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IBM's Last Report Without Red Hat Was a Mixed Bag

Anders Bylund, The Motley Fool

Technology giant IBM (NYSE: IBM) reported second-quarter results on Wednesday. Revenue slid lower on a year-over-year basis but earnings and cash flows expanded anyhow. Here's a closer look at IBM's second quarter.

IBM's second-quarter results: The raw numbers

Metric

Q2 2019

Q2 2018

Change

Revenue

$19.2 billion

$20.0 billion

(4%)

Net income

$2.50 billion

$2.40 billion

4%

GAAP earnings per share (diluted)

$2.81

$2.61

8%

Data source: IBM. GAAP = generally accepted accounting principles.

What happened with IBM this quarter?

  • The $34 billion buyout of open-source software veteran Red Hat closed on July 9, about a week after the reported quarter's end. The largest buyout in IBM's long history will start to affect business results and year-over-year comparisons in the third quarter. This all-cash transaction added more than $20 billion of new debt to IBM's balance sheet in order to finance the deal.
  • Big Blue's share-based metrics were aided by the company's usual shareholder-friendly buyback tactics. IBM bought back and retired 3% of its outstanding shares over the last four quarters, including a $316 million share repurchase budget in the second quarter alone. That being said, IBM has hit the pause button on its buyback policy in order to focus on repaying debt and raising dividends for a couple of years.
  • The cloud and cognitive software segment saw sales rise 3.2% year over year, accounting for 29% of IBM's total revenue. Business services held revenue almost perfectly steady at $4.16 billion or 22% of total sales. Technology services took a 7% revenue cut but still delivered a 36% slice of IBM's overall sales. Systems sales crashed 19% lower due to fading sales of System Z mainframes -- a cyclical business that waxes and wanes as IBM updates the product line roughly every other year.
  • Free cash flows increased by 28%, landing at $2.4 billion. Capital expenses came in at $431 million, less than half of the year-ago period's $1 billion. A $270 million real estate sale played a large part in that year-over-year comparison as it effectively worked out as a negative capital expense on IBM's cash flow statement.
Three red fedoras hanging on hooks in a perfectly white hallway.

Image source: Red Hat, now a subsidiary of IBM.

What management had to say

In the earnings call, CFO Jim Kavanaugh highlighted what IBM expects to gain from the Red Hat buyout.

"This acquisition is an important milestone for IBM, and one that will significantly impact the cloud landscape," Kavanaugh said. "It is clear that the next chapter of cloud will be about shifting mission-critical work to the cloud and optimizing everything from supply chains to core banking systems. This requires a hybrid, multicloud, open approach to provide portability, management consistency and security for these enterprise workloads."

Red Hat is a leading provider of exactly these cloud computing tools, having championed a hybrid cloud structure since before it became a de facto industry standard.

"Now, with the acquisition of Red Hat, we'll be combining the power and flexibility of Red Hat's open hybrid cloud technologies with the scale and depth of IBM's innovation and industry expertise," Kavanaugh continued. "In short, IBM and Red Hat will be better together, accelerating our clients' journey to the cloud and lifting all of IBM as we grow Red Hat and sell more software and services."

Looking ahead

IBM decided not to provide any financial guidance for the next quarter or full fiscal year at this point, as the game-changing Red Hat deal alters those calculations dramatically and management hasn't had the time to work out the detailed bottom-line implications quite yet. The company is planning to present a full-year update on Aug. 2, including the impact of owning Red Hat. Until then, management simply reminded analysts that Red Hat should add value to IBM's cash flows right away and to operating earnings by the end of the second year.

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Anders Bylund owns shares of IBM. The Motley Fool is short shares of IBM and has the following options: short January 2020 $200 puts on IBM, short September 2019 $145 calls on IBM, and long January 2020 $200 calls on IBM. The Motley Fool has a disclosure policy.