Good afternoon ladies gentlemen. Thank you for standing by. Welcome to the Research In Motion Limited Third Quarter Fiscal 2006 Results Conference Call. At this time, all participants are in 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 here in the conference, please press “*” “0” for operator assistance at anytime. I would like to remind everyone that this conference call is being recorded on Wednesday, December 21, 2005 at 5.00 PM Eastern Time.
I will now turn the conference over to Mr. Dennis Kavelman, CFO of Research In Motion. Please go ahead sir.
Dennis Kavelman, Chief Financial Officer
Thank you and welcome to RIM’s fiscal 2006 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 upcoming quarters. I will then turn the call over to Jim who’ll 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 general public via 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 6.00 PM 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. These include statements about our expectations and estimates with respect to revenue, gross margin, operating expenses, CapEx, investment income, earnings, earnings per share and ASPs for Q4 and Q1 and beyond. Our plans and expectations regarding our ongoing litigations with NTP including our intention to move forward with a software workaround solution, if necessary, our expectation 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 and timing, developments relating to our carrier partners, new and expanding markets for our products and other statements regarding our plans and objectives.
I’ll indicate forward-looking statements by using words such as, “expect”, “anticipate”, “estimate”, “may”, “well”, “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 achievements to be materially different from those expressed or implied by forward-looking statements including the outcome of RIM’s litigation with NTP, risks relating to our intellectual property, our ability to enhance our current products and develop and bring to market new products including our software workaround solution, if necessary. Our reliance on others including carrier partners, our reliance on carrier partners and their systems accurately report subscriber account activations and deactivations to RIM on a timely basis. Our reliance on suppliers, our ability to effectively manage our growth, risks relating to possible product defects and product liability, risks relating to competition, general economic conditions, foreign exchange risks, risks associated with our expanding foreign operations and other factors set forth in the risk factors in MD&A sections in RIM’s filings with the SEC in 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.
Now as an overview, Q3 revenue was within our guided range. Gross margin was at the high-end of our guided range and operating expenses were inline with expectations. Adjusted EPS as $0.71 was slightly higher than our previous forecast. Subscriber account additions were approximately 645,000 are inline with the revised forecasts, given in our November 23, press release. I’ll now discuss the third quarter results.
Revenue for the third quarter was 561 million. This represented 14% increase over 490 million in the prior quarter and 53% increase from the same quarter last year. Handheld devices represented 392 million or 70% of RIM’s revenue during the quarter, flat from a revenue mix perspective with the prior quarter and up from 343 million in the previous quarter. Total devices that shipped in the quarter of approximately 1.12 million are up from the 960,000 shipped in the prior quarter. This quarter, the difference between devices shipped and net activations was approximately 475,000. Approximately 2/3rd of this difference represented sell-through by a way of upgrades and replacement handsets and approximately 1/3rd went into channel inventory, resulting in overall channel inventory increasing by just over one week. This makes sense, given the shift in the launch schedule of the 8700 and the 7130 handsets until the last few weeks of the quarter for initial stock and carriers. We continued to see strong handset replacements.
As expected, average device ASPs decreased approximately $350 versus $360 in the prior quarter. This decrease was related to the mix of product shift in the quarter. As a result of expected shift in product mix toward the newer handsets, we expect ASPs increase slightly in Q4 and Q1.
Service revenue was 104 million or 19% of revenue for the quarter, an increase over the 86 million in the prior quarter. RIM added approximately 645,000 BalckBerry subscriber accounts during the quarter, which was within the revised range we announced on November 23. As we discussed in our November press release, the lower than expected additions for the third quarter, were primarily as a result of the shift in launch schedules of the 8700 and 7130 handsets. The total base of BlackBerry subscriber accounts at the end of the quarter was approximately 4.3 million.
Software revenue was flat with the prior quarter at 40 million or 7% of revenue. We are forecasting software revenue to increase in Q3, sorry in Q4 and Q1, with the introduction of BES 4.1, in early calendar ’06. Other revenue such as accessories and durable repairs was 25 million or 4% of revenue.
Gross margin for the third quarter decreased slightly to 55.8% from the pro forma 56.2% in the prior quarter and this was slightly higher than our forecast. R&D spending was 41.6 million or 7.4% of revenue for the quarter, selling marketing and administrative expenses increased by 16% to 84 million versus 72.3 million in Q2 and were 15% of revenue, slightly lower than we had expected.
RIM has updated its accounting for the NTP litigation following the District Court’s ruling on November 30, which found that the March 2005 settlement agreement between NTP and RIM was not binding. Although it is difficult to estimate when any future settlement or cost associated with the litigation maybe, we are maintaining the previously recorded 450 million as the best current estimate. The actual liability maybe significantly higher or lower than this amount, depending on further developments or resolution of this matter and will be booked at that time in accordance with GAAP.
At the time of the March 2005 agreement, RIM recorded 20 million of the 450 million litigation accrual as an acquired license on its balance sheet. The District Court’s ruling that the settlement was not binding led to the writedown of this asset which after accumulate depreciation had a net book value of 18.3 million. This writedown and an incremental charge of 7.9 million for NTP related legal and professional fees were offset by related tax recovery of 7.2 million.
The tax rate for the quarter was approximately 27.5%. GAAP net income for Q3 was 120.1 million or $0.61 per share diluted. Adjusting for the write down of the 18.3 million intangible assets, the NTP legal expense accrual and the related tax recovery, adjusted EPS was $0.71 which was higher than the expected range for EPS given on our last call. This was due to slightly lower than expected operating expenses and slightly higher than expected gross margin. The GAAP reconciliation of our adjusted EPS was included in the earnings press release in a chart this afternoon.
Weighted average diluted shares used in the GAAP EPS calculation for the quarter were 196 million. Actual shares outstanding in November 26 were 185 million. Total options outstanding were 9.9 million. During the quarter, RIM repurchased 6.3 million shares at an average price of just under $62. Under the normal Court’s issue or that announced on October and taking into account repurchases to date, RIM is eligible to repurchase an addition of 3.2 million shares between now and October 2006.
RIM’s balance sheet continues to be strong with substantial cash reserves and appropriate working capital balances. At the end of the third quarter, RIM had 1.6 billion in cash, cash equivalents and investments. This was down 293 million from the prior quarter. This decrease was due to the repurchase of shares during the quarter and excluding the share buyback, cash would have increased by approximately 100 million.
Trade receivables were slightly higher than the prior quarter at 276 million. The DSO is decreased to 41 days compared to 43 days in Q2. Inventory increased to 112 million from 84 million in the prior quarter. This was due to increased raw material, component inventory related to the launch of new products in the quarter. These products did not launch until near the end of the quarter causing inventory level at quarter end to be higher than normal. RIM manufactures on a bill-to-order basis and does not holds significant quantities of finished goods inventory.
Net capital assets increased to 297 million up from 270 million in the prior quarter. We expect CapEx to be approximately 50 million to 60 million in both Q4 and Q1 due to spending on increased capacity, BlackBerry infrastructure and campus facilities.
At this time I’d like to discuss our outlook for upcoming quarters. 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 the beginning of the call and outlined in our public filings.
On the September conference call, we provided a revenue estimate for the fourth quarter in the range of 590 million to 620 million. This range was also reiterated in the November 23 press release. We are maintaining this range as we expect hardware shipments to be solid due to the high level of demand we are seeing from the new products and as launches of new handsets continue with carriers around the world.
In our November 23 press release, we indicated that we expect Q4 subscriber account additions to be in the range of 750, 000 to 800,000. However, as I’ve mentioned early this numbers becoming increasingly difficult to forecast, as everyone is likely seeing over the past several weeks, there have been an overwhelming amount of media coverage, the NTP matter which is played up of the possibility of an injunction against RIM. The impact of this has been to create some uncertainty among customers. The timing of any resolution of the NTP matter and the removal of this uncertainty is difficult to predict. Therefore, taking into account these factors, we believe it’s prudent to lower the Q4 range of subscriber additions to 700,000 to 750,000.
We have not adjusted revenue guidance for Q4 despite the subscriber reduction as we are seeing strong upgrades occurring with the launch of the new products and expect this trend to continue. For the first quarter of fiscal 2007, we are currently forecasting revenue to be higher than Q4 in the range of 610 million to 650 million. We previously guided Q4 gross margin to be in the range of 56% to 58% and we are maintaining this range. For Q1, we’re forecasting gross margin from 55% to 57%. We expect an operating expense increase for Q4 of approximately 11% to 13% from Q3 levels, to support the launch of new products, retail programs and new branding and marketing initiatives. In Q1, we expect to have an increase in total OpEx of approximately 9%. We expect R&D to increase by approximately 12% in Q4 and 6% in Q1. We expect sales, marketing and admin to increase to approximately 12% in both Q4 and Q1.
Beginning in Q1, RIM will begin recording employee stock option expense in accordance with FAS 123R. We estimate this expense to be in the range of 5 million to 7 million per quarter, next year. We expect depreciation and amortization to be approximately 14 million to 15 million in Q4 and Q1. Investment income is expected to be modestly higher in the range of 18 million to 19 million in Q4, and 19 million to 20 million in Q1. As we’ve discussed previously, we expect RIM’s overall tax-rate to decrease overtime as RIM’s international business activities continue to expand. We are currently expecting the rate to be approximately to 26% to 27% in Q4 and 25% to 26% in Q1. The reminder of fiscal ’07, we expect the rate to be in the range 20% to 25%.
We continue to expect Q4 EPS to be in the range $0.76 to $0.81 per share, we just tighten up the bottom or enter the range from $0.74 to $0.81 to the $0.76 to $0.81. For Q1, we are expecting EPS to be higher than Q4, in the range of $0.78 to $0.84 per share. And this Q1 guidance includes approximately $0.03 per share of stock option expense impact. We plan to change the way we give quarterly financial guidance for fiscal 2007.
Starting with the Q4 earnings release in April, we plan to give forward guidance for one quarter only similar to many other companies in our industry. Visibility beyond one quarter is a challenge and this has been compounded by the expansion in RIM’s channels, the number of carrier partners we’re relying around the world and a frequency of new product launches as we grow. As well, we’ve returned to our practice of providing specific guidance for net subscriber account additions for one quarter.
I’d like to remind everyone that RIM’s fiscal fourth quarter which ends on March 04, has 14 weeks instead of usual 13 similar to many other companies, the rolling 13 week quarterly cycle that RIM employees maintains every five to six years, there’s a 14 week quarter to allow the fiscal yearend to realign with our February calendar month end. So, I’ll now turn the call over to Jim.
Jim Balsillie, Chairman and Co-Chief Executive Officer
Thanks so much Denny. Before I provide the usual quarterly business update, I’d like to take a few moments to address the ongoing litigation that has been the focus of so much attention over the past several weeks. Our views are pretty, are summed up pretty well in the op-ed piece in Monday’s Wall Street Journal, which I’m sure many of you have read already. For those of you that who haven’t read it and are interested, it is available in the investor relations section of RIM’s website.
From our perspective, we have acted responsibly throughout the process and have tried in good phase to settle with NTP. We have tried to play by the rules throughout and respect the admonitions of Courts and mediators. We believe that RIM has been vindicated by the recent actions of US Patent Office over the past several weeks. In particular, the latest rejections issued this past week which be into NTP’s arguments “unpersuasive” and in which the NTP disclosed, that had setup a special team to act with dispatch in a matter are particularly important. We were also encouraged by the strength of the rejections based on three independent forms of prior work, and the fact that the PTO indicated that these rejections would have been final rejections had it not been for the fact that NTP was negligent in their duty to provide the US Patent Office with the relevant TeleNav prior work, even though they were aware of its existence.
We believe that these unusual actions by the PTO and their acknowledgement of the Court’s concerns with respect to the timing of final office actions constitute significant new information that is not previously been considered but should be considered by the Court, with respect to the legal process, the Court has set a briefing schedule for the next stage of litigation, initial briefs from both sides are to be submitted by January 17, and response briefs as well as the justice department’s brief are due on February 1. There has not currently been a date set for hearing; there is a good possibility that there maybe further office action from the PTO prior to the date of any hearing, which the Court may consider. If we do not prevail in convincing the Court to give appropriate weight to the actions of patent office and that the public interest is not served by an injunction, RIM intends to move forward with the software workaround solution we have referenced in the past.
Well, this is not a preference; we will deploy the solution if necessary. We have not yet provided details of the workaround but we are very close to making available information, detailed information which will provide the specifics of the workaround solution. In addition, we are continuing to engage in settlement discussions with these systems of a mediator.
At the end of the call, I’ll take question and answer as best I can; given the restrictions I have with respect to confidentiality, and mediation privilege. I’ll now provide a brief business update.
Product launches in the quarter included the 7105t with T-Mobile in September, 7100i would Sprint Nextel on October, the 8700 with Cingular and Rogers, and the 7100e with Verizon and Bell in November. In addition, we have continued to aggressively launch new BlackBerry carriers around the world and recently launch MDS 4.1, which will make application enablement for BlackBerry even easier than before. With the launch of the 8700 and 7130e occurring later in Q3 than we had anticipated, these products are now available and have received an overwhelmingly positive reception in the market, and have received excellent reviews from numerous publications.
As we move into the last quarter of fiscal 2006, we are looking forward to finishing the year on a solid footing and heading into fiscal 2007 with a strong slate of products that were launched this quarter as well launching BES 4.1 launching additional new handheld devices and continuing to expand and grow our carrier relationships around the world. The BlackBerry connects and built-in programs are thoroughly accelerating and we look forward to expanding the presences of existing connect products and introducing new connect products over the coming months.
As I mentioned before, the response to the new 8700 platform has been overwhelmingly positive. These much anticipated products are now available throughout both Cingular and Rogers retail and enterprise channel and many retail stores sold out their entire initial allotments within a few hours of receiving them. Cingular has launched the 8700c with very attractive pricing of $299 with a two years contract and data plans ranging between $35 for the basic plan and $6499 for unlimited domestic and international data usage. Rogers has also launch the product with attractive pricing plan and both carriers are aggressively marketing the products through promotional and advertising campaigns.
Since launch, there have been an enormous number of favorable reviews in the media through out North America, and the product has already, won a number of awards despite being in the market for less than a month. We expect that heading into next fiscal year, the 8700 platform will lead the way in terms of driving growth and we anticipate that many carriers in North America and around the world will adopt the platform over the next several months. The 7100i, which was launched in October with Sprint Nextel has also been very well received in the market and is driving significant activations in the channel. The 7100i was 64 megabyte of flash memory, 8 megabyte of SRAM, offers a phone-like form factor with a large bright color screen and BlackBerry SureType technology.
In addition to features such push-to-talk, walkie-talkie capabilities, the BlackBerry 7100i offers GPS technology for real-time audible and visual turn-by-turn driving instructions. For example, BlackBerry handheld operating on the Nextel national network support GPS enabled navigation with TeleNav in the United States. In addition, MapQuest has an application to take advantage of the GPS capabilities of the 7100i and the 7250 handsets on the Nextel network.
“MapQuest Find Me” lets users automatically find their locations, access maps and directions and locate near five points of interest, including Airports, Hotels, Restaurants, Banks and ATMs. It is our belief that location-based services and presence-based applications will continue to grow the importance as GPS enabled handsets become increasingly common. Both Verizon and Bell Mobility launched the 7130e for EVDO networks this past quarter. The phone-like 7130e with 64 megabyte flash memory and a bright color display also offers tethered modem capability. This enables customers to use their BlackBerry 7130e as a modem for downloading large documents to a laptop at high-speed for a small additional fee on top of their BlackBerry service.
We launched the 7105t with T-Mobile in the US in September. The 7105t is an update to this 7100t and offers a bright, easy-to-read display, increased memory and integrated access to Yahoo e-mail. This launch was supported by a substantial marketing campaign that consisted of print media magazines and newspapers as well as online advertising. The 7105t was launched to all channels at $199 and was featured on Oprah’s Favorite Things show on November which gained that product increased visibility in a retail channel.
With respect to carriers in the Fast100 update, we launched the Fast100 carrier program approximately 1 year ago, and we can confidently say that the program has been a success. So far this year, we’ve added over 80 carriers, 23 in this quarter alone and have well over 100 in backlog. New carriers this quarter include PERSONAL in Argentina, Movilnet in Venezuela, TSTT in Trinidad and Tobago, Mobilink in Pakistan, Tricomm in Norway, Amena in Spain, Vodafone MNC and Vodafone Luxembourg and Telefónica in Argentina, Brazil, Chile, Columbia, Equator, Guatemala, El Salvador, Nicaragua, Panama, Peru, Mexico, Uruguay and Venezuela. While subscriber account additions in North America this quarter has been were lighter than expected due to the delayed launch of the 8700 and 7130e handset, we are seeing strong demand for these products. Now that they are available and expect this trend to continue as channel penetration increases.
We are particularly excited to see the launching of the 8700f in Europe with Orange brand this month and expect to see similar strong demand for the product in this market. Our efforts in Latin and South America also beginning to payoff as demonstrated by the new carriers we announced in the past quarter and we are extremely excited about the opportunities in this region.
With respect to China, we remain on track to launch nation wide BlackBerry service with China Mobile this fiscal quarter. In addition to the successful corporate Best Trails I spoke about in last quarter call, we have now completed many of the operational aspects of the upcoming launch including training of the technical support personal, feeding up billing systems and deploying infrastructure. We look forward to providing more details to you in the coming weeks.
Elsewhere in Asia, we’ve seen activity pickup with a number of carriers including Bharti in India; with a launch of a number of BlackBerry connect handsets, Hutchison in CTM an expanded availability in to Macau. And the launch of the BlackBerry Connect on the Nokia 9300 and 9500 handsets and the launch of integrated Yahoo IM on BlackBerry by SingTel.
We expect to see an up tick in subscriber account growth in Europe following the launch of the 8700 platform in the region. Orange brand has announced the 8700f, which is currently available in enterprise channels with retail availability plan for late in January. The 8700f will also be available in other Orange markets across Europe in base rollout during calendar 2006. For BlackBerry Enterprise Server update, this quarter we launched the mobile data service with support for web services. Among the new enhancements is a visual developed tool that tops into the XML based service-oriented architecture, enabling systems integrators, independent software vendors and in-house corporate developers to rapidly create wireless applications.
NTS removes complexity from the application development process, reducing the amount of time, cost and specialized skills required to create and deploy wireless applications. BlackBerry MDS was support for web services is now available as an upgrade for the BlackBerry Enterprise Server 4.0. We expect the BES 4.1 to ship in the first quarter of calendar 2006. This is slightly later than previously anticipated as we trying to do further testing and improvement to ensure that the commercial release provides the best possible experience for our customers. The release of BES 4.1 will improve administration scalability, with the addition of group and well based administration. With BES 4.1, RIM is also helping customers respond to tighter regulatory environment for example Sarbanes-Oxley compliance by enhancing ordering capabilities to wireless SMS and pin-to-pin messaging. Customers on the domino platform are looking forward to Lotus notes encryption, same time in DV2 support all of which will be available in BES 4.1. For BES, a BlackBerry Internet service and retail update, BlackBerry continues to progress well in retail channel in the past quarter and retail distribution began with six new carriers this quarter. This quarter RIM also launched its new indirect business unit to support the needs of the non-exclusive indirect channels across all BlackBerry products and services. This team has been running a number of promotions to provide incentives to sales representatives in the indirect channel throughout the holiday season.
The integrated Yahoo Instant Messaging on BlackBerry continuing to gain traction with Rogers in Canada, Nextel in the US and O2 in the UK all launching this quarter. The BlackBerry Connect and BlackBerry Built-In program continues to gain momentum with strong growth particularly in Asia and Europe. BlackBerry Connect is now launched with over 60 operators worldwide and customers can choose from over 15 different devices with BlackBerry Connect or BlackBerry Built-In.
Q3 saw 2 key milestones for the BlackBerry Connect and BlackBerry Built-In program. The launch by Cingular the first BlackBerry Connect carrier in North America, and the announcement of the attention to provide BlackBerry Connect on the Palm Treo 650 with launches planned with carriers in the United States, Spain Australia and Singapore. This past quarter BlackBerry Connect and Built-In was also launched with several new carriers including O2 Germany, Optus Australia, Vodacom and MTN in South Africa, Airtel Bharti in India, Vodafone Sweden and the UK and SMART in Philippines.
At the Symbian smartphone expo in October, RIM announce BlackBerry connect support for Symbian OS version 9. BlackBerry Connect uses the device as native application to connect to BlackBerry services, in this case using, utilizing the enhanced series 60 and UIQ 3.0 application platform. Symbian OS 9 version 9 will see more variety and choice of Symbian OS based handsets in the market. As a result more users will benefit from the advanced capabilities of BlackBerry Connect for the Symbian OS.
The first such product to be available will be the Sony Ericsson P990 and the Nokia E-series, devices the E60, E70 and E61. All will be offered in the first half of 2006, and will provide users with robust of BlackBerry services. This development follows the success of the BlackBerry Connect for Symbian OS version 7 which is currently available from carriers worldwide on the Sony Ericsson P910, the Nokia 9300 smartphone and the Nokia 9500 communicator. These devices have represented an unqualified success in expanding the BlackBerry platform to new users and into new market segment. Offered now by over 60 carriers worldwide BlackBerry Connect for Symbian OS has been the center piece of major marketing campaigns with our carriers partners in Europe and Asia Pacific. RIM continues to provide strong BlackBerry Connect support for the Windows mobile platform. Today, we have globally launched over 8 Windows mobile products from partners such as HTC in Taiwan and Motorola and with a broad, wide variety of leading carriers such as T-Mobile, Vodafone, O2 and StarHub. RIM continues to invest in Windows mobile BlackBerry Connect application support for Windows mobile 5 expected early in Q1, I think calendar Q1 2006.
In summary, during the third quarter, we launched the new product platforms and initiatives that will form the basis for our growth in the fiscal 2007. Our business remains strong despite the late launches of certain products and the ongoing litigation, which we are currently managing. We look forward to finishing fiscal 2006 in a position that will allow RIM to capitalize on a strong product portfolio and market share that we have built over the past year. This concludes our formal comments, due to the large number of people on the call, we ask let you please limit yourself to one question per person. We plan to end the call today by approximately 6 PM. Would the operator, please come on to handle questions.
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