IBM's third-quarter earnings drop, attributed to slowing China growth

IBM reported a 4 percent drop in third-quarter revenue, worse than expected by Wall Street, amid a decline in hardware and emerging markets even as it beat earnings estimates.IBM shares fell 6 percent in after-hours trade to $175.56.
Chief Financial Officer Mark Loughridge said on a conference call for investment analysts that third quarters tended to be difficult for the world's largest technology service provider but added the company faced some particular challenges this year.
Profitability in its hardware business declined by $1 billion year-to-date and currency effects had a $500 million year-to-year negative impact, he added.
There is increasingly less demand for hardware as software replaces traditional infrastructure. IBM has recognized that trend and is itself shifting to become a more software focused business.
Hardware was mostly hit in China, which Loughridge said broadly accounted for about 5 percent of IBM's business and about 40 percent of that business was hardware.
China's growth has slowed this year, impacting corporate and public spending as the country develops an economic reform plan.
"As far as the growth markets are concerned, we will be dealing with the China impact for another couple of quarters," Loughridge said.
Revenue dropped 4 percent to $23.7 billion, below Wall Street analysts' expectations of $24.74 billion, mainly due to the decline in its hardware division, excluding its System z mainframe servers, and in emerging markets, which were down 9 percent.
Hardware revenue was down 17 percent, while System z mainframe revenue rose 6 percent.
Quarterly net income rose 6 percent to $4.0 billion, or $3.99 a share on a non-GAAP basis from $3.62 a year earlier, above estimates of $3.96 a share, according to Thomson Reuters I/B/E/S.
The revenue drop was worse than investors expected, RBC Capital analyst Amit Daryanani said.
Edward Jones analyst Josh Olson agreed, saying it was a disappointing quarter from a revenue standpoint.
"I think that the hardware business is going to be something they need to work through, and growth markets are down much more than expected," he said.
Olson added that the services backlog was healthy, but "we are not seeing the conversion of that backlog into meaningful revenue."
The company reiterated its full year outlook of non-GAAP EPS of at least $16.25.
But ISI Group analyst Brian Marshall said there was concern that IBM's days of double-digit EPS growth are nearing an end.
"Increasingly, we believe IBM has been relying on non-operating, inorganic drivers of EPS growth," he said.
Asked on the call if investors should prepare for no revenue growth and less than double-digit earnings growth in the future, Loughridge promised "stronger operational performance as we go into 2014."
IBM's hardware business should return to profit growth in the second half and stabilize profit on a year to year basis for the year, he said. Emerging markets would return to mid-single-digit performance for the 2014 full-year especially after the implementation of China's new economic plans, he added, without specifying the measure of performance.
Asked about the impact of the U.S. federal government shutdown, Loughridge said that there would not be much of an impact to the company if the issue is resolved this month.
"If this extends into December, then it's going to get to be a meaningful number, say around a nickel, that we would probably not be able to contain," he said.
The U.S. federal government business was a little less than 3 percent of the total revenue mix, Loughridge said.

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