IBM Has Its Financial Ups and Downs in Q2

Published: July 25, 2006

by Timothy Prickett Morgan

IBM reported its financial results for its second quarter last Tuesday after the markets closed, and as is often the case with a company as large as Big Blue, there were some good things and not so good things in the quarter. IBM's sales of System z mainframes and various software were up, but the transition to the Power5+ chip in the System p and System i Power-based servers and other issues with System x servers resulted in disappointing sales for these products, and services books and revenues were also down.

IBM posted $21.9 billion in sales for the quarter, a decrease of 2 percent, but because every hard fact has a sunnier way of looking at it in the IT business, when you take out the divested PC business (which IBM sold off to Lenovo) and take out currency effects, then sales were only down 1 percent. Net income for the quarter was a tiny bit over $2 billion, up 9.2 percent excluding discontinued operations. That worked out to $1.30 per share, an increase of 14 percent compared to the second quarter of 2005.

Global Services, IBM's biggest business unit, had sales of $11.9 billion in the quarter, off 1 percent. IBM's short-term contract signings in the quarter were $5 billion, and its long-term singings came to $4.6 billion. These signings were down significantly from the signings a year ago, which totaled $14.6 billion for both short and long contracts. As has been the case for the past year, IBM once again said that companies are stretching out long-term deals, and booking more short-term ones. However, Mark Loughridge, IBM's chief financial officer, didn't want to give Wall Street the impression that it would not be able to show an increase in signings this year, which pushes revenues out further into the future. And in a conference call with analysts, he definitely did not want to make people think that there is a general slowdown in IT spending.

"Customers have increased the level of scrutiny on their transactions," he said. While growth in the small and medium business segment was solid in the quarter, sales in the enterprise segment (where IBM gets a lot of its revenues) slowed once again. "We have managed these issues before," he said, explaining that IBM has taken actions to bolster enterprise sales and that this was not indicative of IT sales as a whole. "There is no definitive indicator that this is a trend," he explained, adding as IBM CFOs have done for as long as anyone can remember that IBM's broad portfolio of products allows it to rise out such storms. Still, to get growth in signings in the services business, IBM has to grow substantially in the second quarter, since it is off in the mid-teens percentage wise so far in 2006.

Within the services unit, IBM's Global Technology Services unit had sales of $8 billion, up 1 percent, while its Global Business Services segment had sales of $3.9 billion, off 5 percent. Within Global Technology Services, strategic outsourcing sales were up 3 percent, business transformation services were up 15 percent, but signings, which tend to be long term, were off 73 percent, which will impact future quarters. Integrated technology services fell 5 percent. Maintenance revenues were off 1 percent.

On the hardware front, IBM's Systems and Technology Group had sales of $5 billion in the second quarter, up 3 percent. While mainframe sales had slumped in past quarters, the advent of the new System z BC midrange machines help boost sales, accounting for 15 percent of the mainframe MIPS booked in the quarter. Overall, mainframe MIPS shipments increased by 7 percent, and revenue also grew by 7 percent. Beleaguered by product transitions to its Power5+ processors and heightened competition from rivals Sun Microsystems and Hewlett-Packard, IBM's System p Unix boxes saw sales decline by 10 percent. The System i line, which also uses the Power5+ processors, declined by 7 percent in the quarter, but IBM said that the main reason here was that it was having difficulty meeting demand for the boxes as it rejiggers its manufacturing processes and the i5 servers to be RoHS complaint. System x X86 and X64 server sales were flat, and IBM also said that it could not meet demand for its products. If RoHS wasn't an issue, IBM said that System i sales would have been "about flat" and that System x sales would have been up about 6 percent. IBM's overall storage business declined by 2 percent, with disk array sales down 1 percent. Midrange disk array sales were up 15 percent, according to Loughridge, and while overall high-end disk sales declined, sales of the DS8000 arrays (IBM's biggest units) rose by 10 percent. Tape sales were off by 4 percent. The savior for hardware sales for IBM, other than mainframes, was of course its Microelectronics Division, which is pumping out Power chips for game consoles. The overall chip business saw sales go up by 45 percent.

Software Group, with sales up 5 percent to $4.2 billion, was a relatively bright spot in the quarter for Big Blue, but presents its own sets of challenges every quarter, as you would expect such a dizzying array of products and customers to do. IBM's key software brands--WebSphere, Lotus, DB2, Tivoli, and Rational--accounted for 48 percent of sales in the quarter, with WebSphere and Tivoli growing 17 percent and 12 percent, respectively. Database and related tools sales were up 6 percent, Lotus groupware products were up 6 percent, and Rational development tools increased by 8 percent. Other middleware--mostly mainframe and OS/400 stuff--accounted for 26 percent of software sales, but fell by 3 percent, while operating systems (particularly z/OS and OS/400) accounted for 13 percent of sales, but decreased by 6 percent in the quarter. Loughridge banged the SOA drum pretty hard, and said this was one of the key drivers for software sales.

In terms of where IBM makes its sales and where it is seeing growth, the picture is, as always, mixed. In the Americas region--which includes North, Central, and South America--sales were up 2 percent to $9.5 billion. The EMEA region accounted for $7.2 billion in sales, down 1 percent. France and Spain were growing again, but Germany, Italy, and the United Kingdom were off. Sales in the Asia/Pacific region were down 9 percent to $4.2 billion, and IBM actually saw its sales fall in China, if you can believe it. (Loughridge said some big mainframe deals in the second quarter of 2005 in China made the compares very tough.) OEM revenues, which are not counted by geographic region, were up 34 percent to $939 million in the quarter, driven mostly by those game console chips.