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There has been lots of speculation surrounding BlackBerry (BBRY)'s margins for the Z10. I've read articles suggesting that margins could be anywhere from 20% to 40%, and what this number actually is has significant implications for BlackBerry's future profitability. Z10 margins will likely increase as production quantities increase, but the initial margin sets an important baseline to work with.

To determine Z10 margins, we are going to look at the previous quarter's financials (Q3 FY2013) and determine the ASP and cost for BB7 devices and the PlayBook. The PlayBook represents a small percentage of sales, but not addressing its impact will render our BB7 calculations less accurate.

The PlayBook Effect

BlackBerry overestimated the demand for the PlayBook and took a $485 million writedown in December 2011. The effect of that would be to reduce the inventory value of the PlayBook down to what they could expect to sell it for. At the time, the PlayBook was retailing for $199, but the price BlackBerry was selling it for was unknown.

A recent article by the Channel gives us some information about this. The PlayBook was selling to retailers for £86 (about $132 USD), with a suggested retail price of £129 (about $198 USD). We can therefore assume that the most likely current value of PlayBook inventory is $132, and use this figure in cost of sales calculations later.

Fiscal Quarter

Q3 FY2013

Q4 FY2013

PlayBooks Shipped

255,000

370,000

Revenue ($ Million)

$34

$49

Cash Cost of Sales ($ Million)

$34

$49

Figuring Out BB7 Device Margins

Now that we know PlayBook pricing, we can attempt to calculate ASP and cost of sales for BB7 devices by removing the PlayBook costs and revenues from Q3 FY2013 numbers. We know that 6.9 million phones were shipped that quarter, and that hardware revenues were $1.627 billion. Removing the $39 million in PlayBook revenue, leaves us at $1.593 billion, and an ASP of $230.87 for BB7 phones.

The total cost of sales during Q3 FY2013 was $1.897 billion. The Software, Service, and Other segments are estimated to have a combined cost of sales of $191 million. This is determined by the 13.88% cost of sales rate for Software & Service derived from BlackBerry's financials, and a 75% cost of sales rate for the Other segment (which includes non-warranty repairs and accessory sales). Accessories are said to command 20-25% margin rates.

This leaves us with $1.706 billion in hardware cost of sales, $34 million of which was the PlayBook. Another $32 million of cost of sales was attributed to the CORE program, and $350 million in amortization expenses were recorded as cost of sales. We will remove these items to determine the cash cost of sales per BB7 phone. The total remaining cost of sales is $1.29 billion, which translates into $186.96 per phone.

Fiscal Quarter

Q3 FY2013

Phones Shipped (Million)

6.9

Hardware Revenue ($ Million)

$1,627

Hardware Revenue Exc. PlayBook ($ Million)

$1,593

ASP per Phone

$230.87

Total Cost of Sales ($ Million)

$1,897

Service, Software & Other Segment Cost of Sales ($ Million)

$191

Hardware Cost of Sales ($ Million)

$1,706

Playbook Cost of Sales ($ Million)

$34

Cost of Sales Attributable to CORE ($ Million)

$32

Cost of Sales Attributable to Amortization ($ Million)

$350

Hardware Cost of Sales Exc. Playbook, CORE, Amortization ($ Million)

$1,290

Cash Cost of Sales Per Phone

$186.96

Determining Z10 Margins

Now that we know the cash cost of sales and ASP for BB7 phones, we can determine the Z10 ASP and margins. We are assuming that BB7 ASP and cash costs are unchanged from Q3 FY2013 for lack of better information. If both ASP and cash costs went down or up by a similar amount for the BB7 phones, then this would not affect our margin calculations for the Z10, at least in absolute dollar terms.

Hardware revenue was $1.64 billion, $49 million which was for the PlayBook, leaving us with $1.591 billion. At $230.87 per unit, the 5 million BB7 phones resulted in $1.154 billion in revenue. The remaining $437 million in revenue is for 1 million Z10 phones, suggesting a $437 ASP.

The total cost of sales during Q4 FY2013 was $1.603 billion. The Software, Service, and Other segments are estimated to have a combined cost of sales of $161 million. This is determined by the same cost of sales rates as used in Q3 above.

This leaves us with $1.442 billion in hardware cost of sales, $49 million of which was the PlayBook. Recovery of $4 million of cost of sales was attributed to the CORE program, and $213 million in amortization expenses were recorded as cost of sales. We will remove these items to determine the total hardware cash cost of sales (excluding the PlayBook). This total is $1.184 billion. At $186.96 per unit, the 5 million BB7 phones resulted in $935 million in cash costs. The remaining $249 million in cash costs is for 1 million Z10 phones, suggesting a cash cost of $249 per unit.

Type of Phone

BB7

Z10

Total

Phones Shipped (Million)

5

1

6

ASP Per Phone

$230.87

$436.65

$265.17

Hardware Revenue Exc. PlayBook ($ Million)

$1,154.35

$436.65

$1,591

Cash Cost of Sales Per Phone

$186.96

$249.20

$197.33

Hardware Cost of Sales Exc. Playbook, CORE, Amortization ($ Million)

$934.80

$249.20

$1,184

Cash Margin Per Phone

$43.91

$187.45

$67.84

Cash Margin (As % of Revenue)

19.0%

42.9%

25.6%

Amortization at $33.44/Unit

$33.44

$33.44

$33.44

Gross Margin Per Phone

$10.47

$154.01

$34.40

Gross Margin (As % of Revenue)

4.5%

35.3%

13.0%

Conclusion

With an ASP of $436 and a cash cost of $249 for the Z10, the cash margin is $187 per phone, or 42.9% cash gross margin.

Morgan Stanley's Ehud Gelblum suggests that much of BlackBerry's amortization expenses are tied to volume now, so if we include amortization back in at the same $33.47 per unit average as in BlackBerry's Q4 FY2013 financials, we end up with a gross margin of 4.5% for BB7 phones and a 35.3% margin for the Z10 phones.

The 35.3% margin for Z10 phones is at the high end of the estimated range and bodes well for BlackBerry's future profitability, especially with the potential for cost reductions as production expands. In a future article I will use these margin figures to assess BlackBerry's profitability in several scenarios.

Source: BlackBerry: Z10 Margins Are Higher Than You Think