Updated from 9:37 a.m. EDTA deeper look at IBM's ( IBM) third-quarter earnings release put investors in a forgiving mood Tuesday morning. Amid a burst of positive analyst commentary, shares of the hardware and services giant rose $1.41, or 1.7%, to $84 in recent trading. While noting a spotty revenue performance, Wall Street embraced strong margins and hardware sales in bidding up the stock. After the bell Monday, IBM posted third-quarter earnings of $1.52 billion, or 94 cents a share, on sales of $21.53 billion. During the same quarter last year, the company earned $1.55 billion, or 92 cents a share, on sales of $23.35 billion. The latest quarter included a one-time charge this year of 32 cents a share for the repatriation of overseas profits. Excluding that, IBM earned $1.26 a share in the third quarter, compared with a precharge $1.03 a share in the same period a year ago. IBM's bottom line easily beat analyst estimates of $1.13 a share excluding items, as gathered by Thomson First Call. But sales fell short of the $21.71 billion that Wall Street targeted, by more than $100 million. Excluding 2004 revenue from IBM's PC business, which the company sold May 1, third-quarter revenue increased a modest 4% from the same period a year ago. Still, analysts at Goldman Sachs, Bear Stearns and Citigroup all reiterated buy ratings Tuesday morning and raised their earnings targets for the fourth quarter and 2006. Two of the analysts set 12-month price targets of $100 on the stock. "IBM's Q3 results were solid, and soundly reaffirm our belief that the company's earnings power is stronger than many investors realize," Bernstein analyst Toni Sacconaghi wrote in a note Tuesday. "We note that IBM's quarterly strength is not really a reflection of any market strength, but rather of several positive unique forces at work at IBM, namely its work force reductions, improving microelectronics business, healthier services profile (less backlog erosion, better mix of business), and new mainframe cycle, all of which are likely to continue in Q4," he added.
Sacconaghi, who has an outperform rating on IBM, said he expects analysts to raise their estimates again after the company reports its fourth quarter results in January because its outlook is still conservative. His firm doesn't do investment banking. Overall gross margin was 40.6% in the third quarter, up from 36.5% in the third quarter last year and 39.4% in the previous quarter. Excluding the PC unit, gross margin was 40.0% in the third quarter last year. Big Blue's services unit, which made up 54% of total sales, posted a 3.3% increase in revenue from a year ago to $11.69 billion. The unit, which suffered a major slowdown in the first quarter and then rebounded in the second quarter, marked its second consecutive quarter of increasing contract bookings, to $11 billion from $9.8 billion last year. That's a sequential decline, however, from $14.6 billion in signings in the second quarter. Niles noted that shorter-term contract signings -- which he calls a good near-term indicator of the services unit's health -- dropped to $4.7 billion from $5.4 billion in the previous quarter. Services backlog remained flat sequentially at $113 billion, which represents an increase of $3 billion from a year ago. The services unit's pretax operating margin improved by 1.1 points from a year ago to 9.7%. On a post-close conference call, CFO Mark Loughridge did not provide explicit fourth-quarter guidance but offered some cryptic clues to help analysts adjust their estimates. He told investors to "roll through" the company's third-quarter earnings upside to full-year results and to expect double-digit earnings growth for the fourth quarter and full year. The CFO reiterated that the second half of the year would be characterized more by cost and expense management than by revenue growth, with the fourth quarter "similar in texture" to the third quarter even as the hardware unit benefits from a new mainframe cycle and video-game chip sales.
Earlier in the year, IBM announced
plans to lay off thousands of workers after its services division surprised Wall Street with weak first-quarter results. Loughridge indicated on Monday that IBM's services pipeline is continuing to grow from the just-reported third quarter. Analysts responded to his comments by raising earnings estimates. The consensus estimate for IBM's fourth-quarter earnings climbed Tuesday to $1.92 a share from $1.87 a share a day earlier, while analyst targets for fiscal 2006 earnings climbed to $5.62 a share from a previous target of $5.48 a share a day earlier. Outside of the services unit, IBM's hardware sales (excluding the PC business) rose 7% to $5.1 million, software sales increased 5.5% to $3.82 billion, and global financing sales dropped 5.8% to $600 million in the third quarter. IBM's hardware unit suffered from a 4% decline in mainframe sales compared with a year ago. The company began shipping its new z9 mainframe line in the last two weeks of the quarter; this is expected to result in rising mainframe sales starting in the fourth quarter. But hardware's gross margin of 40.6% was higher than anticipated, due in part to higher-than-expected yields on microprocessors for new video game consoles. IBM's microelectronics unit grew sales 14% year over year.