Falling Handset Sales, Slow EMM Software Ramp-Up Hurt BlackBerry’s Q1 Results

BlackBerry (NASDAQ:BBRY) published its Q1 FY2016 earnings on June 23, missing market expectations on both earnings and revenues, as its expensive new flagship handsets failed to prop up its struggling smartphone business, while its lucrative service access fee (SAF) revenues continued to plummet. Things remained mixed for the software business as well. While software and licensing revenues rose by 150% year-over-year, to about $137 million, a significant chunk of this number apparently came from two patent cross-licensing deals. The company declined to disclose revenues from the core enterprise mobility management (EMM) software products that it is betting its long-term earnings growth on.

Quarterly revenues stood at $658 million, marking a 32% decline over the same period last year, while adjusted net losses narrowed to about $28 million, owing to better operating cost management. Hardware sales accounted for 40% of quarterly revenue, SAF revenues and software and technology licensing accounted for 39% and 21% of revenues, respectively. ^[1] The markets didn’t take too kindly to the results, sending BlackBerry’s stock down by about 4% in Tuesday’s trading.

While BlackBerry is certainly on stable ground financially, generating positive free cash flow and holding over $3 billion in cash and investments, the recent earnings indicate that the outlook for the company remains hazy at best. Handset and SAF revenues continue to fall (15% quarterly service revenue declines projected), and the company has not been particularly forthcoming with any hard numbers for its crucial software business (related: Why BlackBerry Shareholders May be Better Off It Were Acquired).

We have a $10 price estimate for BlackBerry, which is slightly ahead of the current market price. We will be revisiting our valuation model to account for the earnings release.

Software Growth Driven By Licensing Deals; EMM Ramp-Up Is Slow

Blackberry’s software and technology licensing revenue stood at $137 million for the quarter, a 150% increase over Q1 FY15. The growth was largely driven by patent licensing deals with Cisco Systems and a second, unnamed company. BlackBerry did not disclose the terms of these deals and it’s unclear whether these revenues will be recurring. The agreement is part of the company’s push to license and monetize its deep portfolio of fundamental patents.

Since licensing accounted for much of the growth, this implies that company’s core enterprise mobility management business likely only saw a modest uptick during Q1. BlackBerry said that had 2,600 enterprise customer wins for BES 12 in the quarter, an improvement from the 2,200 customers that it added during the previous quarter. Roughly 40% of those were new customers, while the other 60% came from those who’ve switched to BES 12 via the EZ Pass program. The company did not disclose the number of paying subscribers. It’s important to note that Blackberry has transitioned to a subscription model for BES, so there is likely to be more stickiness in software revenues and an expansion of the customer base is likely to provide a reasonably strong foundation for growth. The company has also been scaling up its software distribution footprint, A total of 19 carriers have signed on to adopt its enhanced SIM-based licensing solution, which essentially allows bundling of BlackBerry solutions with data plans for billing.

BlackBerry is targeting $500 million in software revenues this year, and by the looks of it the company still has a long way to go (related: Why BlackBerry’s Fortunes Ride Heavily On BES). However, management appears reasonably confident about hitting its target, indicating that the core BES business is expected to grow by around 20% year-over-year (it posted revenues of about $247 million in 2014). Recently acquired value-added offerings such as Movirtu, Secusmart, and WatchDox are also expected to begin contributing to revenues later this year (related: A Look At BlackBerry’s Deals And Acquisitions In 2014). Management also expects the licensing business to contribute meaningfully to software revenues.

Device Sales Continue To Falter, But Profitability Likely To Improve

BlackBerry recognized revenue on about 1.1 million handsets during Q1, down from about 1.3 million handsets during Q4 FY 2015. However, ASPs improved to $240 from around $210, aided by a lower mix of legacy handsets. It’s increasingly apparent that the two new premium devices – BlackBerry Passport and Classic – which are targeted at core business users and BlackBerry loyalists, have failed to rekindle interest in the BlackBerry brand. We think that the company will most likely have to be content with current levels of sales, catering to a niche in the market, while focusing on improving the overall profitability of its hardware operations.

BlackBerry indicated that the devices business was profitable for the fourth straight quarter on a gross margins basis, although it still remains in the red on an operating basis. BlackBerry has been progressively reducing the headcount of its devices division (the last cut of an undisclosed number of jobs took place at the end of May) while also increasingly using contract manufacturers to design and produce devices. The company signed development and manufacturing agreements with two new contract manufacturers – Wistron and Compal – during the quarter and already has a deal in place with Foxconn. The company said that intends to cut about $100 million to $200 million in hardware spending this year and divert that into software. ^[2]

We have some concerns relating to the new product lineup for 2015 as well. Earlier this year, BlackBerry introduced a new all-touch smartphone, dubbed the Leap, that has met with a tepid response from customers. The company also intends to release a new device later this year with a dual-curved screen and slide out keyboard. This strategy could be questionable, given that its recent attempts at mainstream consumer smartphones and all-touch devices have largely fallen flat.

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1. BlackBerry Earnings Press Release [↩]
2. BlackBerry’s (BBRY) CEO John Chen on Q1 2016 Results – Earnings Call Transcript, Seeking Alpha, June 2015 [↩]