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What Wall Street will be looking for in IBM's earnings

As the drumbeat around artificial intelligence grows louder in the tech world, Wall Street will watch for IBM's progress with Watson in Monday's earnings.

The enterprise technology company is expected to report second fiscal quarter earnings Monday after the bell. Analysts expect IBM to report earnings of $2.89 per share on revenues of $20.03 billion, according to Thomson Reuters consensus estimates.

Scott Eells | Bloomberg | Getty Images

The earnings come as Big Blue, founded in 1911, continues its transition from a legacy technology company to the cloud. The company's data intelligence play, Watson, is branded as "cognitive," or artificial intelligence plus, and aims to add value compared with its cloud competitors.

IBM has continued to push Watson: As of last quarter, there was a 300 percent increase, year over year, of developers on the Watson platform. It's also performed 25 acquisitions in the past 18 months, mostly around what CEO Virginia Rometty dubs "strategic imperatives": cloud, analytics, security, and social and mobile technologies.

IBM is closing in on a "crossover point, " where its new fast-growing components set off declines in its mature businesses, said Greg McDowell of JMP Securities.

Meanwhile, the environment has shifted in the latest quarter, writes Cantor Fitzgerald analyst Joseph Foresi, who sees the "progression of the digital movement" and Brexit impact as the two biggest storylines for the period.

Challenges in the landscape

Executives from Google's Sundar Pichai to Amazon's Jeff Bezos have indicated this spring they are all-in on artificial intelligence. Amazon, already a leader in cloud, now has 1,000 people working on its Alexa platform, Bezos has said. Pichai sees AI hitting an "inflection point. "

Perhaps most notably, Microsoft announced its acquisition of LinkedIn and a partnership with GE, likely to provide Microsoft's data intelligence and industrial partners a big boost.

About a third of IBM's revenues come from a division in Europe, the Middle East and Africa, regions whose economies have been under pressure after Britain's surprise vote to exit the European Union. And while that shouldn't have an impact on this earnings report, it could affect guidance going forward.

Economic uncertainty in the region could leave IT spending budgets flat, Gartner told Cantor Fitzgerald in a separate note. "Brexit is expected to have an immediate currency impact," wrote Cantor's Foresi and colleague Michael Reid. "The UK is a small portion of overall IT spending; however, there is the possibility of contagion."

How IBM could respond

Despite the international exposure, the year-over-year foreign exchange impact on IBM could be benign, said Drexel Hamilton analyst Brian White.

"Barring a major economic slowdown or execution issue, we believe the growth in IBM's strategic imperatives businesses can begin to offset the decline in its core businesses within the next 12 to 18 months," White wrote in a research note.

Cognitive solutions are expected to rake in $4.52 billion in revenue in the second quarter, while technology and cloud platforms are slated to bring in $8.84 billion, according to a StreetAccount consensus estimate.

On top of guidance and currency headwinds, investors will look at the company's margins, which are projected to show a strong expansion as the year progresses, according to Foresi. Gross margins are predicted to be about 49.7 percent, StreetAccount estimates.

Also of note is top line, which, despite beating Wall Street expectations, fell for the 16th-straight quarter last quarter. That dip, marking the worst revenue in 14 years, had the stock sliding about 5 percent the next day.

This quarter's estimates call for a 4 percent year-over-year revenue decline. Shares of IBM are up about 16 percent so far this year.

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