5 Things International Business Machines Corp's Management Wants You to Know

By Markets Fool.com

IBM's Thomas J Watson Research Center. Image source: IBM.

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IBM recently reported mixed first-quarter results. Big Blue presented strong earnings in spite of disappointing sales, all against a backdrop of difficult currency exchange effects.

That's IBM's quarter by the numbers. But there's always more to the story. Curious investors with a penchant for digging deeper into the business always have an advantage over the pure number crunchers.

So let's take a swan dive into IBM's earnings call, where CFO Martin Schroeter discussed the quarter in endless detail with a select handful of Wall Street analysts. Here are five of the most enlightening passages from IBM's first-quarter call. Let's start with the basics.

Currency effects
The rising value of the U.S. dollar has been hurting all sorts of American businesses during the last year. IBM expected some pain from this trend back in January when it issued modest first-quarter guidance. But the currency effect turned out to be stronger than the trends showed at the start of the year. According to Shroeter:

In the first quarter, we had an eight point impact from currency translation. This impact is even greater than 90 days ago, and also from the update we provided at the end of February. ...So it's a bit over $1.7 billion in terms of translating the first quarter revenue back to dollars. We saw some significant movements not only since January, but also even since we provided an impact on the day of our Investor Day, so a pretty big impact on the revenue line.

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After outlining this billion-dollar impact on the top line, Schroeter went on to explain that the currency effect on bottom-line profits was "unknowable." Customer psychology and purchasing strategies, direct exchange effects falling through the income statement, impact on local tax payments abroad -- there are just too many moving parts in this border-crossing machinery.

That being said, you can always estimate things, even if the true figure is a riddle wrapped in a mystery inside an enigma. Schroeter speculated that currency effects might have reduced first-quarter profits by as much as $0.20 per share.

"If you just took that $0.15 to $0.20 impact at the high-end assuming the rates stay here, you could see an $0.80 year-to-year impact full year on earnings from this, again, without us having done anything," he explained. "So obviously, it's something we are thinking about and working on pretty hard."

IBM CFO Martin Schroeter held court with analysts in late April. Image source: IBM.

Shifting sands
IBM may not have the power to adjust currency exchange rates, but Big Blue does have a big say in what its business model should look like.

Right now, the classic one-stop-shop model is going away. The strategy that made IBM a blueprint for other tech giants to emulate has worn out its welcome. The company is busy offloading low-margin hardware operations to refocus on business units with stronger growth prospects and wider profit margins.

As Schroeter puts it, IBM runs two types of businesses side by side. One side offers stability and generous cash flows, while the other is more of a growth play. Schroeter said:

We have a core portfolio that's high value to our clients and high value to us. Quite frankly, it's essential. While the market for these capabilities isn't necessarily growing, we continue to reinvent and innovate to deliver that value.

We have also been investing in our strategic imperatives, our solutions that address the opportunities in data, cloud, social, mobile, and security.

These are high-value solutions and we're able to grow at a rate significantly faster than the market, because our offerings are highly differentiated and because our core businesses provide the industry perspective and deep insight into how our clients operate.

In February, we showed you the revenue across our strategic imperatives has been up 19% to 20% in each of the last five years. And now in the first quarter, revenue in our strategic imperatives grew more than 30%, so a good start toward another strong double-digit year.

Later, Schroeter added more detail to the business drivers inside the fast-growing "strategic imperatives" sector:

Our cloud solutions more than tripled year to year, analytics grew double digits, and we had very good growth in mobile and social. We're helping clients create new business models and opportunities for client engagement.

Data analytics, cloud computing solutions, mobile, and social. These are the rising stars that should counterbalance outmoded storage and server systems for IBM. Big Blue's big iron can also pull its own weight nowadays.

What mainframes can do in 2015
If you thought mainframes were a dusty relic from the aging chronicles of computing history, you may be in for a surprise. IBM doesn't exactly break out its mainframe sales, dollar for dollar, but it does offer precise year-over-year growth figures for each piece of the hardware business.

For example, mainframe sales grew an astonishing 128% compared to the year-ago period. Following the sale of the System X product line to China-based rival Lenovo, IBM's Unix-based server sales have almost disappeared.

Based on these figures and some educated guesswork, it looks like System Z mainframes make up the vast majority of IBM's hardware sales today. We're talking something like $1.1 billion, or more than 60% of IBM's total hardware revenues.

Schroeter was happy to explain how these hulking systems attract customer attention in this day and age, pulling an example from major System Z buyer UPS :

Let me give you a real example of what we're talking about. If you are UPS, one of the largest logistics companies in the world, you have to manage nearly 5 billion deliveries a year with highly seasonal changes in demand. Your customers expect their packages to arrive on time, and they expect to schedule, manage and track shipments anywhere, anytime, and increasingly through their mobile devices.

These mobile transactions can lead to dramatic increases in overall traffic as customers complete transactions at will. This requires a system that can handle the growth and scale seamlessly when activity spikes, maintaining a secure system that's always available.

That's why UPS chose to upgrade to the IBM z13 mainframe because it could meet the expanding demands of the mobile economy.

In other words, these machines were always built for data-heavy workloads that few other solutions can handle. Sure, you can probably construct data analysis handlers of a similar scale from hundreds, or even thousands, of smaller machines glued together by specialized software and networks. But the mainframe still offers a simple, cost-effective solution that's easier to install and to manage.

IBM continues to lean on this mature workhorse. In fact, Schroeter expects an even stronger mainframe result in the second quarter. That's just the way the seasonal cookie usually crumbles.

Elementary, my dear Watson
IBM is betting big on data analytics and artificial intelligence under the Watson banner. Schroeter merely dipped a toe in those waters this time:

Just this month, we have made two major announcements, Internet of Things and Watson Health. These are a continuation of what we started last year with Watson, then earlier this year with analytics, commerce and security.

There are some common threads throughout. They are all based on a unique point of view around cloud and the value of hybrid. They all use analytics to leverage data. And they all have an industry dimension.

Other IBMers have already filled in plenty of the blanks in the Watson story, particularly as it relates to the Internet of Things. For a deep dive in that trillion-dollar pool, check out my interview with Erick Brethenoux who spearheads business analytics and decision management strategy at IBM.

IBM Revenue (TTM) Chart

IBM Revenue (TTM) data by YCharts.

The road ahead
At the end of the day, IBM's strategy shift continues as planned. Here's how Schroeter ended the analyst call:

Looking forward, we'll continue to deliver strong growth in our strategic imperatives, while the transitions in some of our businesses continue. We'll continue to expand our margin as we shift to higher value, and we'll continue a high level of investment, shifting to areas where we see the best opportunity.

IBM is burning some old bridges loaded with large volumes of low-margin sales. At the same time, the company continues to dig deeper into growth opportunities like the Internet of Things and highly profitable software sales.

The article 5 Things International Business Machines Corp's Management Wants You to Know originally appeared on Fool.com.

Anders Bylund owns shares of International Business Machines. The Motley Fool recommends United Parcel Service. The Motley Fool owns shares of International Business Machines. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.