BlackBerry Q3 Preview: Expect Another Quarter Of Transition

BlackBerry (NASDAQ:BBRY) is expected to announce its FY Q3 2015 earnings on Friday, December 19, reporting on a quarter that saw the company release the latest version of its mobile device management (MDM) software BES 12, and launch its new flagship phone, he BlackBerry Passport. We largely expect Q3 to be another quarter of transition for the company, with continued declines in service subscribers and sluggish software revenues owing to the EZ Pass promotion. However, we believe that the company could post a smaller sequential loss aided by its restructuring initiatives and a potentially improved performance from the handset division. During the second quarter, the company’s adjusted net losses declined sequentially from around $60 million to $11 million while quarterly revenues fell from around $966 million to around $916 million. In this note, we take a look at what to expect from BlackBerry’s three key business divisions this quarter.

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Service Revenue Declines Will Continue

BlackBerry’s services business, which remains one of the company’s largest revenue drivers, has been under significant stress amid user attrition and customer migration onto other smartphone platforms. Service revenue is a monthly infrastructure access fee that the company bills to users of Blackberry 7 (and prior) operating systems as well as users of the latest BlackBerry 10 devices who require value-added encryption or enhanced enterprise mobility services. ^[1] During Q2, the company noted that its subscriber base had declined by around 10% sequentially. Since many new BlackBerry buyers are unlikely to opt for the paid enhanced services, and as the base of BlackBerry 7 users declines, BlackBerry is likely to see its revenues and subscriber base fall meaningfully going forward. Over the last several quarters, BlackBerry has been seeing system access fees (SAF) decline by 10-15% each quarter and the company expects service revenue to decline by 50% to about $850 million in FY 2016.

Watching The Transition Of The Software Business

BlackBerry’s software revenue is largely derived from its BlackBerry Enterprise Service offering, which is a mobile device management service. BES allows corporations to remotely manage a fleet of mobile devices and applications while providing encryption, containerization and other features to improve security. The company is counting on BES to be an important driver of its turnaround strategy, targeting users in the enterprise and regulated industries space by highlighting the platform’s security advantages. According to Radicati Group, a market research firm, the mobile device management market is expected to more than quadruple to $5.75 billion by 2018. BlackBerry launched BES 12, the latest version of its MDM software, towards the end of Q3. The offering rectifies many of the shortcomings of the previous versions of BES, by allowing organizations to manage older versions of BlackBerry devices running BB7 along with BB10 and other third-party devices on a single infrastructure.

BlackBerry is moving to a subscription-based model with BES 12, making customers pay an annual fee for the software, while discontinuing the perpetual pricing model. BlackBerry has been offering its promotional “EZ Pass” program, which allows users of older versions of BES and customers of competing MDM platforms to trade up to the latest version of BES for free. Although the company doesn’t earn revenues from these licenses yet, it intends to eventually monetize these users by charging them for tech support and by encouraging them to upgrade to more premium versions of the service. As of the end of Q2, BlackBerry had a total of 3.4 million customers receiving free mobile device management services under EZPass. The program could possibly begin contributing to BlackBerry’s revenues from Q4 FY2015 onwards, given that customers will have to start paying for support starting February 1, 2015. While we don’t expect the company to report a meaningful change in the software business this quarter, we will be interested to hear the number of EZ Pass licenses issued, and also the number of customers that traded up from competing MDM platforms.

Passport Launch Could Help The Handset Business

The smartphone market momentum has clearly not been working in BlackBerry’s favor over the past few years, with the company’s global market share declining to a mere 0.5%. ^[2] During Q2 FY 2015 the company shipped about 2.1 million smartphones, down from 3.7 million units a year ago and the company’s smartphone revenues have declined by about 45% year-over-year as of Q2.  Much of the woes of the company’s smartphones business can be attributed to its strategy of going after the mainstream smartphone market with products such as the BlackBerry Z10, which were designed to compete with the likes of the iPhone and Android based devices. This led to massive inventory write downs and losses during the last year. However, the company has been looking to tweak its smartphone strategy by focusing on its core base of business users by offering devices such as the BlackBerry Passport and the upcoming BlackBerry Classic. The Passport – which is positioned as a productivity-focused device – was well received by customers and critics when it was launched in September. Initial demand for the device was strong, with BlackBerry quickly selling its initial supply of 200,000 units, leading to stock outs in most countries. The device – which currently retails for about $600 – is manufactured through a contract manufacturer in Mexico. We believe that the launch of the Passport, coupled with the effects of BlackBerry’s restructuring initiatives, could have a positive effect on the performance of the smartphone division this quarter.

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More Trefis Research

1. BlackBerry: Expected 50% Decline In FY16 Service Revenue Spooks Investors, Seeking Alpha, November 2014 [↩]
2. Smartphone OS Market Share, Q3 2014, IDC [↩]