International Business Machines (IBM) posted mixed first-quarter results after the close Tuesday. Though the firm showed material bottom-line expansion, the firm's top-line growth was relatively modest and its services backlog fell before adjusting for a favorable impact from currency. We are sticking with our fair value estimate for the company.
Revenue was essentially flat from the same period a year ago as software, services and a doubling of cloud-based revenue helped offset a stiff decline in hardware sales. We were pleased to see the strength in software revenue (up 5%), but we're slightly disappointed by the company's services business, where revenue edged up just 1%, and services backlog declined 2% before adjusting for currency. We'll be keeping this important "yellow flag" data point on the top of our minds as we navigate through first-quarter earnings season. So far, however, we've been very impressed from the performance (and earnings beats) of some of the bellwethers reporting thus far: JPMorgan (JPM), Coca-Cola (KO), and Alcoa (AA), just to name a few. This supports our view on earnings outlined in the recent edition of our newsletter.
Revenue from IBM's hardware division was the biggest drag on quarterly performance, falling 7% from the same period a year ago. Sales from 'System z' mainframe server products fell 25% compared with the year-ago quarter, and ancillary revenue (system storage, retail store solutions, and microelectronics OEM) also left something to be desired. We don't expect a snapback in the segment at least for a few quarters, as the company will continue to lap strong performance from the previous year (as it did this quarter).
The bottomline performance was better, but not great. Operating (non-GAAP) earnings per share advanced 15%, to $2.78 per share (consensus was at $2.65 per share). But share buybacks materially bolstered the 9% jump in quarterly operating (non-GAAP) net income, which itself was helped by a lower tax rate. Though earnings growth in the period wasn't of pristine quality due to the lower tax rate and share buybacks, the company pulled in an impressive $1.9 billion in free cash flow, up from $1.1 billion in the year-ago period. And while we're big fans of the company's dividend coverage with cash flow, its annual yield, however, is still a bit too low to get us excited.
Looking ahead, IBM increased its full-year 2012 operating (non-GAAP) diluted earnings-per-share outlook to be at least $15 per share (from $14.85 previously). We think the company will be able to hit that forecast.