BlackBerry Limited
Q3 2013 Earnings Call Transcript

Published: 21 Dec 2012

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to the Research In Motion Third Quarter Fiscal 2013 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded today, Thursday, December 20, 2012 at 5

[Paul Carpino:]

Okay. Thank you, Luke. Welcome to RIM's Fiscal 2013 Third Quarter Results Conference Call. With me on the call today are Thorsten Heins, our Chief Executive Officer; and Brian Bidulka, our Chief Financial Officer. After I read our cautionary note regarding forward-looking statements, Thorsten will provide a business update, and Brian will then review the third quarter results and our outlook. We will then open up the call for questions. This call is available to the general public via call-in numbers and via webcast in the Investor Relations section at rim.com. The webcast can be accessed through your personal computer or your BlackBerry PlayBook tablet. A replay of the webcast will be available on the rim.com website. We plan to wrap up the call around 6

[Thorsten Gerhard Heins:]

Thank you, Paul. As we can imagine, this is a very dynamic time at Research In Motion, and Q3 was a very busy and active quarter for the company. Since becoming CEO just less than 1 year ago, we have put in place a clear roadmap to transition us into our new mobile computing platform, running a leaner and much more efficient organization. Today, we are on the verge of launching BlackBerry 10, and our core restructuring process has delivered results. This highlights the talent of the group that we have put together in RIM to run our business. I want to start by giving you a high-level recap of Q3, which Brian will discuss in more detail later. I will also provide you an update on our 3 main initiatives

[Brian Bidulka:]

Thank you, Thorsten. Before I discuss our GAAP and adjusted results this afternoon, I would like to note the comments I make today related to our third quarter results and their comparisons to prior quarters are primarily focused on continuing operations. I will discuss discontinued operations shortly. Please also note that a reconciliation of our adjusted results to our GAAP results was included in the press release today. Revenue for the third quarter of fiscal 2013 was $2.7 billion compared to $2.9 billion in the second quarter. The decline was primarily -- driven primarily by lower volumes in handsets where we shipped 6.9 million smartphones compared to 7.4 million in the second quarter. Sales outside the U.S., U.K. and Canada grew 7% this quarter, and made up approximately 65% of total revenue compared to 58% in Q2. Some of the larger markets comprising the other segment in the quarter included Indonesia, South Africa and Venezuela. In the U.S., sales were 19% of consolidated revenue compared to 22% in the second quarter. Sales in Canada and the U.K. this quarter represented 5% and 11% of revenue, respectively, compared to 8% and 12%, respectively, last quarter. Estimated sell-through in the quarter was approximately 8.4 million units, including phone-only sales, and channel inventory declined slightly. Shipments of PlayBook were approximately 255,000 units compared to approximately 130,000 last quarter. Strong promotional activity with our retail partners on our Wi-Fi tablet continues through the holiday season, particularly in North America and the U.K. Our overall inventory position in PlayBook is significantly improved over the prior quarters, and we're continuing to sell our 4G PlayBook in North America and Europe with a focus on enterprise users. Looking at our revenue mix, hardware revenue was approximately $1.6 billion or 60% of revenue, similar to 60% in the second quarter. Service revenue was $974 million and represented approximately 36% of revenue. On a dollar basis, this was down $19 million from Q2, reflecting the pricing pressures and fee reduction activities we have discussed throughout the year. Subscribers were approximately 79 million compared to 80 million in the second quarter. The declines in the U.S. were the predominant factor for the reduction in the base, offset by more stable and slightly growing subscribers in non-U.S. regions. Software and other revenue represented 4% of consolidated revenue in the third quarter compared to 5% in Q2. As part of the CORE program and our strategic review process, the company has been reviewing all aspects of its operations, including the sale of certain assets. In the second quarter, we classified some assets as held for sale, which will now be reflected in our statements as discontinued operations until we dispose of them. Assets held for sale include businesses, property, plant and equipment, as well as certain intangible assets, which are expected to be sold within the next 12 months. Revenue from discontinued operations in the third quarter was $11 million and operating losses were $7 million. This compared to revenue of $12 million and operating losses of $5 million from discontinued operations in Q2. GAAP gross margin was approximately 30% in the quarter compared to gross margin of approximately 26% in Q2. Excluding pretax core restructuring charges of approximately $32 million included in cost of sales, adjusted gross margin was approximately 32%. This was driven by 3 key items

[Operator:]

[Operator Instructions] Your first question today comes from the line of Kevin Smithen of Macquarie.

[Kevin Smithen:]

Can you discuss pricing trends for the tiering of services going forward? You mentioned there'll be some premium service tiers and there'll be some basic tiers. And how quickly will that impact service revenue over the coming quarters?

[Thorsten Gerhard Heins:]

So what we see, Kevin, in the market is that instead of 1 service kind of fits all, that security mobile device management is basically segmenting across various sizes of enterprise and various businesses, be it regulated or not. So there's not just one entity or question of what other pricing tiers, it depends on the interest industry, it depends on the set of services that are being subscribed. But it's kind of a variable addition of services. It's a little bit of a menu thing that you can choose and pick and that then will basically govern the pricing. But clearly, the service offering in those enterprises are going to be segmented and specific to those segments.

[Kevin Smithen:]

How quickly will that impact your service revenue? I mean adverse impact over the -- in the short term? Or is this more of a longer-term mix issue?

[Thorsten Gerhard Heins:]

As we transition to BlackBerry 10 and the mobile computing platform, we do the same transition basically in our service environment moving from the BB OS services to BES 10 services. So we're working on that transition. We're trying and working hard to make this as easy as possible in terms of the financial impact. However, right now, it is too early to say how that will evolve really in concrete numbers. But we are absolutely confident that we can manage that transition competently and also achieve the objective that we want to achieve in BES 10.

[Operator:]

Your next question comes from the line of Kulbinder Garcha of Crédit Suisse.

[Kulbinder Garcha:]

Thorsten, it's the same question, kind of, I'm afraid. I guess what I really want to understand is this, in terms of the service fees that you guys will collect, so you go to an enterprise or a customer, you give them BB10, this menu service. At that point, they can start -- just to be clear, they can start deciding which service menu offerings they want, and they can stop paying you altogether or can you please explain the dynamics? Because that's going to really impact the rate at which your service revenue starts declining over the next 12 months.

[Thorsten Gerhard Heins:]

So again, it is a segment of service packages that we're going to offer and we have to realize that some of the smaller enterprises -- they're actually good enough with just some e-mail exchange protocol connectivity to their main server or their exchange server that they're running. So there's very little value add in this. And then as we invest into BES 10, you think about cross-platform mobile device management. You think about security that you can offer and you think about the platinum package that is basically the all-in package that I would describe today as being the full BlackBerry package as you know it today, right, all in. So how that is going to be priced, what is the penetration rate into the market, that depends also on what is the BB10 penetration rate into those enterprises. So these things are dependent on each other and we will provide more insight into this once we have a clear view on those launch numbers and those launch plans.

[Operator:]

Your next question comes from the line of Jim Suva of Citi.

[Jim Suva:]

Can you comment on -- you talked about going into mobile device management. There's a lot of companies in there, a lot of them are very ingrained, very big, rooted in it and already have had a lot of traction and history. How will you be able to do that? What type of services and how will you basically unseat those people that are MDM? They already are embracing MDM and rolling out with Android, iPhone, BlackBerry, lots of MDM management today.

[Thorsten Gerhard Heins:]

So the very first step here is, Jim, that we have a pretty large installed base out there, right, of customers that use BlackBerrys and that manage BlackBerrys overall. So that's the first starting point. Then second, there is the BYOD trend out there but I think that it's fair to say that BlackBerry, the BlackBerry mobile device management is a leading edge solution that we will even enhance further with BES 10. And then on top of that, we will provide additional services that go beyond just the pure mobile device management. And I think that there's an area of innovation. You're right. It's an area of competition. You're also right with that. But I feel that the company is very well positioned based on its install base, based on BB10 platform and BES 10 capabilities to compete successfully in that domain.

[Operator:]

Your next question comes from the line of Todd Coupland of CIBC.

[Todd Coupland:]

Two quick questions. Firstly, some carriers are already opening up for pre-orders of BB10. Would you expect to make public comment on that, firstly? And secondly, when will the QWERTY BB10 device be available?

[Thorsten Gerhard Heins:]

So it is with the carriers that they basically decide along their marketing and promotional windows when they're really going to launch. But what I can see is, we see them placing orders with us way ahead of time, and that is a very good thing. As I said in my earnings call, there's quite an excitement around the BlackBerry 10 out there and I wouldn't go so far to say there's a rush to be the first, but there's certainly quite a dynamic in all that. The partners that we have want to be really fast and early to market. From that perspective, we will announce those dates collectively with our carriers on the 30th of January. But I think there's a very good dynamic at play here, and I'm looking forward to fulfill those requirements and request and purchase orders from our customers.

[Operator:]

Your next question comes from the line of Amitabh Passi of UBS.

[Amitabh Passi:]

I just wanted to understand the OpEx gyrations for the fourth fiscal quarter R&D, I think was at probably the second highest level we've seen in the last 12 quarters. Just wanted to understand, do you expect R&D to stay at these high 300s level? And with respect to sales and marketing, should we look at your prior history the incremental spend 3Q to 4Q and assume it'll be something similar?

[Brian Bidulka:]

In terms of the R&D, it's dependent upon some of the timing of the BlackBerry 10 initiatives that we're undertaking. But I think what we're certainly trying to do is maintain some efficiency within our R&D group, and that's part of our ongoing CORE -- CORE program. I did mention that part of the "increase" to quarter on quarter is really some of the retention packages and just incentive plans that we've got in place, and that was impacting the Q3 numbers as well. And in terms of the sales and marketing, we're certainly looking to, as Frank is rolling out his marketing program, that number is going to increase quarter-on-quarter and into Q1 as well. So in terms of just benchmarking it to prior, I don't necessarily think that, that to a prior quarter can really articulate it right now. I think that just -- we're going to continue to look at efficient ways to spend marketing dollars. Frank's team is obviously working on that. And but also looking at it on a country-by-country basis and the timing of the rollouts.

[Operator:]

Your next question will come from the line of Simona Jankowski of Goldman Sachs.

[Simona Jankowski:]

It's a two-part question. Just the first part is back on the services side. So you commented on the enterprise piece of that. But is it fair to assume that by and large on the consumer side is where you no longer would expect to get meaningful services revenues going forward, whereas on the enterprise side you'll have more of this steering approach? And then the second question was, as you look at the timing of when either consumers or enterprises will move to BB10, is it fair to assume that most of the enterprise upgrade opportunities in the second half of the calendar year, given that it sounds like the full functionality of BES 10 does not become available until May?

[Thorsten Gerhard Heins:]

Those transitions, Simona, don't happen overnight, right? Specifically in enterprise, there is budget cycles, there is planning cycles. And we know from our experience in corporations that actually product lifetimes is longer than in the consumer domain. So I think the time line is very well aligned to what our customers can do and want to. And as I said, we have those Beta tests going on in another 20 [ph] of our enterprise installations, which is actually quite exciting and allows us to really prove the process of introducing BB10, BES 10 and the additional new services into the enterprise market. So from that perspective, I feel that the process of introducing this and getting this into the market is actually pretty well-aligned from a timing perspective. Now on the consumer services, there is -- we discussed that in prior earnings call, there is a strong trend that is the Bring Your Own Device to work trend. So you have to be attractive to consumers first, the device which BB10 will absolutely cover. And then when these devices get connected to whatever corporate infrastructure and the selection of services that then is being done by the corporation, then that creates additional service revenue for us, an additional channel, an additional go-to-market that we're going to go after. And then as you can imagine, we have a very, very strong installed BBM base out there. BBM is a fantastic social network that is really distinct from other messaging applications because of its intermediacy, because of its richness of services, and we're going to evolve that. So the point is that what we're working on is how do we evolve BBM, BBM services to a stage where we can actually also create additional service revenues out of BBM.

[Operator:]

Your next question will come from the line of Ehud Gelblum.

[Ehud A. Gelblum:]

I just want to clarify a bunch of things around the structure of the service contract and the service ARPUs. So just to rattle off a couple of points, just to make sure I understand, the current service fees that you collect on BB7 and below, are those contracts in any long-term contracts? And when you're talking about moving to a new fee structure, does that impact any current BB7 subscribers or as long as they stay with their current BlackBerry, nothing changes for them? And then if they upgrade or if someone comes in to a BlackBerry 7 device, putting aside BlackBerry 10, does the new fee structure impact them, or are they still under the old -- the current structure right now of $4, $5, $6, $7? And then the other thing is that for people who are under the new fee structure and hopefully in answer to the first question we'll know if it's only BB10 device holders going forward or of it's existing BB7 or future BB7. But for anyone under the new subscription service, are we to understand that all services fees, whatever they may be, are going to be paid by the user and no longer paid by the carrier, as in the user will pay a fee, it will flow through the carrier to you but the carrier will no longer pay anything out of its own pocket?

[Paul Carpino:]

Hey, that's a lot of questions in there. Generally right now, the company is sort of starting to roll out these plans on the service plans as we get into launching services and we'll provide more details around some of the activities that we'll be offering to the enterprises. We just aren't providing the detail on it that at this time, Ehud. I just -- you'll have to wait until we start to launch some of these services to get more detail.

[Operator:]

Your next question will come from the line of Rod Hall of JPMorgan.

[Roderick B. Hall:]

I just wanted to ask you guys, you've been reducing channel inventory over the last few quarters, which is commendable. And I'm just wondering what you're thinking about channel inventory as you head into BlackBerry 10. Are you happy with current levels of channel inventory? Do you think channel inventory needs to go up quite a bit, because it sounds like you've got quite a bit of demand and you need to have availability. And I wanted, Brian, if he could just clarify his commentary on the gross margin. He mentioned 3 drivers. Brian, could you -- can you rank order those at all as -- where cost reduction is the #1 driver or if you can put those in rank order, that would be helpful.

[Thorsten Gerhard Heins:]

Ron, this as Thorsten. So to the channel inventory question, I think at this moment we're doing a really, really good job at managing our channel inventory on the BlackBerry 7 devices, which I think is really, really important in the transition phase. We're very comfortable where we are today in inventory at hand. And also what Brian was alluding to on the CORE, we have changed our manufacturing and our delivery logistics process quite substantially, so we're able to weigh quicker and faster than we probably were in the past. So we're in a pretty good position to fulfill demand on BlackBerry 7. Now naturally, as we're heading into the launch and into building BB10 devices, you will see an increase in inventory first in our factories and our warehouses and then loading the channels on BB10. That is expected, and that is part of our reinvestment of cash into inventory. Brian, I'll let you comment on the share point of the gross margin.

[Brian Bidulka:]

Sure, Rod. I don't have the details on how to rank order those. But I would say -- I mean, 2 of them are mix related in that favorable mix and hardware, but also higher service revenue. But I would stress the benefits that we've achieved through the CORE program in helping to drive that favorable gross margin.

[Operator:]

Your next question will come from the line of then Ben Bolan [ph] of Cleveland Research.

[Unknown Analyst:]

Two-part question. When you look at CapEx, can you talk about how you're thinking about that into fiscal '14 and how it might change as you start to support this new menu-driven service approach? And then the second part, does the implied margin of the service revenue look different with BB10 than it does with the current service revenue?

[Brian Bidulka:]

In terms of the CapEx question, I think we're certainly -- and we're working this through our CORE program as well and looking at prioritizing different programs. So we're obviously doing with the eye of how do we get our overall cost structure competitive. And so as we've rolled out in that '14, we'll continue on that track. You could see in our last few quarters the amount of our CapEx has come down to around $87 million, $85 million mark. And we're going to continue to try and drive efficiencies in how we're spending CapEx and making sure that we're doing it on a thoughtful program-by-program basis. And I'd say that if we're looking at expanding in any particular markets, we may see some need to do some type of investing as well, and we'll look at that on a pragmatic basis.

[Operator:]

Your next question comes from your next question comes from the line of Mark Sue of RBC.

[Mark Sue:]

Maybe just additional thoughts on just the early feedback of BlackBerry 10. You spoke about the positive order trends. Is that concentrated in North America, or is that more broad-based? And also some thoughts on just the marketing dollars. We understand that you had to spend quite a bit to drive the success of the product. Wondering if the carriers are also committing meaningful advertising dollars for the initial launch?

[Thorsten Gerhard Heins:]

So on the early feedback, I referenced to the global roadshow that we were doing, Mark, and we basically hit all continents. I think we hit something like 120 carriers. We also met with CIO and CRO roundtables now. It's absolutely global feedback because BlackBerry today is a globally used device and service. So we were actually really kind of getting into the aspect [ph] with that wherever we went and all those various regions that sometimes have different drivers for being attracted to BlackBerry and all of them were very, very positive. And what really struck me as being really -- the excitement was not around that much specifications, although BlackBerry 10 has great hardware specs, it was really, really around the next-generation user interface, the innovation around peak, hub and flow that just caught their attention, right? And we will talk about this on June -- on January 30th. And you will see that there -- it is just -- that was really the core. That is at the core beside the new architecture for mobile computing at the feedback of the carriers, absolutely global and good feedback. Marketing base, yes, absolutely. We, as Brian said, we are ready to invest in some very, very exciting marketing activities that you will see coming. We have an upfront leadership. I think we have developed and you'll see that already today happening. We have developed a pretty subtle way of getting into the marketing domain. And absolutely. And part of talking to our carrier partners, they want to launch this product as one of their forefront products. So yes, they're absolutely ready and they're committed to spending marketing dollars on BB10 as well.

[Operator:]

Your next question will come from the line of Tal Liani of Bank of America.

[Tal Liani:]

My question, hold on, let me just pick up the phone. Can you hear me? My question is about the migration to BB10. For an average corporate user, what do they have to do in order to migrate to BB10? Do they have -- is there a new server that needs to be installed, and do they need to go through new specification processes given that the system is so different? What have you done on your side to shorten the migration to BB10?

[Thorsten Gerhard Heins:]

So there is, as you can imagine, when we do those tests with those 120 corporate customers, there is a BES 10-ready program where we lead them through the process together with them, training, education, actually really installing -- how do we move to BES 10. And BES 10 will be a fully integrated capability to manage BlackBerrys, but also manage other manufacturer brand devices. And this is a detailed process we're going through with our customers, and that's going way into detail, way too much into detail to take spending [ph] on the earnings call. But happy to share that and get you into touch with our experts on the BES 10 side if you want more detailed information.

[Paul Carpino:]

Yes, Tal, Paul, there are programs that we've announced and stuff that is on the web talking about some of the certification and some the stuff that's going on now. But more detail will follow as well.

[Thorsten Gerhard Heins:]

It's a very well program-managed and executed process, Tal.

[Operator:]

Your next question will come from the line of Jeff Kvaal of Barclays.

[Jeffrey T. Kvaal:]

I was wondering if we could focus in specifically on the non-enterprise service fees and the fee structure there. It's been many years, but in the past you talked about $3 a month in that particular segment, and this is like emerging market consumer-ish segment. Could you talk about, obviously not an absolute sense, but just in general sense what the trends are there? Are the same pressures that are hitting the enterprise portion of that service fee also applicable to the consumer side as well? And then on top of that, I think towards then, you might have said you expect service revenues to grow next year. I just wanted to clarify that.

[Brian Bidulka:]

Hey, Jeff, it's Brian. So just on the service revenue as it relates to the consumer side. When we -- I don't think I mentioned in my comments, our ARPU was down slightly quarter-on-quarter, and that reflects some of the initiatives that we're doing with some of the carriers on -- like we said, on how we're trying to use pricing initiatives in certain instances in order to drive and maintain our subscriber base. So as it relates to the -- our current view, we've seen that ARPU coming down slightly quarter-on-quarter.

[Thorsten Gerhard Heins:]

Yes, and on your discussion about the question about our service revenue is going to grow next year. So as Brian just said, we will see pressure on pricing for BB OS-based services in order to make sure we stay relevant in our markets and we manage through the transition phase. So that was not my statement, just to really clarify this. What I was talking about is we are in a transition. We have to manage that transition not just from BB10, from BB OS to BB10, we have to manage the same transition in Service business, and that's what we're doing.

[Operator:]

Your next question will come from the line of Richard Kramer of Arete.

[Richard Kramer:]

Thorsten, I'd like to ask a little bit more about your software strategy. When Nokia announced that they were going to end-of-life Symbian, the platform and sales fell off very quickly. And given the need to support both BB7 and BB10, can you talk about what steps you might take to support -- to avoid that problem? And equally, if you're considering licensing BB10, have you set up a group within your organization to support licensees, which obviously will need a lot of handholding and a new platform to get anything, any products to market? Thanks.

[Thorsten Gerhard Heins:]

So just to be very clear, we will not just kind of stop BB7 from being supported. We have a significant R&D team working and continuing to work on BB7. And you just saw us innovating on BB7 as well when we announced the BBM voice capability. So we will maintain BB7. There is a strong success with BB7 devices in the Asia Pac markets. And as you can see on the devices that we're launching with BB10, you can probably get an idea of in which price points they fit. So no, we will support those on-boarding, entry-level smartphone markets. We will continue to support them with BlackBerry 7, and you might expect us to even build one of the other new products based on BlackBerry 7. Because for those messaging-oriented markets, it's an exciting platform and it’s a really perfect platform. Licensing BB10 -- I think what is important here is that we prove and we are ready to do this, the capability to have BlackBerry 10 once we launch it on January 30. And then to your question, do we have the tools, the people, the processes, you're absolutely right. That requires a certain business set-up. However, we have, as you know, QNX is the company that runs our OS business, and they're already in it. I mean, the QNX business model is exactly licensing, the OS licensing the toolkits into embedded systems. So yes, the company has knowledge about how to do this. Would we have to expand this and grow this and build on this? Yes, certainly.

[Paul Carpino:]

Thanks, Richard. That concludes the call for tonight. Hope everyone has a happy holidays season, and all the best in 2013 as well. Thank you.

[Operator:]

And thank you. Ladies and gentlemen, that does conclude the conference call for today. We do thank you for your participation, and you may now disconnect your lines.