BSQUARE CORP /WA - Annual Report: 2021 (Form 10-K)

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

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

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

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

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

PART I

Overview

Bsquare develops and deploys technologies for the makers and operators of connected devices. These fleets of business-oriented devices, often called the Internet of Things (IoT), offer a powerful means to connect organizations, people, information, and ideas. Hundreds of millions of connected devices have already been deployed and it is estimated that billions more will be. Despite their growing prevalence, these devices and the systems in which they operate remain a significant source of complexity, unplanned and often uncontrolled expense, and operational risk. Our customers are undergoing a massive change in their business practices and Bsquare provides technology that helps them capture the value of connected devices and reduces the cost and risk of doing so.

Since our founding in 1994, Bsquare has helped embedded device manufacturers (“Original Equipment Manufacturers” or “OEMs”) design and build cost-effective products. For most of our history, we operated at the intersection of hardware and software, helping our customers select, develop, and configure system software for a variety of purpose-built devices, from mobile computing to point-of-sale systems to healthcare equipment to hospitality, gaming, and more. Our expertise in hardware, device configuration, and operating systems became essential to our customers’ design cycles and purchasing decisions. As our customers deployed ever-larger fleets of devices, our understanding of the requirements for large-scale device operations increased.

More recently, our expertise and business prospects have shifted to cloud-connected devices that have been connected to create intelligent systems. This shift coincides with the overall growth of IoT technologies and with our customers’ recognition that connected intelligent devices create significant business opportunities. Device makers have increasingly specified their products not only to be connection-ready, but also to be enhanced by the breadth and depth of functionality that connection creates. We have taken to market a valuable and expanding portfolio of products and services that meet the needs of connected device makers. This portfolio captures our experience and our expertise can enable our customers to be more productive, flexible, and financially successful. And, in turn, our customers can then help make people and organizations more productive, improve quality of life, and reduce demands on the limited resources of our planet.

Embedded Operating System Software and Services

Customers frequently engage us because of our technical expertise in device operating system (“OS”) image development and configuration, device software development and testing, and our experience in embedded and mobile systems design. Our long and successful history as a Microsoft Corporation (“Microsoft”) embedded OS distribution and technology partner is a source of many customer opportunities and a pillar of our reputation in the IoT ecosystem. We believe working with Bsquare engineers can result in shorter development cycles, faster time-to-market, lower overall development costs, and a more robust product. Our software and configuration services are designed to help ensure that our customers’ devices are secure, updateable, and operable as part of a connected IoT system. A decade ago, our customers typically built devices on a single OS. Today, they increasingly have a multi-OS product strategy. Accordingly, we believe that the need for our embedded OS expertise and services is expanding and accelerating. We recognize revenue and cost of sales for this segment of our business under the name “Partner Solutions”.

Our target market for OS software and services includes makers of connected, intelligent devices such as point-of-sale terminals, kiosks, tablets and handheld data collection devices, smart vending machines, ATMs, essential equipment in buildings and facilities environments, digital signs, and in-vehicle telematics and entertainment devices. These devices work on a variety of operating systems, including the most common: Windows IoT, Android, and Linux. They are deployed in various cloud environments, such as Microsoft Azure, Amazon Web Services (“AWS”), or Google Cloud, and are typically connected to a network via a wired or wireless connection. Our customers for these smart devices include world-class OEMs, original design manufacturers (“ODMs”), silicon vendors, and peripheral vendors.

IoT Operations Services and Software

Our customers’ devices are frequently components of complicated operating networks, creating new requirements for updating, maintaining, and evolving the capabilities of devices in the fleet. Once configured and deployed, this device fleet then becomes part of an operational environment that requires long-term attention to the challenges of IoT operations. These demands have created operational burdens that are difficult to meet through traditional technologies and support models. For that reason, our customers are increasingly relying on Bsquare’s extensive experience developing, deploying, and operating large IoT systems at scale. Our experience using Microsoft Azure and AWS cloud services is an asset we believe to be seldom found inside a customer’s technology team. Outsourcing fleet management and 24/7 operations services to Bsquare can result in lower system development costs, greater security, better maintainability, lower operating costs, and improved return on investment (“ROI”) for a customer’s IoT system. We have built and now operate 24/7 mission critical IoT systems for customers of varying size and complexity, and we believe the software and processes we have used to do so may be a sustainable competitive advantage and a potential opportunity for new revenue. We recognize revenue and cost of sales for this segment of our business under the name “Edge to Cloud”.

Our target market for our IoT operations service and software includes our OS and software OEM customers as well as companies that purchase from those OEMs and operate their devices as a fleet. This market represents business and industrial segments in a wide range of vertical markets such as retail, point of sale, medical equipment, gaming, buildings and facilities management, manufacturing, robotics, autonomous vehicles, utility management, and transportation. The IoT market continues to evolve as companies understand the possibilities and economics of IoT technology and operations. Increasingly, customers are realizing that IoT operations are not core competencies of their business and that outsourcing operations can lower costs, reduce downtime, and mitigate the reputational risk of security and operational failures.

Bsquare Solutions Portfolio

We provide a suite of software, tools, and services to our customers that are packaged based on technical and business requirements that includes:

Embedded OS and System Software Sales and Support

We resell Windows IoT, Windows Embedded, and Windows Server IoT software as well as system utility software for Adobe and McAfee. We provide license compliance services, technical support, and manufacturing support. See Software Distribution and Relationship with Microsoft, below, for additional details about our Embedded OS and System Software products.

OS Configuration and Device Hardening Services

We create for customers a manufacturable image for a specific version of OS software (Windows IoT, Linux, and Android) based on the unique requirements of the hardware and the intended operating environment. In the fourth quarter of 2021, we announced a suite of services for making connected devices, secure, recoverable, upgradable, and updatable. This packaged offering analyzes and addresses the differences in security architectures across Windows, Linux, and Android operating systems, and implements our recommended practices for device hardening. We also tailor Device Hardening specifications based on a customer's operating system, hardware configuration, application software, security policies, and operating environment.

Device Management Solutions

In the fourth quarter of 2021, we announced early availability of SquareOne, a software as a service (“SaaS”) product. SquareOne captures workflows to be stored and managed centrally and deployed as needed for the purposes of secure remote device management. The product supports devices running Windows, Linux, and Android operating systems. The technology is a step-change in the way devices are connected and managed. The solution unlocks the data and telemetry on devices to provide secure, accurate, and reliable intelligence. SquareOne registers and maps embedded devices to provide heartbeat monitoring, telemetry analysis, content updates, and preventative maintenance routines, which helps connected device fleets to become simultaneously secure, intelligent, and efficiently managed.

IoT and Fleet Transition Services

Our professional services help transition a collection of devices to a specific OS and software configuration in preparation for management and operations as part of an intelligent system. We work with customers to understand and bring together multiple versions of OS software and hardware, connectivity, security, personnel, operating hours, and other factors that could affect previously deployed equipment. Bsquare also offers software utilities and professional services to migrate a fleet of devices to 24/7 IoT operations, allowing individual device and system performance to be managed centrally and integrated into existing business systems.

24/7 IoT Operations

Our outsourced IoT operations services include 24/7 infrastructure monitoring, automated issue escalation, incident response and troubleshooting, management protocols, uptime and service level reporting, and cloud instance management. We also offer related data engineering services to assist customers with the development and implementation of IoT systems and data-driven operations, including machine learning and predictive analytics that allow IoT systems to operate as an intelligent system.

Software Distribution

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

The majority of our revenue continues to be derived from reselling Microsoft Windows Embedded and IoT operating system software to device makers. The sale of Microsoft operating systems has historically accounted for substantially all of our Partner Solutions revenue.

Relationship with Microsoft

We have a long-standing relationship with Microsoft, which is important to the continuing success of our business:

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

Competition

Microsoft controls who can distribute its OS software. Microsoft Authorized Distributors that we compete with include Advantech, Inc., Arrow Electronics, Inc., Avnet, Inc., and Dell Computer, Inc. Our competition is not limited to these Microsoft Authorized Distributors. We compete with other consulting firms for services related to device design and development, system software development, and engineering firms that offer similar services.

Despite competition from these larger organizations, we have retained a loyal customer base, largely due to our technical support and business services. We are known as the company that can manage difficult problems at the intersection of hardware and software.  Our competitors have directed customers to us to resolve issues and Microsoft’s OS team regularly seeks our guidance on customer technical challenges. Further, as a software-only company with multi-OS experience, we have always offered customers independence from OS or hardware biases.

Our history provides us with a unique position in the market. Our legacy OS distribution, our reputation as a technology provider, and our recent experience building and operating significant IoT systems sets us apart. These factors enable and enhance the market credibility of our claims of expertise, experience, and insight. As our customers evaluate products and services for purchasing decisions, we believe that they are and will remain more likely to buy from a company that has the history and experience to meet their requirements and provide a long-term operational perspective.

Our product portfolio is composed of solutions that are highly complementary across our customers’ product lifecycles. Supplying a customer with Device Hardening and OS licensing put us in a unique position to sell SquareOne. Similarly, if a customer selects our SquareOne product, the first implementation consideration is the configuration of the software on the devices, creating an opportunity for our Device Hardening solution and operating system license sales.

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

Competition for our IoT software and operating services include:

Sales and Marketing

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

Our sales and marketing efforts with embedded OS customers will also be beneficial in our efforts to attract customers for our IoT software and services, and vice versa. The two markets we have traditionally served are converging, and our sales and marketing will increasingly reflect that convergence. The cross-selling opportunities between our two primarily markets could be a source of strength as we continue to expand our presence and reputation among the makers of IoT devices and those responsible for IoT device operations.

International Operations

Our international operations outside of North America are conducted through our offices in Trowbridge, UK. We maintain a European sales and marketing presence through the UK office exclusively in support of our IoT software and services, reported in our Edge to Cloud business segment. The majority of our global technical personnel also work from the UK office. 

Our OEM Distribution Agreement with Microsoft for the sale of Microsoft Windows IoT operating systems is currently restricted to North America. As a result, the majority of our revenue continues to be generated from North America. Revenue generated from customers located outside of North America was approximately 14% of total revenue in both 2021 and 2020.

Human Capital

We had a total employee headcount of 53 on December 31, 2021, with 33 people located in North America and 20 in the United Kingdom. As compared to December 31, 2020, our total employee headcount was smaller by seven.

In response to ongoing orders by local governments to “stay at home,” “shelter-in-place” and similar actions intended to reduce the spread of COVID-19, we closed our offices in Trowbridge in the United Kingdom and stopped all non-essential activities in our Seattle, Washington office. Bsquare’s operations are, at the time of this filing, largely virtual. We will continue to monitor local regulations and may adjust our policies and work-from-home mandates and conditions as requirements change.

In the second quarter of 2020, we moved our corporate headquarters from Bellevue, Washington, to Seattle, Washington. From the outset, we conceived of our new location as a collaboration space and its design was based on a review of how and where we collaborate, our teams’ commuting patterns, facilities costs, and our long-term space requirements. With our engineering team in the UK and customers all over the globe, collaborating over long distances and time zones was an operating imperative. We purchased and deployed technologies that enabled and enhanced remote work and as early as the fourth quarter of 2019 asked our team members to begin to consider how they could begin to work more often from remote locations. This planning work allowed us to move seamlessly to virtual operations when the COVID-19 pandemic arrived. While the new Seattle facility remained largely unoccupied throughout 2021, we believe it will serve us well and we look forward to hosting visitors when it is safe again.

Diversity and Inclusion

We operate a standing Anti-racism and Inclusion Task Force to help us reckon with the ways in which our company and the technology industry at large have contributed to systemic racism and the marginalization of underrepresented and underserved groups in both the US and the UK. In this area, we favor action over performative speech. We are expanding our recruiting outreach to find candidates from communities currently underrepresented in technology companies and are renewing our commitment to inclusive hiring practices. We are particularly interested in building a team composed of people who have made diversity, equity, and inclusion in the workplace a central part of their professional journey. We are also holding our partners accountable to their own actions in pursuit of racial equity, and we are offering every employee a day of Community Engagement Leave to vote, volunteer in their community, or participate in other civic activities.

Compensation and Benefits

We strive to provide market-competitive compensation and benefits that attract and retain employees whose values align with our mission and goals. Our compensation packages include combinations of competitive base pay, sales commissions, performance based short-term incentives, health care, retirement benefits, paid time off and family leave. In addition, we offer employees the benefit of equity ownership in the Company through stock option grants. We also provide access to a variety of health and wellness resources.

Intellectual Property and Other Proprietary Rights

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

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

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

Available Information

We were incorporated in the State of Washington in July 1994. Our principal office is located at 1415 Western Ave, Suite 700, Seattle, Washington 98101, and our telephone number is (425) 519-5900. Our website address is www.bsquare.com. Information contained on or that can be accessed through our website is not a part of this Form 10-K.

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

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

Risks Related to General Business Conditions

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

Throughout 2021, we continued to update our product strategy to bring to market technologies and related services that build on our history of helping our customers deploy and operate intelligent devices. While we will continue to meet customer commitments previously made, we are developing new products and services that may expand our opportunities in the IoT market. The attractiveness of these new offerings remains uncertain, as does the size of the investment required to bring them to fruition. Our strategy to focus on the IoT market is subject to a number of additional risks and the occurrence of any of them could harm our business:

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

The competition in the growing market for IoT-related software and engineering services is significant. Further, we anticipate that we will encounter and attract competitive attention from a number of new software and service providers as we continue to focus on this market in 2021 and beyond, and as we expand our IoT-related service offerings. We currently face, or expect to face, competition from the following:

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

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

The unprecedented nature of the COVID-19 pandemic creates ongoing uncertainty for Bsquare and our customers, and for the overall global business environment.

As the scope and impact of the COVID-19 pandemic continue to evolve, a number of potential risks to our business may emerge and many affected our business and our financial results in 2021. We may face ongoing challenges selling or delivering our software and services, as our employees and many of those of our customers are still working from home, may be unable to attend company and industry events, and often face restrictions on travel and in-person meetings. Closures of manufacturing facilities and warehouses, or staffing shortages, continue to disrupt supply and distribution chains. Our customers could continue to experience a slow-down in demand for their products, decreased budgets, or delayed business initiatives, further reducing the need for our software and services. If our customers’ global supply chains are disrupted because of COVID-19, they may not be able to meet demands for their end-product and they may reduce or eliminate their purchases from us for an uncertain period of time, if not permanently. Our customers may be slow to collect from their customers or otherwise face liquidity problems, which may cause delays in satisfaction of their financial obligations to us. Some of our customers may be forced to reduce their workforce through layoffs or furloughs, to cease operations temporarily, or, in extreme cases, declare bankruptcy. In those situations, disruptions to our business could range from a loss of key customer relationships to an inability to timely collect potentially significant receivables.

We have experienced a reduction in sales in our Partner Solutions segment since the second quarter of 2020, which we believe is primarily the result of the pandemic. The adverse effects of the COVID-19 pandemic on our financial results may continue for an unknown time. The extent, depth, and duration of the impact of the COVID-19 pandemic on our operational and financial performance will depend on many factors, including new variants of the coronavirus that causes COVID-19 and the speed with which vaccines are manufactured, distributed, delivered, and accepted by the populace. Specifically, our customers’ demand for our products is uncertain and is likely affected by disruptions in their component supply chains, their own sales cycles, their industry verticals, their ability to sell through traditional distribution channels, their ability to convene or attend employee or industry events, or other factors created and made persistent by the uncertain COVID-19 environment. The decline in Partner Solutions revenue experienced in 2021 suggests the effect of these disruptions can be significant. The lingering economic effects of COVID-19, even after resolution of the immediate public health crisis, may result in adverse conditions for our business that may impact our financial condition or results.

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

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

Large customers with significant resources may resort to litigation to recoup economic loss and other damages caused by what those customers perceive to be a deficiency in our products or a breach in our contractual arrangements.

We have a number of larger customers that have entered into longer-term contracts for our products and services. Further, we have actively engaged with those customers in recent months to retool our previously delivered products and to improve our previous agreements. Despite these efforts and investments, new issues may arise, or previous problems may re-occur, causing these customers to choose to initiate litigation against us. While we have no indication that these customers intend to pursue litigation, a decision to do so could cause us to incur significant defense costs, which would be significantly distracting, and may damage our reputation in our markets.

We may be subject to product liability, infringement or other legal claims that could result in significant cost and ongoing liabilities.

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

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

Stock markets are subject to significant price and volume fluctuations that may be unrelated to the operating performance of particular companies and the market price of our common stock may therefore frequently change as a result. For example, during the year ended December 31, 2020, the high and low closing prices of our common stock were $1.83 and $0.93 per share, respectively, but in February 2021 our stock price reached an intraday high of $11.83 per share. Our stock price has at times appeared to be disassociated with our financial condition or results of operations. In addition, the market price of our common stock has fluctuated and may continue to fluctuate substantially due to a variety of other factors, including quarterly fluctuations in our results of operations (including as a result of fluctuations in our revenue recognition), our ability to execute on our current growth strategy in a timely fashion, announcements about technological innovations or new products or services by us or our competitors, market acceptance of new products and services offered by us, developments in the IoT market, changes in our relationships with our suppliers or customers, our ability to meet analysts’ expectations, changes in the information technology environment, changes in earnings estimates by analysts, sales of our common stock by existing holders and the loss of key personnel. Possible exogenous incidents and trends may also impact capital markets and our own common stock prices, including but not limited to foreign and cross border altercations, political unrest, cyberterrorism on a global scale, and increasingly disruptive weather systems.

In the past, following periods of volatility in the market price of a company’s stock, class action securities litigation has often been instituted against such companies. Such litigation, if instituted against us, could result in substantial costs and diversion of management’s attention and resources, which would materially adversely affect our business, financial condition and operating results.

Our common stock may become the target of a “short squeeze.”

In 2021, the securities of several companies experienced significant and extreme volatility in stock price due to short sellers of shares of common stock and buy-and-hold decisions of longer investors, resulting in what is sometimes described as a “short squeeze.” Short squeezes have caused extreme volatility in those companies and in the market and have led to the price per share of those companies to trade at a significantly inflated rate that is disconnected from the underlying value of the company. Sharp rises in a company’s stock price may force traders in a short position to buy the stock to avoid even greater losses. Many investors who have purchased shares in those companies at an inflated rate face the risk of losing a significant portion of their original investment as the price per share has declined steadily as interest in those stocks have abated. We may be a target of a short squeeze, and investors may lose a significant portion or all of their investment if they purchase our shares at a rate that is significantly disconnected from our underlying value.

Future sales of substantial amounts of our common stock, or the possibility that such sales could occur, could adversely affect the market price of our common stock.

We may issue up to $25.0 million of common stock from time to time pursuant to a prospectus supplement dated July 2, 2021 relating to the offering of up to $25.0 million in shares under the At-Market Issuance Sales Agreement between us and B. Riley Securities, Inc. (the “Sales Agent”) (the “Current Offering”). The issuance from time to time of shares in the Current Offering, as well as the possibility that we may issue shares in future offerings, could have the effect of depressing the market price, or increasing the market price volatility, of our common stock. The number of shares we may sell, and any resulting impact on market price or volatility, is highly uncertain because we have the broad discretion regarding the number of shares we instruct the Sales Agent to sell, the market price of the common stock during the sales period, the limits we set with the Sales Agent in any applicable placement notice, and the demand for our common stock during the sales period. It is not currently possible to predict the number of shares that will be sold or the gross proceeds to be raised in connection with those sales.

You may experience future dilution as a result of future equity offerings.

In order to raise additional capital, we may in the future offer additional shares of our common stock or other securities convertible into or exchangeable for our common stock. We may not be able to sell shares or other securities in any offering at a price per share that is equal to or greater than prevailing market prices, and investors purchasing shares or other securities in the future could have rights superior to existing shareholders. The price per share at which we sell additional shares of our common stock or other securities convertible into or exchangeable for our common stock in future transactions may be higher or lower than currently prevailing prices per share.

Our common stock has experienced and may continue to experience price and volume fluctuations, which could cause you to lose a significant portion of your investment, lead to costly litigation for us and interfere with our efforts to grow our business.

Stock markets are subject to significant price and volume fluctuations that may be unrelated to the operating performance of particular companies, and accordingly the market price of our common stock may frequently and meaningfully change. For example, during the year ended December 31, 2020, the high and low closing prices per share of our common stock were $1.83 and $0.93, respectively, with an intraday high of $2.00 and an intraday low $0.83 per share, and with daily trading volume at a low of 500 shares and a high of 837,100 shares. In 2021, through June 30, 2021, the high and low closing prices per share of our common stock were $8.40 and $1.44, respectively, with an intraday high of $11.83 and an intraday low of $1.40 per share, and with a daily trading volume at a low of 32,100 shares and a high of 240,691,000 shares. We have not had any recent change in our financial condition or results of operations that is consistent with the recent change in our stock price. In addition, the market price of our common stock has fluctuated and may continue to fluctuate substantially due to a variety of other factors, including quarterly fluctuations in our results of operations (including as a result of fluctuations in our revenue), our ability to execute on our current growth strategy in a timely fashion, announcements about technological innovations or new products or services by us or our competitors, market acceptance of new products and services offered by us, developments in the IoT market, changes in our relationships with our suppliers or customers, our ability to meet analysts’ expectations, changes in the information technology environment, changes in earnings estimates by analysts, sales of our common stock by existing holders and the loss of key personnel. Possible exogenous incidents and trends may also impact the capital markets generally and our common stock prices specifically, such as foreign and cross border altercations, political unrest, cyberterrorism on a global scale, and disruptive weather systems. The timing of your purchase of our common stock relative to fluctuations in its trading price may result in you losing all or a significant portion of your investment.

In the past, following periods of volatility in the market price of a company’s stock, class action securities litigation has often been instituted against such companies. Litigation may arise out of facts and circumstances, or disclosure relating thereto, that we do not currently regard as material. For example, in 2021, we pre-released our expected financial results for the first quarter of 2021, we announced that our shareholders approved amended and restated articles of incorporation then retracted the filing, we pre-released our expected financial results for the second quarter of 2021, and we revised certain prior period financial statements due to a $77,000 error related to the recognition of certain revenues in our Edge to Cloud segment. We have also recently sold shares in the public markets during periods of volatile market activity. Such volatility may entice shareholders to challenge our disclosure, whether or not they are correct. Any litigation, if instituted against us, could result in substantial costs and diversion of management’s attention and resources, which would interfere with our ability to execute our business plan, sell our software and services, and otherwise materially adversely affect our business, financial condition and operating results.

If securities or industry analysts fail to continue publishing research about our business, if they change their recommendations adversely or if our results of operations do not meet their expectations, our stock price and trading volume could decline. 

The trading market for our common stock will be influenced by the research and reports that industry or securities analysts publish about us or our business. If one or more of these analysts cease coverage of our company or fail to publish reports on us regularly, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline. In addition, it is likely that in some future period our operating results will be below the expectations of securities analysts or investors. If one or more of the analysts who cover us downgrade our stock, or if our results of operations do not meet their expectations, our stock price could decline.

Because we do not intend to declare cash dividends on our shares of common stock in the foreseeable future, shareholders must rely on appreciation of the value of our common stock for any return on their investment.

We currently anticipate that we will retain future earnings for the development, operation and expansion of our business and do not anticipate declaring or paying any cash dividends in the foreseeable future. In addition, the terms of any existing or future debt agreements may preclude us from paying dividends. As a result, we expect that only appreciation of the price of our common stock, if any, will provide a return to investors in this offering for the foreseeable future.

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

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

It might be difficult for a third party to acquire us even if doing so would be beneficial to our shareholders.

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

Risks Related to Our Business Operations

Investments in new products and services may not deliver the returns that were anticipated when the development process was initiated, which will have a detrimental effect on our financial results.

As we bring new products and services to market, the acquisition rate, amount, and profitability of the revenue produced by these new offerings will be highly uncertain. Customers may not choose to adopt our technologies or may choose to adopt them more slowly than expected. The investment models that caused us to initiate product development efforts may have contained faulty assumptions about customer adoption rates and/or pricing. As a result, we may be required to sustain losses from product development for a longer period than expected, which could harm our financial results and diminish our ability to make additional investments in new products or in improving our existing set of products and services. 

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

Throughout 2021, we continued our efforts to reduce unnecessary or excessive costs, with particular emphasis on personnel costs, in order to better align our organizational structure with our strategic focus. Factors which may affect the potential operating efficiencies we realize from our restructuring plans include the adverse impact of job eliminations, uncertainties associated with loss of customer and vendor confidence, potential negative impact on sales and customer service as well as factors outside of our control such as changes in the economic environment. We may not realize the anticipated benefits under our restructuring plans, which could result in additional restructuring efforts. If our restructuring plans are not successful, our business and results of operations may be negatively impacted. 

The efforts to improve our cost structure and business outlook could result in the departure of key personnel or in costly employment-related litigation. Such outcomes would adversely affect our business and financial results. 

In many areas, we now operate with single and primary points of function and expertise for some positions.  Ongoing organizational adjustments, combined with the tight labor market, could cause the sudden departure of key individuals, which could in turn have a detrimental effect on our ability to innovate rapidly and serve our customers. Further, because the market for technology employment remains highly competitive, filling key vacancies may extend these negative effects. Further, employees who have had or who may have in the future their employment relationship terminated, or who are simply disgruntled with the direction of the company’s strategy may decide to pursue litigation against us or may choose to disparage us in social media. These activities could damage our reputation, divert our attention from operating our business, and otherwise cause our business to suffer.

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

Customers outside of North America generated approximately 14% of our total revenue in both 2021 and 2020. We currently have operations outside of North America and in the United Kingdom (“U.K.”). Our international activities and operations expose us to a number of risks, including the following:

These risks could have a material adverse effect on the financial and managerial resources required to operate our foreign offices, as well as on our future international revenue, which could negatively impact our business and operating results.

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

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

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

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

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

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

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

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

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

We did not generate taxable income in 2021 or 2020 and, as a result, we were unable to use our net operating loss and tax credit carryforwards with respect to such tax years. In addition, Sections 382 and 383 of the Internal Revenue Code restrict the ability of a corporation that undergoes an ownership change to use net operating loss and tax credit carryforwards. We have performed analyses of possible ownership changes which included consideration of a third-party study, and do not believe that an ownership change, as defined by Section 382, has occurred. However, if a tax law ownership change has occurred of which we are not aware, or if a tax law ownership change occurs in the future, we may have to adjust the valuation of our deferred tax assets and could be at risk of having to pay income taxes notwithstanding the existence of our sizable carryforwards. Further, to the extent that we have utilized our carryforwards from prior years, the existence of a previous tax law ownership change that we did not account for could result in liability for back taxes, interest, and penalties. If we are unable to utilize our carryforwards and/or if we previously utilized carryforwards to which we were not entitled, it would negatively impact our business, financial condition and operating results.

If we are unable to attract, hire, and retain employees with the skills and experience required by our business, our ability to compete may be harmed.

Competition for qualified personnel in the technology industry has historically been intense, particularly for software engineers and other technical staff. Recently, that competition has surpassed even historical norms and the fight for talent has expanded beyond technical roles and into virtually all areas of our company. The loss to competitors of any of our key employees, or the inability to hire, train, retain, motivate, and manage qualified personnel, could harm our business. Recruiting efforts, particularly for senior employees or employees with specialized skills, may be time-consuming, which may delay the execution of our plans. Failure to ensure effective transfer of knowledge and smooth transitions involving key employees who do depart could hinder our strategic planning and execution. If we are not successful in managing these risks, our business, financial condition, and operating results may be harmed. 

Our customers face manufacturing and supply chain risks that could reduce demand for our products, harming our financial condition, operating results, and prospects.

Our customers purchase software products from us that are incorporated with other components into finished goods for sale into their own markets. They rely on a variety of third-party suppliers, contract manufacturers and service providers to provide raw materials, parts and sub-systems. Recent global shortages in energy, raw materials, and labor have harmed our customers' ability to acquire the necessary components for their products, which have in turn caused them to delay or cancel some of their orders with us. If our customers experience ongoing supply shortages and price increases driven by raw material shortages, part availability, manufacturing capacity, labor shortages, industry allocations, tariffs, trade barriers, natural disasters, and/or pandemics (including COVID-19), their buying patterns and volumes may continue to be volatile. As a result, our revenue, overall financial condition, and operating results could be harmed.

Risks Related to Technology and Intellectual Property

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

Software and hardware components as complex as those needed for dedicated purpose intelligent systems frequently contain errors or defects, especially when first introduced or when new versions are released. We have had to delay commercial release of certain versions of our products until problems were corrected and, in some cases, have provided product enhancements to correct errors in released products. Some of our contracts require us to repair or replace products that fail to work. To the extent that we repair or replace products, our expenses may increase. In addition, it is possible that by the time defects are repaired, the market opportunity may decline which may result in lost revenue.

Moreover, to the extent that we provide increasingly complex and comprehensive products and services, particularly those focused on IoT hardware, and rely on third-party manufacturers and suppliers to manufacture these products, we will be dependent on the ability of such third-party manufacturers and suppliers to correct, identify and prevent manufacturing errors or defects. Errors or defects that are discovered after commercial release could result in loss of revenue or delay in market acceptance, diversion of development resources, damage to our reputation and increased service and warranty costs, all of which could negatively impact our business and operating results.

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

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

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

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

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

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

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

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

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

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

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

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

If we fail to adequately protect our intellectual property rights, competitors may be able to use our technology which could weaken our competitive position, reduce our revenue and increase our costs.

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

We license our computer source code to customers. Customers with access to our source code may not comply with the license terms. We may not discover any violations of the license terms and, in the event of discovery of violations, we may not be able to successfully enforce the license terms or recover the economic value lost from such violations. To license some of our software products, we rely in part on “shrink-wrap” and “click wrap” licenses that are not signed by the end user and, therefore, may be unenforceable under the laws of certain jurisdictions. As with other software, our software products are susceptible to unauthorized copying and uses that may go undetected, and policing such unauthorized use is difficult.

A significant portion of our marks include the word “BSQUARE.” Other companies use forms of “BSQUARE” in their marks alone, or in combination with other words, and we cannot prevent all such third-party uses. We license certain trademark rights to third parties. Such licensees may not abide by our compliance and quality control guidelines with respect to such trademark rights. Any of these outcomes could negatively impact our brand, dilute its recognition in the marketplace, or confuse potential customers, all of which could harm our business.

The computer software market is characterized by frequent and substantial intellectual property litigation, which is often complex and expensive, and involves a significant diversion of resources and uncertainty of outcome. Litigation may be necessary in the future to enforce our intellectual property or to defend against a claim of infringement or invalidity. Litigation could result in substantial costs and the diversion of resources and could negatively impact our business and operating results.

Risks Related to Our Partnership with Microsoft

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

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

We have entered into ODAs with Microsoft pursuant to which we are licensed to sell Microsoft Windows Mobile operating systems to customers in North America, South America, Central America (excluding Cuba), Japan, Taiwan, Europe, the Middle East, and Africa. The ODAs to sell Windows Mobile operating systems are effective through April 30, 2022. If any of our other ODAs are terminated by Microsoft (which Microsoft can do unilaterally) or not renewed, Partner Solutions revenue and resulting gross profit could decrease significantly and our operating results would be negatively impacted. Future renewals by Microsoft, if any, could be on less favorable terms, which could also negatively impact our business and operating results.

We currently recognize revenue from the sale of Microsoft software generally upon shipment of physical software licenses. If Microsoft were to change the method of providing software licenses to a digital rather than physical medium, our revenue recognition policies may need to change, and that change in policy could result in a significant decrease in revenue. While such a change is not expected, and would not immediately impact our cash flows, the full financial scope of the impact is uncertain and potentially significantly negative.

Microsoft can change its product pricing at any time, and unless we are able to pass through price increases to our customers, our revenue, gross profit and operating results would be negatively impacted.

Further, Microsoft currently offers a rebate program in conjunction with our resale activities in which we earn money for achieving certain predefined objectives. If Microsoft changes the way that rebates are earned by eliminating or negatively modifying the rebate program, our gross profit and operating results would be adversely impacted. If we are unable to meet rebate criteria, or if the rebate criteria is modified, we may not be able to sustain the financial benefits of the rebate program and our operating results could be harmed.

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

Microsoft has historically implemented significant pricing changes for its operating systems products and Microsoft could make further pricing changes in the future. These changes have altered the competitive dynamics because the same pricing discounts are available to all distributors of these Microsoft products. As a distributor of Microsoft products, this may impact both the sales prices we charge our customers and the cost of goods sold that we incur for many of the Microsoft products we sell. Microsoft has indicated that a new version of an operating system product we frequently sell to customers will be released in the near future. While Microsoft has not indicated the pricing of this new product version, any significant declines in the market price for the product will reduce our revenue and may reduce our gross profits. The amount and impact of the change, and other pricing changes, on our revenue and gross profit are currently not determinable; however, they may negatively impact our operating results in future reporting periods.

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

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

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

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

There are provisions in the ODAs that require us to maintain certain internal records and processes for auditing purposes. Non-compliance with these or other contractual requirements could result in the termination of our distributor relationship with Microsoft. Microsoft conducted previous audits of our records pertaining to the ODAs, none of which had material findings. It is possible that future audits could result in charges due to any material findings that are found. We may also be contractually liable for payment of royalties to Microsoft in the event that certificates of authenticity are lost, damaged or stolen.

None.

During the second quarter of 2020, we completed a move of our corporate headquarters from the prior location in Bellevue, Washington to a 6,780 square-foot facility in downtown Seattle, Washington. As of December 31, 2021, we have consolidated almost all our operations into that single location. The lease term on the Seattle facility ends in July 2027.

We also lease 8,217 square feet of office space in Trowbridge, England, U.K. for use by the team of engineers and sales and marketing personnel operating from that location. In the fourth quarter of 2020, we renewed the lease for that facility for a 10-year term with substantially the same terms as the now-terminated lease. We have an option to cancel the second half of the lease term (5 years).

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

None.

Not applicable.

PART II

Market Information

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

Holders

As of February 28, 2022, there were 108 holders of record of our common stock. Because many shares of our common stock are held by brokers and other institutions on behalf of shareholders, we are unable to determine the total number of shareholders represented by these holders of record.

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

Overview

Bsquare develops and deploys technologies for the makers and operators of connected devices. These fleets of business-oriented devices, often called the Internet of Things (IoT), offer a powerful means to connect organizations, people, information, and ideas. Hundreds of millions of connected devices have already been deployed and it is estimated that billions more will be. Despite their growing prevalence, these devices and the systems in which they operate remain a significant source of complexity, unplanned and often uncontrolled expense, and operational risk. Our customers are undergoing a massive change in their business practices and Bsquare provides technology that helps them capture the value of connected devices and reduces the cost and risk of doing so.

Since our founding in 1994, Bsquare has helped embedded device manufacturers (“Original Equipment Manufacturers” or “OEMs”) design and build cost-effective products. For most of our history, we operated at the intersection of hardware and software, helping our customers select, develop, and configure system software for a variety of purpose-built devices, from mobile computing to point-of-sale systems to healthcare equipment to hospitality, gaming, and more. Our expertise in hardware, device configuration, and operating systems became essential to our customers’ design cycles and purchasing decisions. As our customers deployed ever-larger fleets of devices, our understanding of the requirements for large-scale device operations increased.

More recently, our expertise and business prospects have shifted to cloud-connected devices that have been connected to create intelligent systems. This shift coincides with the overall growth of IoT technologies and with our customers’ recognition that connected intelligent devices create significant business opportunities. Device makers have increasingly specified their products not only to be connection-ready, but also to be enhanced by the breadth and depth of functionality that connection creates. We have taken to market a valuable and expanding portfolio of products and services that meet the needs of connected device makers. This portfolio captures our experience and our expertise can enable our customers to be more productive, flexible, and financially successful. And, in turn, our customers can then help make people and organizations more productive, improve quality of life, and reduce demands on the limited resources of our planet.

2021 Key Highlights

The COVID-19 pandemic, including its impact on the microchip supply chain, continued to affect our customer ordering patterns and caused ongoing disruptions and revenue variability in 2021, particularly in the Partner Solutions segment. After experiencing year-over-year revenue increases in the second and third quarters of 2021, fourth quarter 2021 revenue decreased $1 million or 11% from the fourth quarter of 2020. Full year 2021 revenue reflected a $7 million or 14% decrease from 2020. We believe our Partner Solutions revenue was also affected by other Microsoft distributors offering deep discounts on Windows IoT OS software as part of hardware / software bundles. We expect this market trend may continue in future quarters. We are working to retain and attract customers with superior service and technical support, pricing that rewards loyalty, and a clear upgrade path for efficient, effective, and secure IoT operations.

In 2021, our Edge to Cloud segment revenue reflected a strategic and intentional shift away from many smaller customers to a few key customers, all operating in the IoT space. While this shift was the primary driver of the year-over-year decrease in revenue, we believe the experience we gained serving our large IoT customers has positioned us to improve our IoT software and services in 2022 and beyond. We plan to leverage this expertise both to expand existing customer relationships and to attract new customers to our offerings.

Our work in 2019 and 2020 to right-size our operating expense structure was evident in 2021 as our selling, general and administrative expenses were $1.3 million less than selling, general and administrative expenses in 2020. We anticipate increasing our marketing spend during 2022 as we support the launch of new products and build brand awareness.

Throughout 2021, we invested in the development of new product offerings for our customers, two of which we announced in the fourth quarter of 2021: SquareOne, a secure device management solution and Device Hardening, a solution ensuring appropriate OS configuration. In 2021, our product development investment totaled over $1.7 million, of which $0.4 million was capitalized as internally developed software and the remainder is captured on the income statement as research and development expense.

Our cash, cash equivalents, and restricted cash increased by $27.1 million during 2021. This increase in cash was driven by the receipt of net proceeds of $31.9 million from the sale of our common stock. This increase was partially offset by the use of cash for R&D investment, operational shortfalls (primarily soft Partner Solutions revenue) and variations in working capital items.

Cash will be invested strategically to grow our business and enhance our value proposition to customers.

Critical Accounting Estimates

Revenue recognition

Our revenue recognition accounting methodology contains uncertainties because it requires us to make significant estimates and assumptions, and to apply judgment. For example, for arrangements that have multiple performance obligations, we must exercise judgment and use estimates in order to (1) determine whether performance obligations are distinct and should be accounted for separately; (2) determine the standalone selling price of each performance obligation; (3) allocate the transaction price among the various performance obligations on a relative standalone selling price basis; and (4) determine whether revenue for each performance obligation should be recognized at a point in time or over time.

We have not made any changes to the significant estimates utilized to determine the total transaction price and stand-alone selling prices at contract inception. Our customer contracts that involve perpetual licenses are less sensitive to changes in estimates than contracts involving SaaS as those arrangements require us to estimate customer usage. Changes to our customer usage estimates could have a material impact on the total transaction price.      

In addition, we exercise judgment in certain transactions when determining whether we should recognize revenue based on the gross amount billed to a customer (as a principal) or the net amount retained (as an agent). These judgments are based on our determination of whether or not we control the service before it is transferred to the customer.

Taxes

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

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

Results of Operations

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

Revenue

We generate revenue from the sale of software, both embedded operating system software that we resell and our own proprietary software, and related professional services. Total revenue decreased in 2021 compared to 2020, due to decreased sales in our Partner Solutions segment, primarily in North America and Europe, as well as decreased revenue in our Edge to Cloud segment.

Additional revenue details are as follows:

Partner Solutions revenue

Partner solutions revenue decreased $5.7 million (or 14%) in 2021 compared to 2020. We believe customer demand for embedded operating systems was adversely impacted by the economic downturn and related uncertainty stemming from the global COVID-19 pandemic. We have some moderate customer concentration in industries particularly impacted by COVID-19, such as casino gaming, hospitality, and point-of-sale systems.

Edge to Cloud revenue

Edge to Cloud revenue decreased $1.0 million (or 21%) in 2021 compared to 2020, primarily due to a decrease in professional services revenue driven primarily by purchasing delays from one of our large customers. In addition, our relationships with some smaller customers concluded and we have strategically shifted our focus to larger customers and product development opportunities.

Gross profit and gross margin

Cost of revenue for the Partner Solutions segment consists primarily of embedded operating system software product costs payable to third-party vendors, net of rebate credits earned through Microsoft's distributor incentive program. Cost of revenue for Edge to Cloud revenue consists primarily of salaries, benefits, rebillable expenses, and amortization of certain intangible assets related to acquisitions.

Gross profit and gross margin were as follows:  

Partner Solutions gross profit and gross margin

The year-over-year decline in Partner Solutions gross profit was driven by lower third-party software sales and gross margin rate deterioration due to a decrease in Microsoft rebates and a change in the mix of customer types and in products sold.

Partner Solutions gross profit is impacted by rebate credits earned through Microsoft’s distributor incentives program. In accordance with program rules, we allocate a portion of the incentive earnings to reduce cost of revenue with the remaining portion utilized to offset qualified marketing expenses during the period in which expenditures are approved. During the first half of 2020, we allocated 20% of rebates to reduce cost of sales and 80% to marketing expenses. In the second half of 2020, we began allocating the rebates 50/50 which continued throughout 2021. See Footnote 13 – Significant Concentrations for further information about these rebates.

Edge to Cloud gross profit and gross margin

The year-over-year decrease in Edge to Cloud gross profit was driven by a decrease in revenue partially offset by a decrease in cost of revenue resulting from the conclusion of one-time customer investments.

Operating expenses

Operating expenses were as follows:

Selling, general and administrative

Selling, general and administrative (“SG&A”) expenses consist primarily of salaries and related benefits, commissions and bonuses for our sales, marketing and administrative personnel, facilities and depreciation costs, as well as professional services fees (such as consulting, legal, audit and tax). SG&A expenses decreased in 2021 compared to 2020 due to lower salaries and related benefits resulting from prior period restructuring efforts, partially offset by a reduction in the amount of Microsoft rebates recognized as a marketing contra expense.

Research and development

Research and development (“R&D”) expenses consist primarily of salaries and benefits for software development and quality assurance personnel, and contractor and consultant costs. R&D expenses increased in 2021 compared to 2020, primarily due to higher salaries and related benefits and other costs related to product development.

Other income (loss), net

Other income and loss typically consist primarily of interest income on our cash and investments, gains and losses we may recognize on our investments, gains and losses on foreign exchange transactions and other items. During the second quarter of 2021, we recorded on the statement of operations for the year ended December 31, 2021, a $1.6 million gain on the extinguishment of debt related to the forgiveness of our Paycheck Protection Program loan. See Footnote 14 – Paycheck Protection Program Loan for additional information.

Income taxes

Income tax expense was not recorded in either 2021 or 2020.

Liquidity and Capital Resources

Overview

As of December 31, 2021, we had $40.1 million of cash, cash equivalents and restricted cash, compared to $13.0 million at December 31, 2020, reflecting a net increase of approximately $27.1 million. We generally invest our excess cash in high quality marketable investments. These investments generally include corporate notes and bonds, commercial paper and money market funds, although specific holdings can vary from period to period depending upon our cash requirements. There were no investments held at December 31, 2021 or December 31, 2020.

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

Cash flows from operating activities

Operating activities used cash of approximately $4.4 million during the year ended December 31, 2021. The cash use was primarily driven by a net loss, adjusted for non-cash items, of $2.7 million, a decrease in deferred revenue of $1.0 million, and changes in working capital of $0.7 million.    

Cash flows from investing activities

Investing activities used cash of $0.5 million during the year ended December 31, 2021. The cash use related primarily to property and equipment additions in the form of internally developed software.

Cash flows from financing activities

Financing activities provided cash of $32.0 million during the year ended December 31, 2021. This cash is related primarily to the sale of our common stock, in addition to employee stock options exercised throughout 2021.  See Footnote 11 – Shareholders’ Equity for more information about the sale of our common stock.

Material cash requirements and sources of liquidity

Cash requirements arising from contractual obligations relate to our office leases, see Footnote 9 – Leases for further information. Other significant cash requirements include software royalties, which become a liability at the point we sell third-party software to our customers, and salary and benefit expenditures related to our personnel. Our sources of liquidity include cash and cash equivalents currently on-hand, and cash generated from operations. We believe that our existing cash and cash equivalents are sufficient to meet our cash requirements for the foreseeable future.

Recently Issued Accounting Standards 

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

Not applicable.

BSQUARE CORPORATION

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders and the Board of Directors of

Bsquare Corporation

Opinion on the Financial Statements

We have audited the consolidated balance sheets of Bsquare Corporation (the “Company”) as of December 31, 2021 and 2020, the related consolidated statements of operations and comprehensive loss, shareholders’ equity, and cash flows for the years then ended, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2021 and 2020, and the consolidated results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

Basis for Opinion

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

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

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

Critical Audit Matter

The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.

Edge to Cloud Revenue Recognition

As described in Notes 1 and 2 to the consolidated financial statements, the Edge to Cloud revenue stream comprises multiple performance obligations, and generally include professional services, a perpetual or term license, and support and maintenance. Due to the multiple element nature of the Company’s contracts, appropriate revenue recognition requires the Company to exercise significant judgment in the following areas:

Given these factors, the related audit effort in evaluating management's judgments in determining revenue recognition for these customer agreements was extensive and required a high degree of auditor judgment. These were the principal considerations that led us to determine that the matter was a critical audit matter.

The primary procedures we performed to address this critical audit matter included:

/s/ Moss Adams LLP

Seattle, Washington

March 10, 2022

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

BSQUARE CORPORATION

CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)

See notes to consolidated financial statements.

BSQUARE CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(In thousands, except per share amounts)

See notes to consolidated financial statements.

BSQUARE CORPORATION

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(In thousands, except share amounts)

See notes to consolidated financial statements.

BSQUARE CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

See notes to consolidated financial statements.

BSQUARE CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Description of business

Bsquare develops and deploys technologies for the makers and operators of connected devices. These fleets of business-oriented devices, often called the Internet of Things (IoT), offer a powerful means to connect organizations, people, information, and ideas. Hundreds of millions of connected devices have already been deployed and it is estimated that billions more will be. Despite their growing prevalence, these devices and the systems in which they operate remain a significant source of complexity, unplanned and often uncontrolled expense, and operational risk. Our customers are undergoing a massive change in their business practices and Bsquare provides technology that helps them capture the value of connected devices and reduces the cost and risk of doing so.

Since our founding in 1994, Bsquare has helped embedded device manufacturers (“Original Equipment Manufacturers” or “OEMs”) design and build cost-effective products. For most of our history, we operated at the intersection of hardware and software, helping our customers select, develop, and configure system software for a variety of purpose-built devices, from mobile computing to point-of-sale systems to healthcare equipment to hospitality, gaming, and more. Our expertise in hardware, device configuration, and operating systems became essential to our customers’ design cycles and purchasing decisions. As our customers deployed ever-larger fleets of devices, our understanding of the requirements for large-scale device operations increased.

More recently, our expertise and business prospects have shifted to cloud-connected devices that have been connected to create intelligent systems. This shift coincides with the overall growth of IoT technologies and with our customers’ recognition that connected intelligent devices create significant business opportunities. Device makers have increasingly specified their products not only to be connection-ready, but also to be enhanced by the breadth and depth of functionality that connection creates. We have taken to market a valuable and expanding portfolio of products and services that meet the needs of connected device makers. This portfolio captures our experience and our expertise can enable our customers to be more productive, flexible, and financially successful. And, in turn, our customers can then help make people and organizations more productive, improve quality of life, and reduce demands on the limited resources of our planet.

Basis of consolidation

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

Recently adopted accounting standards

We adopted Accounting Standard Update (ASU) No. 2019-02, Simplifying the Accounting for Income Taxes (Topic 740) on January 1, 2020.  Since we maintain a full valuation allowance on our net deferred tax assets, the adoption did not have a material impact on our financial condition, results of operations and cash flows, or financial statement disclosures.

Standards issued and not yet implemented

In June 2016, the Financial Accounting Standards Board issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326). The new standard is effective for reporting periods beginning after December 15, 2022. The standard replaces the incurred loss impairment methodology under current GAAP with a methodology that reflects expected credit losses and requires the use of a forward-looking expected credit loss model for accounts receivables, loans, and other financial instruments. The standard requires a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. We plan to adopt the new credit loss standard effective January 1, 2023. We do not expect the new credit loss standard to have a material impact on our financial condition, results of operations and cash flows, or financial statement disclosures.

Use of estimates

Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Examples include provisions for bad debts and income taxes, estimates related to contracts with customers, useful lives of property and equipment, fair value of stock-based awards, and assumptions used to determine the net present value of operating lease liabilities, among other estimates. Actual results may differ from these estimates.

Income (loss) per share

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

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

Common stock equivalent shares of approximately 480,000 and 1,837,000 were excluded from the computation of diluted per share amounts for the years ended December 31, 2021 and 2020, respectively, because their effect was anti-dilutive.

Cash, cash equivalents and investments

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

Restricted cash

Restricted cash represents security on our corporate card credit lines.

Financial instruments and concentrations of risk

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

Allowance for doubtful accounts

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

Property and equipment

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

Leases

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

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

Intangible assets

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

Third-party software fees payable

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

Research and development

Research and development costs are expensed as incurred except as noted below under Internally developed software. Research and development costs include compensation and benefit costs for engineering and product development personnel, third-party contractor expenses, software development tools and other expenses related to researching and developing new solutions, or upgrading and enhancing existing solutions, that do not qualify for capitalization.

Internally developed software

We incur certain costs associated with the development of internal-use software, which are primarily related to activities performed to develop our SaaS solutions. Internal and external costs incurred in the preliminary project stage of internal-use software development are expensed as incurred. Once the software being developed has reached the application development stage, qualifying internal costs including payroll and payroll-related costs of employees who are directly associated with, and devote time to, the project are capitalized. Capitalization ceases at the point at which the developed software is substantially complete and ready for its intended use, which is typically upon completion of all substantial testing. Capitalized software development costs are classified as property and equipment on our consolidated balance sheet. We capitalized $0.4 million and $0.2 million in 2021 and 2020, respectively.

Qualifying capitalized software development costs are amortized over the software asset’s estimated useful life. Amortization expense is classified as research and development on our consolidated statement of operations. We evaluate the useful lives of these assets on an annual basis and test for impairment whenever events or changes in circumstances occur that could impact the recoverability of these assets. There were no impairment charges related to capitalized software development costs during the years ended December 31, 2021 and 2020.

Advertising costs

All costs of advertising are expensed as incurred.  Advertising expense was approximately $375,000 and $112,000 in 2021 and 2020, respectively. A portion of these expenses are offset by rebates received from Microsoft. See Footnote 13 - Significant Concentrations for additional information.

Stock-based compensation

The estimated fair value of stock-based awards is recognized as compensation expense over the requisite service period, net of estimated forfeitures. We estimate forfeitures of stock-based awards based on historical experience and expected future activity. The fair value of RSUs is determined based on the number of shares granted and the quoted price of our common stock on the date of grant. The fair value of stock options is estimated at the grant date based on the fair value of each vesting tranche as calculated by the Black-Scholes-Merton (“BSM”) option-pricing model. The BSM model requires various highly judgmental assumptions including expected volatility and option life. If any of the assumptions used in the BSM model change significantly, stock-based compensation expense may differ materially in the future from that recorded in the current period. The fair value of performance stock units ("PSUs") is estimated at the grant date based on the fair value of each vesting tranche as calculated by a Monte Carlo simulation.

Comprehensive loss

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

Income taxes

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

We apply judgment as to the appropriate weighting of all available evidence when assessing the need for the establishment or the release of valuation allowances. As part of this analysis, we examine all available evidence on a jurisdiction-by-jurisdiction basis and weigh the positive and negative information when determining the need for full or partial valuation allowances. The evidence considered for each jurisdiction includes, among other items, (i) the historical levels of income or loss over a range of time periods that extends beyond the two years presented, (ii) the historical sources of income and losses, (iii) the expectations and risk associated with underlying estimates of future taxable income, (iv) the expectations and risk associated with new product offerings and uncertainties with the timing of future taxable income, and (v) prudent and feasible tax planning strategies. Based on the analysis conducted as of December 31, 2021, we determined that we would not release, in full or in part, the valuation allowance against our U.S. gross deferred tax assets.

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

Foreign currency

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

Revenue recognition

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

Partner Solutions

We sell embedded operating system software licenses based upon a customer purchase order, shipping a Certificate of Authenticity ("COA") to satisfy this single performance obligation. These shipments are subject to limited return rights; historically, returns have been insignificant. In accordance with ASC Topic 606, Revenue from Contracts with Customers, (“Topic 606”), we recognize revenue from these products at the time of shipment which is when the customer accepts control of the COA (point-in-time revenue recognition).

Edge to Cloud

We analyze each customer contract within the Edge to Cloud segment and determine revenue recognition through the following steps: (i) identification of the contract, or contracts, with a customers; (ii) identification of the performance obligations in the contract; (iii) determination of the transaction price; (iv) allocation of the transaction price to the performance obligations in the contracts; and (v) recognition of revenue when (point-in-time), or as (over-time), we satisfy performance obligations.

Disaggregation of revenue

The following table provides information about disaggregated revenue by primary geographical area and operating segment (in thousands):

For the years ended December 31, 2021 and 2020, $38.1 million and $43.7 million of revenue was recorded at a point-in-time, and $2.3 million and $3.4 million of revenue was recorded over-time, respectively.

Contract Balances

We receive payments from customers based upon contractual billing schedules. Accounts receivable are recorded when the right to consideration becomes unconditional. Contract assets include amounts related to our contractual right to consideration for completed performance obligations not yet invoiced. We had no asset impairment charges related to contract assets during 2021 or 2020. Contract liabilities, presented as deferred revenue on our consolidated balance sheet, include payments received in advance of performance under the contract and are recognized as revenue when performance obligations are satisfied.

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

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

Contract acquisition costs

We capitalize certain contract acquisition costs consisting primarily of commissions paid when contracts are signed. We capitalized contract acquisition costs for contracts with a life exceeding one year. Amortization of contract acquisition costs was $61,000 and $89,000 for fiscal year ended December 31, 2021 and December 31, 2020, respectively. There were no asset impairment charges for contract acquisition costs for the periods noted above.

Transaction Price Allocated To Remaining Performance Obligations

The following table includes estimated revenue expected to be recognized in the future related to performance obligations that are unsatisfied or partially unsatisfied at the end of the reporting period (in thousands). The estimated revenue does not include contracts with original durations of one year or less, amounts of variable consideration attributable to royalties, or contract renewals that were unexercised as of December 31, 2021.

Practical expedients and exemptions

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

When applicable and appropriate, the Company utilizes the 'as-invoiced' practical expedient which permits revenue recognition upon invoicing. 

Cash, cash equivalents and restricted cash consisted of the following (in thousands):  

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

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

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

Property and equipment consisted of the following (in thousands):

Depreciation and amortization expense related to these assets was $70,000 and $187,000 in 2021 and 2020, respectively.

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

Amortization expense was $71,000 and $98,000 for 2021 and 2020, respectively. As of September 30, 2021, the gross carrying amount of the intangible assets has been fully amortized.

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

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

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

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

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

As of December 31, 2021, our deferred tax assets were primarily the result of U.S. net operating loss, research and development credit carryforwards and stock-based compensation expense. We have applied a full valuation allowance against the U.S. deferred tax assets in the U.S. and foreign jurisdictions.

We use judgment as to the appropriate weighting of all available evidence when assessing the need for the establishment or the release of valuation allowances. As part of this analysis, we examine all available evidence on a jurisdiction-by-jurisdiction basis and weigh the positive and negative information when determining the need for full or partial valuation allowances. The evidence considered for each jurisdiction includes, among other items, (i) the historical levels of income or loss over a range of time periods that extends beyond the two years presented, (ii) the historical sources of income and losses, (iii) the expectations and risk associated with underlying estimates of future taxable income, (iv) the expectations and risk associated with new product offerings and uncertainties with the timing of future taxable income, and (v) prudent and feasible tax planning strategies. Based on the analysis conducted as of December 31, 2021, we determined that we would maintain a full valuation allowance against our U.S. gross deferred tax assets.

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

At December 31, 2021, we had approximately $83.7 million of federal and $12.8 million of state net operating loss carryforwards, which have begun to expire. Of the federal net operating loss carryforwards, approximately $62.7 million will expire by 2037 and $21.0 million are indefinite. We also have approximately $2.7 million of tax credit carryforwards, which have begun to expire. Use of these carryforwards may subject us to an annual limitation due to Section 382 of the U.S. Internal Revenue Code that restricts the ability of a corporation that undergoes an ownership change to use its carryforwards. Under the applicable tax rules, an ownership change occurs if holders of more than five percent of an issuer’s outstanding common stock, collectively, increase their ownership percentage by more than 50 percentage points over a rolling three-year period. We have performed analyses of possible ownership changes in the past, which included consideration of third-party studies, and do not believe that an ownership change of more than 50 percentage points has occurred.

We have evaluated all the material income tax positions taken on our income tax filings to various tax authorities, and we determined that we did not have unrealized tax benefits related to uncertain tax positions recorded at December 31, 2021 and 2020.

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

In December 2019, we entered into an operating lease agreement for a new corporate office facility in Seattle, Washington. The term of the lease is 87 months, with a rent date starting on May 1, 2020 and the lease term ending on July 31, 2027. 

In November 2020, we renewed the lease for our office facility in the UK. The term of the lease is 120 months, with rent payments starting on November 30, 2020 and the lease term ending on November 8, 2030. The Company has an opportunity to break the lease at the five-year mark in November 2025. As it is reasonably certain that we will utilize this option, the accounting for this lease utilized November 2025 as the end date. The lease commencement date was November 9, 2020. As a result of entering this lease agreement, we recorded additional ROU assets and net lease liabilities of $0.4 million on our consolidated balance sheet as of December 31, 2020. There was no material impact to our statement of operations or statement of cash flows as a result of entering into this lease. 

Our leases have remaining terms of four to six years. Both of our leases contain renewal options. Because of changes in our business, we are not able to determine with reasonable certainty whether we will renew our Seattle or Trowbridge, UK lease. As a result, we have not considered renewal options when recording ROU assets, lease liabilities or lease expense.

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

Lease and rent obligations

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

Loss contingencies

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

Equity compensation plans

We have a stock plan (the “Stock Plan”) and an inducement stock plan for newly hired employees (the “Inducement Plan”) (collectively the “Plans”). Under the Plans, stock options may be granted with a fixed exercise price that is equivalent to the fair market value of our common stock on the date of grant. These options have a term of up to 10 years and vest over a predetermined period, generally four years. Incentive stock options granted under the Stock Plan may only be granted to our employees. The Plans also allow for awards of non-qualified stock options, stock appreciation rights, restricted and unrestricted stock awards, RSUs and PSUs.

Stock-based compensation

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