Tonight RIM posted Q2 financial results that disappointed investors enough to send the stock tumbling close to 20% in after-hours trading. Since I covered the stock as an analyst in the financial community dating back to 2000, Kevin asked me to share my perspective on the results with CrackBerry Nation. So here goes.
The Reported Numbers
Q2 revenue was $4.2 billion, which is at the low end of the guidance that RIM had provided on last quarter's conf call. Earnings, expressed as EPS (earnings per share), was $0.80 while Wall Street expected $0.87. Another miss.
Gross margin also came in a tad under the company's guidance of 39%. No big deal, but guidance for the upcoming quarter is what really bugs Wall Street. More on that in a bit.
I think the reported numbers were disappointing. RIM should have been better prepared to issue more conservative guidance after missing expectations for the last few quarters. Apple, for example, has a strong history of issuing very conservative earnings guidance and then beating expectations. I can't even begin to tell you how many large institutional investors have expressed their frustration on this.
But the real focus is on what's coming
Wall Street tends to pay more attention to forward-looking guidance than what happened last quarter. Makes sense, right? Focus on the future, not the past ...
So, RIM actually provided a pretty good revenue outlook. They expect $5.3 to $5.6 billion in revenue. Analysts expect the low end of that range. I think that most analysts don't realize just how high the wholesale prices are for BlackBerry 7 devices. Seeing "average selling price" (ASP) rise, should tell analysts that RIM has a way to compete effectively in the market. At least that's my opinion.
But revenue doesn't tell the whole story. If revenue beats expectations, shouldn't earnings be stronger too? RIM only expects to post between $1.20 and $1.40 in EPS next quarter. Wall Street expects $1.36. So if you are an analyst, you see a disconnect between revenue and earnings. Revenue is rising faster, which can only mean costs are also rising faster.
As it turns out, gross margin is falling. RIM expects margin to drop to 37% next quarter. This was a definite source of confusion among analysts and investors. In my opinion, RIM could have walked people through the issues in greater detail.
Here's what I think is happening. The Playbook is getting discounted because they just aren't seeing the sales they expected. RIM eats that discount entirely, hurting margins. Management did confirm on the call that BlackBerry device margins (ex-Playbook) are at least flat, if not up in Q3. That's a good sign.
Why is the stock taking such a beating
Wall Street is sick of seeing RIM over promise and under deliver. It really is that simple. Remember that RIM originally estimated it could earn over $7.50 in EPS this year. Now, only 6 months later, that figure has been revised lower to about $5.25. This kind of result breeds negativity.
Also remember that RIM stock had rallied from the low $20s (just prior to the BlackBerry 7 launches) to the low $30s prior to the earnings report. Wall Street was catching on to the idea that BlackBerry 7 is a hit among customers. There was a certain level of expectation that RIM would deliver very strong numbers, not weak numbers along with mediocre guidance for next quarter.
Full year 2012 earnings guidance tells an interesting story
RIM had established an EPS guidance range of $5.25 to $6.00 last quarter. This quarter they're saying they will hit the lower end of that range. Let's do some math on this.
In Q1 and Q2 so far, RIM has delivered a total of $2.13 in EPS. The forecast for Q3 adds another $1.30 (mid-point of guidance range). That adds up to $3.43. Unless my BlackBerry Calculator is broken, this means RIM has to achieve $1.82 in the final quarter of the year.
Just to be crystal clear about this, EPS of $1.82 would be a record quarter for the company. Kinda throws a monkey wrench into the "RIM is a dying company" argument, doesn't it? Last time I checked "dying" and "record earnings" don't go hand in hand.
But they have to actually deliver on this promise, and let's face it - their track record for delivering on guidance has been pretty brutal lately. That said, Q4 is the February-ended quarter and includes the massively important holiday season (but not Black Friday). RIM has always seen a pretty good uptick in sales and earnings during the February quarter.
For investors, this means you have to wait 13 weeks before RIM either re-confirms this guidance on its next conference call, or revises its estimate lower. Personally, with the stock back in the low 20s as of Friday morning (based on Thurday night's after hours prices), I'm more likely to buy stock than sell. But that's just me. Do your own research please! I've been wrong plenty of times before.
BlackBerry 7 strength is key
I think a big part of RIM's confidence in the final half of their fiscal year comes down to the strong customer response from BlackBerry 7. We knew things were going pretty well, but now we have some numbers from RIM to back it up.
"Sell through" is a term used to describe devices that are sold to end customers, as opposed to "sell in", which is devices that are sold into the channel (carriers, retailers). RIM disclosed that 35% of North American sell through came from BlackBerry 7 devices in the final week of Q2. That's a good sign. It means BB7 is ramping fast.
Here's another important set of sell through numbers: There were 13.4 million devices sold in Q2 versus 13.3 million in the prior quarter. Yes, that's an increase. Not exactly earth shattering growth, but not too shabby considering that BlackBerry 6 devices fell off faster than they had expected. What this tells me is that, again, BB7 is doing very well.
And the risks remain the same ...
Even if the BlackBerry 7 launch is the most incredible launch in RIM's history, it really doesn't prove that RIM will remain a long term player in the smartphone market. To prove this they need to make one more major transition over to QNX. As a shareholder, I'm optimistic,but not willing to close my eyes and hope for the best.
QNX devices will come out sometime in early 2012. For the record my bet is calendar Q2 (meaning April or later). So we'll be waiting a while. But the devices are not the only risk. RIM needs to deliver compelling apps, and higher quality developer tools.
I also think RIM needs to completely transform itself into a company that won't settle so far away from perfection. From BBM buddy list problems on upgrades to less-than-ideal user interfaces on app world ...RIM simply hasn't put enough effort into making its products flawless. Nobody is perfect, but they need to shoot for getting much closer.
But given the balance of risks to the business and the current valuation of the stock (which trades at under 5 times earnings as of tonight), I'm hanging in a while longer. If I'm not satisfied with the pace of progress then I'll be selling.
Disclosures: I own shares of RIM, Apple and Google.
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