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IBM Corp.’s business continued to shrink in its fiscal second quarter, although its profit grew at a faster clip than analysts expected and the company reaffirmed its full-year earnings guidance.

The news initially buoyed investors, but sentiment turned negative after the company’s earning call with analysts, sending shares down more than 1% after hours. Update: In Thursday morning trading, investors had changed their minds again, bidding shares up 4%.

Profit for the quarter grew 3%, to $3.17 per share, above analyst consensus estimates of $3.08. The figures did not include results from Red Hat Inc., the acquisition of which was finalized last week. IBM said it would provide more details about Red Hat’s impact on the parent company financials, as well as further integration plans, on Aug. 2.

Closely watched revenue from cloud computing products and services hit $19.5 billion for the trailing 12-month period, up 8% on a currency-adjusted basis. Strategic areas such as cloud and data platforms, cognitive applications and transaction processing platforms all showed growth in the mid-single digits, with cloud-related revenue from the Global Business Systems services business up 17%.

“That unit’s continuing growth can be taken as a sign that IBM Cloud is weathering increasing onslaughts from [Amazon Web Services Inc] and Microsoft [Corp.] Azure,” said Charles King, principal analyst at Pund-IT Inc.

Although IBM is sometimes seen as a distant laggard in cloud computing, “only AWS and Azure have larger cloud revenue, and cloud accounts for 25% of IBM’s revenues,” said Patrick Moorhead, president and principal analyst at Moor Insights & Strategy. “Thirty percent of its services backlog is cloud, which is a good sign.”

IBM has placed its bets on hybrid and multicloud computing, where it hopes to leverage its strength with global enterprises to manage both on-premises and public cloud infrastructure. The Red Hat acquisition is core to that strategy, but IBM’s value proposition is still unclear, said Andrew Bartels, principal analyst at Forrester Research Inc. “There are opportunities there, but IBM is not very differentiated and private cloud and hybrid cloud solutions are growing much slower than public cloud offerings,” he said.

However, King gave IBM credit for “recognizing the impact and influence of hybrid cloud well ahead of other players. It’s hard to find another major cloud player whose services are better aligned with the needs of enterprise organizations,” he said.

Cognitive struggles

Cognitive software, which is IBM’s shorthand for analytics and artificial intelligence applications, continues to struggle to find breakout growth. “This is the part of the IBM business that has the most growth potential, but it has not yet realized that potential,” Bartels said. “Core offerings like Cognos [business intelligence] are relatively old. Its Watson AI offerings also look high-cost and lag behind AI offerings from AWS, Google, Microsoft and even Salesforce.com after its acquisition of Tableau.”

Growth in strategic areas was offset, to some extent, by declines in the Global Technology Services business unit and an 18% currency-adjusted dropoff in sales of hardware and operating systems as the current line of Z-series mainframes reaches the end of  its life prior to an expected refresh later this year. Chief Financial Officer James Kavanaugh said sales of servers based on the company’s own Power processors increased 9% in the quarter. Global financing revenues fell in line with IBM’s plans to exit that business.

IBM continues to focus on strengthening its balance sheet, and in that area the quarter was good one. Gross profit margins, a metric upon which Kavanaugh said IBM is “maniacally focused,” improved a percentage point to 47%, the largest increase in five years. Pre-tax margins rose 2%.

The company also generated $12.7 billion in cash over the past 12 months. “We are managing this business for increased margin, profit and cash contribution,” he told analysts. “As part of that, have been taking actions to de-emphasize lower-value projects.”

However, backlogs fell as the number of large deals closed in the quarter fell 20% from a year ago. Kavanaugh cited changing buying preferences as customers hedge their bets against long-term deals. “Our absolute backlog is down, but it’s still $111 billion overall,” he said.

Although IBM has yet to return to sustainable growth, it’s making the right bets for the long term, King said. “The obsession with quarterly earnings often obscures issues like whether a company is meeting its shareholders’ expectations and how well it’s investing in the future,” he said. “Those are particularly important points for IBM because it pays out quarterly dividends that far exceed those of its competitors.”

In April, IBM raised its second-quarter dividend for the 24th straight year, going from $1.57 to $1.62 per share.

Photo: IBM