IBM Q4 sales stable, profits hurting

IBM Corp might have an equally sized rival in Hewlett Packard Co, but Big Blue, more than HP, is still a bellwether for the IT industry because of the broad range of markets that it plays in,

writes Timothy Prickett Morgan. And if IBM's fourth quarter 2002 financial results are any indication, the IT market might finally be stabilizing.

But don't get too excited. Stable does not necessarily mean the kind of high-growth we all remember in the IT sector as fondly as we remember our earlier glory days. And IBM is having a tough time bringing money to the bottom line, even if it is slightly beating the highly managed expectations it sets on Wall Street.

That IBM's results for the fourth quarter ended December 31 were buoyed significantly by a $5bn outsourcing contract with banker JP Morgan Chase that the company inked as the year was ending certainly helped, but so did exiting the manufacturing of PCs and jettisoning the entire hard disk drive business.

The acquisition of Rational Software in December has not yet had any material impact on IBM's numbers.

For the fourth quarter, IBM reported $23.7bn in sales, up 7% as reported from the year earlier. SG&A costs were up 15.8% in the quarter to $5.4bn, but IBM shaved R&D expenses by 2.9% to help offset that. After writeoffs from discontinued operations and other charges associated with restructurings, IBM brought just over $1bn to the bottom line in the quarter, which worked out to $1.11 per share prior to taking off 52 cents a share for discontinued operations.

IBM's chief financial officer, John Joyce, said in a conference call with Wall Street analysts yesterday that when you pull all of these unusual factors out of IBM's numbers, Wall Street was expecting about $1.30 a share, and IBM delivered $1.34 a share, which is better than expected. What matters is the real bottom line, which is 59 cents a share assuming full dilution. You can't sift failures from successes and only talk about how successful units are doing, as most public companies are always trying to do.

For the year, IBM's worldwide revenue was down 2.3% to $81.1bn, and net income was down 53.7% to $3.6bn. Fully diluted net earnings worked out to $2.06 a share, down 52.6%. These are only good numbers in relation to the relatively worse numbers that many other companies inside and outside the IT sector have reported. And that is what Wall Street will say today.

On a geographic basis, the Americas region, IBM's biggest market, brought in $10.3bn, up 5% (7% at constant currency). Sales in Europe, Middle East, and Africa were up 13% (but only 1% at constant currency, so this growth came by and large through currency exchange rates). Sales in the Asia/Pacific region were up 7% (4% at constant currency) to $4.8bn. IBM's OEM technology sales, which it keeps distinct from its geographic breakdown, were down 11 percent to $828m. (These results do not include results from the discontinued hard disk drive business that IBM has sold to Hitachi Ltd.) Joyce said that the last couple of weeks in Europe were very good, and that is an encouraging sign.

IBM's Global Services unit inked $18.1bn in signings, the second best quarter in the company's history and twice the amount it booked in the third quarter.

The acquired PricewaterhouseCoopers consultancy unit accounted for about $1bn in signings. Revenue in the Global Services unit came in at $10.6bn, and grew 13% at constant currency from last year's fourth quarter. Maintenance revenue was flat, as was strategic outsourcing (which accounts for 35% of services revenues). IBM's integrated technology services (about 30% of services sales, and which includes maintenance) saw growth of 1% in the quarter, and driven by the PwC acquisition, IBM's business consulting services were up 52% (this latter unit is about 30% of worldwide services sales). Joyce said that the company has retained nearly all of PwC's 1,100 partners, it has added 30,000 PwC employees, and has been able to retake 99 of the 149 accounts that PwC had lost prior to the IBM acquisition because of accounting-consulting conflicts of interest, which caused a furor in 2002.

Sales of servers and storage was down 1% at constant currency to $4.2bn.

zSeries mainframe sales, said Joyce, were down 4%, but MIPS shipments were up 13% and Linux-on-mainframe MIPS shipments were up 45% in the quarter. He said that pSeries Unix server sales were flat compared to this time last year, but he expected that IBM would make market share gains even if revenues were not up. He added that IBM's new Power4+ pSeries 650 midrange machine was sold out, but that could be as much to do with chip yield issues as with customer enthusiasm. iSeries sales were down 13% at constant currency in the quarter, but Joyce firmed up rumors that IBM would next week announce a new, refreshed line of iSeries servers that offered new on-demand utility computing and that he expected sales to start picking up once that new line is shipping. IBM saw strong sales at the high-end of its Intel-based xSeries Intel-based server business, with overall sales up 14% at constant currency. Tape storage sales plummeted 17%, which he characterized as consistent with the industry, and Shark disk array sales were up 5%, with terabytes shipped up 70% compared to the fourth quarter of last year.

PC and printer sales were $3bn in the quarter, flat from last year, and the unit reported a $47m profit, and he added that the PC and printer unit was profitable to the tune of $210m for the year. IBM's technology sector had overall sales of $1.2bn, down 20% at constant currency, with $800m of those sales done external to IBM, down 12%. When you shake out all the internal IBM sales between units, IBM reported hardware sales of $8.1bn, up 1.3% as reported. For the year, hardware sales were down 10.3% to $27.5bn.

IBM's Software Group sales were flat as reported to $3.8bn, and down 2% at constant currency. Sales of WebSphere middleware was up 4% in the fourth quarter, a slowing pace compared to the 21% growth that IBM set for all of 2002 with its middleware products. IBM's database and related tools saw sales down 3% in the quarter, compared to 9% growth for the year. DB2 database sales specifically were up 11% in the quarter and 9% for the year. Tivoli systems management product sales were flat in Q4 and up 1% for 2002, while Lotus groupware and knowledge management software was flat in Q4 as well and down 5% for the year. Operating systems sales were down 2% at constant currency in the fourth quarter, with middleware sales (meaning anything that is not an operating system) being down 1%.

As for 2003, Joyce said his crystal ball was no better than anyone else's, but he was clearly happy to be working for IBM and not one of its competitors. "A year ago, we all looked ahead to 2002 and said it was going to be another demanding year, and a tough one to forecast. As we start the year, we already have about half of our earnings under contract," he bragged. "So what's different a year later? Strategists and analysts are still undecided about the timing of a turn, but there is greater confidence that the tech sector has steadied. Now the question seems to be more one of how strong the recovery will be."

Clearly not wanting Wall Street to react with irrational exuberance to these comments, Joyce warned that Wall Street consensus estimates pegged IBM's first quarter 2003 at nearly 10% revenue growth and 9% earnings per share growth, and that he "would not get ahead of the curve and expect more than that." He added that IBM could grow revenue and earnings in 2003 without a growth in the overall IT market. And if that is the case, maybe IBM is not such a good bellwhether for the IT sector after all.

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