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There are two purposes of this article. First, I will remind you of what we heard in IBM's (NYSE:IBM) Q2 2013 Earnings announcement. It'll be a brief overview of what mattered in the Q2 earnings announcement.

As investors, I believe that we must track what management says and does. Are they being honest? Are they providing all the information we need to make smart decisions? Are they taking credit for success and failure? This is about integrity, intelligence and responsibility. The brief 2013 Q2 history recap will help us.

Second, I'll specifically pinpoint what we must be listening for in the Q3 announcement. I believe that there are just a few things that we must listen for in the 2013 Q3 earnings announcement. I'll give you the simple scorecard that matters.

On Wednesday, October 16th, IBM will make their Q3 2013 Earnings Announcement. Let's be ready.

IBM's Q2 2013 Earnings Announcement: Brief Recap

In the second quarter, IBM reported revenue of $24.9 billion and operating earnings per share of $3.22. That EPS included a $1B charge for workforce rebalancing. Without rebalancing, EPS was $3.91 per share.

Here's a good overview for you:

Q2 Overview
(Click to enlarge)

Smarter Planet did well and was up 25%. Cloud also did well and was up over 70% for the first half of 2013. Business Analytics was up 11% in Q2. The Americas saw $10.7B in revenue, Europe was at $7.8B and Asia Pacific was $5.8B.

Per Mark Loughridge (senior vice president, chief financial officer) performance in high-value, higher-margin businesses contributed to sequential improvement in IBM's year-to-year revenue performance and to margin expansion.

Here's a quick view of revenue and gross profit by operating segment:

IBM Q2 Revenue Profit
(Click to enlarge)

There was a cash balance of $10.4B on the balance sheet and total debt was $34.1B. However, about $25 billion of that debt supports IBM's financing business. Furthermore, non-financing debt was $9.3B and non-financing debt-to-cap was 39%. Many investors see IBM's debt and get worried, but a huge fraction of their overall debt is for financing activities.

OK, so that's a brief recap.

IBM's Q3 2013 Earnings Announcement: What to Watch

IBM's number one goal is hitting $20 EPS in 2015 on an all-in basis. The objective for 2013 is hitting $16.90 EPS excluding rebalancing and $16.25 including rebalancing. Plain and simple, is IBM performing per plan or not?

So, that's the number one thing to watch. With Q3, is IBM on track for $20 EPS in 2015? And, in the short run, is IBM on track for $16.25 "all in" for 2013? If not, exactly what is going wrong, and why?

As a quick sidebar, hitting $16.25 would be $1 more than 2012's earnings of $15.25. Interestingly, EPS in 2012 was a record 10th year of double digit EPS growth. But, IBM doesn't seem to be planning on an 11th year of double digit EPS growth. Expectations are muted a bit.

Next, we need to be watching Free Cash Flow and Operating Margins. The reasons are simple. First, FCF and OM provide empirical evidence of IBM's shift into more profitable and higher value segments. Second, this will back up IBM's claim that workforce rebalancing is driving gains in the second half of 2013. The idea is that rebalancing drives productivity. Let's see if the FCF and OM numbers are moving in the right direction. Is management telling the "truth" about productivity? How are their predictions?

As an important reference, take a look at FCF and OM from 2000 to 2012 right here:

IBM 2000-2012 FCF and OM
(Click to enlarge)

Next, I want an update on share repurchasing. A huge part of the IBM story is the return of cash to investors. In August, we saw that IBM scheduled a $0.95 dividend which was an 11.76% increase from the same period last year. I'm not as interested in the dividend as I am about the stock buybacks. In the previous 12 months, IBM bought back about $12B in stock. I want to see these massive buybacks continue, especially with prices well below $200.

There are a few other things to watch, such as currency impacts, their tax situation, M&A activity, the backlog situation, and so on. However, I can wait for the full year on those. So, to summarize, in Q3 we need to watch:

  • Is IBM on track for $20 EPS in 2015?
  • How are Free Cash Flow and Operating Margins?
  • Is IBM strongly buying back stock?

In summary, I don't expect anything too radical in the Q3 2013 announcement. There might be a struggle with margins but nothing far off from the overall 2013-2015 plan. If things are way off, pay very close attention to why.

I also expect the IBM marketing machine to trumpet progress in growth areas like Cloud and Smarter Planet. IBM's moat will continue to grow. Perhaps there will be an earnings surprise. Expectations are moderate at this point. I don't know how things will go, and I won't predict. I'm more focused on the bigger picture from now through 2015, and beyond. How about you?

Disclosure: I am long IBM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: IBM Q3 Earnings Announcement: What Matters

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