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IBM wrings more profit from revived IT market

UK (still) soaring like a BRIC

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Looks like all of those pink slips IBM handed out in the first quarter and the improving global economy is going to yield some big fat bonuses for the bigwigs thanks to a steady second quarter financial performance and the ongoing march to higher profits for Big Blue.

In the quarter, IBM's overall revenues were up a meager 2 per cent, to $23.7bn, but if IBM has proved anything in the past year and a half, it is that it doesn't need revenue growth to drive profits – and it no longer covets such growth.

What is more important to IBM's top brass is the bottom line, which grew by 9.1 per cent in the second quarter, to $3.39bn, and shelling out enough cash on stock buybacks to get that double-digit earnings per share growth that is now as much a part of IBM as the stripey logo and the admonition from a stern Presbyterian proto-Steve Jobs named Thomas Watson for us to Think. Thanks to the financial engineering, and against a pretty severe currency headwind that shaved 10 to 11 cents off earnings, IBM was nonetheless able to deliver 12.5 per cent EPS growth, hitting $2.61 per share in the quarter.

With the System zEnterprise 196 mainframe, entry Power7 servers, and high-end Power 795 big iron all on the way in the coming weeks and expected to help revenues and margins along after some harsh declines in the past several quarters, IBM is raising its EPS guidance for the year once again. Mark Loughridge, IBM's chief financial officer, said in a call with Wall Street analysts that IBM could now deliver at least $11.25 per share in earnings for 2010, up from the $11 target Big Blue set in January and the $11.20 IBM set when it reported its Q1 results back in April.

An extra nickel doesn't seem like a lot. But that's over nearly 1.3 billion shares. As actor Charlie Sheen once so elegantly put it when talking to a judge about his exorbitant prostitution bills, "It sure do mount up."

Loughridge said that for the first time in IBM's history, its growth markets – the hot countries like Brazil, Russia, India, and China, shortened to BRIC, and including a number of other fast-growing countries around the world – matched the revenue levels IBM extracted from the Euro zone. And with current growth trajectories, these growth markets would soon surpass the Euro zone.

Interestingly, the United Kingdom is seeing particularly strong growth, with revenues up 11 per cent in the quarter, building momentum from a 4 per cent growth in the fourth quarter of 2009 and an 8 per cent spike in the first quarter of this year. That's not too shabby at all, considering consolidation in the banking industry and tight local government spending. The overall EMEA region, by contract saw a 6 per cent revenue decline to $7.4bn thanks to the financial woes of Portugal, Ireland, Italy, Greece, and Spain – the so-called PIIGS of Europe.</p.

IBM's revenues in the Americas were up 3 per cent to $10.2bn, while sales in the Asia/Pacific region were up 9 per cent, to $5.4bn. Revenues in the BRIC countries were up 22 per cent, while the broader growth markets saw a 14 per cent bump. The United States had only a 1 per cent bump – the first time biz in IBM's home country has been up in 11 quarters – and Japan was down 1 per cent.

Services continue to be the main revenue engine for Big Blue, and software continues to be the profit - profits that are only possible because IBM still sells its own servers and storage, from which it gets increasingly difficult to extract direct profits.

IBM's Global Business Services unit posted $4.5bn in revenues in the quarter, up 3 per cent as reported, while its Global Technology Services unit booked $9.2bn in sales, up only 1 percent. GBS is the part of the Global Services behemoth that peddles business transformation and optimization services, while GTS does the more IT-related tech support, outsourcing, consulting, and systems integration work.

Loughridge said in the call that outsourcing contract extensions took it on the chin in the quarter, which helped push outsourcing signings (including application outsourcing) down 19 per cent to $6.5bn. IBM's "transactional" services signings – meaning everything that was not outsourcing – fell by 3 per cent, to $5.8bn. Total signings in the quarter dropped by 12 per cent, to $12.3bn, and that IBM's services backlog nonetheless grew by $1bn, to $129bn.

Over in the Systems and Technology Group, sales were up 3 per cent, to $4bn.

System z mainframe sales were off 24 per cent and MIPS shipments were down 14 per cent, which is no surprise at all given that new mainframes are being announced this week.

IBM's Power Systems line continued to have problems as well, but with entry and high-end machines on the horizon, this was again no surprise. In a measure of how poorly IBM's midrange and blade AIX and i boxes must have been doing in the year-ago quarter and how well the new Power7 midrange machines announced in February and the Power7 blades that debuted in April, Loughridge said that midrange Power server sales were up 11 per cent in the quarter and that Power blade sales were up an impressive 65 per cent. (IBM has never said how well or poorly the Power-based blades had been selling in the past, but I suspect not all that great.) Loughridge said IBM did 225 takeouts of competitive Unix iron in Q2, bringing in about $225m in revenues. About two-thirds of those takeouts were at Oracle/Sun shops.

IBM's System x server line saw a respectable 30 per cent revenue spike in Q2, with BladeCenter blade servers using x64 processors seeing 16 per cent growth and the high-end System x rack server business seeing 17 per cent growth and gaining share, according to Loughridge, on the relatively few companies that build big x64 boxes. Big Blue's storage revenues were up only 5 per cent, but disk storage was up 12 per cent. Loughridge didn't mention tape-based storage, which had to be down quite far to make the math work, but he did say that the XIV clustered disks added more than 130 customers in the quarter and revenue doubled compared to the prior year. IBM's Microelectronics division, which makes and sells chips as well as intellectual property, had a 23 per cent sales increase in Q2.

That leaves Software Group, which had three times the growth of IBM overall, up 6 per cent to $5.3bn, and that was after losing about 1 per cent of revenue through the divestiture of its product lifecycle management (PLM) software to Dassault Systemes and a pretty bad showing by its Lotus groupware products, which declined by 6 per cent. IBM's WebSphere middleware had 17 per cent growth in the second quarter, with 7 per cent growth in the Information Management line (DB2, IMS, and other database products). The Tivoli systems management line of software products kept pace with WebSphere, rising 18 per cent, and the Rational development tools squeaked out 1 per cent revenue growth.

The key branded middleware mentioned above accounted for 62 per cent of IBM's Software Group revenues, up four points from a year ago; other middleware, mostly on mainframes, fell to 21 per cent. Operating systems accounted for 10 per cent of Software Group's revenues, and the remaining 7 per cent were for other software products. Software Group had 87.1 per cent gross margins, up 1.2 points compared to Q2 2009. And this, as far as share buybacks and EPS growth is concerned, is what really matters.

Loughridge did not provide any specific revenue guidance, but said he expected both services and hardware to see steady improvement as 2010 moved on and that software growth would continue at about the same pace. ®

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