IBM Drives Home a Strong Second Quarter Across the Board

July 21, 2008 Timothy Prickett Morgan

When you get to be a company the size of IBM, attaining 5 percent or 6 percent revenue growth in a quarter in the local economies where you operate is pretty good. To do it two years in a row, across many geographies where the economies are not all doing so hot, is something of a feat. But that is just what Big Blue did in the second quarter ended June 30, posting sales of $26.8 billion, up 13 percent as reported and up 6 percent when reckoned in the local currencies where the deals were done.

Mark Loughridge, IBM’s chief financial officer, hosted a call with Wall Street after the market close last Thursday, and talked about twice as fast as usual because he was so happy. (Well, that’s a bit of an exaggeration–but only a bit.) He led off by saying that IBM had broad growth across established and emerging markets, and added that the growth even matched the constant currency revenue growth rate that the company posted in the second quarter of 2007, which he characterized as “very strong” itself. Because business is going so swimmingly, IBM is raising its 2008 full-year earnings per share guidance, boosting it to $8.75 per share; that’s up 85 cents since IBM started talking about 2008 when it announced year-end results for 2007. This is why Loughridge was so giddy, and the second quarter is a big part of it. Net income for Q2 rose by 22.3 percent to $2.77 billion, and earnings per share in Q2 was up 27.7 percent to $1.98. IBM is clearly thinking that it can accelerate its profits in the second half of 2008.

“Now, I think it’s obvious, but we achieved all of this with the U.S. economy as a headwind and currency as a tailwind. But, bottom line, the IBM business really executed this quarter.”

While IBM talks a lot about services, I like servers, so I am going to talk about servers and software first and then services. We all know IBM makes more than half of its money in services, but I still believe that servers and software drive those services businesses, not the other way around.

IBM’s Systems and Technology Group reported sales of $5.2 billion, up only 2 percent as reported and down 3 percent in local currencies. But don’t blame servers. The System z mainframe line, which was refreshed with quad-core z10 mainframes earlier this year, had a 32 percent revenue boost on MIPS shipment growth of 34 percent. “We entered the second quarter with a strong deal pipeline, and this quarter, frankly, we were sold out,” Loughridge said of z10 sales. “Performance was particularly strong in the Americas and Europe as well as in the financial services sector.” He added that IBM shipped a record number of mainframe specialty engines in the quarter, too.

As it did in the first quarter, IBM is doing some funky math to make sales of the System i-style computers look worse so it can make sales of the so-called Converged System p line–what we should be calling Power Systems, if you ask me–look better. Loughridge said that legacy System i sales–by which he apparently means any System i products that do not include Power6 processors–fell by 47 percent as reported, while Converged System p–by which IBM seems to mean any System p box with any processor (Power5, Power5+, or Power6) and any Power6-based System i or Power Systems box running i5/OS or i 6.1–rose by 29 percent. As I pointed out when discussing the first quarter of the year, IBM should either break out i, AIX, and Linux sales on Power Systems machinery, or just call everything Power Systems and give one number with some color on sales of different operating systems. IBM’s System x machinery–which is supposed to be called Modular Systems and which includes System x products as well as BladeCenter blade servers–saw a 5 percent decline in the quarter, mostly due to tepid entry and midrange System x server sales; high-end System x and BladeCenter machines had double-digit growth of 32 percent and 14 percent, respectively.

IBM is starting to talk about server sales in terms of capacity, not brand. Loughridge said high-end server sales (which presumably include mainframes, but maybe only non-mainframe gear) rose by 21 percent, pushed by the high-end Power 595. (That sounds like mainframes are not in there to me. Go figure.) Loughridge added that in the first quarter, midrange server sales rose by nearly 60 percent, but Q2 beat that with 68 percent growth. He did not give figures for entry servers.

Storage sales within Systems and Technology rose by 12 percent, retail store equipment sales were flat, and OEM chip sales fell by 19 percent. So blame the game console manufacturers for STG’s relatively weak overall growth in the quarter. Loughridge said that disk array sales rose by 20 percent, with sales of the high-end DS8000 growing at 24 percent. Midrange and low-end disk arrays had 28 percent growth, but tape dropped by 2 percent in anticipation of new 1 TB tape drives.

IBM’s software business is a little bit larger, and grew a lot more, too. Software Group posted sales of $5.6 billion in the second quarter, up 17 percent as reported and up 9 percent in constant currency. Operating systems accounted for $616 million, with key branded middleware–WebSphere, DB2, Tivoli, Lotus, and Rational–accounting for 55 percent of total software sales in the quarter, or just shy of $3.1 billion, up 21 percent. IBM’s other middleware, used mostly on mainframes and AS/400s, accounted for just over $1.2 billion in sales. This business has a gross margin of 84.6 percent and pre-tax income of 23.7 percent. And it is driven, as I have said, largely by Big Blue’s server business with some contribution coming from other server platforms. Within Software Group, the WebSphere line of middleware and Tivoli system management and security products both posted growth of 9 percent, DB2 and other databases and their related tools had 30 percent growth, Lotus groupware had 21 percent growth, and Rational had 37 percent growth.

OK, so now we can talk about Global Services. IBM breaks this group into two pieces just so it doesn’t make the other groups look too puny. (It doesn’t really work, and that is why I think IBM will break Global Services into three units sooner or later.) Global Technology Services had sales of $10.1 billion, up 15 percent as reported and 8 percent at constant currency. (This is the unit that includes outsourcing, systems integration, hardware maintenance, and business technology optimization.) Global Business Services raked in $5.1 billion, up 18 percent (9 percent at constant currency), and if you put a gun to my head, I can make up a description of what I think this unit does, but Global BS seems to just about cover it as far as I am concerned. But anyway. . . . $5.1 billion is real money, and all kidding aside, I suspect this is a real profitable unit, too.

By geography, IBM’s sales were pretty balanced. The Americas region reported $10.9 billion in sales, up 8 percent (but 6 percent when measured in local currencies), while Europe, the Middle East, and Africa rose by 20 percent to $9.8 billion. (That was only 7 percent growth in local currencies, and you can see the affect of having oil priced in dollars and a debtor nation status for the United States has had on the dollar-euro exchange rate. U.S. IT manufacturers that sell lots of stuff overseas just love it.) Sales in the Asia/Pacific region rose by 16 percent to $5.3 billion, but only rose by 6 percent in local currencies. Ditto for the dollar in this region. OEM sales were $706 million, down 17 percent, mostly thanks to IBM Microelectronics not selling as many game console chips.

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