BLACKBERRY Ltd Q4 FY2022 Earnings Call

Good afternoon, and welcome to the BlackBerry Fourth Quarter and Full Fiscal Year 2022 Results Conference Call. My name is Brent, and I will be your conference moderator for today’s call. During the presentation, all participants will be in a listen-only mode. We will be facilitating a brief question-and-answer session towards the end of the conference. As a reminder, this conference is being recorded for replay purposes. I would now like to turn today’s call over to Tim Foote, BlackBerry Investor Relations. Please go ahead.

Thank you, Brent. Good afternoon, and welcome to BlackBerry’s fourth quarter and full fiscal year 2022 earnings conference call. With me on the call today are Executive Chair and Chief Executive Officer, John Chen; and Chief Financial Officer, Steve Rai. After I read our cautionary note regarding forward-looking statements, John will provide a business update, and Steve will review the financial results. We will then open the call for a brief Q&A session. This call is available to the general public via call-in numbers and via webcast in the Investor Information section at blackberry.com. A replay will also be available on the blackberry.com website. Some of the statements we’ll be making today constitute forward-looking statements and are made pursuant to the safe harbor provisions of applicable U.S. and Canadian securities laws. We’ll indicate forward-looking statements by using words such as expect, will, should, model, intend, believe and similar expressions. Forward-looking statements are based on estimates and assumptions made by the Company in light of its experience, and its perception of historical trends, current conditions and expected future developments as well as other factors that the Company believes are relevant. Many factors could cause the Company’s actual results or performance to differ materially from those expressed or implied by the forward-looking statements. These factors include the risk factors that are discussed in the Company’s annual filings and MD&A. You should not place undue reliance on the Company’s forward-looking statements. Any forward-looking statements are made only as of today, and the Company has no intention and undertakes no obligation to update or revise any of them, except as required by law. As is customary during the call, John and Steve will reference non-GAAP numbers in their summary of our quarterly and full year results. For a reconciliation between our GAAP and non-GAAP numbers, please see the earnings press release published earlier today, which is available on the EDGAR, SEDAR and blackberry.com websites. With that, I’ll turn the call over to John.

Thank you, Tim. We need to modify the introduction of the script now. Tim has been appointed Vice President—congratulations to him. Good afternoon, everyone, and thank you for joining the call. I'll begin with the IoT business unit. I'm happy to announce that we achieved our first quarter with revenue over $50 million since the pandemic began, despite the ongoing difficulties in the auto industry. This quarter, our revenue reached $52 million, representing a 21% increase sequentially and 37% growth year-over-year. Our gross margin rose to 85%, and our IoT annual recurring revenue increased for the fourth straight quarter to $93 million, an 11% rise year-over-year. Along with a slight uptick in production-based royalty, we also set a new quarterly revenue record from design activities. These revenues come from development seats and professional services that customers use to integrate our QNX software into vehicles and other IoT devices. This robust performance not only brings short-term revenue but also indicates long-term business prospects as these designs move into production. We have clear visibility into our upcoming professional services backlog from confirmed design wins and are hiring more staff to accommodate the demand. Furthermore, we see promising opportunities in our pipeline for potential new design wins in FY23. Regarding royalties, as I mentioned earlier, there was some improvement in volume this quarter, although production challenges persist. Major OEMs have reported ongoing supply chain difficulties, particularly chip shortages, but they expect conditions to improve as the year continues. The Ukraine conflict has also caused further disruption to an already tough auto industry landscape, which we will be monitoring closely. As you may recall, there has been a significant increase in the share of our QNX business from safety-critical foundation software, such as ADAS, digital cockpits, and autonomous driving. This segment now constitutes the largest part of our total business, surpassing infotainment. Our strategy to focus on functional safety leverages QNX's strengths and is supported by market trends towards ECU consolidation and software-defined vehicles. We also anticipate significant growth in safety-critical design opportunities in our pipeline. The gross margin for this quarter improved from 81% to 85%, driven mainly by better production royalties, which incur minimal costs for us at this stage of the design life cycle, resulting in a high gross margin. I will now discuss the new design wins we secured this quarter. It was a record quarter for the number of new design wins, with 17 new auto designs and 28 wins in the general embedded market. ADAS led the wins, followed by digital cockpits and instrument clusters. We successfully partnered with leading automakers and Tier 1 suppliers, including Hyundai, Bosch, Visteon, and Denso, and for Tim, with Skyships for the new Gordon Murray T.50 hypercar. In January, we gained wins across multiple sectors, including defense, aerospace, and medical, which is our strongest general embedded market segment. Similar to the auto sector, we hold the highest level of functional safety certification for medical software, and we are experiencing increased momentum there. Design wins this quarter included analytical devices for medical labs and surgical robots. Now, let's move to IVY. At CES in January, we showcased a product operating with live data on auto-grade hardware. This demonstration led to many productive discussions with OEMs, resulting in a multitude of requests to initiate proof-of-concept trials. Currently, we have more requests than we can accommodate, a favorable situation to be in. The first proof-of-concept is with Pateo, a leading Chinese EV automaker, aimed at integrating IVY into the digital cockpit. We expect successful proof-of-concepts to translate into design wins, meaning customers will commit to integrating IVY into their vehicles. The CES demonstration also featured potential applications for IVY, such as Car IQ for in-vehicle payments and Electra's AI-driven battery management application, which were both well-received by OEMs and are part of the IVY proof-of-concepts. IVY product development is progressing as planned, and last month we released the latest version ready for proof-of-concept trials. Now, I'll address our cybersecurity segment. This marked the third consecutive quarter of sequential billings growth. Billings not only increased double digits compared to Q3 but also year-over-year. Cyber revenue totaled $122 million, and our gross margin improved by 200 basis points to 61%. Annual recurring revenue was $347 million, with a dollar-based net retention rate of 91%. The market conditions for our cybersecurity products remain positive, partly due to the increased level of cyber threats. Our Guard-managed XDR cybersecurity team has encountered a significant rise in threats recently, especially with Waifu malware, which aims to disrupt services. This has been a prominent issue across industries, including notable instances of the Hermetic Wiper malware in Ukraine and beyond. Our Protect product has successfully blocked these threats at BlackBerry customer sites. The same applies to WhisperGate, another form of wiper malware that targeted Ukrainian government and nonprofit organizations. In fiscal year '22, we launched 48 new products, and growth in our cybersecurity pipeline is strongest for Gateway Zero Trust Network Access, Guard-managed service, and Persona behavioral analytics. On the marketing side, we plan to leverage the strong recognition of the Cylance brand for our Cylance products, which continues to resonate with customers. Investors appreciate insights into how our cyber products are performing in the market, so I’d like to share a couple of recent examples. One involves a leading publicly traded medical supplies company in the U.S. They were struggling to manage a 24/7 security operations center and evaluated offers from BlackBerry, CrowdStrike, and Arctic Wolf. They acquired over 10,000 licenses for our Guard-managed service due to our performance and security credentials. The second instance involved a prominent manufacturer in Asia that chose BlackBerry over CrowdStrike, Fortinet, and Carbon Black after a thorough proof-of-concept, emphasizing our product's strong performance and ability to uncover multiple threats during the trial. Legacy secure-based vendors remain prevalent in the market, particularly among smaller customers. This has been a key area for Cylance. Recently, a logistics company sought to replace their existing McAfee and Microsoft Defender solutions. After a rigorous assessment that included McAfee, Symantec, and CrowdStrike, they opted to purchase about 3,000 licenses for our Guard Advanced product due to our ability to detect threats that others missed and our superior customer service. I would also like to update you on talent acquisition. Building on our progress last year in enhancing our sales force, we have successfully attracted further industry expertise to bolster our cybersecurity team. This quarter, we brought in sales and product development leaders from direct competitors. Cybersecurity is a competitive talent market, and we are pleased to attract and retain high-quality individuals. As mentioned earlier, our annual recurring revenue was $347 million, a decrease of $11 million from the previous quarter, mainly due to two factors. First, in January, we stopped operations for legacy BlackBerry mobile devices, saving significant infrastructure costs moving forward. However, this led to a decline in revenue for our Enhancing SIM-based Licensing. Second, we experienced some churn among smaller UEM customers, with a shift towards less feature-rich UEM products from competitors as part of bundled offerings. BlackBerry UEM, conversely, is a premium product known for high security. We have seen some smaller, cost-conscious customers opting for free UEM products bundled with other offerings at the expense of security, but they represent a small fraction of our UEM base. It's noteworthy that our strong security profile continues to resonate with major institutions such as large banks and government agencies. To highlight this, we secured UEM renewals with the U.S. Air Force, the U.S. Department of Defense, and the U.S. National Grid, as well as several international governments including those from Poland, Northern Ireland, Sweden, and Italy. We renewed contracts with major banks this quarter, including Deutsche Bank, and several notable banks from the U.S., Canada, India, Switzerland, and a global credit card company. Additionally, we renewed a three-year agreement with White & Case, a law firm that handles confidential data and found that none of our competitors met their security needs as well as we do. During this quarter, we also successfully upsold Cylance cybersecurity products to UEM customers. We might face some UEM headwinds in the near future, but we are implementing strategies to mitigate this impact. This includes exploring opportunities to bundle BlackBerry UEM with other appealing products for mid-market customers and continuing to develop features that our clients value. Please stay tuned for updates on this. Finally, I'd like to mention that we will begin providing quarterly billings information for our cybersecurity business in our ongoing reports, which we believe will be appreciated by shareholders and will help clarify the business's progress.

Thank you, John. As usual, my comments on our financial performance this past quarter will be in non-GAAP terms, unless otherwise noted. And also, please refer to the supplemental table in the press release for the GAAP and non-GAAP details. Total company revenue for the quarter was $185 million. Fourth quarter total company gross margin was 68%. Our non-GAAP gross margin excludes stock compensation expense of $1 million. Fourth quarter operating expenses were $117 million. Our non-GAAP operating expenses exclude $22 million in amortization of acquired intangibles, $4 million in stock compensation expense, and a $165 million fair value gain on the convertible debentures. As John mentioned, we are continuing to invest in our core IoT and cyber businesses, including headcount growth and new product development to drive top-line growth. The planned investment is sizable. We expect to increase headcount by approximately 250 people across both of our core business units this fiscal year. This quarter, non-GAAP operating profit was $8 million and non-GAAP net profit was $6 million. Our basic GAAP earnings per share was $0.25, while non-GAAP earnings per share was $0.01 in the quarter. Our adjusted EBITDA was positive $20 million, excluding the non-GAAP adjustments previously mentioned. I will now provide a breakdown of our revenue in the quarter. Cybersecurity revenue was $122 million, and IoT revenue was $52 million. Software product revenue remained in the range of 80% to 85% of the total, with professional services making up the balance. The recurring portion of software product revenue remained at approximately 80%. Licensing and other revenue was $11 million, given the ongoing limitations to monetization activity prior to closing the sale of the transaction that John referred to. I’ll now move to our balance and cash flow performance. Total cash, cash equivalents and investments remained consistent at $770 million as of February 28, 2022. Our net cash position remained at $405 million. Despite the ongoing investment in the business, we generated positive free cash flow of $8 million. Cash generated from operations was $10 million and capital expenditures were $2 million. That concludes my comments, and I’ll now turn the call back to John.

Thank you, Steve. Let me provide the outlook for the new fiscal year. Licensing revenue is expected to be minimal, excluding anything related to the patent sale. For the cyber business, we expect to deliver billings growth between 8% to 12% this fiscal year, mainly as a result of increased traction from our security products. In fact, we expect to see higher billings in all four quarters when compared to the same quarter in the prior year. However, we model revenue for the year in total to be broadly flat year-over-year, factoring in the time for billings growth to convert to revenue. Despite having delivered three consecutive quarters of billings growth in cyber, we’re not satisfied with our results, particularly in ARR. We feel, however, positive about the trajectory of this business for a number of reasons: first is the cyber market is strong and demand appears to be getting stronger. Second, following our recent product enhancement, the performance of our product is being recognized. A good proxy for this is winning awards in independent testing, including receiving the maximum AAA rating in the SE Lab’s recent Enterprise Advanced Security Test. Third is that we have increased the number of sales reps since the start of our fiscal year, and we’ll continue to step up and expand hiring. Our plan is to recruit more than 100 additional cyber go-to-market professionals in the coming fiscal year. Fourth, we continue to record head-to-head wins against our competitors. Now switch to the IoT business. For the IoT business, we expect to see continued strong growth despite the ongoing headwind for the auto industry. We expect revenue for the year to be in the range of $200 million to $210 million, representing a 12% to 18% growth year-over-year. Despite the macro environment for the auto industry, we base our confidence on the following factors: first, the visibility of the backlog of professional services from design wins already awarded; second, the strong pipeline of potential new design wins this coming year; and thirdly, the upward trend in the royalty ASP in the new designs. We see a fairly even distribution of revenue across the four quarters. Before we move to Q&A, let me quickly summarize the key points for the quarter. The IoT business is executing well despite industry-level challenges, and we’re encouraged by the line of sight we have for the years to come. IVY continues to execute well with both a new product release and strong demand for POC trials in the quarter. Our cybersecurity business is tracking in the right direction, once again, delivering solid billing growth and recording some encouraged head-to-head wins. And the sale of our noncore IP patent portfolio is progressing. Despite our ongoing investment in the business, we generated positive operating cash flow and net profit this quarter. That concludes my remarks. Brent, could you please open the line for Q&A?

Your first question comes from the line of Daniel Chan with TD Securities. Your line is open.

We've had another strong quarter with notable wins in the general embedded sector. For several quarters now, we've been seeing more wins in general embedded than in the automotive sector. Can you discuss how the lifetime revenue streams are structured for these programs, particularly regarding production royalties compared to designs? I assume that some of the new wins in the general embedded area may have lower volumes than what we usually see in the automotive space. Please remind us how the revenue streams are organized for general embedded.

Yes. Are you referring to general embedded or auto? For general embedded, production tends to occur significantly sooner, likely a couple of years out compared to five, six, or even seven years. The average selling price is usually lower, especially in larger organizations like hospitals or medical devices, where volumes aren't as high as in the automotive sector. However, the market remains quite healthy. In the general embedded vertical, particularly in the medical field, we are experiencing great success and strong momentum due to safety certifications. There are other segments within general embedded that aren't as economically promising; that's a fair assessment. Therefore, we generally avoid those areas.

That’s helpful. Thanks. And then, on the headcount increase, I think you mentioned you guys are budgeting for an increase of 250 people this year. Just wondering where that’s going. I think you mentioned 100 going towards cybersecurity sales professionals, where are the rest going?

In regards to IoT, while we are focused on sales personnel, we also have a significant backlog in professional services. It is essential for us to address these backlogs in order to generate revenue.

Your next question comes from Trip Chowdhry with Global Equity Research. Your line is open.

Good morning. So, another very strong quarter on Cylance. A very quick question. I was wondering, like if you could put some more color to it. Like what kind of activity was, say, before the Ukraine war and while we are in the war, you’re getting a lot of interest in Cylance. Where is that interest coming from? Is it from U.S.-based companies or European-based companies or the whole world? Just provide us some anecdotal comments what you are hearing? I would appreciate that. And again, a very good quarter.

Thank you. The cybersecurity sector is facing an increase in threats and attacks, and we observe a significant rise in demand. Similar to others in the market, we've noticed this demand growing rapidly. There is also a transition occurring as older signature-based companies like McAfee, Symantec, and Microsoft are being replaced. Companies utilizing advanced AI and machine learning, including ours and several others, are successfully taking over these legacy systems. Cylance, in particular, is performing well in the mid-market and small to medium-sized businesses. Our activity has increased nicely, partly due to the Guard software we launched about a year ago, and we expect this trend to continue improving each quarter. As a result, our performance numbers are becoming significant. Additionally, we have been expanding our sales team aggressively for over a year, which is beginning to yield positive results. We've attracted strong talent from the cybersecurity industry, particularly under John Giamatteo, who has valuable experience from McAfee in recruiting both individuals and channel partners. While we still have progress to make, things are beginning to align.

I just want to point out that the IVY platform offers a machine learning and AI-driven battery management system that is unlike anything available, not even from the largest electric vehicle manufacturers. This feature is very unique to your IVY platform. Keep up the good work.

Okay. Thank you. Thank you very much.

Your next question comes from Paul Treiber with RBC Capital Markets. Your line is open.

I have a question about the go-to-market strategy in cybersecurity. You've indicated that UEM performs well in large enterprises, while Cylance is effective in the SMB space. How do you integrate these two businesses from a go-to-market standpoint, considering the distinct nature of their customer bases and the differing competitive advantages?

Yes, that’s a great question. We now have three go-to-market teams coordinated under one senior management, thanks to John G. The three teams focus on strategic accounts, which include large government and regulated industries like banks; the SMB market; and the channel team. The primary goal of the first team is to secure our existing business in strategic accounts and upsell technology applicable to that UEM base, such as zero-trust technology, which is currently a hot topic, especially within the U.S. government. The new Biden administration has allocated specific funds for zero-trust implementation across all agencies and armed forces as part of their cybersecurity strategy. We already have a presence in many of these institutions, making the upsell of Cylance products in this area a key growth opportunity. For the SMB segment, we take two approaches. One involves our Guard services, which are managed services that SMBs often need to help augment or replace their resources due to hiring challenges. We combine this service with the Cylance product and package it with UEM for more comprehensive offerings. Additionally, the channel typically focuses on cybersecurity, and we have some promising channel partners that will come into play soon. While I can’t provide details right now, I will be able to share more in 90 days. This illustrates how we approach each different customer category. I hope that answers your question.

Yes. That was helpful. And I can’t wait for the announcement in 90 days. Just a second question, just on the sale of the patent portfolio. To the extent that you can, can you just walk through some of the assumptions in terms of the longer-term outlook that went into that arriving at that price? Because one of the things that investors look at as you look at the revenue in that segment, in the previous year, it was quite a large number. How do we put the sale price in context to the previous revenue that you generated in that segment?

There is still significant potential for this noncore set of patents. However, time is running out on the validity of the portfolio. Typically, even with noncore patents, we have around 8 to 10 years of remaining average lifetime. In recent years, we have experienced some success, particularly with major companies. Now, the business needs to focus on developing relationships with smaller companies, which often takes more time and involves more communication. While larger companies can also require time, they produce bigger financial returns. We have essentially tackled the easier opportunities, so I believe the results from our market tests are reasonable for both parties.

There are no further questions at this time. I would like to turn the call back over to John Chen, Executive Chair and CEO of BlackBerry for closing remarks.

Thank you. I’m pleased to announce that on May 18, we’ll be hosting a hybrid in-person and virtual Analyst Day from San Ramon, California. Some of the questions asked earlier regarding our go-to-market will be addressed by John Giamatteo and Mattias Eriksson, the two BU presidents. I will strongly suggest you don’t miss it. In the case of Mattias, we’re also going to prepare to annually talk about backlog during that meeting. So, I really encourage investors to join us and hear about key developments in our product and strategy as well as financial-focused sessions that will provide additional color on the IoT and cyber business. More details will follow in due course, so please stay tuned. Thank you for joining the call today, everyone, and have a good evening. I hope to see you in person soon.

Ladies and gentlemen, this concludes today’s call. Thank you for your participation. You may now disconnect.