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Research In Motion Limited (RIMM)

F3Q07 Earnings Call

December 21, 2006 5:00 pm ET

Executives

Dennis Kavelman - CFO

Jim Balsillie - Chairman and Co-CEO

Analysts

Maynard Um - UBS

Gus Papageorgiou - Scotia Capital

Rob Sanderson - America Technology Research

Christin Armacost - Lazard Capital Markets

Mike Ounjian - Credit Suisse

James Faucette - Pacific Crest

Mike Abramsky - RBC Capital Market

John Bucher - BMO Capital Market

Presentation

Operator

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Research In Motion Limited Third 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 question. (Operator Instructions).

I would like to remind everyone that this conference call is being recorded on Thursday, December 21, 2006, at 5:00 p.m. Eastern Time. I would now like to turn the conference over to Mr. Dennis Kavelman, Chief Financial Officer. Please go ahead, sir.

Dennis Kavelman

Thank you, and welcome to RIM’s fiscal 2007 preliminary third quarter results conference call. With me is Jim Balsillie, RIM Chairman and Co-CEO. After reading the required forward-looking statements disclaimer, I will begin by providing an overview of third quarter results, as well as our guidance for Q4. I will then turn the call over to Jim who will provide a business and strategic update. We will open up the call for questions after that.

I would like to note that this call is available to the general public by a call-in number and webcast. A replay of the webcast will also be available on the rim.com website. We plan to wrap up the call at approximately 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 RIM’s ongoing management-initiated voluntary review of its historical option granting practices, including statements regarding preliminary determinations and current expectations, our expectations and estimates with respect to revenue, gross margin, operating expenses, stock option expense, CapEx, depreciation and amortization, investment income, earnings, earnings per share, and ASPs for Q4 and beyond, our expectations regarding RIM’s near and long-term tax rates, our estimates of the number of BlackBerry subscriber accounts, subscriber accounts additions and other non-financial estimates, our product development initiatives and timing, 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 and assumptions we have made.

Many factors could cause our actual results, performance or achievement to be materially different from those expressed or implied by forward-looking statements, including risks relating to RIM’s ongoing management-initiated voluntary review of its historical options granting practices, including final determinations made by RIM’s audit committee, outside advisers and others based on findings of fact and analysis in the ongoing review, 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 account 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 risks, and other factors set forth in the risk factors and MD&A sections in RIM’s filings 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.

Today’s call will focus on a discussion of RIM’s preliminary results for the third quarter. These results are preliminary pending the completion of the management-initiated voluntary review of RIM’s historical option granting practices. We do not expect a material change to these quarterly operating results as a result of the review. We saw a significant growth in revenue and subscriber account additions in Q3 even beyond the levels forecasted in September.

Operating expenses were slightly higher than expected, so preliminary earnings were in line with our expectations. The primary driver of the revenue upside was higher handset shipments. The subscriber account growth was driven by strong adoption of new products and continuing strength in the enterprise business. Revenue for the third quarter ended December 2 was $835 million, which is up 27% from the prior quarter and is above the top-end of the range we guided in September.

Handheld devices represented $626 million or 75% of RIM's revenue during the quarter, up from the 72% of total revenue in the previous quarter. Total devices shipped in the quarter of approximately 1.8 million were up from 1.4 million in the prior quarter. Total handsets of 1.8 million was slightly higher than expected, as subscriber account additions were stronger than forecast, as carriers received initial shipments for their Pearl launches, and as a number of upgrades remained high. As expected, total global channel inventory increased by approximately 200,000 units during Q3 because of this initial stocking of new products, as well as because overall run rates have increased.

On a weeks of inventory basis, channel inventory remained approximately flat. Average device ASPs decreased slightly to approximately $345 due mainly to the percentage of the lower ASP Pearl in the hardware mix. We expect ASPs in Q4 to continue to decrease approximately $340 due to continued growth of Pearl, as well as some planned price decreases in some mature products.

Service revenue was $142 million or 17% of revenue for the quarter, up $14 million from Q2. Overall blended ARPU continue to decrease slightly as a result of increasing BES in the mix, continued churn of older direct legacy Mobitex accounts to new carrier plans and normal pricing decreases as carriers surpass certain subscriber account milestones.

RIM added approximately 875,000 BlackBerry subscriber accounts during the quarter, which is higher than our September forecast of 800,000 and significantly higher than the 705,000 subscriber accounts added in Q2. New products were very successful in driving new subscribers in new markets. The majority of this 170,000 subscriber account increase over Q2 came from carriers that had launched new products such as the Pearl and the 8703 during the quarter, and we noted a meaningful increase in BES activations at these carriers. The total base of BlackBerry subscriber accounts at the end of the quarter was approximately 7 million. Approximately 27% of our total subscriber base with outside of North America consistent with the previous quarter. As I said, we're seeing a number of BES or prosumer and consumer accounts grow, and BES now represents over 26% of the total subscriber account base.

Software revenue was $43 million or 5% of revenue and consisted of BES and CAL fees, as well as T-Support contracts. We expect software revenue to increase modestly in Q4.

Other revenues such as repairs and accessories was $24 million or 3% of revenue.

Gross margin for the second quarter decreased to 54.2%, which was slightly below the expected range. The decrease relative to our forecast was mainly due to the larger than expected percentage of hardware, specifically Pearl in the revenue mix. As well we incurred charges for inventory obsolescence relating to the end of life cycle for certain older products.

In Q4, we are expecting to further increase of hardware and the revenue mix to lower gross margin slightly to approximately 53% overall.

R&D spending was $61 million or 7% of revenue for the quarter, inline with our forecast.

Selling, marketing and administrative expenses increased by 26% to $146 million versus $116 million in Q2 and were 18% of revenue. This was higher than our previous forecast. In addition to the branding and channel programs launched in the quarter, we also ran a number of incremental programs to support the launch of Pearl and 8703, which translated into increased demand and net new subscriber account additions. As well, legal expenses for the quarter were higher than we had previously forecasted in September. The tax rate for the quarter was approximately 26%.

Preliminary GAAP net income for Q3 was $176 million or $0.93 per share diluted. Excluding the regular stock option expense of approximately $3.6 million preliminary adjusted net income was $179.6 million or $0.95 per share diluted.

Weighted average diluted shares using the preliminary GAAP EPS calculation for the quarter were 189.8 million. Actual shares outstanding at December 2 were 185.6 million. Total options outstanding at December 2 were 6.3 million.

RIM's balance sheet continues to be strong with substantial cash reserves and appropriate working capital balances. At the end of third quarter, RIM had approximately $1.3 billion in cash, cash equivalents, and investments. This was up $155 million from the prior quarter. During the quarter, RIM generated approximately $215 million in cash from operations. Use of cash in the quarter included capital expenditures of approximately $64 million. CapEx was slightly lower than forecast due to the deferral of certain investments into Q4. We expect CapEx to be approximately $100 million in both Q4 and Q1.

From a working capital perspective, trade receivables were up from the prior quarter. The DSOs decreased to approximately 45 days from 53 days in the prior quarter. Going forward, we expect DSOs to increase somewhat as payment terms are trending longer in the industry. Inventory on hand increased by approximately $20 million, as we continue to purchase additional raw materials to support demand for Pearl and other new product launches.

At this time, I would like to discuss our outlook for Q4. Again, a reminder that these forward-looking statements reflect managements best current estimate and should be taken in the context of the risk factors listed at the beginning of the call and outlined in our public filings. We are forecasting fourth quarter revenue to be significantly higher than Q3 in the range of $900 million to $940 million. We expect hardware shipments to be over 2 million units and to be a larger percentage of sales in Q4 due to the ongoing ramp of Pearl, existing customer demand for replacement and upgrade devices, and new products that we are planning on launching in late Q4 and early Q1. We are targeting new product introductions late in Q4 and total revenue depends on the timing of carrier product acceptance. Timely acceptance would lead to revenue being in the top half of the forecasted range while any delays in acceptance could lead to revenue coming in at the bottom half of the range.

We are targeting net subscriber account additions for Q4 to be up to approximately 950,000 to 975,000, which would get us very close to 8 million subscribers by year end. We're seeing strong growth in subscriber account additions thus far in December with average weekly additions over 80,000. We do think that these weeks before Christmas are higher than normal due to holiday buying, particularly by consumers, prosumers which is relatively new for RIM. Extrapolating this additions rate over the 13 weeks of the quarter would lead to subscriber additions of over 1 million subscriber accounts. However, in the past, we traditionally experienced a seasonal slowdown in the weeks following Christmas. We are estimating this year that this seasonality will reduce the overall quarterly subscriber additions by approximately one week or approximately 80,000 account additions before run rates return to normal midway through January. Factoring this seasonality into our forecast leads to the 950,000 to 975,000 range.

As I'd said earlier, we expect gross margin for Q4 to be approximately 53%. We're expecting strong hardware revenue growth over the coming quarters which means that hardware will be a higher percentage of the revenue mix leading to lower overall gross margin. As well, some planned pricing decreases from mature handsets will impact Q4 as we prepare for new product launches in the New Year. We expect a total operating expense increase for Q4 of approximately 10% to 11% from Q3 levels.

We expect R&D to increase by approximately 9% in Q4 and continue to be approximately 7% of revenue. We expect the sales, marketing, and admin increase in Q4 to be less than in Q3 at approximately 9% to 12%. As I'd mentioned on the call in September, we have undertaken increased marketing and branding activities to capitalize on new product introductions. These efforts are ongoing and it will continue into the fourth quarter. As a result, we expect sales, marketing, and admin to be approximately 17% of revenue in Q4.

As we move into fiscal 2008, we are targeting sales and marketing and admin expenses to decrease as a percentage of sales as we leverage the programs currently underway. We estimate regular stock option expense to be approximately 5 million in Q4. This expense does not include any impact of the restatement that occurs as a result of the ongoing stock option review.

The gross margin and OpEx 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 $23 million to $24 million in Q4, higher than Q3 due to ongoing CapEx. Investment income is expected to be in the range of $14 million to $14.5 million in Q4. In Q4, we expect the tax rate to be in the range of 26% to 28%. Going forward, we expect the tax rate to be in the range of 27% to 30% with fiscal 2008 being at the high end of the range and decreasing thereafter.

We expect Q4 GAAP EPS to be in the range of $0.92 to $0.99 per share and $0.95 to $1.02 per share adjusted excluding regular stock option expense. This expectation is subject to determinations made relating to our ongoing review of stock option grants. I will now turn the call over to Jim.

Jim Balsillie

Thank you Dennis. We're pleased with the results from our third quarter. The response to the recent product launches exceeded our expectations and we're seeing good momentum in our business as we head into the New Year. Both the prosumer and enterprise segments are performing well and growth in international markets is strong.

For business update, the launch of the Pearl has been the most successful BlackBerry launch that we've ever had, and the early momentum that we've discussed on the last call has continued. Pearl is now available on 36 carry networks in 22 countries, and we expect the pace of rollout around the world to continue.

Reviews of the Pearl have been overwhelmingly positive. For example, Walt Mossberg of the Wall Street Journal called Pearl "a beautiful piece of work, a very nice combination of hardcore e-mail capability and fun feature." David Pogue of the New York Times said, in the end this very polished Pearl is all about the sweet spot; for such a wisp of a thing, it's an awful lot of machine. Consider how many things it does, and how well, you may be amazed to learn that no laws of physics were broken in the making of this phone. And, Russ Fischer from Laptop Magazine said, "the Pearl is the sexiest phone yet and a strong performer to boot."

Our intention with Pearl was to open up a new market segment for BlackBerry and this is what we've experienced. There has been no decline in the 8700 run rate after Pearl was launched at a new carrier, and we're seeing the split between BES and BIS activations on Pearl much more heavily weighted to BIS than on our enterprise oriented devices. This clearly indicates that we're getting into a part of the market where BlackBerry has not been focused before.

In addition, in those markets were carriers have launched pay-as-you-go pricing or low price introductory plans, we've seen an even larger spike in non-enterprise activations. We are now approaching 2 million total BIS subscriber accounts versus 1 million at the end of last year. Some carriers are selling Pearl without a data plan, but even those carriers were receiving data tax rates for Pearl of approximately 80%.

Report from our carrier partners has been exceptional, with aggressive handset and service pricing plans and significant advertising and promotional campaigns underway.

In North America, Cingular launched Pearl with push-to-talk technology on December 1, and has started a major promotional push over the holidays and into the New Year. We've also seen tremendous support from the Cingular retail channel, with some regions testing additional subsidy dollars to bring the price of Pearl to as low as $99. The response has been excellent, with strong growth in subscriber additions following the launch and many retails stores rapidly selling out of initial quantity.

T-Mobile and Rogers also continued to do extremely well with the Pearl. Rogers made Pearl a future product for the calendar fourth quarter, putting a significant marketing push behind the product in the form of print, radio, TV, outdoor advertising and direct mail effort.

The 8703 for CDMA/Ev-DO network is also doing well in market. At Verizon, the 8703 drove substantial new subscriber account growth and strong upgrades. Growth on the enterprise side continue to be strong as Verizon and RIM have expanded their focus to BlackBerry beyond the email more aggressively to this segment. There was also a strong focus on growing retail and indirect channels at Verizon in Q3, and we saw a meaningful increase in BIS activations as a result of this.

Sprint also launched the 8703E, highlighting the GPS capabilities of the device. They offered attractive service pricing, and supported the launch with a national advertising campaign. Bell and TELUS in Canada have also been successful with their launches, and have seen growth in subscriber accounts addition since the launch of the 8703.

In carrier -- in Europe, 20 carrier networks have already launched Pearl and the reviews and the response has been exceptional. We are seeing strong growth in the majority of European markets, and the European carriers are leading the way with aggressive pricing and promotion plan. For example, '02 is offering the Pearl for free with 30 pound voice plan. Orange is offering a 9 euro BES plan in France. Vodafone, Germany is offering 5 euro introductory BES and both TIM and Telefonica are offering a free Pearl to customers who are new to them. There are number of marketing campaigns underway in European as well. Europe is promoting Pearl and Air France business launches. T-Mobile in Germany has deployed a fleet of smart cards covered with Pearl advertisement throughout Germany. Vodafone launched a Pearl advertising campaign in the UK and both TIM and Telefonica have undertaken significant media campaigns in Air Force throughout their respective regions. We are pleased with the growth in Europe, and we are very optimistic on the potential in this market going forward.

In Asia-Pacific, Pearl has launched successfully in India, Hong Kong, Australia, New Zealand, and Singapore. Initial customer demand and market response have been very enthusiastic, results were supported by numerous advertising and sales and marketing campaigns by our carrier partners, as well as by RIM sponsored customer event.

In addition to the Pearl, the UMTS/BlackBerry is also getting good traction in the region. China mobile continues to promote and sell BlackBerry service in mainland China with interest in demand for BlackBerry particularly strong in the key markets Beijing, Shanghai, and Guangzhou. We are also working with partners to provide BlackBerry devices in mainland China, and expect to have commercial availability in fiscal 2008.

India continues to gain momentum for BlackBerry with the ongoing strength of Bharti Airtel and the recent launch of Pearl, as well as the launch this month of BlackBerry by Hutch India.

The number of carriers offering BlackBerry continues to grow and they are now well over 200 carriers around the world offering BlackBerry. Partners launched since the last call include Saudi Telecom and Mobily in Saudi Arabia; American Mobile in Chile, El Salvador and Guatemala; Djezzy in Algeria; Eurotel in the Czech Republic; Glo in Nigeria; Telefonica Moviles in Nicaragua; and Hutchison in India.

In Q3, we completed the expansion of our manufacturing facilities, ramped 8703 production, and continued our ramp of Pearl. We have aggressively added capacity for Pearl and are presently manufacturing a high volume both in our own facility and with Alcatech in Mexico and Hungry.

So, launch of Pearl, we achieved the fastest ramp to volume of any product in RIM history, and are confident in our ability to meet market demand.

Area marketing and promotional support for the Pearl in 8703 has been exceptional throughout all geographies. Supplement to carrier programs, we have launched a number of independent BlackBerry marketing and promotional campaigns in the past quarter. These campaigns are utilizing various print, Internet, and out-of-home media to communicate the lifestyle advantages of BlackBerry beyond the traditional BlackBerry market and to promote BlackBerry in the retail channel.

In Q3, we supported the Pearl launch with a multi-fast campaign and launched the "live large, fly high" promotion, whereby purchases of a BlackBerry in retail received a free companion airline ticket. These programs have been very successful, as evidenced by the strong Pearl take up we've seen. We have also launched the brand campaign in North America in November that is ongoing. In addition to marketing promotion, we have also been doing significant channel development work with our VAR and indirect channel partners. RIM is currently providing agnostic sales and marketing support to approximately 220 indirect partners throughout North America. These partners represent more than 5,000 retail points of presence and BlackBerry sales within these channels grew approximately 45% quarter-over-quarter. We are also in the process of rolling out pilot programs with national retailers including Best Buy mobile stores, RadioShack and Cosmo locations throughout the United States.

In the third quarter, RIM's North American field marketing team conducted 1,000 of store visits, calls, and training sessions through retail store representatives. These activities together with the marketing programs noted above work in tandem to drive increased awareness, understanding BlackBerry sales in these very important emerging channel.

In the last few months, we have achieved some significant milestones with the BlackBerry Smart Card Reader. We've recently received approval for use of the reader within the U.S. Department of Defense after undertaking two in-depth security reviews. This has allowed us to take Bluetooth, which was considered as a security liability and turn it into a security enhancing technology.

This past quarter, we also released our 1.5 software upgrade for the reader to allow support for both BlackBerry and desktop use. This expands the market opportunity as it takes the product from being a BlackBerry specific accessory to being a broad based PC accessory.

These two events have combined to greatly increase demand for the product, and many customers are now moving past pilot deployment into large deployments. The orders of 20 or 30 trial devices in the first half of the year are now turning into multi-thousand unit deals with some of our larger customers. While revenue of this product is still immaterial, we believe that the success of the Smart Card Reader is important in order to meet the growing security need of our government and large enterprise customer base.

This quarter we've seen tremendous growth in the adoption of lifestyle application as our growing base of diverse customers continues to look for new applications to personalize their BlackBerry and enhance their life. You will BlackBerry, you are seeing BlackBerry in Yahoo! Go, you are seeing instant messaging and yahoo mail as well, you are going to see a plethora of news and information services involving Bloomberg writers, financial times, weather channel.

QuickPlay has pioneered a podcast service on BlackBerry with ABC News, Wall Street Journal, ESPN and AccuWeather to name a few of the over 100 titles in their offering. Turn by turn navigation, travel companions, news and sports, office productivity tools and restaurant guides have become a favorite for the mobile worker community, where travel is a large part of their business. Handmark, MobiMate, Transclick, TeleNav, Impatica, SplashData, Ascendo, and Mobile Voice Controls are just a few of the partners doing a great job with new and powerful applications in this space.

With the launch of the BlackBerry Pearl including camera, companies are inventing new ways to create an experience around photo sharing, blogging and social network that you will begin to see soon. Casero, [Pa Mobile], Tiny Pictures and [Visria] have developed some very interesting applications for the BlackBerry Pearl camera that were not -- that are not available in other devices.

Our gaming community is also quite active. Magna continues to produce new games at a rapid pace and new partners Concrete Software, Microforum, Skava, MobiBLU, Fun Technologies, and Real Device have all recently launched great games and will continue to do so in the new year.

BlackBerry continues to work with our carrier partners in order to create unique offerings and content services that are preloaded on BlackBerry at point of purchase.

The developer community continues to grow strong and rally around BlackBerry for both enterprise and consumer applications. We're proud to announce that we have over 500 ISB partners in our alliance program focusing on enterprise application, and we have just gone over the 100,000 mark of developers, who have adopted our Java development environment in total.

This community has doubled in the past year and is producing great applications from games to financial applications. We continue to see strong demand from enterprises, wireline and wireless service providers for our Ascendant products. Ascendant delivers BlackBerry for voice integrating the PBX with the wireless phone and wireless data applications.

During the past quarter, we sold three times the volume of Ascendant servers that we did during the previous quarter, that's 300% quarter-over-quarter growth. This included a significant business continuity deployment in addition to our core mobility offering.

We also initiated conversations with multiple large carriers and infrastructure providers to offer Ascendant as a wireline and wireless convergent solution. We anticipate that this technology will not only extend the current capabilities of the desk phone, but will offer transcendent applications that deliver dramatic productivity increases for our customers.

BlackBerry Connect is now launch with over 80 carriers worldwide and customers can now choose from 40 different phones. New devices launched this quarter include the E50 from Nokia, P990 from Sony Ericsson, the Treo 750 from Palm, and the latest windows mobile devices from HTC.

This quarter we also launched the 838 Pro Pocket PC and C720W Smart Phone with HTC's new distributor Dopod International. In addition, RIM and Sony Ericsson exhibited at Symbians Smartphone show where the newest BlackBerry Connect enabled enterprise smart phone, the W950 was demonstrated. The W950 is the third of the Symbian 9.1 smart phone devices in Sony Ericsson's portfolio to offer BlackBerry Connect. While Connect continues to do well in the European and Asian markets, growth in North America is also strong, with Cingular recently offering BlackBerry Connect on the Nokia E-62 and Rogers recently launching on the E-62.

The company's management-initiated voluntary review of stock option grants is ongoing. As previously disclosed, the audit committee of RIM's Board of Directors has made a preliminary determination that a restatement of RIM's historical financial statements will be required. The company does not concurrently -- does not currently anticipate a material adjustment to the preliminary second quarter operating results reported on October 28, 2006 and the preliminary operating results of the third quarter of fiscal 2007 announced today, or to current the future financial year's operating results as the result of the restatement. Unfortunately, I am unable to comment further on the stock options review while this is ongoing, but I encourage you to review RIM's biweekly status reports, including the one issued this afternoon, for information about the review and RIM's expectations regarding timing and other matters.

In summary, the performance and growth that we saw in the third quarter validates the potential in the market and demonstrates the readiness of non-enterprise customers to embrace BlackBerry. We are looking forward to reporting back to you on our progress in the New Year, and we would like to take this opportunity to wish you all the very best of the holiday season. This concludes our formal comments. Due to the large number of people on the call, we ask that you to please limit yourself to one question per person. Would the operator, please come on to handle question.

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen, we will now conduct a question-and-answer session. (Operator Instructions). Your first question comes from Maynard Um from UBS. Please go ahead with your question.

Maynard Um - UBS

Hi. Thank you. Just looking at the enterprise side of the business, can you talk about how Europe is ramping? Are we starting to see that inflection point that we've all been expecting? And somewhat related if you could just talk about, do you think Europe and the entrants into this consumer market might help offset any of the subscriber seasonality as we look forward? Thanks.

Jim Balsillie

Well, we're definitely seeing the enterprise accelerate in Europe, and we're seeing tremendous increase in BES sales. So there is no question Europe is galloping ahead, but as fast as BES growth, BIS is also growing because big parts of Europe, there are a lot of different countries that aren't as sort of corporate oriented or more SME and SOHO oriented. So, it's grown there. But there is no question in my mind the enterprise aspect of Europe has really turned the corner. And the whole retail aspect which we spend a little time talking about has really turned the quarter. Why this is important is because 80% of B2B sims are bought in B2C channels, but they tend not to sell B2B apps unless they got strong B2B relevance because that’s the larger portion of traffic. So, the fact that we have such an attractive device, and a solution it's really transparent between B2B apps and B2C apps or can be combined has really sort of cracked the code there. So, at the core, both are doing well but there is no question that the enterprise part of Europe has really turned the corner. And I think there were some very important security concerns and security priorities raised in Europe. And now we're seeing so much media and so much media, and so much authority saying not only BlackBerry, as BlackBerry approved it’s the only approved and the only secured wireless offering out there. So, it’s a little harder to crack the European markets because there is so many different carriers, so many different country, so many different languages. It’s kind of more complex to sort of become kind of standard but I would really like to say that I think we've really crossed that region we are really there.

Maynard Um - UBS

And does that help offset any subscriber seasonality because the consumer market is so new? As we look forward, in forward quarters?

Dennis Kavelman

Maynard this is Dennis. I mean the answer is, we don’t know. I think this is going to be interesting year because we're going to see how these things play out, especially over the Christmas holidays, clearly you would expect some consumer demand ahead of Christmas, what happens after Christmas, we're not sure and that’s why we're forecasting a bit of a depth that we've seen before after the holidays. When we come back around to in the summer, in the month of August again, you know, there I mean you could see a back to school thing, maybe offset some of the normal enterprise slowdown but its way to really to tell and I think we're going to learning as we go this year to see how that consumer channel does changes some of the seasonality impacts we’ve had in the past.

Maynard Um - UBS

Great, thanks congratulations.

Dennis Kavelman

Thanks.

Operator

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

Gus Papageorgiou - Scotia Capital

Thanks. Congratulations on a good quarter. Dennis, just on the gross margins, could you kind of contrast the gross margins on the Pearl relative to traditional BlackBerry devices. Would it be fair to say it is probably lower than other BlackBerry devices and if so, over its life cycle do you think it will trend higher or is your intention to keep the gross margin of that device below kind of where your traditional levels have been.

Dennis Kavelman

It’s a tough question to answer Gus, because we don’t break it out by product. I would say that it's clear the ASP as well on the Pearl as we are going into these new markets, but to get that all ASPs at channel or the challenge gets put back to Mike and Larry and the team to get cost down. So, I would say that margins on the Pearl are in line with sort of our overall average hardware products, some of them are better, some of them are worse as Pearl has scaled up very quickly and we are using our outsourcing partners. I think there are some improvements there. There is no question that going forward one of the big tasks before the engineering team is to continue to drop cost faster, faster than we are dropping ASPs into these new markets.

Gus Papageorgiou - Scotia Capital

Okay. And just as a point of clarification, did you say that subscribers outside North America represented 27% of total subs?

Dennis Kavelman

Yeah, on an overall basis, not in the quarter, but overall it is 27%.

Gus Papageorgiou - Scotia Capital

Great. Thanks.

Operator

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

Rob Sanderson - America Technology Research

Yeah. Thank you. Good afternoon everyone, and congratulations on the continued acceleration and adoption, very good sign. A couple of quick ones, first Dennis, can you help us think through how we should be thinking about software revenues going forward? I think it's your most lumpy segment and we have seen a sort of a drop off without a new platform upgrade, what should be we thinking about for the forward year in software?

Dennis Kavelman

Well, when I said for Q4 that we expected to be up a little bit over the $43 million in Q3, I think we expected to steadily creep up as we go through next year. T-Support is part of that software line and we are definitely selling more and more T-Support contracts and haven’t even really cracked the outside of North America market for T-Support. So I think there is some growth there, but as always we do use BES software packages as part of our marketing programs that we do with carriers, and that offsets some of the growth. So I think you just model it as sort of a modest growth quarter-over-quarter, and I will keep providing updates whenever we get any visibility on it.

Rob Sanderson - America Technology Research

Okay. Great, thanks. Quickly, you mentioned inventory write-down on gross margin, was that a material impact, could you give us a little bit of color on maybe how many basis points that may have taken from --

Dennis Kavelman

I won’t give the exact number. It wasn’t huge. It's a kind of thing we always go through whenever we're transitioning to new products and end of life in old ones. It's you want to have just enough parts so that you can build everything you need without having too many leftover and you certainly don’t want to stock out. So whenever you do have products that you are taking to end of life, you have sometimes these small write-downs. So I would say, it wasn’t significant on the order of few million dollars, but every little bit counts and it's something that we will have going forward from time to time. It's just how good can you forecast this end of life transitions.

Rob Sanderson - America Technology Research

Great, keep up the good work guys. Thanks.

Dennis Kavelman

Thanks.

Operator

Your next question comes from Christin Armacost from Lazard Capital Markets. Please go ahead.

Christin Armacost - Lazard Capital Markets

Hi. Thank you, good afternoon. I was wondering if you are not going to breakout the Pearl unit sold in the quarter, if you can at least help us understand how much of the growth from Pearl came from the US versus outside -- the North American market versus outside the North American market.

Jim Balsillie

Sure. I mean well clearly the first carriers to launch Pearl were T-Mobile and Rogers in North America and they were very, very significant, but we also had a number of large carriers launched across Europe later in the quarter. So I think it's safe to say that the majority of the Pearl impact in Q3 was in North America, with Europe coming on in the latter part of the quarter.

Christin Armacost - Lazard Capital Markets

Great, thank you.

Operator

Your next question comes from Mike Ounjian from Credit Suisse, please go ahead.

Mike Ounjian - Credit Suisse

Great, thank you. Jim clearly the Pearl is driving a lot of success on the consumer side of the market given the ramp up in BIS activations. I mean how -- I guess how do you think about going into '08 as you're broadening addressable market, just what that means for the number of product launches we've to do and tell me how that’s going to impact the breadth of the marketing programs you're going to have to do?

Jim Balsillie

Well, I'd have to say that there is no question we've entered into a unexciting space. So we're well positioned and obviously, we're very well positioned and the opportunity is as attractive as one would think. And, so our focus is on the execution that goes into that. So there is definitely a big focus on marketing because it drives such near-term and long-term sales results. So the execution intensity here is just that, very intense. And so I think for '08, I mean, I think Dennis gave you an indication of our expectations on guidance. I think we have the framework of Pearl in now itself is so successful, but quite frankly there are some nicely aligned hardware plans that are going to go with it. And I think are going to dazzle a lot of people. I think the application framework of the BIS and the BES has really proven itself, and I'll try to talk about the applications and the channel. Well now people are (inaudible) wireless so much of the channel focus, I forget there is some dramatic overwhelming majority goes into B2C -- of the activations come out of B2C channels. But really the marketing has been really focused on brand creation and fulfillment to bid these channels, and they are really -- and they sort of take it from there. Well, it shifts with data because you need more capacity or expertise in the channel. So, we’ve invested very heavily in building expertise in the channel in partnership with the carriers and they've really sort of hit, sort of, I guess, to use sort of mining vernacular or vein here that’s very rich.

And so, the Pearl and the BES and associate but every time we do a retail blip 40% to 50% of the activations will be there. So, there is this funny kind of pinball thing going on. And at the core, the carriers are delighted because they are making a lot of returns on this. It's really driving their EBITDA, and the users are delighted, and I think that sort of whole vision that the world sees the carrier as a strategic platform is really becoming a reality. And my view of it is that A, a very small percentage of the people are really there right now. So, the open opportunity is quite big compared to what is fulfilled. But even those that are using it, I think are using maybe 10% of the power that this really has to offer in either the current capacities or the near-term enhancements because this -- and I sort of gave some taste on the platform aspect. So, that’s why I sort of talk like this pinball vernacular word, the ball hits one and it bounces another and it goes faster and faster and faster because they all start reinforcing one another. Users are delighted, organizations are delighted, carriers are delighted, application vendors are delighted, and it's transformative and so what's my view Mike for '08? I mean it's hard not to be -- it's hard not to think this is something that's going to be really -- it has many positive aspects to it.

Mike Ounjian - Credit Suisse

Great thanks, that's helpful. And Dennis, just one clarification you mentioned on the legal expense being a little higher than expected this quarter. How meaningful was that in the uptick in SG&A?

Dennis Kavelman

It was -- I don’t want to break out a specific number, but it was in the single digit millions of dollars.

Mike Ounjian - Credit Suisse

Okay. Thank you very much and happy holidays for both of you.

Dennis Kavelman

Thanks.

Operator

Your next question comes from James Faucette from Pacific Crest. Please go ahead.

James Faucette - Pacific Crest

Thanks. I just had follow-up questions related to the mix between BIS and BES customers and subscribers, specifically on the Pearl, I know you said that the Pearl is growing in a lot more BIS customers and subscribers. But can you give us an idea kind of what that mix looks like firstly, and how that matched-up versus what your expectations were as you want a Pearl? And then looking forward, how should we think about the new devices, as they come to market are these going to be devices that you expect to draw more BES type subscribers or will it continue to be the push into the BIS market? Thank you.

Dennis Kavelman

James, this is Dennis. I can't go down into giving you the mix breakout. What I can say is clearly the Pearl sold into both markets, into enterprise users and into but we did, I wanted to highlight that when we were launching, and we talked a lot about it was targeted to really open up this new market for us and that's the point of where our emphasis is that that in the carriers that launched Pearl, we saw a substantial increase in percentage of BIS users amongst their subscriber as compared to prior quarters. So yes, it drill new subs, in the enterprise so we did see a big increase in BIS, and that’s really what I was trying to get out is that, it certainly appears to have done its job and hit its target, and I can't provide you the specific breakout. As far as new products for next year, some of them will target enterprise users, some of them will be targeting both and sell well into both market. So, it's pretty tough to talk about things that haven’t been officially announced yet.

James Faucette - Pacific Crest

So, it's clear obviously on -- that the BIS -- that the post brand BIS subscribers, how -- but I guess may be in the more general sense, did that basically live up to your expectations or was there a more crossover into the BES than may be you would have anticipated?

Jim Balsillie

The Pearl?

James Faucette - Pacific Crest

Yes.

Jim Balsillie

The Pearl was way more corporate than we expected. It did great, don't get me wrong. It drove a -- it drove a lot of BIS but we didn’t realize it would be so popular in corporate, we were planning on that. And you expected -- and I expected more cannibalization which it didn’t. So, that was kind of interesting. The new devices that are just going to be, may be something else, I think you are going to see them really be something else both on the consumer and something else on the enterprise, and a lot of crossover stuff. So, I can only sort of say that, a whole lot is going to become a lot clearer in the next six calendar months. I think six months from now, because there is a lot -- there is a whole sequencing of things -- you are going to see a heartbeat of application partners and upgrades by us and new hardware and new capacities and new channels, new carriers where -- I mean you work on these things for two or three years and then they're all starting to sort of gel right now. But they don’t really separate well. They just become this pinball thing. They just bang, bang, bang, bang, bang in a very -- there has got to be some derivative to [Metcash] law for this kind of interrelated aspect because it's not just a square of the value of networks, it is the square of participants on sort of exponential sort of uniform basis. It's other constituencies hallowing -- constituencies you didn’t think they would. And so, it's a bit of a surprise right now, but clearly a positive surprise, but a bit of a surprise.

James Faucette - Pacific Crest

Great, thank you.

Operator

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

Mike Abramsky - RBC Capital Market

Yes, thanks very much. Dennis perhaps you could -- could you just help us -- give us maybe a bit of color on ARPU, which you see maybe as the trend in ARPU is going forward, is there is a mix shift to lower cost data plans and I think you discussed that the data attach rates maybe different on the consumer side and also maybe what you see is the trend in your rev share?

Dennis Kavelman

Sure. I mean the enterprise ARPU has been pretty consistent. The changes there are mainly, as I've said, as carriers hit certain levels of numbers that have subscriber accounts, they move down into different price points. But that’s absolutely nothing new. Full BIS pricing hasn’t changed much. We are seeing carriers launch pay-as-you-go in some lower price plans. So, as those come on that could have an impact in terms of mix but they're still around the low end of the BIS range, that we’ve talked about before the $3 to $5 range. Certainly if BIS becomes a larger percentage of the mix of users that will impact overall ARPU, but we also get good economies of scale as we grow adding close to 1 million subscribers a quarter, I mean, who would have thought it even a short time ago has some very good scale benefit. So, again we're decreasing cost very quickly there. But we're seeing the ARPU unfold as we thought. There is not too many of legacy Mobitec subscribers still to turn off. So, I think that’s been a large part of the ARPU decrease this quarter-over-quarter in the last several years. On a go forward basis, it will be mainly mix and perhaps some of the impact of introducing some of these lower price or pay-as-go plan.

Mike Abramsky - RBC Capital Market

And maybe this is more for Jim, but what do you think the important kind of monthly data price points, do you think the carriers in the North America and Europe maybe get to, to accelerate consumer growth and we're hearing Canada, and if you are going to Rogers and buy a Pearl, the upfront cost of the phone is very attractive, but the data plans are still fairly expensive for say more of a consumer walking in.

Jim Balsillie

Yeah. I mean they have a lot of market power being the only GSM operator. So, I think that’s a bit of an anomaly. And, I think you are seeing in Europe, the really powerful adoption of greater aggressive plan. It's really a strategic thing from the carriers, they -- I mean, some carriers you sort of have them say, we want to be a closed media platform, but here's in all you can eat PC card on our broadband network at a fixed price, which are really kind of contradictory strategies. And then or you could say BlackBerry is nice, and I can do some skim pricing just by charging AlaCard as you add services. The carriers that I think are really excelling sit there and say on a profit basis BlackBerry is -- they realize it's 4, 5, 6x the normal subscriber, but their penetration rates are not sort of -- they are not of magnitude away from where they should be and why they put in these advanced networks. And I think if carriers are smart, they can morph their relationship and they are morphing their relationship to be a strategic platform versus just opportunistic pricing for whatever.

And then at that point, they play a much more different role in the ecosystem, which I think it's an enormous opportunity for the carriers to step into like -- I really do believe that this well played two or three years from now people will look back and go, oh, my goodness, the carrier is the epicenter of way more than anyone ever -- and that’s a big swing from the world as you may remember three or four, five years ago when people would say, no, the carrier is just going to be a disintermediated bit pipe. So what you are really doing is gradations of what I would view as enlightenment and opportunity versus near-term skim pricing. And do I get, sort of, 4x my normal profitability over this one customer or 5x versus the last disti curve of much greater adoption. What we are seeing is that those that take the sort of more adoption approach, are getting dramatically greater contributions and more importantly strategically morphing themselves in the markets. So, that’s just something, that’s the carrier's prerogative. It's their strategy, we encourage, we try to show them best of -- best practices and what’s worked elsewhere in the world without breaking any confidentiality.

We only have so much and I think when you see some of these sort of MP3 companies planning MVNO opportunities, and on portal companies growing up the food chain and media company is doing MVNOs and Wi-Fi WiMAX things, if they don’t morph their platform play from an adoption profile, they may really surely regret it, two years from now when its too late. But that’s our view, and so its really playing out -- but these are sort of evolutionary and integrated but like when we see these guys go to variable business stuff like that or pre-activate, we are seeing three, four Xs in the number of data sales with hardly doing anything else, and virtually all go to all-you-can-eat plan, but they just sort of walk into it, rather than sort of being preempted by, it seems to much to start with. And so, I think this is for analytics and investments thesis. On the carrier side, this is really, really important sort of ecosystem evolution and food chain evolution and tech and telecom because it's all blurred. There is no separation any more. It's all just, who has users and who plays an important role and how and is it indefensible, that this is really, really it would be kind of like, Google could have charged people a buck a month, for a good search, three, four years ago. What would that have done to their evolution? They probably have been perfectly justified but they took a more acceleration model and the rest is history. I am not saying the carriers need to give anything away, but I think they are sitting on maybe the biggest shift in opportunity that we'll see for a long, long time and we're just delighted that our strategy was to OEM into them and sort of hitch arm-and-arm together, but we'll see.

Mike Abramsky - RBC Capital Market

Thanks. Congratulations on a great result.

Operator

Gentlemen, would you like to take another question at this time?

Dennis Kavelman

Yeah, I think, we'll take one more operator.

Operator

Your final question comes from John Bucher from BMO Capital Market. Please go ahead with your question.

John Bucher - BMO Capital Market

John Bucher, thank you. Questioned on update on your positioning of the BES platform within the enterprise? Can you give us an idea I think that your last Capital Markets Day 60% of the BES servers you indicated were being utilized for MDS traffic. Can you update that? And also, there has been a fairly substantial increase in the number of independent software vendors that you mentioned 500 up from 370 than at that same Analyst Day. Have you increased the resource through allocating to your independent software developer program and just a general update on sort of the stickiness of your platform within the enterprise market? Thank you.

Jim Balsillie

This is maybe the most fun, my work is the [op] guidance, like. For those of you that haven't sort of ripped CDs on a Blackberry or taken a picture and sent it or seen guys that - those companies coming out where you can order flowers and or play games, online games and there are companies -- games of skill and if you've seen the drive-by-drive directions and you're going to see tremendous Yahoo! Go stuff in the near term and Google Local and can see a lot of Microsoft Live, and you're going to see some tremendous multimedia integration both on the enterprise and the non-enterprise side, multimedia on the BlackBerry and the whole PBX integration is really central math because that was considered sort of important. And then putting a Wi-Fi in these things, I mean it just, you know on the push-to-talk. Playing songs and push to talk is just a software at. On a presentation terminal for a strategic platform and everything is impact. So, it just, those of you that follow us closely, I would argue that if you really paid attention to us and you are real expert, you might have sense of 20% of what's really going on. But the general person analyzing sort of (inaudible) revise, I would say, is still a single digit of that. So, we’re investing heavily, you will be blown away by if you knew all the app stuff is going on, and that’s why, I sort of try to say like, carriers are delighted but they want to be that strategic platform. Users and corporations have finding it transformative both for organizational productivity and individual delight and the other pony in that here is, all the keepers of what I call the stores, the PBX stores or the search store or the IM store or the ERP store.

There is kind of -- they are finding them relevant and opportunity multiplying. And so, this is the biggest enabler that I am seeing by an order of magnitude anywhere in Tech and Telecom and anyone who is touching it is being positively dragged along. So, we're investing aggressively in it, there is no question in ad services and channel programs and in ISP programs, we're aggressively enriching the environment, the platform, and we are spending a ton of time opening up new APIs and supporting them, and it's just super, super exciting, and just really -- you're just going to keep seeing more and more stuff, not days and not weeks going to go by when there aren’t two or three subsequent developments as it happened in the last quarter, as it happened in the last year, and it's happening at increasing rate.

Dennis Kavelman

Okay, I think this concludes the call. I would like to thank everyone and there is a post fee service available 416-640-1917. I'll give the reservation number 21212410 pound, but you can also listen to the call, which is recorded and it's on the Investor Event section of our website. So happy holidays and we'll see you all in the New Year.

Operator

Ladies and gentlemen, this concludes the conference call for today. Thank you for participating. You may now disconnect your lines.

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Source: Research In Motion F3Q07 (Qtr End 12/2/06) Earnings Call Transcript
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