BLACKBERRY Ltd (BB) Q1 2024 Earnings Call Transcript

Good afternoon, and welcome to the BlackBerry First Quarter Fiscal Year 2024 Results Conference Call. My name is Andrea, 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, Vice President of BlackBerry Investor Relations. Please go ahead.

Thank you, Andrea. Good afternoon, and welcome to BlackBerry's first quarter 2024 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. And with that, I'll turn the call over to John.

Thanks, Tim. Hi, Tim. Good afternoon, everybody, and thanks for joining the call today. Let me start with the IoT business unit. Revenue for the quarter was $45 million and gross margin remained strong at 80%. Revenue came in lower than expected for two main reasons. The first related to a number of leading industry players that are revising their development plans as they step up their software-defined vehicle efforts. This has caused some programs to be delayed. While seeing our customers facing a higher priority on the SDV transition is a good thing for both QNX and IVY, the delayed rollout of QNX Development Seat License has therefore pushed our revenue this quarter. So, this was purely a timing issue. As we have outlined in the past, from quarter to quarter, design phase revenues will fluctuate depending on the timing of large design awards and when the work begins. However, we haven't seen any weakening of the strong secular trends driving the business, we remain confident in our ability to win new designs. The second factor is the macro environment, which has impacted some regional production volumes and with it, royalty revenues. As has been the case in recent quarters, the impact appears to be mixed across OEMs and geographies. While production in China in the early part of this year was much softer than expected, elsewhere in North America, Europe, Japan, and Korea, output continues to look relatively steady, helped of course by an easing of supply-side constraints. We will closely monitor the situation and assess for any potential impact for the year. And at this time, we continue to expect to achieve the full-year revenue consensus for IoT. Further, we are reiterating the 18% to 22% three-year revenue CAGR that we provided at our Analyst Day last month. These targets are based on a number of factors, including our strong QNX backlog, which we reported as being $640 million at last fiscal year-end. Our pipeline of upcoming potential design wins and our assessment of ongoing secular trends. A data point that illustrates those trends and our leadership position in the market is our annual vehicle count. TechInsight, a leading technology analysis and market research firm, has published that QNX is now embedded in over 235 million vehicles, a year-on-year net increase of 20 million or 9%. When compared to annual global vehicle production, this supports a growing market share for QNX. QNX remains the foundational software of choice for leading automakers and Tier 1 suppliers around the globe as we continue to add new design wins. In the quarter, QNX had seven design wins in auto and seven in general embedded market verticals. In auto, we continue to secure design wins in the digital cockpit domain. This fast-growing domain has largely led the way in consolidating various software stacks onto a single high-power chip in the car. This quarter, we recorded wins with two of the Top 5 global automakers. The first win includes our real-time operating systems, as well as our Hypervisor and acoustic middleware. The second win would deploy two instances of QNX supporting the digital cockpit and main body domain, both running on high-performance compute engines. We also secured a win with a leading U.S.-based EV automaker with multiple instances of QNX being deployed. QNX, in that case, will support a zonal, central compute architecture, including the digital cockpit and the vehicle telematics. These wins demonstrate how we expanded both the number of domains deploying QNX and a number of layers of QNX deployed in each domain. Outside auto, we recorded wins supporting a range of different applications. In industrial, we secured an ADAS platform for heavy industrial machinery that requires both our Hypervisor and OS for safety. We also secured wins for industrial testing and control, including a next-generation controller for use in marine and aerospace applications, and a win with a leading global household appliance manufacturer for production line testing equipment. In medical, wins include medical iLASER equipment with a leading surgical technology manufacturer. These designs in operational technologies like medical and industrial demonstrate our ability to win in this very large and growing market. These verticals are showing similar trends to auto, including significantly higher compute at the edge and the need for complex safety-critical software stacks, which is where QNX is the market leader. On the product front, last month we announced the early access release of our next-generation kernel. This is a significant step change for QNX. The new release helps deliver significantly higher performance, particularly scaling almost linearly as the number of cores on the underlying chip increase up to 64 cores. While safety and reliability are essential parts of the QNX value proposition, it is also our leading performance in complex compute stacks that helps differentiate us from our competitors. This release will position QNX to support the future of rapidly increased compute power at the edge for many years to come. Moving onto IVY. As planned, we have now released a general availability version of IVY. This is a much more standalone version of the product than before and requires far less support from the IVY technical team. We see this as a significant step forward for scaling our go-to-market efforts, allowing us to support a much wider range of proof-of-concept trials than before. We are making good progress rebuilding the IVY system, which is an important part of the overall value proposition. This past quarter, we announced an investment in the Michigan-based CerebrumX. Ford, Stellantis, and Toyota are all currently working with CerebrumX as they offer AI-driven solutions that analyze vehicle data on driver behavior and vehicle health. They harness this data to deliver applications such as fleet management and personalized insurance plans. IVY's end-to-end edge-to-cloud platform will provide CerebrumX with higher quality, easier-to-use data in a standardized development environment. We also announced a go-to-market partnership with a leading automotive cybersecurity firm, Upstream Security. Upstream Security partners with BMW, Volvo, and Renault, as they are already protecting over 20 million vehicles against cyber-attacks with their Vehicle Detection and Response platform. This new partnership with BlackBerry will allow them to leverage IVY's edge capabilities to pre-process data in near real-time, maintaining cybersecurity while significantly reducing cloud overhead. The strategic decision by BlackBerry and AWS to develop a primarily edge-based architecture is proven to be the right call, especially as some cloud-only players have struggled to achieve profitability. Turning now to the Cybersecurity units. Revenue for the quarter was $93 million, representing 6% sequential growth. Like many others in this market, we have also seen delays from an elongated sales cycle, with additional layers of approval, compared to previous quarters, slowing our ability to convert our growing pipelines into revenue. That said, a leading indicator for revenue for this business is billings and this quarter we booked total contract value or TCV billings of $122 million, significantly higher than revenue for the second consecutive quarter. TCV billings grew for the fourth consecutive quarter with 14% sequentially and 37% year-on-year growth. This growth was anchored on multi-year deals in our core government vertical where we continue to have a lot of success. In the quarter, we closed one of the deals that slipped from Q4, with the other two still progressing well and likely to close later in the year. We also see two new large potential deals in government that have entered the pipeline. Given this pipeline and billings momentum, we expect to achieve full-year revenue consensus and expect TCV billings for the year to be in the range of $430 million to $480 million. Finally, we are reiterating the three-year revenue growth CAGR of 9% to 12% that we provided at our Analyst Day. Gross margin for the quarter improved to 60%, which is 700 basis points higher than the prior year, largely due to product mix. In addition, the decline in ARR slowed and came in at $289 million. This trend is encouraging as we remain on track for ARR to return to sequential growth in the second-half of this fiscal year. The dollar-based net retention rate or DBNRR also stabilized at 81%. As a reminder, DBNRR doesn't include new logos. As mentioned in the quarter, we secured new, renewed, and expanded business with a number of leading government institutions. These include Shared Services Canada, Transport Canada, the Canadian House of Commons, the U.S. Special Ops Command, the U.S. Navy, the U.S. Army Corps of Engineers, the White House Communication Agency, and the U.S. Transportation Security Administration. Outside North America, we secured business with the French Ministry of Defense, the German State Police, the Netherlands Ministry of General Affairs, the New Zealand Ministry of Foreign Affairs, and the British Transport Police, just to name a few. We also closed business in healthcare and financial services, including John Muir Health, Kaiser Permanente, and Hartford Healthcare, and a number of leading international banks. On the channel front, a critical element of scaling our SMB go-to-market presence, this quarter we saw promising signs of progress from our renewal channel programs. In North America, Deal Registration and new logos brought by the channel increased significantly, both sequentially and year-over-year. Moving briefly to product. Leading independent test lab, The Tolly Group, recently performed an assessment of a number of Endpoint Protection Platforms, EPPs, including Cylance ENDPOINT, Microsoft Defender, and others, and tested performance for detection rates, CPU utilization, and total scanning time. Cylance ENDPOINT came out on top with a market-leading 98.9% detection rate, both online and offline, while also using the lowest amount of CPU capacity. In comparison, competitors allowed between 9 times to 52 times more malware through than Cylance. Moving now to licensing. Last quarter, we were pleased to have closed the deal with Key Patent Innovations for the sale of the non-core portion of the patent portfolio. The deal includes an initial $170 million cash payment, which we have received, and the deal value could total as much as $900 million over time. KPI has already started to ramp up their monetization activities, including adding to their experienced team by hiring executives and patent lawyers, as well as starting to engage with potential licensees. That said, it will take some time to be fully ramped up, and we do not expect any meaningful additional revenue from the sale to be recognized this fiscal year. Under the terms of the deal, we retain ongoing revenue for any licensing arrangement in place prior to the sale. And in this quarter, this was $17 million. We expect revenue to be approximately $5 million per quarter for the remaining of this fiscal year. Let me now hand the call over to Steve, who will provide more color on our financials.

Thank you, John. As usual, my comments on our financial performance for the first quarter will be in non-GAAP terms unless otherwise noted. Total Company revenue for the quarter was $373 million. IoT revenue was $45 million. Cybersecurity revenue was $93 million, and licensing revenue was $235 million. Software product revenue as a percentage of total revenue remained in the range of 85% to 90%, with Professional Services forming the balance. The percentage of Software product revenue that was recurring remained at approximately 90%. The $235 million of Licensing and other revenue represents the $17 million of revenue from pre-existing arrangements that John mentioned earlier, and $218 million relating to the patent sale. More details will be available in our 10-Q. Related to this, there was $147 million of intellectual property assets previously classified as held for sale on our balance sheet, which were sold as part of the transaction. Accordingly, with the sale completed in Q1, these were reclassified to cost of sales. Total company gross margin was 48% and 22 percentage points higher when excluding the patent sale. Operating expenses for the first quarter were $145 million. These non-GAAP operating expenses exclude a $22 million fair value expense on the convertible debentures, $10 million in amortization of acquired intangibles, $8 million in stock compensation expense, and $5 million in restructuring expenses. Both the non-GAAP operating profit and non-GAAP net profit for the first quarter were $35 million. A $0.06 non-GAAP basic earnings per share for the quarter beat expectations. Adjusted EBITDA, excluding the non-GAAP adjustments previously mentioned, was $41 million. Total cash, cash equivalents, and investments increased by $91 million to $578 million as at May 31st, 2023. Net cash generated from operations was $99 million. The cash generated from the patent sales strengthens our balance sheet and helps finance our plans for profitable growth. Given the macroeconomic backdrop, we remain selective on potential investments and remain committed to significantly reducing the level of EPS loss and operating cash flow usage this fiscal year.

That concludes my comments, and I'll now turn it back to John. Thank you, Steve. Before we open the lines up for Q&A, I'd like to touch on the announcement we made in May regarding the strategic review of our portfolio. Our strategy is clear. We have robust operating plans for both our business units to address their large and growing market opportunities. In addition, we see potential upside to the thesis from the convergence of Cybersecurity with the IoT. Indeed, McKinsey recently issued a report on this trend of convergence and named BlackBerry as being well-positioned to capitalize on what they estimate to be a $750 billion TAM. We believe that executing against this strategy, hitting our three-year targets, and achieving profitable growth will generate significant shareholder value. Notwithstanding, the Board and Management are constantly focused on optimizing shareholder value and have therefore asked the question as to whether there are alternative approaches for delivering greater shareholder returns, for example, by means of the two business operating as standalone companies. As per our press release on May 1st, we have engaged leading investment bankers, Morgan Stanley and Perella Weinberg, and established an internal program management office to support this review, and I can tell investors that there is a lot of activity ongoing. Although the review is in the early stage, a lot of progress has already been made and the team is focusing on performing a thorough process as quickly as we practically can. It wouldn't be appropriate to provide further commentary until the Board has approved a specific outcome or has terminated this review. That ends my prepared remarks. Andrea, could you please open the line for Q&A?

We will now begin the question-and-answer session. And our first question will come from Luke Junk of Baird. Please go ahead.

Hi, there.

Good afternoon. Thanks for taking the questions. The first question, I want to ask about IoT. So, you cited some temporary delays to the start of new programs, as a few of your customers review their software-defined Vehicle plans. I guess what I'm trying to understand is, how close you are to these customers as they made that change and your level of confidence that this is solely a timing issue versus something that could be more disruptive, and related to that, should we be thinking about the low-end of full-year guidance or where would you expect to be within the guidance range given this result?

Good question. The design delay is typically tied to our forecast based on the project being awarded to us. This is included in the $640 million backlog that we announced, as we have already secured the design. We have a high level of confidence and maintain close relationships with these major customers globally. I feel assured about this situation. While there may be some design wins impacted in the second, third, and fourth quarters, we want to observe these developments before making any adjustments. I believe there might be some minor shifts in timelines, but I do not anticipate that we will fail to win these projects or that there will be significant delays.

The outlook John. Would you be towards the bottom end of the range?

Well, Tim has looked at the consensus number and when we look at our range and our forecast, we feel comfortable with the consensus number and I don't know what is high or low end.

It's towards the lower end.

Oh, okay. I think you estimated based on the consensus number that should be reasonable for now.

Okay. Thank you for that. And then for my follow-up, I want to stay within IoT John, could you just comment on the level of engagement that you've seen since IVY's GA release earlier this month? I'm curious, both, with respect to OEMs and Tier 1 partners, if you could comment and is there anything that has surprised you in the first month post-release? Thank you.

On IVY, I prefer not to disclose the specific number of requested or ongoing proof of concepts, but it's quite significant. There is a high level of interest. Typically, IVY encounters competition, but it is currently unique in the market. The competition we face often comes from customers themselves, as they think they can develop a data and analytics platform that may not necessarily be edge-to-cloud, leaning more towards cloud implementation. However, once they experience the simplicity of our solution and the range of applications we have ready and will continue to develop, it’s akin to creating an app store for vehicles. Many are interested in testing IVY through a proof of concept before deciding whether to proceed with their own solution or partner with us. Some have already opted to work with us, and that's as much as I can share.

I will leave it there. Thank you very much.

Sure.

Hey you. Hey, John. Switching gears maybe to the cybersecurity business, with the fourth consecutive quarter of billings growth, can you share a little more color, just what's driving the improving billings or maybe more specifically, what solutions in the portfolio are some of these multi-year government contracts choosing?

I think there are a few points to mention. First, we faced challenges in the past, particularly with the SMB sector for our UEM offerings. We experienced significant churn, but that churn has now stabilized. Secondly, with the Cylance product line under UES, we struggled with integration, but we have successfully integrated it and caught up with our EDR technology. As a result, we are now succeeding in competitive evaluations. Customers are not negatively impacted by this, indicated by our improving renewal rates. Additionally, we are acquiring new clients by replacing legacy providers in the SMB market, which is supported by a strong channel that brings us more business than usual. Lastly, we are seeing growth, albeit from a smaller base, in both AtHoc for critical event management and secure communication software, typically linked to government contracts, which do take time to finalize. However, these contracts have very high renewal rates. It is quite rare for us to lose a renewal, and while we are gaining new contracts, that process can also take time. Overall, I believe all components of our cybersecurity offerings are gaining momentum and addressing some earlier issues we faced.

That's very, very helpful, and maybe just a follow-up question, just going back to IoT and your big pipeline there. I know it's tough on the development seat timing, but as these new design wins turn to production, what are you thinking about in terms of revenue uptick, in terms of what you're getting today from current royalties?

The first source of revenue from our design wins will be the developer seat. As we enter a robust development phase, each OEM will typically purchase more seats. Additionally, they may require professional services support, which we also provide, to ensure optimal use of QNX. Regarding the timeline, a design win's start of production generally occurs three to four years after we secure it, but I believe this timeline may shorten due to competition from China and other Asian countries like Vietnam. Consequently, we anticipate revenue growth. The $640 million mentioned refers solely to royalties and does not account for professional services or developer seats. We expect to eventually capture, if not all, the majority of that $640 million, and we will continue to expand on it.

Great. Well, thanks for taking my questions, and congrats on finalizing the latest Intel.

Thank you.

Hi John. Good afternoon. I apologize for bringing up an accounting question, but can you explain why you are recognizing $218 million in revenue from the patent sale when you only received $170 million in cash? What accounts for the difference?

I could ask Steve to tell you, because I think we should recognize a lot more, but my accounting guru, so said that this is the right proper constrained revenue. I think they used the word constrained. I have never used that term before, but I'll let Steve answer the question on how this came about.

Sure. As we shared the details of the deal, there is a fixed amount due within a few years in addition to the initial $170 million payment we received, plus a royalty component. These elements, under the accounting framework, require some discounting to determine their net present value, with only a small portion of the near-term royalty being accounted for now. The remainder will be recorded in future periods as the amounts become clear over the next several years.

And the earn-out per se of the future royalty, like, is it a risk-adjusted measure, or like how do your accountants arrive at that number?

There's basically a lot of factors that go into it and there is some risk weighting in it, but by no means does the accounting framework allow you to kind of look at the full stream and value the full stream over the remaining period. So, don't think of it as a fair value because the accounting does not represent the full fair value of the…

Okay. That's helpful to understand. Just in terms of cash flow though, if you exclude the patent sale this quarter, cash flow from operations was negative. What were the headwinds to cash flow this quarter?

At the beginning of the year, our usual pattern is to have net cash usage in the early months. Therefore, if we exclude the amount related to the IP sale, it aligns with our typical profile for the year, followed by generating cash in later periods.

Hey Paul, and it's is driven mainly by bonuses for last year, so for our VIP payment and compensation.

Okay. Good to know. The last question and I'm not sure you can answer it, but I'll throw it out there. This arbitration in regards to the patent sale, any comments there, any sort of outlook on that?

I can't really comment on that, as I'm sure the lawyer would prefer that I don't. However, I see no merit to the issue, and we will contest it vigorously, so there's no need for concern.

Hey, John. On the new Software-Defined Vehicle plans, you mentioned that there are timing differences, but just wondering if there are any changes to the scope of those programs that could either generate potential upside to what you originally had agreed to them?

Yes. Well, you or anyone of the people in your firm gone to the Moto Trend event at CES in Vegas this beginning of the year? The reason I ask that question is because nearly every OEM, we should try to get tickets for you guys in the future. Even every OEM is having a SDV plan, Software-Defined Vehicle. So yes, the scope is expanding. We just don't want to get overly carried away with our estimates, but the scope is definitely expanding. It is truly a timing thing. We, in particular, one case, we're relying on some really good developer seats that didn't come in and that was purely a timing issue, because they wanted to step up the program, and there are some very visible public announcement that they are reorganizing some of their efforts and stepping up some of the car release dates because of software. There are at least a handful of them, because they are all my customer, I prefer not to mention here.

Okay. That's helpful. Thanks for that. On the Cybersecurity side, could you provide any details on how much of the billings you secured were renewals versus new business? Thank you.

Oh, that's interesting. I don't have it. We could have Tim follow up with you. I don't have the breakdown of the $122 million.

Okay. Thanks. Just looking for some color on how much of that is just backfilling contracts that have expired versus how many…

The most significant factor was an extension of several years and an expansion of the number of licenses. So, in this case, it encompasses both aspects.

Congratulations. Very good backlog and billing numbers. I have a question, in terms of IVY, you have very strong machine learning models for Cylance and I was wondering, is there a way using maybe some transfer learning or some other secret sauce that this intellectual horsepower you have in the Cylance machine learning AI products, we could transpose into IVY and if so, that would be great. Any thoughts you may have on that end?

Yes, like every company, we are evaluating this plan. Firstly, our threat hunting team continually utilizes AI, and we have recently started offering threat hunting services to our customers. Essentially, it's an AI-driven model built over several generations, supported by billions of malware profiles and enhanced through our machine learning experience. So, you'll likely see that becoming a focus for us. Regarding additional AI capabilities in our products, we haven't finalized our approach yet; we are currently assessing it. We want to ensure that we don’t expose too much of our internal model as we navigate the open AI landscape. We are actively analyzing this while also awaiting guidance from the government, as they will likely have regulations on AI usage in products. We are particularly attentive to government policies since we provide significant software systems to governments worldwide. Therefore, we must proceed cautiously to comply with their regulations. I have teams dedicated to both product development and understanding the relevant policies.

Very good. A follow-up on the same IVY and battery management system, which is a very critical component of the modern electric vehicle, and again, you have technologies like in Cylance, and I was wondering if you may have thought about using the machine learning models that you already have; maybe it needs to be trained on a different set of data, to automate, they may be battery management system for some performance enhancements, which could literally differentiate yourself and maybe you will be the only player who can offer in Software Defined Vehicles, complete intelligence in the battery management solutions. Any thoughts on that? And that's all from my side.

Yes. Yes, Trip. Our lab people will know a lot more about that, and we of course will try to take advantage of the two from a business side. But it's not something that we are deep into yet, but that's a good suggestion.

Hey, John. I was wondering if you could talk about the expected quarterly cadence of IoT and cyber. What does it look like for Q2 and then the back half of the year?

I typically don't offer a quarterly outlook, but considering the current environment, I think we need to be somewhat cautious in the short term. However, I remain optimistic about our pipeline, especially regarding the government deals in the cyber sector. We are awaiting the original equipment manufacturers to share their development schedules for the vehicle side. These are the two key areas we need to monitor closely. I anticipate that Q2 will likely be slightly better than Q1, and I expect that in the second half of the year, particularly in the cyber area, our annual recurring revenue will show a positive sequential increase.

Okay, I appreciate that. And then, what are your thoughts on your contract extension, which is coming up this year? I know you've talked about it in the past, if you have anything incremental to say there, I would be interested. Thanks a lot.

It's a bit complicated with the Imperium project. I'm waiting to see what direction the Imperium takes; once I have that information, I will make my own decision on what to do next. Rest assured, it's all in capable hands, so there's no need for concern. I've informed the Board that we should wait to see where the Imperium project stands before making any decisions.

Right. And you had indicated, there was a lot of activity around that project, would you expect it still to take at least the summer before you get your initial findings or can it happen sooner than that?

I believe it will take some time because we have a lot of effort involved in separating the business. First, we need to separate the income statement, which is straightforward. Then, we have to separate the balance sheets and consider the tax implications. Additionally, we need to evaluate what the market provides and what it does not, and there are many factors to weigh, so this cannot be rushed. I still anticipate this will be completed by the end of summer timeframe.

Yes. Okay. Appreciate that color. Thanks a lot.

Absolutely.

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

I don't have any closing remarks. Thank you, everybody, for participating. We're always cognizant of the fact that you are in the East Coast and it's late for you folks and I appreciate it. So, I'll talk to you guys more, hopefully, sooner than next quarter, if not, at least next quarter. Thank you all very much. Have a good evening.

That concludes today's conference. Thank you for attending today's presentation, and you may now disconnect.