IBM is back to its revenue declining, non-GAAP-EPS-beating-through-low-tax-gimmick ways.
With Wall Street expecting IBM to report (non-GAAP) EPS of $4.82 in Q4, the company "beat" by the tiniest of margins, reporting non-GAAP, adjusted EPS of $4.87, a 5% drop from last year.
So far so good, but as usual, there was a gaping difference between GAAP and non-GAAP, and in this case, it was more than double, with the company reporting a paltry $2.15 in GAAP EPS, more than 50% below the Non-GAAP number. Unfortunately for IBM, unlike last quarter when non-GAAP pre-tax and net income both posted modest increases even as their GAAP equivalents dropped, this quarter, both non-GAAP and GAAP pre-tax net Income declined Y/Y by -1% while non-GAAP Net Income dropped by 8% (GAAP Net Income was not meaningful).
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How did IBM bridge the traditionally lower GAAP EPS number to the higher non-GAAP? Simple: here is the full breakdown.
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More importantly, the EPS only beat because the company reverted back to its tax gimmick ways, as IBM's effective GAAP tax rate was 56% yet its non-GAAP EPS once again managed to tumble to only 12%, which while laughable was double the 6% effective non-GAAP - and lowest ever - tax rate in Q4 2017.
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Meanwhile, IBM reported Q4 revenue of $21.8 billion, which was just better than the $21.7 billion expected...
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... however, after three-quarters of top-line growth - which followed 22 consecutive quarters of declines - IBM's Q4 revenue once again dropped after a similar decline in Q3, sliding by 3.3% Y/Y in Q4, and reminding investors that for all its non-GAAP and tax fudges, IBM remains a melting ice cube.
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And yet despite this now traditionally accounting gimmickry and deteriorating top line, investors appeared to like the results for two simple reasons: the first, IBM's cloud revenue did not collapse:
- Technology services & cloud platforms revenue $8.93 billion down from $9.20 billion Y/Y
Of note, revenue from cloud-based offerings alone grew about 12% to $19.2 billion in 2018, half the growth rate of last year. Of course, in a bet to jump-start its efforts to catch up in the cloud, IBM famously agreed to buy software maker Red Hat Inc. for $33 billion in October, which CEO Rometty called "a game changer" for IBM.
The other closely watched segments also did relatively better:
- Cognitive solutions revenue $5.46 billion vs $5.43 billion Y/Y
- Global business services revenue $4.322 billion vs $4.152 billion Y/Y
- Systems revenue $2.62 billion vs $3.33 billion q/q
The second reason investors appeared impressed with IBM's numbers is that the company now sees 2019 operating EPS at least $13.90 vs estimate $13.80. We assume all the upside is from even greater non-GAAP addbacks. The company also expects GAAP diluted earnings per share of at least $12.45, as well as free cash flow of approximately $12 billion, same as last quarter.
Going back to the bad news, gross margins grew slightly in the fourth quarter, to 49.1%, but once again missed the average analyst estimate.
IBM also announced that it generated Q4 cash from operations of $4.1 billion. And as has been the case for the past several years, the company returned much all of its cash, or $3.5 billion, to shareholders through $1.4 billion in dividends and $2 billion in stock buybacks. At the end of 2018, IBM had $3.3 billion remaining in the current share repurchase authorization; for new readers, IBM has repurchased billions and billions of its stock in the past decade, which is the only reason non-GAAP EPS hasn't imploded.
IBM ended the fourth quarter with $12.2 billion of cash on hand, down from $14.7 billion at the end of Q3. And while cash declined by $2.5 billion, debt declined by far less, with IBM reporting $45.8 billion in debt, down from $46.9 billion a quarter prior. Of course, both of these numbers will change drastically once the Red Hat deal is completed.
In short: after several strong quarters, IBM's Q3 and Q4 results - when in addition to everything IBM decided to purchase Red Hat and massively overpaying at that - saw the return of all that investors had grown to loathe about big blue. Even so, the stock is up after hours, as investors clung to the positive news of a modest improvement in the cloud and slightly stronger guidance, although like on prior quarters don't be surprised if IBM fades all of its after-hours upside.
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