IBM Closes Out 2006 With a Strong Fourth Quarter

January 22, 2007 Timothy Prickett Morgan

IBM may have started out 2006 with some bumps and bruises as various hardware, software, and services products were a bit stuck in the mud. But as the year progressed and Big Blue tweaked these businesses–and IT departments rushed to spend down their budgets for the year–the company was able to ramp up its sales, ending the year with a strong fourth quarter. Revenues in the fourth quarter were up 7.5 percent, to $26.3 billion, with earnings up 11.1 percent to $3.5 billion.

As in the third quarter, high-end servers (particularly mainframes and Unix boxes), software (particularly database and middleware), and services were the main drivers of revenues, and in the final quarter of 2006, services was particularly strong. For instance, IBM booked a number of large deals, including a 10-year deal with the German Federal Armed Forces that it is sharing with Siemens Business Services worth more than $9.3 billion. In fact, services signings hit $17.8 billion, up 55 percent from the year-ago quarter, and the backlog of services not yet delivered but under contract, which had been stagnating in recent quarters, has grown again to $116 billion. IBM booked a staggering $11.6 billion in long-term deals and $6.2 billion in short-term deals in the quarter.

Of course, in the services racket, bookings can’t come to the top line all at once; the money comes in monthly and quarterly installments. Global Services booked $12.8 billion in sales, up 7 percent and aided significantly by the relative weakness of the dollar against other currencies in the countries where IBM does business. (At constant currency, Global Services only would have increased sales by 3 percent in the quarter.) As part of its restructuring in services a year ago, IBM cut its services business into two units. The Global Technology Services unit, which includes strategic outsourcing, business transformation outsourcing, integrated technology solutions (which is IBMspeak for systems integration), and maintenance, accounted for $8.6 billion in sales, compared to $4.2 billion in the Global Business Services unit, which does more general business consulting with some technology thrown in.

Systems and Technology Group, which makes chips, servers, storage, and other hardware for sale by IBM and other technology suppliers, posted sales in the fourth quarter of 2006 of $7.1 billion, up only 3 percent and flat at constant currency. As in the third quarter, shipments of System z mainframes led the way, with MIPS shipments up 6 percent and revenues up 5 percent. This is the sixth consecutive quarter of MIPS shipment growth for IBM, despite two product transitions–or, perhaps more accurately, because of them. IBM has slashed prices on its mainframe hardware and software and made them more relevant for running Java and Linux workloads, and this has expanded their appeal in traditional mainframe shops.

Sales of System x servers were up 7 percent, despite flat blade server sales. IBM’s chief financial officer, Mark Loughridge, danced around a question about why blade server sales were flat in a call with Wall Street analysts after the market closed last Thursday, but it seems likely that Hewlett-Packard and its new C-class blade servers are seeing some traction in the market. Loughridge did not provide much color on the System x business, which peddles servers based on Intel and Advanced Micro Devices X64 chips in blade, rack, and tower formats. He did say that IBM saw good growth in the System x line in both Europe and Asia/Pacific, but saw a decline in the Americas region.

System p servers, which are Power-based servers running AIX or Linux as their primary operating system, had sales increase by 4 percent (but flat at constant currency), driven by decent sales at the high-end of the Unix server space as customers consolidate smaller Unix boxes onto bigger, virtualized machines, according to Loughridge. The System i product line, which is also based on IBM’s Power processors but which has i5/OS as the primary operating system, had a decline in sales of 10 percent in the fourth quarter. “Sales of upgrades improved sequentially, however they remain down year-to-year as customers continue to leverage their existing capacity,” said Loughridge. “We expect the upgrade activity to ramp during the year.”

Systems and Technology Group also sells disk and tape arrays as well as Power chips on an OEM basis. Storage sales were up 9 percent in the quarter across all products, with disk sales up 12 percent across all types of arrays and midrange arrays and storage area networks both seeing double-digit growth. Shipments of the DS8000 disk arrays grew by more than 14 percent year-over-year. Tape drive and library sales were up 4 percent in the fourth quarter.

IBM Microelectronics, which has been selling Power chips to Microsoft, Sony, and Nintendo in large numbers as these three companies ramped up their new game consoles, had a tough compare with the last quarter of 2005, when vendors first started taking shipments for these consoles. Loughridge said the Microelectronics unit saw sales decline by 6 percent in the quarter, and said that the expected demand for these chips to “moderate through the first half of 2007” as supply and demand get in synch.

Thanks to the acquisitions of Filenet, MRO Software, and Micromuse last year, Software Group, the third leg in the IBM revenue stool, had the best growth among all of IBM’s groups, with sales up 14 percent to $5.6 billion.

Revenues for the key software IBM products–WebSphere, DB2, Lotus, Tivoli, and Rational–together accounted for $3.15 billion in sales and 25 percent growth, collectively. The Rational development tools grew at only 12 percent in the quarter, but the others all were higher than 20 percent.

Host-based middleware sold on mainframes and System i servers accounted for $1.18 billion in sales in the fourth quarter, and grew by only 3 percent, pulled down by slack System i sales and System z price cuts. Operating systems accounted for $620 million during the quarter, down 2 percent, and other software got a similar piece of the software pie.

Looking at IBM’s sales by geography, sales in the Americas were up 6 percent to $11.1 billion during the fourth quarter. Sales in Latin America were up in the double-digits, were up some in the United States, but fell in Canada. The Europe/Middle East/Africa region did better in terms of growth, with sales up 11 percent as reported back at headquarters in New York, but at constant currency based on sales using the pound, euro, and so forth, sales were only up 3 percent. But EMEA sales are still lower than sales in the Americas for IBM, with only $9.3 billion in sales. Italy apparently had the strongest sales in the quarter, with improvements in the United Kingdom as well. IBM’s sales of $4.8 billion in the Asia/Pacific region (up 7 percent) were propped up by the expanding economies in China and India and also by improving conditions in the Japanese economy. (For the full 2006 year, China, India, Brazil, and Russia together accounted for $4.5 billion in sales, up 16 percent.) IBM’s OEM sales declined by 3 percent to $1 billion, and this is mostly Power chips for game consoles.

For the full year, IBM raked in $91.4 billion, up 4 percent if you don’t include the divestiture of its PC business to Lenovo Group. IBM brought $9.4 billion to the bottom line from continuing operations, up 19.6 percent. IBM also spent $8.1 billion to acquire over 97 million shares from the open market, bringing total shares outstanding to 1.6 billion. Since 1995, IBM has spent an estimated $75 billion to buy back over 1.2 billion shares to make earnings per share outgrow actual earnings. IBM also paid out $1.7 billion in dividends in 2006.

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