IBM Fails To Offset Legacy Declines With Q3 Earnings

IBM Watson: 10 New Jobs For Cognitive Computing

IBM delivered good news and bad news with its third quarter financial announcement Monday.

First, the bad news: Revenue from continuing operations was down 1% from last year's third quarter, hitting $19.3 billion. This missed analysts' estimates by $340 million.

Net income for the same period was $3.3 billion, down 11%. Earnings per share, however, beat expectations by four cents to reach $3.34.

The good news is that "strategic imperative" revenues were up 27% year-to-year, adjusted. Cloud revenue hit $9.4 billion over the trailing 12 months, up 65%, adjusted. Business analytics was also up 19%, adjusted.

After-hours trading saw IBM's stock price drop 3.7%.

"In the third quarter we again made progress in the transformation of our business to higher value, with strong growth in our strategic imperatives and expanded operating margins," said Ginni Rometty, IBM chairman, president, and CEO, in a prepared statement.

IBM considers cloud, business analytics, mobile, and security as "strategic imperatives" -- future technologies that promise sufficient growth to offset declines in more mature business lines such as hardware, software, and services.

Revenues in those three mature sectors declined this quarter. Services dropped 10% to $7.9 billion. Software was down 10% to $5.1 billion. Middleware was off 7%, logging $3.4 billion in revenue. And hardware plummeted 39% to $1.5 billion. The one bright spot was z Systems mainframes, with sales up 15%.

IBM CFO Martin Schroeter, speaking in a conference call with analysts, underscored Rometty's remarks about the shift to strategic imperatives. "We always said it would play out over time," he said.  

IBM's Global Business Services (GBS), which posted a 5% drop in revenues down to $4.2 billion, is seen as one channel to deliver IBM's strategic imperatives. The unit is labor-intensive and will take time to shift over to delivery of higher-value services, Schroeter explained.

Margins from strategic imperatives delivered via GBS are higher than other services GBS handles, Schroeter noted. Likewise, cloud has a hardware dimension as well, given the increase in sales for the z System and Power product lines, he added.

IBM is not ignoring shareholder value, having bought back 24 million shares, or about 2% of its outstanding shares, for $1.5 billion.

IBM also continues to make acquisitions, having bought nine companies year-to-date, two of which are cloud-related. Big Blue spent a total of $800 million buying smaller companies that could add value to its technology portfolio.

[Read about IBM revealing its source code to the Chinese government.]

Not booked yet was the $1 billion purchase of Merge Healthcare, which provides medical imaging, handling, and processing. IBM aims to attach Merge to Watson Healthcare to develop a cognitive-computing capability that can read medical imaging.

The strong US dollar will be a "headwind" dampening IBM's earnings from foreign sales for the next several quarters, Schroeter continued. "We are not losing our competitiveness in the marketplace due to currency," he stressed.

To sum up, IBM is not trying to be the biggest, according to Schroeter. "We are trying to be of highest value," he said.  Some investments have "long tails" such as Watson and Watson Healthcare. "We're managing for the long term," he said.