This morning BlackBerry published its Q2 fiscal 2014 financial results by way of press release. They’ve made what I believe is a horrible decision to skip the usual conference call. My understanding is their SEC filing with management discussion and analysis (MD&A) will be out next week. This leaves me with less information than I’d like to base my analysis on. As usual, I’m going to tell it how I see it. No sugar coating. Just balanced commentary.
First of all, the published numbers are worse than they indicated last Friday, the date of their layoff announcement. The pre-announcement was certainly truthful by saying the GAAP loss was close to a billion dollars. What they didn’t tell us until this morning is that the pre-tax loss was actually $1.44 billion. I’m not a tax expert, so when I looked at last week’s pre-announcement I thought that, excluding the Z10 inventory write down, they were pretty close to break even. That’s not the case. They are bleeding badly.
With revenue of $1.6 billion, they had adjusted gross margin of 36%, or $570 million. That’s what is left to fund all expenses. Unfortunately operating expenses amounted to $1.06 billion, so they’re losing loads of cash.
They went from having $3.1 billion in cash last quarter to $2.6 billion now
This is, of course, confirmed on the cash flow statement. They went from having $3.1 billion in cash last quarter to $2.6 billion now. That’s $2 billion annualized, folks. Hopefully this paints you a crystal clear picture of exactly why they had to cut 4500 jobs last week. It’s sad, but it’s a no brainer. This company can’t survive without the cuts.
Operating expenses consist mostly of R&D and Selling, General and Administrative (SG&A), as most of you who pay attention to financials already know. The company spent almost $900 million on these two line items in Q2. If they are successful in cutting 50% of their operating expenses and hold revenues in place, they should get back to break even.
Let’s now talk about shipments and sell-through. As most of you already understand, the company sells hardware to carriers and other partners, who then sell it to end users. This quarter they recognized revenue on 3.7 million BlackBerry devices, although end customers actually took possession of 5.9 million devices. For comparison, last quarter they shipped 6.8 million devices and sell-through was also 6.8 million.
I’ve always felt that sell-through was the more important metric. Sell-through tells you what actual customers are doing, as opposed to sell-in, which tells you how carriers are behaving. Sell-through is down by 13%, which doesn’t seem horrible but it is. BlackBerry 10 is now in full force, and it only produced one solid quarter of growth (Q1), and is now in decline. This is a very bad sign.
What about the 3.7 million “shipments” this quarter? The company explained in the press release (and the pre-announcement) that actual shipments were higher, but they could only recognize revenue on 3.7 million units. Have they changed their accounting policy? No, they have not. I confirmed this with the company myself just today. I will offer my explanation on things. BlackBerry 10 sales are declining. BlackBerry 7 sales are declining. This is causing the company to be more conservative in recognizing revenue on product that can be returned by carriers if it doesn’t sell. The revenue recognition rules have not changed. What has changed is the risk around the shipments, therefore causing BlackBerry to use these existing rules as best it can to accurately report sales. After all, a device that gets returned to BlackBerry by the channel should never have been counted as revenue.
Another bad sign for the company is the consistent weakness across all geographical regions. Let’s look at some numbers:
That’s a very consistent drop in sales!
Of course all of this is relative to three month ago, and I’ll repeat myself here because it’s important: This is probably a reflection of the difference in management’s perception between Q1 and Q2 of how realistic it is that a shipment becomes an end customer sale. Sell-through numbers are down 13%, which is very different form the near-50% drop in reported revenue. I believe sell-through is a more important metric in terms of understanding the business trend.
I’d also like to point out that on the cashflow statement this company is still spending a lot of money on intangible asset purchases. The total was $268 million in Q2 and $335 million in Q1. My understanding is that this spending reflects upfront patent licensing expenses. Obviously this is not sustainable. BlackBerry can’t be doing $771 million in quarterly hardware sales while paying a huge portion of this out for licensing. This would make it impossible to continue in the hardware business. So either these licensing fees will drop proportionately with shipments, or BlackBerry has an impossibly unprofitable hardware business that nobody will ever buy, and will get shut down. I think the former argument is more likely at this point.
The only real good news is the growth in BES 10. Since July they’ve taken the installed base of servers from 19,000 to 25,000. This is pretty much the only part of their business that is growing. They absolutely need to keep this momentum going, just as they need to get the cross platform BBM launched, and grow that user base.
Although the sell-through decline isn’t as horrible, it’s still bad, and it has put the company in a very precarious position
All in all, the Q2 results look very scary because of the sequential revenue decline. Although the sell-through decline isn’t as horrible, it’s still bad, and it has put the company in a very precarious position. They need to swiftly execute the job cuts and decide whether or not they can remain in the smartphone business (actually making phones) or move to just software and services. They need to figure it out pretty fast, because they’re bleeding cash in a way that might accelerate as BB7 users transition off the platform or move to BB10.
Next week I’ll have a chance to look through the company’s SEC filings with full MD&A, so I’m sure I’ll be back with more at that time.