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What to Expect When International Business Machines Corp. Reports Earnings

By Timothy Green - Jan 17, 2016 at 8:32AM

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Big Blue will likely see another major revenue decline, thanks largely to currency fluctuations, but investors should look beyond the headline numbers.

International Business Machines (IBM 0.90%) is set to report its fourth-quarter results after the market close on Tuesday, Jan. 19. The company has reported year-over-year revenue declines in each of the past 14 quarters, and that number will likely rise to 15 as negative effects from a strong dollar continue to weigh on Big Blue's results.

IBM's headline numbers are almost certainly going to look terrible, but there are a few things that investors should pay special attention to. Here's what to expect when IBM reports its fourth-quarter earnings.

Image source: IBM.

What analysts are expecting
Revenue is expected to decline by 8.5% year over year to $22.07 billion during the fourth quarter, according to the average analyst estimate. This would mark an improvement over the third quarter, when IBM reported a revenue decline of 14%.

IBM's revenue isn't really declining by as much as it seems, however. The U.S. dollar strengthened against other currencies throughout much of 2014, meaning all of IBM's international businesses have been reporting starkly lower revenue simply because of unfavorable changes in exchange rates. During the third quarter, nine percentage points of IBM's revenue decline was attributed to currency, and another four percentage points was attributed to divested businesses. On an adjusted basis, IBM's revenue declined by just 1% year over year.

IBM's non-GAAP earnings are also expected to decline, in part due to these currency issues. Analysts expect IBM to report non-GAAP earnings of $4.81 per share, down about 20% year over year. While IBM doesn't provide quarterly earnings guidance, the company does expect full-year non-GAAP earnings to be between $14.75 and $15.75 per share, implying the company expects fourth-quarter earnings to be in the range of $4.66-$5.66 per share.

IBM has beat analyst estimates for earnings in each of the past four quarters, and with analysts expecting earnings to come in at the low end of IBM's implied guidance, another earnings beat could be in the cards.

Strategic imperatives
IBM's transformation revolves around growing a group of businesses that the company refers to as its strategic imperatives. These include cloud, analytics, security, mobile, and social, and revenue from these areas have been growing at a breakneck pace. During the third quarter, strategic imperative revenue rose by 27% year over year on an adjusted basis.

Other parts of IBM's business are declining, so the net result is flattish adjusted revenue growth overall. But at some point in the next couple of years, investors should expect these strategic imperatives to become a large enough part of the business to begin driving revenue growth. Many of IBM's initiatives, like its cognitive computing system Watson, are long-term by nature, and meaningful revenue generation may still be a few years away.

IBM has forged a variety of partnerships in order to expand Watson's reach, including various deals with healthcare organizations in an effort to provide personalized treatment options. Recently, Under Armour partnered with IBM to use Watson to create and provide data-backed health and fitness insights. Watson needs to be trained for each specific application, and while this means it can take years for the system to become useful for a specific task, it also creates meaningful switching costs, which helps keeps customers with IBM.

Investors should expect strong double-digit growth of IBM's strategic imperatives during the fourth quarter, and management should provide additional details during the company's earnings conference call. Another area to watch is the services backlog; IBM's services segments generated $12.1 billion of revenue during the third quarter, and the growth of the backlog is an indicator of how strong demand is for IBM's services. During the third quarter, the backlog grew by 1% year over year on an adjusted basis.

Another terrible (looking) quarter
IBM's fourth-quarter numbers aren't going to be pretty. Revenue is going to decline, potentially by a double-digit percentage, and IBM's earnings for 2015 will fall comically short of the company's previously abandoned goal of hitting $20 per share.

As the year goes on, assuming the U.S. dollar doesn't strengthen further, IBM will lap the big decline in exchange rates, as well as its previous divestitures. This means the headline numbers should get dramatically better, although nothing will have really changed with the business itself. For investors, currency fluctuations are largely irrelevant in the long run, and what really matters is how the business is performing, adjusted for all of the noise. IBM still has a long way to go before its transformation is complete, but the company has been making progress, and investors should expect to see continued progress during the fourth quarter.

Timothy Green owns shares of International Business Machines. The Motley Fool owns shares of and recommends Under Armour. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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