Research In Motion Limited F1Q07 (Qtr Ending June 3, 2006) Earnings Conference Call Transcript (RIMM)

Jun.30.06 | About: BlackBerry Ltd. (BBRY)

Research In Motion Limited (RIMM)

F1Q07 Earnings Conference Call

June 29, 2006 5:00 pm ET


James L. Balsillie - Chairman and Co-CEO

Dennis Kavelman - Chief Financial Officer


Andrew Lee - TD Newcrest

Maynard Um - UBS Securities

Rob Sanderson - American Technology Research

Jeffery Kvaal - Lehman Brothers

Gus Papageorgiou - Scotia Capital Markets

Mike Abramsky - RBC Capital Markets

Paul Coster - JP Morgan Securities Inc.

Peter Misek - Canaccord Capital

Richard Windsor - Nomura International

Tim Long - Banc of America


Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the First Quarter Fiscal 2007 Results Conference Call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. Instructions will be provided at that time for you to queue up for questions. If anyone has any difficulties hearing the conference, please press star, zero for operator assistance at any time.

I would like to remind everyone that this conference call is being recorded on Thursday, June 29, 2006, at 5:00 p.m. Eastern. I will now turn the conference over to Mr. Dennis Kavelman, CFO. Please go ahead, sir.

Dennis Kavelman

Thank you, and welcome to RIM’s fiscal 2007 first quarter results conference call. With me is Jim Balsillie, RIM’s Chairman and co-CEO. After reading the required forward-looking statements disclaimer, I will begin by providing an overview of first quarter results as well as our guidance for Q2. I will then turn the call over to Jim who will provide a business and strategic update. We will then open up the call for questions.

I would like to note that this call is available to the general public by a call-in number and webcast. Replay of the webcast will be available on the website. We plan to wrap up the call at 6:00 p.m. Eastern this evening.

Some of the statements Jim and I will be making today constitute forward-looking statements within the meaning of the United States Private Securities Litigation Reform Act of 1995 and applicable Canadian securities laws. These include statements about our expectations and estimates with respect to revenue, gross margin, operating expenses, stock option expense, Cap-Ex, depreciation amortization, investment income, earnings, earnings per share, and ASP’s for Q2 and beyond, our expectations regarding RIM’s near- and long-term tax rates, our estimates of the number of BlackBerry subscriber accounts, subscriber account additions and other non-financial estimates, our product development initiatives, developments relating to our carrier partners, new and expanding markets for our products, and other statements regarding our plans and objectives.

We will indicate forward-looking statements by using words such as “expect”, “anticipate”, “estimate”, "may", "will", "should", "forecast", "intend", "believe", and similar expressions.

All forward-looking statements reflect our current views with respect to future events and are subject to risks and uncertainties in assumptions we’ve made. Many factors could cause our actual results, performance or achievements to be materially different from those expressed or implied by our forward-looking statements, including risks relating to our intellectual property, our ability to enhance our current products and develop and bring to market new products, our reliance on carrier partners to grow our blackberry subscriber base and to accurately report subscriber account activations and deactivations to RIM on a timely basis, risks relating to competition, risks relating to possible product defects and product liability, our reliance on suppliers, our ability to effectively manage our growth, risks associated with our expanding foreign operations, general economic conditions, foreign exchange risk and other factors set forth in the risk factors and MD&A sections in RIM’s filing with the SEC and Canadian securities regulators.

We base our forward-looking statements on information currently available to us and we do not assume any obligation to update them.

We are pleased with our results for the first quarter, as subscriber additions were in line with our forecast and revenue and earnings were slightly higher than our April forecast. Revenue for the first quarter ended June 3rd with $613 million, our highest quarter ever, which is up 9% from the prior quarter and is slightly above the top-end of the range we guided in April.

Handheld devices represented $433 million, or 71% of revenue, consistent with the previous quarter. Total devices shipped in the quarter of approximately 1.2 million was up from 1.1 million in the prior quarter.

In addition to new devices going to new users, device upgrades continued to be strong in Q1. Of the 1.2 million devices shipped in the quarter, approximately 1.1 million were sold through to end users, with the remaining 100K going into the channel, largely due to initial stocking by carriers of new handsets such as the 7130 and 8707.

The increase in quarterly handsets sell-through rate means that overall weeks of channel inventory remained approximately the same as at the end of Q4 at reasonable levels as we expected. We expect a strong, upgrade trend to continue going forward.

Average device ASP’s increased to approximately $357. This was slightly higher than expected and was product mix related. We expect ASP’s to be approximately $350 in Q2.

Service revenue was $117 million, or 19% of revenue, flat with the prior quarter. Q4 service revenue was abnormally high because it was a 14-week quarter, so the $117 million for Q1 is actually a run-rate increase and in line with our expectations.

RIM added approximately 680,000 BlackBerry subscriber accounts during the quarter, which was in line with our April forecast. The total base of BlackBerry subscriber accounts at the end of the quarter was approximately 5.5 million. Approximately 26% of our total subscriber account base was outside of North America, up from the previous quarter.

I would like to note that we round the total base number to the nearest hundred-thousand. We did have some subscriber account base adjustments during the quarter due to reconciliations of a few North American to European carriers, but the total was in the several tens-of-thousands, not nearly the scale of the adjustments we had last year. We continue to work with the carriers to improve their systems and expect these adjustments to continue to decrease in size and frequency.

As expected, software revenue was higher than the prior quarter at $43 million, or 7% of revenue.

Other revenue, such as accessories and repairs, was $20 million, or 3% of revenue.

Gross margins for the first quarter increased slightly to 55.1% from the 55% in the prior quarter. This was at the high end of our forecasted range, as software revenue rebounded from Q4 levels and ASP’s were slightly higher than forecasted.

R&D spending was $51.5 million, or 8% of revenue for the quarter, slightly higher than the April forecast. As expected, selling, marketing and admin expenses increased by 16% to $107 million versus $92 million in Q4, and was 17.5% of revenue.

The tax rate for the quarter was in line with our forecast at approximately 26%. Taxes in the same quarter last year were lower than the current year due to a one-time favorable tax ruling relating to investment tax credits. So if you’re looking at year over year comparisons, you have to look at the adjusted table in our press release from last year. We expect this 26% rate to continue in Q2.

GAAP net income for Q1 was $129.8 million, or $0.68 per share diluted. Excluding stock option expense of $4.4 million, adjusted net income was $134.2 million, or $0.70 per share diluted. This was above the high end of the range, which makes sense given higher revenue, gross margin, and in line expenses. The GAAP reconciliation of our adjusted EPS was included in the earnings press release we issued this afternoon.

Weighted average diluted shares used in the GAAP EPS calculation for the quarter were 192.1 million. Actual shares outstanding at June 3rd were 186.5 million, and total options outstanding were 8.5 million.

RIM’s balance sheet continues to be strong, with substantial cash reserves and appropriate working capital balances. At the end of the first quarter, RIM had approximately $1.26 billion in cash, cash equivalents, and investments. This was up $6.5 million from the prior quarter.

Uses of cash during the quarter included the Ascendant acquisition as well as cap-ex of $44 million. Cap-ex was lighter than planned in Q1 due to the deferral of some real estate acquisitions until Q2. As a result, we expect cap-ex to be higher than normal in Q2 at approximately $110 million to $120 million, due to this investment of BlackBerry infrastructure and expanded campus facilities. We expect Q3 cap-ex to be lower than Q2.

From a working capital perspective, trade receivables were up from the prior quarter due to timing of shipments, and inventory was flat with the prior quarter. I expect trade AR to decrease in Q2.

At this time, I would like to discuss our outlook for Q2. Again, a reminder that these forward-looking statements reflect management’s best current estimates and should be taken in the context of the risk factors listed at the beginning of the call and outlined in our public filings.

As we have discussed every year, and talked about on the last conference call as well as at the capital markets day in May, the August quarter is typically affected by summer seasonality in both North America and in Europe. Europe is typically affected to a greater extent than North America. This weakness is most evident in subscriber account additions and in service and software revenue. Simply put, our corporate customers take holidays in July and August. They all take their BlackBerrys with them on vacation, but they are not activating as many new users until they come back in September.

This being said, we work hard with our carrier partners to execute channel programs to encourage people to continue buying during this period and keep positive momentum. We’re forecasting second quarter revenue to be higher than Q1 in the range of $620 million to $650 million. Handset shipments are expected to remain strong, with our new products now broadly available and continuing healthy upgrades, and we are encouraged by a stronger order book than we would normally have, relative to our forecast this early in the quarter.

In Q2, we expect software revenue to be steady with Q1, and for normal growth in service revenue.

We continue to be bullish about the growth prospects for the second half of the year for both existing products and expected new products.

We expect subscriber account additions to be up slightly from the first quarter in the range of 675,000 to 700,000. To give a little color on this, our average weekly run-rate in Q1 works out to just over 52,000 per week. So far in June, we are over 55,000 per week, which would extrapolate to a full quarter subscriber number of well over 700,000. While we are certainly going to work very hard to hit the 700,000 mark, I think it’s prudent to be conservative, given expected August seasonality. As with revenue, we expect growth in subscriber additions to accelerate in the fall.

We expect gross margin for Q2 to be in the range of 55% to 56%, higher than the previous quarter, mainly due to positive hardware product mix as well as continued build of materials and scale efficiencies.

We expect a total operating expense increase for Q2 of approximately 8% from Q1 levels.

We expect R&D to increase by approximately 9% in Q2, and continue to be 8% to 9% of revenue. We continue to invest in many areas of R&D to support plans for new hardware and software launches in the fall/winter time frame, as well as BlackBerry Connect and new carrier launches.

We expect sales, marketing and admin to increase by approximately 5% to 6% in the second quarter. We expect sales, marketing and admin to continue to be approximately 17% to 18% of revenue in Q2. We continue to anticipate increased marketing and branding activities beginning in the fall to capitalize on new product introductions.

In Q1, RIM began recording employee stock option expense in accordance with FAS 123. We estimate this expense to be approximately $4 million to $5 million in Q2, consistent with the $4.4 million in Q1.

The gross margin and op-ex guidance provided on this call does not include stock-option expense. We will provide earnings guidance, including and excluding stock-option expense, and our GAAP financial statements will have stock-option expense allocated to appropriate cost of sales and operating expense accounts.

We expect depreciation and amortization to be approximately $18 million to $19 million in Q2, higher than Q1 due to the new cap-ex I mentioned a few moments ago, as well as the recent acquisition of Ascendant.

Investment income is expected to be in the range of $12.5 million to $13 million in Q2.

As we discussed previously, we expect RIM’s overall tax rate to decrease over time as RIM’s international business activities continue to expand. We are currently expecting the Q2 rate to be approximately 26%, consistent with Q1.

We expect Q2 GAAP EPS to be in the range of $0.67 to $0.73 per share, and adjusted EPS, excluding stock-option expense, to be $0.69 to $0.75 per share.

I will now turn the call over to Jim.

James L. Balsillie

Thanks very much, Dennis. We are pleased that RIM’s fiscal 2007 got off to such a great start. Subscriber account growth was strong in both North America and the rest of the world, and revenue and earnings were slightly higher than the levels we forecasted back in April.

We are seeing momentum return in our carrier channels, and enterprise customers are continuing to expand existing deployments and seek ways to extend the benefits of BlackBerry to many new areas of their businesses.

BlackBerry’s market leadership in the enterprise is translating into strong progress in the retail market. With almost 25% of our subscriber base using BIS, we believe that we are nearing the critical mass required to really grow our presence in the retail channel.

We have a number of initiatives underway to leverage our position. We will be finalizing these plans this summer in preparation for fall launches, and we look forward to sharing more details with you in the near future.

During Q2, we launched a number of new devices around the world, and the success of the 8700 series of device is continuing. We are pleased this quarter that T-Mobile became the second carrier to launch the 8700 in the U.S., and we saw a meaningful contribution to our subscriber base from this launch. T-Mobile is supporting its BlackBerry portfolio of products with an aggressive marketing and advertising campaign this summer.

This past quarter, RIM hosted the fifth Wireless Enterprise Symposium in Orlando. Attendance was exceptional, with 3,000 attendees participating in the three-day event. Sessions were held in three tracks, with over 100 partners showcasing leading edge wireless solutions.

I will now provide you with a business and strategic update.

We continue to add new carrier partners at a rapid rate, with 29 added this quarter alone, and many more in backlog. Partners recently launched include Etisalat in the United Arab Emirates, Si.mobil in Slovenia, Entel in Chile, NTELOS in the U.S., LUXGSM in Luxembourg, and Amena in Spain. They launched with aggressive EURO15 per month pricing on BlackBerry.

We have also finalized agreement with Alcatel to work with carriers throughout Africa, Asia, and the Middle East to bring BlackBerry to these markets. This past quarter, RIM launched the first UMTS-enabled BlackBerry device, the 8707V with Vodafone. This product was launched across multiple Vodafone properties around the world, and the initial response from customers has been very positive.

This quarter, we also launched the 7130 device for Edge networks with multiple carriers around the world, including O2, Cingular, Rogers, Telstra, Optus and Vodafone. The 7130g and 7130c devices offer slim handset design and feature the popular SureType keyboard, increased memory, and the same fast processor as in the 8700 series products for Edge networks.

The BlackBerry 7130e for EVDO and BIS 2.0 was launched by Sprint into all channels on June 1st. Sprint is supporting this launch with two pricing promotions: an instant discount of $130 off the hardware price, bringing down the advertised price of BlackBerry 7130e to $199; and offering the data service price at a reduced price of $39.99 a month, which includes BlackBerry tethered modem usage as well. Sprint is running an extensive advertising campaign to support this launch, consisting of television, print, and online media vehicles throughout the summer. BlackBerry has also recently become available through Sprint’s online stores, and there have been a series of launch events and seeding programs held throughout key markets in the United States.

Cingular has increased its focus on the retail channel this past quarter with the launch of the 7130e and BIS 2.0. Cingular is supporting these efforts with an aggressive new pricing plan for BIS service of $29.99 a month. This quarter, Cingular also became the first carrier in the United States to offer the Nokia 9300 with BlackBerry Connect.

Our activities in Latin American are progressing well. Since the last call, we’ve launched BlackBerry in a number of countries throughout the region, in both the retail and enterprise channels, and we’re now seeing strong early adoption.

We also have entered into an agreement with American Mobile to expand BlackBerry into countries beyond Mexico.

In addition, Brightstar has now launched distribution of BlackBerry throughout Latin America.

We are continuing to gain grounds in Asia-Pacific. The BlackBerry 8700 was launched with numerous carriers throughout the Asia-Pacific region in Q2. These launches were supported by extensive advertising and sales and marketing campaigns by our carrier partners. The new BlackBerry 8700 devices have garnered a lot of positive customer feedback and healthy demand. Overall, BlackBerry adoption and sales across the Asia-Pacific continue to grow strongly.

China Mobile launched BlackBerry service in mainland China. China Mobile is now offering BlackBerry-enabled SIM cards with the 31 provincial operators who comprise the China Mobile nationwide network. They are initially targeting multi-national corporations with operations in China. We expect to announce later this year the availability of BlackBerry product, including RIM devices and BlackBerry Enterprise Server for the mainland China market.

Significant new carrier relationships in Asian markets were also announced in Q2. PCCW Mobile launched BlackBerry in Hong Kong, and is now offering BlackBerry 8700g, BlackBerry 7100g, and BlackBerry 7290 for both corporate and individual customers. KT Powertel launched BlackBerry in South Korea, and with the 7100i together with the BlackBerry Enterprise Server. NTT DoCoMo announced plans to offer BlackBerry in Japan this fall. Taiwan Mobile announced plans to offer BlackBerry later this year.

For an enterprise update, while BlackBerry remains very strong in the enterprise, in large enterprises, we are increasingly making in-roads into the small- and medium-sized business market as well. We recently announce BES Express, which is a new offering targeted at small and medium businesses, branch offices, and companies new to BlackBerry. BES Express provides the same enterprise level security, reliability, features, and functionality as the BlackBerry Enterprise Server 4.1 and is available as a free download from RIM via the Internet to any customer who purchases a new BlackBerry.

This new offering gives small businesses, which may have otherwise found the cost of BIS too prohibitive to try, an opportunity to experience the industry-leading features and security of BlackBerry. Should the customer wish to add more users to the BES, they can purchase a key and license to open up the BES to more users.

We have seen an excellent response to this new offering, both from our channel and from our end users. We have already had several thousand downloads of BES Express from our website.

At WES, we announced the BES for MDS applications, which is targeted at organizations looking to easily mobilize applications and have the flexibility to run them independent of wireless e-mail deployments. This allows corporations to extend applications to mobile workers that do not have mail accounts, or do not require wireless e-mail, with all the same enterprise class security and manageability the BlackBerry is known for.

In addition, BES for MDS offers support for a host of applications that service providers can offer to their customers, independent of hosting an e-mail environment for those users. We have received very positive feedback from our channel and customers since the launch of BES for MDS.

We are making excellent progress with Ascendant systems, the enterprise voice mobility company RIM acquired in Q1. Ascendant has defined and is leading an entirely new category, known as Enterprise Voice Mobility. Enterprise enables us to securely extend the identity and function of a desktop phone to wireless phones and desktops, regardless of the underlying telecommunication equipment. In essence, we’re doing for the PBX what RIM did originally for desktop e-mail with BlackBerry.

The Ascendant system supports heterogeneous environments, including traditional and IP-based PBX’s from multiple suppliers and multiple wireless carriers. In fact, the Ascendant solution won a 2006 Stevie Award for the best new product or service in the telecommunications category at the American Business Awards ceremony this month.

In the midst of its integration into RIM, Ascendant has continued to generate sales to global 500 firms, including a recent 2000-user win for a major U.S. enterprise. We’re seeing incredible interest from investment banks, government agencies, defense firms, health care institutions, and manufacturing environments that need their employees to be immediately reachable, not only on the PBX but also with the traditional BlackBerry data environments.

We are excited about the potential of this entirely new, multi-billion dollar market, the underlying technology, and the demonstrated ability to deliver what we’ve seen from the Ascendant management team.

A retail update, as I mentioned previously, we’re seeing good traction in the retail channel. Close to 25% of our subscriber base is using BES, and we expect this strength to continue. BES 2.0, which launched globally in Q1, is seeing broad acceptance by carriers around the world. There are now almost 40 carriers supporting BES 2.0, and we expect this number to continue to grow. Telecom Italia became the first carrier in the world to offer pay-as-you-go pricing for BlackBerry, whereby customers can choose a BlackBerry pricing plan that is not flat rate and they will only be charged for the amount of data they consume each month. Since launch, the average bill has been just over EURO $7 per month, based on TIM pricing of EURO $3.6 per megabyte. We believe this is an exciting new model for growing BlackBerry adoption with a more price-sensitive, prosumer user.

Google Talk for BlackBerry, which has been available in North America for several months, was made available in Europe and Asia this past quarter, and we’ve seen strong adoption and use of the application. In addition, Yahoo Messenger for BlackBerry is now available through most of RIM’s carrier partners around the world, and offers support for six languages. We’ve also entered into partnership with Microsoft for MSN Messenger real-time MM solution and real-time Hotmail/MSN mail synchronization with the BlackBerry Internet service.

During the remainder of fiscal 2006, we plan to focus heavily on growing BlackBerry’s presence in this channel. We will continue to expand our partnerships with key Internet application and content providers to ensure that BlackBerry users have access to the personal data applications and features that they enjoy on their desktop. Over the next several months, we will launch new initiatives in terms of hardware and software to expand RIM’s market presence, and we plan to undertake a number of new marketing programs to further stimulate demand for BlackBerry in the small-medium business and prosumer markets.

For an update on BlackBerry Connect, this past quarter, Nokia announced the launch of their E-series devices and the availability of BlackBerry Connect on many of the devices at launch. Numerous Asia-Pacific carriers are launching the E61 with BlackBerry Connect, including SingTel and StarHub in Singapore, Indosat in Indonesia, Smart and Globe in the Philippines, Varti in India, and Optus in Australia.

Carrier launches in other regions are expected to follow in the coming months. Nokia is also offering the BlackBerry Connect client for the E61 to end users by a free download from the Nokia corporate website. This is the first of the E series products to be available for download and will be followed by similar downloads for the E50, E60, and E70.

In North America, we are seeing good momentum with Cingular sales of BlackBerry Connect on the Nokia 9300. Q1 saw the first launches of BlackBerry Connect of the Palm Trio, with SingTel in Singapore, Telstra in Australia, Optus in Australia, and StarHub in Singapore. These launches were well-received in market and carriers launched significant promotional campaigns to support the launches. We expect additional carriers to support BlackBerry Connect on the Trio in the near-future.

BlackBerry Connect is now available on 23 devices, and we expect many more launches throughout fiscal 2007.

In summary, we are pleased with our performance in the first quarter. We are looking forward to pushing ahead with our plans for strong growth in the second half of the year, fuelled by new products, partnerships, and marketing initiatives.

This concludes our formal comments. Due to the large number of people on the call, we ask that you limit yourself to one question per person. We plan to end the call today by approximately 6:00 p.m.

Dennis Kavelman

Could the Operator come on to handle questions, please?

Question-and-Answer Session


Thank you. Ladies and gentlemen, we will now conduct the question-and-answer session.

(Operator Instructions)

Your first question comes from Andrew Lee from TD Newcrest. Please go ahead with your question.

Andrew Lee - TD Newcrest

Jim, if you could comment on the state of growth year over year of the wireless e-mail market, primarily on the corporate side. If you look at the 680 you guys just delivered in this quarter and take the top end of the next quarter, you’re looking at around 13% to 15% year over year growth on net subscriber additions. I’m wondering if that’s the rate of growth of the whole market on the corporate side that you’re seeing, or there’s something specific happening with RIM’s subscriber base?

James L. Balsillie

Well, we’re pretty aware of what other solutions are out there and what they’re adding, and in spite of what is posturing, you know, we’re still the over-overwhelming market share leader and very, very high market shares, so much of our sales is really a proxy for the market. There’s no question the market continues to grow. There’s no question that there’s a resurgence setting up after all the IPR overhang and hype that was going on in the market in the last 6 to 9 months. All the misinformation and hype and that kind of stuff tends to do is slow down an overall market growth, so we’re definitely pleased with the growth surging back. We definitely think it’s set to surge very strong, though of course we have to guide flatly. I think it’s very fair to consider it a proxy of growth for the market.

Will the growth accelerate? We hope so. We expect it, but you never know until you know, but it’s definitely a market with a tremendous amount of growth going on, but we’re not seeing any end of the growth opportunities -- anything but. We’re not seeing anyone sort of taking some kind of share of what we’ve traditionally had. Those kinds of activities haven’t manifested themselves in the market yet.


Your next question comes from Maynard Um from UBS Securities. Please go ahead with your question.

Maynard Um - UBS Securities

My question is on hardware pricing, looking out longer term. How should we look at the hardware pricing, particularly in the consumer segment, given some of your competitor pricing, in particular for consumers? Do you think your end-to-end solution differentiation will allow you to maintain your ASP’s and your margins at the current levels? Thank you.

James L. Balsillie

Well, I mean, we’re actually ASP leaders in the high-performance converged devices, so in terms of -- when I mean leaders, I mean in terms of price competitiveness. You have to be very careful in mixing the commodity, low-end phones with the more conversed appliances, so when it comes to functionality and performance, I think we’re at the top of the class. When it comes to price and the value, I think we really lead the charge on that.

I think really what is happening in this industry is there’s so much innovation going on in the converged appliance space is that there’s obviously always kind of a price, ASP erosion on standard products, but there’s so much innovation going on in the devices in so many different dimensions that the innovation more than compensates for the sort of price erosion of sort of a standard product.

We’re just seeing a very, very dynamic space right now. I don’t think you’re going to see any radical shifts in ASP’s, and I think we’re incredibly well-positioned competitively, not only on price but also on functionality.

Dennis Kavelman

$299 right now on our retail targeted product is price leadership, and that’s priced into the carrier, because then they subsidize it down, and Jim talked about I think Sprint at $199 and others down in that price range.

The other key is that we’re working to drive costs down even faster than any potential ASP movement, so I think you’re seeing that reflected in us maintaining our margins and raising margin expectations for next quarter. On a long, long-term basis, I think there’s going to be stratified products for us. As I said at the analyst day, you know, there’s certainly going to be retail-targeted products. You could see different ASP’s, but our overall blended ASP has been holding in nicely.


Your next question comes from Rob Sanderson from American Technology Research. Please go ahead with your question.

Rob Sanderson - American Technology Research

Thanks, good afternoon. Congratulations on solid execution, guys. Maybe a quick housekeeping, then a real question on the housekeeping side. Dennis, could you give us any color on the breakdown of stock comp across the various expense lines? Then, a broader question, how do you really galvanize consumer adoption and really move beyond e-mail here? I think we’re seeing the beginning of what’s possible with the new processors, new networks, etc., but how do you take that to the next level? Do you expect that to be an iterative process, or do you see breakthroughs on the horizon?

Dennis Kavelman

Why don’t I do housekeeping first, and Jim can think about his response to your question. I’m not going to give you the exact breakout. The majority is split along with our employee base between R&D and sales and marketing. There’s a relatively small component in cost of sales, so I think it’s fairly even between SG&A and R&D.

James L. Balsillie

Rob, repeat the second piece?

Rob Sanderson - American Technology Research

I was just asking about how to really drive consumer adoption and move application beyond e-mail, and whether you think that that’s an iterative process or whether you see breakthroughs on the horizon.

James L. Balsillie

I think there’s a tremendous set of stuff going on right now. We have over 1,000 lifestyle apps on the BES right now. It’s happening. We’re seeing just a tremendous amount. With the public MDS and all the web services that’s going to drive, the network’s are going to be a platform for application, so we’re seeing a tremendous amount of stuff, not only on the portal and ISP and the Google-type maps, the MSN, the Microsoft Live, the Yahoo! Go, the e-bay’s, the Amazon, but all kinds of more niche type things, the more entertainment and more information -- when you start adding in media players and storage capabilities and image capture type things, I think without a doubt these things are happening and they’re iterative, but they’re happening in a positive, iterative way that’s up into the right. We’re enormously excited.

The other thing to keep in mind is that users, even if you’re corporate, you also have a non-corporate life -- I hope -- and so this idea of this kind of a life window for things beyond enterprise rings very, very true. With the root key type capability and the fact that with prepaid plans, people refresh their cards. Well, that’s a form of micropayments. It’s the same architecture to prepay a phone for $5 as it is to buy anything else.

There’s no question it’s iterative and evolutionary, but it’s absolutely happening right now. It is well beyond e-mail -- gaming, ticket purchasing, merchandising, information, IM, personalization -- and it’s going to lead to stuff beyond that. It’s just as exciting as the enterprise base.

It’s happening, and it’s growing very, very fast. In a couple of years, it’s gone from sort of nothing to a quarter of our user base, and it’s accelerating. There’s all kind of retail channel programs, and we definitely have products evolving to more suit that segment.

Yes, I think that’s an area where a smart person would pay attention and possibly be somewhat optimistic.


Your next question comes from Jeffery Kvaal from Lehman Brothers. Please go ahead with your question.

Jeffery Kvaal - Lehman Brothers

Thanks very much for taking the question. Just to dive into this a little bit more, could we circle back to the impact of the Q that you may have seen in your business? Certainly there’s been a lot of talk about that gaining some traction in the prosumer market. I’m wondering if that has shown up for you at all. Also, has it led Verizon to come back to you and say “hey, let’s talk about pricing” in any way? Thank you.

James L. Balsillie

Well, the Q, it’s not an inexpensive unit and you get the price that you get from it if you sign up for a two-year contract, so when it comes to price competitiveness, we’re fine on that. As you mentioned, Motorola gave an exclusive to Verizon and a CDMA product there.

I think the reviews that you read out there, they kind of accurately characterize what we’ve seen in the market. Just read the performance reviews and all that and seek out the scuttlebutt from those at Verizon, and I think they’ll give you a very fair characterization of what’s going on.

It was targeted, even though it was call sort of the “BlackBerry Killer” and this and that, which I don’t know who came up with it or whatever -- its impact wouldn’t even qualify as noticeable.

Jeffery Kvaal - Lehman Brothers

Even in the BES section of your crew?

James L. Balsillie

I guess I would say -- the way I would characterize it, its impact, I wouldn’t even put it in the category of noticeable.

Jeffery Kvaal - Lehman Brothers

Okay, all right, Jim, thanks very much.


Your next question comes from Gus Papageorgiou from Scotia Capital. Please go ahead with your question.

Gus Papageorgiou - Scotia Capital Markets

Dennis, a question for you. You guys are talking about launching new hardware targeted more to the prosumer than perhaps the retail, and you mentioned that you’ll probably going to look for increased SG&A spending in the fall, I guess to support these product launches and marketing efforts. I’m just wondering, do you think you’re going to have to kind of spend ahead of the product launches to stimulate demand, so we’ll probably see an increase in expenses before we hit the revenue? Or do you think they’re be in tandem? I’m just kind of wondering, as we look to the second half, is there a chance that this increased SG&A spending is going to hurt the operating margins?

Dennis Kavelman

Well, Gus, I think it comes together. If I was forecasting a big ad spend in the summer, then I would say yes, that was ahead of when we're expecting growth, but we’ve been pretty consistent in the second half of the year, meaning Q3, Q4. There’s no question that’s a period where we do every year spend more on branding and advertising.

This year in particular, with some focused launches, particularly at the global scope of what we do now, I think and I’ve said before that we’re going to be investing there. At the same time, as you said, it will be in tandem or in conjunction with these products shipping and flowing through to carriers and end users, so hopefully the two go together.

Gus Papageorgiou - Scotia Capital Markets

Just a quick follow-up then. For the most part, you really depend on the carriers as your channels to the market, and a lot of the advertising that we’ve seen have been largely through the carriers. Do you think you’re going to break that model and do more direct advertising on BlackBerry on your own?

James L. Balsillie

I think that’s a fair question, and my answer would be I think we’re going to advertise in tandem. Every now and then we really surge our brand positioning and all that stuff. We keep doing things in partnership with carriers for sure, but probably doing some complementary activities beyond that for a certain phase in the back-end of ’07 is probably a smart thing to do.

Gus Papageorgiou - Scotia Capital Markets

Great, thanks a lot.


Your next question comes from Mike Abramsky from RBC Capital Markets. Please go ahead with your question.

Mike Abramsky - RBC Capital Markets

Thanks very much. The service pricing trends, it was sort of -- maybe a similar question to what was asked earlier on hardware. Your subscribers were a little bit above what we were expecting, certainly, but your service revenues are a bit softer. I’m just wondering what trends you might see on service pricing out there and maybe in the back half of the year as you move with your new launches?

Dennis Kavelman

Mike, it’s Dennis. I’ll start, then Jim can jump in, if he wishes.

We talked about the mix of BIS users being 25%, and certainly there’s a pricing difference between BIS and BES, as I think everybody is familiar. We’ve also said that as volumes really ramp, you see gradual decreases in ARPU charged to the large carriers, etc. So I would say that the blended ARPU is in the range that we had expected. Service revenue look a little funny, being flat Q4 to Q1 because Q4 was 14 weeks, and therefore we had an extra week in Q4, and Q1 was more normalized.

We’re not seeing any radical decreases in pricing, as we said at the analyst day. It’s holding in very, very nicely. We had the one new part to the model where TIM is charging on a pay-as-you-go basis, but it’s working out to roughly the same amounts on BIS, so that’s not really impacting it.

Jim, I don’t know if you have thoughts on what they should think about going forward.

James L. Balsillie

Some of the pricing you know has got a bit of a downward trend when you -- the mobile text units shift over to GPRS or CDMA, so in those cases, we’re reselling air time, so that’s really just a pass through that’s moved away. I think there’s a lot of ways you value add it. I don’t think you’ll see anything dramatic for a while.

Mike Abramsky - RBC Capital Markets

Thanks very much.


Your next question comes from Paul Coster with JP Morgan. Please go ahead with your question.

Paul Coster - JP Morgan Securities Inc.

Yes, I would just like to address the future state, if I may, as we think about your consumer products. Are you going to differentiate the branded experience in some way, whether the BlackBerry or the device?

With Ascendant, when we will see the business model coming to market? What do you think it’s going to look like? Is it going to be a subscription service, for instance?

James L. Balsillie

The branding of the consumer thing is a very, very fair question and one that I really can’t answer in too great a detail right now, but definitely I think there needs to be a brand positioning that’s complementary to the enterprise BlackBerry, but distinct. I think that’s a fair thing and that’s a fair activity point and it’s a fair exercise, so that it’s clear, the separation but it’s also clear the commonality.

That’s something that’s very, very active in a near-term aspect of what we’re doing right now for fairly imminent plans in this area.

For Ascendant, you can really just think that it’s going to evolve to an integrated BES experience. Really, and this is something that we’ve kind of -- there’s kind of two ways to think of wireless middleware. You can think of it as an application, forward integration, or what someone would call a stack leverage strategy, and there’s certain companies that are doing that. Or you could think of it as a middleware that’s generic for a plurality of applications, and that’s sort of an unaligned middleware strategy.

Clearly, we’re in the latter camp. When you think of the four categories of information that interface to: one is desktop, which is IMAP or MAPI; two is the IM interfaces for corporate real-time computing; third is the web services, or services-oriented architecture interfaces, the XML HTTP through MDS; and the fourth category is voice PBX interfaces, whether it’s Legacy TDM or more sort of VOIP-oriented zip interfaces.

It would be a deviation from our model to really just charge more in a CAL for additional functionality. Our view of it is that would be like charging more for a management console, or more for a security function, or more for an attachment view or whatever.

Our model is really you get a CAL, you get everything and we’re going to work real hard to preserve that.

Now, because we just bought Ascendant, even though they’re very active in marketing, very successful -- and let me tell you, IT directors and line of business people, their jaw drops over this. It’s like the “wow” thing that they never thought of. It’s an absolute jaw-dropper. We just have to catch it in sort of a bundle basis in the next product rev. That’s all it is.

You can expect it to be an integrated part of the solution offer.

Paul Coster - JP Morgan Securities Inc.

So you see it driving forward revenue in the existing manner -- through devices, through software, and through ARPU’s? It doesn’t sound like it’s an incremental business, then.

James L. Balsillie

No, because what happens is -- I mean, it’s always a decision, but we really go for a very simple model because we’re trying to put a zero on -- we’re trying to build an adoption profile. This is anything but a mature market, and so everything about our stuff is driving adoption. So if you start putting complexity and feature and component pricing and all that stuff, it’s a much more complex sale process and there’s parasitic drag on adoption. That’s fine for a well-adopted market, but for an emerging market, we’ve made a strategic decision that that’s not the approach that ensure we get the most out of the opportunity.

Paul Coster - JP Morgan Securities Inc.

Okay, got it. Thanks.


Your next question comes from Peter Misek from Canaccord Capital. Please go ahead with your question.

Peter Misek - Canaccord Capital

Good afternoon, gentlemen. Just a follow-up question to that. Our discussions with carriers sort of center around the fact that you’re so much more than mobile e-mail now, and when they look at some of these IMS architectures and they look at certainly what you’re offering, it seems that you’re capability to be that application platform and leverage in the consumer market is greater than ever. Can you help us understand that? I know you said you’re going to keep the model simple and not introduce complexity, but certainly the carrier’s desire to be much more than a silly pipe is growing. It certainly seems like you have this ability. Can you help us understand that? That would be great.

James L. Balsillie

The most vexing issue for carriers that I’ve come across globally is how to go up the value chain. They’re very experienced in voice versus voice competitions, which is a lot of rate plan and branding and service coverage-type stuff -- very traditional.

When you go to the value chain, you’re really contending in the ecosystem. Much of the competitive frameworks involves independent hardware vendors, independent software vendors, portals, ISP’s, PTT’s, and others in the value chain.

It’s very, very vexing for the carriers in this place, and I sort of spend a fair bit of time talking to them. If you sort of assumed a normal distribution, three standard deviations out in the tail I view is the sort of walled-garden approach, which is a high control strategy, but it suffocates user experience and thus the adoption is very weak. That’s proven out in WAP and MMS because those are walled-garden architectures.

Then, you go to the other extreme of three standard deviations out on the other tail, and that’s the broadband pipe strategy. You know, we’re just a PC card and we’re just a pipe.

Strategically, it takes the carrier out of the value equation with a broadband pipe. We’re just a disintermediated bit-pipe. I think right in the middle of that great big, juicy value-added platform play for the carrier, where they’re the natural incumbent to do it. They build, provision and brand and care for this window.

Last time I checked, not a single person I know of in the world has ever said I don’t want a mobile phone anymore. So this is a constant in life, assured going forward and it’s natural to overlay a data platform into the window.

So the question is, other than those two strategies of going out several standard deviations from the tail, the walled-garden on the one side and the disintermediated bit-pipe on the other side, how do you become an intelligent platform, a thoughtful platform where you’re interesting to customers so that you enable them, but you also don’t just roll over and lose a play in the value chain.

Our approach is that I think the carriers have a natural advantage structure. We 100% sell and OEM our stuff through carriers so it’s a service offering, so they know they’re not going to get disintermediated.

We’re a multi-platform set of middleware for enterprise and non-enterprise, so we try to position it as an opportunity for carriers to leverage themselves into that app platform framework. Quite frankly, to date in BIS and BES, the carriers are printing a ton of money. Many carriers have told us, for instance, one of the leading carriers in the world told us we’re about 1% of their data subs, but we’re upwards of 25% of their data revenue. Another carrier said we’re 5% of their data subs, 50% of their data revenue.

It’s clearly very, very profitable -- very profitable. I think there’s something there in the model of a relationship and the enabling of the platform and that ability to work that platform equation in the middle. I also think this ecosystem cultural thing is a bit of a shift for carriers, and it’s a shift that they need to make and they are starting to recognize they need to make, but they’re finding a little vexing.

So going to the extremes -- walled-garden, MMS, and WAP -- or going to just the pure [bit-rate] PC card, I think one suffocates the market so another happens and the other one just throws away the market and gives it to other ecosystem players. I think there’s a much, much more relevant and much, much, much more profitable role for the carriers in the middle.

So does BlackBerry take them there? Irrefutably. Do we want to scale it with them? Without a doubt. How does that play vis-à-vis IMS? Well, there’s all kinds of acronymitis going on in the industry and we’re, bottom line, trying to address it with what we’re doing. It’s an open environment but that doesn’t stop other ways and other discussions from happening.

Peter Misek - Canaccord Capital

Thank you, Jim.


Your next question comes from Richard Windsor from Nomura International. Please go ahead with your question.

Richard Windsor - Nomura International

Hi, good evening. I was wondering if you could give us an idea of your expectations for BlackBerry Connect over the next couple of years or so. What percentage of your adds would you expect, or your subscribers do you expect to go on the BlackBerry Connect with a non-BlackBerry device? Perhaps in the U.S.A. and outside the U.S.A.? Thank you very much.

James L. Balsillie

I would say it’s growing very well. We expect it to continue to grow. We have over 20 devices -- I’ve been saying 20 launched on BlackBerry Connect but I’ve just been corrected; it’s 23. I know we have another 20 in backlog to launch this year. We think it’s going to grow very substantial.

In key BlackBerry Connect launches, say in the United States that you’ve seen recently, over half of the high-end phones sold have been activated on BlackBerry Connect. So yes, again, to the extent that you want to be a platform that allows the carrier to grab that sweet spot in the middle, you must allow them to leverage all aspects of device diversity and device innovation and device marketing that’s out there. I see it becoming an increasingly important and increasingly relevant thing we do, and I’m unbelievably excited and fully supportive of it.

I think we’re starting to see the traction. I also think that some of these device vendors realize that doing this data, high-performance data environment is rather challenging, and so you have to have a very hardened product, and you have to think through persistence and battery life and application features and reliability and care, and we provide a lot of that, but it’s a different set of dimensional imperatives than the voice market, the voice SMS market.

There’s a bit of a learning curve for a lot of these players, but we support them as much as we can. We integrate it fully in our key support. We fully integrate in all of our tier 3 and 4 customer care. We do a lot of joint marketing, but I think you’re going to see some real winners and losers out there, and the one that addresses all the issues that somebody’s looking for will do quantum bases better -- it won’t be incremental than those that hang out a couple fundamental flaws. So that’s why you have to watch the hype. It’s not about another pretty face and device design, though certainly appearance matters. You have to have a very thorough platform underneath.

I have to be careful in talking about how many units different partners are selling, but we have very good visibility on which of them are doing well and which of them are doing so-so. I would say certainly, just as a bit of a hint, the Nokia stuff is doing particularly well. We’re seeing some real strong interest in the Sony Ericsson, but then again you’re seeing some of the Palm and some of the Microsoft stuff also do well.

It’s for the customers and for the carriers to decide.

Richard Windsor - Nomura International

So you don’t see it detrimental to your own device business? You think it makes the whole market bigger? Would that be the right…

James L. Balsillie

Not within a heartbeat. If you were to metaphor it for what it does for our business, it’s five steps forward in terms of platform enabling, one step back for device competition. You have to understand that if you platform enable in a very positive way, you turbo-charge the opening up of the addressable market. At the end of the day, someone could play market share percentage games, but also when you drive the TAM, there’s a whole lot to be said about TAM driving too.

As the overwhelming market leader in this, we have to really play a thoughtful role here.

Richard Windsor - Nomura International

Great, thank you.

Dennis Kavelman

Operator, it’s five to, so I think we’ll take our last question.


Your final question comes from Tim Long from Banc of America. Please go ahead with your question.

Tim Long - Banc of America

Thank you. If I could just make it a clarification and a question. Dennis, on the device side guidance for next quarter, I’m pretty sure you said gross margins would be flat to up, based on positive mix, but ASP’s would be down on mix. Could you just clarify that’s correct and how that is?

The question would be you also talked about a stronger order book than normal into the quarter. Could you give us a little more color on that, what type of products? Is this just driven by the greater than 55,000 per week on the net add front, or is it more broad than that and spanning across upgrades, etc.?

Dennis Kavelman

Sure, I’ll take the order book one first. You go through periods where you have P.O.’s in hand versus just plain old forecast, and what we’re seeing and what we’ve been working very hard to do is work closely with our carrier partners so they understand and we understand exact sell-through rates -- not just based on new sub-adds, but on what’s happening for upgrades, etc. We fine-tuned that to the point where we’re getting much better clarity and much quicker P.O.’s from them. My point was simply that I think -- sorry, the last fact was that channel inventory is at a very reasonable level. I mean, the times when you would see orders not in hand and you have to go out and work for the P.O.’s would be if channel inventory was high and people were trying to work it down, and we’re not in that scenario right now. We feel the channel inventory is at a very good level.

I think that they’re seeing the upgrade cycle continue strong. I think a number of carriers are seeing good subscriber growth, and we’re working closely with them so the net net is we’ve got a lot of P.O.’s in hand and a high percentage of the order book, which is nice to have.

What I meant on the margin side was just because a product may have lower ASP, it could also have higher gross margin. It depends on the technology that we’re selling in terms of GSM-based or CDMA-based or IM-based, etc. It depends on the generation of the product, so it’s not quite as simple as higher ASP means higher margins. The product families have slightly different margins, and that can be because of royalties and licenses and all kinds of different things that are tied in.

So you can’t tie them exactly together, but yes, we do expect gross margin to be up slightly in Q2.

Tim Long - Banc of America

There’s no specific product or product set that spans across those two points that’s really leading your device shipments in one direction or another? I assume it’s more new products skewed in the stronger order book?

Dennis Kavelman

You’re talking about order book now?

Tim Long - Banc of America

Yes, but I’m assuming that leads into your guidance on devices, because I’m assuming the order book is driving it.

Dennis Kavelman

Yes. It’s ironic. There are a lot of products that have been in the market for a little while that we continue to sell through very, very well in big markets and in new, some of the emerging markets, and yes, of course, the new products, people are very excited about and they’re broadly available around the world. We have a lot of -- you see all the press releases on the launches of 8700’s around the world and 7130’s and 8707’s.

Tim Long - Banc of America

Thank you.

James L. Balsillie

I think that’s a wrap. It’s six o’clock. I’d like to remind everyone that there’s a post view service available and you can listen to the call on the website. Thanks very much.


Ladies and gentlemen, this concludes the conference call for today. Thank you for participating. Please disconnect your line.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to All other use is prohibited.


If you have any additional questions about our online transcripts, please contact us at: Thank you!