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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15[d]
COMMISSION FILE NUMBER 000-27687
BSQUARE CORPORATION
(Exact name of registrant as specified in its charter)
WASHINGTON 91-1650880
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3150 - 139TH AVENUE NE, SUITE 500
BELLEVUE, WASHINGTON 98005-4081
(Address of principal executive offices)
(425) 519-5900
(Registrant's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock, no par value
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of voting stock of the registrant held by
non-affiliates of the registrant as of February 18, 2000 was approximately
$263.5 million based on the closing sales price of the registrant's common stock
as reported on The Nasdaq National Market. For the purposes of this response,
executive officers, directors and persons who own 5% or more of the outstanding
shares of common stock are deemed to be affiliates of the registrant. This
determination of affiliate status is not necessarily a conclusive determination
for any other purpose. The registrant had 32,569,125 shares of common stock, no
par value, outstanding at February 18, 2000.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive proxy statement to be delivered to
shareholders in connection with the annual meeting of shareholders to be held on
May 2, 2000 are incorporated by reference into Part III of this Form 10-K.
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BSQUARE CORPORATION
FORM 10-K
TABLE OF CONTENTS
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PART I......................................................................................12
Item 1. Business...................................................................12
Item 2. Properties.................................................................24
Item 3. Legal Proceedings..........................................................24
Item 4. Submission of Matters to a Vote of Security Holders........................24
PART II.....................................................................................24
Item 5. Market for Registrant's Common Equity and Related Shareholder Matters......24
Item 6. Selected Financial Data....................................................26
Item 7. Management's Discussion and Analysis of Results of Operations and
Financial Condition........................................................26
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.................31
Item 8. Financial Statements and Supplementary Data................................32
Item 9. Changes in and Disagreements with Accountants on Auditing and Financial
Disclosure.................................................................49
PART III....................................................................................49
Item 10. Directors and Executive Officers of the Registrant........................49
Item 11. Executive Compensation....................................................49
Item 12. Security Ownership of Certain Beneficial Owners and Management............49
Item 13. Certain Relationships and Related Transactions............................50
PART IV.....................................................................................50
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K...........50
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FORWARD-LOOKING STATEMENTS
This Form 10-K and the documents incorporated herein by reference
contain forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934
based on current expectations, estimates and projections about our industry and
our management's beliefs and assumptions. When used in this Form 10-K and
elsewhere, the words "believes," "plans," "estimates," "intends," "anticipates,"
"seeks" and "expects" and similar expressions are intended to identify
forward-looking statements. These forward-looking statements include, but are
not limited to, statements about our plans, objectives, expectations and
intentions and other statements that are not historical facts. These
forward-looking statements are not guarantees of future performance and are
subject to certain risks and uncertainties that are difficult to predict.
Accordingly, actual results may differ materially from those anticipated or
expressed in such statements. Particular attention should be paid to the
cautionary statements contained in this Form 10-K under "Risk Factors" involving
potential fluctuations in our quarterly operating results, our reliance on
Microsoft, uncertainty about the Windows CE market, unpredictability of future
revenue, the intensely competitive nature of our industry, our limited operating
history, management of growth, the integration of any future acquisitions and
our reliance on third parties, manufacturers, distributors and suppliers.
Readers are cautioned not to place undue reliance on the forward-looking
statements, which speak only as of the date made. Except as required by law, we
undertake no obligation to update any forward-looking statement, whether as a
result of new information, future events or otherwise. Readers, however, should
carefully review the factors set forth in this and other reports or documents
that we file from time to time with the Securities and Exchange Commission.
RISK FACTORS
In addition to other information in this Form 10-K report, investors
evaluating us and our business should carefully consider the following risk
factors. These risks may impair our operating results and business prospects and
the market price of our stock. The risks set forth below and elsewhere in this
Form 10-K report could cause actual results to differ materially from those
projected.
UNANTICIPATED FLUCTUATIONS IN OUR QUARTERLY OPERATING RESULTS DUE TO FACTORS
SUCH AS ADVERSE CHANGES IN OUR RELATIONSHIP WITH MICROSOFT OR A DECLINE IN THE
MARKET FOR WINDOWS-BASED INTELLIGENT COMPUTING DEVICES COULD CAUSE OUR STOCK
PRICE TO DECLINE SIGNIFICANTLY.
Our operating results have fluctuated in the past, and we expect that
they will continue to do so. We believe that period-to-period comparisons of our
operating results are not meaningful, and you should not rely on such
comparisons to predict our future performance. If our operating results fall
below the expectations of stock analysts and investors, the price of our common
stock may fall. Factors that may cause our quarterly operating results to
fluctuate include:
- the failure or perceived failure of Windows CE, the operating system
upon which demand for the majority of our products and services is
dependent, to achieve widespread market acceptance;
- the failure of the intelligent computing device market to develop;
- adverse changes in our relationship with Microsoft, from whom a
substantial portion of our revenue is generated and on whom we rely
to continue to develop and promote Windows CE;
- our inability to develop and market new and enhanced products and
services on a timely basis;
- unanticipated delays, or announcement of delays, by Microsoft of
Windows product releases, which could cause us to delay our product
introductions and adversely affect our customer relationships;
- changes in demand for our products and services;
- increased competition and changes in our pricing as a result of
increased competitive pressure;
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- our ability to control our expenses, a large portion of which are
relatively fixed and which are budgeted based on anticipated revenue
trends, in the event that customer projects, particularly Microsoft
projects, are delayed, curtailed or discontinued;
- changes in the mix of our services and product revenue, which have
different gross margins;
- underestimates by us of the costs to be incurred in significant
fixed-fee service projects; and
- varying customer buying patterns which are often influenced by
year-end budgetary pressures.
In addition, our stock price may fluctuate due to conditions unrelated
to our operating performance, including general economic conditions in the
software industry and the market for technology stocks.
SUBSTANTIALLY ALL OF OUR REVENUE, INCLUDING 88% OF OUR TOTAL REVENUE FOR THE
YEAR ENDED DECEMBER 31, 1999, IS GENERATED FROM OUR RELATIONSHIP WITH MICROSOFT,
WHICH CAN BE MODIFIED OR TERMINATED BY MICROSOFT AT ANY TIME.
For the years ended, December 31, 1997, 1998 and 1999 approximately 39%,
79% and 88% of our revenue, respectively, was generated under our master
development and license agreement with Microsoft. The master agreement, the
current renewable term of which concludes in July 2000, includes a number of
project-specific work plans. We bill Microsoft on a time-and-materials basis,
although each project has a maximum dollar cap. We expect the revenue generated
from work plans with Microsoft will continue to comprise the majority of our
revenue for the next several years. We presently have dedicated approximately
200 of our 300 engineers to these projects. However, the master agreement and
each of the individual work plans may be terminated or modified by Microsoft at
any time. In addition, there is no guarantee that Microsoft will continue to
enter into additional work plans with us. In the past, Microsoft has modified
the timing and scope of certain projects, requesting that our engineers be moved
from one project to another. For example, in late 1997 Microsoft decided to
contract with us to provide Windows CE support services to semiconductor vendors
with whom we had previously contracted directly. As a result, from late 1997
through late 1998 our revenue shifted from being generated by a variety of
semiconductor vendors to being generated primarily by Microsoft. We do not
believe that we could replace the Microsoft revenue in the short- or medium-term
if existing work plans were canceled or curtailed, and such cancellations or
curtailments would substantially reduce our revenue. Microsoft is a publicly
traded company that files financial reports and information with the Securities
and Exchange Commission. These reports are publicly available under Microsoft's
Exchange Act filing number, 000-14278.
IF THE MARKET FOR THE WINDOWS CE OPERATING SYSTEM FAILS TO DEVELOP FULLY OR
DEVELOPS MORE SLOWLY THAN WE EXPECT, OUR BUSINESS AND OPERATING RESULTS WILL BE
MATERIALLY HARMED.
Windows CE is one of many operating systems developed for the
intelligent computing device market and the extent of its future acceptance is
uncertain. Because all of our revenue through 1999 has been generated by
software products and services dependent on the Windows CE operating system, if
the market for Windows CE fails to develop fully or develops more slowly than we
expect, our business and operating results will be significantly harmed. Market
acceptance of Windows CE will depend on many factors, including:
- Microsoft's development and support of the Windows CE market. As the
developer and primary promoter of Windows CE, if Microsoft were to
decide to discontinue or lessen its support of the Windows CE
operating system, potential customers could select competing
operating systems, which would reduce the demand for our Windows
CE-based software products and services. In addition, Microsoft has
developed a version of its Windows NT operating system for
intelligent computing devices and could decide to shift its support
to this operating system to the detriment of Windows CE;
- the ability of the Windows CE operating system to compete against
existing and emerging operating systems for the intelligent computing
device market including: VxWorks from WindRiver Systems Inc., pSOS
from Integrated Systems, Inc., VRTX from Mentor Graphics Corporation,
JavaOS from Sun Microsystems, Inc. and LINUX. In particular, in the
market for palm-size devices, Windows CE
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faces intense competition from PalmOS used on 3Com Corporation's Palm
devices and to date has had limited success in this market. In the
market for cellular phones, Windows CE faces intense competition from
the EPOC operating system from Symbian, a joint venture between
several of the largest manufacturers of cellular phones, which
recently announced it has agreed to discuss cross-licensing its
technology with the Palm Computing unit of 3Com. Windows CE may be
unsuccessful in capturing a significant share of these two segments
of the intelligent computing device market, or in maintaining its
market share in those other segments of the intelligent computing
device market on which our business currently focuses, including the
markets for Internet-enabled television set-top boxes, handheld
industrial devices, consumer Internet appliances such as kiosk
terminals and vehicle navigational devices, and Windows-based
terminals;
- the acceptance by original equipment manufacturers and consumers of
the mix of features and functions offered by Windows CE; and
- the willingness of software developers to continue to develop and
expand the applications that run on Windows CE. To the extent that
software developers write applications for competing operating
systems that are more attractive to intelligent computing device end
users than those available on Windows CE, potential purchasers could
select competing operating systems over Windows CE.
IF THE MARKET FOR INTELLIGENT COMPUTING DEVICES FAILS TO DEVELOP FULLY OR
DEVELOPS MORE SLOWLY THAN WE EXPECT, OUR REVENUE WILL NOT GROW AS FAST AS
ANTICIPATED, IF AT ALL.
The market for intelligent computing devices is emerging and the
potential size of this market and the timing of its development are not known.
As a result, our profit potential is uncertain and our revenue may not grow as
fast as we anticipate, if at all. We are dependent upon the broad acceptance by
businesses and consumers of a wide variety of Windows CE-based intelligent
computing devices, which will depend on many factors, including:
- the development of content and applications for intelligent computing
devices;
- the willingness of large numbers of businesses and consumers to use
devices such as handheld and palm-size PCs and handheld industrial
data collectors to perform functions currently carried out manually
or by traditional PCs, including inputting and sharing data,
communicating among users and connecting to the Internet; and
- the evolution of industry standards that facilitate the distribution
of content over the Internet to these devices via wired and wireless
telecommunications systems, satellite or cable.
IF MICROSOFT ADDS FEATURES TO ITS WINDOWS OPERATING SYSTEM THAT DIRECTLY COMPETE
WITH SOFTWARE PRODUCTS AND SERVICES WE PROVIDE, OUR REVENUE COULD BE REDUCED AND
OUR PROFIT MARGINS COULD SUFFER.
As the developer of Windows, Microsoft could add features to its
operating system that directly compete with the software products and services
we provide to our customers. Such features could include, for example, faxing,
hardware-support packages and quality-assurance tools. The ability of our
customers or potential customers to obtain software products and services
directly from Microsoft that compete with our software products and services
could harm our business. Even if the standard features of future Microsoft
operating system software were more limited than our offerings, a significant
number of our customers and potential customers might elect to accept more
limited functionality in lieu of purchasing additional software. Moreover, the
resulting competitive pressures could lead to price reductions for our products
and reduce our profit margins.
IF WE DO NOT MAINTAIN OUR FAVORABLE RELATIONSHIP WITH MICROSOFT, WE WILL HAVE
DIFFICULTY MARKETING OUR SOFTWARE PRODUCTS AND SERVICES AND MAY NOT RECEIVE
DEVELOPER RELEASES OF WINDOWS CE, AND OUR REVENUE AND OPERATING MARGINS WILL
SUFFER.
In the event that our relationship with Microsoft were to deteriorate,
then our efforts to market and sell our software products and services to
original equipment manufacturers could be adversely affected and our business
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would be harmed. Microsoft has great influence over the development plans and
buying decisions of original equipment manufacturers utilizing Windows CE for
intelligent computing devices. Many of our original equipment manufacturer
customers are referred to us by Microsoft. Moreover, Microsoft controls the
marketing campaigns related to its operating systems, including Windows CE.
Microsoft's marketing activities, including trade shows, direct mail campaigns
and print advertising, are important to the continued promotion and market
acceptance of Windows CE and, consequently, of our Windows CE-based software
products and services. We must maintain mutually successful relationships with
Microsoft so that we may continue to participate in joint marketing activities
with Microsoft, including participating in "partner pavilions" at trade shows
and listing our services on Microsoft's website, and to receive referrals from
Microsoft. In the event that we are unable to continue our joint marketing
efforts with Microsoft or fail to receive referrals from Microsoft, we would be
required to devote significant additional resources and incur additional
expenses to market our software products and services directly to potential
customers. In addition, we depend on receiving from Microsoft developer releases
of new versions of and upgrades to Windows CE and related Microsoft software in
order to timely develop and ship our products and provide services. If we are
unable to receive these developer releases, our revenue and operating margins
would suffer.
UNANTICIPATED DELAYS, OR ANNOUNCEMENT OF DELAYS, BY MICROSOFT OF WINDOWS CE
PRODUCT RELEASES COULD ADVERSELY AFFECT OUR SALES.
Unanticipated delays, or announcement of delays, in Microsoft's delivery
schedule for new versions of its Windows CE operating system could cause us to
delay our product introductions and impede our ability to complete customer
projects on a timely basis. These delays or announcements by Microsoft could
also cause our customers to delay or cancel their project development activities
or product introductions. Any resulting delays in, or cancellations of, our
planned product introductions or in our ability to commence or complete customer
projects may adversely affect our revenue and could cause our quarterly
operating results to fluctuate. For example, in 1998 Microsoft delayed the
release of a version of its Windows CE Platform Builder, which delayed our
introduction of a complementary product for an original equipment manufacturer
customer.
THE FIXED-FEE ARRANGEMENTS WE HAVE WITH MANY OF OUR CUSTOMERS EXPOSE US TO THE
RISK THAT WE MAY UNDERESTIMATE OUR COSTS FOR PROJECTS, WHICH COULD LOWER OUR
PROFIT MARGINS.
In addition to the capped-fee arrangements we have with Microsoft, we
provide our services to many of our customers under fixed-fee arrangements. In
1998 and 1999, approximately 12% and 8%, respectively, of our total revenue was
derived from fixed-fee contracts. In the event that we underestimate the scope
or work effort required for a customer's project, we may be required to complete
the project at a loss or at a significantly reduced gross margin. If we
underestimate the fees for a series of projects and/or a very large project, our
gross margins for a fiscal period may decline. In addition, revenue from these
contracts is recognized on the percentage-of-completion method, measured by the
cost incurred to date relative to the estimated total cost for the contract. If
we underestimate the time necessary to complete these projects, we may be
required to recognize revenue at a later time than we had anticipated, which
would have a negative impact on our financial condition and cause our quarterly
results to fluctuate.
IF WE FAIL TO SECURE CONTRACTS ON SUFFICIENTLY PROFITABLE TERMS, OR AT ALL, WITH
THE LIMITED NUMBER OF MARKET-LEADING ORIGINAL EQUIPMENT MANUFACTURERS OUR
REVENUE AND PROFIT MARGINS WOULD SUFFER.
Currently substantially all of our non-Microsoft revenue is generated
from sales to original equipment manufacturers. For the year ended December 31,
1999, approximately 11% of our revenue was from sales to original equipment
manufacturer customers. There are a limited number of original equipment
manufacturer customers that are capable of building and shipping large
quantities of intelligent computing devices. In some market segments, one or two
original equipment manufacturers account for a majority of all unit sales.
Competition for the business of these original equipment manufacturers is
intense. If we fail to secure and maintain service and licensing contracts with
the limited number of original equipment manufacturers in these markets we may
not be able to participate in those market segments. In addition, as a result of
their strong market position, these companies are typically able to secure
favorable terms, including favorable pricing, in their technology licensing and
service agreements. Further, many of these potential original equipment
manufacturer customers have the capability to replace our services and products
by utilizing internal resources. For these reasons, there is no guarantee that
we will
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be able to secure contracts on profitable terms, or at all, with the
market-leading original equipment manufacturers, which could harm our business.
OUR MARKET IS BECOMING INCREASINGLY COMPETITIVE, WHICH MAY RESULT IN PRICE
REDUCTIONS, LOWER GROSS MARGINS AND LOSS OF MARKET SHARE.
The market for Windows CE-based software products and services is
becoming increasingly competitive. Increased competition may result in price
reductions, lower gross margins and loss of market share, which would harm our
business. We face competition from:
- our current and potential customers' internal research and
development departments that may seek to develop their own
proprietary solutions;
- large professional engineering services firms that may enter the
market;
- established intelligent computing device software and tools
manufacturers;
- small- and medium-size engineering services companies; and
- software and component distributors.
As we develop new products, particularly products focused on specific
industries, we may begin competing with companies with whom we have not
previously competed. It is also possible that new competitors will enter the
market or that our competitors will form alliances, including alliances with
Microsoft, that may enable them to rapidly increase their market share.
Microsoft has not agreed to any exclusive arrangement with us nor has it agreed
not to compete with us. The barrier to entering the market as a provider of
Windows based intelligent computing device software and services is low. In
addition, Microsoft has created a marketing program to encourage systems
integrators to work on Windows. These systems integrators are given the same
access by Microsoft to the Windows technology as we are, with respect to system
integration. New competitors may have lower overhead than us and may therefore
be able to offer advantageous pricing. We expect that competition will increase
as other established and emerging companies enter the Windows based intelligent
computing device market and as new products and technologies are introduced.
IF WE FAIL TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, COMPETITORS
MAY BE ABLE TO USE OUR TECHNOLOGY OR TRADEMARKS, WHICH COULD WEAKEN OUR
COMPETITIVE POSITION, REDUCE OUR REVENUE AND INCREASE OUR COSTS.
If we fail to adequately protect our intellectual property, our
competitive position could be weakened and our revenue adversely affected. We
rely primarily on a combination of patent, copyright, trade secret and trademark
laws, confidentiality procedures and contractual provisions to protect our
intellectual property. These laws and procedures provide only limited
protection. We have applied for three patents relating to our engineering work.
These patents, if issued, may not provide sufficiently broad protection or they
may not prove to be enforceable against alleged infringers. There can be no
assurance that any of our pending patents will be granted. Even if granted,
patents may be circumvented or challenged and, if challenged, may be
invalidated. Any patents obtained may provide limited or no competitive
advantage to us. It is also possible that another party could obtain patents
that block our use of some, or all, of our products and services. If that
occurred, we would need to obtain a license from the patent holder or design
around their patent. The patent holder may or may not choose to make a license
available to us at all or on acceptable terms. Similarly, it may not be possible
to design around such a blocking patent.
In general, there can be no assurance that our efforts to protect our
intellectual property rights through patent, copyright, trade secret and
trademark laws will be effective to prevent misappropriation of our technology,
or to prevent the development and design by others of products or technologies
similar to or competitive with those developed by us. We frequently license the
source code of our products and the source code results of our services to
customers. There can be no assurance that customers with access to our source
code will comply with the license terms or that we will discover any violations
of the license terms or, in the event of discovery of violations, that we
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will be able to successfully enforce the license terms and/or recover the
economic value lost from such violations. To license many of our software
products, we rely in part on "shrinkwrap" and "clickwrap" licenses that are not
signed by the end user and, therefore, may be unenforceable under the laws of
certain jurisdictions. As with other software products, our products are
susceptible to unauthorized copying and uses that may go undetected, and
policing such unauthorized use is difficult.
A significant portion of our marks include the word "BSQUARE" or the
preface "b." Other companies use forms of "BSQUARE" or the preface "b" in their
marks alone or in combination with other words, and we cannot prevent all such
third-party uses. We license certain trademark rights to third parties. Such
licensees may not abide by compliance and quality control guidelines with
respect to such trademark rights and may take actions that would harm our
business.
The computer software market is characterized by frequent and
substantial intellectual property litigation, which is often complex and
expensive, and involves a significant diversion of resources and uncertainty of
outcome. Litigation may be necessary in the future to enforce our intellectual
property or to defend against a claim of infringement or invalidity. Litigation
could result in substantial costs and the diversion of resources and could harm
our business and operating results.
THIRD PARTIES COULD ASSERT THAT OUR SOFTWARE PRODUCTS AND SERVICES INFRINGE
THEIR INTELLECTUAL PROPERTY RIGHTS, WHICH COULD EXPOSE US TO ADDITIONAL COSTS
AND LITIGATION.
Third parties may claim that our current or future software products and
services infringe their proprietary rights, and these claims, regardless of
their merit, could increase our costs and harm our business. We have not
conducted patent searches to determine whether the technology used in our
products infringes patents held by third parties. In addition, it is difficult
to determine whether our software products and services infringe third-party
intellectual property rights, particularly in a rapidly evolving technological
environment in which there may be numerous patent applications pending, many of
which are confidential when filed, with regard to similar technologies. If we
were to discover that one of our software products violated a third party's
proprietary rights, we may not be able to obtain a license on commercially
reasonable terms, or at all, to continue offering that software product.
Moreover, any indemnification we obtain against claims that the technology we
license from third parties infringes the proprietary rights of others may not
always be available or may be limited in scope or amount. Even if we receive
broad third-party indemnification, these indemnitors may not have the financial
capability to indemnify us in the event of infringement. In addition, in some
circumstances we could be required to indemnify our customers for claims made
against them that are based on our solutions.
There can be no assurance that infringement or invalidity claims related
to the software products and services we provide or arising from the
incorporation by us of third-party technology, and claims for indemnification
from our customers resulting from such claims, will not be asserted or
prosecuted against us. We expect that software product developers will be
increasingly subject to infringement claims, as the number of products and
competitors in the software industry grows and the functionality of products in
different industry segments overlaps. Such claims, even if not meritorious,
could result in the expenditure of significant financial and managerial
resources in addition to potential product redevelopment costs and delays.
IF WE DO NOT RESPOND ON A TIMELY BASIS TO TECHNOLOGICAL ADVANCES AND EVOLVING
INDUSTRY STANDARDS, OUR FUTURE PRODUCT SALES COULD BE NEGATIVELY IMPACTED.
The market for Windows based software products and services is new and
evolving. As a result, the life cycles of our products are difficult to
estimate. To be successful, we must continue to enhance our current product line
and develop new products. We have experienced delays in enhancements and new
product release dates in the past and may be unable to introduce enhancements or
new products successfully or in a timely manner in the future. Our business may
be harmed if we must delay releases of our products and product enhancements or
if these products and product enhancements fail to achieve market acceptance
when released. In addition, our customers may defer or forego purchases of our
products if we, Microsoft, our competitors or major hardware, systems or
software vendors introduce or announce new products or product enhancements.
Such deferrals or failures to purchase would decrease our revenue.
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OUR FIVE-YEAR OPERATING HISTORY MAKES IT DIFFICULT TO EVALUATE OUR FUTURE
PROSPECTS, AND WE CANNOT ASSURE YOU THAT OUR REVENUE GROWTH RATE WILL NOT
DECLINE OR THAT WE WILL BE ABLE TO SUSTAIN OR INCREASE OUR PROFITABILITY.
We were founded in July 1994, generated our first revenue in October
1994 and shipped our first product in November 1996. Accordingly, we have a
limited operating history and you should not rely on our past results to predict
our future performance. The rate of growth of our revenue over the prior year
was 245% from 1996 to 1997, 71% from 1997 to 1998, and 62% from 1998 to 1999.
The rate of growth of our revenue over prior periods may continue to decline. We
anticipate that our expenses will increase substantially in the foreseeable
future as we continue to develop our technology and expand our product and
service offerings. These efforts may prove more expensive than we currently
anticipate, and we may not succeed in increasing our revenue sufficiently to
offset these higher expenses. If we fail to increase our revenue to keep pace
with our expenses, we may experience losses.
IF WE ARE UNABLE TO MANAGE OUR GROWTH OUR BUSINESS WILL SUFFER.
Our rapid growth has placed, and is expected to continue to place, a
significant strain on our managerial, technical, operational and financial
resources. From August 1996 to December 1999, we grew from 21 employees to 379
employees, and we expect this rapid growth to continue for the foreseeable
future. To manage our growth, we must implement additional management
information systems, further develop our operational, administrative and
financial systems and expand, train and manage our work force. We will also need
to manage an increasing number of complex relationships with customers,
marketing partners and other third parties. We cannot guarantee that our
systems, procedures or controls will be adequate to support our current or
future operations or that our management will be able to effectively manage our
expansion. Our failure to do so could seriously harm our ability to deliver
products and services in a timely fashion, fulfill existing customer commitments
and attract and retain new customers.
OUR INTERNATIONAL OPERATIONS EXPOSE US TO GREATER INTELLECTUAL PROPERTY,
MANAGEMENT, COLLECTIONS, REGULATORY AND OTHER RISKS.
In late 1998 we opened offices in Munich, Germany and Tokyo, Japan. For
the year ended December 31, 1999, less than 1% of our total revenue was
generated by our international offices. Our international operations expose us
to a number of risks, including the following:
- greater difficulty in protecting intellectual property due to less
stringent foreign intellectual property laws and enforcement
policies;
- greater difficulty in managing foreign operations due to the lack of
proximity between our home office and our foreign operations;
- longer collection cycles in Japan than we typically experience in the
U.S.;
- unfavorable changes in regulatory practices and tariffs;
- adverse changes in tax laws;
- seasonal European sales declines in the summer months;
- the impact of fluctuating exchange rates between the U.S. dollar and
foreign currencies; and
- general economic and political conditions in Asian and European
markets.
These risks could have a material adverse effect on the financial and
managerial resources required to operate our foreign offices, as well as on our
future international revenue, which could harm our business.
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IF WE CONDUCT FUTURE ACQUISITIONS, THEY COULD PROVE DIFFICULT TO INTEGRATE,
DISRUPT OUR BUSINESS, DILUTE SHAREHOLDER VALUE AND ADVERSELY AFFECT OUR
OPERATING RESULTS.
Although we currently have no specific understandings, commitments or
agreements for any acquisition, we may make investments in complementary
companies, services and technologies in the future. If we fail to properly
evaluate and execute acquisitions and investments, they may seriously harm our
business and prospects. To successfully complete an acquisition, we must
properly evaluate the technology, accurately forecast the financial impact of
the transaction, including accounting charges and transaction expenses,
integrate and retain personnel, combine potentially different corporate cultures
and effectively integrate products and research and development, sales,
marketing and support operations. If we fail to do any of these, we may suffer
losses or our management may be distracted from our day-to-day operations. In
addition, if we conduct acquisitions using debt or equity securities, existing
shareholders may be diluted, which could affect the market price of our stock.
IF WE ARE UNABLE TO LICENSE KEY SOFTWARE FROM THIRD PARTIES OUR BUSINESS COULD
BE HARMED.
We often integrate third-party software with our internally developed
software to provide software products and services for our original equipment
manufacturer customers. If our relationships with our third-party vendors were
to deteriorate, we might be unable to obtain licenses on commercially reasonable
terms, if at all, for newer versions of their software required to maintain
compatibility. In the event that we are unable to obtain additional licenses, we
would be required to develop this technology internally, which could delay or
limit our ability to introduce enhancements or new products or to continue to
sell existing products.
OUR SOFTWARE PRODUCTS OR THE THIRD-PARTY HARDWARE OR SOFTWARE INTEGRATED WITH
OUR SOFTWARE PRODUCTS AND SERVICES MAY SUFFER FROM DEFECTS OR ERRORS THAT COULD
IMPAIR OUR ABILITY TO SELL OUR SOFTWARE PRODUCTS AND SERVICES.
Software and hardware components as complex as those needed for
intelligent computing devices frequently contain errors or defects, especially
when first introduced or when new versions are released. We have had to delay
commercial release of certain versions of our software products until software
problems were corrected, and in some cases have provided product enhancements to
correct errors in released products. Some of our contracts require us to repair
or replace products that fail to work. To the extent that we repair or replace
products our expenses may increase resulting in a decline in our gross margins.
In addition, it is possible that by the time defects are fixed the market
opportunity may have been missed which may result in lost revenue. Moreover,
errors that are discovered after commercial release could result in loss of
revenue or delay in market acceptance, diversion of development resources,
damage to our reputation or increased service and warranty costs, all of which
could harm our business.
WE MAY BE SUBJECT TO PRODUCT LIABILITY CLAIMS THAT COULD RESULT IN SIGNIFICANT
COSTS.
Our license agreements with our customers typically contain provisions
designed to limit our exposure to potential product liability claims. It is
possible, however, that these provisions may be ineffective under the laws of
certain jurisdictions. Although we have not experienced any product liability
claims to date, the sale and support of our software products and services
entail the risk of such claims and we may be subject to such claims in the
future. A product liability claim brought against us, whether successful or not,
could harm our business and operating results.
THE LENGTHY SALES CYCLE OF OUR PRODUCTS AND SERVICES MAKES OUR REVENUE
SUSCEPTIBLE TO FLUCTUATIONS.
Our sales cycle is typically three to six months because the expense and
complexity of our products and services generally require a lengthy customer
approval process, and may be subject to a number of significant risks over which
we have little or no control, including:
- customers' budgetary constraints and internal acceptance review
procedures;
- the timing of budget cycles; and
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- the timing of customers' competitive evaluation processes.
In addition, to successfully sell our products and services, we frequently must
educate our potential customers about the full benefits of our products and
services, which can require significant time. If our sales cycle lengthens
unexpectedly, it could adversely affect the timing of our revenue which could
cause our quarterly results to fluctuate.
A SMALL NUMBER OF OUR EXISTING SHAREHOLDERS CAN EXERT CONTROL OVER US.
Our executive officers, directors and principal shareholders holding
more than 5% of our common stock together control a majority of our outstanding
common stock. As a result, these shareholders, if they act together, could
control our management and affairs of the company and all matters requiring
shareholder approval, including the election of directors and approval of
significant corporate transactions. This concentration of ownership may have the
effect of delaying or preventing a change in control of us and might affect the
market price of our common stock.
IT MIGHT BE DIFFICULT FOR A THIRD PARTY TO ACQUIRE US EVEN IF DOING SO WOULD BE
BENEFICIAL TO OUR SHAREHOLDERS.
Certain provisions of our amended and restated articles of
incorporation, bylaws and Washington law may discourage, delay or prevent a
change in the control of us or a change in our management even if doing so would
be beneficial to our shareholders. Our board of directors has the authority
under our amended and restated articles of incorporation to issue preferred
stock with rights superior to the rights of the holders of common stock. As a
result, preferred stock could be issued quickly and easily with terms calculated
to delay or prevent a change in control of our company or make removal of our
management more difficult. In addition, as of this year's annual meeting of
shareholders, our board of directors will be divided into three classes. The
directors in each class will serve for three-year terms, one class being elected
each year by our shareholders. This system of electing and removing directors
may tend to discourage a third party from making a tender offer or otherwise
attempting to obtain control of our company because it generally makes it more
difficult for shareholders to replace a majority of our directors.
In addition, Chapter 19 of the Washington Business Corporation Act
generally prohibits a "target corporation" from engaging in certain significant
business transactions with a defined "acquiring person" for a period of five
years after the acquisition, unless the transaction or acquisition of shares is
approved by a majority of the members of the target corporation's board of
directors prior to the time of acquisition. This provision may have the effect
of delaying, deterring or preventing a change in control of our company. The
existence of these antitakeover provisions could limit the price that investors
might be willing to pay in the future for shares of our common stock.
IMPACT OF THE YEAR 2000
Even though we have not experienced any immediate adverse impact from
the transition to the year 2000, it is possible that other dates in the year
2000, may further affect computer software and systems. While we believe that
all of our systems are year 2000 compliant, we may discover problems during 2000
that may require expenditures in order for our computer and software systems to
be upgraded, modified or replaced. In addition, we do not currently have any
information concerning the year 2000 compliance status of our clients or other
parties with whom we do business. It is possible that some of the internal
systems of our clients or other parties with whom we do business have already
been or will be negatively affected by the year 2000 date change. We currently
have no contingency plan to manage any year 2000 issues that may arise.
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PART I
ITEM 1. BUSINESS.
OVERVIEW
We provide a broad range of software products and services that both
facilitate the integration of Microsoft Windows operating systems into a variety
of devices we call intelligent computing devices (ICDs) and enhance the
functionality of those devices. Original equipment manufacturers, semiconductor
vendors and software developers rely on our products and services to help bring
customized intelligent computing devices and intelligent computing device
applications to market in a timely fashion. We have been providing Windows
CE-based software services since before the commercial release of Windows CE in
September 1996, and therefore we believe that we offer a greater breadth and
depth of Windows CE expertise than any of our current competitors. In addition,
in late 1999, we began offering Windows NT Embedded integration services, thus
expanding the breadth of our service offerings, and in January 2000, the
acquisition of Blue Water Systems broadened our product line for developers of
ICDs based on additional Windows operating systems including Windows 98, Windows
2000, Windows NT and Windows NT Embedded.
Intelligent computing devices are an emerging class of products with
sophisticated processing power that are designed for specific computing and
communications applications. Examples of intelligent computing devices include
television "set-top boxes," which sit on top of television sets and provide
users with interactive cable TV services, sophisticated video gaming features
and Internet access; handheld and palm-size PCs; gaming systems; handheld
industrial data collectors; consumer "Internet appliances" such as kiosk
terminals and navigational devices used in cars and trucks; and Windows-based
terminals. Compared to traditional computers, intelligent computing devices are
often less expensive and more adaptable in terms of their size, weight and
shape, while still providing sophisticated computing and communications
capabilities, including Internet connectivity. Increasingly, intelligent
computing devices are able to connect directly to the Internet, either through
wired or wireless telecommunications systems. As businesses and consumers
increasingly use the Internet to transact business and as demand for smaller and
more mobile devices grows, original equipment manufacturers are developing new
intelligent computing devices to better meet the needs of end users. Because of
space constraints and other design and resource limitations inherent in the
intelligent computing device environment, original equipment manufacturers
require a computer operating system that is both scalable and highly
customizable, with lower system requirements than traditional PC operating
systems. There are several different operating systems that can be used in
intelligent computing devices. Windows CE, a versatile and highly adaptable
operating system modeled after Microsoft Windows, is gaining market acceptance
among original equipment manufacturers as an operating system that meets these
requirements. As increased use of the Internet by consumers and businesses helps
fuel the growth of the intelligent computing device market, we believe that the
market for Windows CE will in turn benefit. In addition, the Windows NT Embedded
(NTE) operating system is used for "computerizing" larger, more complex devices
with a need for real time functionality. Examples of devices for which NTE is
targeted include Windows-based terminals, office machine equipment such as
printers, and telecommunications equipment.
We develop products and provide services that facilitate the development
of Windows-based intelligent computing devices. We generate revenue in three
distinct ways. First, we provide software code-writing and related engineering
services to Microsoft and semiconductor vendors to adapt Windows CE to different
microprocessors and to enhance Windows CE's user-specific features and
functions. Second, we offer a comprehensive set of software products and
services that help enable original equipment manufacturers to cost-effectively
integrate Windows CE, NTE and other Windows operating systems into their
intelligent computing devices. These offerings include original equipment
manufacturer adaptation kits, software development products, test programs and
Microsoft Windows CE licensing, along with engineering, quality assurance
services and training. Our service and product offerings are designed to ensure
that Windows works properly with the original equipment manufacturer's computer
boards, which are the internal hardware constituting the core of their
intelligent computing devices. We also offer software engineering services for
the integration of Window NT Embedded into ICDs, and for other Windows-based
operating systems we offer the BlueWater Systems software development products.
Third, we license a wide range of Windows CE-based software applications to both
original equipment manufacturers and intelligent computing device consumers to
provide additional functions to Windows CE-based intelligent computing devices,
such as printing and faxing capabilities.
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INDUSTRY BACKGROUND
The increasingly widespread use of electronic communications, including
the Internet, is enabling networks of businesses and consumers to collaborate,
access information and conduct business and personal interactions more
effectively. As the number of Internet users grows, so does the diversity of
content, services and applications available via the Internet. While the
Internet is already having a significant and highly visible impact on
business-to-consumer and consumer-to-consumer relationships, the market for
business-to-business Internet transactions is expected to expand at a greater
rate. According to a November 1998 report by Forrester Research entitled
"Re-sizing On-line Business Trade," U.S.-based Internet commerce between
businesses is expected to grow from $43 billion in 1998 to $1.3 trillion in
2003.
As more businesses and consumers access the Internet, new ways of
conducting business electronically are emerging. Examples of users who are
leveraging this ability to communicate electronically include:
- businesses that use mobile computing devices to permit their
employees to access server-based network applications and the
Internet from remote sites;
- retail businesses that use handheld point-of-sale terminals to
provide real-time inventory tracking, automate their procurement
processes and publish information instantly to both internal and
external users via the Internet;
- healthcare professionals who use mobile computing devices to record
and access patient information that can then be shared via the
Internet among a broader group of professionals responsible for
providing medical care; and
- consumers who use Internet-enabled television set-top boxes, smart
cellular phones, gaming systems and other devices to access Internet
content, communicate and conduct transactions online.
The increasing need for connectivity among both business and consumer
users is driving demand for easy-to-use, cost-effective and customizable methods
of electronic communication. Although the PC has been the traditional means of
electronically connecting suppliers, partners and customers, a new class is
emerging. This includes Internet-enabled television "set-top boxes," handheld
and palm-size PCs, gaming systems, handheld industrial data collectors, and
consumer "Internet appliances" such as kiosk terminals and vehicle navigational
devices. These intelligent computing devices are particularly attractive to
business and consumer users because they are often less expensive than
traditional computers; have adaptable configurations, including size, weight and
shape; and are able to support a variety of customized applications and user
interfaces that can be designed for particular tasks. In addition, these devices
are typically compatible with existing business information systems. According
to information we received in August 1999 from International Data Corporation, a
provider of information technology data and industry analysis, the market for
consumer information appliances, a subset of the overall intelligent computing
device market, is expected to grow from $2.2 billion in 1998 to $18.7 billion in
2003.
Because intelligent computing devices can be used for a number of
purposes, from consumer information to industrial automation, and can be
designed for a range of unique applications, the intelligent computing device
industry is characterized by a wide variety of hardware configurations and
end-user applications, each often designed for a specific market. To accommodate
these diverse characteristics in a cost-effective manner, semiconductor vendors
and original equipment manufacturers require operating systems that can be
integrated with a number of different intelligent computing devices and can
support an expanding range of industry-specific content and applications. The
Microsoft Windows family of operating systems, specifically Windows CE and
Windows NT Embedded, helps satisfy these requirements because it leverages the
existing industry-wide base of Microsoft Windows developers and technology
standards; can be customized to operate across a variety of intelligent
computing devices and integrate with existing information systems; offers
Internet connectivity; and reduces systems requirements compared to traditional
PC operating systems. Because of these characteristics, we believe Windows CE
and Windows NT Embedded are emerging as operating systems of choice for many
hardware and software applications vendors. Venture Development Corporation
estimates in a December 1998 report entitled
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"Windows CE and the Future of Embedded Systems Development" that the number of
intelligent computing devices utilizing Windows CE will increase from just under
one million units in 1999 to more than 14 million units by 2003.
To take advantage of the multiple benefits of these Windows operating
systems, many original equipment manufacturers and semiconductor vendors require
the services of a software product and service provider with the breadth of
experience and depth of capabilities to fully support the Windows CE and Window
NT Embedded operating systems and related applications across different
semiconductors and intelligent computing devices. These products and services
should encompass the full cycle of the intelligent computing device development
process, including hardware support, software development products and services,
system validation and end-user software applications. In addition, these
products and services should use existing Microsoft and other industry
technologies and standards to promote rapid low-cost development, reduced
time-to-market and integration with existing enterprise software applications.
These products and services should also be designed to accommodate the varying
industry-specific needs of semiconductor, equipment and software developers
without compromising functionality and performance.
OUR BUSINESS
We provide a variety of software products and services that facilitate
the integration of Microsoft operating systems into a wide range of intelligent
computing devices and enhance the functionality of those devices. Original
equipment manufacturers, semiconductor vendors and Windows CE software
developers rely on our products and services to help bring customized
intelligent computing devices and intelligent computing device applications to
market in a timely fashion. Key elements of our solutions include:
A BROAD SET OF END-TO-END SOFTWARE DEVELOPMENT PRODUCTS AND SERVICES TO
SUPPORT A DIVERSE RANGE OF INTELLIGENT COMPUTING DEVICE HARDWARE, SYSTEMS AND
APPLICATIONS DEVELOPMENT REQUIREMENTS:
- Software development. We provide software development, testing and
program management services to Microsoft in connection with its
ongoing development and modification of the Windows CE operating
system. We also provide these services to both Microsoft and
semiconductor vendors to assist with the creation of software
development tools sold in conjunction with Windows CE and the
integration of Windows CE with various microprocessors. Software
development tools are software packages that help engineers develop
new software applications. By using our services, Microsoft can draw
on our extensive expertise and experience with Windows CE and can
devote its' internal resources to other projects.
- Hardware support. We provide software products and services to
original equipment manufacturers that support a variety of
microprocessors and other intelligent computing device computer
hardware. For example, our CE Xpress Kits provide pre-configured
software packages that enable original equipment manufacturers to
integrate Windows CE into their intelligent computing devices.
- System validation. We provide software products and services to
assist original equipment manufacturers in the validation and
verification of their hardware and software executing Windows CE and
Windows NT Embedded, including services designed to help original
equipment manufacturers develop testing programs to validate the
performance and reliability of their intelligent computing devices.
- Applications software. We provide software packages that facilitate
the third-party development of Windows CE-based intelligent computing
device user interfaces. We also license software applications to both
original equipment manufacturers and intelligent computing device end
users that enhance the functionality of their intelligent computing
devices.
PRODUCTS AND SERVICES THAT USE EXISTING MICROSOFT TECHNOLOGIES AND
STANDARDS. Our Windows-based products and services use existing Microsoft
technologies and standards to enable semiconductor vendors and original
equipment manufacturers to deliver highly customizable and cost-efficient
intelligent computing devices to their end users. These technologies enable
original equipment manufacturers to efficiently utilize the existing pool
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of programmers familiar with the Windows operating system to develop
differentiating applications for intelligent computing devices based upon the
Windows family of operating systems. Our use of common programming standards
also allows intelligent computing devices designed with our development products
and services to integrate with existing information systems, as well as with
other Microsoft technologies and applications. By enabling original equipment
manufacturers to standardize on a given software platform, our products and
services help original equipment manufacturers more rapidly deploy new hardware
technologies without having to re-implement their software investments across
multiple platforms.
CAPITALIZING ON OUR DEPTH OF EXPERIENCE IN DEVELOPING WINDOWS-BASED
SOFTWARE PRODUCTS AND SERVICES AND OUR VARIETY OF STRATEGIC RELATIONSHIPS TO
DELIVER TANGIBLE BENEFITS TO WINDOWS-BASED INTELLIGENT COMPUTING DEVICE
DEVELOPERS. We have been providing Windows CE-based services for the
development, integration and deployment of the Windows CE operating system and
industry-specific applications since prior to the commercial release of Windows
CE in September 1996. In addition, we have developed strategic relationships
with Microsoft, including our master development and license agreement, and our
distributor agreement with Microsoft, and through other arrangements.
Specifically, we are a provider of software services to Microsoft under our
master agreement, a Microsoft-sanctioned Windows CE systems integrator, as
indicated on Microsoft's website, a licensed distributor of Windows CE under our
distribution agreement and a developer of Windows CE-based software
applications. Moreover, we have worked with several semiconductor vendors to
integrate Windows CE with their proprietary microprocessors. This depth and
breadth of experience enable us to bring tangible benefits to Microsoft and to a
variety of original equipment manufacturers, semiconductor vendors and software
developers. Such benefits include:
- REDUCED TIME-TO-MARKET. By using our software services and
pre-configured software components, our customers can take advantage
of our experience with the Windows-based platforms to help bring
quality intelligent computing devices to market faster than if they
had chosen to develop their hardware, operating systems and software
applications internally.
- LOWER DEVELOPMENT COSTS AND REDUCED RISKS. By using our extensive
library of software tools for developing Windows CE-based intelligent
computing devices, instead of developing these tools internally, our
customers can reduce the implementation and training time required
for their engineers and lower their intelligent computing device
development costs. Our software components are thoroughly tested for
performance and reliability, reducing the risk of project failure.
- RAPIDLY CUSTOMIZABLE GRAPHICAL USER INTERFACES. A graphical user
interface is the set of visual images through which the user
interacts with the intelligent computing device. Our software
development solutions help enable our customers to more rapidly
design user- and industry-specific graphical user interfaces to meet
the specific needs of intelligent computing device users across a
variety of markets.
- ENHANCED INTELLIGENT COMPUTING DEVICE FUNCTIONALITY. Our
pre-developed software components help enable original equipment
manufacturer customers to quickly add new and differentiating
application features to their existing intelligent computing device
hardware components, which can help extend product life cycles.
STRATEGY
Currently, the market for providing software solutions for the
development of ICDs is very fragmented. Our strategy is to become one of the
primary providers of software products and services for facilitating the
integration of operating systems into intelligent computing devices. Key
elements of our strategy include:
Continue to enhance our position as a provider of Windows-based
integration services. We intend to enhance our leadership position in the
development and provision of Windows-based integration services to support a
wide variety of intelligent computing devices. Specifically for Windows CE-based
solutions, because we have been providing Windows CE-based software services
since prior to the commercial release of Windows CE in September 1996, we
believe that we offer a greater breadth and depth of Windows CE expertise than
our current
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competitors. We intend to continue to utilize this expertise by maintaining
strong, quality-focused engineering groups, developing market-focused products
and services, and undertaking sales and marketing activities that highlight key
design wins, product awards and other third-party endorsements. In addition, we
believe that our experience with Windows CE as an embedded operating system, and
our in-depth experience with Windows NT provide a foundation of technical and
engineering process expertise to offer our Windows NT Embedded software service
customers.
Expand our strategic relationships with hardware and software vendors.
We intend to continue to strengthen and extend our relationships with
third-party hardware and software vendors that are designing products based on
Windows CE, Windows NT Embedded and other Windows-based operating systems where
applicable. We provide software products and services that enable manufacturers
of microprocessors, computer boards and other components to develop hardware
designs compatible with Windows CE. We have also entered into licensing
arrangements with software developers to provide connectivity technologies for
products that interface with Windows CE. We believe that the use of our products
and services by a broad group of industry leaders is important in increasing
market awareness and generating new business opportunities.
Continue to build on our relationship with Microsoft. We have developed
a close working relationship with Microsoft and under the terms of our master
agreement are a "preferred Microsoft vendor" for the development of the Windows
CE operating system and accompanying tools. We are also Microsoft's exclusive
partner in their new Porting Partners Program, for which we will provide
software engineering services to microprocessor vendors seeking compatibility
with Windows CE. Currently, we provide software code-writing and related
engineering services to Microsoft for a number of different Windows CE projects
and we intend to continue this relationship in the future. We believe that our
success is related to the overall adoption of Windows-based as an operating
system on ICD platforms, and therefore we intend to continue to work with
Microsoft to promote the Windows family of operating systems as the systems of
choice for ICDs.
Utilize our extensive Windows CE expertise to develop additional
software applications. We believe that as Windows CE is widely adopted in the
marketplace, there will be an increasing demand for complete, end-user software
applications that enhance the capabilities of Windows CE-based intelligent
computing devices. We intend to use our Windows CE expertise, our alliances with
original equipment manufacturers and our relationship with Microsoft to develop
a leading position in the market for Windows CE-based software applications. We
currently offer a variety of personal productivity software applications,
including calendar, address book and task-list functions, as well as utility and
communications software for Windows CE-based intelligent computing devices. We
intend to continue to make use of our Windows CE expertise to develop additional
applications to address the evolving requirements of this market.
Expand our international presence. We intend to continue to expand
internationally in order to enhance our profile and market reach. We believe
that Windows CE is gaining acceptance in the Asian and European markets. These
markets are attractive to us because of their high concentration of OEM
customers focusing on the development of intelligent computing devices. During
late 1998, we established sales offices in Tokyo, Japan and Munich, Germany;
during 1999 we negotiated relationships with distributors throughout fourteen
European countries, Taiwan, Singapore and China.
SOFTWARE SERVICES AND PRODUCTS
We develop, market and support a wide variety of Windows-based software
products and services for the development and integration of the Windows family
of operating systems across a diverse selection of intelligent computing
devices.
Operating system development and accompanying tools
We provide software code-writing and related engineering services to
Microsoft and numerous semiconductor vendors to support and enhance the
following:
- the continued development of the Windows CE operating system;
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- the utility of the Microsoft Visual Tools series, a set of software
development tools for use with the Windows CE operating system; and
- the integration of Windows CE with multiple microprocessors.
The services we provide these customers include software development,
software testing and program management. We provide these services both as a
comprehensive solution and on a point basis to address specific needs depending
upon individual customer requirements.
The following table summarizes the key features and benefits of the
services we offer to Microsoft and semiconductor vendors:
<TABLE>
<CAPTION>
BSQUARE SERVICE DESCRIPTION BENEFIT
--------------- ----------- -------
<S> <C> <C>
Software development - We aid Microsoft in the - The Visual Tools are
services to Microsoft development of its Visual necessary for the adaptation
Tools series of development of Windows CE to new
tools for Windows CE intelligent computing devices
and for the development of
Windows CE software
applications
Software engineering - We assist Microsoft and - Allows semiconductor vendors
consulting services to semiconductor vendors in to make their products
Microsoft and the development of available for use in Windows
semiconductor vendors system-level software that CE-based intelligent
enables Windows CE to computing devices in a timely
control the functions on a and cost-effective manner
particular microprocessor
</TABLE>
Integration of Windows CE and Windows NT Embedded with intelligent computing
devices
We offer software products and services that are used by original
equipment manufacturers to integrate Windows operating systems with intelligent
computing devices. We offer a comprehensive set of software products and
services that enable original equipment manufacturers to cost-effectively
integrate Windows CE or Windows NT Embedded with intelligent computing devices,
thus reducing time-to-market and decreasing the risk of project failure.
Products -- The following table summarizes the key features and
benefits of the products we offer to original equipment manufacturers for the
integration of Windows CE with intelligent computing devices.
<TABLE>
<CAPTION>
BSQUARE PRODUCT DESCRIPTION BENEFIT
--------------- ----------- -------
<S> <C> <C>
CE Xpress Adaptation Kits - A set of pre-developed and - Designed to save original
tested code for low-level equipment manufacturers time
support of hardware in a developing low-level software
Windows CE-based device support, reducing time-to-market
- Available for a broad range - Pre-tested components increase
of chip sets including those reliability of target device
manufactured by AMD, Cyrix,
Hitachi, Intel and Motorola
- Sold in source code format
to allow customer
modifications
CE Xpress Binary Kits - Includes same functionality - Enables original equipment
as CE Xpress Adaptation Kit manufacturers to rapidly
without access to source code evaluate Windows CE on a
specific reference board with
minimal investment
- Enables original equipment
manufacturers to bring reference
board-compatible products to
market with no porting or
low-level customization
</TABLE>
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<TABLE>
<CAPTION>
BSQUARE PRODUCT DESCRIPTION BENEFIT
--------------- ----------- -------
<S> <C> <C>
CE Xpress Single Board - A development kit that works - Provides a foundation for
Computer Kits in conjunction with single original equipment
board computers to quickly manufacturers to begin
install and run Windows CE immediate development of
for the development of Windows CE-based intelligent
intelligent computing devices computing devices
- Provides all of the
infrastructure normally
needed for development of
applications and
customizations based on
industry-standard expansion
bus (or "plug-in")
architectures
CE Xpress86 Kit - A development kit that - Eliminates need to wait for
allows original equipment hardware development before
manufacturers to run Windows beginning software
CE on a standard PC-based development, enabling faster
platform time-to-market
- Runs Windows CE without DOS - Reduces the cost of PC-based
Windows CE systems by
eliminating the DOS license
requirement
CE Xpress OnDemand - An online subscription - Enables CE Xpress Kit
service for portable device customers to access the latest
drivers for CE Xpress Kit drivers and driver updates
customers online
CEValidator - A quality assurance and - Designed to save original
testing technology for the equipment manufacturers
validation of Windows CE testing costs Enables original
integration with intelligent equipment manufacturers to
computing devices test software throughout the
- A client/server-based test
design process program of
more than 1,000 individual
test cases for testing
compliance and reliability
- Extendable architecture for
incorporating additional and
custom test programs
CE Interface Composer - A fully customizable desktop - Gives original equipment
building utility manufacturers the ability to
create a device-specific
- Includes a set of
pre-developed components for - graphical user interface
creating a custom desktop
- Helps enable original
- Contains customizable equipment manufacturers to
security and interface rapidly and easily create
features for commercial design prototypes and complete
applications the implementation of
graphical user interfaces
</TABLE>
To augment our own Windows-based software products and services, we
occasionally enter into license and distribution agreements with third-party
software vendors to provide our customers with additional features and
functionality. Our ability to license these third-party software products to
original equipment manufacturers, in conjunction with our own software products
and services, provides our original equipment manufacturer customers with a
single source for Windows CE software products and services. We are currently a
licensed distributor of Windows CE-based software from Communications
Intelligence Corporation, Datalight, Intrinsyc and Microsoft.
Services -- We also provide integration and support services to original
equipment manufacturers developing Windows CE- and Windows NT Embedded-based
intelligent computing devices. For example, we provide implementation services
for companies developing Internet-enabled television set-top boxes, gaming
systems, handheld industrial devices, consumer Internet appliances such as kiosk
terminals and navigational devices in cars and trucks, and Windows-based
terminals. Our software engineering services use our existing products, such as
our CE Xpress Adaptation Kit, CE Interface Composer and CE Validator, to
implement the hardware and software specifications of our customers' intelligent
computing device products. We often retain a license or other proprietary rights
in the resulting work product. At times, we provide new applications or system
software development on behalf of original equipment manufacturers. We believe
that original equipment manufacturer
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customers in need of complex adaptations can save time and resources by
outsourcing this work to us. In addition, to support our original equipment
manufacturer customers, we often "bundle" support services with our software
products and other services. These support services help enable our original
equipment manufacturer customers to complete intelligent computing device
development and reduce time-to-market.
The following table summarizes the key features and benefits of the
services we offer to our original equipment manufacturer customers:
<TABLE>
<CAPTION>
BSQUARE PRODUCT DESCRIPTION BENEFIT
--------------- ----------- -------
<S> <C> <C>
Systems consulting - We provide Windows CE and - Without our software
services to original Windows NT Embedded engineering consulting
equipment manufacturers integration services to services, original equipment
developing intelligent original equipment manufacturers would need to
computing devices manufacturers developing increase their development
intelligent computing devices costs and extend their project
along with custom adaptations schedules to provide the
of Windows CE training and materials
required to complete the
- We provide software projects in-house
engineering consulting
services to write the - Allows original equipment
software code that enables manufacturers to move quickly
Windows CE and Windows NT past the traditionally time
Embedded to integrate with consuming early stage of
intelligent computing device integrating Windows-based
hardware operating systems with their
existing hardware and software
Applications consulting - We provide software - Allows original equipment
services to original applications development manufacturers to avoid the
equipment manufacturers according to customer time and cost of developing
developing intelligent specifications in-house expertise in
computing devices applications development for
Windows CE
Quality assurance - We provide complete quality - Allows early discovery of
consulting services to assurance services on every design problems, a more rapid
original equipment project to ensure the highest development process and higher
manufacturers developing quality quality products for end users
intelligent computing
devices
</TABLE>
Consumer Software Applications
We provide a wide range of commercially available personal productivity,
utility and communications software to enhance the functionality and usefulness
of Windows CE-based intelligent computing devices. We market our consumer
software applications through standard retail and electronic commerce channels
and also license these products to original equipment manufacturers in formats
suitable for bundling with their own products. Our current consumer software
application product offerings include:
<TABLE>
<CAPTION>
PRODUCT DESCRIPTION BENEFIT
------- ----------- -------
<S> <C> <C>
bFAX - A product family that - Provides a practical and
provides faxing capabilities comprehensive faxing solution
for intelligent computing for Windows CE-based devices
devices
- bFAX Pro provides send and
receive capability for
handheld PCs
- bFAX Express provides
send-only capability for
handheld and
palm-size PCs
bPRINT - Print management software for - Users can spool jobs for batch
handheld and palm-size PCs Printing
- Increases the variety of
printers compatible with
Windows CE-based devices
BSQUARE SpreadSheet - A spreadsheet application for - Provides independent
palm-size PCs functionality while
maintaining Pocket Excel
compatibility
bUSEFUL Utilities Pak - Utility suite for handheld - Provides utility applications
and palm-size PCs that which enhance the performance
contains 12 different utility and functionality of Windows
applications CE-based devices
</TABLE>
19
<PAGE> 20
TECHNOLOGY
We have developed a set of technologies incorporated in the software
products described under "-- Integration of Windows CE and Windows NT Embedded
with intelligent computing devices -- Products" that are used by original
equipment manufacturers to integrate Windows CE with their computer boards, the
internal hardware constituting the core of their intelligent computing devices.
The technology contained in our CE Xpress Kits, including the Original Equipment
Manufacturer Adaptation Layer, the CE Platform Layer and the Device Driver
Library, provides the interface between Windows CE and the computer board
contained within the intelligent computing device. The basic features and
functions of these technologies are described below.
Original Equipment Manufacturer Adaptation Layer Library
The Original Equipment Manufacturer Adaptation Layer provides a standard
interface between the Windows CE operating system and the core components of an
intelligent computing device's computer board. A new board-specific Original
Equipment Manufacturer Adaptation Layer must be implemented for each computer
board that will be using Windows CE.
We maintain a library of Original Equipment Manufacturer Adaptation
Layers for several of the computer boards used in Windows CE-based intelligent
computing device products. These Original Equipment Manufacturer Adaptation
Layers are distributed to our customers in our CE Xpress Kits and are also used
by our engineers when we are contracted to create custom solutions. In addition,
our Original Equipment Manufacturer Adaptation Layer library serves as a
starting point for the creation of new Original Equipment Manufacturer
Adaptation Layer implementations.
Device Driver Library
Device drivers provide the interface by which the Windows CE operating
system controls any peripheral devices, including keyboards, display screens and
computer network interface cards, that may be connected to an intelligent
computing device's computer board. A separate device driver must be implemented
for each peripheral device connected to a Windows CE-enabled computer board.
We have created a library of device drivers for inclusion in our CE
Xpress Kits and for use in the custom software products and services we provide
to our customers. The existing set of drivers also provides starting points for
the creation of new device drivers.
CE Platform Layer
A peripheral device normally requires a different device driver for each
model of computer board to which it is to be connected. A device driver for one
model of computer board will not generally work with a different model of
computer board.
Our CE Platform Layer technology allows our engineers and third-party
hardware manufacturers to develop a single driver for a peripheral device that
may then be used on many different models of computer boards. This increases the
value and flexibility of each computer board by increasing the number of readily
available peripheral devices that can be used.
Our CE Platform Layer technology is included in our CE Xpress Kits and
is used for the implementation of the majority of our device drivers.
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<PAGE> 21
CEValidator
Our CEValidator product is a quality assurance and testing tool which we
originally developed for in-house use. We believe that it is important to test
devices early in the design process and to continue testing at a high frequency
throughout the development cycle. We have designed our CEValidator to support
such a testing pattern. CEValidator is based on two primary components:
- a broad suite of over 1,000 tests which evaluate the various
subsystems of Windows CE. These tests have been developed by our
engineers in the course of our own software development efforts. In
addition, CEValidator allows original equipment manufacturers to add
their own test suites to evaluate specific features of their
intelligent computing devices.
- a test control system. This system manages the execution of the tests
suite and the recording of test results. CEValidator provides
communication features which control testing over network
connections, a graphical user interface for displaying user controls
and test results, and simultaneous testing capabilities for multiple
systems.
CUSTOMERS
Microsoft is our largest customer, representing approximately 39%, 79%
and 88% of our total revenue in 1997, 1998 and 1999, respectively. Our other
target customers include semiconductor vendors and original equipment
manufacturers seeking to leverage the numerous benefits of Windows CE in order
to develop high quality, full-feature products that meet the complex and
evolving requirements of numerous end-markets.
Semiconductor Vendors
Through late 1997, we provided services directly to semiconductor
vendors. In late 1997, Microsoft decided to contract with us to provide services
to the semiconductor vendors with whom we had previously contracted directly. In
1996 and 1997 we provided in excess of $1.0 million of services to each of the
following semiconductor vendors:
ARM
Hitachi Semiconductor (America)
Motorola Computer Group
NEC
From late 1997 to early 2000, we provided software products and services
to these and other semiconductor vendors under our master agreement with
Microsoft. In January 2000, we signed a new agreement with Microsoft entitled
the Porting Partners Agreement, in which we were named the exclusive provider of
software engineering services to semiconductor vendors seeking Windows CE
software support for their products. Under this new agreement, we will again
provide services directly to semiconductor vendors new to the Windows CE
operating system.
OEM Customers
The following is a representative list of our original equipment
manufacturer customers in 1999:
AT&T Philips Mobile Computing Group
Boundless Technologies Sainco
Casio Sharp Electronics
Cedar Systems Symbol Technologies
Data General Takaoka Electric
Development Concepts Televideo
Ericsson Telxon
Hewlett-Packard Total Control Products
21
<PAGE> 22
IGEL AG Touchstar Technologies
Lexicon Two Technologies
LG Electronics WebTV
NEC Electronics
Philips Electronics
Due to customer confidentiality requirements, some customers are not
disclosed. For 1999, per-customer revenue for all customers varied from less
than $5,000 to approximately $596,000.
MICROSOFT RELATIONSHIP
We maintain strategic relationships with Microsoft to promote its
Windows CE operating system across a broad range of industries and applications.
Our relationship with Microsoft extends to the following:
Development partner. Under the terms of our master agreement, we are a
"preferred Microsoft vendor" for Windows CE. Approximately 200 of our software
engineers work on a number of different Windows CE-based projects for Microsoft
and on the development of Windows CE-related software tools under various work
plans. These software tools are then provided by Microsoft under the Microsoft
name to semiconductor vendors and various original equipment manufacturers
utilizing Windows CE. We bill Microsoft on a time-and-materials basis, although
each project has a maximum dollar cap. A separate work plan is generated for
each project, which can then be modified or terminated by Microsoft at any time.
Porting Partner. We are the exclusive partner of Microsoft for providing
software engineering services to semiconductor manufacturers seeking Windows CE
software support for the year 2000. Microsoft may expand this program to other
companies in the future.
Systems integrator. We are a Microsoft-sanctioned systems integrator for
Windows CE, as indicated on the "embedded Windows CE" portion of Microsoft's
website. In this capacity, we provide training, consulting and software
engineering services and products to original equipment manufacturers that are
building Windows CE-based intelligent computing devices. We actively participate
in the Microsoft systems integrator program, including participating with
Microsoft in "partner pavilions" at trade shows and listing our services and
posting our product announcements on the "embedded Windows CE" portion of
Microsoft's website. In addition, Microsoft has periodically utilized our
services when an original equipment manufacturer has required additional
software engineering services.
Windows CE distributor. We are a licensed distributor of the Windows CE
operating system. We sub-license Windows CE by reselling the right to bundle
this operating system in intelligent computing devices. Microsoft actively
assists and manages its distributors to secure additional licensing
opportunities for Windows CE. We are promoted on the "embedded Windows CE"
portion of Microsoft's website as a distributor, and Microsoft shares with us
leads generated from Web inquiries and tradeshows.
Windows CE independent software vendor. Microsoft actively encourages
third-party application development through its Developer Relations Group and
Windows CE logo program, which allows third-party applications to receive
Windows CE compatibility logos. We develop several software applications for a
wide variety of Windows CE-based intelligent computing devices, which we market
under our brand names, including bFAX and bPRINT. We also participate in
marketing opportunities offered by Microsoft for third-party developers to
promote our software applications. In addition, Microsoft has from time to time
demonstrated our applications in connection with demonstrations to third parties
of its Windows CE operating system.
SALES AND MARKETING
We market our services to different semiconductor vendors through our
direct sales force. We market our software tools products and related services
that help original equipment manufacturers integrate Windows CE into their
intelligent computing devices through our direct sales force, as well as through
third-party representatives and distributors. We market our Windows CE-based
software applications either bundled by original equipment
22
<PAGE> 23
manufacturers onto particular intelligent computing devices or purchased
directly by consumers for their intelligent computing devices through our direct
sales force, third-party representatives, distributors, or other consumer retail
channels. We have direct sales offices in the United States, Germany and Japan.
As of December 31, 1999, we had 35 employees in our sales and marketing
department. Key elements of our sales and marketing strategy include direct
advertising, event marketing, an active public relations program, channel
marketing programs, customer and strategic alliance partner co-marketing
programs and a comprehensive website.
We are currently developing new sales channels, including value-added
resellers and systems integrators. We believe that these additional channels
will further increase the brand awareness of our software products and services
and will further promote the development of software infrastructures for Windows
CE-based intelligent computing devices.
RESEARCH AND DEVELOPMENT
As of December 31, 1999, we had 302 engineers engaged in software
engineering services and research and development. Our research and development
teams are responsible for the design, development and release of our products.
Members of our research and development staff work closely with our sales and
marketing department, as well as with our customers and potential customers, to
better understand market needs and requirements.
A substantial majority of our research and development engineers are
involved in the development of the Windows CE operating system and accompanying
tools for Microsoft. These responsibilities require significant expertise due to
the radically different nature of the microprocessors and other hardware
components used in Windows CE-based intelligent computing devices. This team has
accumulated detailed knowledge of the Windows CE environment over the past five
years, allowing us to continue to develop software products and services that
enable the expanding capability and compatibility of Windows CE-based
intelligent computing devices. To ensure that compatibility goals are met and
that a high level of product quality is achieved, quality assurance groups
within this team subject our products to tens of thousands of individual tests
in multiple test configurations before the products are released to our
customers. Due to the broad variety of hardware that hosts Windows CE, the
quality assurance groups have had to develop a special expertise in managing and
extending the test tools used to validate the tool kits for these diverse
operating environments.
The remainder of our research and development engineers provide services
and develop Windows CE software for both end-user markets and
product/application developers. The software engineers in this team are
responsible for the development of commercial applications that provide added
breadth and functionality for Windows CE-based intelligent computing devices as
well as standard products used in the development and testing of new products
utilizing the Windows CE operating system. Our engineers have significant
experience in creating products for Windows CE, which enables us to bring
products to market in a timely manner.
COMPETITION
We face competition from:
- our current and potential customers' internal research and
development departments that may seek to develop their own
proprietary products and solutions;
- large professional engineering services firms;
- established intelligent computing device software and tools
manufacturers;
- small- and medium-size engineering services; and
- software and component distributors.
23
<PAGE> 24
As we develop new products, particularly products focused on specific
industries, we may begin competing with companies with whom we have not
previously competed.
We compete principally on the basis of the breadth of software products
and services offered, the experience of the providers, the quality of the
software products and services, the time-to-market and price. We believe we
compete favorably in each of these areas.
INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS
Intellectual property is critical to our success. In general, we attempt
to protect our intellectual property rights through patent, copyright, trademark
and trade secret laws and contractual arrangements. There can, however, be no
assurance that our efforts will be effective to prevent misappropriation of our
technology, or to prevent the development and design by others of products or
technologies similar to or competitive with those developed by us.
We currently have three pending U.S. patent applications. We do not have
any issued patents. BSQUARE, bFAX and BSQUARE View are our registered
trademarks. Additionally, bTRACK, bREADY, bFIND, bPRINT, bMOBILE, bUSEFUL,
bTASK, bPRODUCTIVE, bSTART and CEValidator are our trademarks. We will continue
to pursue registration of these and other marks. This prospectus also contains
trademarks and tradenames of other companies.
EMPLOYEES
As of December 31, 1999, we had 379 employees, excluding independent
contractors and other temporary employees, including 302 employees in software
engineering services and product development, 35 employees in sales and
marketing and 42 employees in general and administrative services (including
executive officers). Of these employees, 369 are located in the United States,
three are located in Germany and seven are located in Japan. In addition, from
time to time, we employ temporary employees and consultants. None of our
employees is represented by a labor union, and we consider our relations with
our employees to be good.
ITEM 2. PROPERTIES.
We lease approximately 126,000 square feet of space in a single location
in Bellevue, Washington, pursuant to a lease that expires in 2009, with the
option to renew for up to an additional 20 years. We also lease office space in
Munich, Germany and Tokyo, Japan. We believe that our facilities will be
adequate to meet our needs for at least the next twelve months.
ITEM 3. LEGAL PROCEEDINGS.
We are not currently involved in any material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of shareholders during the fourth
quarter.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.
MARKET PRICES AND DIVIDENDS ON COMMON STOCK
Our common stock is traded on The Nasdaq National Market under the
symbol "BSQR." The following table sets forth the high and low sales prices of
our common stock as reported on The Nasdaq National Market since October 20,
1999, the date our common stock commenced public trading.
24
<PAGE> 25
<TABLE>
<CAPTION>
Quarter Ended High Low
----------------- ------ ------
<S> <C> <C>
December 31, 1999 $56.50 $15.00
</TABLE>
The closing price of our common stock as reported by The Nasdaq National
market on February 18, 2000 was $36.00 per share. We estimate that at February
18, 2000 there were approximately 134 record owners of our common stock.
DIVIDENDS
We have never paid cash dividends on our common stock other than the
distribution of S corporation earnings prior to October 1997, when we converted
to a C corporation. We currently intend to retain any future earnings to fund
the development and growth of our business. Therefore, we do not currently
anticipate paying any cash dividends in the foreseeable future. In addition, the
terms of our current credit facility prohibit us from paying dividends without
our lender's consent.
25
<PAGE> 26
ITEM 6. SELECTED FINANCIAL DATA.
The following selected consolidated financial data should be read in
conjunction with our consolidated financial statements and related notes and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
1995 1996 1997 1998 1999
-------- -------- -------- -------- --------
(unaudited)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenue .................................................. $ 1,573 $ 4,179 $ 14,405 $ 24,612 $ 39,938
Gross profit ............................................. 778 2,775 8,761 13,407 20,644
Income from operations ................................... 692 1,964 4,564 3,170 1,881
Net income ............................................... $ 693 $ 1,971 $ 3,806 $ 2,300 $ 1,691
======== ======== ======== ======== ========
Basic earnings per share ................................. $ 0.03 $ 0.09 $ 0.18 $ 0.12 $ 0.06
======== ======== ======== ======== ========
Shares used in computation of basic earnings per
share .................................................... 21,000 22,106 21,400 18,372 27,858
======== ======== ======== ======== ========
Diluted earnings per share ............................... $ 0.03 $ 0.09 $ 0.17 $ 0.08 $ 0.06
======== ======== ======== ======== ========
Shares used in computation of diluted earnings per
share .................................................... 21,000 22,106 21,781 27,475 30,539
======== ======== ======== ======== ========
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and short-term investments ........ $ 103 $ 187 $ 2,286 $ 6,906 $ 82,397
Working capital .......................................... 236 658 2,918 10,280 81,178
Total assets ............................................. 514 1,057 6,453 16,158 95,624
Long-term obligations, net of current portion ............ -- -- 1,743 289 --
Mandatorily redeemable convertible preferred stock ....... -- -- -- 14,417 --
Shareholders' equity (deficit) ........................... 261 924 2,330 (1,298) 88,538
</TABLE>
- --------------------
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION.
The following Management's Discussion and Analysis of Financial
Condition and Results of Operations should be read in conjunction with our
consolidated financial statements and related notes.
OVERVIEW
We are a leading provider of software solutions that enable the
development and proliferation of a wide variety of intelligent computing devices
based on the Microsoft Windows-based operating systems. Intelligent computing
devices, or ICDs, are a class of non-personal computer devices that offer
electronic connectivity. We work with semiconductor vendors and original
equipment manufacturers to provide software products and engineering services
for the development of intelligent computing devices.
We enable the rapid and low-cost deployment of intelligent computing
devices by providing a variety of software products and services for the
development, integration and deployment of Windows-powered operating systems
with industry-specific applications. We also develop software applications that
are licensed to end users to provide intelligent computing devices with
additional functionality. Our products and services are marketed and supported
on a worldwide basis through a direct sales force augmented by distributors.
Our revenue totaled $14.4 million in 1997, $24.6 million in 1998 and
$39.9 million in 1999. We generated net income of $3.8 million in 1997, $2.3
million in 1998 and $1.7 million in 1999.
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<PAGE> 27
To date, we have derived substantially all of our revenue from the
provision of services to Microsoft, semiconductor vendors and original equipment
manufacturers. We also generate product revenue from software sales and royalty
licenses. We perform our services under both time-and-materials contracts and
fixed-fee contracts. We also receive a small portion of service revenue from the
provision of contract support services upon the purchase of our software
products. We sell our packaged software products through standard retail
channels, our direct sales force and through indirect channels, such as
resellers. In addition, we receive royalty payments from original equipment
manufacturers related to the bundling of our software on their intelligent
computing devices and, more recently, from the license to them of software
products contained in our intelligent computing device integration tool kits.
MICROSOFT MASTER DEVELOPMENT AND LICENSE AGREEMENT
In 1997, 1998 and 1999, approximately 39%, 79% and 88% of our revenue,
respectively, was generated under our master development and license agreement
with Microsoft. The master agreement, the current renewable term of which
concludes in July 2000, includes a number of project-specific work plans. We
bill Microsoft on a time-and-materials basis, although each project has a
maximum dollar cap, and recognize revenue generated under the master agreement
as the services are rendered. The master agreement and each of the individual
work plans may be modified or terminated by Microsoft at any time. While we
anticipate that our relationship with Microsoft will remain strong, we are
unable to predict the magnitude and number of future projects for Microsoft.
In addition, under a non-competition provision contained in the master
agreement, we must obtain written permission from Microsoft in order to design
or develop products, or provide services in connection with products, which
compete with Windows, or related products in existence as of October 1, 1998 or
which Microsoft is developing or intends to develop or acquire. In January 2000,
Microsoft eliminated this non-competition provision in conjunction with the
execution of a new Porting Partners agreement.
HISTORICAL RESULTS OF OPERATIONS
The following table presents certain financial data as a percentage of
total revenue for the periods indicated. Our historical operating results are
not necessarily indicative of the results for any future period.
<TABLE>
<CAPTION>
AS A PERCENTAGE OF TOTAL REVENUE
YEAR ENDED DECEMBER 31,
--------------------------------
1997 1998 1999
------ ------ ------
<S> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA
Revenue:
Service ................................................ 97% 95% 95%
Product ................................................ 3 5 5
------ ------ ------
Total revenue ..................................... 100 100 100
------ ------ ------
Cost of revenue:
Service ................................................ 39 46 47
Product ................................................ -- -- 1
------ ------ ------
Total cost of revenue ............................. 39 46 48
------ ------ ------
Gross margin .............................................. 61 54 52
Operating expenses:
Research and development ............................... 10 14 17
Selling, general and administrative .................... 19 26 29
Amortization of deferred stock option compensation ..... -- 1 1
------ ------ ------
Total operating expenses .......................... 29 41 47
------ ------ ------
Income from operations .................................... 32 13 5
Interest income, net ...................................... -- 1 2
------ ------ ------
Income before income taxes ................................ 32 14 7
Provision for income taxes ................................ 6 5 3
------ ------ ------
Net income ................................................ 26% 9% 4%
====== ====== ======
</TABLE>
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<PAGE> 28
COMPARISON OF YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
Revenue
Total revenue increased 71% from $14.4 million in 1997 to $24.6 million
in 1998, and an additional 62% to $39.9 million in 1999. Microsoft accounted for
39%, 79% and 88% of total revenue in 1997, 1998 and 1999, respectively. Revenue
outside of North America totaled $4.3 million in 1997, $954,000 in 1998 and $1.2
million in 1999. The decrease in international revenue from 1997 to 1998
correlates with the corresponding increase in Microsoft revenue resulting from
the shift from working directly with semiconductor vendors to working with
Microsoft for the benefit of those customers during this period. The increase in
international revenue from 1998 to 1999 is the result of an increase in the
number and size of software integration service and product contracts with OEMs.
Service revenue. Service revenue increased 67% from $14.0 million in
1997 to $23.4 million in 1998, and an additional 63% to $38.1 million in 1999.
The increases in service revenue for all periods were due to the increasing
number and size of service projects and related hiring of engineering personnel
to fulfill project requirements. As a percentage of total revenue, service
revenue did not change materially.
Product revenue. Product revenue increased 217% from $384,000 in 1997 to
$1.2 million in 1998, and an additional 52% to $1.9 million in 1999. The
increases in product revenue from 1997 to 1999 resulted from the expansion of
product offerings from software applications for handheld PCs to intelligent
computing device integration tool kits and CE Validator quality assurance test
suites. As a percentage of total revenue, product revenue did not change
materially.
Cost of Revenue
Cost of service revenue. Cost of service revenue increased 98% from $5.6
million in 1997 to $11.0 million in 1998, and an additional 70% to $18.8 million
in 1999. These increases resulted from the hiring and training of additional
employees to support our growing customer base. At December 31, 1997, 1998 and
1999, we had 87, 152 and 222 employees, respectively, engaged in engineering
consulting. Cost of service revenue as a percentage of related service revenue
was 40% in 1997, 47% in 1998 and 49% in 1999. The increases in cost of service
revenue as a percentage of related service revenue reflect higher personnel
costs related to the competitive employee recruiting and retention pressures in
the greater-Seattle area, as well as higher facilities and depreciation costs
associated with expansion.
Cost of product revenue. Cost of product revenue increased 113% from
$78,000 in 1997 to $166,000 in 1998, and an additional 186% to $475,000 in 1999.
Cost of product revenue as a percentage of related product revenue was 20% in
1997, 14% in 1998 and 26% in 1999. The decrease in product cost of sales as a
percent of product revenue from 1997 to 1998 relates to a change in mix from
pre-package applications sales in 1997 to royalty revenue earned from the
bundling of software applications in 1998. The increase in product cost of sales
as a percentage of product revenue from 1998 to 1999 relates to a change in mix
of product sales from royalties received from original equipment manufacturers
for licenses of applications in 1998 to a higher proportion of pre-packaged
BSQUARE and third-party applications in 1999.
Operating Expenses
Research and development. Research and development expenses increased
161% from $1.4 million in 1997 to $3.6 million in 1998, and an additional 84% to
$6.7 million in 1999. These increases relate primarily to the increase in the
number of software developers and quality assurance personnel hired to expand
our product offerings and to support our product development and testing
activities. Research and development expenses represented 10% of our total
revenue in 1997, 14% in 1998 and 17% in 1999. The increases in research and
development expenses as a percentage of total revenue primarily reflect the more
rapid investment in our research and development activities compared to the
growth of our revenue during these periods. We anticipate that research and
development expenses will continue to increase in absolute dollars in future
periods.
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<PAGE> 29
Selling, general and administrative. Selling, general and administrative
expenses increased 136% from $2.7 million in 1997 to $6.4 million in 1998, and
an additional 79% to $11.5 million in 1999. These increases resulted primarily
from our investment in finance, executive, administration, sales and marketing
infrastructure, both domestically and internationally, which included
significant personnel-related expenses, travel expenses and related facility and
equipment costs, as well as increased marketing activities, including trade
shows, public relations and other promotional expenses. Selling, general and
administrative expenses represented 19% of our total revenue in 1997, 26% in
1998 and 29% in 1999. The increases in selling, general and administrative
expenses as a percentage of total revenue primarily reflects the more rapid
investment in our administrative and sales and marketing infrastructure compared
to the growth of our revenue during these periods. During the fourth quarter of
1998, we opened sales offices in Munich, Germany and Tokyo, Japan. To establish
and operate these offices, we invested $502,000 in 1998 and $1.9 million in
1999, which are included in the expense amounts above. We anticipate that
selling, general and administrative expenses will continue to increase in
absolute dollars in future periods as we expand our sales and marketing staff
both internationally and domestically, as well as incur expenses associated with
being a public company.
Amortization of deferred stock option compensation. We recorded
amortization of deferred stock option compensation of $81,000 in 1997, $171,000
in 1998 and $583,000 in 1999, resulting from stock option exercises at prices
below the deemed fair market value of our common stock when we were a private
company.
Interest income (expense), net. Interest income (expense), net consists
of earnings on our cash, cash equivalents and short-term investment balances
offset by interest expense associated with debt obligations. Interest income
(expense), net was $(12,000) in 1997, $319,000 in 1998 and $911,000 in 1999.
These increases resulted from higher average cash, cash equivalent and
short-term investment balances over the prior year.
Income taxes. Our provision for federal, state and international income
taxes was $746,000 for 1997, $1.2 million for 1998 and $1.1 million 1999,
yielding effective rates of 16.4%, 34.1% and 39.4% in 1997, 1998 and 1999,
respectively. We were taxed as a subchapter S corporation until October 15,
1997, when our shareholders elected to convert to a C corporation. Accordingly,
taxes on our income were the responsibility of the shareholders until the
conversion. The increase in the effective tax rate in 1999 over 1998 was due
primarily to the effect of the non-deductibility of losses from our
international operations.
LIQUIDITY AND CAPITAL RESOURCES
Since our inception through September 1999, we financed our operations
and capital expenditures primarily through cash flow from operations. As of
December 31, 1999, we had $82.4 million of cash, cash equivalents and short-term
investments. This represents an increase of $75.5 million over December 31,
1998. In October 1999, we completed an initial public offering of 4,000,000
shares of common stock and raised $54.4 million, net of offering costs. In
addition, in September 1999, we sold 1,518,378 shares of our common stock to
Vulcan Ventures for approximately $18.7 million. In January 1998, we issued
mandatorily redeemable convertible preferred stock from which we received net
proceeds of approximately $14.3 million. Concurrent with this transaction, we
repurchased 3,333,333 shares of our common stock for an aggregate of $6.0
million. To a lesser extent, we have financed software system purchases through
traditional financing arrangements. Our working capital at December 31, 1998 was
$10.3 million compared to $81.2 million at December 31, 1999.
Our operating activities resulted in net cash inflows of $4.3 million in
1997, $188,000 in 1998 and $9.8 million in 1999. The sources of cash were
primarily income from operations and increases in accounts payable and accrued
liabilities, partially offset by increases in accounts receivable.
Investing activities used cash of $1.4 million in 1997, $3.7 million in
1998 and $32.8 million in 1999. Investing activities for 1997 and 1998 were
primarily purchases of capital equipment. Investing activities in 1999 included
$25.8 million in purchases of short-term investments and $7.0 million in capital
equipment.
Financing activities used $775,000 in 1997, primarily for shareholder
draws and repayment of long-term obligations. Financing activities generated
$6.5 million in 1998, primarily through the issuance of mandatorily convertible
preferred stock, partially offset by repayment of shareholder loans and the $6.0
million repurchase of
29
<PAGE> 30
shares of common stock. Financing activities in 1999 generated $72.7 million due
to the net proceeds from the initial public offering and from the sale of common
stock to Vulcan Ventures.
We have a working capital revolving line of credit with Imperial Bank
that is secured by our accounts receivable. This facility allows us to borrow up
to the lesser of 80% of our eligible accounts receivable or $5.0 million and
bears interest at the bank's prime rate, which was 8.50% at December 31, 1999.
The facility expires in July 2000. The agreement under which the line of credit
was established contains certain covenants, including a provision requiring us
to maintain specified financial ratios. We were in compliance with these
covenants at December 31, 1999, and at that time there were no borrowings
outstanding under this credit facility. We also maintain with Imperial Bank a
$1.5 million term loan for equipment purchases, which bears interest at the
bank's prime rate plus 0.25%, and a $4.0 million term loan for leasehold
improvement purchases, which bears interest at the bank's prime rate plus 0.50%.
These facilities operate as a revolver through June 2000, after which time any
outstanding balances must be paid over 36-month and 60-month terms,
respectively. These loans also require us to comply with certain financial
covenants, including a requirement that we maintain certain financial ratios. We
were in compliance with these covenants at December 31, 1999, and at that time
there were no borrowings outstanding under these facilities.
As of December 31, 1999, our principal commitments consisted of
obligations outstanding under operating leases. In October 1999, we began
leasing approximately 126,000 square feet in a single facility located in
Bellevue, Washington pursuant to a lease which expires in 2009. The annual cost
of this lease is approximately $3.0 million, subject to annual adjustments.
Although we have no other material commitments, we anticipate an increase in our
capital expenditures and lease commitments consistent with our anticipated
growth in our operations, infrastructure and personnel.
We currently anticipate that we will continue to experience significant
increases in our operating expenses for the foreseeable future as we enter new
markets for our products and services, increase research and development
activities and sales and marketing activities, develop new distribution channels
and broaden our professional service capabilities. We believe that our existing
cash and cash equivalents and available bank borrowings will be sufficient to
meet our anticipated cash needs for working capital and capital expenditures for
at least the next 12 months. Although we believe that we will be able to meet
our anticipated cash needs after that time from cash generated from operations
and do not currently anticipate the need to raise additional capital, if we do
seek to raise additional capital, there can be no assurance that additional
financing will be available on acceptable terms, if at all. We may use a portion
of our cash to acquire additional businesses, products and technologies or to
establish joint ventures that we believe will complement our current or future
business. However, we have no specific plans, agreements or commitments to do
so, and are not currently engaged in any negotiations for any such acquisition
or joint venture. Pending such uses, we will invest our surplus cash in
government securities and other short-term, investment grade, interest-bearing
instruments.
IMPACT OF THE YEAR 2000
Even though we have not experienced any immediate adverse impact from
the transition to the year 2000, it is possible that other dates in the year
2000, may further affect computer software and systems. While we believe that
all of our systems are year 2000 compliant, we may discover problems during 2000
that may require expenditures in order for our computer and software systems to
be upgraded, modified or replaced. In addition, we do not currently have any
information concerning the year 2000 compliance status of our customers or other
parties with whom we do business. It is possible that some of the internal
systems of our customers or other parties with whom we do business have already
been or will be negatively affected by the year 2000 date change. We currently
have no contingency plan to manage any year 2000 issues that may arise.
RECENT ACCOUNTING PRONOUNCEMENTS
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-1 (SOP 98-1), "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use," which establishes
guidelines for the accounting for the costs of all computer software developed
or obtained for internal use. We were required to adopt SOP 98-1 for the fiscal
year beginning January 1, 1999. Our adoption of SOP 98-1 did not have a material
impact on our financial statements.
30
<PAGE> 31
In April 1998, the American Institute of Public Accountants issued
Statement of Position 98-5 (SOP 98-5), "Reporting on the Costs of Start-up
Activities." SOP 98-5, which is effective for fiscal years beginning after
December 15, 1998, provides guidance on the financial reporting of start-up
costs and organization costs. It requires costs of start-up activities and
organization costs to be expensed as incurred. The implementation of SOP 98-5
did not have a material impact on our financial position or results of
operations.
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement requires that all derivative
instruments be recorded on the balance sheet at their fair value. Changes in the
fair value of derivatives are recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is designated as a part
of a hedge transaction and, if it is, the type of hedge transaction. This
statement is effective for all fiscal quarters of all fiscal years beginning
after June 15, 2000. We do not use derivative instruments, therefore the
adoption of this statement will not have any effect on our results of operations
or financial position.
In December 1999, SEC Staff Accounting Bulletin No. 101 ("SAB
101"),"Revenue Recognition in Financial Statements," was issued. This
pronouncement summarizes certain of the SEC staff's views in applying generally
accepted accounting principles to revenue recognition. We are required to adopt
SAB 101 for the year ended December 31, 2001. We are currently reviewing the
requirements of SAB 101 and assessing its impact on our financial statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Interest Rate Risk. We do not hold derivative financial instruments or
equity securities in our investment portfolio. Our cash equivalents consist of
high-quality securities, as specified in our investment policy guidelines. The
policy limits the amount of credit exposure to any one issue or issuer to a
maximum of 20% of the total portfolio with the exception of treasury securities,
commercial paper and money market funds, which are exempt from size limitation.
The policy limits all short-term investments to mature in two years or less,
with the average maturity being one year or less. These securities are subject
to interest rate risk and will decrease in value if interest rates increase.
Foreign Currency Risk. Currently, the majority of our sales and expenses
are denominated in U.S. dollars, and, as a result, we have not experienced
significant foreign exchange gains and losses to date. While we have conducted
some transactions in foreign currencies during the year ended December 31, 1999
and expect to continue to do so, we do not anticipate that foreign exchange
gains or losses will be significant. We have not engaged in foreign currency
hedging to date, although we may do so in the future.
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<PAGE> 32
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
BSQUARE CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Independent Public Accountants................................. 33
Consolidated Balance Sheets.............................................. 34
Consolidated Statements of Income and Comprehensive Income............... 35
Consolidated Statements of Shareholders' Equity (Deficit)................ 36
Consolidated Statements of Cash Flows.................................... 37
Notes to Consolidated Financial Statements............................... 38
</TABLE>
32
<PAGE> 33
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To BSQUARE Corporation:
We have audited the accompanying consolidated balance sheets of BSQUARE
Corporation and subsidiaries as of December 31, 1999 and 1998, and the related
consolidated statements of income and comprehensive income, shareholders' equity
and cash flows for each of the three years in the period ended December 31,
1999. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above,
present fairly, in all material respects, the financial position of BSQUARE
Corporation and subsidiaries as of December 31, 1999 and 1998, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1999, in conformity with generally accepted accounting
principles.
ARTHUR ANDERSEN LLP
Seattle, Washington,
January 21, 2000
33
<PAGE> 34
BSQUARE CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
ASSETS 1998 1999
-------- --------
<S> <C> <C>
Current assets:
Cash and cash equivalents ..................................... $ 5,324 $ 55,029
Short-term investments ........................................ 1,582 27,368
Accounts receivable, net of allowance for doubtful
accounts of $67 in 1998, and $142 in 1999 ................... 5,487 4,203
Prepaid expenses and other current assets ..................... 526 1,664
-------- --------
Total current assets ................................... 12,919 88,264
Furniture, equipment and leasehold improvements, net ............ 3,061 7,150
Deposits and other assets ....................................... 178 210
-------- --------
Total assets ........................................... $ 16,158 $ 95,624
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Current portion of long-term liabilities ...................... $ 157 $ 157
Accounts payable .............................................. 676 579
Accrued compensation .......................................... 1,331 2,274
Accrued expenses .............................................. 308 2,959
Deferred revenue .............................................. 167 1,117
-------- --------
Total current liabilities .............................. 2,639 7,086
Long-term obligations ........................................... 400 --
-------- --------
Total liabilities ...................................... 3,039 7,086
-------- --------
Commitments and contingencies (Note 7)
Mandatorily redeemable convertible Series A preferred
stock, no par value: Authorized 10,000,000 shares,
issued and outstanding, 8,333,333 shares in 1998 and no
shares in 1999, preference in liquidation of $15,000,000 ........ 14,417 --
Shareholders' equity (deficit):
Common stock, no par value: Authorized 50,000,000
shares, issued and outstanding, 18,161,605 shares in
1998, and 32,294,833 in 1999 ................................. 2,123 90,842
Deferred stock option compensation ............................ (401) (868)
Cumulative foreign currency translation adjustment ............ 5 (15)
Accumulated deficit ........................................... (3,025) (1,421)
-------- --------
Total shareholders' equity (deficit) ................... (1,298) 88,538
-------- --------
Total liabilities and shareholders' equity ............. $ 16,158 $ 95,624
======== ========
</TABLE>
See notes to Consolidated Financial Statements.
34
<PAGE> 35
BSQUARE CORPORATION
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
--------------------------------------
1997 1998 1999
-------- -------- --------
<S> <C> <C> <C>
Revenue:
Service .................................................. $ 14,021 $ 23,393 $ 38,082
Product .................................................. 384 1,219 1,856
-------- -------- --------
Total revenue .................................... 14,405 24,612 39,938
-------- -------- --------
Cost of revenue:
Service .................................................. 5,566 11,039 18,819
Product .................................................. 78 166 475
-------- -------- --------
Total cost of revenue ............................ 5,644 11,205 19,294
-------- -------- --------
Gross profit ..................................... 8,761 13,407 20,644
-------- -------- --------
Operating expenses:
Research and development ................................. 1,391 3,628 6,658
Selling, general and administrative ...................... 2,725 6,438 11,522
Amortization of deferred stock option compensation ....... 81 171 583
-------- -------- --------
Total operating expenses ......................... 4,197 10,237 18,763
-------- -------- --------
Income from operations ........................... 4,564 3,170 1,881
Interest income (expense) .................................. (12) 319 911
-------- -------- --------
Income before income taxes ................................. 4,552 3,489 2,792
Provision for income taxes ................................. 746 1,189 1,101
-------- -------- --------
Net income ....................................... $ 3,806 $ 2,300 $ 1,691
======== ======== ========
Foreign currency translation adjustment .................... -- (5) 20
-------- -------- --------
Comprehensive net income ................................... $ 3,806 $ 2,295 $ 1,711
======== ======== ========
Basic earnings per share ................................... $ 0.18 $ 0.12 $ 0.06
======== ======== ========
Weighted average shares outstanding used to
compute basic earnings per share ......................... 21,400 18,372 27,858
======== ======== ========
Diluted earnings per share ................................. $ 0.17 $ 0.08 $ 0.06
======== ======== ========
Weighted average shares outstanding to compute
diluted earnings per share ............................... 21,781 27,475 30,539
======== ======== ========
</TABLE>
See notes to Consolidated Financial Statements.
35
<PAGE> 36
BSQUARE CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
CUMULATIVE
FOREIGN RETAINED TOTAL
COMMON STOCK DEFERRED CURRENCY EARNINGS SHAREHOLDERS'
------------------------ STOCK OPTION TRANSLATION (ACCUMULATED EQUITY
SHARES AMOUNT COMPENSATION ADJUSTMENT DEFICIT) (DEFICIT)
----------- ----------- ------------ ----------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1996 .................. 22,106,000 16 -- -- 908 924
Issuance of common stock for
services rendered ....................... 500,000 25 -- -- -- 25
Repurchase of common stock ................ (1,231,000) (46) -- -- -- (46)
Shareholder note payable on S
to C Corporation conversion ............. -- -- -- -- (2,000) (2,000)
Shareholder draws ......................... -- -- -- -- (460) (460)
Net income from January 1,
1997 to October 15, 1997 ................ 3,670 3,670
Conversion from S corporation
to C corporation ........................ 2,118 (2,118) --
Issuance of compensatory stock
options ................................. -- 653 (653) -- -- --
Amortization of deferred stock
option compensation ...................... -- -- 81 -- -- 81
Net income from October 16,
1997 to December 31, 1997 ............... -- -- -- -- 136 136
----------- ----------- ----------- ----------- ----------- -----------
Balance, December 31, 1997 .................. 21,375,000 2,766 (572) -- 136 2,330
Repurchase of common stock ................ (3,333,333) (649) -- -- (5,351) (6,000)
Exercise of stock options ................. 119,938 6 -- -- -- 6
Amortization of deferred stock
option compensation ...................... -- -- 171 -- -- 171
Foreign currency translation
adjustment .............................. -- -- -- 5 -- 5
Accretion on mandatorily
redeemable convertible
preferred stock ......................... -- -- -- -- (110) (110)
Net income ................................ -- -- -- -- 2,300 2,300
----------- ----------- ----------- ----------- ----------- -----------
Balance, December 31, 1998 .................. 18,161,605 2,123 (401) 5 (3,025) (1,298)
Exercise of stock options ................. 281,517 77 -- -- -- 77
Issuance of compensatory stock
options ................................. -- 1,050 (1,050) -- -- --
Amortization of deferred stock
option compensation ...................... -- -- 583 -- -- 583
Foreign currency translation
adjustment .............................. -- -- -- (20) -- (20)
Accretion on mandatorily
redeemable convertible
preferred stock ......................... -- -- -- -- (87) (87)
Issuance of common stock (net of
offering costs of $13) ................... 1,518,378 18,689 -- -- -- 18,689
Issuance of common stock in
connection with the initial public
offering (net of offering costs of
$5,601) .................................. 4,000,000 54,399 -- -- -- 54,399
Conversion of mandatorily
redeemable convertible preferred
stock into shares of common stock .......... 8,333,333 14,504 -- -- -- 14,504
Net income ................................ -- -- -- -- 1,691 1,691
----------- ----------- ----------- ----------- ----------- -----------
Balance, December 31, 1999 .................. 32,294,833 $ 90,842 $ (868) $ (15) $ (1,421) $ 88,538
=========== =========== =========== =========== =========== ===========
</TABLE>
See notes to Consolidated Financial Statements.
36
<PAGE> 37
BSQUARE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------
1997 1998 1999
-------- -------- --------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income ......................................................... $ 3,806 $ 2,300 $ 1,691
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization ................................. 328 948 2,215
Deferred income taxes ......................................... 262 (387) (922)
Stock and stock option compensation ........................... 106 171 583
Amortization of deferred financing costs ...................... -- 14 13
Changes in operating assets and liabilities:
Accounts receivable ......................................... (2,109) (2,786) 1,283
Prepaid expenses and other current assets ................... (90) (193) (184)
Accounts payable and accrued expenses ....................... 1,111 960 4,282
Income taxes ................................................ 484 (221) (146)
Deferred revenue ............................................ 389 (618) 950
-------- -------- --------
Net cash provided by operating activities ................ 4,287 188 9,765
-------- -------- --------
Cash flows from investing activities:
Purchases of furniture equipment and leasehold improvements ...... (1,413) (2,117) (6,987)
Purchase of short-term investments, net .......................... -- (1,582) (25,786)
-------- -------- --------
Net cash used in investing activities .................... (1,413) (3,699) (32,773)
-------- -------- --------
Cash flows from financing activities:
Repayment of shareholder notes payable ........................... (256) (1,743) --
Payments on long-term obligations ................................ -- (26) (446)
Repurchase of common stock ....................................... (46) (6,000) --
Deferred financing costs ......................................... (13) (2) (25)
Proceeds from exercise of stock options .......................... -- 6 77
Shareholders' draws .............................................. (460) -- --
Net proceeds from issuance of mandatorily redeemable
convertible preferred stock .............................. -- 14,307 --
Net proceeds from sale of common stock ........................... -- -- 18,689
Net proceeds from initial public offering ........................ -- -- 54,399
-------- -------- --------
Net cash provided by (used in) financing activities ...... (775) 6,542 72,694
-------- -------- --------
Effect of exchange rate changes on cash ............................ -- 7 19
-------- -------- --------
Net increase in cash and cash equivalents ................ 2,099 3,038 49,705
Cash and cash equivalents, beginning of period ..................... 187 2,286 5,324
-------- -------- --------
Cash and cash equivalents, end of period ........................... $ 2,286 $ 5,324 $ 55,029
======== ======== ========
</TABLE>
See notes to Consolidated Financial Statements.
37
<PAGE> 38
BSQUARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
BSQUARE Corporation, a Washington corporation, and its subsidiaries
(collectively the Company) provides a variety of software products and services
that facilitate the integration of the Microsoft Windows based operating systems
with a wide variety of intelligent computing devices. The Company works with
semiconductor vendors and original equipment manufacturers to provide software
products and engineering services for the development of intelligent computing
devices.
The Company helps enable the rapid and low-cost deployment of
intelligent computing devices by providing a variety of software products and
services for the development, integration and deployment of Windows-based
operating systems with industry-specific applications. The Company also develops
software applications that are licensed to end users to provide intelligent
computing devices with additional functionality. The Company markets and
supports its products and provides services on a worldwide basis through a
direct sales force augmented by distributors.
CERTAIN SIGNIFICANT RISKS AND UNCERTAINTIES
The Company operates in the software industry, and accordingly, can be
affected by a variety of factors. For example, management of the Company
believes that any of the following factors could have a significant negative
effect on the Company's future financial position, results of operations and
cash flows: unanticipated fluctuations in quarterly operating results; failure
of the market for Windows CE operating system to develop fully; failure of the
market for intelligent computing devices to develop fully; adverse changes in
the Company's relationship with Microsoft; failure to secure contracts with
market-leading original equipment manufacturers; intense competition; failure to
attract and retain key personnel; failure to protect intellectual property;
risks associated with international operations; inability to manage growth; and
litigation or other claims against the Company.
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries. Significant intercompany accounts and
transactions have been eliminated. Accounts denominated in foreign currencies
have been re-measured into the functional currency, using the U.S. dollar as the
functional currency.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.
EARNINGS PER SHARE
In accordance with Statement of Financial Accounting Standards (SFAS)
No. 128, "Computation of Earnings Per Share," basic earnings per share is
computed by dividing net income available to common shareholders (net income
less accretion of mandatorily redeemable convertible preferred stock) by the
weighted average number of shares of common stock outstanding during the period.
Dilutive earnings per share is computed by dividing net income by the weighted
average number of common and dilutive common equivalent shares outstanding
during the
38
<PAGE> 39
period. Common equivalent shares consist of the shares of common stock issuable
upon the conversion of the mandatorily redeemable convertible preferred stock
(using the if-converted method) and shares issuable upon the exercise of stock
options and warrants (using the treasury stock method); common equivalent shares
are excluded from the calculation if their effect is antidilutive. The Company
has not had any issuances or grants for nominal consideration as defined under
Staff Accounting Bulletin 98.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents, include demand deposits, money market
accounts and all highly liquid debt instruments with an original maturity date
of three months or less.
SHORT-TERM INVESTMENTS
The Company's short-term investments consist primarily of
investment-grade marketable securities, which are classified as held to maturity
and recorded at amortized cost. Due to the short-term nature of these
investments, changes in market interest rates would not have a significant
impact on the fair value of these securities that are carried at amortized cost,
which approximates fair value.
At December 31, 1999 and 1998, all short-term investments had a
contractual maturity of two years or less.
FINANCIAL INSTRUMENTS AND CONCENTRATIONS OF CREDIT RISK
The Company has the following financial instruments: cash and cash
equivalents, short-term investments, accounts receivable, accounts payable,
accrued liabilities, bank lines of credit and standby letters of credit. The
carrying value of cash and cash equivalents, short-term investments, accounts
receivable, accounts payable, and accrued liabilities approximate fair value
based on the liquidity of these financial instruments or based on their short
term nature. The carrying value of bank lines of credit, and standby letters of
credit approximates fair value based on the market interest rates available to
the Company for debt of similar risk and maturities.
The Company performs initial and ongoing evaluations of its customers'
financial position, and generally extends credit on open account, requiring
collateral as deemed necessary. The Company maintains allowances for potential
credit losses.
FURNITURE, EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Furniture, equipment and leasehold improvements are stated at cost less
accumulated depreciation. Depreciation is provided on the straight-line method
over the estimated useful lives, as follows: office furniture and equipment --
four years; computer equipment -- three years. Leasehold improvements are
amortized over the shorter of the lease term or the estimated useful life.
Maintenance and repairs are expensed as incurred. When properties are retired or
otherwise disposed, gains or losses are reflected in the income statement. When
facts and circumstances indicate that the cost of long-lived assets may be
impaired, an evaluation of recoverability is performed by comparing the carrying
value of the asset to projected future cash flows. Upon indication that the
carrying value of such assets may not be recoverable, the Company would
recognize an impairment loss by a charge against current operations.
SOFTWARE DEVELOPMENT COSTS
Under the criteria set forth in Statement of Financial Accounting
Standards No. 86, "Accounting for the Costs of Computer Software to Be Sold,
Leased, or Otherwise Marketed," capitalization of software development costs
begins upon the establishment of technological feasibility of the product, which
the Company has defined as the completion of beta testing of a working product.
The establishment of technological feasibility and the ongoing assessment of the
recoverability of these costs require considerable judgment by management with
respect to certain external factors, including, but not limited to, anticipated
future gross product revenue estimated economic life and changes in software and
hardware technology. Amounts that could have been capitalized under this
statement after
39
<PAGE> 40
consideration of the above factors were immaterial and, therefore, no software
development costs have been capitalized by the Company to date.
RESEARCH AND DEVELOPMENT
Research and development costs are expensed as incurred.
INCOME TAXES
The Company computes income taxes using the asset and liability method,
under which deferred income taxes are provided for the temporary differences
between the financial reporting basis and the tax basis of the Company's assets
and liabilities. Deferred tax assets and liabilities are measured using
currently enacted tax rates that are expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. A valuation allowance is established when necessary to reduce deferred
tax assets to the amounts expected to be realized.
FOREIGN CURRENCY TRANSLATION
The functional currency of foreign subsidiaries is the local currency.
Accordingly, assets and liabilities are translated into U.S. Dollars at exchange
rates in effect at the balance sheet date and income and expense accounts at the
average exchange rates during the year. Resulting translation adjustments are
recorded as a separate component of shareholders' equity. The net gains and
losses resulting from foreign currency transactions are recorded in the
consolidated statements of income in the period incurred and were not
significant for any of the periods presented.
REVENUE RECOGNITION
The Company's revenue recognition policy is in compliance with the
provisions of the American Institute of Certified Public Accountants' Statement
of Position 97-2, "Software Revenue Recognition." Service revenue is derived
from software porting and development contracts. Product revenue consists of
licensing fees from software application products and operating system and
software development tool products. The Company's customers consist of software
companies, original equipment manufacturers, distributors and end users.
The Company's revenue is recognized as follows:
Time and Material Consulting Contracts. The Company recognizes revenue
as services are rendered.
Fixed-Price Consulting Contracts. Service revenue from fixed-price
contracts is recognized on the percentage-of-completion method, measured by the
cost incurred to date to the estimated total cost for the contract. This method
is used as management considers expended costs to be the best available measure
of contract performance. Contract costs include all direct labor, material and
any other costs related to contract performance. Selling, general and
administrative costs are charged to expense as incurred. Provisions for
estimated losses on uncompleted contracts are made in the period in which such
losses are determined. Changes in job performance, job conditions and estimated
profitability may result in revisions in the estimate of total costs. Any
required adjustments due to these changes are recognized in the period in which
such revisions are determined.
Product Revenue. Product revenue consists principally of fees from the
licensing and sale of software products. Product licensing fees, including
advanced production royalty payments, are generally recognized when a customer
license agreement has been executed, the software has been shipped, remaining
obligations are insignificant and collection of the resulting account receivable
is probable. The Company recognizes license royalty income as it is reported by
the reseller when it ships its product to distributors.
Deferred revenue consists of deposits received from customers and
unamortized service contract revenue.
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<PAGE> 41
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the
current year presentation.
2. CASH AND SHORT-TERM INVESTMENTS
The Company's cash, cash equivalent and short-term balances consist of
the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1998 1999
------- -------
<S> <C> <C>
Cash and equivalents:
Cash ................................... $ 220 $ 90
Money market funds ..................... 5,104 8,056
Municipal certificates ................. -- 46,883
------- -------
$ 5,324 $55,029
======= =======
Short-term investments:
Commercial paper ....................... $ 1,582 $ 3,064
Corporate notes and bonds .............. -- 12,580
Municipal securities ................... -- 11,724
------- -------
$ 1,582 $27,368
======= =======
</TABLE>
3. FURNITURE, EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Major classifications of furniture, equipment and leasehold improvements
consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1998 1999
------- -------
<S> <C> <C>
Computer equipment and system software ............. $ 2,450 $ 3,508
Office furniture and equipment ..................... 667 1,250
Leasehold improvements ............................. 1,040 4,443
Construction in progress ........................... 118 --
------- -------
4,275 9,201
Less: accumulated depreciation and amortization ... (1,214) (2,051)
------- -------
$ 3,061 $ 7,150
======= =======
</TABLE>
4. INCOME TAXES
The Company was a Subchapter S Corporation for income tax purposes from
inception to October 15, 1997. Effective October 16, 1997, the Company converted
to a C Corporation and was thereafter responsible for U.S. federal income taxes.
A net deferred tax liability of $445, primarily related to the required
conversion for income tax purposes from the cash basis method to the accrual
basis method of accounting, was recorded at the conversion date to reflect the
Company's net taxable temporary differences.
In addition, in accordance with Staff Accounting Bulletin Topic 4.B.,
the Company has reclassified accumulated earnings generated prior to the date of
conversion to C corporation status from retained earnings to common stock and
additional paid in capital.
41
<PAGE> 42
The provision for income taxes consisted of the following:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
------------------------------------
1997 1998 1999
------- ------- -------
<S> <C> <C> <C>
Current
U.S. Current ..................... $ 484 $ 1,549 $ 1,995
International .................... -- 27 28
U.S. Deferred .................... 262 (387) (922)
------- ------- -------
Total tax provision ...... $ 746 $ 1,189 $ 1,101
======= ======= =======
</TABLE>
The components of net deferred tax assets (liabilities) consisted of the
following at December 31:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1998 1999
------- -------
<S> <C> <C>
Deferred income tax asset:
Depreciation ............................... $ 41 $ 88
Accrued compensation and benefits .......... 206 472
Deferred revenue ........................... 57 213
Cash to accrual basis conversion ........... (111) (111)
Other, net ................................. 44 386
------- -------
$ 237 $ 1,048
======= =======
Deferred income taxes payable:
Cash to accrual basis conversion ........... $ (111) $ --
------- -------
$ (111) $ --
======= =======
</TABLE>
The provision for income taxes differs from the amount of income tax
determined by applying the applicable U.S. statutory federal income tax rate to
pre-tax income, as a result of the following:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
--------------------------------
1997 1998 1999
------ ------ ------
<S> <C> <C> <C>
Taxes at the U.S. statutory rate ........................... 34.0% 34.0% 34.0%
Increase (decreases) in income taxes resulting from:
Conversion from an S Corporation to C Corporation ........ 9.8 -- --
Shareholder responsibility for taxes associated with
S Corporation status .................................. (27.4) -- --
Research and development tax credit ...................... (0.8) (6.2) (7.2)
International operations ................................. -- 4.5 14.3
Tax exempt interest ...................................... -- -- (5.5)
Other, net ............................................... 0.8 1.8 3.8
------ ------ ------
16.4% 34.1% 39.4%
====== ====== ======
</TABLE>
5. SHAREHOLDER NOTES PAYABLE
The Company was a Subchapter S Corporation for income tax purposes from
inception to October 15, 1997. Effective October 16, 1997, the Company converted
to a C Corporation. In connection with the conversion, the Company issued notes
payable totaling $2.0 million to the shareholders. Interest accrued at the
applicable federal long-term rate under Section 1274 of the Internal Revenue
Code of 1986, as amended. Although the notes were not due until December 2002,
or earlier if certain conditions were met, the Company paid in full these notes
and related accrued interest on January 30, 1998.
6. BANK LINE OF CREDIT AND NOTES PAYABLE
At December 31, 1999, the Company had available a $5.0 million secured
domestic revolving line of credit, $1.5 million term loan for the purchase of
equipment and a $4.0 term loan for leasehold improvements.
42
<PAGE> 43
Interest accrues at the bank's prime rate for the revolving line of credit, the
bank's prime rate plus 0.25% for the equipment term loan and the bank's prime
rate plus 0.5% for the leasehold term loan. The facility fee is $25. Restrictive
terms of the lines require, among other requirements, that the Company maintain
a minimum quick ratio, tangible net worth and debt service ratio, and limits the
Company's ability to pay dividends without the lender's consent. The line of
credit is secured by substantially all of the assets of the Company. As of
December 31, the Company had $464 in standby letters of credit issued and
outstanding under the domestic revolving line of credit.
7. COMMITMENTS AND CONTINGENCIES
The Company leases its office space under non-cancelable operating
leases that expire at various dates through 2009. During the years ending
December 31, 1997, 1998, 1999, rental expense was $420, $980 and $3,347,
respectively. Minimum rental commitments under non-cancelable operating leases
at December 31, 1999 are as follows:
<TABLE>
<S> <C>
2000................................................. $ 3,081
2001................................................. 2,978
2002................................................. 2,948
2003................................................. 3,044
2004................................................. 3,090
Thereafter........................................... 15,572
-------
$30,713
=======
</TABLE>
In January 1999, the Company signed a ten-year lease for a new corporate
headquarters in Bellevue, Washington, which commenced in October 1999. The
Company has the option to extend the lease for four additional periods of five
years each. The Company must provide a $667 letter of credit as security for the
lease. If certain working capital requirements are not met on the commencement
date, the Company must provide an additional $333 letter of credit. The letter
of credit may be reduced annually by specified amounts the lease agreement upon
the Company's achieving certain economic goals.
8. MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK
The Company has authorized 10.0 million shares of convertible preferred
stock. The Board of Directors has the authority to establish and define, in one
or more series, the price, rights, preferences and dividends of authorized but
unissued shares of preferred stock.
On January 30, 1998, the Company issued 8,333,333 shares of Series A
Convertible Preferred Stock (Preferred Stock) at $1.80 per share. Total
proceeds, net of offering costs, approximated $14.3 million. Concurrent with
this transaction, the Company repurchased 3,333,333 shares of the Company's
common stock from its founders for $6.0 million.
The rights and preferences of the preferred stock are as follows:
- In the event of any liquidation, dissolution or winding up of the
Company, the holders of Series A preferred stock would be entitled to
receive the greater of: (i) an amount in cash equal to $1.80 per
share (adjusted for stock splits, stock dividends and the like) or
(ii), cash in an amount equal to the portion of the assets of the
Company remaining for distribution to shareholders which such
shareholder would have received if each share of Series A Preferred
Stock held had been converted into the number of shares of common
stock issuable upon the conversion of a share of Series A Preferred
Stock immediately prior to any liquidation, dissolution or winding up
of the Company.
- The Preferred Stock is voluntarily convertible at any time at the
option of the holder into shares of the Company's common stock at a
one-for-one conversion. The Preferred Stock is automatically
convertible upon closing of a Qualified Public Offering, as defined
in the agreement.
- Any time following the fifth anniversary of the closing, holders of
the Preferred Stock have the right to cause the Company to redeem up
to 50% of the Preferred Stock at the original purchase price. Any
43
<PAGE> 44
time following the sixth anniversary of the closing, the holders
shall have the right to cause the Company to redeem up to 100% of the
Preferred Stock at the original purchase price.
- The Preferred Stock converts at a one-for-one conversion rate, and is
adjusted in certain circumstances to prevent dilution of the
preferred shareholder's ownership interest.
- The Preferred shareholders have the same voting rights and voting
powers as common shareholders.
The Preferred shares were converted into shares of the Company's common
stock in conjunction with the Company's initial public offering on October 20,
1999.
9. SHAREHOLDERS' EQUITY
INITIAL PUBLIC OFFERING
On October 20, 1999, the Company issued 4,000,000 shares of its common
stock at an initial public offering price of $15.00 per share. Also sold in this
offering were 600,000 shares held by selling shareholders upon exercise of the
underwriters' overallotment options. The net proceeds to the Company from the
offering, net of offering costs of approximately $5.6 million were approximately
$54.4 million. Concurrent with the initial public offering, each outstanding
share of the Company's mandatorily redeemable preferred stock was automatically
converted into common stock.
STOCK PURCHASE AGREEMENT
On August 18, 1999, the Company entered into a stock purchase agreement
to sell 1,518,378 shares of common stock to Vulcan Ventures for approximately
$18.7 million.
COMMON STOCK RESERVED FOR FUTURE ISSUANCE
At December 31, 1999, the Company has reserved the following shares of
common stock for future issuance:
<TABLE>
<S> <C>
Employee Stock Purchase Plan..................................... 1,500,000
Stock Option Plan................................................ 1,773,980
---------
3,273,980
=========
</TABLE>
10. EMPLOYEE BENEFIT PLANS
STOCK OPTIONS
In May 1997, the Company adopted the Amended and Restated Stock Option
Plan (the Plan). Under the Plan, the Board of Directors may grant nonqualified
stock options at a price determined by the Board, not to be less than 85% of the
fair market value of the common stock. Options have a term of up to 10 years and
vest over a schedule determined by the Board of Directors, generally four years.
Incentive stock options granted under this program may only be granted to
employees of the Company, have a term of up to 10 years, and shall be granted at
a price equal to the fair market value of the Company's stock. A summary of
stock option activity follows:
44
<PAGE> 45
<TABLE>
<CAPTION>
PRICE PER SHARE
-------------------------------
NUMBER OF AVAILABLE WEIGHTED
OPTIONS FOR AVERAGE
OUTSTANDING ISSUANCE EXERCISE PRICE RANGE
----------- ---------- -------------- --------------
<S> <C> <C> <C> <C>
Balance, December 31, 1996 ..... -- -- --
Authorized ..................... -- 2,500,000 -- --
Granted ...................... 1,750,100 (1,750,100) $ 0.08 $0.05 -- $1.00
Exercised .................... -- -- -- --
Canceled ..................... (69,300) 69,300 $ 0.05 $0.05 -- $0.05
---------- ---------- ---------- --------------
Balance, December 31, 1997 ..... 1,680,800 819,200 $ 0.08 $0.05 -- $1.00
Authorized ................... -- 1,125,000 -- --
Granted ...................... 1,108,150 (1,108,150) $ 1.15 $1.00 -- $1.80
Exercised .................... (119,938) -- $ 0.05 $0.05 -- $0.05
Canceled ..................... (128,850) 128,850 $ 0.34 $0.05 -- $1.00
---------- ---------- ---------- --------------
Balance, December 31, 1998 ..... 2,540,162 964,900 $ 0.54 $0.05 -- $1.80
Authorized ................... -- 2,000,000 -- --
Granted ...................... 1,345,795 (1,345,795) $ 7.24 $1.44 -- 45.06
Exercised .................... (281,517) -- $ 0.36 $0.05 -- $1.00
Canceled ..................... (154,875) 154,875 $ 0.82 $0.05 --$10.00
---------- ---------- ---------- --------------
Balance, December 31, 1999 ..... 3,449,565 1,773,980 $ 3.15 $0.05 -- 45.06
========== ========== ========== ==============
</TABLE>
The following table summarizes information concerning currently
outstanding and exercisable options at December 31, 1999:
<TABLE>
<CAPTION>
OUTSTANDING EXERCISABLE
------------------------- ------------------------
WEIGHTED
AVERAGE WEIGHTED
REMAINING AVERAGE
NUMBER OF CONTRACTUAL NUMBER OF EXERCISE
OPTIONS LIFE (YEARS) OPTIONS PRICE
--------- ------------ --------- ---------
<S> <C> <C> <C> <C>
Range of exercise price:
$0.05 - $1.00 .............. 1,928,170 7.6 691,255 $ 0.39
$1.44 - $2.50 .............. 860,000 9.1 370,000 $ 1.51
$10.00 - $12.00 ............ 604,895 9.7 5,000 $ 10.00
$30.93 - $45.06 ............ 56,500 9.8 -- --
--------- --------- --------- ---------
3,449,565 8.4 1,066,255 $ 0.82
========= ========= ========= =========
</TABLE>
Had compensation expense been recognized on stock options issued based
on the fair value of the options at the date of the grant and recognized over
the vesting period, the Company's net income would have been reduced to the pro
forma amounts presented below.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------
1997 1998 1999
------- ------- -------
<S> <C> <C> <C>
Net income, as reported ................. $ 3,806 $ 2,300 $ 1,691
Incremental pro forma compensation
expense under SFAS 123 ................ (12) (82) (1,351)
------- ------- -------
Pro forma net income .................... $ 3,794 $ 2,218 $ 340
======= ======= =======
Pro forma basic earnings per share ...... $ 0.18 $ 0.12 $ 0.01
======= ======= =======
</TABLE>
The fair value of options granted in 1997, 1998 and 1999 of $0.03, $0.25
and $4.89, respectively, has been estimated at the date of grant using the
Black-Scholes method with the following weighted-average assumptions:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31
--------------------------------------
1997 1998 1999
-------- -------- --------
<S> <C> <C> <C>
Dividend yield ....................... 0% 0% 0%
Expected life ........................ 5 years 5 years 5 years
Expected volatility .................. 0% 0% 57%
Risk-free interest rate .............. 6.0% 5.5% 6.6%
</TABLE>
45
<PAGE> 46
The effects on pro forma disclosures of applying SFAS No. 123 are not
likely to be representative of the effects on pro forma disclosures of future
years.
1999 EMPLOYEE STOCK PURCHASE PLAN
On July 21, 1999, the board of directors approved the adoption of the
Company's 1999 Employee Stock Purchase (the "1999 Purchase Plan".) Under the
plan, the Company is authorized to sell up to 1.5 million shares of common stock
in a series of eighteen month offerings. The 1999 Purchase Plan permits eligible
employees to acquire shares of the Company's common stock through periodic
payroll deductions of up to 10% of base cash compensation. The price at which
the common stock may be purchased is 85% of the lesser of 1) the fair market
value of the Company's common stock on the first day of the applicable offering
period or 2) the fair market value of the shares on the purchase date. The
initial offering period commenced on the effectiveness of the initial public
offering.
PROFIT SHARING AND DEFERRED COMPENSATION PLAN
The Company has a Profit Sharing and Deferred Compensation Plan (Profit
Sharing Plan) under Section 401(k) of the Internal Revenue Code of 1986, as
amended. Substantially all full-time employees are eligible to participate. The
Company, at its discretion, may elect to match the participants' contributions
to the Profit Sharing Plan. Participants will receive their share of the value
of their investments upon retirement or termination, subject to a vesting
schedule. The Company made no matching contributions to the Profit Sharing Plan
during 1998 or 1997. During the year ended December 31, 1999, the Company made
matching contributions to the profit sharing plan of $514.
DEFERRED STOCK OPTION COMPENSATION
In connection with the grant of certain stock options to employees and
consultants during 1997 and 1999, the Company recorded deferred stock option
compensation of $653 and $1.1 million, respectively, representing the difference
between the estimated fair value of the common stock for accounting purposes and
the option exercise price of such options at the date of grant. Such amount is
presented as a reduction of shareholders' equity and amortized, in accordance
with FASB Interpretation No. 28, on an accelerated basis over the vesting period
of the applicable options (generally four years). During the years ended
December 31, 1997, 1998 and 1999, the Company expensed approximately $81, $171,
and $583, respectively. The balance will be expensed over the period the options
vest. Compensation expense is decreased in the period of forfeiture for any
accrued but unvested compensation arising from the early termination of an
option holder's services.
Included in the expensed amounts noted above for the year ended December
31, 1999 is $30 related to options granted to a consultant for services
rendered. As of December 31, 1999, the consultant had earned 20,833 options to
acquire common stock at $1 per share. The Company has recorded the fair value of
the options as of the date the options were earned based on a Black-Scholes
model utilizing a 50% volatility factor and an expected life of 2 years. During
1999, the agreement was terminated.
11. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1997 1998 1999
------- ------- -------
<S> <C> <C> <C>
Issuance of notes payable for equipment ... $ -- $ 473 $ --
Cash paid for interest .................... 13 57 68
Cash paid for income taxes ................ -- 2,170 2,520
</TABLE>
All significant non-cash financing activities are listed elsewhere in
the financial statements or the notes thereto.
46
<PAGE> 47
12. SIGNIFICANT CUSTOMERS
Sales to customers, which comprised at least 10% of revenue for the
years ended December 31 were as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1997 1998 1999
---- ---- ----
<S> <C> <C> <C>
Microsoft ............................ 39% 79% 88%
Hitachi .............................. 18% 2% --
NEC .................................. 17% 3% --
ARM .................................. 11% 1% --
</TABLE>
As of December 31, 1997, 1998, and 1999, Microsoft represented 73%, 84% and 82%
of total accounts receivable, respectively.
In February 1999, the Company signed a two-year agreement with Microsoft
Corporation to continue to provide services to Microsoft which extend the
capabilities of the Windows CE operating system.
13. GEOGRAPHIC AND SEGMENT INFORMATION
The Company follows the requirements of Statement of Financial
Accounting Standards No. 131, Disclosures About Segments of an Enterprise and
Related Information. As defined in SFAS No. 131, the Company operates in two
reportable segments, Service and Products for Windows-based operating systems.
The following table summarizes total revenue and long-lived assets attributed to
significant countries:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------
1997 1998 1999
------- ------- -------
<S> <C> <C> <C>
Total revenue:
United States ........................ $10,065 $23,658 $38,703
Japan .............................. 2,632 195 376
Other Foreign ...................... 1,708 759 859
------- ------- -------
Total revenue* ............. $14,405 $24,612 $39,938
======= ======= =======
Long-lived assets:
United States ...................... $ 1,378 $ 2,795 $ 6,946
Japan .............................. -- 239 257
Germany ............................ -- 205 157
------- ------- -------
Total long-lived assets .... $ 1,378 $ 3,239 $ 7,360
======= ======= =======
</TABLE>
- ----------
* Revenue is attributed to countries based on location of customer invoiced.
BSQUARE has two operating segments, Services and Products. The Services
segment includes design and development of integration tools for the
semiconductor vendors and the original equipment manufacturer market. The
Product segment derives revenue from licensing of software products to original
equipment manufactures and distributing product through resellers. The
accounting policies of the segments are the same as those described in the
summary of significant accounting policies.
The Company does not track assets or operating expenses by operating
segments. Consequently, it is not practicable to show assets or operating
expenses by operating segments.
47
<PAGE> 48
14. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Summarized quarterly financial information for 1998 and 1999 are as
follows:
<TABLE>
<CAPTION>
MARCH 31 JUNE 30, SEPT. 30, DEC. 31,
-------- -------- --------- --------
<S> <C> <C> <C> <C>
1998 QUARTER ENDED
Revenue: ................................. $ 5,492 $ 5,310 $ 6,579 $ 7,231
Gross profit ............................. 3,089 2,735 3,614 3,969
Income from operations ................... 1,288 416 1,196 270
Net income ............................... $ 856 $ 361 $ 802 $ 281
======= ======= ======= =======
Net income per share, basic .............. $ 0.04 $ 0.02 $ 0.04 $ 0.01
======= ======= ======= =======
Weighted average shares outstanding
used to compute basic earnings per
share ................................... 19,190 18,046 $18,113 18,154
======= ======= ======= =======
1999 QUARTER ENDED
Revenue: ................................. $ 8,809 $ 9,734 $10,033 $11,362
Gross profit ............................. 4,668 5,092 5,106 5,778
Income from operations ................... 722 726 350 83
Net income ............................... $ 432 $ 434 $ 262 $ 563
======= ======= ======= =======
Net income per share, basic .............. $ 0.02 $ 0.02 $ 0.01 $ 0.02
======= ======= ======= =======
Weighted average shares outstanding
used to compute basic earnings per
share ................................... 18,197 18,215 18,583 31,394
======= ======= ======= =======
</TABLE>
15. EARNINGS PER SHARE
The following is a reconciliation of the numerators and denominators
used in computing basic and diluted earnings per share:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
1997 1998 1999
-------- -------- --------
<S> <C> <C> <C>
Net income (numerator diluted), ................ $ 3,806 $ 2,300 $ 1,691
Less: Accretion of mandatorily redeemable
convertible preferred stock .................... -- (110) (87)
-------- -------- --------
Net income available to common shareholders
(numerator basic) ............................ $ 3,806 $ 2,190 $ 1,604
======== ======== ========
Shares (denominator basic):
Weighted average common shares
outstanding ............................... 21,400 18,372 27,858
======== ======== ========
Basic earnings per share ....................... $ 0.18 $ 0.12 $ 0.06
======== ======== ========
Shares (denominator diluted):
Weighted average common shares
outstanding ............................... 21,400 18,372 21,169
Mandatorily redeemable convertible
preferred stock ........................... -- 7,648 6,689
Common stock equivalents ..................... 381 1,455 2,681
-------- -------- --------
Shares used in computation, (denominator
diluted) .................................. 21,781 27,475 30,539
======== ======== ========
Diluted earnings per share ..................... $ 0.17 $ 0.08 $ 0.06
======== ======== ========
</TABLE>
16. SUBSEQUENT EVENT
On January 5, 2000, the Company acquired Blue Water Systems, Inc. in a
transaction accounted for as a pooling of interests. Blue Water Systems, located
in Edmonds, Washington is dedicated to the design of software development tool
kits and system integration services for the creation of Windows based
intelligent computing
48
<PAGE> 49
devices. The transaction was effected through the exchange of approximately
261,000 shares of BSQUARE common stock for all of the issued and outstanding
shares of Blue Water Systems.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON AUDITING AND FINANCIAL
DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by this Item is included in our definitive
proxy statement for our 2000 annual meeting of shareholders to be filed with the
SEC under the captions "Election of Directors and Management Information" and
"Information Regarding the Board and its Committee" and is incorporated herein
by this reference.
Compliance with Section 16(A) of the Exchange Act. Based solely on a
review of Forms 3 and 4 and any amendments thereto furnished to us pursuant to
Rule 16a-3(e) under the Securities Exchange Act of 1934, or representations that
no Forms 5 were required, we believe that with respect to fiscal 1999, all
Section 16(a) filing requirements applicable to our officers, directors and
beneficial owners of more than 10% of our equity securities were complied with
except:
1. Advent Atlantic and Pacific III, L.P.
2. William T. Baxter
3. David J. Bialer
4. Jeffrey T. Chambers
5. Albert T. Dosser
6. Encompass Europe, Inc.
7. Encompass Group US Information Technology Partners I, LP
8. Peter R. Gregory
9. Scot E. Land
10. William L. Larson
11. Northwest Financing, L.L.C.
12. TA/Advent VIII L.P.
13. TA Executives Fund L.L.C.
14. TA Investors L.L.C.
15. TCI Club
16. Brian V. Turner
17. Donald L. Whitt
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this Item is included in our definitive
proxy statement for our 2000 annual meeting of shareholders to be filed with the
SEC under the caption "Information Regarding Executive Officer Compensation" and
is incorporated herein by this reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this Item is included in our definitive
proxy statement for our 2000 annual meeting of shareholders to be filed with the
SEC under the caption "Information Regarding Beneficial Ownership of Principal
Shareholders, Directors and Management" and is incorporated herein by this
reference.
49
<PAGE> 50
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this Item is included in our definitive
proxy statement for our 2000 annual meeting of shareholders to be filed with the
SEC under the caption "Certain Relationships and Related Transactions" and is
incorporated herein by this reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) FINANCIAL STATEMENTS AND SCHEDULES
1. Financial Statements.
A. Consolidated Balance Sheets at December 31, 1998 and 1999.
B. Consolidated Statements of Income and Comprehensive Income
for the Years Ended December 31, 1997, 1998 and 1999.
C. Consolidated Statements of Shareholders' Equity (Deficit).
D. Consolidated Statements of Cash Flows for the Years Ended
December 31, 1997, 1998 and 1999.
2. Financial Statement Schedules
A. Schedule II - Valuation and Qualifying Accounts.
Financial statement schedules not included herein have been omitted
because they are either not required, not applicable, or the information
is otherwise included herein.
(b) REPORTS ON FORM 8-K
No reports on Form 8-K were filed during the last quarter of fiscal
1999.
(c) EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- --------------------------------------------------------------------------------
<S> <C>
3.1* Amended and Restated Articles of Incorporation.
3.2* Bylaws.
10.1* Amended and Restated Stock Option Plan.
10.2* Employee Stock Purchase Plan.
10.3* 401(k) Plan.
10.4* Form of Indemnification Agreement.
10.5* Loan and Security Agreement between Imperial Bank and BSQUARE
Corporation dated February 11, 1998.
10.5(a)* Amended and Stated Loan Agreement between Imperial Bank and
BSQUARE Corporation.
10.6 First Amendment to Office Lease Agreement between WRC Sunset
North LLC and BSQUARE Corporation
10.13*# Master Development & License Agreement between Microsoft
Corporation and BSQUARE Corporation dated effective as of October
1, 1998.
10.14* Stock Purchase and Shareholders Agreement dated as of January 30,
1998.
10.15* Stock Purchase Agreement dated August 18, 1999 by and between
BSQUARE Corporation and Vulcan Ventures Incorporated.
</TABLE>
50
<PAGE> 51
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- --------------------------------------------------------------------------------
<S> <C>
21.1 Subsidiaries of the registrant.
23.1 Consent of Arthur Andersen LLP, Independent Public Accountants.
24.1 Power of Attorney (See Page 52)
27.1 Financial Data Schedule.
</TABLE>
* Incorporated by reference exhibits to BSQUARE's registration statement on
Form S-1, File No. 333-85351.
# Subject to confidential treatment.
51
<PAGE> 52
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized on March 1, 2000.
BSQUARE CORPORATION
By: /s/ Brian V. Turner
-------------------------------
Brian V. Turner,
Senior Vice President, and
Chief Financial Officer
POWER OF ATTORNEY
Each person whose individual signature appears below hereby authorizes
and appoints William T. Baxter and Brian V. Turner, and each of them, with full
power of substitution and resubstitution and full power to act without the
other, as his true and lawful attorney-in-fact and agent to act in his name,
place and stead and to execute in the name and on behalf of each person,
individually and in each capacity stated below, and to file, any and all
amendments to this registration statement, including any and all post-effective
amendments thereto and any registration statement relating to the same offering
as this Form 10-K, and to file the same, with all exhibits thereto, and other
documents in connection therewith, with the Securities and Exchange Commission,
granting unto said attorneys-in fact and agents, and each of them, full power
and authority to do and perform each and every act and thing, ratifying and
confirming all that said attorneys-in-fact and agents or any of them or their or
his substitute or substitutes may lawfully do or cause to be done by virtue
thereof.
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on March 1, 2000 on
behalf of the registrant and in the capacities indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE
- ----------------------------------------------------------------------------------------------
<S> <C>
/s/ William T. Baxter Chairman of the Board, President and Chief
- ------------------------------------ Executive Officer (Principal Executive Officer)
William T. Baxter
/s/ Brian V. Turner Senior Vice President, Chief Financial Officer
- ------------------------------------ and Secretary (Principal Financial Officer)
Brian V. Turner
/s/ Albert T. Dosser Director
- ------------------------------------
Albert T. Dosser
/s/ Scot E. Land Director
- ------------------------------------
Scot E. Land
/s/ Jeffrey T. Chambers Director
- ------------------------------------
Jeffrey T. Chambers
/s/ William Larson Director
- ------------------------------------
William Larson
/s/David M. Moore Director
- ------------------------------------
David M. Moore
</TABLE>
52
<PAGE> 53
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULE
TO BSQUARE CORPORATION
We have audited in accordance with generally accepted auditing
standards, the financial statements of BSQUARE Corporation and subsidiaries
included in this 10-K and have issued our report thereon dated January 21, 2000.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The accompanying schedule is presented
for purposes of complying with the Securities and Exchanges Commission rules and
is not part of the basic financial statements. This schedule has been subjected
to the auditing procedures applied in the audits of the basic financial
statements and, in our opinion, fairly states in all material respects the
financial data required to be set forth therein relation to the basic financial
statements taken as a whole.
ARTHUR ANDERSEN LLP
Seattle Washington
January 21, 2000
<PAGE> 54
BSQUARE CORPORATION
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
----------- ------------------------------ ------------ --------------
BALANCE AT CHARGED TO CHARGED TO
BEGINNING COSTS AND OTHER ACCOUNTS DEDUCTIONS- BALANCE AT
DESCRIPTION OF PERIOD EXPENSES DESCRIBE DESCRIBE END OF PERIOD
- ----------- ----------- ----------- ---------------- ------------ --------------
<S> <C> <C> <C> <C> <C>
For the year ended December 31, 1997:
Allowance for doubtful accounts $ -- $ 10 $ -- $ -- $ 10
For the year ended December 31, 1998:
Allowance for doubtful accounts $ 10 $ 60 $ -- $ 3 $ 67
For the year ended December 31, 1999:
Allowance for doubtful accounts $ 67 $ 75 $ -- $ -- $ 142
</TABLE>
54
<PAGE> 1
EXHIBIT 10.6
FIRST AMENDMENT TO OFFICE LEASE AGREEMENT
The parties to this First Amendment to Office Lease Agreement ("First
Amendment") are WRC SUNSET NORTH LLC, a Washington limited liability company
("Landlord") and BSQUARE CORPORATION, a Washington corporation ("Tenant").
Landlord and Tenant are parties to that certain Office Lease Agreement
dated as of January 15, 1999 (the "Lease") for the lease of certain real
property located in the City of Bellevue, King County, Washington, more
particularly described therein. The terms and conditions of the Lease are hereby
incorporated by reference. Defined terms used in this First Amendment shall have
the meanings given them in the Lease.
Tenant now wishes to exercise its option to lease an additional floor in
the Building in accordance with the provisions of Section 5.B of the Lease.
Accordingly, in consideration of the mutual covenants contained herein, Landlord
and Tenant now agree:
1. ADDITIONAL PREMISES. Pursuant to Section 5.B of the Lease, Tenant has
exercised its option to lease the entire second (2nd) floor of the Building (the
"Additional Premises"). The Additional Premises contain approximately 31,308
rentable square feet of area and 28,205 usable square feet of area. The
Additional Premises shall be part of the Initial Premises and, except to the
extent expressly provided otherwise in this First Amendment, all references in
the Lease to the Initial Premises shall include the Additional Premises. Without
limiting the forgoing, the Base Rental and Allowance applicable to the Initial
Premises shall be applicable to the Additional Premises.
2. AMENDED SECTIONS.
(a) Section 1.A.7 is hereby amended to read in its entirety as
follows:
"INITIAL PREMISES" shall mean the area located on the entire
second (2nd), third (3rd), fourth (4th) and fifth (5th) floors of the
Building, as outlined on Exhibit A attached hereto and incorporated
herein, containing approximately one hundred twenty five thousand four
hundred ninety (125,490) rentable square feet of area and one hundred
thirteen thousand fifty four (113,054) usable square feet of area,
measured on a single tenant per floor basis, using BOMA standards. The
area of the Premises may be adjusted or expanded in accordance with the
provisions of Section 5.A below. The Initial Premises, as later modified
or expanded, is referred to in this Lease as the "PREMISES."
(b) Section 1.A.10 of the Lease is hereby amended to read in its
entirety as follows:
"TENANT'S PRO RATA SHARE" shall mean twenty seven and two
thousand four hundred twelve ten thousandths percent (27.2412%), which
is the quotient (expressed as a percentage), derived by dividing the
Rentable Area of the Premises (125,490) by the Rentable Area of
Buildings 3,4 and 5 (460,663). At
1
<PAGE> 2
such time as the construction of all of the Buildings is completed,
Landlord will cause the rentable square feet of the Buildings and the
Premises to be determined in accordance with BOMA standards, will notify
Tenant of such rentable square feet, and Tenant's Pro Rata Share shall
be adjusted accordingly if the Rentable Area differs from that set forth
above.
(c) Section 5.A shall be amended to read in its entirety as
follows:
Initial Premises. The Initial Premises are depicted on Exhibit A
attached hereto and contain approximately one hundred twenty five
thousand four hundred ninety (125,490) rentable square feet of area. The
precise square footage of the Initial Premises shall be determined based
upon Tenant's Final Plans, and once so determined shall not be further
adjusted except to reflect additions to or other modifications of the
Premises.
3. EXHIBIT A. Exhibit A and Exhibit A-1 to the Lease are hereby deleted
and replaced in their entirety by Exhibit A and Exhibit A-1 attached to this
First Amendment.
4. SECURITY DEPOSIT. The total Security Deposit payable pursuant to
Section 9.A of the Lease shall be increased by $250,000. Section 9.A of the
Lease is hereby amended to read in its entirety as follows:
Tenant shall deposit with Landlord the following amounts on the
dates set forth below to serve as a security deposit under this Lease
(collectively the "Security Deposit"):
1. One Hundred Thousand and no/100 Dollars ($100,000.00),
which was paid upon the original execution of this Lease by Tenant and
Landlord;
2. An Additional Thirty Three Thousand Three Hundred
Thirty Three and 33/100 Dollars ($33,333.33) upon execution of this
First Amendment by Landlord and Tenant.
3. An additional Two Hundred Sixty Six Thousand Six
Hundred Sixty Six and 67/100 Dollars ($266,666.67) upon commencement of
construction of Tenant's improvements in the Premises;
4. An additional Two Hundred Thousand and no/100 Dollars
($200,000.00) on the Commencement Date with respect to the Initial
Premises other than the Additional Premises.
5. An additional Sixty Six Thousand Six Hundred Sixty Six
and 67/100 ($66,666.67) on the Commencement Date with respect to the
Additional Premises.
2
<PAGE> 3
6. An additional Three Hundred Thirty Three Thousand Three
Hundred Thirty Three and 33/100 Dollars ($333,333.33) shall be required
if Tenant's Working Capital (as defined below) is less than Two Million
Five Hundred Thousand and no/100 Dollars ($2,500,000.00) as of the
Commencement Date.
5. CONSTRUCTION DATES. The terms of Exhibit D, the Work Letter
Agreement, shall apply to the Additional Premises, except that the Plan Delivery
Dates set forth in Section IV of Exhibit D shall be modified as follows:
A. Basic Plans Delivery Date: January 25, 1999. These
Plans are required to incorporate only Floors 3, 4 and 5 of the Premises. All
subsequent Plans are required to also include the Additional Premises.
B. Working Drawings Delivery Date: March 26, 1999.
C. Final Plans Review Date: March 26, 1999.
D. Final Plans Delivery Date: June 10, 1999.
6. COMMENCEMENT DATE. The commencement date with respect to the
Additional Premises shall occur on the earlier of Tenant's occupancy of any
portion of the Additional Premises for normal business purposes, or October 15,
1999, but shall in no event occur earlier than the Commencement Date for the
remainder of the Initial Premises.
7. FULL FORCE AND EFFECT. In the event of conflict between the
terms of this First Amendment and the Lease, the terms of this First Amendment
shall prevail. Except to the extent expressly modified herein, all of the terms
and conditions of the Lease shall remain unchanged and in full force and effect.
[Date and signatures on next page]
3
<PAGE> 4
DATED this __ day of __________, 1999.
LANDLORD: WRC SUNSET NORTH LLC, a Washington
limited liability company
By: EOP SUNSET NORTH, L.L.C., a Delaware limited
liability company, its manager
By: EOP OPERATING LIMITED PARTNERSHIP, a
Delaware limited partnership, its sole
member
By: EQUITY OFFICE PROPERTIES TRUST, a
Maryland real estate investment
trust, its managing general partner
By:
--------------------------------
Its:
-------------------------------
By: WRIGHT RUNSTAD ASSOCIATED LIMITED
PARTNERSHIP, a Washington limited
partnership its manager
By: WRIGHT RUNSTAD & COMPANY, a
Washington corporation, its sole
general partner
By:
--------------------------------
Its:
-------------------------------
TENANT: BSQUARE CORPORATION, a Washington
corporation
By:
--------------------------------
Its:
-------------------------------
4
<PAGE> 5
LANDLORD ACKNOWLEDGMENT
STATE OF WASHINGTON )
) ss.
COUNTY OF KING )
I, the undersigned, a Notary Public, in and for the County and State
aforesaid, do hereby certify that _________________________, personally known to
me to be the ______________ of Wright Runstad & Company, the general partner of
Wright Runstad Associates Limited Partnership, a Member of WRC Sunset North LLC,
a Washington limited liability company, the Landlord in the foregoing
instrument, and personally known to me to be the same person whose name is
subscribed to the foregoing instrument, appeared before me this day in person
and acknowledged that as such officer of said entity being authorized so to do,
he executed the foregoing instrument on behalf of said entity, by subscribing
the name of such entity by himself as such officer, as a free and voluntary act,
and as the free and voluntary act and deed of said entity under the foregoing
instrument for the uses and purposes therein set forth.
GIVEN under my hand and official seal this ____ day of _____________,
1999.
Notary Public:
--------------------------
Printed Name:
--------------------------
Residing at:
---------------------------
My Commission expires:
-----------------
STATE OF COLORADO )
) ss.
COUNTY OF ARAPAHOE )
I, the undersigned, a Notary Public, in and for the County and State
aforesaid, do hereby certify that _________________________, personally known to
me to be the ______________ of Equity Office Properties Trust, the general
partner of EOP Operating Limited Partnership, the sole member of EOP Sunset
North, L.L.C., the manager of WRC Sunset North LLC, a Washington limited
liability company, the Landlord in the foregoing instrument, and personally
known to me to be the same person whose name is subscribed to the foregoing
instrument, appeared before me this day in person and acknowledged that as such
officer of said entity being authorized so to do, he executed the foregoing
instrument on behalf of said entity, by subscribing the name of such entity by
himself as such officer, as a free and voluntary act, and as the free and
voluntary act and deed of said entity under the foregoing instrument for the
uses and purposes therein set forth.
GIVEN under my hand and official seal this ____ day of ______________,
1999.
Notary Public:
--------------------------
Printed Name:
--------------------------
Residing at:
---------------------------
My Commission expires:
-----------------
5
<PAGE> 6
TENANT ACKNOWLEDGMENT
STATE OF WASHINGTON )
) ss.
COUNTY OF KING )
On this the ____ day of _______________, 1999, before me a Notary Public duly
authorized in and for the said County in the State aforesaid to take
acknowledgments personally appeared ________________ known to me to be
________________ of BSquare Corporation, a Washington corporation, the Tenant in
the foregoing instrument, and acknowledged that as such officer, being
authorized so to do, (s)he executed the foregoing instrument on behalf of said
corporation by subscribing the name of such corporation by himself/herself as
such officer and caused the corporate seal of said corporation to be affixed
thereto, as a free and voluntary act, and as the free and voluntary act of said
corporation, for the uses and purposes therein set forth.
IN WITNESS WHEREOF, I hereunto set my hand and official seal.
Notary Public:
--------------------------
Printed Name:
--------------------------
Residing at:
---------------------------
My Commission expires:
-----------------
6
<PAGE> 7
EXHIBIT A
PREMISES
This Exhibit is attached to and made a part of the Lease dated as of
January 15, 1999, by and between WRC SUNSET NORTH LLC, a Washington limited
liability company ("Landlord") and BSQUARE CORPORATION, a Washington corporation
("Tenant") for space on the second (2nd), third (3rd), fourth (4th) and fifth
(5th) floors in Building Four (4) located at the Northeast corner of 139th
Avenue Southeast and Southeast 32nd Street, Bellevue, King County, Washington.
The legal description for the property upon which the Premises is located is set
forth on Exhibit A-1, attached hereto and incorporated herein by this reference.
The Premises is outlined on Exhibit A-2 and A-3 attached hereto and incorporated
herein by this reference.
Exhibit A
<PAGE> 8
EXHIBIT A-1
LEGAL DESCRIPTION OF PROPERTY
This Exhibit is attached to and made a part of the Lease dated as of
January 15, 1999, by and between WRC SUNSET NORTH LLC, a Washington limited
liability company ("Landlord") and BSQUARE CORPORATION, a Washington corporation
("Tenant") for space on the second (2nd), third (3rd), fourth (4th) and fifth
(5th) floors in Building Four (4) located at the Northeast corner of 139th
Avenue Southeast and Southeast 32nd Street, Bellevue, King County, Washington.
LOTS 6 THROUGH 10 OF SUNSET RIDGE I-90 CORPORATE CAMPUS, A BINDING SITE
PLAN, AS PER PLAT RECORDED IN VOLUME 154 OF PLATS, PAGES 77 THROUGH 80,
RECORDS OF KING COUNTY;
EXCEPT ANY PORTION CONVEYED FOR 139TH AVE. S.E., BY DEED RECORDED UNDER
RECORDING NO. 9101280422;
TOGETHER WITH AN UNDIVIDED 60% INTEREST IN LOT 11 AND TRACT C OF SAID
PLAT;
AND TOGETHER WITH THOSE CERTAIN EASEMENT RIGHTS AS DELINEATED IN
INSTRUMENT RECORDED UNDER RECORDING NO. 9601091040;
AND TOGETHER WITH THOSE CERTAIN EASEMENT RIGHTS AS DELINEATED IN
INSTRUMENT RECORDED UNDER RECORDING NO. 9107260572;
AND TOGETHER WITH THOSE CERTAIN EASEMENT RIGHTS AS DELINEATED IN
INSTRUMENT RECORDED UNDER RECORDING NO. 9309292404;
SITUATE IN THE CITY OF BELLEVUE, COUNTY OF KING, STATE OF WASHINGTON.
Exhibit A-1
<PAGE> 1
Exhibit 21.1
Subsidiaries of the Registrant
BSQUARE GmbH, a German corporation
BSQUARE K.K., a Japanese corporation
BlueWater Systems, Inc., a Washington corporation
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of
our reports included in this Form 10-K, into the Company's previously filed
Registration Statement on Form S-8 (File No. 333-89333).
ARTHUR ANDERSEN
Seattle, Washington
February 29, 2000
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 55,029
<SECURITIES> 27,368
<RECEIVABLES> 4,345
<ALLOWANCES> (142)
<INVENTORY> 0
<CURRENT-ASSETS> 88,264
<PP&E> 9,201
<DEPRECIATION> (2,051)
<TOTAL-ASSETS> 95,624
<CURRENT-LIABILITIES> 7,086
<BONDS> 0
0
0
<COMMON> 90,842
<OTHER-SE> (2,304)
<TOTAL-LIABILITY-AND-EQUITY> 88,538
<SALES> 0
<TOTAL-REVENUES> 39,938
<CGS> 0
<TOTAL-COSTS> 19,294
<OTHER-EXPENSES> 18,763
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 2,792
<INCOME-TAX> 1,101
<INCOME-CONTINUING> 1,691
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,691
<EPS-BASIC> 0.06
<EPS-DILUTED> 0.06
</TABLE>
