IBM Corp. delivered the kind of upbeat earnings report and forecast that’s been rare in the beleaguered technology industry of late but also said it will lay off 1.5% of its workforce, or about 3,900 employees, amid the gathering clouds of a likely global recession.

Revenues of $16.69 billion fell slightly from $16.70 billion a year earlier but rose 6% in constant-currency terms and came in well ahead of consensus estimates of $16.15 billion. Net income rose 15% from a year ago, to $2.71 billion, or $2.96 a share. Adjusted earnings of $3.60 a share also beat analysts’ estimates of $3.59 a share.

The positive results came despite the fact that Big Blue said the strong U. S. dollar dragged down overall revenue by more than $1 billion.

‘Stranded costs’

IBM executives didn’t refer to layoffs in their call with analysts but Chief Financial Officer James Kavanaugh told Bloomberg that the job cuts will focus on workers who remained after the spinoffs of the Kyndryl and Watson Health businesses. On the earnings call, Kavanaugh referred to the surplus employees as “stranded costs” that “will be addressed early in the year and result in a charge of about $300 million in the first quarter.”

Chief Executive Arvind Krishna was effusive about the success the company is seeing with its business model focused on hybrid cloud and artificial intelligence. “Clients in all geographies increasingly embraced our hybrid cloud and AI solutions as technology remains a differentiating force in today’s business environment,” he said in a statement.

Krishna said IBM expects 2023 full-year revenue growth to be in the mid-single digits, in line with its previous forecasts. However, Kavanaugh later told analysts that they should expect growth to be in the “low single digits.”

Pund-IT Chief Analyst Charles King said IBM may be in a position to avoid the forces that have undercut so many tech firms lately. “Many of the most significant earnings disappointments among tech vendors have been among those with heavy exposure in consumer markets,” he said. “While economic challenges obviously remain, large enterprises have ridden those storm waves more successfully than smaller businesses. That clientele is IBM’s bread and butter.”

“Multicloud has been working well for IBM based on the strength of its OpenShift portfolio,” said Holger Mueller, vice president and principal analyst at Constellation Research Inc. But the company’s reliance on its service business runs “the risk that IBM will neglect software for the sake of services. They are a services business with an adjunct software business.

“The revenue mix needs work,” Mueller added. “Software grew less than consulting and infrastructure for the fiscal year. Investors want software and its inherent higher profitability to be the main growth engine.”

However, Pund-IT’s King said IBM’s multicloud positioning has some built-in protection against competitors. “Cloud percolates across numerous business units,” he said. “It’s not simply a matter of measuring IBM Cloud against rivals like [Amazon Web Services Inc., Microsoft Corp.’s Azure and Google LLC’s Cloud]. IBM’s emphasis on the hybrid cloud means that the company is an important strategic partner of those companies.” The company is so far successfully leveraging its Red Hat business and consulting services to keep it at the center of customers’ hybrid cloud strategies, he said.

Cash flow challenge

The only dark cloud in the results was the reported free cash flow of $10.5 billion, which came up short of the consensus forecast of $11.1 billion. IBM had previously forecast $35 billion in total free cash flow through 2025, leaving it with a steep hill to climb to get there.

Krishna told Barron’s that the original cash flow forecast didn’t anticipate the impact of exiting from the Russian market or the dollar’s strength. But he said he’s sticking with the forecast for now.

In early after-hours trading on the New York Stock Exchange, IBM stock drifted a little more than 2.5% lower. The stock is 3% above its price of a year ago, a claim few information technology vendors can make.

Software revenue grew 8% at constant currency rates, consulting revenue rose 9% and infrastructure sales edged up 7% percent at constant currency. Red Hat revenue grew 15%, automation revenue was up 9%, security sales increased 10% and data/AI revenue grew 8%. The annual recurring revenue across all those businesses is $13.3 billion, Kavanaugh said.

Krishna told Barron’s that IBM is seeing strength in its consulting and recurring software revenue base, although infrastructure sales will probably fall in 2023 after last year’s boost from a mainframe refresh cycle. Sales of zSystems mainframes led by the high-end z16 rose 21% in the fourth quarter.

In downgrading IBM stock last week, Morgan Stanley said the company will have a tough time beating last year’s performance in mainframes and enterprise license agreements because of the end of the mainframe refresh and a general economic slowdown.

But King saw bright spots in the mainframe results. “Today’s announcement shows that z16 sales continue to drive infrastructure revenues today and are likely to enjoy additional blue sky in the quarters ahead,” he said.

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