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IBM Reports Mixed Results as AI Fails to Provide a Boost

Published 20/07/2023, 20:23
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International Business Machines (NYSE:IBM) shares are trading lower in early Thursday trading after the legacy tech company reported second-quarter revenue that missed analyst expectations. The company also maintained its full-year forecast while the management mentioned the importance of generative artificial intelligence (GenAI) several times in the prepared statement and on a subsequent earnings call.

How IBM Performed in Q2?

IBM said its revenue contracted modestly on an annual basis as the company suffered from a bigger-than-expected slowdown in its Infrastructure business segment. Overall, revenue fell 0.4% year-over-year to $15.48 billion, just below the analyst consensus for Q2 sales of $15.58 billion.

Contraction in Infrastructure revenue was partially offset by a 7.2% and 4.2% jump in revenue for IBM’s Software and Consulting businesses, respectively. Another positive from the Q2 earnings report was that the adjusted gross margin expanded by 140 basis points YoY to 55.9%, above the 54.9% expected by analysts.

On the bottom line, the company’s operating earnings per share came in at $2.18, topping the Wall Street estimates at $2.02. IBM generated $2.1 billion in Q2 free cash flow, significantly below the expected $3.03 billion. This is likely another reason why IBM shares modestly fell in the aftermath of the Q2 earnings report.

"In the quarter, revenue performance was led by our growth vectors of software and consulting, and we continued to expand our gross profit margin, driven by our improving portfolio mix and productivity initiatives," said James Kavanaugh, IBM senior vice president and chief financial officer.

"This year we have leveraged our strong cash position to invest for growth, announcing seven acquisitions to bolster our hybrid cloud and AI strategy, while continuing to return value to shareholders through dividends." Despite the mixed Q2 results, IBM reaffirmed its full-year forecast for revenue growth of 3-5% and the generation of free cash flow in the region of $10.5 billion. Analysts were expecting full-year sales growth of 2.9% and FCF of $9.65 billion.

IBM’s report likely confirms the bear thesis that enterprise IT spending remains challenged and that near-term recovery is unlikely at this stage.

It’s Less About Earnings and More About AI

In the earnings press release, IBM didn’t waste time and space and it highlighted its massive AI opportunity even before offering a breakdown of its key second-quarter financial metrics. On the earnings call with analysts, CEO Krishna mentioned “AI” in the first sentence of his speech. While the GenAI boost wasn’t as evident in the company’s Q2 earnings report and offered guidance, CEO Arvind Krishna highlighted that businesses are signing up to use IBM’s hybrid cloud and AI technology “to transform their operations.”

"We continue to respond to the needs of our clients who seek trusted, enterprise AI solutions, and we are particularly excited about the response to the recently launched watsonx AI platform. Finally, we remain confident in our revenue and free cash flow growth expectations for the full year,” he added.

Back in May, IBM launched the Watsonx AI-powered platform that targets foundation models and GenAI by offering a studio, data store, and governance toolkit. The product allows enterprises to ramp up the use of the most advanced GenAI technology. IBM says Watsonx offers a full technology stack that allows enterprises to train, configure, and deploy AI models. Watsonx users can access tools, the latest AI technology, and infrastructure, as well as IBM’s experts and consultants that will help them build their own AI models.

"Foundation models make deploying AI significantly more scalable, affordable, and efficient. We built IBM watsonx for the needs of enterprises, so that clients can be more than just users, they can become AI advantaged. With IBM watsonx, clients can quickly train and deploy custom AI capabilities across their entire business, all while retaining full control of their data," said Krishna.

While unveiled in May, IBM has started rolling out the AI product only in July. Over 150 businesses are using the platform so far, CEO Krishna said on the call, before adding that his company has been “very excited” by the initial reaction.

He specifically named Samsung (KS:005930) and Citi Inc (NYSE:C) – which could be IBM’s biggest AI customers so far – as businesses using WatsonX. Make no mistake, the importance of GenAI for IBM is extremely high. The company sees it as a massive opportunity to catch up with the Big Tech companies and finally deliver top-line growth acceleration that investors had been striving for years.

“We believe the opportunity for large language models for enterprises is immense given the existing amount of business data,” Krishna said on a call.

Prominent tech analysts at equity research firm Bernstein said recently that they see IBM as one of the best-positioned tech companies to capitalize on the GenAI opportunity. They see the consultancy – one of IBM’s strongest areas of expertise – as one of “the initial winners as enterprises are likely to seek help in their AI journeys, akin to digital transformation.” However, Bernstein analysts noted that IBM’s management will have to improve execution as it has struggled so far in commercializing its Watsonx platform.

Summary

IBM reported a mixed set of results for its second quarter while maintaining its full-year sales forecast. However, the focus remains on the ramp-up of the AI-powered Watsonx product that could help embattled IBM stock to finally catch up with other large-cap tech stocks. Another positive was that margins improved while the Consultancy business – which is crucial for the AI push – saw its revenue jump over 4% annually.

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Shane Neagle is the EIC of The Tokenist. Check out The Tokenist’s free newsletter, Five Minute Finance, for weekly analysis of the biggest trends in finance and technology.

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