IBM’s Nine-Quarter Sales Slump Overshadows Cloud Growth

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International Business Machines Corp. (IBM) reported a ninth straight quarter of declining sales as demand fell for hardware and computer services, underscoring the urgency of its plan to get more revenue from newer businesses like cloud computing.

Second-quarter revenue dropped 2 percent from a year earlier to $24.4 billion, compared with the $24.1 billion that analysts projected on average, according to data compiled by Bloomberg. Adjusted earnings rose to $4.32 a share, 1 cent higher than analysts’ estimates, boosted by cost-cutting and share buybacks.

Chief Executive Officer Ginni Rometty is betting that businesses want to store their data and software applications remotely, in the cloud, and they need IBM to help mine the piles of data they’re accumulating. She’s preaching patience to investors, plying them with share repurchases to persuade them to wait for an inflection point where the new technology can propel the company back in the right direction.

“It’s become more of a show-me story,” Bill Kreher, an analyst at Edward Jones & Co., said. “It leaves investors to gauge how much faith they have in IBM’s ability to execute. At some point, investors look at the quality of earnings and would like to see business momentum at its core franchises.”

Cloud Growth

The company maintained its forecasts for $18 a share in adjusted earnings this year and $20 a share next year. Part of that expansion is predicated on the growth of cloud computing sales, which grew 50 percent in the first six months of the year from the same period in 2013.

Cloud offerings delivered as a service are now at an annual run rate of $2.8 billion, compared with $2.3 billion as of the first quarter. That’s still a fraction of IBM’s total $100 billion in revenue last year.

There were signs of improvement in areas where IBM had been struggling. Sales to Brazil, Russia, India and China pared losses, declining 2 percent, compared with an 11 percent drop last quarter.

Sales of mainframe servers, the workhorse machines corporate customers have used for decades to run their crucial computing tasks, decreased 1 percent -- an improvement from the 40 percent decline in the first quarter.

Shares of Armonk, New York-based IBM were little changed at $192.50 at the close in New York. Global services sales, which typically make up more than half of IBM’s business, slid 1 percent to $13.9 billion. Software revenue was up 1 percent from a year earlier to $6.5 billion, a slowdown from 2 percent growth in the prior quarter. And even with the improvement in the mainframe business, total hardware sales dropped 11 percent.

Licensing Model

When companies move to cloud computing, software and data can be stored on remote servers, instead of installed on premise. In the past, many software offerings were sold to customers in a licensing model, where clients pay upfront for the right to use the tools for an allotted amount of time. With cloud-based services, many offerings are pay-as-you-use, giving customers the opportunity to be more efficient and lower the total payments.

While IBM’s cloud business is growing, the fear is that it could take revenue away from its traditional sales model, said Amit Daryanani, an analyst at RBC Capital Markets.

“How much of that is new wins and how much is cannibalistic? You don’t know how much of that is coming from cannibalizing their own software versus net new stuff,” he said.

Services revenue, meanwhile, has been hurt as customers put pressure on IBM to lower its fees.

‘Pricing Pressure’

“Our performance continues to reflect pricing pressure and client contract renegotiations, as well as a reduction in elective projects,” IBM Chief Financial Officer Martin Schroeter said about the company’s outsourcing business on the earnings conference call.

IBM’s contract signings for services -- an indicator of expected future revenue -- fell 33 percent from a year earlier to $11 billion, driven by declines in new business for consulting and outsourcing. That falls short of the 6.2 percent gain from rival Accenture Plc.

The fall in contract signings could drag on IBM’s services revenue in the second half of the year, said Anurag Rana, an analyst for Bloomberg Industries.

Before results were released yesterday, IBM shares had climbed 2.6 percent this year, supported by the company’s repurchases, which brought the number of shares in circulation under 1 billion at the end of June -- the first time they’ve been below that threshold at the close of a quarter since at least 1999.

More Buybacks

IBM ended the quarter with $9.7 billion in cash on hand, little changed from the end of March, after spending $1.1 billion on dividends and $3.7 billion on share buybacks.

Net income climbed to $4.1 billion, or $4.12 a share, from $3.2 billion, or $2.91 a share, a year earlier.

As Rometty tries to shift IBM’s own focus to cloud services and data analytics, she has also tried to offload less profitable businesses -- like the low-end server unit that Lenovo Group Ltd. agreed to buy for $2.3 billion, pending a U.S. national-security review.

Apple Deal

In a deal unveiled this week, IBM will help develop more than 100 mobile-centric applications for businesses catered to Apple Inc.’s iPhones and iPads to help workers do more with the devices than check e-mail or calendars. The companies foresee corporate customers increasingly using handheld devices for daily workplace tasks like supply chain management and human resources functions.

Separately, IBM is spending more than $1 billion to create a new group around its Watson technology, which lets customers use plain English to analyze large troves of data. To remake its cloud business, Rometty bought SoftLayer Technologies Inc. in 2013 for $2 billion and this year committed an additional $1.2 billion to bolster its data centers and offerings.

“Their success is going to be tied to the cloud over the next five to 10 years,” said Daniel Ives, an analyst at FBR Capital Markets. “It’s more of a strategic focus of the company.”

To contact the reporter on this story: Alex Barinka in New York at abarinka2@bloomberg.net

To contact the editors responsible for this story: Sarah Rabil at srabil@bloomberg.net Crayton Harrison

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