IBM Corp.’s earnings declined in the second quarter but beat analysts’ estimates in most critical areas and executives expressed confidence that the company is well-positioned to gain market share when the economy recovers.

Adjusted profit fell to $2.18 a share from $3.17 a share a year ago but ahead of analysts’ consensus estimates of $2.09. Revenue declined to $18.12 billion from $19.16 billion in the same quarter a year ago but again beat estimates of $17.73 billion. It was 28^th quarterly revenue decline in the last 32 quarters.

In after-hours trading, IBM rose more than 4% after jumping nearly 6% immediately after earnings were released. In regular trading, they closed up 1%, to $126.37 a share.

Despite the overall declines, IBM said its business showed resilience during a time of great uncertainty. Cloud computing revenue rose 34%, to $6.3 billion on an adjusted basis, well ahead of the 23% growth rate recorded in the first quarter.

As they did last quarter, IBM executives declined to offer full-year guidance, saying the economic landscape is too uncertain as the coronavirus shows no signs of slowing down in the U.S. “The economic recovery is looking to be longer than we had hoped for back in March,” said Chief Executive Arvind Krishna (pictured).

IBM has laid off thousands of employees in the past two months, spurred by both the pandemic and a broader reorientation of its business. Those business initiatives include simplified a geographic organization and a more streamlined structure for sales teams, said Chief Financial Officer James Kavanaugh. In response to the pandemic, IBM has enhanced virtual selling capabilities and shifted to contactless delivery even for most complex projects. “We’re creating a virtual dynamic delivery model to reimagine services delivery,” Kavanaugh said.

“Overall, the company did a bit better than I expected,” said analyst Charles King of Pund-IT Inc. “The large enterprises that make up IBM’s core customer base are more resilient and have fared generally better than smaller organizations, which could underscore IBM’s generally positive news.”

Patrick Moorhead, principal analyst at Moor Insights & Strategy, said the quarter was pretty good considering the effects of the pandemic.

The divisions that were down were mainly services divisions that require a lot of personal interaction (GBS and GTS), so I’m not surprised those were down so steeply,” he said. “I am pleased to see the RedHat backlog to be so high, to $4.6 billion, up nearly 23%. This is a good sign that the combined strategy is working.”

But the quarter didn’t quell ongoing concerns. “It was another positive earnings call putting a positive spin on what is a continuing decline,” said Ian Campbell, CEO of Nucleus Research. “IBM is still not finding the successes that Oracle, Microsoft and Amazon have been able to find.”

All eyes on Red Hat

Revenue from the acquisition of Red Hat Inc., which closed a year ago, was up 18% on a currency-adjusted basis. That was a bit below the 20% growth logged in the first quarter but further indication that Red Hat is an important factor in driving cloud-related deals where the company’s Linux and software container platforms are strong.

“When IBM and Red Hat come together clients are making larger and more strategic purchases,” Kavanaugh said. IBM said more than 2,400 of its clients now run Red Hat’s OpenShift container platform.

Cloud and cognitive software sales, which includes the Red Hat business, came in at $5.75 billion, compared with $5.65 billion in the year-ago quarter and slightly ahead of analysts’ forecasts of $5.74 billion. Systems revenue, which includes mainframes, was $1.85 billion against expectations of $1.68 billion, marking strength in the refreshed z-series mainframe line that was announced last fall as well as strong growth in storage demand. Hardware sales grew 13% year-over-year as customers “looked to IBM for consistency and reliability,” Kavanaugh said.

“Much of the massive shift toward credit-based purchasing that we’ve seen this year is being supported by IBM z,” said Pund-IT’s King. “IBM has also continued to drive valuable new mainframe-based services and offerings, including confidential computing solutions that fully secure business processes and transactions.”

Mainframes have held up well against incursions by public cloud providers attempting to draw business away, as evidenced by Google LLC’s acquisition of mainframe migration specialist Cornerstone Technology B.V. earlier this year, said Bola Rotibi, research director for software development at CCS Insight Ltd.

“IBM made a number of good software announcements in this quarter,” she said. “IBM has not been idle and has evolved its mainframe platform to operate effectively as a first-class asset for cloud. It will be interesting to see if it is doing enough to remain compelling to its customer base.”

Faith in hybrid

Having failed to become a top-three player in the public cloud market, IBM has set its sights on hybrid cloud as its niche. Revenue from hybrid cloud was $23 billion over the last 12 months, and IBM has “a tremendous advantage with Red Hat Linux,” Krishna said. “IBM’s vast software and middleware portfolio has been containerized and runs on OpenShift so clients can now deploy our software anywhere OpenShift runs.”

But even with that advantage, IBM is “up against two very formidable competitors in Amazon Web Services and Microsoft,” Campbell said. “They’re going to need to show some traction and do it rather quickly.” He noted that Microsoft Corp. stock is up over 50% from February lows while IBM’s is up a little over 30%.

IBM’s services businesses, which comprise more than half its revenue, were down overall but ahead of expectations. Global Technology Services revenue was $6.32 billion compared to estimates of $6.24 billion. Global Business Services came in at $3.89 billion, down 6% but ahead of estimates of $3.87 billion.

“As we entered the year GBS had good momentum and we expected it to accelerate throughout the year, but as the pandemic took effect clients shifted their focus to cash preservation,” Kavanaugh said. The outlook has since improved and business grew modestly in June, he said.

“It was no surprise services are down,” Campbell said. “Projects are on hold or delayed and we see more companies move to integrated suites where the total cost is lower.”

Both services organizations “are in the midst of serious reinvention efforts, with cloud-related offerings showing solid growth while traditional offerings are under pressure,” King said. “If the shift toward cloud-based IT continues, the struggles for IBM’s traditional technology and business service offerings is likely to continue.”

IBM ended the second quarter with $14.3 billion of cash on hand, which includes marketable securities, up $5.2 billion from year-end 2019. Debt, including Global Financing debt of $21.9 billion, totaled $64.7 billion.

Image: Red Hat Summit