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BlackBerry is no longer focused on hardware like the Priv (pictured) for growth. Image source: BlackBerry.

BlackBerry (NASDAQ:BBRY) released another quarter of revenue decreases and net losses. Overall, the Canadian mobile firm saw its top line drop nearly 50% over last year's fiscal third-quarter results, falling from $548 million in generally accepted accounting principles, or GAAP, to $289 million. Its bottom line fared no better: BlackBerry reported a GAAP loss of $0.22 this quarter versus a $0.17 loss in last year's corresponding period.

Those unfamiliar with BlackBerry's story would assume the company would be under significant pressure after reporting deteriorating results. Instead, shares rallied approximately 3% in pre-market trading. The market's early response to BlackBerry's report shows that "bad earnings" is a relative concept. In fact, BlackBerry's earnings are better than they initially appeared. CEO John Chen is turning the company around -- similar to his reign at Sybase.

BlackBerry is turning around, despite top-line results

The majority of BlackBerry's revenue loss can be attributed to the fact that the company changed its hardware business model. Last year, hardware accounted for $214 million, or roughly 40% of its revenue haul in the fiscal third quarter. In September 2016, BlackBerry announced it would no longer perform the manufacturing for its hardware business, and instead the company would license the manufacturing to a group of handset makers in Indonesia.

As far as the income statement is concerned, the company no longer reports device sales as revenue, but instead records licensing revenue when a unit is sold. The upside is the company no longer reports cost of goods either -- the end result is BlackBerry reports less, but reports higher-margin revenue when a BlackBerry unit is sold.

More importantly, BlackBerry is rapidly transitioning to a high-margin software and services company. For year-over-year comparisons, a better comparison metric would be to follow BlackBerry's gross margin growth rather than its top line. On this metric, BlackBerry looks much better versus revenue comparisons with an 18% drop year-over-year and a 97% increase quarter-over-quarter.

MetricQ3 2016Q2 2017Q3 2017
Revenue $548 million $334 million $289 million
Cost of Sales $312 million $236 million $96 million
Gross Margin $236 million $98 million $193 million
Gross Margin Percentage   43.1% 29.3% 66.8%

Figures in GAAP revenue. BlackBerry's fiscal year is one year ahead of calendar.

BlackBerry's higher-margin operations and new revenue-recognition for device sales means the company does not have to record as much revenue to record positive EPS.

Positive commentary for the fourth quarter

Perhaps the best news for the stock was Chen's commentary:

We remain on track to deliver 30 percent growth in company total software and services revenues for the full fiscal year. We are raising our outlook on profitability for FY17. We now expect to achieve non-GAAP EPS profitability for the full year, up from a prior range of breakeven to a five cent loss. This is the third consecutive quarter we have increased our EPS outlook, reflecting the traction we are achieving in our shift to a software business model. We also anticipate breakeven non-GAAP EPS and approximately breakeven free cash flow in Q4.

There's a lot to unpack here. First, Chen's turnaround has centered on growth in the company's software and services. That's important because that segment is the company's highest margin business with a near 80% gross margin percentage this quarter.

The second-most important section of Chen's announcement is the fact that the company projects breakeven free cash flow (broadly defined as operating cash minus capital expenditures) in the fourth quarter. This is an obvious improvement from the company's negative operating cash flow through the first nine months of its fiscal year.

Lastly, the company is now upgrading its non-GAAP EPS outlook. While investors want to see constant improvement on all EPS related metrics, non-GAAP metrics can vary widely from GAAP ones. Earlier I noted BlackBerry reported a GAAP loss of $0.22 per share. On a non-GAAP basis, it reported positive EPS of $0.02. The upgrade is nice, but Blackberry's numbers are also a reminder that investors should be wary of non-GAAP metrics.

Overall, BlackBerry's results show a company still in transition but with a possible light at the end of the tunnel. John Chen appears to be on his way to cementing his legacy as a turnaround specialist.

 

Jamal Carnette owns shares of BlackBerry. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.