BlackBerry (NASDAQ:BBRY) announced a bleak earnings report for Q1 FY 2014, posting a surprise loss for the quarter and withholding key information about its BB10 smartphone sales for about an hour until the earnings call. This provided ample fodder for the bears, sending the stock down more than 20% in pre-market trading. Even the release of the BB10 numbers later in the morning did little to pacify investors, as the 2.7 million figure was far below what the markets were expecting considering that the Z10 sold for the full quarter and the Q10 was launched in between. The fact that BB10 sales did not benefit much from the launch of the QWERTY-based Q10 last quarter is disconcerting, given that QWERTY-based models have traditionally been BlackBerry's forte. Although the company did not break out Q10 and Z10 sales figures, this could be a sign that the company isn't succeeding in attracting enough of its existing user base to try out the new phones.
More than the sales miss, what was perhaps most disappointing was the drop in gross margins as compared to the previous quarter. BlackBerry reported Q1 gross margins of less than 34%, a steep decline of more than 6% over the surprise 40% posted last quarter. The fact that BlackBerry launched its new phones in what is traditionally an off-season market for smartphone sales, and had to face steep competition from the likes of Samsung (OTC:SSNLF) -- which recently launched its Galaxy S4 smartphone -- may have been a factor. That BlackBerry doesn't expect to turn a profit in the second quarter as well means that the pain may last for some time, with the holiday quarter crucial to its turnaround hopes. The only positive to come out from the earnings report was that the company didn't burn through its cash reserves, which could act as a support to its valuation in the near term. We are in the process of updating our model for earnings.
BlackBerry Loses More Subscribers
Last quarter was a bit of a mixed bag for BlackBerry as the company turned in decent numbers for BB10 sales, but continued to bleed subscribers due to the lack of a low-end BB10 handset. This hit the emerging markets especially hard as the BB7-based Curve handsets were becoming outdated and in need of a major refresh. The company lost as many as 3 million subscribers last quarter, three times the subscriber losses of the previous quarter. The issue wasn't addressed in Q1, with the company launching only the high-end QWERTY-based Q10 handset during the quarter. That the Z10 and the Q10 seem to have failed to attract new subscribers in the developed markets has only amplified the subscriber loss further, with BlackBerry reporting a decrease of 4 million in its subscriber base. This is its third straight quarter of subscriber loss.
The extent of the decline shows that BlackBerry is in dire need of a low-end Curve replacement. The recently announced Q5, a QWERTY-based $400 mid-range cousin to the Q10, may be the answer to BlackBerry's woes. But it's hard to see how that might be the case with cheap Android phones flooding the emerging markets and pushing prices below the $200 barrier. There are three more BB10 launches scheduled for the second half of the year, but the company remained surprisingly mum on those plans failing to clarify if a low-end BB10 phone is in the works. Instead, it said that a new BB7 handset will be announced later in the year, which probably means the company hasn't found a way to get BB10 to work on cheap hardware. This is definitely a big concern, and one that is likely to not go away with BlackBerry saying that it won't be reporting subscriber numbers going forward.
Services Decline a Big Concern
On the services front, there was more bad news for investors as the company almost failed to meet its guidance from last quarter. BlackBerry saw services revenues of about $800 million in Q1, which is a drop of over 16% as compared to Q1. Granted, the company took a $72 million hit due to a foreign currency issue in Venezuela (which is one-time, hopefully), but adding that back to the reported figure implies a quarter-over-quarter decline of 9%. CEO Thorsten Heins had provided guidance of a single-digit decline in service revenues during last quarter's earnings call, but a drop as high as 9% is concerning.
With BlackBerry's smartphone sales floundering, services have been the sole saving grace and cash cow for the company in hard times. As a result, we estimate this division to be the most valuable to the company, ahead of its devices one. However, management's decision to more or less do away with service fees for users who do not want value-added features, such as advanced security, as part of its BB10 transition plan is having an impact on this high-margin business. BB10 retail customers do not need to subscribe to a special BlackBerry data plan to access the Internet -- a ploy to attract more users from rival platforms. Even the smaller enterprises that do not need the full suite of BlackBerry services may subscribe to one of the low-priced tiers, impacting service ARPUs further. The impact may be gradual initially since most of BlackBerry's subscriber base in international markets uses a BB7 handset currently, but will only gather pace with time as cheaper BB10 handsets make an appearance in these markets.
Disclosure: No positions.