(By Mani) Research In Motion Limited (NASDAQ: RIMM) (TSE:RIM) reported a better than expected third quarter results reflecting gross margin improvement, restructuring and good balance sheet management. However, shares tanked more than 15 percent as RIMM's subscriber base declined and service revenue is at risk.
Shipments fell 51 percent to 6.9 million. At the end of the third quarter, BlackBerry subscriber base was approximately 79 million users, a 5 percent increase from 75 million last year. On a sequential basis as shipments dropped 6.8 percent and subscriber base fell by 1 million from 80 million in the second quarter of 2012.
[Related -Why Apple's (AAPL) Outlook Is Improving Heading Into 2014]
The decline in shipments and subscriber base triggered the panic button among the investors as they are sensing that the decrease in the metrics is a sign that customers are migrating to other platforms such as Apple, Inc. (NASDAQ: AAPL) and Google Inc.'s (NASDAQ: GOOG) Android.
Moreover, RIM's move to cut its high-margin services fees, which it earns via its messaging services for retaining and attracting customers, makes difficult for the BlackBerry maker to sustain its profitability.
"Service revenues declined and appear at risk moving forward. We see continued pressure on volumes and BB10 acceptance is uncertain," Oppenheimer analyst Ittai Kidron wrote in a note to clients.
[Related -Fusion-IO, Inc. (NYSE:FIO): Stiff Competition May Hurt Margins; M&A Remains Key Catalyst]
Currently, service revenues account for about 36 percent of RIM's overall sales and investors and analysts are wondering how this will be impacted by the transition and eventual adoption of BB10.
"We believe that the consumer segment will be challenged to extract the same fees as its preceding platforms and enterprise looks to be following suit. As a result, we are now modeling a 20% decline in services revenues in each of the next two years," Deutsche Bank analyst Brian Modoff said in a client note.
Moreover, enterprises will be required to add a completely new server infrastructure, which could be a significant hurdle. This would sit alongside the current infrastructure needed to support older devices.
"We think many enterprises will hold a cautious tack in order to first understand the traction with their employees before moving forward," Modoff noted.
As service revenues decline with the introduction of the BB10, it will place added pressure on the handset business to return the company to profitability. The new platform requires a dual core processor, which will increase its bill of materials costs meaningfully. With carrier subsidies peaking alongside overall average selling prices, generating a decent margin could be difficult.
Another important question on the call was about the migration to BB10. In developing markets, it sounded as if they were going to continue supporting BB7, and it would be a significant challenge to support two operating systems at the same time. The biggest casualty in this arena is Nokia Corp. (NYSE:NOK).
For the third quarter, RIM reported net income of $9 million or 2 cents per share, compared with net income of $265 million or $0. 51 per share last year. Results for the reporting quarter included charges of $55 million and an income tax benefit of $166 million. Excluding items, adjusted loss for the quarter totaled 22 cents per share while analysts expected a loss of 35 cents per share.
Quarterly revenues plunged 47 percent to $2.73 billion, better than analysts' consensus of $2.66 billion. At the end of the quarter, RIM had a cash flow of $2.9 billion, up $600 million from the prior quarter.
However, RIM said it is likely to report a loss next quarter as it ramps up its marketing campaign for its new BlackBerry 10 operating system and smartphones, which are slated to go on sale Jan. 30. The timing of the BlackBerry 10 launch event could also impact sales of current BlackBerry 7 products as some customers may defer purchasing decisions and wait for BlackBerry 10 devices. All these factors are expected to impact unit volumes, subscribers, margins and service fees.
Waterloo, Ontario-based RIM is betting on BlackBerry 10 for its change of fortunes, which has been hurt ever since the launch of iPhone and Android ecosystem. More than 150 carriers are currently testing BlackBerry 10 products while beta trials of BlackBerry Enterprise Service 10 are underway at more than 120 enterprises including 64 Fortune 500 companies.
Although, the sky is not bright for RIM, at least in the near-term, as it controlled less than 5 percent of smartphone market in 2012, and it will own just 4 percent of the market in 2016, according to IDC.
"While BB10 platform looks promising, we think they still have multiple significant challenges in the form of BB10 app developer support, the conversion of their current user base to an entirely new platform and managing the decline in their service revenues," Modoff said.