08162017Headline:

BlackBerry Ltd (BBRY): Blackberry CEO Discusses F3Q14 Results

Question-and-Answer Session

Operator

[Operator instructions.] And your first question today will come from the line of Maynard Um of Wells Fargo. Please go ahead.

Maynard Um – Wells Fargo

How should we think about the bottoming of your business segments? In hardware, you talked about the Foxconn business. Will that mark the bottom, as those units ramp up? And then in the services, once those free trials and the license upgrade end at the end of the year, will that uptick there mark the bottom for that segment? And then if you could just, as a follow up, talk about bringing Blackberry to other operating systems, iOS and Android?

John Chen

First of all, it will probably take us a couple more quarters to engage the Foxconn move. For example, we’re building these handsets eventually, starting up the Indonesian plant, or Foxconn is starting up the Indonesian plant, to build our first joint design. So I think you might, unfortunately, see our handset volume not going to uptick, and maybe even shrink a little bit, before we bounce back.

So you have to factor that in. I would say my estimate is probably middle of next fiscal year, because we’re going to launch it in March-April in both channels, in our channel as well as in Foxconn’s channel. So it’s going to take a little bit of time. So that’s how you should think about it.

In terms of the debt, yes, I believe that this is about correct, about our bottom and top of the software numbers.

James Yersh

Agreed.

John Chen

About the bottom of the numbers. You should start seeing uptick. My number one focus is to build the field and account engagement from the ground up again, and invest in that. That will take a little while, but on that score, we are seeing some of the trials coming on to switching online. You see that we have the numbers. They’re laid out, like 31,000 BES10 servers out there. Of course, not every one of them is in production, but that number grew from 20,000 a quarter ago. So I believe that that will be [bottom]. I’m comfortable with that, at least for now. QNX will grow, and BBM, in investment mode. So that’s the first question, right?

And what was the follow up question?

Maynard Um – Wells Fargo

Just Blackberry and iOS and Android, if there were plans to move that over?

John Chen

We’d love to do it. I hate to just kind of articulate a plan. I will give you the statement. The one great thing about Blackberry is we are well-known, not only in security, but productivity. And I would love to find a way to make our Blackberry experience on the Android and the iOS. It’s not without difficulties, as you all know. But it’s something that we’re very interested in trying.

Operator

Your next question will come from the line of Ehud Gelblum with Citigroup. Please go ahead.

Ehud Gelblum – Citigroup

A couple of questions and clarifications. On the phones that Foxconn will be making, they are phones that they are making and designing? I was a little fuzzy on whether you actually sell them and/or gain any revenue from them, or does that just kind of expand the base? I wasn’t sure if that was something that accrues to you revenue-wise or not.

Can you give us an update, also, on the sub count? I know it was auspiciously missing from the press release. Just to give us a sense, in that sub count, how do you see the service revenue? Because that’s sort of the length of your runway that you’ve got to land the plane in. And it was down only 13% this quarter, not that bad. That sub count that you have probably gives us a sense as to how long that service revenue is going to last before your other pieces of the business have to start lifting up the whole company. So if you could give us a sense as to what the sub count, and then what your view of the service revenue looks like?

And then finally, on BES10, you have 30,000 companies, enterprises using it. Right now it’s now that they’re on free trials. How many of those do you expect to convert? And if we’re doing modelling, how should we look at the revenue from each one of those 30,000 as we go into fiscal ’15?

John Chen

On the Foxconn revenue, we are selling those handsets. In fact, it is a joint development manufacturing agreement, so as they are successful in selling a handset, that revenue will grow for us. So that’s the exciting part. We’re both going to sell it, and with the revenue we have, maybe [unintelligible].

On the design of that, it is completely BB10. All software designs will be provided and will be managed by Blackberry. And the hardware design, initially, the first one we are jointly designing it, together. We’ve obviously taken advantage of their efficiency, their parts, their supply chain, and their ability with the logistics. It’s very impressive, as you all know.

But over time, I really would love for them to design more and more phones for me, from the handset point of view, and I just get our designers to design some really high-end, cool stuff. But that’s kind of my thinking. My plan is eventually it is going to be the right model for us.

I don’t know about the answer to the sub count. I’ll let James answer that question. Do you have the numbers? And the decline, interesting enough, it is about our model, 12-13%. There’s one thing. Blackberry does have very, very loyal customers. I have seen customer I have spoken with where the phone was about to fall apart, the BB7, and they’re still using it. And so there might be a longer tail than most people think.

And so I’m not counting on it, that it will be an upside to our model. And of course I’ll also ask James.

James Yersh

I would say that there is some volatility to that number, but we’ve been fairly consistent on our decline for the last couple of quarters, even in terms of the revenue decline. But, you know, I think the last couple of quarters we’ve been fairly consistent. So for modeling purposes, I think that’s a good estimate to use going forward.

Ehud Gelblum – Citigroup

The same? Low to mid-teens decline?

James Yersh

I think you’re thinking about it right.

Ehud Gelblum – Citigroup

James Yersh

Definitely we still have a strong customer base that will be using the server, so we expect it to start materially contributing kind of as I said in my prepared remarks, in fiscal ’15. There’s still a lot of demand for the product, and we expect the conversion rate to start to pick up. In terms of [quantum], it should, as we go forward, as adoption continues, kind of replace where we go now. But effectively our aspiration is for it to exceed it and to start being a more significant contributor of our revenue profile going forward.

John Chen

Also, the other thing is, I’m really excited about the potential selling or offering more different features on the BES10. So I’m really looking at BES10 as a base server, and there will be other options that I will take into the market. For example, just for one, enterprise BBM, for the regulated industry, it’s a really really strong offering, from a compliance, audit, and privacy, secure environment. And you guys know a lot about our messaging system. I think that’s also an addition to the BES10 that we’ll differentiate ourselves against other competitors who have just the basic, vanilla MDM, for example.

Operator

Your next question will come from the line of Peter Misek of Jefferies. Please go ahead.

Peter Misek – Jefferies

Firstly, on the clarification, can you help us understand tax refunds, how much they benefited cash flow in the quarter? Cash flow was clearly a little bit better than we would have been fearing and modeling. And then as we look at the strategy for handsets going forward, notwithstanding the Foxconn partnership, if you could help us understand how the carrier relationships are, and how to reengage them, whether you’re going to reengage them, on both the consumer and business side.

James Yersh

I’ll take the first one. In terms of the tax refund, as I mentioned in my prepared remarks, it was a significant number. We’re going to file our disclosure documents this afternoon, and more details will be provided in the cash flow reconciliation, when we do that.

John Chen

As far as the strategy, yes, I’m already in touch with Verizon and AT&T, as well as I’m going to be in touch with other phone and a number of really key carriers around the world. And they’re very interested in our enterprise offering, so the enterprise side I could feel comfortable in telling you that we have established various different reengagement models and engagement models.

On the retail side, I’m still working on it. This has been a good thing for me to work on, and I can’t really tell you a lot about how successful we’re going to be. Of course, we want to be successful, but this is something that will take a little bit of time to do.

So regarding the strategy of the handset, we’ve talked about the Foxconn JDM and we also spoke about the fact that we’ve got to focus ourselves on building high-end handsets. And we’re probably going to continue to work the JDM angle more so than anything else.

Operator

Your next question comes from Gus Papageorgiou of Scotia Bank. Please go ahead.

Gus Papageorgiou – Scotia Bank

Just a couple of questions. Just on the handsets, just so I’m clear, basically, you’re going to rely on Foxconn to both help you design and manufacture handsets for the developing, fast-growing markets, which are generally lower to mid-range ASPs. But it sounds like you’re still going to maintain your own designers for the higher end markets and the enterprise and the Western world, North America and Europe.

I’m just wondering, how do you plan to position these devices in the Western world. Clearly there’s been challenges there. Are you strictly going to address the enterprise? Is that the strategy for the developed markets? Or do you think you can still maintain the high-end consumer.

And then James, just for you, this is the second quarter in a row where you’ve recognized your devices in terms of revenue that you shipped. Should we expect that at some point the revenue recognition will come in and that we will see the revenue from the devices that you’ve been shipping?

John Chen

For the foreseeable future, our designer in North America will focus on enterprise handset only. This does not imply, again, that over the long term we’re not going to get ourselves back into the consumer space. But in the next foreseeable future, until we get our financials back on solid footing, that is what we are going to do.

Most of all, the other designs, I’m going to rely on Foxconn to do, including the one that we will take to the [unintelligible] countries and the developed Western world. Those designs, we already have an agreement with Foxconn. Those devices will be jointly developed, but I’m hoping that they do more hardware and I do more software. And we’re going to manufacture and build that from their Mexico plant.

So they would do it at the Mexico plant, so in a NAFTA country, to supply to the developed and Western markets. So more and more this is a truly collaborative partnership.

James Yersh

So over to your question on deferred revenue. The activity in the quarter basically resulted in channel inventories going down overall, on an absolute basis. And so if you look at the balance sheet, and the deferred revenue continuity specifically, you actually see a decrease from Q2 to Q3. So I think some of the phenomenon that you’re asking about going forward, you’re starting to see happen in this quarter.

Now, we’re going to continue to work with our carrier partners and some of our enterprise customers, as John described, to make sure that flow through continues, even within some of the challenges we’ve faced recently. So definitely I would expect that deferred number to start coming off the balance sheet.

Operator

Your next question comes from the line of Mark Sue of RBC Capital Markets. Please go ahead.

Mark Sue – RBC Capital Markets

Thanks, John, for not being a lawyer.

John Chen

[Laughs] Probably the lawyer will want to talk to me right after this meeting.

Mark Sue – RBC Capital Markets

If I look at the high-end enterprise, Blackberry has been under attack on so many sides, for many years. And many of your customers, even the most loyal, seem to have made contingency plans. We understand the risk transfer to Foxconn, yet the competitive landscape remains the same. You have one large competitor who’s combining hardware and software. The other has an open OS. So if I’m an enterprise customer, what do I get from Blackberry that I didn’t get before, even with the changes that you’re making now?

John Chen

First of all, I would have to be very security based. That’s number one. We are the only one where you actually have end-to-end security. We have the handset, the best, the messaging, and any of the embedded machine-to-machine. Of course, our NOCs. We are also, in many of the government arenas, we are on the highest end rights to operate. For example, in the United States defense and high end defense government environments, as well as in NATO.

So I think this heritage is something that we have kind of shifted away from, or not paid attention to, for a little while, and I’m going to come right back to it. In that environment, in that secure environment, for a regulated industry, we’re going to add more features and more integrations, both on the communications side and the productivity side of the equation.

So this is going to be coming back and challenging the people who are trying to attack our base, so to speak. You are correct. This is by no means a stand down to be done. But it’s worth a fight, and I think it’s a good opportunity and a good probability of winning.

Mark Sue – RBC Capital Markets

Would it be fair to say that you’re narrowing the number of verticals? So you’re not going after the enterprise verticals as widely as before, but it’s just a narrow, specific, and deeper penetration into these critical secure verticals?

John Chen

For the immediate future, I am going to focus on the regulated vertical. I’m building a sales force to go after that.

Operator

And your next question will come from the line of Amitabh Passi with UBS. Please go ahead.

Amitabh Passi – UBS

John, sorry to beat a dead horse, but I am a little confused about the device strategy here. Why even bother to stay in the devices business? I think there’s only two companies in the industry that have tremendous scale, that make money. So just trying to understand your strategy. Would you be happy having a breakeven devices business and then just monetizing software and services? That was the first question.

And then maybe James, if you could just clarify how we should be thinking about opex for the next quarter?

John Chen

Great question. Yes, the short answer to your question, yes, I’ll be happy to have a breakeven or low-margin device business and then have that help us to monetize software, services, by providing an end-to-end solution. However, I don’t think the jury is out. The one reason why the last 45 days, what I worked on, with the Foxconn arrangement and some of the internal arrangements and investment areas, is to make sure that we don’t lose money from the device business. And then I’m going to examine that maybe as soon as we get stabilized.

This is going to be an ongoing conversation. I don’t have any preconceived notion of we have to do it this way versus the other way. I just want to make sure that we serve our customer well, and people want to buy our stuff, and make money. And that’s what I want to make sure we do.

James Yersh

So, speaking of making money, coming to the opex part of your question, definitely the target that I laid out, the reductions compared to the Q1 base of earlier this year, probably implies another 10% decrease or so. If you just go back and look at the levels versus where we’re targeting to take the program. And of course, as I said before, it’s not necessarily that we’re going to stop there. We’re going to look to continue to turn over every rock and look for every dime that we can.

Operator

Your next question will come from the line of Kulbinder Garcha with Credit Suisse. Please go ahead.

Kulbinder Garcha – Credit Suisse

A question for John on the services stream. Today your services, as I understand it, are all linked to your subscriber base. And we were kind of under the impression from the previous management that number one, your subscriber base is probably going to shrink. I think it’s safe to assume that. But also that the transition within your Blackberry subscriber base, as you go from BB7 to BB10, where the subscriber activity has significantly dropped.

And so the question I really have is is that really the dynamic? Especially as you’re emphasizing the unit run rate in the device business, why wouldn’t that services stream see an accelerated decline going forward? I’m kind of confused as to why that wouldn’t happen.

And then on things like BBM, my follow up is kind of linked to this, how do you exactly monetize that? Because there’s lots of these messaging apps out there that are free or integrated. I’m just trying to understand if you think this is going to be an advertising business model? Do you think you’ll actually get paid by the consumer users, or the enterprise users, or is it bundled as part of enterprise services? Any clarification there would be helpful.

John Chen

Good question. I don’t have a formulated idea. I will have to come back and report to the group here as time progresses on how we monetize it, on the BBM side. Yes, currently most of our services fees, the majority of them are tied to the SAF, which is the services activation fee. And that number, as James pointed out, is going to come down on a quarterly basis, probably in the mid-teens or 10-12% area. And we have 13% last quarter. So that’s where we’re expecting to see it.

However, the BES will kick in. That will offset some of the decline. That ties to the BBM question. We launched the enterprise BBM, so it will be a service that we’ll offer in conjunction with our BES strategy, and I think the model is going to come from enterprise paying from the per-user, per month model. I would not rule out the monetization from advertising model. But on the other hand, at this point in time, I think we’re very far away from knowing how to do it. That doesn’t mean we cannot do it for a partner, but it’s far from doing this. It’s not in my math. But it’s an opportunity.

Operator

Your next question will come from the line of Rod Hall with JPMorgan. Please go ahead.

Rod Hall – JPMorgan

On Foxconn, I’m still not completely clear how you guys pay Foxconn for management of the inventory. So maybe James or you could comment on how the accounting is impacted. Do we see lower gross margins as those devices mix in, or some other costs coming through for that?

And then it would be great if we could get a little more detail on the asset impairment. I assume mostly the devices business, but were there other things like the NOC that you might have impaired in that impairment as well? Just maybe walk us through the big chunks of that. Maybe James could do that.

And then lastly, you were asked about Android and iOS strategy. Could you just give us some indication of when you might be willing to go public with what your plans for an enterprise application for Android and iOS might be?

James Yersh

I’m going to take the first two aspects, and then I’ll let John take the iOS and Android one. The Foxconn relationship, I think you referred to them paying us for inventory, and that’s not the model.

Rod Hall – JPMorgan

Oh no. Just to be clear on that, I was asking what you might pay them. Because obviously, if they’re managing inventory for you, there’s some value transfer from you to them, probably. And I’m just trying to get a feel for what that looks like.

James Yersh

Okay. So here are the big benefits for us. Maybe one layer lower than we’ve been talking about. What Foxconn is going to do for us, if I’m thinking about margin holistically, is we’ve talked in the past about our fixed cost base associated with manufacturing and some other costs. Moving things to them basically gives us relief on that. So that’s more of a cost avoidance type of thing.

And you’re right that they are going to take on some of the risk of excess and obsolete inventory. But that will be built into the product cost, effectively, that we pay them for. So the model that we have with them is, of course we’re going to be paying them for the built product, but we’re going to resell it, so there’s some margin that’s inherent in doing that.

And of course that margin, where we are as a handset business, is much better than what we’re getting here today. So if I’m just thinking about hardware and devices margin, I can get some benefit as we move that relationship almost immediately, from just fixed costs and that particular model.

Moving on to the asset impairments, definitely the bulk of the impairment related to intangible assets and not our own patents, really some of the past investments we’ve made in licensing agreements and effectively prepaying those.

So we had a balance sheet that was skewed to a high growth hardware devices company, which as you can appreciate from John’s comments, we’re at a reset point. We’re pivoting to something else. So definitely the largest portion of that was associated with that type of asset, and not the network operating center that you just went through.

John Chen

I’ll come back to the iOS conversation, but since I helped negotiate the contract with Foxconn, I’m sorry if there’s a little bit of confusion. It’s actually pretty straightforward. We both, Foxconn and Blackberry, will be joining forces to design a number of devices. The first device is going to come out, as I said, in the March/April timeframe. And so that you all know, I already held one in my hand, that actually runs our BB10 software.

And we have some identified markets that we go after through both of our distribution channels. That first device is going to be built in Indonesia. They will carry all the inventory. They will provide a bill for materials, their logistics to acquire the supply chain, and then of course it will transfer to us at that manufacturing cost, which is, by the way, much lower than what we’re doing today. And of course we will no longer pay for fixed costs or inventory exposure, which was the number one thing that I wanted to go after.

Then we of course have our software costs on top of that. Then will will bring it back out to the market when they sell it, and we sell it, and we’ll take the revenue off that sale. And there is an agreement that if the volume gets to a certain amount, that they also should start sharing some portion of the margin. We do enjoy the majority of the margin of all the handset sales.

So I hope this is a little clearer. If I’ve further confused you guys, we’ll have to talk offline on that. Regarding iOS and Android, I’m working hard at it. So I’m going to have to ask you guys to be a little bit more patient and give me a little break here. Because I’ve only been here 45 days. So it will probably take me another, I don’t know, one or two quarters to formulate that strategy in my head and with the team’s support and advice. And in addition to that, obviously, we also need to kind of tap various people in the ecosystem to make sure that we’re not just smoking our own stuff here. So collaboration is very important.

So it’s too early for me to talk about it. The only thing I can promise you is I’m working hard at it.

Operator

Your next question comes from the line of Tim Long of BMO Capital Markets. Please go ahead.

Tim Long – BMO Capital Markets

First, on the MDM, mobile device management, specifically, I think you mentioned about 80,000 subs or so in the press release this morning. So obviously much bigger than your Blackberry enterprise sub base. Would just love some thoughts there on kind of how that splits between Blackberry devices and other, and maybe just talk about the monetization there and how that might be different on your devices and other devices.

And then secondly, back to the devices, specifically on gross margin, it looks like a pretty deeply negative number for hardware gross margin this quarter. Just talk a little bit about the timing for that return back to positive.

John Chen

The second one is the easier one. You can look at our total numbers and financials. You can see that the negative part predominantly comes from our handset business. We talked in the last hour on the whole Foxconn equation, and James talked about our cost reduction and purchasing obligation, and inventory clearing costs, and obsolescence.

You know, all that combined, this will tie to our ability to become cash flow positive and profitable. And so you should be looking at it towards the end of fiscal year ’15, sometime early in fiscal year ’16 as our targeted date for that to become hopefully a positive number, but at least not a negative number.

And regarding the MDM, we sell it as server licenses. So I don’t think there’s any difference whether we’re managing an iOS device or Android device, or Blackberry devices. You know, because we’re in the business for so long, this is why the numbers are a lot bigger than everybody else in terms of installation. We need to refresh that.

This is our base to go in and reengage the market and engage with our customers to be able to offer other, beyond MDM. Like I said, the productivity suite, identity management, all the security features, and BBM, of course. The list goes on. And so this is exciting because it’s at least an opportunity for us to go back and reengage and get focused on that part of the business.

Operator

And your next question will come from the line of Simona Jankowski of Goldman Sachs. Please go ahead.

Simona Jankowski – Goldman Sachs

Just had a few questions on the cash side. You mentioned in the press release something about a significant tax refund in the first half of next fiscal year. Can you just give a little more color on the magnitude of that. And then is this a sustainable level of capex for you here, or should that bounce back higher in future quarters? Similarly, on the trends on the intangibles, about $ 230 million in the quarter, is that a sustainable level, or should we expect that to go lower? And then just lastly, given that you’re reducing the fixed cost base, is that already reflected in the writedowns this quarter so that on a go-forward basis we’re going to see that in this new run rate in the operating cost of business? Or is there yet another step down to look forward to?

James Yersh

I’ll start with your tax question. Two things about tax. We did get a tax refund, as I said in my prepared remarks, in the quarter. And we did, in our last quarter’s filings, talk about future tax refunds. So both of those components are relevant. And as I said before, we will provide further details in our disclosure documents this afternoon.

In terms of capital spending, I think in terms of steady state business, the current levels are appropriate. But as John and I have been talking about, we know that investment is going to be required. So we have the capital to make those investments, we’ll go about it wisely, but we know we have to invest. And capex will be part of that to allow the other businesses to grow.

On the intangible spending, I did give an end date at least to the bigger drivers of our spending. You know, $ 500 million as of the end of Q3. That will terminate or be done by our Q3 of fiscal 2015. Now, it will step down, probably in the first or second quarter a little bit. But once we get to Q3, I would expect that number to decrease drastically.

And finally, on the fixed cost base, if I’m thinking about depreciation, yes, some of the benefit was reflected based on the writedown, but as we talked about ad nauseam almost, with the Foxconn discussion, there’s a lot more that we need to go after on the fixed cost base that we can, not only with Foxconn and moving to that relationship, but that we need to look at as management and come up with some efficiencies there.

Operator

Your final question will come from the line of Ben Bollin with Cleveland Research. Please go ahead.

Ben Bollin – Cleveland Research

Looking at Blackberry 10 as the platform, it arguably hasn’t been terribly successful. And I’m curious how you’re thinking about the platform going forward and what features, functions, capabilities can you do with that to improve adoption in the future.

John Chen

Good question. Yes, it is something that the result is less than desirable. I will say that. But as I said earlier, a number of times, there are a lot of features I want to add that are in the productivity area, communication area, security areas, messaging areas. And well, I guess messaging is part of productivity and communication as well.

So I think about us providing those suites on the BES10, and also making sure it’s operating system agnostic. So I don’t have the line by line functionality, but I have groups of people working on it right now that define what that Blackberry experience and Blackberry advantage is going to be.

But it’s going to literally help our customer using BES10 as the basis to securely communicate and securely make it a work engine, so to speak, especially in the mobile world and also machine-to-machine and also payments, the whole bunch of things that we have identified that we need to do. And some of them will be organically done. Some of them will be inorganically done.

And I hope by now all you realize that going forward we have a reasonable plan to invest, and it’s already a very clean balance sheet. We have good cash coming in. We’re strong in cash. We’re no longer worrying about whether we’re going to be around.

And then I have certain areas where I would like to really beef up. We talked about it already a lot. And we have a good relationship on the manufacturing side of the equation that takes away the biggest chokehold on the company in the last two or three years. And now we’re ready to fight back.

Ben Bollin – Cleveland Research

If you look at your installed base, just the users who are currently paying service revenue, what’s the mix of existing enterprise users versus kind of consumer type users?

John Chen

I think the majority, 80-plus percent, are enterprise users.

Okay, thank you very much. I really appreciate it. I enjoyed the call. I hope you did too. And James and I look forward to having an ongoing dialogue with you all, especially since we’re going to do this quarterly discussion in this kind of format going forward. And have a good day, and I hope you guys support the company.

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