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IBM profits hum along nicely in second quarter

Centenarian mints money like prime-of-life mogul

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The name is International Business Machines, and perhaps better than any other company in the corporate IT sector, 100-year-old Big Blue is able to follow growth wherever it is on the planet, and capitalize on it.

In the second quarter ended in June, IBM raked in $26.7bn in sales, up 12.4 percent, and brought $3.66bn to the bottom line, up 8.2 per cent. Yes, net income did not grow as fast as revenues, but IBM has taught Wall Street and its own employees to care only about growth in earnings per share – and that rose by 14.9 per cent to $3 a share in the quarter, thanks to $3bn in share repurchases.

The Global Services behemoth continued to generate the largest portion of IBM's revenues in the quarter, with $15.1bn in sales, up 10 per cent from the year ago quarter. But everything is not rosily perfect in Global Services: the bulk of the $160m in "workforce rebalancing" (IBMese for layoffs) that the company did in the quarter was focused on Global Services, predominantly in Europe.

Mark Loughridge, IBM's chief financial officer, said in a call with Wall Street analysts that this kind of rebalancing would simply be the norm at Big Blue going forward – although he did not confirm that quarterly layoffs that stay under the radar and that are spread across IBM's many geographies and divisions have been, in fact, the norm for many years.

Showing just how anemic the US dollar is these days, the backlog of Global Services unfulfilled but booked services work rose $15bn (up 10.4 per cent) in the quarter, to $144bn. But $13bn of that backlog growth was due just to currency effects, with only $2bn being an actual increase in business.

Global Technology Services, the part of IBM that maintains gear and does outsourcing and other services, had $10.2bn in sales in Q2, up 11 per cent, with pre-tax income of $1.4bn, up a point. Barring the layoffs and resulting charges, GTS would have had 8 points of pre-tax margin growth, Loughridge said.

Global Business Services, which does application hosting/outsourcing, systems integration and consulting, and business process re-engineering, had $4.9bn in sales, up 9 per cent, and brought in $800m in pre-tax income, up 11 per cent compared to the year-ago period.

The real profit engine at IBM in recent decades has been software, as Big Blue becomes less and less dependent on its venerable mainframes and their incredibly expensive systems software with each passing year.

But don't get the wrong idea. Take away those mainframes, their systems software, and related services that mainframe shops buy, and you have a Littler Blue that would not only be fighting to turn a reasonable profit, but would also have Wall Street circling it like hungry hyenas demanding asset sales and job cuts. Call it Akers, Part Deux.

But IBM's current president, CEO, and chairman Sam Palmisano has no intention of following in the footsteps of the man who had those jobs in the early 1990s, and who nearly broke Big Blue. Palmisano has engineered an IBM – with a lot of help from his former boss in the 1990s, Lou Gerstner – that is continually growing its software footprint in places that do not usually put it in direct opposition with application-software partners.

In Q2, IBM's software sales were up by 16.9 per cent to $6.17bn, and gross margins for the Software Group were up a smidgen to 88.4 per cent. Loughridge said that this was the fifteenth quarter in which the key IBM brands as a group – WebSphere middleware, Information Management databases, Tivoli systems management and security, Lotus groupware, and Rational development tools – gained market share.

As a group, those products grew by 21 per cent to just under $4bn, representing just under two-thirds of IBM's software sales in the quarter. IBM does not give a margin number of these products, but if the mainframe and AS/400 software products, where IBM has absolute monopolies, had a gross margin of 99 per cent, that would put the gross margins of the five Software Group brands at 82 per cent or so.

Loughridge said that WebSphere sales continued to grow like gangbusters in the quarter, up 55 per cent thanks in part to acquisitions and organic growth. IBM's database products had 18 per cent growth, while Tivoli tools grew only 9 per cent, and Lotus products were up 12 per cent. Rational tools posted 4 per cent revenue growth in the quarter. Operating systems accounted for $620m in revenues, while other middleware (mostly on mainframes but some on AS/400s) accounted for $1.1bn. That "other" middleware – notably the CICS transaction monitor and the RACF security software for mainframes – is the juiciest software that IBM has in its portfolio.

Hardware selling like hotcakes

IBM's Systems and Technology Group, which makes servers, storage, chips, and retail systems as well as managing and selling its vast portfolio of patents and intellectual property, had "a great second quarter," according to Loughridge. Revenues were up 17.5 per cent to $4.68bn, and gross margins expanded by nearly five points to 40.6 per cent.

IBM's System z mainframes had 61 per cent revenue growth, and aggregate processing capacity (as measured using MIPS ratings that bear little relation to actual millions of instructions per second from eons gone by on System/360 mainframes) rose by 86 per cent. IBM has continued to cut is mainframe prices on a per-MIPS basis, and like an economics textbook this is stimulating demand across the 4,000-strong global mainframe base.

Interestingly, Loughridge said that since the System zEnterprise 196 mainframes were announced a year ago and started shipping in late September last year, Big Blue has added 68 new mainframe customers – with 24 of them coming from growth and emerging markets.

IBM's Power Systems revenues were up 12 per cent as a group, and the entry portion of the product line more than doubled, compared to the year-ago period. This time last year, customers were waiting for Big Blue to get the Power7 chips into its entry line, and sales for small Power-based servers were not so great. So this was an easy compare. Ditto for high-end boxes. In the current quarter, sales of enterprise-class servers – the Power 770, 780, and 795 – rose by 23 per cent.

IBM said very little about sales of its System x rack and tower server, and BladeCenter blade servers, except that across all x64-based products, revenues rose by 15 per cent (with a 27 per cent increase in the growth markets) and high-end System x sales were up 26 per cent. Loughridge didn't say diddly about BladeCenters, and that is probably because despite all of its own issues, Cisco Systems has kicked Big Blue in the blades with its "California" Unified Computing System.

IBM's storage sales were up 10 per cent, with disk-based product sales rising 13 per cent in the quarter. Retail point-of-sale and other gear posted an 8 per cent revenue bump in Q2 for Big Blue, and OEM chip sales rose by 4 per cent.

Because everything is going so peachy right now, IBM raised its profit guidance for 2011 again, to $13.25 per share on an operating basis, up 10 cents from three months ago. IBM has shelled out $8bn for share repurchases in the first half of the year and still has $8.7bn in authorizations from the board remaining, so engineering $13.50 or maybe even $14 a share in operating EPS is probably not all that difficult. It depends on how many acquisitions IBM wants to do. ®

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