International Business Machines (IBM – Free IBM Stock Report) shares pulled back meaningfully in Wednesday morning premarket trading after the company, a provider of computer software, services, and systems, as well as a Dow-30 component, reported September-quarter results. Earnings were flat, and revenues remained disappointing.
On a reported basis (including $0.48 a share of acquisition and retirement costs), IBM earned $2.94 in the September period, better than our estimate of $2.70, but about flat with results in the year-earlier quarter of $2.92.
Revenues slipped 2% year over year, owing to the stronger U.S. dollar, but were flat adjusted for currency. The gross margin in the quarter also matched the year-earlier tally, with improvement in the Global Business Services and Technology Services & Cloud segments offset by contraction in the Cognitive Solutions (software) and Systems lines. Efforts to drive efficiency (acquisition synergies, automation, and changes in the way employees work) helped reduce operating expenses. But interest and other costs rose. A discrete tax benefit lowered the tax rate slightly, and stock repurchases enhanced earnings per share.
By segment, Cognitive Solutions revenues declined 5% but the division's gross margin expanded. The business has been taking actions, like modernizing its offerings, to deal with shifts in its markets and indicated that it had a good pipeline in transaction processing software going into the December quarter.
Meanwhile, efforts to improve revenues in the services businesses are apparently working. Global Business Services revenues grew 3%, aided by a strong performance in Consulting, which rose 7%. The segment's gross margin also expanded nicely, supported by efforts to shift the mix to more profitable offerings. Technology Services revenues were flat, adjusted for currency, with Cloud offerings up 22%. The segment's margin also expanded nicely, reflecting economies of scale in the cloud business and productivity initiatives.
But Systems revenues slowed dramatically, from a 23% increase in the June term to 2% in the September interim, as sales of IBM's newest z system, introduced more than a year ago, faced tougher comparisons. Sales of systems often moderate after an initial good reception. Systems margins also contracted, reflecting mix issues, lower intellectual property income, and investment in the business.
Looking ahead, we now expect revenues to decline in the December quarter and in 2019, owing to the slowdown in z system sales. But IBM's productivity efforts probably will support modest margin improvement. The company is holding to its 2018 share-net forecast of at least $11.60, which includes an estimated $2.20 of acquisition and retirement costs. We tentatively look for results of $11.70 a share in 2018 and $11.80 in 2019.
We still expect IBM's comeback to proceed at a glacial pace. To be sure, income investors may be attracted to the stock's well above-average dividend yield. The issue also has worthwhile total return potential following the recent share-price pullback. But long-term investors probably will need to be extremely 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
