Last quarter, IBM – once again – almost fooled the market when it “beat” but only thanks to using the lowest (until then) effective non-GAAP tax rate in recent history (excluding one charge-filled quarter when the rate was negative and thus N/M). Fast forward to this quarter when IBM has done it, or at least tried it, again: in the three months ended Sept 30, IBM reported Non-GAAP EPS of $3.30, above the expected $3.28. How did IBM “beat” again? By once again applying a lower tax rate than a year ago: a paltry 11.0%, down from the already laughable 12.5% in Sept 30, 2016. Had IBM used even last quarter’s 12.5% tax rate, it would have missed.
Amusingly, and just like in Q2, while both GAAP EPS and margins declined Y/Y, non-GAAP EPS was the only thing that was magically flat (with even non-GAAP net income down):
At this rate IBM will soon need a negative non-GAAP tax rate to make its negative non-GAAP earnings turn positive, or some other double negative…
Although for some reason IBM is confident it won’t need to:
The company continues to expect a full-year effective operating (non-GAAP) tax rate of 15 percent, plus or minus 3 points, excluding discrete items.
Considering IBM’s effective tax rates in Q1-Q3 have all been below 12%, this would mean that in Q4 IBM’s tax rate will have to be well over 20%. Good luck.
However while IBM is an undisputed wizard when it comes to fudging the bottom line, there was nothing it could do about the top line, and it was here that IBM’s remained, because while it beat modest expectations of $18.6 billion, generating $19.2 billion in revenue…
… this was also the 22nd consecutive quarter of declining revenues for the company which lately can’t seem to get any traction on the top line.
Oh, and while IBM beat on the top line, it still missed its Q3 adjusted gross margin of 47.6%, which came in below the estimate of 47.9%
Away from the top and bottom line, IBM reported that in Q3 it generated net cash from operating activities of $3.6 billion, or $3.3 billion and free cash flow of $2.5 billion. And, as has been the case every quarter, IBM returned $1.4 billion in dividends and $0.9 billion of gross share repurchases to shareholders, virtually covering all its free cash flow. At the end of September 2017, IBM had $1.5 billion remaining in the current share repurchase authorization. We expect the company will have authorize another $5-10 billion or so in new buybacks.
“We finished the first half of the year where we expected, including continued strong free cash flow generation,” said Martin Schroeter, IBM senior vice president and chief financial officer. “This allowed us to continue our strong R&D investment levels and return more than $5 billion to shareholders through dividends and gross share repurchases during the first half.”
IBM ended the third quarter of 2017 with $11.5 billion of cash on hand, a decrease of $0.8BN from the second quarter. And since the company drew down on its cash, debt predictably remained flat at $45.6 billion, which is up from $42.2 billion at the end of 2016.
For now, the stock is happy by the modest revenue beat, although once it becomes apparent that the company used the exact same gimmicks as last quarter, we expect this to change.