BlackBerry (BBRY) reported results that were considered broadly negative to the investor community. The stock opened down 10% Friday, but somehow magically managed to reach near the unchanged mark by the closing bell. Was this move irrational? Read my commentary below and you'll find the answer.
Chen Has Meet His Goals
As I wrote in my previous BlackBerry article, I evaluate how management performs versus its own targets and Chen has easily met the goals he set. In an interview with BNN (The Canadian business network), he said that "the [revenue] expectations are theirs [analysts], not mine. I have always been saying about cash flow and profits, being positive."
Investors should note the wording of the outlook statements. Below is the wording on the earnings press release in September:
The Company continues to anticipate maintaining its strong cash position, while increasingly looking for opportunities to prudently invest in growth. The Company continues to target break-even cash flow results by the end of fiscal 2015.
Did BlackBerry maintain its strong position? Yes, cash position actually increased $43 million, excluding the $31 million for the Movirtu acquisition. Did the company look for opportunities for growth? The answer should again be yes. On the Q3 MD&A Filling, some of the highlights includes:
• the launch of BES12;
• the launch of the BlackBerry Classic, a new device built upon the iconic BlackBerry heritage;
• the acquisition of Secusmart GmbH, a leader in high-security voice and data encryption and anti-eavesdropping solutions for government organizations, enterprises and telecommunications service providers in Germany and internationally;
• the acquisition of Movirtu Limited, a provider of virtual identity solutions for mobile operators that allow multiple numbers to be active on a single device, complementing BlackBerry's Secure Work Space, BlackBerry Balance and other partitioning technologies;
• the appointment of Mike Daniels, a leading expert in cyber security, with extensive experience in the U.S. government and the private sector, to the Board of Directors;
• a strategic partnership with Samsung Electronics Co., Ltd. to provide a tightly integrated, end-to-end secure solution that brings together BES12 with Samsung Galaxy smartphones and tablets that are embedded with Samsung KNOX;
• the announcement of new value-added enterprise solutions, including BlackBerry Blend, WorkLife by BlackBerry, Enterprise Identity by BlackBerry and VPN Authentication by BlackBerry (discussed in further detail below);
• the appointment of Dr. Sandeep Chennakeshu as President of the BTS unit;
• a series of initiatives to help businesses easily connect people, devices and machines and derive value from these connections, offering end-to-end solutions for the Internet of Things. The initiatives include a secure public application platform to be powered by QNX technology, the facilitation of an Internet of Things ecosystem and strategic partnerships;
• an agreement with Salesforce to connect its customer relationship management platform to BlackBerry's EMM solutions;
The current outlook statement, released in Q3 press release, contains the following wording:
The Company continues to anticipate maintaining its strong cash position, while increasingly looking for opportunities to prudently invest in growth. The Company continues to anticipate break-even or better cash flow from operations.
Notice the statement did not include guidance for revenue growth. However, it does suggest the company will continue to build partnerships and expand its distribution network for growth. The reference to "break-even or better cash flow from operation" does suggest better cash flow performance going forward. Given the conservative nature of BlackBerry's guidance statement in the past, I'm confident the cash flow position will improve.
What About The Revenue Decline?
One cause of the revenue miss is the low bookings of Passport sales. Chen clarified in the BNN interview that due to supply constraints, the 200K orders were mostly filled by end of quarter, which implies the booking on then financial statement is around 200K, but was probably less than that due to sell-through accounting, which I discussed in a prior article. BlackBerry does not recognize revenue until the customer actually turns on and activates the device. Other than the 200K pre-orders, the Passport was mostly unavailable for most of Q3 except near the end with the Black Friday sale, which included an extra $100 discount for the Black Passport. However, due to sell-through accounting, it is likely that the bulk of the sales during the Black Friday sale will not be recognized until Q4.
Another cause of the low revenue was the large November sales on older BB10 devices. BlackBerry cut the price on Q10 from $399 to $199 and Z30 from $499 to $225. The discounts led the lower ASP from $200 last quarter to $180 in Q3. However, given the large 50% discounts on old models, why didn't ASP decline further? Even with a mix of around 10% Passports, the ASP managed to only decline by 10% even when 90% of the mix had a large reduction for ASP due to the November sale. The implication for future quarters when newer models are 100% of the mix is very positive. ASP will be materially higher than the $180 in last quarter. The Classic sells for $449 while Passport's selling price is still $599 (Amazon currently has a discounted price of $549).
All in all, those two factors significantly affected revenue last quarter, but revenue should gradually improve. As Chen said on the conference call, the targeted software revenue increase will happen in the latter half of FY2016 (year beginning March 2015) since lead time for software is usually 6-9 months. BlackBerry just recently launched BES 12 in November and has introduced two enterprise bundles to sell. The technical support fees for the current installed base will flow in after January 31,2015. Next quarter won't see the full effect of those revenue but revenue will grow eventually in FY2016.
What About The Transparency Problem?
I'm confused when people claim BlackBerry is not transparent with its reporting and data. I think the company gave more than enough data for investors. Investors just have to know where to look.
Regarding the criticism regarding the non-GAAP profits, BlackBerry has nicely provided a income statement supplement for investors to see all the adjustments. For those who believe its non-GAAP reporting is bad, I think you should look at some other companies' non-GAAP measures including Twitter (NYSE:TWTR) or Groupon (NASDAQ:GRPN). The items in BlackBerry's non-GAAP earnings are legitimate and reasonable. The biggest item that has impacted GAAP earnings is the fair value adjustment for convertible debt, which is a non-operating item. The large CORE restructuring charges have largely disappeared. Moreover, BlackBerry does not add back option expenses, a very bad practice in my opinion, like many other tech companies.
Regarding the recent acquisitions, the MD&A revealed that the Movirtu acquisition was for $32.5 million in cash consideration. $30.5 million was booked in net assets while $2 million was expensed as transaction expense. The Secusmart acquisition was for $82 million in cash consideration, which will affect the cash in Q4 since BlackBerry announced the closing in December. All information on the acquisitions will be in note 6 to the financials titled "Business Acquisition"
All in all, those two factor significantly affected revenue last quarter but revenue should gradually improve. As Chen said on the conference call, the targeted software revenue increase will happen in latter half of FY2016 (year beginning March 2015) since lead time for software is usually 6-9 months. BlackBerry just recently launched BES 12 in November and has introduced two enterprise bundles to sell. The technical support fees for the current installed base will flow in after January 31,2015. Next quarter won't see the full effect of those revenue but revenue will grow eventually in FY2016.
One positive is the $0.01 profit, which shows BlackBerry is on track to meet its goal of profitability in FY2016. While the lower operating expenses definitely contributed to the profit, the profits on new devices is another major source that are ignored. Since BlackBerry slashed the prices on older models by 50%, there is no doubt that those devices were sold at a loss. The fact that company still managed to turn a small profit means the new devices are extremely profitable, partially attributable to Chen's work to optimize the supply chain and eliminate fixed costs. With the sales mix shifting towards the new devices, I'm very optimistic regarding profits. Although revenue would be lower because device unit sales will drop materially, I'm more concern with profits. After all, a business's goal is to make money, not revenue.
One other positive is the cash flow. Chen's first goal when he came in as CEO was to ensure cash flow break-even. He technically accomplished that in the prior quarter when cash burn was only $11 million. This quarter the company performed much better, generating $43 million of cash excluding the $31 million spent to buy Movirtu. If the company at least remain cash flow neutral for the next few quarters, the $3.1 billion cash position provides a good floor for valuation of the company.
The final positive is the working capital management. If investors look on the company's balance sheet, working capital has improve substantially especially looking at the inventory line. Also figure 1 below shows BlackBerry's Cash Conversion Cycle, which measures how fast, in days, the company turns working capital into cash. The number of days fell from 66 days in Q3/14 to 42 days in Q3/15.
Figure 1: BlackBerry's Working Capital Measures
Source: BlackBerry Financial Filings. DSO is days of sales outstanding, DIO is days of inventory outstanding, and DPO is days of payable outstanding.
99% Is A Pretty Good Number
In June, Chen cautiously improved the odds of success to 80%, up from the 50% he said when he took on the job. In a Bloomberg interview right after the earnings announcement, he quietly upped his estimate to 99%. It's never 100% because there could still be some unforeseen negative event but 99% is a very bullish number. From all the seeds he laid during the past quarter (BES 12, Classic, and partnerships ranging from Samsung to Salesforce), there is no doubt that the future looks much brighter.
Long-term investors are the best to benefit from the improved financials and Chen's 99% confidence in the turnaround. If the stock price declines (and I"m actually hoping it'll will), they can add to their positions. As a value and long term investor, I have no problem seeing the stock decline 10% or 30% in the short term, I just view the decline as a "Black Friday" sale on BBRY stock. With cash representing 60% of the current market cap, I have no problem buying into a decline, especially with the cash flow burn problem eliminated. Judging from the large rally on earnings day after the 10% gap down, I think some investors share my view.
Overall I think the Q3 results were generally considered good for a long-term investor. The cash flow and expenses are under control and the company has laid the seeds for revenue growth. When I invested in BlackBerry, I took a long term that incorporated Chen's estimated turnaround time to 2016-2017. For those who keep point to revenue decline, they are underestimating the amount of work in business turnaround. Revenue growth will eventually come and BlackBerry's quarterly revenue of $793 million, although low compared to its historical revenues, is still much higher than tech companies that have market cap that are multiple times higher than BlackBerry's.
Disclosure: The author is long BBRY.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This article is for informational purposes only and does not constitute an offer to buy or sell any securities discussed in the article. The stock mentioned in this article does not represent financial advice. Investors are recommended to conduct further due diligence before committing capital to any investment.