BlackBerry (NASDAQ:BBRY) reports quarterly results before the market opens on Friday. Analysts expect revenue of $794 million and earnings per share ("eps") of -0.04. Revenue estimates are down 19% Y/Y and flat sequentially. I am one of the biggest BlackBerry bulls out there, but I am bracing myself for an ugly quarter.
This Is Almost A Transitional Quarter
BlackBerry is still in the restructuring phase. The company has culled unprofitable handsets and cut costs amid a much lower revenue base. In the meantime it has transitioned to more revenue from services and handsets. However, the following issues remain:
Service Fee Revenue In Free Fall
CEO John Chen let the cat out of the bag when he said service activation fee ("SAF") revenue was expected to decline 50% to $800 million in FY16. SAF is a monthly infrastructure access fee billed to subscribers of BlackBerry 7 and prior operating systems. As the universe of BlackBerry 7 users has declined, SAF revenue also has declined. To be more in line with competitors' fee schedules, BlackBerry has had to de-emphasize these fees. Analysts have soured on the BlackBerry story ever since. There is no guarantee that BlackBerry can grow revenue from handsets and software rapidly enough to offset the decline in SAF. And that's what scares Wall Street analysts who crave certainty.
Handsets Could Be Drain On Cash Flow
Despite declining revenue and consistent GAAP losses, BlackBerry has been able to mute cash burn. The company has done this by cutting costs, laying people off, selling corporate real estate and keeping inventory levels low. Low inventory caused the company to be unable to fulfill demand for the BlackBerry Passport last quarter. To offset declining SAF, the handset division has to pull its own weight. I previously estimated that the company needed to sell 8 - 9 million handsets to reach its FY16 revenue bogey. That will require that Chen takes some risks on the inventory side, though.
This quarter I fully expect the company to build inventory in advance of demand for the BlackBerry Passport and BlackBerry Classic. If sales disappoint, it could create a drain on cash flow. In the past Chen has been prudent on managing working capital, but going forward it would make sense to take the cash flow hit from inventory build to fulfill demand and meet revenue expectations.
Software Revenue Not At Full Strength
Chen expects software revenue - mainly from enterprise mobility management ("EMM") - to double to $500 million in FY16. To entice customers to migrate to one operating system, BlackBerry developed an "EZ Pass" program which offered free upgrades to BES 10 for both new and existing customers. BlackBerry hopes to entice many of those EZ Pass customers to migrate to BES 12 and pay ongoing fees for the service. The company currently has about 7 million clients in EZ Pass, up from 3.4 million in November.
The company's best-in-class security is the one moat that it has; it can extend that moat by managing devices for the enterprise. This is BlackBerry's best hope to offset its declining ecosystem. The rub is that EZ Pass customers who re-up with BES12 do not go on subscription pay until next quarter. This is a long-winded way of saying, I expect software revenue to be underwhelming during the quarter.
Conclusion
With SAF in free fall and software revenue not expected to ramp up until the end of February, I am bracing myself for an ugly quarter. Investors may have to stomach a dismal fiscal Q4 to enjoy the upside to come. I am long the stock.
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