Will BlackBerry Ltd. Report Another Record Gross Margin This Quarter?

BlackBerry Ltd (TSX:BB)(NASDAQ:BBRY) reported a record U.S.  GAAP gross margin of 67% in its latest reported quarterly update for the three months ended November 30, 2016. While this was an improvement on the previous quarter, will the company beat this margin once again when it reports in March 2017?

The 67% record margin was up from a historical high of 62% reported for the second quarter and significantly higher than the 45% reported a year ago.

BlackBerry reports on three operating segments now: Software and Services, Mobility Solutions and Service Access Fees (SAF). Driving gross margin improvements for BlackBerry has been the increasing dominance of the high-margin Software and Services segment as the company is shifting its focus from hardware to becoming a pure software play.

The other two segments, Mobility and SAF, are both on a declining path with SAF revenues expected to fall another 25% this quarter from US$67 million to around US$50 million. Mobility revenues have been shrinking at above 30% a quarter in the last two quarters too, but with improving gross margins quarter on quarter since May 2016.

The good news, and probably the only reason investors still hold on to their BlackBerry shares, is the rising contribution of the Software and Services segment to corporate revenues. BlackBerry gave a guidance of a 30% increase in this segment’s revenues for financial year 2017, implying a probable 7.5% growth per quarter through to March 2017.

Given the above possible scenario and anticipating that BlackBerry maintains the lucrative gross margins of 79.88% or so for Software and Services, 44% gross margin for Mobility Solutions, and almost 72% for SAF, then it’s very possible that BlackBerry may have another record-breaking gross margin to report in March 2017, probably between 71.5% and 72% at best, albeit on a lower revenue figure.

Investor takeaway

BlackBerry’s gross margins are indeed improving as a result of the company’s transition from being a hardware manufacturer to a pure software provider. The contribution of the low-margin mobility segment to corporate revenues is fast vanishing, and in its place will be the high-margin software licensing fees and the exponentially growing high-margin Software and Services segment revenues.

However, these high-gross margins are from a smaller projected revenue base.

Most noteworthy, the company’s prospects are still weighed down heavily by huge overheads. Operating expenditures are still expected to increase in the next quarters as the company continues to invest in developing secure software for connected cars and autonomous driving automobiles as well as in the Federal Cybersecurity Operations Center in the U.S. to support FedRAMP and other government security-certification initiatives

Monetisation of the connected car project is still long off — probably by 2019.

However, the Ford QNX deal, the TCL phone licensing deal, the Radar project, and the recently reported BlackBerry Secure deal with Giuliani Partners and other software contracts could offer some hope for improvement in non-GAAP metrics going forward. There are high-margin recurring revenue deals that are beginning to stream in for the company, creating a positive momentum for BlackBerry Software and Services.

Investors should be on the watch for the early signs of potential GAAP profitability and cash flow improvement so as to take positions early enough.

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Fool contributor Brian Paradza has no position in any stocks mentioned. David Gardner owns shares of Ford. The Motley Fool owns shares of Ford.

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