Weak Dollar, Services, and Power6 Give IBM a Solid Fourth Quarter

Published: January 21, 2008

by Timothy Prickett Morgan

After pre-announcing on last Monday morning that it would have better than expected profits in its fourth quarter, giving Wall Street a helping hand as it tries to climb up the steep cliff it has tumbled off in recent weeks, IBM reported its full and official financial results for the quarter last Thursday afternoon after the market closed. This turns out to be one of the best quarters IBM has turned in during the past decade, in terms of both revenue and profit growth.

The big hero for the quarter is probably the increasing prices for oil, which is driving the value of the U.S. dollar into the ground like a pile driver slams piles. (Oil is still priced in dollars, and when oil demand outstrips supply, as it has been doing for a while now, it is not just that oil gets more expensive, but that dollars get cheaper.) The net effect on a large multinational company like IBM is that sales that it gets overseas are ballooning as those deals are converted back into U.S. dollars for the books back in Armonk, New York. This is probably one reason why IBM changed its financial presentation to Wall Street analysts starting today, shifting its traditional constant currency figures to the foils in the back of the presentation. IBM wants to brag about how good the fourth quarter was--and make no mistake, it was good--but it was not as strong as it could be back home in the States.

Of the $28.9 billion in sales IBM booked in Q4 (up 9.9 percent), 65 percent of that total came from outside the United States. Across all of IBM, the growth in constant currencies--if you added up the deals in their own currencies and did the percent change--was only 4 percent. Interestingly, sales in Europe, the Middle East, and Africa (EMEA) was $10.8 billion for IBM in the fourth quarter, up 6 percent at constant currency and up 16 percent as reported in U.S. dollars. EMEA is catching up to the Americas region, which is dominated by sales in the United States but which includes fast-growing IT markets like Brazil and Mexico. The Americas region reported sales of $11.7 billion in the quarter, up 5 percent in dollars but up only 2 percent at constant currency. Asia/Pacific grew like EMEA and is roughly half the size, at $5.5 billion in sales, up 15 percent as reported. IBM's OEM sales, which is comprised mostly of chips and intellectual property from its Microelectronics chip division, hit $894 million, down 13 percent compared to the fourth quarter of 2006.

For the fourth quarter of 2007, IBM brought $3.95 billion to the bottom line, up 11.6 percent; this works out to $2.80 per share, up 23.9 percent thanks in part (roughly half) to IBM's share buybacks. This was, as IT Jungle reported earlier this week, considerably more than Wall Street expected. According to the analysts polled by Thomson Financial, IBM was expected to book $27.82 billion in sales and $2.60 per share in profits in the fourth quarter.

For the full year, IBM has sales of $98.8 billion, up 8.1 percent, with net income of $10.4 billion, up 9.7 percent. Those share buybacks that were part of the accelerated share buyback program from 2007 (which exploited a loophole that the Internal Revenue Service has since closed to help IBM get a lot more bang for the buck) and helped IBM push up its net earnings per share by 18.5 percent to $7.18. IBM spent a whopping $21 billion on stock repurchases and dividends in 2007.

If currency was a big hero for IBM's quarter, Big Blue's vast services business was another one. IBM split its Global Services unit into two pieces in 2006 to make it more manageable and to make its financials look less lopsided. Global Technology Services had sales of $10 billion in the quarter, up 16 percent, while Global Business Services booked $4.9 billion in sales, up 17 percent. (Both divisions grew 10 percent at constant currency.) IBM exited the quarter with a $118 billion services contract backlog, an increase of $2 billion over a year ago, according to Mark Loughridge, IBM's chief financial officer, who spoke to Wall Street analysts after the markets closed. He added that IBM had $15.4 billion in services bookings in the quarter, with short-term signings up 8 percent and long-term signings down 25 percent against a tough compare.

Over in Systems and Technology Group, sales were essentially flat as reported at $6.8 billion, if you exclude Printing Systems (which IBM sold to Ricoh in the second quarter of 2007). At constant currency, this server and storage business actually saw sales drop by 4 percent, but again, luckily all of those fast-growing companies and reasonably stable European countries don't have the U.S. dollar as currency. The System z mainframe line was not going to have a great quarter, not with the new quad-core z6 mainframes expected in early 2008. Sales of System z mainframes fell by 15 percent in Q4, even after double-digit revenue growth in Asia/Pacific. Worldwide MIPS shipments fell by 4 percent, but the MIPS capacity on specialty mainframes to boost the performance of Java or DB2 or to run Linux rise by 11 percent in the quarter and rose in all three of IBM's key geographies. Loughridge confirmed the rumors that IBM was polishing up the boxes on the next-generation mainframes, which will be announced in late February using the z6 chips and which will have approximately 50 percent more processing capacity than the z9 machines. He added in a question and answer session later in the call that IBM was not expecting the first quarter of 2008 to be a high growth one for mainframes, but that the second half would see more growth. (This is all predicated on the economies of the world not swooning because of the gluttony and carelessness of big mortgage companies and the financial institutions that turned these into risky stocks.)

The other hero of the fourth quarter of 2007 was the Power6 processor. The System i business was able to eke out a 2 percent growth in sales, this product line's first positive revenue growth in eight quarters. (Of course, just to be precise and fair, at constant currency, the System i business still fell by 3 percent, but IBM is claiming that the product maintained market share.) The stabilization of the System i business in the wake of the expected announcements of a new line of Power6-based systems and the upcoming release of the i5/OS operating system can be attributed in large measure, I am guessing, on the success IBM had selling the Power6-based i5 570 machines in the fourth quarter. On the AIX side of IBM's server and storage business, System p business posted a decent 9 percent revenue growth in the fourth quarter (up 5 percent at constant currency), and undoubtedly buoyed by the Power6-based p5 570 and price cuts on Power5+ machines. Loughridge said that IBM was going to roll the Power6 chip into the entry System p product line during the first quarter, but did not say anything about System i variants for the first quarter. He did say that Power6 would be introduced to the rest of the System p and System i lines during the first half of the year. So forget those February or March System i hardware announcements we have heard rumors about.

IBM's System x servers had sales growth of 6 percent in the quarter (only 1 percent at constant currency), and Loughridge said that IBM had maintained market share and sold out of its new quad-core enabled servers. BladeCenter blade server sales rose by 31 percent in the quarter, helped a bit by the new BladeCenter-S SMB blade chassis, which really doesn't get rolling until this quarter. IBM was particularly pleased about improving its margins in System and Technology Group, but this probably had as much to do with ditching printers as it did with virtualization compelling customers to buy richer server configurations. IBM's storage sales (for disk and tape arrays mostly) rose by 11 percent in Q4. IBM's tape product sales rose by 22 percent, with overall disk product sales up 7 percent. The DS8000 high-end disk arrays were singled out for their 21 percent growth in the quarter.

On the software front--where IBM really gets its profits and gross margins approach 90 percent across all software products--IBM's Software Group posted sales of $6.3 billion in the quarter, up 12 percent (6 percent at constant currency). WebSphere sales rose by 23 percent, and Information Management (databases and related tools) increased by 11 percent. Tivoli systems management and security product sales were up by 19 percent, followed by Lotus groupware's increase of only 7 percent and Rational development tool sales growth of 22 percent. Sales of these key branded middleware products combined for an average growth of 15 percent, while other middleware sales (mostly for mainframes) grew by only 8 percent. Operating system sales, dragged down by falling mainframe sales, rose by only 3 percent in the quarter.

What everyone wanted to know from Loughridge on the conference call was what IBM thought about the possibility of a downturn in the economy and how IBM was positioned for it. And while he answered the question in many different ways, Loughridge never gave out any specific expectations that IBM had about economic growth or decline or IT spending in 2008, except to say a number of times that the end of 2007 positioned IBM for a great beginning to 2008. He said that IBM's models going ahead would assume the situation looked much as it did in the fourth quarter--uncertainty in financial services, stability in the more established economies, and high growth in emerging markets. He didn't mention the weak dollar, but that sure is going to help IBM, too. And as Loughridge and his predecessors have always pointed out, about half of IBM's sales in any quarter come from software rentals and services contracts that have an annuity-like nature to them. And this is always a good thing to have if you are heading into an economic storm.

For a closer look at IBM's System i sales as well as for other servers lines, see How Did the System i Line Get Growth in the Fourth Quarter?, also in this issue.

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