Steady as She Goes for IBM’s Third Quarter

October 19, 2009 Timothy Prickett Morgan

If there is an economic meltdown, the top brass at IBM seem to be relatively unaffected by it, at least based on its increasingly profitable financial situation. Last Thursday, Big Blue reported that once again its revenues had dropped compared to the prior year, but thanks to cost cutting it was not only able to report very good profit growth but also is raising its profit guidance for 2009 for the third time.

In the third quarter, IBM’s total revenues were $23.6 billion, down 6.9 percent compared to the year-ago period. Gross profits were down 3 percent to $10.6 billion, but after slashing sales, research, development, interest, and other costs not related directly to the manufacturing of its products, IBM was able to boost its net income in the quarter by an impressive 13.8 percent to $3.2 billion. (That’s impressive unless you are one of the 10,000 IBM employees who have been given the sack this year.)

IBM’s Systems and Technology Group doesn’t talk about the System i or even the Power Systems i business any more, but isn’t it funny how Mark Loughridge, the company’s chief financial officer, and other executives call the converged i-p Power Systems business unit and its products “System p” almost two years after the products were converged? I guess we know who won that political battle among the bean counters.

Anyway, Loughridge said in a conference call with Wall Street analysts after the market closed on Thursday that the Systems and Technology Group had sales of $3.92 billion, down 11.6 percent, which is a decline that suggests IBM is doing better than some of its peers out there in the server racket. Loughridge said that while Power Systems sales (which he called Converged System p, grrrrrrr) fell by 10 percent compared to the third quarter of 2008, IBM believed that it actually gained 5 points of market share in the Unix server business because Sun Microsystems and Hewlett-Packard fell even further. IBM was also bragging that it did $150 million in competitive takeouts against HP and Sun Unix iron in Q3, and that for the year it has done more than $400 million in such business.

IBM’s System z mainframe business stomached a 26 percent revenue decline in Q3, which Loughridge said was against “a very strong compare.” Indeed, in the year ago period, IBM’s System z revenues rose by 25 percent and its MIPS shipped was up like a rocket, by 49 percent. The word on the street is that IBM has not only been selling its lower-cost specialty engines at a low, low price, but often giving them away to sell real z/OS engines and to at least be able to keep the MIPS shipments up. But this time around, in Q3 2009, MIPS shipments were down 20 percent. Customer appetites for mainframe capacity seem to be on the wane.

The company’s System x server business, which consists of X64-based machines in rack, tower, and blade form factors (remember when these were going to be put into a division called Modular Systems?), reported a sales increase of 1 percent compared to a year ago, according to Loughridge, who added that IBM believes it actually gained 2 points of market share in the quarter in the X64 space. It would be hard to not improve over last year’s X64 server business in Q3, when IBM had an 18 percent revenue decline and even blade servers had an 8 percent decline. IBM added that this time around, blade revenues are up 20 percent, and it has taken 2 points of share back in blades.

IBM said that it believed that it gained market share in both disk and tape storage in the quarter ended in September, and the Microelectronics division had sales down only 1 percent, a marked improvement over recent quarters.

Overall, STG had gross profit margin growth across most of its brands, according to Loughridge, and he said that IBM expected STG to show double-digit profit growth in the fourth quarter.

Software Group, which has been bigger than STG for some time now, had only a 3 percent decline in the third quarter, with sales falling 2.6 percent to $5.11 billion. Database and related database tool sales were flat in the quarter, and Lotus middleware and client software sales were down 9 percent. But WebSphere middleware posted an impressive 14 percent growth rate. Tivoli Systems management tools had a 5 percent increase, and Rational development tools eked out a 2 percent increase in Q3. All told, the key branded middleware products had 2 percent growth, to a $2.91 billion. Other middleware (mostly legacy stuff like CICS, VSAM, and a slew of things running on mainframes) accounted for $1.17 billion in sales, down about 1.5 percent by my estimates based on IBM’s financial presentation. Operating systems accounted for around $510 million in sales and other software accounted for a roughly equal amount, and these had to be down quite a bit for the overall Software Group to shrink by 3 percent. Like something on the order of 16 percent if the decline was spread evenly over operating systems and other software. But no one did the math to figure this out, as far as I can tell, and IBM sure didn’t bring it up.

IBM’s massive Global Services group had sales of $13.8 billion in the quarter, a decline of 6.7 percent. Global Business Services, which includes consulting, systems integration, and application outsourcing (I think IBM means something akin to software-as-a-service there, had $4.34 billion in sales in the quarter, down 11.5 percent. Maintenance services on all of IBM’s hardware and software products (and third party stuff covered in maintenance contracts) had flat sales, at what I estimate to be $1.79 billion, or 13 percent of total sales at Global Services. Strategic outsourcing (the regular kind of outsourcing) posted $4.96 billion in sales in the quarter, down 2 percent, while integrated technology services (which no one has ever successfully explained to me) had sales of $2.2 billion, down 4 percent. Business technology optimization had a 7 percent revenue shrink, to $551 million. IBM ended the quarter with a staggering $134 billion services backlog, and had $11.8 billion in new contract signings. Not bad for an economic meltdown, but expected when an economic meltdown is compelling many customers to outsource.

Everyone wants to know what IBM thinks about the fourth quarter, and Loughridge was more than happy to provide a few hints once the Wall Street analysts did enough poking and prodding. After the question and answer session part of the conference call was over, IBM’s CFO said that the “stable to improving economy” and gave Big Blue the confidence to say that it would return to revenue growth in Q4, topping the $27 billion sales level it hit in Q4 2008. IBM was also happy to report that it was boosting its earnings per share guidance again, now saying that it would have $9.85 per share in earnings. With $11.5 billion in cash, IBM will buy some of the EPS, but a lot of it will come merely because IBM has removed $3.5 billion in cost from its operating expenses in 2009 and will be benefiting now that sales are on the upswing.

Maybe IBM can take a tiny, miniscule, nanoscale slice of these profits and invest it in the iManifest marketing efforts underway in Japan, Europe, and the United States? That would be a huge increase in the Power Systems i marketing budget, now wouldn’t it? But, alas, IBM will probably use the profits to buy back stock and acquire some obscure software company that needs lots of services to integrate its products with the gobbledygook already chugging away in data centers.

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