Currency Helps Pump Up IBM's First Quarter

by Timothy Prickett Morgan

IBM reported its financial results for the first quarter last week, and like many vendors based in the United States that do a lot of business overseas, the crashing dollar is helping Big Blue to report decent revenue growth and reasonable profits for the quarter. On an as-reported basis, IBM booked $22.2 billion in sales, up 11 percent. If IBM booked sales in local currencies around the world, revenues would have been up by only 3 percent.

John Joyce, IBM's chief financial officer, said in a conference call with Wall Street analysts last week that pretax profits in the quarter were up 16 percent, to $2.3 billion, but he admitted that profits were under pressure because intellectual property sales were down, pension and healthcare costs went up, and workforce reductions ate money. IBM's intellectual property sales amounted to only $180 million (down $102 million from the first quarter of 2003). The company had to kick in $187 million more for healthcare and pension costs, compared with a year ago. And workforce "rebalancing" (IBMese for layoffs) cost $163 million, up $85 million from this time last year. After taxes, IBM had net income of $1.6 billion, up 16 percent, and earnings of $0.95 a share, up 18.8 percent. (Those stock buy-backs are still helping Big Blue pull off the growth in earnings per share.)

IBM's juggernaut Global Services unit accounted for $11.1 billion in sales, up 9 percent as reported and 1 percent at constant currency. Joyce said that the company had booked $10.5 billion in new services contracts in the first quarter and had increased its services backlog to approximately $120 billion. Strategic outsourcing, which accounts for about 40 percent of Global Services' sales, was the revenue driver for the quarter, with sales up 16 percent. IBM's integrated technology services (about 30 percent of sales and comprised of continuity and recovery services as well as software and hardware maintenance) increased by 6 percent, while business consulting services (about 30 percent of sales) was up only 4 percent in the quarter.

IBM's hardware business did well in the first quarter, for a change. Lumping all hardware together, IBM sold $6.7 billion in gear, up 16 percent as reported and up 10 percent at constant currency. Companies and consumers in every geography are buying computers. "Customers have worked off the excess capacity of the late 1990s and are buying again," explained Joyce. "Customers' infrastructures are getting old, and they need to upgrade." He added that so much of that old iron has been depreciated, that it is effectively off the books, which means companies can better afford to put new capital expenditures on the books, especially now that they have some prospects of real profits to offset the depreciation costs.

IBM recently merged its Systems Group and its Technology Group into a single Systems & Technology Group, and that group accounted for $3.8 billion of hardware sales, up 14 percent. Joyce said that overall server sales were up by 19 percent in the quarter. Sales of the zSeries mainframe line were up 34 percent, with nearly 100 percent MIPS growth. New workloads, Linux partitions, and growth of existing mainframe applications were the three drivers behind this big bump in mainframe sales. Joyce said that IBM had stopped being aggressive in the early part of 2003 with mainframe prices, and it slowed sales, and in the first quarter IBM cut prices more aggressively and it boosted sales while not adversely impacting margins.

On the Power-based iSeries server front, sales were down 7 percent as customers are anticipating new machines. Joyce confirmed that the new Power5-based iSeries line would launch soon, and would start shipping by the end of the second quarter (see the separate story in this issue for more on this development).

Sales of Power-based pSeries Unix servers were up 15 percent, with decent sales in the entry and high-end markets. These pSeries machines seem to be more immune to product transitions, but that could be simply because OS/400 V5R3 (which is required for the Power5 machines) has been ready for months and AIX 5L 5.3 (which will also be required on Power5s) is not expected to be ready until the end of September or early October.

Joyce said that pricing for Unix kit was no more or less aggressive than in the fourth quarter, and that IBM had to fight hard to compete against Hewlett-Packard and Sun Microsystems to win Unix sales. He said that when IDC put out its first quarter market share analysis, it would show that IBM had market share gains for the seventh quarter in a row. Sales of X86-based xSeries servers, which include a huge number of Intel Pentium 4 and Xeon machines and a smattering of Intel Itanium and Advanced Micro Devices Opteron machines, were up 28 percent in the quarter. Storage revenues were up 16 percent in the aggregate, with midrange disk arrays and tapes doing well. (Disk arrays were up 11 percent, while tape products were up 25 percent.) IBM's Personal Systems unit booked $2.8 billion in sales, up 18 percent, thanks to increasing demand for laptops and notebooks, which carry premiums, compared with desktops.

On the software front, sales were up 11 percent as reported, to $3.5 billion, but at constant currency, this is only 3 percent growth. Sales of Rational development tools increased by 88 percent, and WebSphere-branded sales were up 25 percent (with the WebSphere Application Server up 33 percent, and probably driven in large measure by booming mainframe sales). Domino and related middleware products were up 15 percent, compared with the first quarter of 2003, and Tivoli showed better signs, with 18 percent growth against a weak compare. Perhaps most significant, gross profit margins in the Software Group were 86 percent, up 1.4 percent compared with last year. IBM really loves those MVS-z/OS and OS/400 mini-monopolies, since they are still the profit engines of the company.

By geography, IBM's sales were $9.1 billion in the Americas region, up 6 percent as reported, and up 4 percent at constant currency. In the European market (into which IBM lumps the Middle East and Africa), sales were up 15 percent as reported, but only 1 percent at constant currency. Without the falling dollar, IBM's numbers might not have shown any growth in Europe at all. That said, even 1 percent of real growth across Europe is better than what IBM has done in some recent quarters. Sales in the Asia/Pacific region were up 6 percent in constant dollars, which is the best growth IBM posted, and which translated into 16 percent growth when all the yen, yuan, rupees, rupiah, ringgits, won, and Australian, Hong Kong, and Singapore dollars were booked back in New York State as greenbacks. These numbers suggest that companies around the world, even in Asia, might be willing to spend, as Joyce suggests, but they are being very careful about how much.