Guild Companies

Everybody is looking for a little good news these days, and IBM did its part by telling Wall Street analysts and investors last week that although 2002 was a tough year, the company would, as Sam Palmisano expected, do better than many of the other companies running in the IT pack and, more important, would return to double-digit profit growth in 2003. Yippee! And everybody started talking about how Big Blue is bucking the IT spending crunch.

The fact that IBM can get customers to spend $20 billion or so per quarter on information technology is a staggering thought, until you think about it for a second. For a large portion of its revenue--about half, I reckon--IBM is just operating a thresher, harvesting the IT budget dollars that its 500,000 or so customers worldwide set aside each month to run IBM's share of their data centers and desktops. IBM can count on this money because of customer lock-in on mainframe and midrange platforms and because of long-term service agreements and leasing contracts that span years and often a decade. Setting itself up for this predictable revenue stream has taken more than a decade, and it was smart to do so. But I'm not impressed with IBM's prowess in depositing checks. This doesn't take any skill at all, any more than Microsoft needs much skill to sell Windows licenses on PCs, given the monopoly it has. With that said, I am impressed that IBM has been able to meet a lot of its targets on that other half of its revenues, which actually involves creating competitive products and services, and using its own sales staff and that of its channel partners to compete with Hewlett-Packard, Sun Microsystems, Microsoft, Oracle, EMC, and others. I get annoyed when IBM claims its prowess in foreseeing a shift toward software and services and away from hardware and operating system platforms, because IBM, as the dominant IT supplier in the world, shapes the markets as much as it participates in them. Nonetheless, IBM has called its shots, and through hard work, competition, and financial engineering that is no better or worse than any other company's, it has hit its targets in a very tough environment.

The third quarter of 2002 was no exception to IBM's management of its financial results, and Big Blue has fared a lot better than its competition in holding revenues and profits. The company booked $19.8 billion in sales worldwide and brought $1.3 billion of it to the bottom line. Revenues were up 0.2 percent in the quarter, compared with last year's third quarter, but profits were down by nearly 18 percent. IBM cut costs enough that it could actually boost earnings to 99 cents a share from 97 cents a share, but then had to take a 22-cent write-down for its discontinued hard disk drive business, which it is selling to Hitachi. Wall Street and IBM act like we should ignore this 22 cents and make it sound like IBM actually boosted revenues, but the fact is that, when you have to shutter factories, fire people, and close a business that you founded in 1956, as the first disk drive maker in the world, it counts. It is not an exception. It is not something anyone should ignore.

IBM's eServer unit, which includes servers and storage sales combined, accounted for $3 billion in sales for the quarter, down 3 percent (at constant currency, which IBM prefers as a measure, compared with all sales converted to dollar sales as they are brought back from all over the world to Armonk, New York). John Joyce, IBM's chief financial officer, said that IBM's Server Group sales in the third quarter were up 1 percent from the last quarter, and that IBM believed that it was taking market share away from its competitors. Revenues from Intel-based xSeries servers were up 15 percent in the quarter and up 3 percent sequentially. Sales of Shark and Silvertip disk arrays helped push disk storage revenues up 11 percent, with those aforementioned enterprise disk arrays and FastT midrange storage products for the Wintel and Lintel markets up 19 percent. Tape subsystem sales declined by a whopping 30 percent.

Sales of iSeries machines were off 20 percent but down only 2 percent sequentially from the second quarter. Sales of zSeries servers were off 8 percent, even as IBM shipped 7 percent more MIPS into the mainframe base than in the third quarter of 2001. Sales of pSeries Unix servers were up only 1 percent, but were up 13 percent sequentially.

IBM doesn't provide real revenue figures for its various server lines when it does its financial filings--that would be too easy--but leaves it to Wall Street analysts to build models of IBM's sales and profits by category. Steve Milunovich of Merrill Lynch figures that overall server and storage sales at Big Blue came to $3.03 billion in the third quarter, as reported (meaning not constant currency sales levels in each local currency). Milunovich figures that zSeries sales were $614 million, down 6 percent; iSeries sales were $432 million, down 18 percent; pSeries sales were $683 million, up 3 percent; xSeries sales were $647 million, up 18 percent; and disk and tape storage sales were $652 million, down 3 percent. Milunovich figures that zSeries will rake in $2.8 billion in sales in 2002; xSeries and pSeries will account for $2.7 billion in sales; and iSeries will take in about $1.6 billion. In 2003, his model shows zSeries and iSeries growing modestly, pSeries shrinking some, and xSeries continuing to grow. If this turns out to be the case, IBM's Power-based iSeries-pSeries servers will still be its biggest line, with $4.25 billion in sales, followed by the xSeries line with $2.9 billion and zSeries with $2.85 billion.

Outside of the server biz, Global Services pulled in $8.9 billion (flat, compared with last year's third quarter at constant currency) and made $9 billion in bookings, but IBM's services backlog shrank some to $103 billion. IBM is not seeing as many long-term contracts as it did only a few quarters ago, and all deals are taking longer to close. IBM's PC and printer unit saw sales drop 5 percent, to $2.7 billion, and this unit booked a loss of $20 million, a big improvement over the $70 million loss it had this time last year. Software sales declined by 5 percent (constant currency), to $3.1 billion, as operating systems sales (primarily affected by declining sales of zSeries and iSeries machines) dropped by 2 percent and middleware sales (including DB2 and other databases, WebSphere middleware, Domino messaging, and Tivoli systems management and security products) dropped by 5 percent. Even though middleware sales on Unix and Windows platforms declined by 13 percent in the quarter, IBM is doing better than its competition, which has seen much steeper declines.