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Global Services Saves IBM's Financial Cookies Again by Timothy Prickett Morgan Former chairman and CEO Louis Gerstner may have left IBM, but his decision a decade ago to shift Big Blue away from hardware products and toward services and software has been proven valid yet again with IBM's first quarter 2003 financial results. Had it not been for a 23.6 percent surge in services sales in the quarter, IBM would have seen revenues decline and would not have made any money at all in the quarter just ended. 
As it turned out, the strength of its sales in services pushed up revenues and gross profits by 11.3 percent each, to $20.1 billion and $7.2 billion, respectively. IBM's acquisition of the consulting business PricewaterhouseCoopers is one of the major factors of the success of Global Services in the quarter, with the Business Consulting Services unit that PwC was melding into experiencing a 63 percent growth in sales in the quarter. It is safe to say that had IBM not acquired PwC, it might not be in such a good position right now. The weak dollar also helped IBM's numbers a certain amount, because IBM does a large portion of its business overseas and a weak dollar means relatively modest sales in non-U.S. markets will translate into more bucks when the books get done. IBM does a lot of sophisticated hedging to prevent this from getting out of hand and to keep its profits as predictable as possible. That said, IBM's net earnings per share came in a penny shy of Wall Street consensus, which is arguably not a tragedy considering the volatility in the economic and political environments around the world right now. Sam Palmisano, IBM's chairman and CEO, didn't participate in the financial analysts call yesterday as the company's financial results were announced, but he did release a statement as is the tradition among IBM's past leaders. "In the face of an ongoing difficult environment, we delivered another strong quarter and continued to gain share across our strategic businesses. Our results demonstrate that our e-business on demand strategy, which draws on IBM's strengths in business transformation services and open IT infrastructure, is responsive to the needs of our customers. It is exactly this ability to help customers transform their business operations with leadership technology that is at the heart of our on demand strategy, and what sets us apart from our competition. Going forward, we are well positioned to set the agenda and help customers transform their enterprises to realize the benefits, efficiencies and productivity gains of e-business on demand." If you wanted to translate that gobbledygook into plain English instead of an amalgam of MBAspeak and IT jargon, you might do it thus: We--meaning IBM--win. Nah nah nah nah nah. IBM's chief financial officer, John Joyce, reiterated these comments several times throughout his presentation, and said IBM was on track to meet Wall Street's expectations for $4.30 in net earnings per share for the year, and that IBM had good momentum at the end of 2002 and this momentum is continuing this year. He said the second quarter pipeline remains strong, and the key will be the timing on customers' buying decisions. This is something that IBM, to a large extent, cannot control. When pressed by analysts for whether or not IBM would meet consensus for the second quarter, Joyce said there were 75 days left in the quarter and that he would leave it to them to make their guesses for what would happen in the short term. Joyce said the war in Iraq only caused a pause in spending for a few days, and that customers' feelings on the economy were far more important in determining their spending habits than the war. IBM's Global Services revenues were $10.2 billion as reported, up 23.6 percent. Gross profits in services decreased a little more than a point as a result of the shift to shorter term, lower margin services. IBM booked $12.1 billion in new signings during the quarter, giving it a backlog going forward of $113 billion. IBM's Strategic Outsourcing business had 13 percent growth in the quarter (6 percent at constant currency), and its Integrated Technical Services unit (which includes hardware maintenance) had 10 percent growth (2 percent at constant currency). Joyce said IBM signed 15 deals, each worth over $100 million, one of which was a contract with Visteon for on-demand utility computing worth over $2 billion. While sales at the BSC unit of Global Services were up (with the former PwC bringing in over $1 billion), sales in this unit in Europe lagged the Americas region, although Joyce did say he expected BCS sales in Europe to pick up in the second quarter. On the systems front, sales of zSeries mainframes were off 16 percent even though MIPS shipments were up 3 percent in the quarter. Clearly there is still pricing pressure here even though IBM is the only mainframe supplier left that supports the various IBM mainframe environments. Joyce attributed this decline to a deferral of acquisitions, in part driven by the economy, in part by the knowledge that IBM would soon be delivering a 64-way "T-Rex" mainframe. (This machine is due in May or June.) pSeries Unix server sales were up 15 percent, with low-end sales and midrange sales going well, and xSeries Intel-based server sales were up 20 percent, but Joyce said that supply constraints in these two product lines hurt IBM's overall hardware sales, which slipped by 1.3 percent to $5.8 billion. Sales of the iSeries actually picked up by 22 percent in the first quarter, thanks in large measure to a revamping of the product line in January that gave customers a decent price/performance improvement. Shark storage array sales were up 22 percent and tape storage sales were flat. Overall systems sales (meaning servers plus storage) were up 6 percent as reported to $2.6 billion and flat at constant currency. Sales in IBM's Personal Systems Group, which includes PCs and printers, were down 5 percent to $2.4 billion, and this segment posted a $69 million loss in the first quarter of 2003 compared to a $203 million loss this time last year. According to a financial model built by analyst Steven Milunovich at brokerage house Merrill Lynch, the iSeries accounted for $316 million of IBM's $2.6 billion sales in the Server Group, which also includes storage. That's 21 percent growth in actual revenue (IBM's percentages are at constant currency, not as reported). This is great growth, but that is also against one of the worst quarters in the history of the OS/400 server line. Milunovich reckons that the zSeries accounted for $463 million in sales, down 16.5 percent; that the pSeries accounted for $658 million, up 14.4 percent; and the xSeries accounted for $665 million, up 19 percent. Storage sales were up modestly under his IBM model, with $543 million in sales across all disk and tape storage products. IBM's software revenues were up 8 percent as reported, 2 percent at constant currency, to $3.1 billion. Improving iSeries sales helped drive operating system revenues by 8 percent, and middleware sales were up by 9 percent. Sales of middleware--which includes databases, Web application servers, groupware, etc--were up 12 percent on Unix, Windows, and Linux platforms and up 8 percent on mainframe and OS/400 servers. WebSphere sales (across all products) were up 14 percent, but sales of Lotus products were down 3 percent and of Tivoli products were down by 5 percent. Total revenues for the quarter came to $20.1 billion compared to $18 billion a year ago. Net earnings were $1.4 billion, up 16 percent, and earnings per share came in at 79 cents, up 8.2 percent from a year ago. On a geographic basis, the Americas region came to $8.6 billion, up 5 percent and comprising 43 percent of IBM's sales in the quarter. Europe, Middle East, and Africa accounted for 31 percent of IBM's sales, with 23 percent growth as reported (but only 3 percent in local currencies) to $6.3 billion. Sales in the Asia/Pacific region were $4.5 billion, up 14 percent as reported and 5 percent at constant currency. OEM product sales through IBM's largely irrelevant Technology Group (excepting its portfolio of intellectual property and some custom chip-making services it offers to offset its own expenses in developing the Power family of processors for its eServer line) were down 15 percent to $742 million.
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