Reading the runes of IBM's Q2s

6 per cent down, but maybe good all the same

ComputerWire: IT Industry Intelligence

IBM Corp reported its financial results for the second quarter yesterday, and John Joyce, the company's chief financial officer, spent a great deal of time explaining the ins and outs of charges due to restructurings, layoffs, and the ongoing (and as yet uncompleted) sale of its hard disk drive business to rival Hitachi Ltd,

writes Timothy Prickett Morgan.

While such disclosures are important, in light of all the shenanigans going on with corporate books and executive crooks in American business these days, what everyone really wanted to know is what exactly IBM is selling or not selling and how the rest of the year looks for Big Blue. IBM, like Hewlett Packard now that it has eaten Compaq Computer Corp, is a bellweather for the IT industry and the rise and fall of its fortunes in all of the market sectors it plays in say something about how those markets are doing.

IBM's overall revenues were down 5.7% in the second quarter to $19.65bn, which compared to a lot of other IT players looks pretty good. Revenues in the discontinued hard disk drive business plummeted to $379m, about half of IBM's normal sales rate for disk drives on the OEM market. The consensus estimate on Wall Street for IBM's revenues - if these figures really mean anything these days - was about $600m lower than what IBM achieved, said Joyce in his conference call with those analysts yesterday. The slide of the dollar against other currencies may have helped this discrepancy in IBM's favor, he said, because IBM does not know what currency assumptions the analysts build into their models. You need a PhD in numerology to reckon how IBM fared against expectations for earnings per share - not because IBM is fudging the numbers, but because of the charges IBM took and whether or not HDD operations are included.

Suffice it to say, IBM's gross profits were down 9% to $7.27bn, and net income from continuing operations was down 78.7% to $445 million compared to last year's second quarter. When all the math is done, IBM reported earnings per share of $0.25 a share, with a $0.22 per share loss on discontinued operations, leaving three pennies a share left over. This is, all things considered, better than a loss that IBM had expected to report. Incidentally, these figures include $825m in charges due to restructuring in its Microelectronics Division (including the writeoff of aluminum chip making capacity, shuttering of circuit board units, and layoffs) and $802m in charges associated with office closings, layoffs in other units, and other resource reductions. IBM has booked an $85m loss on the sale of disk assets to Hitachi and $343m in writeoffs of fixed assets (probably 10K RPM disk drive inventory) associated with the deal. IBM says that the total pretax charges for the workforce reductions, resource writeoffs, and disk sale will be in the range of $2.5bn to $3bn when the year ends.

Sam Palmisano, IBM's president and chief executive officer, said he was proud that IBM was able to get $20bn in revenues in the second quarter, which he characterized as "one of the most difficult capital spending environments we've seen in decades." Despite big downturns in server sales and some slippage in services revenues, Palmisano says that he was encouraged by the steadiness in software sales and IBM's prospects for the remainder of the year. "As we look forward, we remain confident that IBM will continue to gain or hold share in our high-priority growth areas of our industry."

Sales in the Global Services unit that is IBM's biggest revenue generator these days were down 2% at constant currency to $8.7bn. Joyce had been predicting bookings in the range of $14bn to $15bn in the quarter, but IBM only brought in $10.6bn in new signings. He said that IBM typically books 15% of the revenue for new signings in the quarter where those deals closed, and that a number of very large deals slipped into the third quarter, which means that IBM took a fairly large hit to services revenues in Q2. IBM's services backlog stands at about $106bn, which is an enormous reservoir of business, provided that companies don't shift their priorities or change the scope of their services contracts if the economy stays bad or worsens. Joyce indicated that this changing of scope had already happened on a number of big deals, but gave the impression that most of this was behind IBM at this point, with the economy already suffering for more than a year.

Sales in the Server Group, which encompasses servers and storage arrays, were down 17% (again at constant currency), but improved by 15% from the first quarter. Total server revenues across all product categories were down 16%, with xSeries Intel-based server sales being the one bright spot with revenues up 13%. IBM's MIPS shipments in the zSeries line were up 4% in the second quarter, but revenues nonetheless dropped by 19%. The low-end of the pSeries Unix server line was hammered by intense price competition among the Unix players and by the encroaching of Wintel and Lintel solutions into the commercial market, and even though IBM's high-end "Regatta" pSeries 670 and 890 servers sold well, overall pSeries sales were down 27%. Sales of the proprietary iSeries server line were down almost the same amount, by 26%, suggesting that this product line is also suffering at the hands of Wintel and Lintel suppliers, including IBM's own xSeries unit.

Joyce said sales at Software Group were up 7% to $3.3bn, with operating system sales off 4% (comprising about 20% of total software sales worldwide) and middleware sales (including databases, application servers, messaging and every other program IBM sells) up 10%. Middleware sales on Unix and Windows platforms were up 25% in the quarter, driven by DB2, Informix, and WebSphere sales. Middleware sales on host platforms (zSeries and iSeries as well as older proprietary equipment) were up 7%, helped significantly by IBM's relatively new line of database software tools.

In the Personal and Printing Systems unit, sales were in line with the industry, with sales down 10% to $2.8bn. In the Technology Group, which is now comprised mostly of IBM Microelectronics, sales were off 30% to $800m.

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