International Business Machines Corp. Earnings: The Strategic Makeover Is 40% Complete

By Anders

Cloud computing is at the very core of IBM's growth strategy. Image source: Getty Images.

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IBM (NYSE: IBM) just reported earnings, sharing results for the third quarter of fiscal year 2016 after the closing bell on Monday.

Let's have a closer look at the report.

IBM's Q3 results: The raw numbers

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Data source: IBM. YOY = year over year.

What happened with IBM this quarter?

The shift into what IBM has labeled "strategic imperatives" continued relentlessly, and management focused the spotlight on that progress in the earnings release.

  • While total revenue held steady year over year, the strategic imperatives increased their sales by 16%. Cloud computing services led the way with a 42% revenue surge, followed by double-digit increases in mobile products, data analytics, and security tools.
  • If you're wondering how those growth numbers could fit within a flat overall revenue trend, the answer can be found in 21% lower systems hardware sales and 8% lower financing revenue. The systems segment suffered a steady outflow of Unix system orders as customers transition to Linux platforms running on commodity hardware systems. However, the biggest pain point came from the z Systems mainframe portfolio, which had to measure up against a fresh product launch cycle in the corresponding 2015 period.
  • Big Blue produced $2.43 billion of free cash flows in the third quarter, returning $2.20 billion directly to shareholders in the form of dividends and share buybacks. In the year-ago period, $2.55 billion in free cash flows supported a total of $2.81 billion in dividend and buyback expenses.

Management touched up existing full-year guidance figures ever so lightly:

  • Operating earnings (IBM's name for adjusted or non-GAAP earnings) are still expected to exceed $13.50 per share. Getting there would require reaching operating earnings of at least $4.91 per share in the fourth quarter.
  • Free cash flow is now expected to hit "the higher end" of the original view that IBM published in January. That would put the full-year free cash flows very close to the operating income target, which works out to something like $5 billion in the fourth quarter.

What management had to say

CEO Ginni Rometty waxed poetic about the success of IBM's cognitive solutions and cloud services:

Her words were backed up by impressive growth tallies in these segments, as discussed above.

Looking ahead

Going forward, Big Blue will keep on pushing deeper into its chosen strategic imperatives. This is not the one-stop-shop IBM of old, but an increasingly focused specialist in a few handpicked sectors. It's been a difficult struggle so far, as IBM has traded in low-margin hardware sales for a lower volume of strongly profitable software and services. That's been a bitter pill for investors to swallow, and the long-term payoff always seems to hover just out of reach.

Will the big payoff finally arrive in 2017? IBM's management didn't want to paint any guidance targets for the next fiscal year this early, so we shareholders can only come back again in three months to get a reading on that crucial point. That being said, strategic imperatives accounted for 40% of IBM's total sales in the third quarter and should start to truly steer the ship someday soon.

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Anders Bylund owns shares of IBM. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days.

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