BlackBerry Posts Surprise Profit, Weak Revenues Remain A Concern

BlackBerry (NASDAQ:BBRY) published its Q3 FY 2015 earnings on December 19, posting a surprise quarterly profit on the back of better cost management, although its top line missed consensus by a wide margin due to disappointing handset sales. While quarterly revenues fell by around 13.5% sequentially to $793 million, the company posted an adjusted (Non-GAAP) net profit of $6 million compared to an adjusted loss of $11 million during the previous quarter. ^[1] Over the last year, the company has made meaningful progress in restructuring its business by lowering its headcount and reining in costs, while also reworking its hardware and software strategy. However, BlackBerry still remains a company in transition. The company’s lucrative service business is facing significant declines on the back of user attrition, while the handset business is still looking for firmer ground in a smartphone market dominated by Android and iOS based devices. The company’s small, yet promising software business also faces its biggest test yet as it ends its promotional program and seeks to monetize its licensees. In this note, we take a look at the performance of BlackBerry’s key business divisions and where they could be headed.

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Trefis has an $9.00 price estimate for BlackBerry, which implies a 10% downside to the current market price. We are currently updating our valuation model to account for the earnings release.

BlackBerry Service Revenues Continue To Fall

While BlackBerry services still remains the company’s largest division, accounting for over 46% of consolidated quarterly sales, the division has been posting revenue declines of over 10% each quarter owing to user attrition and customer migration onto other smartphone platforms. Service revenue consists of monthly system access fees (SAF) that the company bills to users of Blackberry 7 (and prior) operating systems. Users of the company’s latest BlackBerry 10 devices get the basic services for free, although they need to pay for value-added encryption or enhanced enterprise mobility services. ^[2] During Q3, the company noted that SAF had declined by around 13%, and the company expects the number to decline by another 15% during the next quarter, possibly due to the launch of the BB10-based BlackBerry Classic, which is expected to get users to upgrade from their Blackberry 7 (and prior) devices. The company expects service revenue to decline by 50% to about $850 million for FY 2016.

EZ Pass Additions Encouraging, Real Test Lies In Monetization

BlackBerry’s software revenue is largely derived from its BlackBerry Enterprise Service offering, which is a mobile device management (MDM) service. As expected, BlackBerry’s software revenues remained almost flat sequentially at $54 million, owing to the company’s EZ Pass promotional 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 licensees 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. This quarterly report indicates that the interest in BlackBerry’s enterprise mobility management software is quite strong, with the company reporting that it had issued a total of 6.8 million licenses, marking 100% growth over last quarter. Additionally, over 30% of the licenses were traded in from competing MDM platforms. However, the program’s real test will begin in Q4, as the company intends to end new EZ Pass enrollments this month, while existing EZ Pass licensees will have to begin paying for technical support beginning February 1, 2015.

Handset Business Disappoints

The burden of BlackBerry’s recovery and earnings growth rests heavily on the handset business, given the company’s fleeting services revenue and the relatively small size of the software business. This will not be an easy task, given that the smartphone market momentum has not been working in BlackBerry’s favor. During the quarter, the company’s handset sales to end customers stood at just 1.9 million units, marking a 20% sequential decline and a 56% decline year-over-year. A meaningful portion of the sales during Q3 are likely to have come from an inventory clearing exercise that saw the company reduce stock of poorly-received legacy BB10 and BBOS devices by offering discounts. The company says that its inventory of old devices is down by around 93% compared to the last year. ^[3]  BlackBerry had adopted a somewhat misguided strategy of going after the mainstream smartphone market with products such as the BlackBerry Z10 – a touch screen device without a physical keyboard – which were designed to compete with the likes of the iPhone and other Android based devices. However, these devices failed to find favor with customers owing to their weaker software and app ecosystem.

BlackBerry has since reworked its smartphone strategy by focusing on its core base of business users by offering devices such as the BlackBerry Passport, launched during Q3, and the BlackBerry Classic, which was launched earlier this month. The Passport handset was off to a reasonably good start, with BlackBerry quickly selling its small initial supply of 200,000 units, leading to stock outs in most regions. However, the company remained tightlipped about full quarter sales volumes for the Passport, although it did indicate that its impact on Q3 numbers was relatively small owing to weak supplies and also due to the company’s new sell-through method of accounting for the device. The company also noted that the recently launched BlackBerry Classic was seeing a strong response, with pre-orders for the device surpassing those of the Passport. That said, we don’t expect these new devices to meaningfully improve the company’s smartphone volumes, since they cater to a relatively niche market. However, we believe that the new devices could prove positive from a margins standpoint, given their higher average selling prices (the Passport currently retails for about $600, unlocked, while the Classic sells for about $450). Additionally, BlackBerry has been increasingly sourcing its new devices from contract manufacturers, allowing it to rein in fixed costs while lowering inventory risk.

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1. BlackBerry Q3 Earnings Press Release [↩]
2. BlackBerry: Expected 50% Decline In FY16 Service Revenue Spooks Investors, Seeking Alpha, November 2014 [↩]
3. BlackBerry’s (BBRY) CEO John Chen On Q3 2015 Results – Earnings Call Transcript, Seeking Alpha, December 2014 [↩]