What to Expect When IBM Reports Earnings on Monday

Image source: International Business Machines

Investors will get another update on the transformation efforts of International Business Machines (IBM 0.06%) when the company reports its second quarter results after the market close on July 18. IBM has reported 16 straight quarters of year-over-year revenue declines, and barring a major surprise, that number will likely rise to 17 next week. Here's what investors need to know.

What happened last quarter

IBM managed to beat analyst estimates across the board when it reported its first quarter results back in April. Revenue came in at $18.68 billion, down 4.6% year-over-year but $400 million higher than the analyst consensus. Adjusted for currency, revenue declined by just 2%. IBM's strategic imperatives, which includes all of the company's major growth businesses, grew by 17% year-over-year, adjusted for currency.

Non-GAAP earnings per share was $2.35 during the first quarter, down 19% year-over-year but $0.26 higher than the average analyst estimate. A $1.5 billion pre-tax charge related to workforce adjustments and other items was offset by a $1.2 billion one-time tax benefit, with the net effect being essentially null.

IBM also took the opportunity to reiterate its full-year earnings guidance. The company expects non-GAAP earnings in 2016 to be at least $13.50 per share, with GAAP earnings expected to top $12.35. Free cash flow, previously forecasted in a range of $11 billion to $12 billion, is now expected to be at the high end of that range.

What analysts expect this quarter

Another revenue decline is expected during the second quarter, with the average analyst estimate calling for a 3.8% year-over-year drop to $20.03 billion. Analysts aren't expecting revenue growth to return this year or next year, meaning that IBM's streak of top line declines may be far from over.

Non-GAAP earnings per share is expected to come in at $2.88, down from $3.84 during the same period last year. This estimate represents a 33% drop, far larger than the decline during the first quarter. IBM pointed out in its first quarter conference call that its ongoing transformation is changing when earnings are typically realized. The company expects to achieve between 38% and 39% of its full-year earnings guidance by the end of the first half, and that lines up with the current analyst estimate.

One thing that could throw a wrench in IBM's plans for the rest of the year is Brexit. The company has been dealing with currency headwinds for quite some time, driven by a strong dollar and its exposure to international markets. During 2015, only 37% of IBM revenue came from the United States, with 32% coming from Europe, the Middle East, and Africa, and another 21% coming from the Asia-Pacific region. Canada and Latin America accounted for the remaining 10% of revenue.

With the Brexit vote sending the British pound plunging relative to the dollar, the impact of currency on IBM's results this year is now more uncertain. Expect management to discuss currency issues during the company's conference call.

Growth where it counts

Despite IBM's lackluster revenue performance over the past few years, there are parts of the business that are growing quickly. IBM's strategic imperatives, which include cloud, analytics, social, mobile, and security products, are still growing at a double-digit pace despite accounting for 37% of the company's total revenue over the past 12 months. Cloud computing brought in $10.8 billion of revenue over the past year, with half of that coming from cloud delivered as a service.

The turnaround story at IBM revolves around these fast-growing businesses eventually becoming large enough to more than offset declining legacy businesses. In the long run, IBM aims to grow revenue by a low single-digit percentage and earnings per share by a high single-digit percentage annually. The company isn't there yet, and it may still be quite a while before IBM turns the corner.

IBM's second quarter will probably look a lot like the first quarter. Revenue and earnings will almost certainly decline, with rapid growth in some areas unable to counteract weakness elsewhere. The market has bid up shares of IBM over the past few months, with the stock rebounding strongly off of its February lows. IBM will need to show some progress in its turnaround efforts to keep investors on board.