International Business Machines (IBM – Free IBM Stock Report), a global provider of computer software, services, and systems hardware, and a member of the Dow 30, said its reported earnings in the final quarter of 2017 were hurt by a $5.5 billion one-time charge associated with the passage of the Tax Reform and Jobs Act. Despite the slight uptick in the company's currency-adjusted revenues, IBM shares, which have lagged the market averages in the past year, declined sharply in Friday mid-morning trading.
The company reported a loss of $1.14 a share in the December quarter, compared to our expectation for earnings of $4.70 and results in the year-earlier period of $4.73. For all of 2017, it earned $6.14 a share, well short of our estimate of $11.95 and 2016's tally of $12.39. Absent the tax reform-related charge, which boosted tax expense, the company indicated that it would have earned $5.18 a share in the quarter and $13.80 for the full year. The company didn't disclose whether this figure also excludes acquisition and retirement costs.
The encouraging news is that revenues rose 3.6% year over year in the quarter, or 1% adjusted for currency shifts. A 28% advance in its Systems segment more than offset declines in Global Business Services and Technology Services revenues and a flat performance by the Cognitive Solutions (software) segment.
Systems revenues reflected very strong performances by IBM's new z System mainframes, as well as by its Power systems and information storage hardware. Business Services revenues were hurt by declines in traditional ERP managed services and the completion of some large contracts, but consulting, previously a weak area, grew 1%. Technology Services faced difficult comparisons because of some large contracts in the year-earlier period.
Cognitive Solutions (software), which account for 80% of annual revenues, turned in a flat performance, with double-digit growth in software-as-a-service revenues offset by lower transactional revenues, due to weakness in a few of IBM's more traditional analytics offerings. Companywide strategic revenues, from areas like cloud computing and analytics, rose 11% in the period and accounted for 46% of the top line.
Meanwhile, IBM's gross margin in the fourth quarter contracted a little over 1% year over year, reflecting an unfavorable mix. Productivity measures in the company's services businesses are also taking longer than expected to pay off. Results were also hurt by a 6% increase in operating expenses, partly due to currency, and lower intellectual property income. On a reported basis, pretax results declined 10%, and the one-time tax reform charge pushed December-quarter results into the loss column.
In 2018, the company looks to earn at least $13.80 a share (excluding nonoperating costs, which have not been disclosed). That would at minimum match IBM's operating results in 2017. The company aims to gain ground with its analytics and as-a-service offerings, and further improvement in consulting is possible. But investment spending to build its artificial intelligence, cloud, security, and blockchain capabilities is expected to remain high. In addition, IBM's tax rate will increase about four basis points as a result of the new tax law, in contrast to the declines reported by many other U.S.-based companies. Assuming no nonoperating expenses, we have raised our share-net estimate for 2018 to $13.80, up from our previous forecast of reported earnings of $12.10 (which included an estimated $1.50 of so-called nonoperating expenses).
Signs of improvement in the revenue trajectory notwithstanding, IBM's turnaround continues to progress at a glacial pace. The dividend yield is attractive, but the stock's total return potential to 2020-2022 is below average, based on the company's not very well-defined long-term prospects. Investors in IBM shares will need to be very patient.
About The Company:International Business Machines is a worldwide supplier of computer systems, services, and software. Revenues in 2017 can be broken down as follows: Cognitive Solutions, 23%; Global Business Services, 21%; Technology Services & Cloud Platforms, 43%; Systems, 10%; Global Financing, 2%; and Other, 1%.
— Theresa Brophy
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.