IBM Earnings: Shift To Cloud, Strategic Imperatives Impact Results

IBM (NYSE:IBM) posted its Q1 results on April 18th. In line with our expectations, IBM reported a marginal slowdown in business as the shift to cloud computing and currency headwinds continued to plague the company. During the quarter, the company reported (on an adjusted basis) a 2% year-over-year decline in revenues to $18.15 billion (3% decline y-o-y). Furthermore, its consolidated gross margin declined by 370 basis points to 42.8% for Q1. Net income from continuing operations declined by 114 basis points to $1.75 billion in Q1 2017 as cloud deployment took center stage.

During the quarter, IBM’s Cognitive Solutions and Cloud segments, buoyed by strategic imperatives, continued to report growth, while its other segments (Technology Service & Cloud Platform, Global Business Services and Systems) reported declining revenue. The Systems segment revenue reported the greatest decline (16.8%) primarily due to transitions in its POWER and storage systems business. ^[1] Below are the key takeaways from the earnings announcement.

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Strategic Imperatives And Cloud Services Boosts Revenues

Over the past few years, IBM has been building its portfolio of services around strategic imperatives, which include analytics, cloud and mobile computing, security, and social media. These services are spread across IBM’s verticals and have been the primary driver for revenue growth across divisions.

During Q1, IBM reported that revenue from its Strategic Imperatives was $7.8 billion, a growth of 12% (13% in constant currency) y-o-y. Strategic Imperatives revenues of $33.6 billion over the last 12 months make up 42% of IBM’s total revenues. Within the Strategic Imperatives, Analytics grew by 7% to $4.5 billion, Cloud revenue grew by 35% to $3.5 billion, mobile revenue grew by 22% to $1 billion and security revenue grew by 10% to $500 million.

The growth in Strategic Imperatives revenue was driven by adoption by IBM’s customers of new Cognitive Solutions offerings and capabilities related to the Watson platform, in particular Watson Health, Watson Financial Services and Watson IoT. Additionally, expanded partnerships to accelerate adoption of enterprise hybrid clouds played a vital role in the growth of these services as well.

Cognitive Solutions Segment Revenues Grows

IBM’s Cognitive Solutions segment includes Solutions Software (roughly two-thirds of the business) and Transaction Processing Software (the remaining third). The segment includes many of the company’s strategic areas, including analytics, commerce and security, as well as several of the new initiatives around Watson, Watson Health, and Watson Internet of Things.

During the quarter, revenues for this division grew by 2.1% year-on-year (2.8% in constant currency) to $4.1 billion, driven by 7% growth in strategic imperative revenues. Furthermore, adoption of Watson solutions for analytics and the expansion of Watson capabilities to various industries contributed to growth in revenues. Cloud revenue for Cognitive Solutions division grew by 45% to $600 million. However, the company posted a 1% decline in Transaction Processing Software revenue as the transition to the Software as a Service (SaaS) model continues. In the future, we expect that the company will continue to post robust revenue growth for the Cognitive Solutions segment through the adoption of strategic imperatives solutions and cloud computing.

The Technology Services And Cloud Platforms Revenues

The Technology Services and Cloud Platform Segment accounts for about 22% of IBM’s value, according to our estimates. During the quarter, Technology services and cloud platforms reported a 2.5% y-o-y decline (2% for adjusted currency) in revenue to $8.2 billion. Furthermore, infrastructure services reported a 2% decline in revenues. Infrastructure services revenues failed to report growth as the company failed to close some of its deals during the quarter. Furthermore, the revenue trajectory also reflects that a couple of large clients brought their operations in-house due to regulatory and other unique circumstances. However, strategic imperatives within this division continue to witness double digit growth as revenues grew by 31% to $2.4 billion. Furthermore, cloud revenue was up over 40% to $1.7 billion as the company builds out a hybrid cloud environment for its clients.

Revenue At GBS Declines Amidst Shift To Cloud

The Global Business Services division (GBS) contributes over 7.5% to IBM’s value, according to our estimates. In line with our expectations, GBS reported a 3% year-on-year (1.9% for adjusted currency) decline in revenue to $4 billion, primarily due to declines in traditional consulting and packaged application implementation, especially from the U.S. Moreover, the company continues to be impacted by pricing pressure and a reduction in elective projects as IBM’s clients continue to move away from on-premise enterprise application work to new business models focused on the cloud. This has led to modest growth in signings in Q1 and as a result GBS backlog is declining.

However, double-digit growth in strategic imperatives ($2.2 billion with 13% growth), which includes business analytics and cloud ($900 million revenue with 57% growth), offset the decline in packaged (on-site perpetual license) implementations to some extent. For the quarter, IBM reported that cloud-as-a-service revenues achieved a $1 billion in annual run rate.

Revenues And Profitability Across Server and Storage Division Decline

During the quarter, revenues for server and storage division declined by 16.8% y-o-y (16.1% adjusted for currency) to $1.4 billion, and the pretax loss came in at $186 million. The primary reason for this was the decline in shipments for POWER system, which is suffering due to the ongoing shift to a growing Linux market, and lower shipments of Z system, which is in a later stage of its product cycle. The company plans to introduce a new systems product later in the year, which is expected to drive improved performance in the second half of the year.

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1. IBM First Quarter 2017 Results [↩]