IBM Delivers, Does Not Dazzle

On October 15, IBM (NYSE:IBM) reported third-quarter results that topped estimates, and the company raised its full-year guidance. However, IBM’s shares dropped because its results were not as good as investors had hoped and there was a drop in contract signings. Let’s take a closer look.

Q3 revenue was down 7% y-o-y and up 1% q-o-q to $23.6 billion versus analyst estimate of $23.59 billion. Net income grew 14% to $3.2 billion or $2.40 per share, beating analyst estimate of $2.02 per share. Analysts expected earnings of $2.39 per share on revenue of $23.5 billion. Q2 analysis is available here.

Gross profit margin was 45.1% versus 43.3% last year, driven by improving margins in services and software. IBM generated free cash flow of $3.4 billion and ended the quarter with $11.5 billion in cash. It reduced debt by $4 billion in the quarter and total debt was $25.5 billion, versus $33.9 billion at the end of the year. It bought back shares for $930 million and paid $726 million in dividends.

During the quarter, the company closed its acquisition of SPSS, a leader in predictive analytics. With this, IBM has spent $9 billion on strategic acquisitions since 2005 to build its business analytics capabilities. It remains a bit of a mystery to me that Omniture went to Adobe and not IBM, however, given the latter’s strong focus on analytics.

IBM also continued to invest in Smarter Planet solutions and cloud computing. IBM is not offering applications as a service but is trying to reach the SME segment by offering integrated services through the cloud. Its LotusLive iNotes and hosted services in China are acting as its testing grounds. It is now working on nearly 50 smart grid engagements across growth and major markets. For example, IBM is helping Oncor, the largest electric delivery business in Texas, replace over 3 million standard meters with advanced meters by 2012. IBM will be providing expertise in smart metering, large meter data management, business analytics, and security. In my most recent post on the company, I suggested some acquisitions for its health-care portfolio: athenahealthand Omnicell (and interview with the CEO is available here.)

By region, revenue from the Americas was down 5% to $9.9 billion, EMEA was down 12% to $7.8 billion, and Asia-Pacific was flat at $5.2 billion.

By segment, Systems and Technology revenues were $3.9 billion, down 12%, and Software revenue was down 3% to $5.1 billion. Revenues from IBM’s middleware products including WebSphere, Information Management, Tivoli, Lotus and Rational products, were $2.9 billion, up 2%. IBM’s branded middleware had a strong quarter, and it gained almost 3 points of share in WebSphere, where it competes head-to-head with Oracle. It also gained share in Information Management, Tivoli, and Rational.

Global Financing revenues were down 15% to $536 million. Total Global Services revenue was down 7%, with Global Technology Services revenues down 4% at $9.4 billion and Global Business Services revenue down 11% at $4.3 billion.

Services signings were down 7% to $11.8 billion, below expectations of around $13 billion. IBM signed 13 contracts greater than $100 million, down from 17 last quarter. It also signed three deals worth nearly $1 billion in the first two days of October.

Based on its performance, IBM expects EPS of at least $9.85 per share for the year, up $0.15 from its previous view of at least $9.70. The company expects to return to revenue growth in the fourth quarter and said that it is ahead of pace to achieve its 2010 goal of EPS of $10 to $11 per share. The stock is currently trading around $123 with a market cap of about $163 billion. It hit a 52-week high of $128.61 on October 14 before the earnings announcement.