Wall Street was disappointed with BlackBerry's (BB 3.21%) fiscal first-quarter performance even though the company beat analyst estimates on both revenue and earnings. Investors were dissatified with the slowdown in the company's enterprise software and services business, which tumbled nearly 18% year over year, dragging down revenue by 11%.
But a closer look at BlackBerry's latest results makes it clear that investors are overreacting.
Image source: Getty Images.
A temporary slowdown
BlackBerry has done well to reinvent itself after falling from grace in the smartphone market. It has been increasingly targeting the software and services space as it continues to wind down the legacy device and service access businesses. Together, these two segments supplied $24 million in revenue last quarter, down from $75 million in the prior-year period. The declining clout of these two businesses was a big reason behind the double-digit decline in BlackBerry's top line last quarter.
Investors shouldn't be fixated on the 14% drop in enterprise software and services revenue that was caused by a change in accounting principles. BlackBerry has adopted the ASC 606 standard for reporting sales. Under this method, it will be recognizing the revenue from certain enterprise contracts over the entire term of the contract length instead of recognizing them up front.
The company used to get around 20% to 30% of its revenue by selling perpetual licenses wherein it used to recognize the revenue up front, so there will be transition pains thanks to the change in accounting practice. But at the same time, investors shouldn't miss the fact that BlackBerry's deferred revenue grew massively due to this shift.
The company is now sitting on $277 million in deferred revenue, which will be recognized on the income statement once the actual delivery of services takes place. By comparison, it had $195 million in deferred revenue in the prior-year period. So, the 42% increase in the deferred revenue indicates that BlackBerry will eventually overcome the enterprise weakness, as it is now getting more revenue from recurring sources.
In fact, recurring sources now supply 86% of BlackBerry's software and services revenue, up from 70% in the preceding quarter. Looking ahead, the company believes that it can boost its recurring revenue to more than 90% of software and services revenue, allowing it to predict its revenue streams with better accuracy.
Licensing and technology are taking off
There's nothing alarming about BlackBerry's enterprise business, and there's a lot to cheer about the way its technology solutions and licensing businesses are growing. The combined revenue of these two segments increased almost 62% year over year during the latest quarter to $110 million. This pushed BlackBerry's total software and services revenue (including the enterprise) up 14% from the prior-year period to $193 million.
BlackBerry saw massive growth in these two areas thanks to the impressive uptake of its automotive solutions, as well as an increase in the number of licensing partners. The good part is that the company is witnessing strong deal momentum in both areas.
The technology solutions group, for instance, scored a design win at a major automotive original equipment manufacturer (OEM) for the use of BlackBerry's QNX software in digital instrument clusters. Meanwhile, the company has also increased the number of channel partners to sell its QNX software in the Asia-Pacific region.
The licensing business is also witnessing similar momentum, as its handset partners in China and India are slated to launch several BlackBerry-branded smartphones. But the big news in this segment is the company's deal with the Bullitt Group, a British smartphone maker that manufactures phones for specific brands such as Caterpillar and Land Rover.
Bullitt will start embedding BlackBerry Secure technology into the phones that it makes for these two companies. This gives BlackBerry access to customers in over 100 countries where Bullitt's devices are used.
The big picture
BlackBerry's terrific traction in the software business is driving its margins in a big way. The company's gross margin stood at 76% during the first quarter, up from 63.8% during the prior-year period. As a result, its adjusted net income came in at $17 million this time as compared to $10 million a year ago.
BlackBerry attributes this jump to the higher contribution from its software and services business to the overall product mix. So, there's still some room for BlackBerry to improve its margin profile, as the company still gets 12% of its revenue from legacy businesses as compared to 30% a year earlier. In fact, BlackBerry's gross margin profile has improved significantly as the software and services business has gained more traction.
Data source: BlackBerry. Chart by author.
In all, BlackBerry is progressing in the right direction, because it is getting more revenue from software and services, which is boosting its margins. As such, there's no reason for investors to panic given the company's solid long-term potential.
