BLACKBERRY Ltd (BB) Q2 2023 Earnings Call Transcript

Good afternoon, and welcome to the BlackBerry Second Quarter Fiscal Year 2023 Results Conference Call. My name is Brent, and I will be your moderator for today's call. During the presentation, all participants will be in a listen-only mode. We will have a brief question-and-answer session towards the end of the conference. As a reminder, this conference is being recorded for replay purposes. I will now turn today's call over to Mr. Tim Foote, Vice President of BlackBerry Investor Relations. Please go ahead, Sir.

Thank you, Brent. Good afternoon, and welcome to BlackBerry's Second Quarter Fiscal 2023 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 notes 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 results. For a reconciliation between our GAAP and non-GAAP numbers, please see the earnings press release published earlier today, which is available on EDGAR, SEDAR, and BlackBerry.com website. And with that, I'll turn the call over to John.

Thank you, Tim. Good afternoon, everyone, and thanks for joining today's call. This was a solid quarter for BlackBerry, delivering revenue in line with expectations and beats on the earnings. I'll start today with a view of the IoT business unit. This quarter, IoT delivered strong 28% year-over-year revenue growth. QNX design-phase revenue remains the top performer. That is revenue from development fees and professional services. Q1 was the third consecutive quarter that we set an all-time record in this category, and this quarter, we almost set another. When we win a new design, this revenue is the first to be recognized, with royalties coming later when a vehicle enters into production. This strength in design-phase revenue is expected to continue, given the significant amount of professional services we already have lined up and the pipeline of potential new design wins in the next few quarters. On the production front, we saw an uptick in royalty revenue, but it remains below the pre-pandemic level, mainly due to supply chain headwinds. Gross margin came in at 82%. The strength of design wins was clearly illustrated by Volkswagen, one of the world's largest automobiles selecting BlackBerry QNX for its new VW.OS platform. This platform will be deployed in all brands across the Volkswagen group, with BlackBerry being trusted to power the safety-critical ADAS and autonomous drive applications where QNX is currently the market leader. This builds on design wins in recent quarters with BMW, Volvo, and a long list of electric vehicle players in China. BlackBerry continues to win market share in core safety-critical domains. A couple of examples included an ADAS design win with Hyundai and a digital cockpit design with one of the world's largest Tier 1 suppliers that utilizes the QNX hypervisors. The hypervisor will host a safety-critical instrument cluster along with non-safety-critical infotainment applications all on the same chip. On the EV front, we won another ADAS design with the Chinese automaker, and BlackBerry QNX is now embedded in 7 of China's 10 largest EV OEMs. In addition to our strong position in auto, we have significant opportunities in other verticals, too. This quarter, we announced additional support for the aerospace and defense market, with QNX achieving the latest technical standard known as the Future Airborne Capability Environment, or FACE. FACE is a software standard jointly developed by government and industry that establishes a common operating environment. It enables the reuse of software components across different hardware, reducing developer friction and costs. In addition to aerospace and defense, we saw progress in the medical and industrial markets with wins that include surgical robotics, a retail distribution pick-and-pack robot, as well as control for a nuclear power plant. Overall, in the quarter, we won 19 new designs, with 9 in auto and 10 in the general embedded market. We successfully added talent to our IoT team this quarter despite the tight labor market. This investment is supported by the large and growing schedule of professional services secured through the recent design wins, and by adding headcount, we will enable additional revenue. The macro environment for auto remains a mixed picture with varying dynamics across regions and OEMs. The Chinese market where BlackBerry has won a number of designs recently appears to be bouncing back due to the end of some COVID-related shutdowns and the impact of robust stimulus measures. In North America and Europe, however, there appears to be a short-term contraction with certain chip supplies constraining the ability of OEM to build inventory and meet demand. Going forward, the impact of rising interest rates on consumer financing, together with economic uncertainty created by the possibility of future choppiness. Despite this ongoing challenge, we're delivering strong year-over-year growth and have a solid pipeline of potential new designs coming in the upcoming quarters. Normally, given the strength of the QNX business, we would adjust our revenue outlook upwards. However, given the macro headwind, we've been prudent in holding our outlook as is. We expect fiscal year '23 revenue for the IoT business unit to still be in the range of $200 million to $210 million, as previously stated. On the IP front, we made good progress. Our product development road maps remain firmly on track. We have had another new release in August that enabled support for a greater range of in-vehicle hardware and software. This new release incorporates not only roadmap features but also value from real-time feedback that we are getting from the ongoing proof of concept trials. You may recall that we are currently running a limited number of these trials, including the top OEM and Tier 1s, and these are progressing well. We continue to receive requests for additional trials, and this ongoing demand remains a positive sign of the customer receptivity of IVY. On the ecosystem side, we were excited to close another investment by the IVY fund this quarter in a German start-up named COMPREDICT. COMPREDICT uses AI to enable automakers and fleet providers to utilize predictive maintenance, using vehicle sensor data to get ahead of maintenance issues. The predictive maintenance use cases are added to many others that IVY is enabling, including usage-based insurance, intelligent EV battery management, in-vehicle payments, and the next-generation 911 emergency response, just to name a few. Looking ahead, we expect our next product release in December and remain focused on IVY design wins, which we currently expect to secure in calendar year 2023. We also plan to showcase more of IVY's exciting capabilities and use cases at CES in January. So, please stay tuned for more details on that in the coming months. Moving on to the Cybersecurity business unit. Revenue for the quarter was in line with expectation at $111 million. The business also delivered sequential billing growth of 15% to $102 million. Cyber billing for the first half of this fiscal year grew 6% year-over-year. Gross margin was 55%, and ARR came in at $321 million; the dollar-based net retention rate was 85%. In the quarter, we closed business with a wide range of customers but saw particular strength in our core verticals of government and financial services. In North America, we secured business with the Department of Treasury, the Federal Trade Commission, Department of Energy, the IRS, the New York Stock Exchange, and the U.S. Mint. We also won business with leading merger agency such as the U.S. Army Corps of Engineers, U.S. Central Command, U.S. Marine Corps, and other branches of the Department of Defense. Internationally, we secured business with the UK Treasury, the UAE Ministry of Presidential Affairs, the New Zealand Parliamentary Services, the Australian Electoral Commission, and the Polish Ministry of Foreign Affairs, just to name a few. In financial services, we won new logos as well as renewal and upsells with leading banks in the U.S., UK, Switzerland, Japan, Israel, Italy, and more. In addition to these core verticals, we recorded a strong quarter for new business in the middle market. This is a large segment of the market dominated by legacy players, offering legacy solutions and one where our Cylance product portfolio is resonating well. BlackBerry is very well placed to grow in this market for a number of reasons. The level of Cylance risk for mid-market customers is high. Our current research team identified that SMBs face upwards of 11 cyber attacks per device per day. SMBs are also often those with the lowest level of insurance against ransomware demands. Our study with Corvus Insurance shows that they can often ill afford a breach. Customers in this segment particularly like our lightweight agent and how effective our products are at detecting threats. Our AI engine, the most mature in the market, has seen billions of data points, both malicious and non-malicious, and used machine learning over several years to effectively distinguish between the two. Further, mid-market customers are among those with the fewest resources and expertise to staff a 24/7 security operating center. Customers like how our managed service offering, CylanceGUARD, helps solve the issues for them. As we described in previous quarters, there have been some headwinds for Cyber ARR. However, we expect ARR to return to growth early next fiscal year. A lot of efficient investment made in the past two quarters are starting to bear fruit, and we see some data points that give us confidence in this outlook. First, we saw the total pipeline of potential opportunity for our Cylance product at the end of Q2 increased by 23% year-over-year; and for new logos specifically, the increase was 73%. Second, significant progress has been made with the product portfolio in recent quarters and is continuing. For example, recent enhancements to our PROTECT EPP product have positively impacted our false positive rates as evidenced by trusted third-party VirusTotal. Third, on the go-to-market front, we’re working to replicate the success we already had, particularly with the mid-market customer. We added a lot of cybersecurity industry experience this year, and we expect to see more traction as these new hires fully ramp up. Fourth, this coming quarter, we’re commencing a program to build strong relationships with key channel partners and distributors that are well-established players in the cybersecurity market. We also received a lot of positive feedback following the Cylance product rebrand, including a significant increase in both website traffic and new leads. Turning to the overall demand environment for cybersecurity, the rest of FY23 looks fairly solid. As I mentioned earlier, BlackBerry has a strong government footprint and demand in this vertical appears to still be robust. Overall, we’re not seeing customers cutting back on the cybersecurity budgets, even in the middle market, given how critical it is to maintain their cyber defense. Therefore, there are no changes to the outlook that we have provided previously. We continue to expect the Cybersecurity business unit’s revenue to be broadly in line with fiscal year ‘22. Let me now turn to Licensing. Revenue in the quarter came in at $6 million. The sales process for the non-core patent portfolio continues. We understand that the length of time that this has taken is frustrating for shareholders, and we are equally as frustrated, if not more as we work on it every day. However, we firmly believe that divesting the portfolio remains the best option for shareholder value. While the portfolio is still relatively fresh, the IP that’s part of the deal and the businesses monetizing it, it’s not related to our core business. At the time we were required to announce the deal, we understand that getting the government approval could take up to 210 days, if not longer, but we were pleased that the process was completed much sooner. Catapult, who are working to conclude their financing in parallel to getting government approval. Unfortunately, we believe the turmoil in the financial markets created unexpected challenges for their original financing syndicate. However, there has been much interest from other parties wanting to step in to take their place, and Catapult are currently working to lock down their final syndicate. In parallel to this, we’re actively working on an ordinance where financing is not a contingency, as well as finalizing our plan to restart the monetization engine ourselves, should that be necessary. We will, of course, keep shareholders posted until our final outcome is achieved. Let me now hand over the call to Steve, who will provide additional colors on our financial results for the quarter.

Thank you, John. As usual, my comments on our financial performance for the second quarter will be in non-GAAP terms, unless otherwise noted. Total Company revenue for the quarter was $168 million. Total Company gross margin was 64%. Our non-GAAP gross margin excludes stock compensation expense of $1 million. Operating expenses for the second quarter were $129 million. These non-GAAP operating expenses exclude $22 million in amortization of acquired intangibles, a $10 million fair value gain on the convertible debentures, $5 million in stock compensation expense, $4 million from the impairment of long-term real estate lease assets, and $3 million of restructuring expenses. BlackBerry continues to make carefully considered investments for top line growth, such as adding additional headcount to the IoT team in response to our strong schedule of professional services from design wins, as well as expanding our reach in the cyber market, as John outlined earlier. The non-GAAP operating loss for the second quarter was $22 million, and the non-GAAP net loss was $29 million. The GAAP basic loss per share was $0.09, and the non-GAAP loss per share was $0.05. Adjusted EBITDA, excluding the non-GAAP adjustments previously mentioned, was negative $16 million. Now, breaking down revenue in the quarter. IoT revenue was $51 million, and Cybersecurity revenue was $111 million. Software product revenue remains in the range of 80% to 85% of total revenue, and professional services formed a balance. As before, approximately 80% of software product revenue was recurring. Licensing and other revenue was $6 million. Now, turning to the balance sheet and cash flow. Total cash, cash equivalents and investments were $699 million at August 31, 2022. Free cash flow was negative $26 million with cash used by operations of $23 million and capital expenditures of $3 million. That concludes my comments. I’ll now turn the call back to John.

Thank you, Steve. Before we open the line up for Q&A, let me summarize the key points for the quarter. Number one, our IoT business unit delivered strong year-over-year revenue growth, in large part driven by ongoing strength from design-phase revenue. IVY remains firmly on track with proof-of-concept trials progressing well, and the team is executing on the product development roadmap as planned. Our Cybersecurity business unit, net revenue expectation, delivering strong sequential business growth and continues to implement a strategy to build the business with ARR expected to return to growth early next fiscal year. Despite the volatility in the macro market, we are maintaining our revenue outlook for both business units and continue to execute against our plan. That concludes my remarks. And operator, could you please open the line for Q&A?

Your first question comes from the line of Mike Walkley with Canaccord Genuity. Your line is open.

Hey, Mike.

Thanks. Hey, John. Thanks for taking my question. If you kind of delve in a little bit more to the Cybersecurity business, the billings commentary sounds promising. Can you just update us maybe on the UEM side, kind of where we are and that’s falling off and confidence that gives you that ARR will start to grow next year?

The UEM market is highly price-sensitive, especially in the mid and low-end segments, and is primarily dominated by one major competitor, along with Cylance and others. In higher-end markets where better security is crucial, we maintain our customer base well and can even expand it. Besides UEM, we also have secure communication offerings and opportunities to upsell our UES product, including the Cylance solution. Overall, we anticipate our UEM sales will remain relatively flat, but we plan to drive growth next year by bundling additional products and features. A key point to note is that Microsoft's Intune primarily acts as a mobile application manager and does not serve as a true UEM. Customers are starting to realize that their security needs are not being fully met by them. This presents us with a strong opportunity to either outperform Microsoft Intune or coexist with them in accounts that require mission-critical security. This is our current strategy, and we feel optimistic about it, particularly given the feedback we've received from major customers.

And as a follow-up question, how has pricing in the endpoints security market as you go head-to-head with both legacy and some of the other next-generation vendors? And then, also with the progress on your platform, are you sharing any metrics or give any rough color on how upsell is going and how maybe some of your new customers are landing with more than just one product from Cylance? Thanks.

I get the first part about the legacy. What’s the second part?

It was about platform and the ability to upsell. Is that right, Mike? Platform?

Yes. Just how you’re upselling? Any metrics on customers taking more than one Cylance module?

Oh, I see. I don’t have that information handy with me. So either we’re going to have to follow up with you, and you’ll want to check with John G on those information. And the legacy product line, it’s interesting, we see actually the most progress we made is against the legacy player, particularly in the mid-market, where the mid-market doesn’t really have a CECL and doesn’t have a SOC, what we offer, and particularly Guard, which is the managed service, resonates really well. We see pretty big strong growth. The numbers are not huge in terms of the actual amount of dollars, but the number of accounts that we’re winning are reasonably sizable.

Thanks for taking my question. I’ll pass it on.

Thank you.

Thanks.

Your next question is from the line of Luke Junk with Baird. Your line is open.

Hello there.

Good afternoon and thank you for taking the questions. My first question, maybe a little bit of a bigger picture question. John, I’d be curious to get your updated perspective on the auto software competitive landscape in regards to the IoT business. In the last few months here, we’ve seen both companies that haven’t traditionally played in auto looking to make inroads here and in some cases, announcements with customers and some of the chip companies as well talking a bigger game of auto software. Love your thoughts on both, especially any comments that you’d be able to offer on your direct engagement with the chip companies and how that’s evolved or incrementally grown recently? Thank you.

QNX is the leading player in the automotive embedded software industry, especially in operating systems. We have secured most of the significant contracts recently with companies like BMW, Volvo, and Volkswagen, as well as many electric vehicle manufacturers. We hold a unique position in the market, as larger companies typically focus on user interfaces and infotainment rather than the core operating systems. For instance, Volkswagen is developing their own software stack and has chosen to collaborate with only a few key players, including us, due to our expertise in operating systems. We are confident in our focus on mission-critical and safety-certified components, and we have the highest level of ISO Certification in safety. Regarding chipsets, we work closely with major chip manufacturers who are committed to our partnership. Qualcomm and NVIDIA are particularly dominant in the automotive sector, and we are assured in our collaborative positioning in this market. Additionally, Google has adopted our Hypervisor for their Android Auto platform, which highlights our unique role in the ecosystem.

Okay. Thank you for that elaborated color there. And then, staying within IoT for my follow-up, you recently announced that you’ve gained certification in the aerospace market. I was just hoping you can expand on the strategic approach to that market. Are there any parts of the market that you’re focusing on initially? How are you investing and resourcing that initiative? And anything similar that would be worth adding? Thank you.

Yes, it's a bit early for us, but we do have the intent. Looking at our success in the auto market, it largely depends on achieving the highest level of safety certification. We also have a new product that emphasizes a high level of scalability. Considering other sectors with similar requirements, we see that medical and industrial markets align with our needs. We've been performing fairly well in what we refer to as the general embedded market, which includes medical and industrial. However, we are keen on the opportunity to replace some of the legacy software in aerospace, particularly in the aircraft sector. This is why we aim to ensure that we’re certified so that developers can reuse the code. We will likely collaborate with large system integrators like Raytheon and others, but that's all I can share for now.

Yes, understand and helpful color to just understand where you are headed. Thank you.

All right. Thank you.

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

Hi, Paul.

Hi, John. Good afternoon. I just wanted to follow up on your previous comments about auto software. What’s changed in your mind in terms of the mentality of these auto OEMs and even Google to adopt QNX as a foundational layer?

First of all, QNX, the operating system, has been in the business for over 30 years. Some of us may remember that it started as the infotainment company owned by Harman before BlackBerry acquired it. They were developing an operating system with it, and the safety certification has always been its strong point, especially for infotainment. Since I joined, we have expanded from infotainment into more safety and security-oriented applications in vehicles. Concurrently, the industry has shifted towards software-defined vehicles, which means OEMs are taking more control over the design and software stack. However, they realize that they cannot simply replicate their operating systems and get them certified. While some attempted to use Auto Grade Linux, it struggled with certification and faced its own business challenges. Consequently, many have returned to using QNX. Currently, over 200 million cars actively utilize our software, representing a significant market that cannot be overlooked. This is why companies like Google, Qualcomm, NVIDIA, and TI collaborate with us. We will continue to develop various applications and features within this foundational layer.

That’s helpful. And it leads into my next question. How do you think about the economics within the foundational layer? What’s the strategy to try to maximize economics over the long term?

Our strategy is obviously to use more of our foundational modules in the stack. That’s the basic strategy. If you have multiple copies, as we get deeper into the engine and deeper into the safety side of the equation of a car operation, QNX will be able to command a little bit more ARPU. So, we have more copies and higher-value copies like Hypervisor, which has a higher value than infotainment, for example. That’s kind of the move up the stack in ARPU and broaden it to be multiple copies in the car. It’s our general business strategy. Don’t forget IVY, because IVY is our next-generation push into edge-to-cloud. It not only provides security and privacy but also provides economics because cloud-only solutions are too expensive, and it’s too much data being generated along the operation of a car. So, we feel that we have a pretty good one, two, three punches on the auto space or at least on the IoT side, and we’re going to expand it beyond auto, as I said. But today, we’re very focused on auto.

And if I can just squeeze in one more. Regarding the patent portfolio, I know you’re limited in terms of what you can say. How should we think about the timeframe? The clock is ticking in terms of the ability to monetize the patents. As time goes on, does the value of the patents decrease to you or to a potential buyer, or is there a way to get back damages, per se, or back royalties, so the time is less critical?

Yes. There are two data points; you already answered one, which is those that needed our license will have to address the past deployment. That’s one answer to your question. The other one is there is a miss out there about the time. There was an article published; it’s factually incorrect, and it’s factually incorrect throughout almost the entire article about the number of years for our portfolio and the value of that. That is absolutely not true. If that had been true, then it wouldn’t have been syndicated still, wanting to make this thing happen. I will just leave it at that. I don’t want to do a public debate with the writer, but I’m sorry, the writer is absolutely wrong. Even though this article has been around for a little while, this was reprinted by a newspaper that would like to sensationalize something that is not true. And anyway, I’ll leave it at that. Yes, we could capture the past deployment, and no, it’s not that shorter life.

Okay. Thank you for clarifying.

Absolutely.

Your next question comes from the line of Todd Coupland with CIBC. Your line is now open.

Hey, Todd.

Hey there, John. Good evening.

Hi, Todd.

Hey there. Good evening. I wanted to ask you about the cyber unit. You indicated you still expect revenue to be roughly flat year-on-year but implied in that comment is a seasonal uptick in the fourth quarter. I’m just wondering, is that also still expected in line with prior expectations? And I just wanted you to close the logic on that point with growth expected early in fiscal 2024?

Earlier in fiscal 2024? Okay.

Well, you commented on ARR growth expected early next year.

Yes. Of course. It’s a little bit of a complicated set of math, but I’ll focus on the high level. Yes, our Q4 pipeline is a lot bigger than Q3. Therefore, we believe that my statement about the revenue relatively flat in line with the last fiscal year, it’s a proper statement. There will be some billings growth because of that. We also take a look at where the headwinds are. If you look at all the headwinds from all the deals that we expected to either get or renewed and ones that are being attacked, especially in the mid-market stage, we believe that the major part of our headwind is behind us after Q4. Sorry, I should say that because we kind of look through it on a quarterly basis. Therefore, next fiscal year, I don’t know whether it’s Q1 or definitely Q2, that we expect ARR to have a year-over-year increase, and we should continue that trend going forward. Does that answer your question?

Yes. That’s clear. And on that point, just remind us what you think the potential growth in cyber is, once you start to benefit from improved product bundling and go-to-market?

You saw the three- and five-year plan we outlined for the release area. I recently presented to the Board, and we have stayed on course with that plan. From John G's Cyber Security group, the expected compounded annual growth is around 10%. That will be our focus moving forward.

Okay. Thank you very much for the clarification.

Sure. Of course.

Your final question comes from the line of Trip Chowdhry with Global Equities Research. Your line is open.

Hi, Trip.

Thank you for the solid execution in a challenging environment. I have two questions. First, regarding your Volkswagen deal, which is quite important. Can you provide some guidance or metrics on what we should expect in terms of production revenues once these vehicles are in production? Should we consider it 1x, 2x, or 3x the design win revenues? Is production generally more lucrative than design wins? Any insight on this would be appreciated. I also have a follow-up question.

In general, I’ll discuss the auto sector because our backlog numbers are tied to it. Typically, the cycle for an auto win is between seven to ten years. For instance, if we consider a deal worth $1 million over its total lifetime, then we can anticipate that about 10% of that will come upfront, particularly for development seats. Additionally, there will likely be some professional services revenue, which I estimate to be in the range of 5% to 10%. The majority of production revenue is expected to come in years four through eight, although we are seeing this period compress due to the shift towards electrification. The electric vehicle market accelerates the product cycle, especially in China, where it's around three to five years instead of the traditional seven to ten. While it's uncertain if others will reach that three to five-year mark, it will definitely reduce the typical seven to ten years. So, initially, we expect some upfront revenue, followed by professional services, and then production royalties.

Excellent. I noticed you have a strong offering with IVY. You mentioned the hybrid approach that's available both in the cloud and on devices, which I find very innovative. The goal seems to be about enhancing data rather than simply acting as an AWS reseller, and I really support that strategy. I'm curious if there are any plans for customers like Volkswagen, who are already using your operating system, to make it easier to migrate or experiment with IVY, perhaps with just a simple click. Are there any such plans in place? That's all from me. Thank you very much.

Yes, that’s a good question. I don’t want to make this an announcement, but I can say it makes sense. It would be illogical for BlackBerry not to leverage all its assets. There is a good reason why both IVY and QNX are in the same IoT group.

I would now like to turn the call back over to John Chen, Executive Chair and CEO of BlackBerry for closing remarks.

Well, thank you. Thank you, operator. Before we conclude today’s call, I’d like to remind everyone about the upcoming BlackBerry Security Summit on October 27th, in that particularly assess the keynote addresses with BlackBerry executives, customer-led case studies, interactive talks on cybersecurity innovation, and best practices from the BlackBerry Research and Intelligence team and more, all virtual and all on-demand. Investors could register for the event on the Investor page of our BlackBerry.com website. I want to thank you all for joining our call. I’m sorry it’s always late on the East Coast. I truly appreciate it. Thank you and see you next time.

This concludes today's call. Thank you for your participation. You may now disconnect.