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IBM Corp. (IBM) Q2 Earnings Beat; Imperatives Gain Steam

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International Business Machines Corp (IBM - Free Report)  reported second-quarter 2016 results wherein both non-GAAP earnings per share of $2.95 and revenues of $20.238 billion easily surpassed the respective Zacks Consensus Estimate of $2.89 and $20.082 billion. However, on a year-over-year basis, the metrics declined 23.2% and 2.8%, respectively.

International Business Machines Corporation (IBM - Free Report) Street Actual & Estimate EPS - Last 5 Quarters | FindTheCompany

IBM continues to reel under the effects of a painfully long drawn business transition that has been wreaking havoc on sales and profitability. Sales have now shrunk for 17 straight quarters. IBM has been moving away from its traditional businesses to newer (read lucrative) business avenues like cloud and data analytics. Though IBM’s Strategic Imperatives are performing well, these are not enough to make up for the weakness in its traditional business yet.

Segment Details

From the first quarter, the company has changed its reporting segments to provide a better insight into its strategic imperatives performance. The company’s new segments are as follows:

Cognitive Solutions (solutions software and transaction processing software) revenues grew 3.5% year over year to $4.7 billion. IBM reported that Software solutions registered strong growth of 6%, driven primarily by analytics and security. Cloud was up an impressive 54%. Acquisitions continue to cushion growth.

Revenues from Technology Services and Cloud Platforms (includes infrastructure services, technical support services, integration software) fell 0.5% to $8.9 billion. Segmental revenues pertaining to Strategic Imperatives grew 35%.

Revenues from Global Business Services (includes consulting, global process services, application management) segment were $4.3 billion, down 2% from the year-ago quarter. Segmental revenues pertaining to Strategic Imperatives grew 14%.

Systems (systems hardware and operating systems software) segment was down 23.2% on a year-over-year basis to $2 billion. Hardware revenues fell 28% while operating systems was down 4%.

Global Financing (includes financing and used equipment sales) revenues declined 11.3% on a year-over-year basis to $424 million.

The company’s strategic initiatives (cloud, analytics and engagement) revenues in the quarter increased 12% on a year-over-year basis to $8.3 billion in the quarter. IBM’s cloud revenues jumped 30% while Business Analytics revenues increased 5% in the same time period. Revenues from mobile and security increased about 43% and 18%, respectively.


Non-GAAP gross margin decreased 190 basis points (bps) to 49% from the year-ago quarter. Pre-tax margin from continuing operations was 17.3% compared with 22% reported in the year-ago quarter. Operating margin was 14% compared with 18.2% reported  in the year-ago period.

Balance Sheet & Cash Flow Details

IBM ended second quarter 2016 with $10.6 billion in total cash and marketable securities. Total debt (including global financing) was $44.5 billion. Core (excluding global financing) debt was $18 billion.

IBM reported cash flow from operations (excluding Global Financing receivables) of $3.1 billion in the quarter and generated free cash flow of $2.1 billion in the quarter.

In the quarter, IBM returned $2.1 billion to shareholders — $1.3 billion as dividends and $0.8 billion through share repurchases. The company has $3.9 billion worth of shares left for repurchase.

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For 2016, the company continues to projects non-GAAP earnings to be around $13.50. The Zacks Consensus Estimate for the same is currently pegged at $13.50. Also, the company continues to expect to generate free cash flow at the higher end of the earlier expected range of $11 to $12 billion.

Our Take

IBM is having a tough time, given the ongoing and heavily time consuming business model transition to cloud. Further, sluggish IT spending particularly on on-premise and data center hardware and foreign exchange volatility remain concerns.Also, intensifying competition in the industry is a major headwind.

Nevertheless, IBM's strategic growth initiatives, including its Big Data & business analytics, cloud computing, mobile and social business are expected to drive growth. Reportedly, IBM estimates SoftLayer to generate $1 billion in revenues in 2016. SoftLayer is the primary infrastructure of IBM’s cloud operations.

In addition, IBM’s policy of making strategic acquisitions (it has acquired over 150 companies since 2000) will lead to incremental revenues, strengthening its technology leadership and resulting in a more favorable mix of business. The acquisitions have also increased its scale of operations globally. This year IBM has made 11 acquisitions so far, worth over $5 billion, which include Bluewolf Group, Resilient Systems, Truven Health Analytics, Optevia and The Weather Company’s B2B, mobile and cloud-based web-properties. Strong cash flow generation is expected to provide the financial flexibility required for strategic investments in achanging business environment.

IBM has a Zacks Rank #3 (Hold). Better-ranked tech stocks include MeetMe, Inc (MEET - Free Report) , Match Group, Inc (MTCH - Free Report)  and Blucora, Inc (BCOR - Free Report) . MeetMe has a Zacks Rank #1 (Strong Buy) while Match Group and Blucora are Zacks Rank #2 (Buy) stocks.

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