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International Business Machines Corp. (IBM - Analyst Report) reported earnings per share of $3.99 in the third quarter of 2013, which surpassed the Zacks Consensus Estimate of $3.95. Revenues fell short of the consensus mark in the reported quarter. Despite the revenue miss, IBM posted a decent outlook for the full year.

Revenues

IBM’s third quarter revenues of $23.72 billion missed the Zacks Consensus Estimate of $24.78 billion. Revenues declined 4.1% from the year-ago quarter. On a constant currency (cc) basis, revenues declined 2.0% from the year-ago quarter.

Except Global Business Service, Software and Global financing all other segment revenues declined on a year-over-year basis.  Software increased 0.6% (up 2.0% on cc) year over year to $5.79 billion. Growth in the Software segment was mainly fueled by the key branded middleware.

Global Technology Services revenue decreased 4.3% year over year to $9.49 billion. Global Business Services segment revenues remained flat, although it moved up by 5.0%, on a constant currency basis to reach $4.6 billion.

Services backlog at the end of the third quarter was up 2.0% year over year to $141.0 billion. The company continues to witness a decline in outsourcing revenues due to sales into existing base accounts and also from the structural work that the company did previously on low margin contracts.

Hardware/System & Technology revenues (including retail store solutions) were down 17.0% (down 16.0% in constant currency) year over year to $3.2 billion in the quarter.

In the Hardware segment, revenues from System x declined 18.0% whereas System Storage declined 11.0%. However, revenues from System z mainframe server products increased 6.0% compared with the year-ago period. This apart, Microelectronics OEM revenues increased 1.0%.

Global Financing revenues increased 6.5% year over year to $502.0 million in the reported quarter.

Region wise, revenues from the Americas’ during the third quarter were $10.3 billion, down 1.0% from the year-ago quarter. This apart, Asia-Pacific revenues declined 15.0% to $5.5 billion whereas OEM revenues were down 1.0% year over year to $534 million. EMEA revenues, however increased 1.0 % to $7.3 billion.

Revenues from growth markets declined 9.0% while revenues from BRIC countries such as Brazil, Russia, India and China declined 15.0% year over year.

Margins

Gross margin expanded 1.0 percentage point from the year-ago quarter. The improvement in gross margin was primarily driven by favorable service margins and the relative strength of software and mainframe.

The company reported total expense and other income of $6.4 billion, which decreased 0.3%. SG&A expense was $5.0 billion, which decreased 10.1% year over year. Whereas, R,D&E expense of $1.45 billion which declined 5.5% compared with the year-ago period.

Net Income

Net income was $4.4 billion were $3.99 per share, which declined 5.6% from $4.2 billion or $3.62 reported in the year-ago quarter. However, excluding the workforce rebalancing charges, earnings per share were $3.91.

Balance Sheet & Cash Flow Details

IBM ended the quarter with $10.23 billion in total cash and marketable securities, compared with $10.36 billion in the previous quarter. At the end of the third quarter, total debt was $36.18 billion compared with $34.10 billion in the prior quarter.

IBM reported cash flow from operations (excluding Global Financing receivables) of $3.28 billion versus $3.60 billion in the previous quarter. In the reported quarter, IBM generated free cash flow of $2.2 billion, flat compared to the previous quarter.

IBM returned $3.0 billion to shareholders through $1.0 billion in dividends and $1.9 billion of share repurchases.

2013 Outlook

IBM forecasts fiscal 2013 EPS of $15.01, including workforce rebalancing charges. operating non-GAAP EPS of $16.25.

Our Take

IBM reported a mediocre third quarter result, with a modest outlook. This will help it to win back investor confidence going forward. We believe that IBM’s decent backlog, improving outsourcing signings and new contract wins will boost the top line going forward.

However, slowing top-line growth in BRIC and growth markets is a headwind in our view. Additionally, sluggish IT spending and strong competition from the likes of Oracle (ORCL - Analyst Report), Hewlett-Packard (HPQ - Analyst Report) and EMC Corp. (EMC - Analyst Report) are the major concerns going forward.

Currently, IBM has a Zacks Rank #3 (Hold).

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