Guild Companies

IBM, like other IT suppliers coping with skittish customers still suffering from a hangover associated with binge IT buying in the dot-com boom and a bad case of the jitters in the current economic climate, nonetheless sold a fair amount of stuff in the second quarter and did better than many Wall Street analysts expected. However, IBM's Server Group took it on the chin, with sales of $2.9 billion, down 17 percent from the second quarter of last year.

IBM's overall revenues were down 6 percent, to $20 billion, including $379 million in revenues from the OEM business that IBM is in the process of selling to rival Hitachi. Hardware sales--including chips, PCs, printers, server, storage, and other products that are not software or services--were down nearly 16 percent, to $6.7 billion, and gross margins on hardware, which reflect the intense pricing pressure IBM is feeling in many of its hardware markets, dropped from 32.1 percent in the second quarter of 2001 to 24.8 percent in the second quarter of 2002. IBM booked a loss on the sale of the hard disk business of $85 million in the quarter and took a write-off of $343 million in the quarter associated with fixed assets and inventory (probably 10K RPM disks) that Hitachi does not want to assume as part of the disk deal.

While sales in the Server Group were down 17 percent in the second quarter, they were up 15 percent sequentially in the quarter. The sliding value of the dollar relative to other currencies probably was a contributing factor here, since IBM sells lots of servers overseas. (In the past couple of years, the strong dollar has hurt reported server and storage financials.) IBM's chief financial officer, John Joyce, said that server sales within Server Group were down 16 percent in the second quarter, disk arrays sales were down 25 percent, and tape subsystem revenues were down 13 percent. Within the different server families, iSeries sales were down 26 percent compared with the second quarter of last year, and pSeries Unix sales were down almost the same, at 27 percent, Joyce said. He didn't elaborate on what was ailing the iSeries, but he attributed the drop in sales in IBM's Unix server line to extreme competition at the low-end of the server market, where Linux and Windows servers are eating share and Unix rivals Sun Microsystems and Hewlett-Packard have strong products and an equal desire to win deals. If IBM was selling machines last year at a 45 percent discount just to get into Sun and HP accounts, I shudder to think about what discounts IBM must be offering today. My guess is that the iSeries is being impacted by all this price competition in the Unix, Windows, and Linux midrange server base, whether IBM likes to admit it or not. Sales of xSeries servers were up 13 percent in this dismal quarter, which only lends credence to this theory. Joyce said that zSeries MIPS shipments in the quarter were up 4 percent, and that Linux accounted for 20 percent of MIPS shipped, but because of price competition with non-mainframe platforms (including IBM's pSeries 670 and pSeries 690 Regatta servers, which apparently sold quite well) and customers' hesitancy to buy anything right now, zSeries sales were down 19 percent.

Sales over at Global Services were down almost 1 percent, to $8.7 billion, which Joyce attributed to a steep decline in bookings, as a number of big deals that IBM had been expecting did not close in the second quarter. The heyday of double-digit revenue increases in IBM's services business seems to be over, and why IBM didn't say this stands to reason, because often the companies that are most eager to outsource some, or all, of their operations in a bad economy are the ones most likely to have a tough time paying their bills. IBM is going to have to balance its desire for revenue growth in services--just about the only place it can hope to see really big gains--against its aversion to making bad deals where it loses money. Joyce said that he had been expecting IBM to close somewhere between $14 billion and $15 billion in services deals in the quarter, but that the company only closed $10.6 billion in new signings. He said that IBM books around 15 percent of new signings to the quarter they are signed in, so a drop in signings has a consequent effect on current-quarter reported revenues in the unit. If IBM had hit its services signings targets, services revenues in the quarter would have been up by around $600 million, and that would have put Global Services revenues in the range of $9.2 billion, up 6 percent. That's a big "if," of course, and one that you cannot take to the bank. Joyce said that the outsourcing pipeline remained good, but customers were cautious about new signings and some had even worked with IBM to change the scope of existing deals. Outsourcing revenues were up 2 percent, product support and maintenance revenues were up 2 percent, but business innovation services, which comprise about a quarter of total services revenues, were down 11 percent. IBM's services backlog stood at $106 billion at the end of the second quarter.

In the other hardware sectors IBM plays with, PC and printer sales were down 10 percent, to $2.8 billion, and custom chip sales were down 30 percent, to $823 million. Including the hard disk business, Technology Group posted revenues of $1.2 billion and a $140 million pretax loss before restructuring charges. Joyce said that the closing aluminum-chip-making facilities and other resource restructurings in the Microelectronic Division (including losses on the sale of the circuit board factory in Endicott, New York, and layoffs in the unit) came to $825 million. Other company-wide restructurings and layoffs forced IBM to incur another $802 million in charges. These amounted to total charges of over $2 billion in the quarter. Joyce said that IBM now expected total write-offs for the year to hit between $2.5 billion and $3.0 billion, with a lot of this coming from further charges associated with the sale of the disk business later this year, when that deal is expected to close. All of these charges reduced IBM's profits in the quarter to $445 million, down 79 percent from last year's second quarter. IBM earned 3 cents a share, down from $1.17 a share this time last year. Many Wall Street analysts had expected IBM to actually post a loss, and, clearly, by delaying some of the write-offs until later this year, IBM's new CEO, Sam Palmisano, was able to prevent the shame of that.

Software Group was a comparative bright spot, like xSeries server sales, in the second quarter. Software revenues worldwide and across all categories were $3.3 billion, up 7 percent. Joyce said that operating system sales, which now comprise about 20 percent of total software sales, were down 4 percent, in large measure because of declining zSeries and iSeries sales. Middleware comprises the remaining 80 percent of software sales, and this category saw 10 percent growth in the quarter. IBM lumps databases (including the DB2 and Informix products that span many platforms, as well as older IMS databases for mainframes), WebSphere application servers and associated products, CICS and other transaction monitors, message queuing middleware, Domino groupware and messaging programs, Tivoli systems management and security programs, and various database tools into this hodge-podge group. DB2 sales were up 11 percent in the quarter (Oracle's database sales were down 16 percent, said Joyce), and WebSphere Application Server sales were up 17 percent (compared with a 13 percent decline for BEA Systems). Sales of middleware software on Unix, Linux, and Windows servers grew by 25 percent in the quarter, while sales of similar programs on the zSeries and iSeries host systems were up 7 percent.