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Big Blue Blows Away Street Estimates

Updated from April 16.

SAN FRANCISCO -- IBM's (IBM - Get Report) improving margins and stronger-than-expected revenue combined to deliver a first-quarter earnings surprise Wednesday.

Net income rose 26% to $2.32 billion vs. a net of $1.84 billion in the year-ago period. Benefiting from a reduced share count, EPS jumped 36.4% to $1.65, from $1.21 in the prior year. Analysts were looking for a bottom line of $2.04 billion, or $1.45 a share.

CFO Mark Loughridge said on the conference call that the company was increasing its full-year EPS outlook by 25 cents to $8.50.

The Armonk, NY-based company said revenue rose 11.4% to $24.5 billion, from a top line of $22 billion in the same period of last year. Analysts polled by Thomson Financial were expecting $23.71 billion.

Part of the additional revenue came from the domestic U.S. market, which grew 8% year over year, or 6% in constant currency, to $9.9 billion, Loughridge said. Asia/Pacific was up 18%, or 10% in constant currency, excluding Japan, which was down 3% in constant currency.

The top line was helped by strong sales of the company's new z Series mainframe 34 days before the end of the quarter. IBM expects the product to continue to deliver during the coming quarters.

The EPS surprise was partly due to a "very good performance in our U.S. organization," Loughridge said. Profitability behind that 6% revenue growth drove earnings. "Given that it was in the U.S., none of it was driven by currency." And the company "did better on the performance behind our Cognos acquisition than we'd anticipated," he added.

While a favorable currency impact from IBM's international businesses contributed 7 cents to EPS, the company's previous forecast of a 6-cent to 7-cent benefit had been factored in by analysts.

Gross profit margin for the quarter was 41.5%, compared with 40.2% for the same quarter of 2007.

In established countries, IBM has put its development and sales resources behind products and services that help businesses cut costs, while targeting infrastructure rollouts in emerging markets -- "a powerful play for us," Loughridge said in an interview with TheStreet.com. "It's another quarter that indicates that this is the right model for good times and tough times."

The stock was up $3.22, or 2.7%, to $123.69 in after-hours trading.

The company had reduced the diluted share count by 118 million shares year over year, or nearly 8%, bringing the total down to 1.4 billion shares.

Services revenue rose 17% year over year, or 9% in constant currency, to $9.7 billion. Contract signings rose 6% to $12.6 billion, which was down 2% on a constant currency basis. The combined services business lines delivered a 36% improvement in pretax income, Loughridge said.

The hardware business grew 12% in constant currency, to $4.2 billion.

In the software business, revenue rose 14% year over year to $4.8 billion, or 6% in constant currency. Middleware revenue was up 19%. The Cognos acquisition, which closed during the quarter, added 1 percentage point to the overall growth rate, Loughridge said.

Free cash flow was $600 million, an improvement of $800 million, year over year, Loughridge said.

IBM is one of several earnings reports that will affect the market Thursday morning. Other stocks with pivotal earnings either released Wednesday night or pending Thursday include Google (GOOG), Nokia (NOK - Get Report), eBay (EBAY - Get Report), Altera (ALTR - Get Report). Altera might benefit from Intel's Tuesday night news that capital spending is going to stay level.

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