Hardware boom boosts IBM in Q1

Software, services keep the dollars rollin'

A bullish hardware upgrade cycle coming out of the Great Recession in the Western economies and continuing booms in several dozen growth markets around the globe helped IBM boost its revenues in the first quarter of 2011 by 7.7 per cent, to $24.6bn.

An ever-weakening US dollar didn't hurt Big Blue's books, either, since a large portion of the company's sales are overseas. Real revenue growth was on the order of ive per cent, as reckoned in local currencies in the 170 countries where IBM does business.

Net income grew faster than sales in the first quarter, which is something IBM works hard to engineer each quarter through continuous share buybacks, "workforce rebalancing," automation, and supply chain wringing. Net income was up 10.1 per cent, to $2.86bn, in the quarter, and earnings per share was up 17 per cent, to $2.34.

In terms of growth this quarter, IBM's Systems and Technology Group, which makes chips, servers, storage, and networking equipment, was the star, with revenues up 19 per cent. Hardware revenues were not just driven by the company's System z mainframes, which started a long-awaited upgrade cycle with lots of pent up demand last fall. The company's upgraded Power Systems line also started pulling its weight, making up in part for somewhat sluggish sales of x64-based systems.

In a conference call with Wall Street analysts, IBM's chief financial officer Mark Loughridge said the hardware unit had the "best first quarter growth in over a decade." At constant currency, STG's sales were up by 16 per cent, and in the growth markets (Brazil, Russia, India, China, and sixteen others Big Blue lumps in together) hardware sales were up 19 per cent.

In Q1, the company's System z mainframes posted 41 per cent revenue growth, with shipments of aggregate mainframe capacity (as measured in MIPS) rising by 34 per cent. This was the best MIPS growth in a first quarter that IBM has seen since 2004, according to Loughridge.

Everyone is wondering when the System z refresh will peter out, and Loughridge said IBM was expecting for 2011 to be a strong year for mainframes, driven by new customers and new boxes, with 2012 driven by upgrades on existing System z10 and zEnterprise 196 machines.

On the Power7 server front, Loughridge said entry Power Systems sales were up by a factor of two, which stands to reason because IBM only upgraded these entry machines with Power7 processors late last summer.

High-end Power Systems sales were up by over 30 per cent, again because IBM kicked out the Power 795 machines at the same time. The midrange of the Power Systems lineup was refreshed in early 2010 and has not been sufficient to give IBM the growth it likes to see in the RISC racket.

Loughridge thinks IBM gained four points of market share in the mainframe and Unix systems markets in the first quarter, and that almost all of the eight per cent growth for the overall Unix market in Q1 that Big Blue estimates will be due to IBM's its growth rate for Power Systems running AIX.

On the x64-based server front, IBM's System x rack and tower server and BladeCenter blade servers had only 13 per cent revenue growth, but Loughridge said this was enough for Big Blue to hold its market share. High-end System x server sales using the beefiest chips from Intel and Advanced Micro Devices was up 42 per cent in the quarter, and the company believes that it gained share here.

Storage sales were up only 10 per cent in the quarter, with disk-based product revenues up 13 per cent. That means tape was a laggard, but Loughridge did not elaborate.

IBM's Software Group continues to be the profit engine, of course, with sales up 10 per cent, to $5.3bn. Thanks to organic growth with application servers and integration products and the acquisition of Sterling Commerce, Unica, and others, the company's WebSphere branded products had a crazy 51 per cent growth spurt in the first quarter.

Information Management software, which includes DB2 and IMS databases as well as the Netezza data warehousing appliance database now, had 13 per cent growth in Q1. Tivoli systems management tools posted eight per cent growth, Rational application development tools were up five per cent, and Lotus groupware tools squeaked out a point of growth. IBM's gross margins on software in Q1 were 87 per cent, more than twice the margins the company rakes in on hardware these days.

If software is the profit engine at Big Blue, services is the revenue engine and even with lower gross margins than even hardware, this people-intensive business nonetheless throws off plenty of cash just from its sheer size.

Global Services represented $14.6bn in revenues in the first quarter for IBM, up six per cent from the year ago period. Global Technology Services – where IBMers manage your technology, either directly or through outsourcing – accounted for $9.86bn of that, with Global Business Services – where IBMers run your applications on Big Blue's own iron, integrate your systems, or mess around with your business processes – accounting for $4.71bn of that.

Wall Street was a little freaked out on the call with Loughridge that services signings had plummeted 18 per cent in the quarter, and IBM's CFO did a lot of singing and dancing to try to convince them there was nothing to worry about. IBM had a services backlog of $142bn as the first quarter came to an end, an increase of $8bn as reported but only up $1.5bn on a year-on-year basis if you look at it on a constant-currency basis.

Everyone, quite predictably, wanted to know about the effect that the earthquake and tsunami was having on IBM's business in Japan. Loughridge said Japan was about 11 per cent of the company's overall sales, with about three-quarters of that coming from services. Based on the trajectories for revenues from January and February, IBM estimates the disaster only caused its business in Japan to take a one per cent hit, and that the company did not expect any big disruptions in its business or its supply chain for parts because of the disaster.

In the quarter, IBM shelled out $4bn for share buybacks and paid out $800m in dividends. It exited the quarter with $13.2bn in case, with about $6.5bn in debt not associated with its Global Financing operations, which lend resellers money to buy gear and provide financing for its systems, software, and services to end users.

Don't expect Big Blue to make any big bang acquisitions. Even if it wanted to, it needs the cash to keep engineering that EPS growth. Speaking of which, business was so good in the first quarter that IBM upped its expected operating EPS for 2011 by 15 cents to $13.15. ®