www.bsquare.com, free of charge, copies of these reports, as soon as reasonably practicable after electronically filing such reports with, or furnishing them to the SEC.

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As discussed under Item 1 of Part I, “Business—Cautionary Note Regarding Forward-Looking Statements,” our actual results could differ materially from those expressed in our forward-looking statements. Factors that might cause or contribute to such differences include, but are not limited to, those discussed below. Additional risks and uncertainties not presently known to us, or that we currently deem immaterial but later emerge as material, may also impair our business operations. If any of the following risks occur, our business, financial condition, operating results, cash flows and the trading price of our common stock could be materially adversely affected.

Risks Related to General Business Conditions

If we are not successful in developing and delivering competitive product and services offerings that keep pace with technological changes and needs, or if our engineering services fail to gain or maintain traction with potential customers, our business would be negatively impacted.

In the third quarter of 2019, we initiated an updated go to market product strategy and pragmatic edge-to-cloud sales and marketing message that we believe builds on our history of helping our customers build intelligent devices. We now offer a complete solution that allows our customers to build and operate the next generation of intelligent devices and systems. While we will continue to support our existing DataV solution customer commitments, we have stopped marketing DataV as a specific product offering. Our ability to grow our higher-margin Edge to Cloud segment is contingent on the success of IoT solution components, solution accelerators and engineering services in certain market segments. If the sales cycle in these segments is longer than expected, or if the solutions we offer to these segments fail to gain or maintain traction with potential customers, or if we are not otherwise successful in developing competitive product offerings that keep pace with market requirements, our business would be negatively impacted.

Expected operating efficiencies from our restructuring plans may not be realized as anticipated.

In the second quarter of 2019, we initiated a workforce reduction program intended to reduce expenses and better align our organizational structure with our strategic focus. The program was implemented in stages throughout the remainder of 2019. Factors which may affect the potential operating efficiencies we realize from our restructuring plans include the adverse impact of job eliminations, uncertainties associated with loss of customer and vendor confidence, potential negative impact on sales and customer service as well as factors outside of our control such as changes in the economic environment. We may not realize the anticipated benefits under our restructuring plans, which could result in additional restructuring efforts. If our restructuring plans are not successful, our business and results of operations may be negatively impacted.

If our IoT-related service offerings fail to gain or maintain traction with potential customers our business would be negatively impacted.

Our strategy to focus on expanding our IoT-related service offerings is subject to a number of risks, including those relating to:

Our marketplace is highly competitive, which may result in price reductions, lower gross profit margins and loss of market share.

The IoT market is still emerging but is already becoming increasingly competitive. Our competitors in this space include, or we anticipate could include, the following:

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In addition, we anticipate that we will encounter increasing competition in the growing IoT market from a number of additional software and service providers as we continue to focus on this market in 2019 and beyond, and as we expand our focus on providing IoT-related service offerings.

The market for device software and engineering services is extremely competitive. We face competition from the following:

Some of our competitors have greater financial and other resources than we do. They may also focus on only one aspect of our business or offer complementary products that can be integrated with our products. As we develop and bring to market new software products and service offerings, we may begin competing with companies with which we have not previously competed. Further, as we expand the geographic markets into which we sell our services and related software solutions, or increase our penetration therein, we may expect to increasingly compete with companies with which we have not previously competed. It is also likely that new competitors will enter the market or that our competitors will form alliances, including alliances with AWS or Microsoft, that may enable them to rapidly increase their market share. New competitors may have lower overhead than we do and may be able to undercut our pricing. We expect that competition will increase as other established and emerging companies enter the connected device market, and as new products and technologies are introduced.

Neither AWS nor Microsoft has agreed to any exclusive arrangement with us, nor has either agreed not to compete with us. Amazon may decide to focus on providing products or services that compete directly with our products and services or partnering with other solution providers that compete with us. Microsoft may decide to bring more of the core embedded development services and expertise that we provide in-house, possibly resulting in reduced software and service revenue opportunities for us. The barrier to entering the market as a provider of Microsoft-based smart connected system software and services is relatively low. In addition, Microsoft has created marketing programs to encourage systems integrators to work on Windows IoT and Windows Mobile operating system software and services, including in the evolving IoT market. These systems integrators may be given substantially the same access by Microsoft to Microsoft technology as we are.

Our operating results may be adversely affected by changing economic and market conditions and the uncertain geopolitical environment.

Uncertain economic and political conditions in the U.S. and worldwide have from time to time contributed, and may in the future contribute, to volatility in the technology industries at large, particularly in an emerging market such as IoT. These factors could potentially result in reduced demand for our products and services as a result of constraints on IT-related capital spending by our customers; purchasing delays; payment delays adversely affecting our cash flow and revenue; and difficulty in accurate budgeting and planning. If global economic and market conditions, or economic conditions in key markets, remain uncertain or deteriorate, we may experience material impacts on our business, operating results and financial condition.

We may be subject to product liability, infringement or other legal claims that could result in significant costs.

Our software license and service agreements with our customers typically contain provisions designed to limit our exposure to potential product liability, infringement and other legal claims. It is possible, however, that these provisions may be ineffective under the laws of certain jurisdictions or that our customers may not agree to these limitations. Although we have not experienced any product liability or infringement claims to date, as our business focus continues to transition to the sale of our own proprietary products, the sale and support of our products and services may be subject to such claims in the future. There is a risk that any such claims or liabilities may exceed, or fall outside, the scope of our insurance coverage, and we may be unable to obtain adequate liability insurance in the future. A product liability, infringement or other legal claim brought against us, whether successful or not, could negatively impact our business and operating results.

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Our common stock has experienced and may continue to experience price and volume fluctuations, which could lead to costly litigation for us and make an investment in us less appealing.

Stock markets are subject to significant price and volume fluctuations that may be unrelated to the operating performance of particular companies and the market price of our common stock may therefore frequently change as a result. In addition, the market price of our common stock has fluctuated and may continue to fluctuate substantially due to a variety of other factors, including quarterly fluctuations in our results of operations (including as a result of fluctuations in our revenue recognition), our ability to execute on our current growth strategy in a timely fashion, announcements about technological innovations or new products or services by us or our competitors, market acceptance of new products and services offered by us, developments in the IoT market, changes in our relationships with our suppliers or customers, our ability to meet analysts’ expectations, changes in the information technology environment, changes in earnings estimates by analysts, sales of our common stock by existing holders and the loss of key personnel. In the past, following periods of volatility in the market price of a company’s stock, class action securities litigation has often been instituted against such companies. Such litigation, if instituted against us, could result in substantial costs and diversion of management’s attention and resources, which would materially adversely affect our business, financial condition and operating results.

Past acquisitions have proven difficult to integrate, and future acquisitions, if any, could disrupt our business, dilute shareholder value and negatively affect our operating results and may not accrete to our revenue or other operating results or to our business generally.

We have acquired the technologies, assets and/or operations of other companies in the past and may acquire or make investments in companies, products, services and technologies in the future as part of our growth strategy. If we fail to properly evaluate, integrate and execute on our acquisitions and investments, our business and prospects may be seriously harmed. In addition, acquisitions may not be as accretive to our revenue or other operating results as expected. To successfully complete an acquisition, we must properly evaluate the business, technology, market and management team of the acquisition target, 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, research and development, sales, marketing and support operations. If we fail to do any of these, we may suffer losses and impair relationships with our employees, customers and strategic partners. Additionally, acquisition activities may distract management from day-to-day operations. We also may be unable to maintain consistently uniform standards, controls, procedures and policies across our entire business as a result, and significant additional demands may be placed on our management and our operations, information services and financial, legal and marketing resources. Finally, acquired businesses may result in unexpected liabilities and contingencies, which may involve compliance with foreign laws, payment of taxes, labor negotiations or other unknown costs and expenses, which could be significant.

Changing growth strategies, negative business conditions, changes in useful lives, and other factors may negatively affect the carrying value of the intangible assets and goodwill we have acquired.

We evaluate goodwill and intangible assets for impairment on an annual basis or more frequently when an event occurs, or circumstances change that indicate that the carrying value may not be recoverable. Reductions in operating cash flows or projected cash flows of our reporting units could result in an impairment charge that would negatively impact our operating results. For example, we performed our annual goodwill assessment for 2018 in the fourth quarter of 2018 and determined that the carrying value of goodwill was impaired. As a result, an impairment charge of $3.7 million was recorded. Further, business conditions and other factors may also require us to reassess the useful lives associated with intangible assets.

Risks Related to Technology

Our software or hardware products or the third-party hardware or software integrated with our products or delivered as part of our service offerings may suffer from defects or errors that could impair our ability to sell our products and services.

Software and hardware components as complex as those needed for dedicated purpose intelligent systems 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 products until 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. In addition, it is possible that by the time defects are fixed, the market opportunity may decline which may result in lost revenue. Moreover, to the extent that we provide increasingly complex and comprehensive products and services, particularly those focused on IoT hardware, and rely on third-party manufacturers and suppliers to manufacture these products, we will be dependent on the ability of such third-party manufacturers and suppliers to correct, identify and prevent manufacturing errors or defects. Errors or defects 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 and increased service and warranty costs, all of which could negatively impact our business and operating results.

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Our business and operations would be adversely impacted in the event of a failure or interruption of our IT infrastructure.

The proper functioning of our own IT infrastructure is critical to the efficient operation and management of our business. Our IT is vulnerable to cyberattacks, computer viruses, worms and other malicious software programs, physical and electronic break-ins, sabotage and similar disruptions from unauthorized tampering with our computer systems. We believe that we have adopted appropriate measures to mitigate potential risks to our technology infrastructure and our operations from these IT-related and other potential disruptions. However, given the unpredictability of the timing, nature and scope of such disruptions, we could potentially be subject to downtimes, operational delays, other detrimental impacts on our operations or ability to provide products and services to our customers, the compromising of confidential or personal information, destruction or corruption of data, security breaches, other manipulation or improper use of our systems and networks, financial losses from remedial actions, loss of business or potential liability, and/or damage to our reputation, any of which could have a material adverse effect on our cash flows, competitive position, financial condition or results of operations.

Interruptions or delays in services from third-party data center hosting facilities or cloud computing platform providers could impair the delivery and availability of our products and services and harm our business.

We currently serve certain customers through third-party data center hosting facilities and cloud computing platform providers located in the United States and other countries. Any damage to, or failure of, these systems generally could result in interruptions in the availability of our products and services. We have from time to time experienced, and may continue to experience, such interruptions, which could cause us to issue credits or pay penalties, cause customers to terminate their subscriptions, and adversely affect our customer attrition rates and our ability to attract new customers, all of which would reduce our revenue. Our business would also be harmed if our customers and potential customers believe our product and services offerings are unreliable. Despite contract provisions to protect us, customers may look to us to support and provide warranties for these third-party systems, which may expose us to potential claims, liabilities and obligations for technology or services we did not develop or sell, all of which could harm our business. Further, third-party software and cloud platforms that we currently or may in the future utilize may not continue to be available at reasonable prices, on commercially reasonable terms, or may become unavailable. Any of these outcomes could significantly increase our expenses and result in delays in the provisioning of our products and services until we are able to procure alternative solutions, either by developing equivalent technology or, if available, obtaining such technology through purchase or license from other third parties.

We do not control the operation or security of any of these hosting facilities or cloud computing platforms, and they may be vulnerable to damage or interruption from earthquakes, floods, fires, power loss, telecommunications failures and similar events. They may also be subject to break-ins, sabotage, intentional acts of vandalism and similar misconduct, as well as local administrative actions, changes to legal or permitting requirements and litigation to stop, limit or delay operation. Despite precautions taken by providers of these facilities and platforms, the occurrence of a natural disaster or an act of terrorism, a decision to close the facilities or platforms without adequate notice or other unanticipated problems at these facilities or platforms could result in lengthy interruptions in or cessation of our services.

Breaches in data security or incidents of cybercrime could damage our customers’ business and our reputation, which may harm our ability to gain new customers or cause our existing customer to look to our competitors for products and services.

Our products and services involve the storage and transmission of customers’ proprietary data and personal information, and security breaches could result in a risk of loss of this data or information, litigation and possible liability. While we have security measures in place, they may be breached as a result of third-party action, including intentional misconduct by computer hackers, employee error, malfeasance or otherwise and result in someone obtaining unauthorized access to our IT systems, our customers’ data or our data, including our intellectual property and other confidential business information. Additionally, third parties may attempt to fraudulently induce employees or customers into disclosing sensitive personal information such as usernames, passwords or other information in order to gain access to our customers’ data, our data or our IT systems. Because the techniques used to obtain unauthorized access, or to sabotage systems, change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques or to implement adequate preventative measures. In addition, our customers may authorize third-party technology providers to access their customer data, and some of our customers may not have adequate security measures in place to protect their data. Because we do not control the IT security of our customers or third-party technology providers, or of the processing of such data by third-party technology providers, we cannot ensure the integrity or security of such transmissions or processing. Malicious third parties may also conduct attacks designed to temporarily deny customers access to our products and services. Any security breach could result in a loss of confidence in the security of our products and services, damage our reputation, negatively impact our future sales, disrupt our business and lead to legal liability.

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Privacy concerns and laws, evolving regulation of cloud computing, cross-border data transfer restrictions and other domestic or foreign regulations may limit the use and adoption of our products and services and adversely affect our business.

Regulation related to the provision of services on the internet is evolving and increasing, as federal, state and foreign governments continue to adopt new laws and regulations addressing data privacy and the collection, processing, storage and use of personal information, such as the E.U.’s Data Protection Directive and General Data Protection Regulation (“GDPR”) and the California Consumer Privacy Act (“CCPA”). Further, laws and regulations are increasingly aimed at the use of personal information for marketing purposes, such as the E.U.’s ePrivacy Directive and ePrivacy Regulation. Country-specific laws and regulations are subject to new and differing interpretations and may be inconsistent among jurisdictions. Existing laws and regulations, as well as future requirements, could reduce demand for our products and services or restrict our ability to store and process data or, in some cases, impact our ability to offer our products and services in certain locations or our customers' ability to deploy our solutions globally. The costs of compliance with and other burdens imposed by laws, regulations and standards such as GDPR and CCPA may also limit the use and adoption of our products and services, reduce overall demand for our products and services, lead to significant fines, penalties or liabilities for noncompliance, or slow the pace at which we close sales transactions, any of which could harm our business. Furthermore, concerns regarding data privacy may cause our customers’ customers to resist providing the data necessary to allow our customers to use our products and services effectively. Even the perception that the privacy of personal information is not satisfactorily protected or does not meet regulatory requirements could inhibit sales of our products and services and could limit adoption of our cloud-based solutions.

Risks Related to Our Partnership with Microsoft

Because we provide software and services to customers building devices utilizing Microsoft’s Windows IoT and Windows Mobile operating systems, as well as the fact that a significant portion of our revenue is derived from the sale of Microsoft Windows IoT and Windows Mobile operating systems, Microsoft has a significant direct and indirect influence on our business. The following Microsoft-related risks may negatively impact our business and operating results.

If we do not maintain our distribution relationship with Microsoft, our revenue would decrease, and our business would be adversely affected.

Effective March 1, 2019, pursuant to a Global Partnership Agreement with Microsoft, we are authorized to sell Windows IoT operating systems in Canada, the United States, Argentina, Brazil, Chile, Mexico, Peru, Venezuela, Puerto Rico, Columbia, and several Caribbean countries. Of our total revenue, 79% in 2019 and 75% in 2018 resulted from the sale of Windows IoT operating systems. Our existing distribution agreement for sales of Windows IoT operating systems in the European Union (“E.U.”), the European Free Trade Association, Turkey and Africa, expired on June 30, 2019 and was not renewed thereafter. We generated approximately 3% of our Partner Solutions software sales under this agreement in 2019.

We have also entered into OEM distributor agreements (“ODAs”) with Microsoft pursuant to which we are licensed to sell Microsoft Windows Mobile operating systems to customers in North America, South America, Central America (excluding Cuba), Japan, Taiwan, Europe, the Middle East, and Africa. The ODAs to sell Windows Mobile operating systems are effective through April 30, 2022.

We generated $49.8 million and $59.5 million of revenue in 2019 and 2018, respectively, through our sales of Microsoft operating systems and expect this revenue stream to continue, although potentially at a declining rate. If the new GPA or any of our other ODAs are terminated by Microsoft (which Microsoft can do unilaterally) or not renewed, third-party software revenue and resulting gross profit could decrease significantly and our operating results would be negatively impacted. Future renewals by Microsoft, if any, could be on less favorable terms, which could also negatively impact our business and operating results.

Microsoft can change its product pricing at any time, and unless we are able to pass through price increases to our customers, our revenue, gross profit and operating results would be negatively impacted. Further, Microsoft currently offers a rebate program in conjunction with our resale activities in which we earn money for achieving certain predefined objectives. If Microsoft changes the way that rebates are earned by eliminating or negatively modifying the rebate program, our gross profit and operating results would be adversely impacted. We qualified for rebate credits from Microsoft of $2.4 million and $1.7 million in 2019 and 2018, respectively, of which 20% and 30%, respectively, was credited against product invoices and accounted for as a reduction in cost of sales, with the remaining portion as a reduction in marketing expense if and when qualified expenditures are made and claimed.

In January 2019, Microsoft changed the way a portion of its earned rebate may be claimed. The process previously in place under its 2018 program for claiming 30% of the rebates against product invoices was changed; these earned rebate amounts are now credited to the Microsoft Azure Sponsorship program and claimed upon delivery of approved Azure programs. We joined this sponsorship program in January 2019; if we are unable to complete enough qualified Azure programs during each qualification period, we may not be able to claim all or a portion of this rebate.

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Our business and results of operations could be negatively impacted by changes Microsoft implements in its pricing of its operating systems.

Microsoft implemented significant pricing changes for its operating systems products, including ending its design registration pricing discounts, terminating its OEM Volume Royalty Program and changing the aggregate volume price structure and product royalties for existing Windows IoT products effective January 1, 2016, and Microsoft could make further pricing changes in the future. These changes have altered the competitive dynamics because the same pricing discounts are available to all distributors of these Microsoft products. As a distributor of Microsoft products, this may impact both the sales prices we charge our customers and the cost of goods sold we incur for many of the Microsoft products we sell. The amount and impact of these changes to our revenue and gross profit are not determinable; however, they may negatively impact our operating results in future reporting periods. The sale of Microsoft operating systems represented approximately 84% and 81% of our total revenue and approximately 70% and 57% of our total gross margin for the years ended December 31, 2019 and 2018, respectively.

In recent years, the markets for Windows IoT and Windows Mobile operating systems have declined; if the markets for these operating systems continue to decline or decline more rapidly than anticipated, our business and operating results would be materially harmed.

A significant portion of our revenue to date has been generated by software and services targeted at customers and devices running various Microsoft Windows IoT and Windows Mobile operating systems. In recent years, the markets for these systems have declined. If the markets for these operating systems continue to decline or decline more rapidly than anticipated, our business and operating results would be negatively impacted. Continued market acceptance of Microsoft Windows IoT and Windows Mobile operating systems will depend on many factors, including:

The willingness of software developers to continue to develop and expand the applications running on Microsoft Windows IoT and Windows Mobile operating systems. To the extent that software developers write applications for competing operating systems that are more attractive to users than those available on Microsoft Windows IoT and Windows Mobile operating systems, this could cause potential customers to select competing operating systems.

Our business and results of operations would be adversely impacted if Microsoft decided to provide Windows IoT or Windows Mobile operating systems free of charge to customers.

Microsoft offers certain consumer Windows phone and tablet-based operating systems to customers free of charge, subject to certain limitations. While we do not distribute these operating systems today under our ODAs with Microsoft, if Microsoft were to offer, free of charge, operating systems that we do distribute, our business and results of operations would be adversely impacted.

Microsoft has audited our records under the ODAs in the past and may audit our records again in the future, and any negative audit results could result in additional charges and/or the termination of our distributor relationship with Microsoft.

There are provisions in the ODAs that require us to maintain certain internal records and processes for auditing purposes. Non-compliance with these or other contractual requirements could result in the termination of our distributor relationship with Microsoft. Microsoft concluded audits of our records pertaining to the ODAs in 2009 and 2006, neither of which had material findings. It is possible that future audits could result in charges due to any material findings that are found. We may also be contractually liable for payment of royalties to Microsoft in the event that certificates of authenticity are lost, damaged or stolen.

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Risks Related to Operating Internationally

Our international operations expose us to greater intellectual property, management, collections, regulatory and other risks.

Customers outside of North America generated 15% and 6% of our total revenue in 2019 and 2018, respectively. We currently have sizable operations outside of North America and in the United Kingdom (“U.K.”). Our international activities and operations expose us to a number of risks, including the following:

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 negatively impact our business and operating results.

As our customers seek more cost-effective locations to develop and manufacture their products, particularly overseas locations, our ability to continue to sell our software products and services to these customers could be adversely affected, which could negatively impact our revenue and operating results.

Due to competitive and other pressures, some of our customers have moved, and others may seek to move, the development and manufacturing of their smart, connected systems to overseas locations, which may limit our ability to sell our software and services to these customers. As an example, under our ODAs with Microsoft, we are currently only able to sell Microsoft Windows IoT operating systems to our customers in the United States, Canada, the Caribbean (excluding Cuba), Mexico, and the European Free Trade Association. If our customers, or potential customers, move their manufacturing overseas to locations in which our business may be limited, we may be less able to remain competitive, which could negatively impact our revenue and operating results.

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Risks Related to Intellectual Property

Our software and service offerings could infringe the intellectual property rights of third parties, which could expose us to additional costs and litigation and could adversely affect our ability to sell our products and services or cause shipment delays or stoppages.

It is difficult to determine whether our software products and engineering services infringe third-party intellectual property rights, particularly in a rapidly evolving technological environment in which technologies often overlap and where there may be numerous patent applications pending, many of which are confidential when filed. If we were to discover that one of our software products or service offerings, or a product based on one of our reference designs, 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 product or service. Similarly, third parties may claim that our software products and services infringe their proprietary rights, regardless of whether such claims have merit. Any such claims could increase our costs and negatively impact our business and operating results. In certain cases, we have been unable to obtain indemnification against claims that third-party technology incorporated into our software products and services infringe the proprietary rights of others. However, any indemnification we do obtain may be limited in scope or amount. Even if we receive broad third-party indemnification, these entities may not have the financial capability to indemnify us in the event of infringement.

In addition, in some circumstances we are required to indemnify our customers for claims made against them that are based on our software products or services. We may face claims of infringement or invalidity 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. Some of our competitors have, or are affiliated with companies with, substantially greater resources than we have, and these competitors may be able to sustain the costs of complex intellectual property litigation to a greater degree and for longer periods of time than we could. In addition, we expect that software developers will be increasingly subject to infringement claims as the number of products and competitors in the software industry grows, and as the functionality of products in different industry segments increasingly overlap. 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. Furthermore, if we were unsuccessful in resolving a patent or other intellectual property infringement action claim against us, we may be prohibited from developing or commercializing certain of our technologies and products, or delivering services based on the infringing technology, unless we obtain a license from the holder of the patent or other intellectual property rights. We may not be able to obtain any such license on commercially favorable terms, or at all. If such license were not obtained, we would be required to cease these related business operations, which could negatively impact our business, revenue and operating results.

If we are unable to license key software from third parties, our business could be harmed.

We sometimes integrate third-party software with our proprietary software and engineering service offerings or sell such third-party software offerings on a standalone basis, such as we do with Microsoft Windows IoT and Mobile operating systems under our ODAs with Microsoft. If our relationships with these third-party software vendors were to deteriorate, or be eliminated in their entirety, we might be unable to obtain licenses on commercially reasonable terms, if at all. In the event that we are unable to obtain these third-party software offerings, we would be unable to continue to generate revenue from our reseller relationships or, with respect to our proprietary software and engineering services offerings, we would be required to develop this technology internally, assuming it was economically or technically feasible, or seek similar software offerings from other third parties assuming there were competing offerings in the marketplace, which could delay or limit our ability to introduce enhancements or new products, or to continue to sell existing products and engineering services, thereby negatively impacting our revenue and operating results.

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 and operating results adversely affected. We rely primarily on confidentiality policies and procedures and contractual provisions as well as a combination of patent, copyright, trade secret and trademark laws, to protect our intellectual property. These laws, policies and procedures provide only limited protection. It is possible that another party could obtain patents that block our use of some, or all, of our software products and services. If that occurred, we would need to obtain a license from the patent holder or design around those patents. The patent holder may or may not choose to make a license available to us on acceptable terms, or at all. Similarly, it may not be possible to design around a blocking patent. Our efforts to protect our intellectual property rights through patent, copyright, trade secret and trademark laws may not 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.

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We license our computer source code to customers. Customers with access to our source code may not comply with the license terms. We may not discover any violations of the license terms and, in the event of discovery of violations, we may not be able to successfully enforce the license terms or recover the economic value lost from such violations. To license some of our software products, we rely in part on “shrink-wrap” and “click wrap” licenses that are not signed by the end user and, therefore, may be unenforceable under the laws of certain jurisdictions. As with other software, our software 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.” Other companies use forms of “BSQUARE” in their marks alone, or in combination with other words, and we cannot prevent all such third-party uses. We license certain trademark rights to third parties. Such licensees may not abide by our compliance and quality control guidelines with respect to such trademark rights. Any of these outcomes could negatively impact our brand, dilute its recognition in the marketplace, or confuse potential customers, all of which could 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 negatively impact our business and operating results.

Risks Related to Taxes

We could become subject to taxation in jurisdictions in which we do not believe we currently have tax nexus, which could expose us to additional tax liability that we have not been subject to in the past.

We make sales in many jurisdictions across the United States. We believe we do not have nexus in most of these jurisdictions and, therefore, we believe we are not subject to sales, franchise, income and other state and local taxes in such jurisdictions. However, if we are determined to have tax nexus in other jurisdictions (as a result of more aggressive interpretations of nexus by taxing jurisdictions or otherwise) and we are unable to pass through this cost to our customers, our tax expense will increase which will negatively affect our results of operations. Further, because state and local tax laws are becoming increasingly complex, we anticipate that our cost to monitor our state and local tax compliance will increase which will negatively affect our results of operations. Additionally, we may have unknown tax exposure in a state or local tax jurisdiction because of recent tax law changes of which we are unaware, and the resulting liability could be significant and would negatively affect our results of operations.

Changes in our effective tax rate may impact our results of operations.

We are subject to taxes in the U.S. and other jurisdictions. Tax rates in these jurisdictions may be subject to significant change due to economic and/or political conditions. A number of other factors may also impact our future effective tax rate including:

There may be restrictions on the use of our net operating loss and tax credit carryforwards due to a tax law “ownership change.”

We did not generate taxable income in 2019 or 2018 and, as a result, we were unable to use our net operating loss and tax credit carryforwards with respect to such tax years. In addition, Sections 382 and 383 of the Internal Revenue Code restrict the ability of a corporation that undergoes an ownership change to use net operating loss and tax credit carryforwards. At December 31, 2019, we had approximately $79.7 million of federal and $12.4 million of state net operating loss carryforwards and $3.6 million of tax credit carryforwards. Of the federal net operating loss carryforwards, an aggregate of $45.7 million will expire by 2024 and we may not generate sufficient taxable income prior to such time in order to fully utilize our net operating loss and tax credit carryforwards before they expire. Moreover, under the applicable

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tax rules, an ownership change occurs if greater than five percent shareholders of an issuer’s outstanding common stock collectively increase their ownership percentage by more than 50 percentage points over a rolling three-year period. As of December 31, 2017, we performed analyses of possible ownership changes which included consideration of a third-party study, and do not believe that an ownership change, as defined by Section 382, has occurred. However, if a tax law ownership change has occurred of which we are not aware, or if a tax law ownership change occurs in the future, we may have to adjust the valuation of our deferred tax assets and could be at risk of having to pay income taxes notwithstanding the existence of our sizable carryforwards. Further, to the extent that we have utilized our carryforwards from prior years, the existence of a previous tax law ownership change that we did not account for could result in liability for back taxes, interest, and penalties. If we are unable to utilize our carryforwards and/or if we previously utilized carryforwards to which we were not entitled, it would negatively impact our business, financial condition and operating results.

Risks Related to Governance

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 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 articles of incorporation to issue preferred stock with rights superior to the rights of the holders of common stock. As a result, preferred stock could be issued quickly and easily with terms calculated to delay or prevent a change in control of our company or make removal of our management more difficult. In addition, our Board of Directors is divided into three classes. The directors in each class serve for three-year terms, one class being elected each year by our shareholders. This system of electing and removing directors may discourage a third party from making a tender offer or otherwise attempting to obtain control of our company because it generally makes it more difficult for shareholders to replace a majority of our directors. In addition, Chapter 19 of the Washington Business Corporation Act generally prohibits a “target corporation” from engaging in certain significant business transactions with a defined “acquiring person” for a period of five years after the acquisition, unless the transaction or acquisition of shares is approved by a majority of the members of the target corporation’s Board of Directors prior to the time of acquisition. This provision may have the effect of delaying, deterring or preventing a change in control of our company. The existence of these anti-takeover provisions could also limit the price that investors might be willing to pay in the future for shares of our common stock.

None.

As of December 31, 2019, our corporate headquarters had 24,061 square feet of leased space in a single location in Bellevue, Washington. The lease term ends in May 2020. We have entered into a lease agreement for corporate headquarters in Seattle, Washington and expect to move in prior to the end of our current lease.

We lease office space overseas in Trowbridge, England, U.K. In the fourth quarter of 2019, we made the decision to close our office in Taipei, Taiwan.

We believe that our facilities meet our current operational needs now and in the near-term future.

None.

Not applicable.

 

 

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PART II

Market Information

Our common stock is traded on The NASDAQ Stock Market, LLC under the symbol “BSQR.”

Holders

As of January 31, 2020, there were 112 holders of record of our common stock. Because many shares of our common stock are held by brokers and other institutions on behalf of shareholders, we are unable to determine the total number of shareholders represented by these holders of record.

Not applicable.

 

 

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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. This Management’s Discussion and Analysis of Financial Condition and Results of Operations may contain some statements and information that are not historical facts but are forward-looking statements. For a discussion of these forward-looking statements, and of important factors that could cause results to differ materially from the forward-looking statements contained in this report, see Item 1 of Part I, “Business—Cautionary Note Regarding Forward-Looking Statements,” and Item 1A of Part I, “Risk Factors.”

Overview

Bsquare builds technology that is powering the next generation of intelligent systems. We help companies realize the promise of IoT through the development of devices and systems that are cloud-enabled, share data seamlessly, facilitate distributed learning and control, and operate securely at scale. We believe that IoT-enabled systems can not only deliver value to our customers, but also can help people make better use of the resources of our planet and work more effectively to improve quality of life. Bsquare's suite of services and software components create for our customers new revenue streams and operating models while providing opportunities for lowering costs and improving operations.

2019 was a year of transition for Bsquare. In March 2019, Ralph C. Derrickson joined as our President and Chief Executive Officer. Upon his arrival we initiated an assessment of our product and service offering including DataV, our Industrial Internet of Things (IIoT) software platform and associated business model, the market landscape, our experience with IoT and device customers, our historical software distribution business and our leadership team. In May 2019 we announced a series of business rebuilding initiatives called “One Bsquare” that included:

We also announced that we would be reducing headcount in our Bellevue location, reorganizing and eliminating positions on our senior leadership team, and no longer marketing DataV as a platform and that it would be replaced by suite of software components harvested from DataV.

We called this suite of software and services Bsquare IQ (or “B2IQ”).

The software components of the B2IQ suite were harvested from our prior DataV efforts and were substantially re-tooled to exploit the capabilities of cloud services that weren’t available when DataV was first conceived. We observed that customers who were buying OS software for their devices were now contemplating their approach to IoT and it was logical for them to consider Bsquare as a software partner. Our B2IQ software and B2IQ OS utilities allowed us to capitalize on our relationships and long history with OS software. Further, where DataV was contemplated as a “one-size-fits-all” platform, our B2IQ software strategy recognized that the requirements for IoT vary widely and we could create more opportunities to win consulting contracts for custom IoT solutions if we switched to a “building blocks” approach to IoT. We expect these components will be licensed on a per-device basis when deployed as part of a customer-specific solution.

In addition to the system design and software engineering services included in the B2IQ suite, we have expanded our services to include 24/7 support, dev/ops, and cloud management – the services that are critical when a customer puts an edge-to-cloud solution into production. Experience with our early IoT customers showed that Bsquare’s role could last well beyond the design and development phase and continue into their on-going operations. This role as an operating partner for our customers represents an opportunity for future collaboration and on-going business in the form of monthly support and services fees to Bsquare.

During the transition of our product strategy we were in close communication with our DataV customers to ensure we were meeting our operating commitments while re-tooling our software. At the end of 2019 we were in active discussions to revise the commercial terms of our relationships to match our B2IQ software and professional services approach.

In September 2019 we relaunched our sales and marketing with new branding, messaging, Bsquare website and full suite of products. The new website emphasized our full offering including software from our partners (Microsoft, Adobe, and MacAfee), our B2IQ software and our suite of software development and operating services. Prior versions of our website focused almost exclusively on DataV with little emphasis on our other products and services, which we believe contributed to the erosion of their related revenue.

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We invested heavily in our longstanding partnership with Microsoft and reaffirmed our new partnership with AWS.  Our move away from DataV paved the way for collaboration at the cloud that was not possible with our DataV platform product strategy. We added new partnerships with Synnex and Arrow that allow us to offer Azure CSP products and services. We also expanded our collaboration with Microsoft to include its Sphere product.

Coinciding with the announcement of our Q3 2019 results, we announced a change in the way we manage and report about our business. The Partner Solutions business segment, formerly Third-Party Software, generates revenue from the re-sale of partners’ software and the consulting services we provide to support them. The Edge to Cloud business segment, formerly and separately reported as Professional Engineering Services and Proprietary Software, generates revenue from the sale and delivery of professional services as well as licensed proprietary software components. We also announced that we were closing our Taiwan offices effective at the end of 2019.

During the year we made a number of changes to our leadership team, Mary Haggard joined in May as VP of Strategic Partnerships, Chris Wheaton joined as CFO and Steven Gottlieb joined as VP of Marketing. In November 2019 we promoted Matthew Inglis to VP of Engineering and John Luethe to VP of Product Management. Also, in November 2019, we announced that we would be adopting the ISO-compliant engineering and project management processes developed in our UK operation.

By year end our results showed that the One Bsquare Initiatives were working and our concerted focus on operational excellence was having a sustained impact. The fourth quarter of 2019 saw our third sequential quarter of continued improvement in the business. Revenue was up in the Partner Solutions segment, margins were steady as a result of continued strength in the Edge to Cloud segment, and operating losses, net of restructuring were at their lowest levels since the fourth quarter of 2016. While we have not yet returned to profitability, we have stabilized the business and are reversing the trends. We are actively setting a foundation that will allow Bsquare to more readily take advantage of growth opportunities as they become apparent.

Critical Accounting Judgments

Revenue recognition

We recognize revenue when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration that we expect to receive in exchange for those goods or services. We generate all of our revenue from contracts with customers.

Embedded operating system software

We sell embedded operating system software licenses based upon a customer purchase order, shipping a certificate of authenticity (“COA”) to satisfy this single performance obligation. These shipments are also subject to limited return rights; historically, returns have averaged less than one-quarter of one percent. We recognize revenue from third-party products at the time of shipment when the customer accepts control of the COA.

Proprietary software

We sell our proprietary software products to customers under a contract or by purchase order. Our Edge to Cloud software contracts generally include professional services, a perpetual or term license and support and maintenance. In contracts with multiple performance obligations, we identify each performance obligation and evaluate whether the performance obligations are distinct within the context of the contract at contract inception. Performance obligations that are not distinct at contract inception are combined. Contracts that include software customization may result in the combination of the customization services with the software license as one distinct performance obligation. The transaction price is generally in the form of a fixed fee at contract inception. Certain Edge to Cloud contracts also include variable consideration in the form of royalties earned when customers meet contractual volume thresholds. We allocate the transaction price to each distinct performance obligation based on the estimated standalone selling price for each performance obligation. We then look to how control of the software transfers to the customer in order to determine the timing of revenue recognition. In contracts that include customer acceptance, we recognize revenue when we have delivered the software and received customer acceptance. We recognize revenue from support and maintenance over the service delivery period. We recognize revenue from royalties in the period of usage.

Our software products generally do not include customization or modification services and are sold in the form of term licenses. These software licenses represent one distinct performance obligation. Revenue is recognized when the software is delivered to the customer.

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Professional services

 

We enter into contracts for professional services, including for our IoT-related service offerings, that include software development and customization. We identify each performance obligation in our professional services contracts at contract inception. The contracts generally include project deliverables specified by each customer. The performance obligations in the contracts are generally combined into one deliverable. The contract pricing is either at stated billing rates per service hour and material costs or at a fixed amount. Services provided under professional engineering contracts generally result in the transfer of control of the applicable deliverable over time. We recognize revenue on service contracts based on time and materials as we have the right to invoice. We recognize revenue on fixed fee contracts on the proportion of labor hours expended to the total hours expected to complete the contract performance obligation. Certain professional service contracts include substantive customer acceptance provisions, in which case, we recognize revenue upon customer acceptance.

 

The determination of the total labor hours expected to complete the performance obligations on fixed fee contracts involves significant judgment. We incorporate revisions to hour and cost estimates when the causal facts become known. In certain situations, when it is impractical for us to reasonably measure the outcome of a performance obligation, and where we anticipate that we will not incur a loss, an adjusted cost-based input method is used for revenue recognition. Equal amounts of revenue and cost are recognized during the contract period, and profit is recognized when the project is completed and accepted.

 

We measure our estimate of completion on fixed-price contracts, which in turn determines the amount of revenue we recognize, based primarily on actual hours incurred to date and our estimate of remaining hours necessary to complete the contract. These estimates factor in such variables as the remaining tasks, the complexity of the tasks, the contracted quality of the software to be provided, the customer’s estimated delivery date, integration of third-party software and quality thereof and other factors. Every fixed-price contract requires various approvals within our company, including by our Chief Executive Officer if significant. This approval process takes into consideration several factors, including the complexity of engineering required. Historically, our estimation processes related to fixed-price contracts have been accurate based on the information known at the time of the reporting of our results. However, percentage-of-completion estimates require significant judgment. During the year ended December 31, 2019, we delivered professional engineering services under three fixed-price service contracts. The estimated remaining labor hours and costs to complete these contracts represent management’s best estimates based on the facts and circumstances as of the filing of this report. If there are changes to the underlying facts and circumstances, we record the revisions to our calculations in the period the changes are noted.

Leases

We lease office facilities, primarily under operating leases, which expire at various dates through 2027. These leases generally contain renewal options for a defined number of years at the then-fair market rental rate or rate stipulated in the lease agreement; which the Company has an option to exercise at the end of the initial lease term.

We determine if an arrangement is a lease at inception. On our balance sheet, our office facility leases, with a lease term greater than 12-months, are included in Right-of-Use (“ROU”) assets and related lease liabilities are included in the Operating leases and Operating leases, long-term statement line items. ROU assets represent our right to use the underlying assets for the lease term and operating lease liabilities represent our obligation to make lease payments arising from the lease agreements. Operating lease ROU assets and liabilities are recognized at the lease commencement date based on the present value of lease payments over the term of the lease. For leases that do not provide an implicit rate, we use an incremental borrowing rate based on information available at the commencement date to determine the present value of lease payments. We will use the implicit rate in the lease when readily determinable. The Company accounts for its lease expense with free rent periods and step-rent provisions on a straight-line basis over the original term of the lease and any extension options that the Company more likely than not expects to exercise, from the date the Company has control of the property. Certain leases provide for periodic rental increases based on price indices. Lease expense for lease payments is recognized on a straight-line basis over the lease term.

Intangible assets and goodwill

We evaluate our intangible assets for indications of impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Our intangible assets consist of customer relationships arising from business acquisitions. We periodically assess the value of our intangible assets. Factors that could trigger an impairment analysis include significant under-performance relative to historical or projected future operating results, significant changes in the manner of our use of the acquired assets or the strategy for our overall business or significant negative industry or economic trends. If this evaluation indicates that the value of the intangible asset may be impaired, we assess the likelihood of recoverability of the net carrying value of the asset over its remaining useful life. If this assessment indicates that the intangible asset is not recoverable, based on the estimated undiscounted future cash flows of the technology over the remaining useful life, we reduce the net carrying value of the related intangible asset to fair value.

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We evaluate goodwill for impairment annually during the fourth quarter or more frequently when an event occurs, or circumstances change that indicate that the carrying value may not be recoverable. We have three reporting units for the purpose of evaluating goodwill for impairment—third-party software, proprietary software and professional engineering services. See Note. 15, Information about Operating Segments and Geographic Areas in the Notes to our Consolidated Financial Statements in Item 8.

For reporting units that carry goodwill, we test for impairment by performing an optional qualitative assessment to determine whether the fair value of the reporting unit is more likely than not less than the carrying amount. Alternatively, at our option, we can forego performing the qualitative assessment and proceed directly to perform the quantitative impairment test by comparing the fair value of the reporting unit with its carrying amount, including goodwill, and recording a goodwill impairment charge for the excess. Any such impairment charges could be significant and have a material adverse effect on our reported financial results.

Taxes

As part of the process of preparing our consolidated financial statements, we are required to estimate income taxes in each of the countries and other jurisdictions in which we operate. This process involves estimating our current tax expense together with assessing temporary differences resulting from the differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities. Net operating losses and tax credits, to the extent not already utilized to offset taxable income or income taxes, also give rise to deferred tax assets. We must then assess the likelihood that any deferred tax assets will be realized from future taxable income, and, to the extent we believe that recovery is not likely, we must establish a valuation allowance. We are required to use judgment as to the appropriate weighting of all available evidence when assessing the need for the establishment or the release of valuation allowances. As part of this analysis, we examine all available evidence on a jurisdiction-by-jurisdiction basis and weigh the positive and negative information when determining the need for full or partial valuation allowances. The evidence considered for each jurisdiction includes, among other items, (i) the historical levels of income or loss over a range of time periods that extends beyond the two years presented, (ii) the historical sources of income and losses, (iii) the expectations and risk associated with underlying estimates of future taxable income, (iv) the expectations and risk associated with new product offerings and uncertainties with the timing of future taxable income, and (v) prudent and feasible tax planning strategies. Significant judgment is required in determining our provision for income taxes, deferred tax assets and liabilities and any valuation allowance recorded against our deferred tax assets. We estimate the valuation allowance related to our deferred tax assets on a quarterly basis.

Our sales may be subject to other taxes, particularly withholding taxes, due to our sales to customers in countries other than the United States. The tax regulations governing withholding taxes are complex, causing us to have to make assumptions about the appropriate tax treatment. Further, we make sales in many jurisdictions across the United States, where tax regulations are varied and complex. We must therefore continue to analyze our state tax exposure and determine what the appropriate tax treatments are, and make estimates for sales, franchise, income and other state taxes.

Results of Operations

The following table presents our summarized results of operations for the periods indicated. Our historical operating results are not necessarily indicative of the results for any future period.

 

 

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Revenue

We generate revenue from the sale of software, both embedded operating system software that we resell and our own proprietary software, and the sale of professional services. Total revenue decreased in 2019 compared to 2018, primarily due to lower sales of Microsoft Windows IoT and Mobile operating systems and lower Edge to Cloud service revenue, predominantly in North America.

One customer, Honeywell International, Inc., accounted for 10% of total revenue in 2018. No other customers accounted for 10% or more of total revenue in 2019 or 2018.

Additional revenue details were as follows:

 

 

Total revenue consists of sales of embedded operating system software and revenue realized from sales of our own proprietary software products, which include software license sales and support and maintenance revenue, and professional services that support DataV software and service customers.

Partner solutions revenue decreased in 2019 compared to 2018, driven primarily by lower sales of Microsoft Windows IoT operating systems. Sales of Microsoft operating systems represented approximately 84% and 81% of our total revenue and 70% and 57% of our total gross profit for 2019 and 2018, respectively.

Edge to Cloud revenue decreased in 2019 compared to 2018, due to declines in service revenue generated in North America, Asia and Europe with the completion in 2018 of several DataV software projects. We expect Edge to Cloud service revenue to grow over time as we focus our strategic focus toward cloud-based and other IoT-related service offerings. We expect Edge to Cloud revenue will continue to vary in timing and amounts.

Gross profit and gross margin Cost of Partner Solutions revenue consists primarily of the cost of embedded operating system software product costs payable to third-party vendors and support costs associated with our proprietary software products. Cost of Edge to Cloud revenue consists primarily of salaries and benefits, contractor costs and re-billable expenses, related facilities and depreciation costs, and amortization of certain intangible assets related to acquisitions.

Gross profit and gross margin were as follows:  

 

 

Partner Solutions gross profit declined in 2019 compared to 2018, primarily as a result of lower third-party software sales and from a decrease in the amount of rebate credits we received from Microsoft in the current year period compared to the prior year period, but gross margins were relatively stable. We experienced increased competition with respect to a number of larger Partner Solutions software accounts during 2019 as price protections under the Microsoft volume pricing arrangement, which ended in 2016, reduced per account revenue. Gross profit on Partner Solutions software was positively impacted in 2019 and 2018 by rebate credits we received from Microsoft for the sale of Windows IoT operating systems earned through the achievement of defined objectives. In accordance with Microsoft rebate program rules, we allocate 20% and 30% of rebates in 2019 and 2018, respectively, to reduce cost of revenue, with the remaining 80% in 2019, and 70% in 2018, used to offset qualified marketing expenses in the period the expenditures are incurred. Under the Microsoft rebate program, we recorded $0.3 million and $0.7 million of rebates in 2019 and 2018, respectively, which

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were accounted for as reductions in cost of revenue. Additionally, we recorded $1.2 million and $0.7 million in rebates in 2019 and 2018 respectively, which were accounted for as reductions in marketing expenses. There was a balance of approximately $1.0 million in outstanding rebates for which we qualified as of December 31, 2019. If qualified program expenditures are subsequently made, these will be accounted for as reductions in marketing expenses in the period in which such expenditures are made.

Edge to Cloud gross profit and gross margin decreased in 2019 compared to 2018, primarily due to decreased sales of DataV software and services in 2019 compared to 2018.

Operating expenses

Operating expenses were as follows:

 

 

Selling, general and administrative

Selling, general and administrative (“SG&A”) expenses consist primarily of salaries and related benefits, commissions and bonuses for our sales, marketing and administrative personnel and related facilities and depreciation costs, as well as professional services fees (e.g., consulting, legal, audit and tax). SG&A expenses decreased in 2019 compared to 2018, due to lower salaries and related benefits and across the board spending reduction efforts that started in the second half of 2018 and continued during 2019.

Research and development

Research and development (“R&D”) expenses consist primarily of salaries and benefits for software development and quality assurance personnel, contractor and consultant costs and related facilities and depreciation costs. R&D expenses decreased in 2019 compared to 2018, primarily due to lower salaries and related benefits resulting from our spending reduction efforts.

Restructuring costs

Restructuring costs include $1.9 million in severance and benefits related to a workforce reduction plan announced by management in the second quarter of 2019 and a non-cash impairment charge in the second quarter of 2019 of $0.4 million related to certain software development cost assets.

Goodwill impairment

Goodwill impairment expense resulted from our annual goodwill assessment in the fourth quarter of 2018, where the carrying value of goodwill was determined to be fully impaired, resulting in an impairment charge of $3.7 million.

Other income and loss

Other income and loss consist primarily of interest income on our cash and investments, gains and losses we may recognize on our investments, gains and losses on foreign exchange transactions and other items. The decrease in 2019 compared to 2018 was primarily due to lower total interest earned on our cash and investments and foreign exchange rate fluctuations.

Income taxes

Income tax expense for 2019 and 2018 related to state and local income taxes.

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Liquidity and Capital Resources

As of December 31, 2019, we had $10.6 million of cash, cash equivalents and investments (including $0.6 million in restricted cash), compared to $16.9 million at December 31, 2018, reflecting a net use of approximately $6.4 million in cash, cash equivalents and investments. We generally invest our excess cash in high quality marketable investments. These investments generally include corporate notes and bonds, commercial paper and money market funds, although specific holdings can vary from period to period depending upon our cash requirements. Our investments held at December 31, 2019 had minimal default risk and short-term maturities.

Operating activities used cash of approximately $6.0 million in 2019, which included a net loss of $9.2 million, partially offset by non-cash adjustments of $1.8 million and a change in working capital of approximately $1.4 million. Cash used in operating activities in 2019 included one-time payment of $1.5 million in restructuring costs. Operating activities used cash of approximately $7.4 million in 2018, which included a net loss of approximately $13.7 million, partially offset by non-cash adjustments of approximately $5.1 million and a working capital usage of approximately $1.3 million.

Investing activities provided cash of approximately $3.9 million in 2019, primarily due to net cash inflows on short-term investments of $4.3 million, partially offset by capital expenditures of $0.4 million. Investing activities provided cash of approximately $5.1 million in 2018, primarily due to net cash inflows on short-term investments of $5.5 million, partially offset by capital expenditures of $0.5 million.

Financing activities provided no cash in 2019 and negligible cash in 2018 resulting from the exercise of stock options.

We believe that our existing cash, cash equivalents and investments will be sufficient to meet our needs for working capital and capital expenditures for at least the next 12 months.

Contractual commitments

Future operating lease commitments were as follows as of December 31, 2019 (in thousands):

 

 

Recently Issued Accounting Standards

See Note 1, “Summary of Significant Accounting Policies” in the Notes to Consolidated Financial Statements in Item 8.

Not applicable.

 

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BSQUARE CORPORATION

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

 

 

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Shareholders

BSQUARE Corporation

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of BSQUARE Corporation (the Company) as of December 31, 2019 and 2018, the related consolidated statements of operations and comprehensive loss, shareholders’ equity, and cash flows for the years then ended, and the related notes (collectively referred to as the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2019 and 2018, and the consolidated results of its operations and its cash flows for the years then ended, in accordance with accounting principles generally accepted in the United States of America.

 

Change in Accounting Principle

As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for leases in 2019.

Basis for Opinion

These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.

Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

/s/ Moss Adams LLP

 

Seattle, Washington

February 24, 2020

 

We have served as the Company’s auditor since 2006.

 

 

 

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BSQUARE CORPORATION

CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)

 

 

 

 

 

See notes to consolidated financial statements.

 

 

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BSQUARE CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(In thousands, except per share amounts)

 

 

 

 

 

 

 

 

 

 

 

 

 

See notes to consolidated financial statements.

 

 

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BSQUARE CORPORATION

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(In thousands, except share amounts)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See notes to consolidated financial statements.

 

 

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BSQUARE CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See notes to consolidated financial statements.

 

 

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BSQUARE CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Description of business

BSQUARE Corporation (“BSQUARE,” “we,” “us” and “our”) was incorporated in Washington State in July 1994. Since our inception, our business has largely been focused on providing software solutions (including reselling software from Microsoft Corporation (“Microsoft”)) and related engineering services to businesses that develop, market and sell dedicated-purpose standalone intelligent systems. Examples of dedicated-purpose standalone intelligent systems include smart, connected computing devices such as smart phones, set-top boxes, point-of-sale terminals, kiosks, tablets and handheld data collection devices, as well as smart vending machines, ATM machines, digital signs and in-vehicle telematics and entertainment devices.

Bsquare builds technology that is powering the next generation of intelligent systems. We help companies realize the promise of IoT through the development of devices and systems that are cloud-enabled, share data seamlessly, facilitate distributed learning and control, and operate at securely scale. We believe that IoT-enabled systems can not only deliver value to our customers but can also help people make better use of the resources of our planet. Bsquare's suite of services and software components create new revenue streams and operating models for our customers while providing opportunities for lowering costs and improving operations.

Basis of consolidation

The consolidated financial statements include the accounts of BSQUARE and our wholly owned subsidiaries. All intercompany balances and transactions have been eliminated.

Recently adopted accounting standards

We adopted Accounting Standard Update (ASU) No. 2016-02, Leases (ASU 2016-02) on January 1, 2019. See Note 9, “Leases.”

In December 2019, the FASB issued ASU 2019-12, Simplifying the Accounting for Income Taxes (Topic 740) by removing certain exceptions permitted under ASC 740, Accounting for Income Taxes, and clarifying existing guidance to facilitate consistent application. We are planning to early adopt this ASU as of January 1, 2020. Since we maintain a full valuation allowance on our net deferred tax assets, the adoption is not expected to have a material impact on our financial condition, results of operations and cash flows, or financial statement disclosures.

Standards issued and not yet implemented

In June 2016, the Financial Accounting Standards Board issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326). The new standard is effective for reporting periods beginning after December 15, 2019. The standard replaces the incurred loss impairment methodology under current GAAP with a methodology that reflects expected credit losses and requires the use of a forward-looking expected credit loss model for accounts receivables, loans, and other financial instruments. The standard requires a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. We plan to adopt the new credit loss standard effective January 1, 2020. We do not expect the new credit loss standard to have a material impact on our financial condition, results of operations and cash flows, or financial statement disclosures.

In August 2018, the FASB issued ASU 2018-15, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (a consensus of the FASB Emerging Issues Task Force), (ASU 2018-15). The amendments in ASU 2018-15 align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). We do not expect the new standard to have a material effect on our financial condition, results of operations and cash flows, or financial statement disclosures. 

Use of estimates

Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Examples include provisions for bad debts and income taxes, estimates of progress on professional service arrangements, bonus accruals, fair value of intangible assets and property and equipment, fair values of share-based awards, and assumptions used to determine the net present value of operating lease liabilities, among other estimates. Actual results may differ from these estimates.

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Income (loss) per share

We compute basic per share amounts using the weighted average number of common shares outstanding during the period and exclude any dilutive effects of common stock equivalent shares, such as options and restricted stock units (“RSUs”). We consider RSUs as outstanding and include them in the computation of basic income or loss per share only when vested. We compute diluted per share amounts using the weighted average number of common shares outstanding plus common stock equivalent shares outstanding during the period using the treasury stock method. We exclude common stock equivalent shares from the computation if their effect is anti-dilutive. Unvested but outstanding RSUs are included in the diluted per share calculation. In a period where we are in a net loss position, the diluted loss per share is computed using the basic share count.

The following table presents a reconciliation of the number of shares used in the calculation of basic and diluted per share amounts (in thousands):

 

 

Common stock equivalent shares of approximately 1,570,000 and 1,714,000 were excluded from the computation of diluted per share amounts for the years ended December 31, 2019 and 2018, respectively, because their effect was anti-dilutive.

Cash, cash equivalents and investments

We invest our excess cash primarily in highly liquid debt instruments of U.S. government agencies and municipalities, debt instruments issued by foreign governments, corporate commercial paper, money market funds, and corporate debt securities. We classify all highly liquid investments with stated maturities of three months or less from date of purchase as cash equivalents and all highly liquid investments with stated maturities of greater than three months and not longer than 12 months as short-term investments.

Short-term investments consist entirely of marketable securities, which are all classified as available-for-sale securities and are recorded at their estimated fair value. We determine the appropriate classification of our investments at the time of purchase and reevaluate such designation at each balance sheet date. We may or may not hold securities with stated maturities greater than 12 months until maturity. As we view these securities as available to support current operations, we classify securities with maturities less than 12 months as short-term investments. We carry these securities at fair value and report the unrealized gains and losses, net of taxes, as a component of shareholders’ equity, except for unrealized losses determined to be other than temporary, which are recorded in other expense.

Restricted cash

Restricted cash represents two deposits at a financial institution; one held as security on a letter of credit expiring during 2020 on our headquarters lease obligation, the other held as security on our corporate credit card line.

Financial instruments and concentrations of risk

Financial instruments that potentially subject us to concentrations of credit risk consist principally of cash, cash equivalents, short-term investments, and accounts receivable.

Allowance for doubtful accounts

We record accounts receivable at the invoiced amount net of an estimated allowance for doubtful accounts to reserve for potentially uncollectible receivables. We review customers that have past due invoices to identify specific customers with known disputes or collectability issues. In determining the amount of the allowance, we make judgments about the creditworthiness of significant customers based on ongoing credit evaluations.

Equipment, furniture and leasehold improvements

We account for equipment, furniture and leasehold improvements at cost less accumulated depreciation and amortization. We compute depreciation of equipment and furniture using the straight-line method over the estimated useful lives of the assets, generally three years. Leasehold improvements are amortized using the straight-line method over the shorter of the lease term or estimated useful lives, ranging from two to ten years. We expense maintenance and repair costs as incurred. When assets are retired or otherwise disposed of, gains or losses are included in the consolidated statements of operations. When facts and circumstances indicate that the value of long-lived assets may be impaired, we perform an evaluation of recoverability comparing the carrying value of the asset to projected undiscounted future cash flows. Upon indication that the carrying value of such assets may not be recoverable, we recognize an impairment loss as a charge against current operations based on the difference between the carrying value of the asset and its fair value.

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Leases

We lease office facilities, primarily under operating leases, which expire at various dates through 2027. These leases generally contain a renewal options for a defined number of years at the then-fair market rental rate or rate stipulated in the lease agreement; which the Company has an option to exercise at the end of the initial lease term.

We determine if an arrangement is a lease at inception. On our balance sheet, our office facility leases, with a lease term greater than 12-months, are included in Right-of-Use (“ROU”) assets and related lease liabilities are included in the Operating leases and Operating leases, long-term statement line items. ROU assets represent our right to use the underlying assets for the lease term and operating lease liabilities represent our obligation to make lease payments arising from the lease agreements. Operating lease ROU assets and liabilities are recognized at the lease commencement date based on the present value of lease payments over the term of the lease. For leases that do not provide an implicit rate, we use an incremental borrowing rate based on information available at the commencement date to determine the present value of lease payments. We will use the implicit rate in the lease when readily determinable. The Company accounts for its lease expense with free rent periods and step-rent provisions on a straight-line basis over the original term of the lease and any extension options that the Company more likely than not expects to exercise, from the date the Company has control of the property. Certain leases provide for periodic rental increases based on price indices. Lease expense for lease payments is recognized on a straight-line basis over the lease term.

Intangible assets

Intangible assets were recorded in connection with business acquisitions and are stated at estimated fair value at the time of acquisition less accumulated amortization. We amortize our acquired intangible assets using the straight-line method using lives ranging from one to ten years. We review intangible assets for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. We measure recoverability of these assets by comparing the carrying amounts to the future undiscounted cash flows the assets are expected to generate. If intangible assets are considered impaired, the impairment to be recognized equals the amount by which the carrying value of the asset exceeds its fair market value.

Goodwill

We evaluate goodwill for impairment annually during the fourth quarter or more frequently when an event occurs, or circumstances change that indicate that the carrying value may not be recoverable. We have two reporting units for the purpose of evaluating goodwill for impairment—Partner Solutions and Edge to Cloud. See Note 15, “Information about Operating Segments and Geographic Areas.”

For reporting units that carry goodwill, we test for impairment by performing an optional qualitative assessment to determine whether the fair value of the reporting unit is more likely than not less than the carrying amount. If we determine that the fair value of the reporting unit is more likely greater than its carrying amount, we test for impairment by comparing the fair value of the reporting unit to the carrying value, including goodwill, recording an impairment charge for the excess. Alternatively, at our option, we can forego performing the qualitative assessment and proceed directly to perform the impairment test by comparing the fair value of the reporting unit with its carrying amount, including goodwill, and recording an impairment charge for the excess.

 

Third-party software fees payable

We record all fees payable and accrued liabilities related to the sale of embedded operating system software, such as Microsoft Windows IoT and Windows Mobile operating systems, as third-party software fees payable.

Research and development

Costs incurred internally in researching and developing a computer software product are charged to expense until technological feasibility has been established for the product. Once technological feasibility is established, all software costs would be capitalized until the product is available for general release to customers. Judgment is required in determining when technological feasibility of a product is established. Generally, this would be reached after all high-risk development issues have been resolved through coding and testing and would occur shortly before the product is released. Research and development expense was $5.8 million and $8.6 million in 2019 and 2018, respectively

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Internally developed software

We capitalize payroll and benefits costs incurred internally during the application development stage of developing a computer software product for general release to customers. Amortization of costs incurred after this point is included in cost of revenue over the estimated life of the products.

Advertising costs

All costs of advertising, including cooperative marketing arrangements, are expensed as incurred. Advertising expense was $154,000 and $171,000 in 2019 and 2018, respectively.

Share-based compensation

The estimated fair value of share-based awards is recognized as compensation expense over the requisite service period, net of estimated forfeitures. We estimate forfeitures of share-based awards 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 options 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, share-based compensation expense may differ materially in the future from that recorded in the current period.

Comprehensive loss

Comprehensive loss refers to net loss and other revenue, expenses, gains and losses that, under generally accepted accounting principles, are recorded as an element of shareholders’ equity but are excluded from the calculation of net loss.

Income taxes

We are subject to income taxes in the U.S. and certain foreign jurisdictions. Significant judgment is required in determining our provision for income taxes. We compute income taxes using the asset and liability method, under which deferred income taxes are provided for on the temporary differences between the financial reporting basis and the tax basis of our assets and liabilities. Our deferred tax amounts are measured using currently enacted tax rates that are expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.

We apply judgment as to the appropriate weighting of all available evidence when assessing the need for the establishment or the release of valuation allowances. As part of this analysis, we examine all available evidence on a jurisdiction-by-jurisdiction basis and weigh the positive and negative information when determining the need for full or partial valuation allowances. The evidence considered for each jurisdiction includes, among other items, (i) the historical levels of income or loss over a range of time periods that extends beyond the two years presented, (ii) the historical sources of income and losses, (iii) the expectations and risk associated with underlying estimates of future taxable income, (iv) the expectations and risk associated with new product offerings and uncertainties with the timing of future taxable income, and (v) prudent and feasible tax planning strategies. Based on the analysis conducted as of December 31, 2019, we determined that we would not release, in full or in part, the valuation allowance against our U.S. gross deferred tax assets.

We recognize tax benefits from an uncertain position only if it is “more likely than not” that the position is sustainable, based on its technical merits. The tax benefit of a qualifying position is the largest amount of tax benefit that is greater than fifty percent likely of being realized upon ultimate settlement with a taxing authority having full knowledge of all relevant information. Interest and penalties related to uncertain tax positions are classified in the consolidated financial statements as income tax expense.

Foreign currency

The functional currency of foreign subsidiaries is their local currency. Accordingly, assets and liabilities are translated into U.S. dollars at exchange rates in effect at the balance sheet date. Resulting translation adjustments are included in other comprehensive loss and accumulated other comprehensive loss, a separate component of shareholders’ equity. The net gains and losses resulting from foreign currency transactions are recorded in the period incurred and were not significant for any of the periods presented.

Revenue recognition

We recognize revenue when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration that we expect to receive in exchange for those goods or services. We generate all of our revenue from contracts with customers.

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Embedded operating system software

We sell embedded operating system software licenses based upon a customer purchase order, shipping a certificate of authenticity (“COA”) to satisfy this single performance obligation. These shipments are also subject to limited return rights; historically, returns have averaged less than one-quarter of one percent. In accordance with ASC Topic 606, Revenue from Contracts with Customers, (“Topic 606”), we recognize revenue from third-party products at the time of shipment when the customer accepts control of the COA.

Proprietary software

We sell our proprietary software products to customers under a contract or by purchase order. Our DataV software contracts generally include professional services, a perpetual or term license and support and maintenance. In contracts with multiple performance obligations, we identify each performance obligation and evaluate whether the performance obligations are distinct within the context of the contract at contract inception. Performance obligations that are not distinct at contract inception are combined. Contracts that include software customization may result in the combination of the customization services with the software license as one distinct performance obligation. The transaction price is generally in the form of a fixed fee at contract inception. Certain DataV contracts also include variable consideration in the form of royalties earned when customers meet contractual volume thresholds. We allocate the transaction price to each distinct performance obligation based on the estimated standalone selling price for each performance obligation. We then look to how control of the software transfers to the customer in order to determine the timing of revenue recognition. In contracts that include customer acceptance, we recognize revenue when we have delivered the software and received customer acceptance. We recognize revenue from support and maintenance over the service delivery period. We recognize revenue from royalties in the period of usage.

Our software products, other than for DataV products, generally do not include customization or modification services and are sold in the form of term licenses. These software licenses represent one distinct performance obligation. Revenue is recognized when the software is delivered to the customer.

Professional services

We enter into contracts for professional services, including for our IoT-related service offerings, that include software development and customization. We identify each performance obligation in our professional services contracts at contract inception. The contracts generally include project deliverables specified by each customer. The performance obligations in the contracts are generally combined into one deliverable. The contract pricing is either at stated billing rates per service hour and material costs or at a fixed amount. Services provided under professional engineering contracts generally result in the transfer of control of the applicable deliverable over time. We recognize revenue on service contracts based on time and materials as we have the right to invoice. We recognize revenue on fixed fee contracts on the proportion of labor hours expended (under Topic 606, the ‘input method’) to the total hours expected to complete the contract performance obligation. Certain professional service contracts include substantive customer acceptance provisions; in which case we recognize revenue upon customer acceptance.

The determination of the total labor hours expected to complete the performance obligations on fixed fee contracts involves significant judgment. We incorporate revisions to hour and cost estimates when the causal facts become known. In certain situations, when it is impractical for us to reasonably measure the outcome of a performance obligation, and where we anticipate that we will not incur a loss, an adjusted cost-based input method is used for revenue recognition. Equal amounts of revenue and cost are recognized during the contract period, and profit is recognized when the project is completed and accepted.

 

 

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Disaggregation of revenue

The following table provides information about disaggregated revenue by primary geographical market, major product line and timing of revenue recognition, and includes a reconciliation of the disaggregated revenue with reportable segments (in thousands):

 

 

 

Contract Balances

The following table provides information about receivables, contract assets and contract liabilities from contracts with customers (in thousands):

 

 

We receive payments from customers based upon contractual billing schedules. Accounts receivable are recorded when the right to consideration becomes unconditional. Contract assets include amounts related to our contractual right to consideration for completed performance objectives not yet invoiced and deferred contract acquisition costs, which are amortized along with the associated revenue. Contract liabilities include payments received in advance of performance under the contract and are realized with the associated revenue recognized under the contract. We had no asset impairment charges related to contract assets in the period. 

Significant changes in contract assets and liabilities balances were as follows (in thousands):

 

 

Contract acquisition costs

 

In connection with the adoption of Topic 606, we capitalize certain contract acquisition costs consisting primarily of commissions paid when contracts are signed. For contracts that have a duration of less than one year, we follow a Topic 606 practical expedient and expense these costs when incurred. For contracts with lives exceeding one year, as is more common with our DataV software bookings, we record these costs in proportion to each completed contract performance obligation. During the years ended December 31, 2019 and December 31, 2018, we recorded $108,000 and $128,000 in amortization of capitalized contract acquisition costs, respectively. There were no impairment losses recorded related to costs capitalized. Contract acquisition costs capitalized during the years ended December 31, 2019 and December 31, 2018 were $151,000 and $748,000, respectively.

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Performance obligations

We did not recognize any revenue from performance obligations satisfied in previous periods.

The following table includes estimated revenue expected to be recognized in the future related to performance obligations that are unsatisfied or partially unsatisfied at the end of the reporting period, in thousands. The estimated revenue does not include contracts with original durations of one year or less, amounts of variable consideration attributable to royalties, or contract renewals that were unexercised as of December 31, 2019.

 

 

Practical expedients and exemptions

We generally expense sales commissions when incurred because the amortization period would have been less than one year. We record these costs within selling, general and administrative expenses.

The Company has the right to invoice customers in an amount that directly corresponds with the value to the customer of the Company's performance to date and recognizes revenue based on the invoiced amount.

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

 

 

We measure our cash equivalents, restricted cash, 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:

We classify our cash equivalents, restricted cash, 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. We review the pricing techniques and methodologies of the independent pricing service for Level 2 investments and believe that the policies adequately consider market activity, either based on specific transactions for the security valued or based on modeling of securities with similar credit quality, duration, yield and structure that were recently traded.

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Assets and liabilities measured at fair value on a recurring basis were as follows (in thousands):

 

 

As of December 31, 2019 and 2018, contractual maturities of our short-term investments were less than one year, and gross unrealized gains and losses on those investments were not material.

Equipment, furniture, and leasehold improvements consisted of the following (in thousands):

 

 

Depreciation and amortization expense related to these assets was $799,000 and $541,000 in 2019 and 2018, respectively.

 

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Goodwill was recorded in connection with the September 2011 acquisition of MPC Data, Ltd. (renamed BSQUARE EMEA, Ltd. in 2015), a United Kingdom based provider of software engineering services.

For 2018, we performed our annual goodwill assessment in the fourth quarter of 2018. We chose to forego performing the qualitative assessment and proceeded directly to performing the quantitative impairment test by comparing the fair value of our Professional Engineering Service (PES) reporting unit (renamed to Edge to Cloud in Q3 2019) with its carrying value, including goodwill, recording an impairment charge for the excess. When performing the assessment, we determined the fair value of our PES reporting unit based on our forecast of future revenue and expense cash flow streams. Based on the uncertainty of future sales for new PES services and the results of this assessment, we determined that the carrying value of goodwill was impaired. As a result, an impairment charge of $3.7 million was recorded.

For 2019, there was no carrying amount of goodwill recorded on the balance sheet.

The carrying value of goodwill consisted of the following (in thousands):

 

 

 

Intangible assets relate to customer relationships that we acquired from TestQuest, Inc. in November 2008 and from the acquisition of BSQUARE EMEA, Ltd. in September 2011 and were as follows (in thousands):

 

 

Amortization expense was $98,000 for both 2019 and 2018. Amortization expense in future periods is expected to be as follows (in thousands):

 

 

Other income and loss consisted of the following (in thousands):

 

 

 

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Pre-tax loss consisted of the following (in thousands):  

 

 

Income tax expense consisted of the following (in thousands):

 

 

Net deferred tax assets and liabilities consisted of the following (in thousands):  

 

 

Net deferred tax assets and liabilities were recorded as follows (in thousands):  

 

 

As of December 31, 2019, our deferred tax assets were primarily the result of U.S. net operating loss, research and development credit carryforwards and share-based compensation expense. We have applied a full valuation allowance against the U.S. deferred tax assets in the U.S. and foreign jurisdictions.

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We use judgment as to the appropriate weighting of all available evidence when assessing the need for the establishment or the release of valuation allowances. As part of this analysis, we examine all available evidence on a jurisdiction-by-jurisdiction basis and weigh the positive and negative information when determining the need for full or partial valuation allowances. The evidence considered for each jurisdiction includes, among other items, (i) the historical levels of income or loss over a range of time periods that extends beyond the two years presented, (ii) the historical sources of income and losses, (iii) the expectations and risk associated with underlying estimates of future taxable income, (iv) the expectations and risk associated with new product offerings and uncertainties with the timing of future taxable income, and (v) prudent and feasible tax planning strategies. Based on the analysis conducted as of December 31, 2019, we determined that we would not release, in full or in part, the valuation allowance against our U.S. gross deferred tax assets.

 

The provision for income taxes differed from the amount of expected income tax expense determined by applying the applicable U.S. statutory federal income tax rate to pre-tax loss as follows (in thousands, except percentages):  

 

 

At December 31, 2019, we had approximately $79.7 million of federal and $12.4 million of state net operating loss carryforwards, which have begun to expire. Of the federal net operating loss carryforwards, approximately $45.7 million will expire by 2024 and $17.0 million are indefinite. We also have approximately $3.6 million of tax credit carryforwards, which have begun to expire. Use of these carryforwards may subject us to an annual limitation due to Section 382 of the U.S. Internal Revenue Code that restricts the ability of a corporation that undergoes an ownership change to use its carryforwards. Under the applicable tax rules, an ownership change occurs if holders of more than five percent of an issuer’s outstanding common stock, collectively, increase their ownership percentage by more than 50 percentage points over a rolling three-year period. We have performed analyses of possible ownership changes in the past, which included consideration of third-party studies, and do not believe that an ownership change of more than 50 percentage points has occurred.

We have evaluated all the material income tax positions taken on our income tax filings to various tax authorities, and we determined that we did not have unrealized tax benefits related to uncertain tax positions recorded at December 31, 2019 or 2018.

Because of net operating loss and tax credit carryforwards, substantially all of our tax years remain open and subject to examination.

 

 

We adopted ASU 2016-02 effective January 1, 2019 and elected the modified retrospective transition method, recording a cumulative-effect adjustment as of that date and presenting comparative prior year periods in accordance with Accounting Standards Codification Topic 840. On the date of adoption, we recorded a cumulative adjustment to recognize new net lease liabilities of $1.7 million and new right-of-use (ROU) assets of $1.2 million, for operating leases on our consolidated balance sheets, based on the present value of remaining rental payments for existing operating leases. As part of adoption, we also de-recognized $0.5 million in deferred rent. Adoption of the standard did not have a material impact on our statement of operations or statement of cash flows. As part of adoption, we elected the short-term lease recognition exemption for our facility rental and equipment leases (all leases that qualified), which means that we did not recognize ROU assets or lease liabilities for existing short-term leases (leases of 12-months or less) as of the January 1, 2019 adoption date. In addition, when adopting ASU 2016-02 we applied the following practical expedients to forego assessing:

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We determine if an arrangement is a lease at inception. On our balance sheet, our office leases are included in ROU assets and related lease liabilities are included in the Operating leases and Operating leases, long-term statement line items. We determined that we do not currently have finance leases.

ROU assets represent our right to use the underlying assets for the lease term and operating lease liabilities represent our obligation to make lease payments arising from the lease agreements. Operating lease ROU assets and liabilities are recognized at the lease commencement date based on the present value of lease payments over the term of the lease. For leases that do not provide an implicit rate, we use an incremental borrowing rate based on information available at the commencement date to determine the present value of lease payments. We will use the implicit rate in the lease when readily determinable. Lease expense for lease payments is recognized on a straight-line basis over the lease term.

Our leases have remaining terms of one to eight years. The only leases that contain renewal options are for office space leases at our Bellevue and Taiwan locations. As of January 1, 2019, because of changes in our business, we were not able to determine with reasonable certainty whether we will renew our Bellevue or Taiwan leases, As a result, we have not considered renewal options when recording ROU assets, lease liabilities or lease expense. In the fourth quarter of 2019, we made the decision not to renew our Bellevue lease, which expires at the end of May 2020 and we do not intend to renew our Taiwan lease (see Note 17, “Restructuring Costs”).

In December 2019, we entered into an operating lease agreement for a new corporate office facility in Seattle, Washington. The term of the lease is 87 months, with a rent date starting on May 1, 2020 and the lease term ending on July 31, 2027. As a result of entering this lease agreement December 2019, we recorded additional ROU assets and net lease liabilities of $1.2 million on our consolidated balance sheets. There was no material impact to our statement of operations or statement of cash flows as a result of entering into this lease.

 

 

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

 

 

 

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Lease and rent obligations

Our commitments include obligations outstanding under operating leases, which expire through 2027. We have lease commitments for office space in Bellevue, Washington; Seattle, Washington; and Trowbridge, UK. See Note 9, “Leases.”

 

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.

 

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 may be granted with a fixed exercise price that is equivalent 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, restricted and unrestricted stock awards, and RSUs.

Share-based compensation

The estimated fair value of share-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 options 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, share-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:

 

 

 

 

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

 

 

 

 

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Stock option activity

The following table summarizes stock option activity:

 

 

 

 

At December 31, 2019, total compensation cost related to stock options granted but not yet recognized was approximately $553,906, net of estimated forfeitures. This cost will be amortized on the straight-line method over a weighted-average period of approximately 2.3 years.

 

The following table summarizes certain additional information about stock options:

 

 

 

 

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 exercised during the periods indicated. We issue new shares of common stock upon exercise of stock options.

Restricted stock unit activity

The following table summarizes RSU activity:

 

 

 

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At December 31, 2019, total compensation cost related to RSUs granted but not recognized was approximately $53,566, net of estimated forfeitures. This cost will be amortized on the straight-line method over a weighted-average period of approximately 0.3 years.

Common stock reserved for future issuance

The following table summarizes our shares of common stock reserved for future issuance under the Plans as of December 31, 2019:

 

 

 

 

We maintain a Profit Sharing and Deferred Compensation Plan, The BSQUARE Corporation 401(k) Plan and Trust (the “Profit Sharing Plan”) under Section 401(k) of the Internal Revenue Code. Substantially all full-time employees are eligible to participate in the Profit-Sharing Plan. We typically elect to match the participants’ contributions to the Profit-Sharing Plan up to a certain amount subject to vesting. Participants will receive their share of the value of their investments, and any applicable vested match, upon retirement or termination. We made matching contributions of $256,000 and $439,000 in 2019 and 2018, respectively.

 

 

Significant customer

Honeywell International, Inc. and affiliated entities (“Honeywell”) accounted for revenue and accounts receivable as follows (in thousands, except percentages):

 

 

No other customer accounted for 10% or more of total revenue in 2019 or 2018 or 10% or more of total accounts receivable at December 31, 2019 or 2018.

Significant supplier

Effective March 1, 2019, pursuant to a Global Partnership Agreement with Microsoft, we are authorized to sell Windows IoT operating systems in Canada, the United States, Argentina, Brazil, Chile, Mexico, Peru, Venezuela, Puerto Rico, Columbia, and several Caribbean countries. Of our total revenue, 79% in 2019 and 75% in 2018 resulted from the sale of Windows IoT operating systems. Our existing distribution agreement for sales of Windows IoT operating systems in the European Union (“E.U.”), the European Free Trade Association, Turkey and Africa, expired on June 30, 2019 and was not renewed thereafter. We generated approximately 3% of our Partner Solutions software sales under this agreement in 2019. We have also entered into ODAs with Microsoft pursuant to which we are licensed to sell Microsoft Windows Mobile operating systems to customers in North America, South America, Central America (excluding Cuba), Japan, Taiwan, Europe, the Middle East, and Africa. The ODAs to sell Windows Mobile operating systems are effective through April 30, 2022.

Software sales under these agreements constitute a significant portion of our software revenue and total revenue. There is no automatic renewal provision in any of these agreements, and these agreements can be terminated unilaterally by Microsoft at any time.

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Microsoft currently offers a rebate program to sell Microsoft Windows IoT operating systems pursuant to which we earn money for achieving certain predefined objectives. In accordance with Microsoft rebate program rules, we allocate 20% and 30% of rebates in 2019 and 2018, respectively, to reduce cost of sales, with the remaining 80% in 2019 and 70% in 2018 used to offset qualified marketing expenses in the period the expenditures are claimed and approved.

Under this rebate program, we recorded rebate credits as follows (in thousands):

 

 

There was a balance of approximately $1.0 million in outstanding rebate credits for which we qualified as of December 31, 2019. If qualified program expenditures are made, these will be accounted for as reductions in marketing expense in the period in which such expenditures are made.

 

Line of credit

In September 2015, we entered into a two-year unsecured line of credit agreement (the “Credit Agreement”) with JPMorgan Chase Bank, N.A. in the principal amount of up to $12.0 million. In September 2016, the Credit Agreement was modified to extend the final due date an additional year to September 2018, at which point it expired. No borrowings were ever outstanding under the Credit Agreement.

 

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. Effective as of July 1, 2019, we made the following changes to our operating segments:

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As of July 1, 2019, we have two major product lines – Partner Solutions and Edge to Cloud– each of which we consider to be operating and reportable segments. We do not allocate costs other than direct cost of goods sold to the segments or produce segment income statements, and we do not produce asset information by reportable segment. The following table sets forth profit and loss information about our segments (in thousands):

 

 

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

 

 

 

 

As a result of an impairment analysis associated with our long-lived equipment, furniture and leasehold improvement assets, the Company recorded a charge of $0.4 million related to certain software development cost assets during the three months ended June 30, 2019. For the twelve months of 2019 and 2018, we incurred charges of $0.4 million and none, respectively, for impairment of software development costs. The charges are reflected in the “Restructuring costs” line item on the Company’s consolidated statement of operations and comprehensive loss.

 

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In May 2019, we approved a severance plan that included a workforce elimination of approximately 38 positions in the U.S. and internationally. In October 2019, we determined to close our Taiwan branch office by December 31, 2019, which resulted in elimination of approximately 17 additional positions. An involuntary termination benefit plan was done in order to reduce go-forward operating costs and re-align our go-forward business model to support future business initiatives. The costs associated with these actions consist primarily of charges for restructuring costs related to severance and benefits, and a non-cash impairment charge related to certain software development cost assets. We incurred aggregate restructuring charges of approximately $2.3 million associated with these actions. During the twelve months of 2019 and 2018, we incurred $2.3 million and none, respectively, in charges for restructuring costs under this plan. For the twelve months ended December 31, 2019, $1.5 million in restructuring costs were paid. The ending balance for accrued restructuring charges is $0.5 million as of December 31, 2019 and is included as part of accrued compensation on the consolidated balance sheets.

Summary of Restructuring Costs

The following tables show the activity and estimated timing of future payouts for accrued restructuring costs (in thousand):

 

 

 

 

 

 

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None.

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that the information required to be disclosed in the reports that we file or submit under the Securities Exchange Act of 1934 (“Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In connection with the preparation of this Form 10-K, our management carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, as of December 31, 2019, of the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) and 15d-15(e) under the Exchange Act. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2019.

Management’s Report on Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of our financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting is defined in Rules 13a-15(f) and 15d-15(f) promulgated under the Exchange Act and includes those policies and procedures that: (a) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (b) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (c) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements. All internal controls, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2019. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control—Integrated Framework (2013).

Based on its assessment, our management concluded that, as of December 31, 2019, our internal control over financial reporting was effective.

Changes in Internal Control over Financial Reporting

There have been no changes in our internal control over financial reporting during the fourth quarter of 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

None.

 

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PART III

The information required by this Item is incorporated by reference to our definitive proxy statement for our 2020 annual meeting of shareholders which will be filed with the SEC no later than 120 days after December 31, 2019 (our “2020 Proxy Statement”).

The information required by this Item is incorporated by reference to our 2020 Proxy Statement.

The information required by this Item is incorporated by reference to our 2020 Proxy Statement.

The information required by this Item is incorporated by reference to our 2020 Proxy Statement.

The information required by this Item is incorporated by reference to our 2020 Proxy Statement.

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PART IV

(a) Financial Statements and Schedules

1. Financial Statements

See “Index to Consolidated Financial Statements” in Part II Item 8 of this report.

2. Financial Statement Schedules

Financial statement schedules not included herein have been omitted because they are either not required, not applicable, or the information is otherwise included herein.

3. Exhibits

Exhibits are incorporated herein by reference or are filed with this report as indicated below.

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(b) Exhibits

 

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Not applicable.

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SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

POWER OF ATTORNEY

Each person whose individual signature appears below hereby authorizes and appoints Ralph C. Derrickson and Christopher Wheaton, and each of them, with full power of substitution and resubstitution and full power to act without the other, as his true and lawful attorney-in-fact and agent to act in his name, place and stead and to execute in the name and on behalf of each person, individually and in each capacity stated below, and to file, any and all amendments to this report, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in fact and agents, and each of them, full power and authority to do and perform each and every act and thing, ratifying and confirming all that said attorneys-in-fact and agents or any of them or their or his substitute or substitutes may lawfully do or cause to be done by virtue thereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on February 24, 2020, on behalf of the registrant and in the capacities indicated.

 

 

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