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IBM Beats on Q3 Earnings & Revenues, Reiterates '17 EPS View

International Business Machines CorpIBM reported third-quarter 2017 non-GAAP earnings of $3.30 per share, which beat the Zacks Consensus Estimate by couple of cents. Earnings per share (EPS) were a penny better than the year-ago figure and surged 11.1% sequentially.

Revenues of $19.15 billion surpassed the Zacks Consensus Estimate of $18.62 billion but were almost flat on a year-over-year basis. At constant currency (cc), revenues declined 1%. Moreover, revenues fell 0.7% sequentially.

The top-line performance was better than expected primarily due to higher cognitive solutions and systems revenues. Cognitive revenues were driven by robust performance from security, Internet of Things (IoT) andanalytics offerings. Systems benefited from strong demand for storage and the launch of new z14 mainframe.

Moreover, Strategic Imperatives (cloud, analytics, mobility and security) grew 10% at cc from the year-ago quarter. On a trailing 12-month basis, revenues increased 10% to $35 billion and now represents 45% (up from 43% in the previous quarter) of the company's total revenue.

Geographically, Americas and Europe/Middle-East/Africa declined 2% and 1%, respectively, on a year-over-year basis. Management noted year-over-year growth in Germany, France, Italy and Spain, partially offset by declines in the UK. The company's services business continues to win customers in the UK, Germany and Spain. Asia-Pacific revenues inched up 2%, driven by good growth in Japan and China.

International Business Machines Corporation Price, Consensus and EPS Surprise

International Business Machines Corporation Price, Consensus and EPS Surprise | International Business Machines Corporation Quote

IBM expects strong revenue growth in the fourth quarter on a sequential basis, driven by an anticipated solid demand for the z14 mainframe. The company began shipment of its z14 mainframe in September. Gross margin is also projected to improve, while currency hedges (due to weak U.S. dollar) will impact operating expenses.

The Zacks Consensus Estimate for EPS is currently pegged at $5.16 on revenues of $21.91 billion for the fourth quarter. EPS is expected to increase 3% on top-line growth of almost 0.6%.

Shares of the company have increased almost 6% in after-hour trading following the third-quarter announcement. Although IBM's stock has lost 11.7% of its value year to date, it has outperformed the industry 's decline of 16.4%.

Cloud & Security Drove Top-line Growth

Cloud revenues surged 20% from the year-ago quarter. The annual run rate for cloud as-a-service revenue increased 24% at cc on a year-over-year basis to $9.4 billion. Cloud revenue on a trailing 12-month basis is now $15.8 billion, more than 20% of the company's total revenue.

Security revenues have surged 49% at cc to $700 million. The growth was driven by robust performance from security software solutions and strong demand for the pervasive encryption capabilities in new z14 mainframe.

Revenues from analytics (largest of the company's strategic imperatives) increased 5% at cc to $5 billion. Revenues from mobile climbed 7% at cc to $1.2 billion.

Cognitive Solutions Grew on Security, Analytics

Cognitive Solutions (solutions software and transaction processing software) revenues increased 3% at cc to $4.40 billion. The figure surpassed the Zacks Consensus Estimate for Cognitive Solutions of $4.17 billion. Both Solutions software and Transaction Processing Software revenues grew 3%, respectively.

Within Annuity content (80% of cognitive), Software-as-a-Service (SaaS) offerings witnessed double-digit growth in revenue and signings.

Analytics results improved on the back of strong growth in Business Intelligence & Data Discovery. SaaS offerings grew triple-digit led by Cognos Analytics. Data Warehousing reported strong results. In September, IBM launched new unified data system, which is supported by the company's DB2 technology and is built on IBM Power.

Segmental revenues pertaining to Strategic Imperatives and Cloud grew 5% and 10%, respectively. Cloud as-a-service revenue annual run rate was $2 billion.

Security software grew double digits in the reported quarter driven by robust sales of Resilient and QRadar, which addresses areas like endpoint protection, incident response and security intelligence.

IBM stated that increasing number of security threats, growing regulatory compliance like General Data Protection Regulation (GDPR) and partnerships with the likes of Cisco Systems Inc. CSCO on threat intelligence drove strong demand for its security offerings.

IoT revenues increased double digits. IBM signed almost 40 new clients on its IoT platform. Moreover, the number of developers grew at a strong double-digit rate. The company also launched new products like IoT for Connected Products during the quarter.

Watson Health continued to drive double-digit growth, with strength in Government, Oncology and Life Sciences markets.

GBS - Consulting Grew, Application Management Down

Revenues from Global Business Services segment were $4.09 billion, down 2% at cc. The figure was better than the Zacks Consensus Estimate of $4.06 billion. Signings improved for the third-consecutive quarter, up 15%. Segmental revenues pertaining to Strategic Imperatives grew 11%. Cloud practice surged 35%. Cloud as-a-service revenue annual run rate was $1.2 billion.

Application Management and Global Process Services revenues decreased 3% and 12%, respectively. Consulting revenues increased 1% driven by IBM's digital strategy and iX platform, which is up more than 40%. The company now has 36 studios around the world. IBM recently announced its plans to acquire Vivant, a digital agency based in Australia.

During the quarter, IBM signed a five-year partnership with Volkswagen AG VLKAY to develop new mobility services that will utilize its cloud and cognitive capabilities to create highly personalized digital experiences for vehicle drivers.

Technology Services & Cloud Platforms: Revenues Dip

Revenues from Technology Services & Cloud Platforms decreased 4% at cc to $8.48 billion, which was better than the Consensus Estimate of $8.37 billion.

Segmental revenues pertaining to Strategic Imperatives advanced 12%, driven by by hybrid cloud services, security and mobile. Cloud increased 16% from the year-ago quarter. Cloud as-a-service revenue annual run rate was $6.2 billion.

Integration Software, Technical Support Services and Infrastructure Services dipped 3%, 2% and 5%, respectively. Overall Global Technology Services (GTS) signings jumped 25% from the year-ago quarter.

Mainframe, Storage Drove Systems Revenues

Systems (systems hardware and operating systems software) segment increased 10% at cc on a year-over-year basis to almost $1.72 billion.

IBM Z revenue grew 62% year over year on 33% MIPS growth driven by the successful launch of the z14 mainframe. Power revenue declined year over year primarily attributed to decline in UNIX. Linux-on-Power now represents more than 20% of IBM's Power portfolio.

Segmental revenues pertaining to Strategic Imperatives surged 25%. Cloud revenues jumped 23%.

Storage hardware grew 4% in the quarter. Operating Systems Software revenues declined 3%, while Systems Hardware increased 14% from the year-ago quarter.

Global Financing (includes financing and used equipment sales) revenues increased 3% at cc to $427 million.

Blockchain Initiatives Gaining Momentum

IBM is involved in a number of Blockchain initiatives as the technology gains rapid mainstream adoption. The company is currently the dominant player in the blockchain market. Recently, CNBC quoted Juniper Research, which placed IBM above Microsoft Corporation MSFT in blockchain-related advancements.

IBM uses hyperledger technology for its blockchain applications and is also a key member of the Hyperledger committee. This enables the company to gain access to prior notification of any changes in the underlying infrastructure.

IBM has been winning significant deals in recent times. The company has struck bank guarantee deals with ANZ and Westpac and a multi-line insurance contract with American International Group and Standard Chartered PLC.

IBM has also inked a deal with global food suppliers and another one with automobile manufacturer, ZF Friedrichshafen to enhance its Car e-Wallet technology.

Margins

Non-GAAP gross margin contracted 40 basis points (bps) to 47.6% from the year-ago quarter. Sequentially, gross margin expanded 40 bps reflecting some improvement from mix and from productivity.

Operating expense declined 0.8% year over year to $5.51 billion reflecting improving efficiency.

Moreover, pre-tax margin from continuing operations contracted 30 bps on a year-over-year basis to 18.8%. Sequentially, pre-tax margin expanded 290 bps.

Segment wise, Global Business Services and Technology Services & Cloud Platforms pre-tax margin contracted 190 bps and 60 bps, respectively. This was partially offset by 30 bps expansion in Cognitive Solutions pre-tax margin.

Sequentially, Cognitive Solutions, Global Business Services and Technology Services & Cloud Platforms pre-tax margin expanded 210 bps, 320 bps and 210 bps, respectively.

Systems pre-tax income was $339 million as compared with income of $136 million reported in the year-ago quarter and $74 million in the previous quarter.

Balance Sheet & Cash Flow Details

IBM ended third-quarter 2017 with $11.50 billion in total cash and marketable securities as compared with $10.70 billion at the end of second-quarter 2017. Total debt (including global financing) was $45.6 billion, which decreased $0.1 million from the end of the last quarter.

IBM reported cash flow from operations (excluding Global Financing receivables) of $3.3 billion and generated free cash flow of $2.5 billion in the quarter. In the reported quarter, the company returned $2.3 billion to shareholders through dividends ($1.4 billion) and share repurchases ($0.9 billion). At the end of the quarter, the company had $1.5 billion remaining under current buyback authorization.

Guidance

IBM reiterated EPS forecast for 2017. Non-GAAP EPS is expected to be at least $13.80. The company also anticipates 2017 free cash flow to remain flat over 2016.

Zacks Rank

IBM currently carries a Zacks Rank #3 (Hold). You can see the complete list of today's Zacks #1 Rank (Strong Buy) stocks here.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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