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IBM defies hardware woes with record 2008

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IBM's software business - which is driven at least in part by its mainframe, Power, and x64 server platform sales - rose by 3 per cent in the quarter to $6.4bn in revenues. In constant currency, it grew at 9 per cent. The key branded middleware products in its Software Group - WebSphere, DB2, Tivoli, Lotus, and Rational brands - accounted for 61 per cent of software sales in the quarter and grew at 6 per cent. That's only because database and information management products had a great quarter.

Other middleware - mostly running on mainframes and proprietary Power Systems i machines - accounted for 20 per cent of software sales in the quarter, while operating systems made up 10 per cent. Gross margins came in at 88 per cent for software, which means IBM has to push more than twice as much services or server dollars to get the same bang it gets from software. Of course, that software margin is propped up by legacy applications on proprietary machines. So: no machines, no profits.

The System and Technology Group did not have a great quarter, thanks in large part to a big drop off in x64 server, disk storage, and tape storage sales. IBM's hardware group had $5.4bn in sales, down 20 per cent as reported and down 16 per cent in constant currency. Gross margins and pretax income fell to 39.9 and 12.7 per cent, respectively. System z mainframe sales fell by 6 per cent in Q4, but Loughridge said MIPS shipments rose by 12 per cent in the quarter, with MIPS capacity on so-called specialty engines (for running Java, DB2 queries, or Linux rather than z/OS workloads) seeing a 43 per cent rise in MIPS shipments. He added that IBM had strong growth for mainframes in the Americas, with particularly strong growth in financial services and industrial sectors. Go figure.

Loughridge said further that Power Systems sales (which includes AIX, Linux, and i/OS machines except for a smidgen of Power5-based iSeries boxes that IBM still sells) grew by 8 per cent as reported and at 14 per cent in constant currency. That legacy iSeries business fell off a cliff, dropping 92 per cent. But that was expected. A 32 per cent decline in System x x64 server sales, which include blade servers as well as rack and tower form factors, was a bit of a surprise, as was a 20 per cent decline in storage sales. Loughridge said that disk array sales fell by 16 per cent in Q4 and tape product sales fell by 31 per cent. Even BladeCenter blade server sales fell, in this case by 27 per cent.

IBM's CFO offered this explanation. "This reflects a significant slowdown in the x86 market, as customers are virtualizing and consolidating workloads into more efficient platforms such as Power and mainframe," Loughridge said. "So as you look at these results, you can see that the industry standard hardware is clearly more susceptible to an economic downturn."

Not so fast there. IBM's drop off in sales in these two areas might mean that IBM's competitive position in x64 servers and storage is bad. Or it might mean x64 customers are waiting to see the forthcoming "Nehalem" servers from Intel before committing to purchasing. It might mean that IBM stuffed its channel in Q2 and Q3 with x64 and storage gear and its partners just couldn't eat any more with the year ending as miserably for them as it most assuredly did.

Or it might mean the virtualization downdraft is hitting IBM's x64 server sales, since IBM has always sold relatively heavy x86 and x64 boxes to big enterprises. You would expect IBM to take the economic hit first when virtualization really took hold, reducing footprints both in the data center and sold each quarter. Mainframe and Power servers are already virtualized and have already seen the virtualization crunch. Whatever the issue that IBM is facing, it is clearly not as simple as Loughridge has portrayed it or as clean as the marketing message he wants to send.

IBM didn't provide much in the way of revenue guidance, except for some mumbling when one Wall Street analyst suggested Big Blue could see revenue declines in the first three quarters of this year. That said, Loughridge is confident that IBM can meet or beat its target of delivering $9.20 per share in earnings, despite the economic downturn. It will be interesting to see if, and how, IBM pulls this off. Particularly if economies weaken further. ®

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