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IBM Earnings: Sales Down, Margins Up

Timothy Green, The Motley Fool

International Business Machines (NYSE: IBM) reported mixed results on Tuesday, beating analyst estimates for earnings but missing on revenue. A strengthening U.S. dollar knocked down revenue by almost four percentage points, and mainframe sales tumbled as the product cycle ran its course.

Profitably improved in most of IBM's segments, and both gross and operating margins edged up. Earnings per share declined on a year-over-year basis, but a higher tax rate was to blame.

Metric

Q1 2019

Change (YOY)

Compared to Average Analyst Estimate 

Revenue

$18.2 billion

(4.7%)

Missed by $330 million

Adjusted earnings per share

$2.25

(8.2%)

Beat by $0.01

Data source: IBM. YOY = year over year.

Currency and mainframes

Adjusted for currency, IBM's revenue declined by just 0.9% year over year in the first quarter. The U.S. dollar strengthened substantially against foreign currencies, particularly the euro and the British pound. The company now sees a negative revenue impact of about 2 percentage points for the full year from currency.

On a constant-currency basis, two of IBM's main segments grew, and the other two shrank.

Segment

Revenue

Change (YOY, constant-currency)

Cloud and cognitive software

$5.0 billion

2%

Global business services

$4.1 billion

4%

Global technology services

$6.9 billion

(3%)

Systems

$1.3 billion

(9%)

Data source: IBM. YOY = year over year.

In the global technology services segment, IBM is de-emphasizing lower-value services. That's hurting sales, but also improving margins.

Within the systems segment, mainframe sales slumped 38% year over year, and storage sales fell 11%. Steep mainframe sales declines are typical at this point in the product cycle. The latest z14 mainframe system began shipping in the third quarter of 2017, so the initial growth has been fully lapped at this point.

Cloud revenue, which spans all four segments, totaled $19.5 billion over the past 12 months. That's up 12% adjusted for currency. The cloud as-a-service exit annual revenue run rate is now $11.7 billion, up 15% adjusted for currency.

IBM's Global Center for Watson IoT in Munich, Germany

Image source: IBM.

Rising margins

While IBM's revenue took a hit in the first quarter, margins were a different story. Gross margin rose by a percentage point from the prior-year period, and operating margin jumped 4.4 percentage points. It was a bit of a mixed bag within the four main segments, but the net result was overall margin expansion.

Segment

Gross Margin

Gross Margin Change (YOY)

Operating Margin

Operating Margin Change (YOY)

Cloud and cognitive software

75.1%

(1.2 percentage points)

30.1%

2.3 percentage points

Global business services

26.2%

2.8 percentage points

7.5%

4.5 percentage points

Global technology services

33.7%

1.1 percentage points

3.8%

3.0 percentage points

Systems

34.9%

0.5 percentage points

(13.5%)

(1.3 percentage points)

Data source: IBM. YOY = year over year.

Some good, some bad

IBM's results are often complicated, and the first quarter was no exception. While slumping revenue is certainly a negative, currency effects and the mainframe product cycle accounted for most of the decline.

The cloud business is still growing at a double-digit pace, even as hardware sales decline. Cloud revenue associated with the systems segment fell 15% from the prior-year period, but growth was strong enough elsewhere to pick up the slack. When IBM completes its acquisition of Red Hat later this year, the cloud business will get a jolt.

IBM reiterated its full-year earnings and free-cash-flow guidance, which calls for adjusted earnings of at least $13.90 per share and roughly $12 billion of free cash flow. Margin expansion, particularly in the services business, will help IBM hit its guidance even though revenue will likely decline in 2019.

While the mainframe cycle helped IBM in 2018, it's hurting the company's results this year. Add in the negative effect of currency, which seems to be never-ending at this point, and you have a recipe for some rough-looking results.

IBM stock isn't going to recover until this era of slumping revenue ends for good. The company isn't there yet, although margin expansion is a silver lining.

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Timothy Green owns shares of IBM. The Motley Fool is short shares of IBM. The Motley Fool has a disclosure policy.