Strong mainframe sales and low expectations are helping IBM (IBM) trade higher post-earnings.
After the bell on Monday, IBM reported Q2 revenue of $18.12 billion and non-GAAP EPS of $2.19. Revenue, which benefited from the July 2019 Red Hat acquisition and to an extent was hurt by 2019 asset sales, fell 5.4% annually but was above a $17.73 billion FactSet consensus. EPS was down 31% annually but above $2.09 consensus.
As was the case in April, when the company pulled the full-year EPS and free cash flow guidance it issued in January, IBM declined to provide a full-year outlook, citing the uncertainty caused by COVID-19.
IBM's stock rose 4.7% in after-hours trading to $132.30. Low investor expectations are helping: IBM went into earnings down 6% on the year and 16% over the prior 12 months.
Here are some notable takeaways from IBM's earnings report and call.
1. IBM's Commentary About Near-Term Demand Was Very Mixed
On one hand, new CEO Arvind Krishna and CFO James Kavanaugh both signaled that deal activity has improved from its late-Q1 and early-Q2 lows. And at a time when many companies are being forced to rethink how they do business on the fly, Krishna asserted that Big Blue is "seeing an increased opportunity for large transformational projects," and noted that it saw a healthy growth acceleration for its "cloud" revenue (it covers a variety of hardware, software and services revenue).
Officially, IBM's "cloud" revenue grew 30% annually to $6.3 billion in Q2, up from Q1's 19% clip. Growth in both quarters benefited some from the Red Hat acquisition.
On the other hand, Krishna admitted that IBM is "feeling the impact of austerity measures that businesses have put in place to preserve cash and capital." Along similar lines, Kavanaugh said that "many clients continued to delay projects, defer purchases, and favor opex over capex spending."
Later on, in the Q&A session, Krishna admitted that "the economic recovery is looking to be longer and more protracted than we might have hoped for back in March." He also mentioned that IBM's transactional business activity "was significantly worse than we would normally expect" in May, and that while it improved some in June, it didn't return to normal levels.
2. Mainframe Sales Were a Q2 Standout
Driving much of the Q2 revenue beat: IBM's Systems segment, which covers sales of hardware and related operating systems, rose 6% to $1.85 billion, topping a $1.68 billion consensus. This in turn was fueled by a 69% increase in IBM Z mainframe revenue (up from Q1's 59% growth), as the z15 mainframe (launched last September) continues seeing a healthy upgrade cycle.
The Power server business, which has gradually been losing share to Intel (INTC) and AMD-powered (AMD) servers, continues having a tough time: Its sales fell 29%. Storage revenue grew 2%.
3. Red Hat Also Did Pretty Well
On a normalized basis, Red Hat's revenue rose 17% annually to $1.09 billion, nearly matching Q1's 18% growth in spite of COVID-19-related deal disruptions. In addition, per tech analyst Patrick Moorhead, Red Hat's backlog rose nearly 23% to $4.6 billion.
"Across the board, we are seeing greater demand for Red Hat products," said Krishna on the call. Kavanaugh later added that IBM saw "a significant increase" in large Red Hat deals, and that IBM "expanded Red Hat's presence in under-penetrated focus markets."
4. Other Software Businesses Were Generally Weaker
Officially, IBM's Cloud & Cognitive Applications segment saw revenue grow 3% to $5.75 billion. However, with the Red Hat deal providing a major top-line boost (partly offset by software asset sales), it looks as if the segment's organic growth was negative.
While Red Hat helped the segment's cloud & data platforms revenue rise 29%, its cognitive applications revenue, which among other things covers industry-specific apps and security software, fell 9%. And its transaction processing software sales, which cover mission-critical software that often runs on mainframes, fell 16%.
Echoing some other software firms, Kavanaugh noted IBM's perpetual software license sales were hurt by corporate spending pauses. But he did add that software demand within "critical priority areas" improved during the second half of Q2, and -- in comments that could have some read-through for peers -- that software renewal rates improved sequentially "as clients favored subscription models."
IBM's Q2 performance by business line. Source: IBM.
5. Services Businesses Also Had a Rough Time
Global Business Services (GBS) revenue fell 7% to $3.89 billion, after having been flat in Q1. The segment's consulting, global process services and application management revenue respectively fell 4%, 14% and 10%.
Global Technology Services (GTS) revenue fell 8% to $6.32 billion, a bigger decline than Q1's 6% drop. The segment's infrastructure & cloud services revenue fell 7%, while its technology support services revenue fell 10%.
Total services signings were down 14% to $8.2 billion, and the services backlog fell 4% to $107.1 billion.
Kavanaugh said a weakening macro environment led to delays for both existing GBS projects and new commitments, particularly for projects that are discretionary or take a longer time to pay off. GTS, meanwhile, was hurt by weaker demand within pressured industries such as retail, automotive and travel.
Cloud services demand was a relative strong point: GBS and GTS respectively saw 12% and 18% cloud revenue growth, and GBS' cloud signings also grew at a double-digit clip.
6. Job Cuts and Asset Sales Boosted EPS, While a Higher Tax Rate Was a Headwind
In spite of containing a $140 million worth of "workforce rebalancing" costs, IBM's SG&A spend fell 6% annually to $4.96 billion. This more than offset a 12% increase in R&D spend (driven in large part by the Red Hat deal) to $1.58 billion.
Also boosting EPS: IBM's "other income & expense" line benefited from $580 million worth of gains related to divestitures. This was partly offset by $85 million worth of other charges.
On the flip side, IBM saw its non-GAAP tax rate rise to 15.9% from 11% in the year-ago period. Big Blue's tax rate was actually negative in Q1, thanks to a "non-cash discrete tax benefit."
