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Currency flux incapacitates IBM's Q4 sales

Earnings better than expected

The fact that IBM's $29.5bn in sales in the fourth quarter (up 1.6 per cent) was about $200m shy of Wall Street's expectations was not as big a deal to the company's top brass as the fact that net income of $5.5bn was up 4.4 per cent and higher than the Street anticipated.

Why? Simple. As it has proved in the past decade as it divested itself of various businesses, Big Blue doesn't give a rat's patootie about revenue growth. The company's financial wizards are only focused on two things: growing share in the market segments and geographies it plays within and growing profits.

IBM said that currency fluctuations in the fourth quarter knocked down its reported revenues in Q4 by $300m, and you can blame the PIGS – Portugal, Ireland, Greece, and Spain – for that. Toss in Hungary, as well.

For the full year, IBM's overall revenues were $106.9bn, up 7.1 per cent, with net income of $15.85bn, up 6.9 per cent.

Technically speaking, this was former president and CEO Sam Palmisano's last quarter running IBM. But just the same, new prez and CEO Ginni Rometty got to do the talking in the statement IBM put out accompanying the financials for Q4 and the full 2011 year. And just like Palmisano, Rometty did not sit in on the call with Wall Street'; she let Big Blue's CFO Mark Loughridge do all the talking.

"We had a strong fourth-quarter performance, capping a year of record earnings per share, revenue, profit and free cash flow," Rometty said in the canned statement. "We delivered outstanding results in all four of our strategic initiatives for the quarter and the year, as we continued to realize the benefit of our long-term investments in growth markets, business analytics, Smarter Planet solutions and cloud. We are well on track toward our long-term roadmap for operating earnings per share of at least $20 in 2015."

Funny how Rometty sounds just like Palmisano there. I guess they had the same speechwriter. Perhaps it's Watson?

Blame Intel

IBM had a very tough compare in its hardware business in the final quarter of 2011, with the System zEnterprise 196 mainframes launching in the summer of 2010 and shipping in volume in Q4. But it is also safe to lay some of the blame on Intel, which did not ship its "Sandy Bridge-EP" Xeon E5 processors for those workhorse two-socket x86 servers last year, as expected.

IBM's Systems and Technology Group, which makes servers, storage, systems software, and chips, took a 7.6 per cent revenue dive to $5.8bn in the quarter. IBM does not provide revenue figures for its various product lines, but says that mainframe sales dropped 31 per cent in the quarter against a gross capacity shrink of 4 per cent (as measured by MIPS).

This implies that IBM is slashing hardware prices to keep peddling iron, and also implies that specialty engines running Linux or accelerating DB2, XML, and Java workloads are making up a larger portion of mainframe sales. The good news is that what Loughridge called "microcode upgrades" were up on mainframes, which pushed overall System z gross profits up. (I think Loughridge meant to say operating systems and related systems software.)

IBM's Power Systems line of servers, which run its AIX and IBM i (formerly OS/400) operating systems with a smattering of Linux, had 6 per cent revenue growth in the quarter. Loughridge boasted that IBM had 350 competitive takeout deals with Power7 iron in Q4, which generated over $350m in sales; about 60 per cent of the revenue from those takeouts displaced HP iron, with the remainder mostly being for Oracle systems. System x rack and tower and BladeCenter blade server sales based on x86 processors took a 2 per cent hit, which Loughridge said was "in line with the market." We'll see, since no other server maker has reported yet.

For the full year, the Systems and Technology Group had sales of just under $19bn, an increase of 5.6 per cent, and pre-tax income of $1.6bn, up 12 points year-on-year. This is the best that IBM's hardware business has done on an annualized basis in a long time.

Back in the heyday of the mainframe and minicomputer, the profit engine at IBM used to be iron because the software and services were largely bundled in. Now, IBM sells software for its own machines as well as those made by others and will service anything – really, anything. And thus, the profit engines at Big Blue are now software and services, both of which are a way of packaging up the smarts of propellerheads. IBM has not changed what it does so much as change the way it talks about itself and the buckets it pours money into.

IBM's Software Group raked in $7.65bn, up 8.7 per cent, had gross margins of 89.8 per cent, and pre-tax income of $3.7bn, up 12 per cent.

Database and related information-management product sales were up 9 per cent, with the Netezza data warehouse appliance business showing revenue growth of 70 per cent year-on-year and winning around 85 per cent of the competitive bids it was in.

Time to fire up the oven

Two things. First, Netezza is mostly hardware and based on BladeCenter machinery, so it's kinda weird having it in Software Group. Second, Loughridge said in the call that IBM sold out of Netezza boxes, which can only mean one thing: the company ran out of the special FPGA chips that do a lot of the database processing in those Netezza boxes. Time to bake some more wafers, Big Blue.

The WebSphere family of middleware products, which runs the gamut from application servers to e-commerce and marketing software, posted 21 per cent revenue growth, driven in part by the substantial number of acquisitions that IBM has done in the past several years. The Tivoli systems management and security software line grew by 14 per cent, Rational development tool sales were up 4 per cent, but Lotus groupware sales were off 3 per cent. When you add up these five key branded middleware segments, they brought in $5.2bn, up 11 per cent.

For the full year, Software Group had $24.9bn in sales, up 10.9 per cent, and just under $10bn in pre-tax income, up only 5.3 per cent.

The Global Services behemoth grew more modestly at 2.7 per cent to $15.33bn, but profit margins increased dramatically. On the call with Wall Street analysts, Loughridge ducked the question about if this was due to offshoring of employees. There's no question that some of this "workload rebalancing", as IBM calls it, is helping to boost profits, but Loughridge said that shifting to higher-value services and staying away from the low-margin grunt work was the profit driver.

The Global Technology Services part of IBM had $10.45bn in sales, up 2.8 per cent, peddling outsourcing, maintenance, and technology integration. The Global Business Services part brought in $4.88bn, up 2.5 per cent, selling application outsourcing and various business process engineering and consulting services. Loughridge said that outside of the Japanese market and the public sector, GBS revenues rose 9 per cent.

For the full year, revenues in the Global Services group rose 6.6 per cent to $60.16bn, and pre-tax income was up 14.9 per cent to $9.29bn.

IBM's services backlog was $141bn as it exited 2011, down $2bn as reported but flat at constant currency. Loughridge explains that for 2012, about 70 per cent of total Global Services revenues will come from the run-out of the portion of the services backlog that comes due in 2012. Just based on this backlog run-out alone, IBM can push 3 per cent growth in Global Services this year – essentially matching 2011's growth.

Looking ahead to this year, Loughridge put an earnings-per-share stake in the ground with a $14.85 pennant waving from it. He warned Wall Street that IBM expected to see higher EPS growth in the second half of the year than in the first, driven in part by new system announcements coming in the second half. IBM is expected to refresh its Power Systems and System z lines this year and will, of course, get new Xeon E5 server out the door as soon as Intel does its launch, sometime soon – maybe in March with real volume shipments in April. ®

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