Credit Suisse senior analyst Kulbinder Garcha said that Research In Motion Ltd (NASDAQ:BBRY) (TSE:BB)’s 10-K filings reveal that BlackBerry Z10 gross margins were much lower than what Wall Street supposes.
Credit Suisse has an “underperform” rating on the stock with a $10 price target. In its fourth quarter results, Research In Motion Ltd (NASDAQ:BBRY) (TSE:BB) reported lower revenues but surprisingly higher than expected earnings per share. Most of the Wall Street analysts attributed to Z10 handset sales.
However, Credit Suisse said in its latest research report that improvement in gross margin from Q3 to Q4 was a result of amortization by Research In Motion Ltd (NASDAQ:BBRY) (TSE:BB) due to an accounting change. The BlackBerry maker’s latest annual filing shows that its intangible amortization reduced from $340 million in Q3, 2013 to $207 million in Q4, 2013, which was split by $71 million and $136 million between COGS and OPEX. The analysts also found that amortization and acquisition of intangible assets both decline from Q3 to Q4 as shown below.
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In the fourth quarter, the company’s gross margins improved by 840 basis points Q-o-Q to 40 percent. Garcha estimates that the $127 million decline in amortization improved the hardware gross margin by as much as 510 basis points. The gross margin recovery would have been much less without a decline in amortization.
So, why are the acquired intangible assets and amortization declining? Credit Suisse says that Research In Motion Ltd (NASDAQ:BBRY) (TSE:BB) has historically acquired “Prepaid Licenses” over a long period of time, which the BlackBerry maker amortized over a short span of around three years.
Many of these licenses were agreed at much higher volume in the glorious days of Research In Motion Ltd (NASDAQ:BBRY) (TSE:BB), which resulted into a fixed commitment and subsequent amortization.
The graph below shows that when the company’s revenues started declining, the amortization cost was almost fixed, so it resulted into higher costs as a percentage of the device ASP, which can be partially blamed for negative hardware gross margins last year. Analysts believe that Research In Motion Ltd (NASDAQ:BBRY) (TSE:BB) has renegotiated some of these prepaid licenses, so the amortization and the intangible asset acquisition are declining.
Coming to the gross margin of BB10, the actual gross margin of hardware comes down to 21 percent if you remove the impact of amortization. Assuming that gross margins from BB7 were almost flat, the gross margin from BB10 comes at 35 percent. Now, if you subtract the amortization impact, then BlackBerry10 gross margin touches the level of 26 percent, much lower than 40 percent that people think.
Research In Motion Ltd (NASDAQ:BBRY) (TSE:BB) will have to lower the prices in future to drive volume. That will further eat into the gross margins.
Research In Motion Ltd (NASDAQ:BBRY) (TSE:BB) shares were down 1.01 percent to $14.70 at 1:43 PM EDT.