IBM “Beats” Thanks To Near Record Low Tax Rate As Revenue Barely Grows

After years of declining revenues, IBM finally posted its first revenue increase at the end of the last year, an inflection point which may have marked the low point for the company, notorious for its accounting gimmicks and pro forma adjustments. And now, in its Q2 2018 earnings report, IBM continued this trend of revenue growth, posting its third consecutive quarter of revenue growth.

In the second quarter, the company reported non-GAAP EPS of $3.08, up 5% Y/Y and beating expectations of $3.04 (not to be confused with GAAP EPS as noted below). Revenue of $20.0 billion was also better than the expected $19.9 billion, and a 4% increase to the $19.3BN reported last year. This was the third straight quarter of revenue growth after 5 years of declines, if a decline from last quarter’s 5.2% revenue growth.

Broken down, revenue was mixed:

  • Cognitive solutions revenue $4.6 billion, unchanged Y/Y
  • Global business services revenue $4.2 billion, up 2% Y/Y
  • Technology services & cloud platforms revenue $8.6 billion, up 2% Y/Y
  • Systems revenue $2.2 billion, up 25%

Even when looking at IBM’s tax rate, where IBM traditionally engages in accounting magic, things appeared to be normalizing, as the non-GAAP effective tax rate was a respectable, for IBM, 16%.

All of the above was great news and would have sent the stock soaring. Only, it was not meant to be, because a closer look once again revealed some of the company’s traditional dirty laundry.

First, while IBM did report 4% revenue growth Y/Y in Q2, this was only if one excludes currency impact, something which IBM always says to include. And, as IBM disclosed in its report, revenue growth was only 2% Y/Y when adjusted for currency.

Going down the income statement reveals that gross profit declined Y/Y, dropping from 46.5% in Q2 2017 to 46.0% this quarter on a GAAP basis.  Even on an adjusted basis, the profit margin dropped, printing at 46.5%, down 0.6% Y/Y.

Finally, while an improvement from last quarter’s bizarre -47.5%, IBM’s effective GAAP tax rate was once again surprisingly depressed, at just 13.5%, well below the non-GAAP 16.0% reported. The delta in the tax rate once again meant the difference between IBM beating on EPS, and missing.

Meanwhile, coming well below the non-GAAP print, Q2 GAAP EPS was $2.61, which was a 5% increase Y/Y, for once the same percentage change Y/Y as non-GAAP.  How did IBM bridge the traditionally lower GAAP EPS number to the higher non-GAAP? Here is the full breakdown.

IBM reaffirmed its guidance, and said it expects operating (non-GAAP) diluted earnings per share of at least $13.80 and GAAP diluted earnings per share of at least $11.60. IBM expects free cash flow of approximately $12 billion, with a realization rate greater than 100 percent.

Finally, in the latest another bizarre corporate decision, IBM announced that it generated Q2 free cash flow of $1.9 billion. And yet, as has been the case for the past several years, the company returned more than it made, or $2.4 billion to shareholders through $1.4 billion in dividends and $1.0 billion in gross share repurchases. At the end of June 2018, IBM had $2.0 billion remaining in the current share repurchase authorization. As a result, the only reason why IBM saw its cash level increase thanks to $1.5BN in short-term financing receivables.

IBM ended the second quarter with $11.9 billion of cash on hand, down $1.3BN from the $13.2BN at the end of Q1. As a result of the cash burn, Debt totaled $45.5 billion, down from $46.4BN a quarter ago. Separately, Global Financing debt was $31.1BN.

In short: while IBM’s results had some gimmicks in Q2, they were far less than in prior quarter, and perhaps to reward the company, IBM stock is modestly higher after hours, even as investors will be looking forward to IBM’s new share repurchase authorization.

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