Slow server, services sales drag down IBM

Stung by ongoing IT spending sluggishness worldwide, IBM reported sharply lower first quarter earnings of $56 million.

Stung by ongoing IT spending sluggishness worldwide, IBM on Wednesday reported sharply lower first quarter earnings of $56 million or 3 cents a share.

The earnings figure, which included $1.4 billion in restructuring charges, was down from net earnings of $2.04 billion or $1.15 per share in the second quarter of 2001.

IBMs results were slightly better than what analysts had forecast. Analysts at Thomson Financial/First call had predicted a profit of 83 cents a share for IBM compared to the 84 cents a share net before extraordinary charges that the company reported. The companys revenues for the quarter--$19.65 billion--beat the First Call expectation of $19.4 billion. Still, IBMs revenue for the quarter was down seven percent compared to the second quarter of last year.

The significant charges were due to cost-cutting restructuring efforts announced in June. Besides planning to sell its hard disk manufacturing business to Hitachi Ltd., IBM said it would reduce headcount across most of the business. Although IBM has not said how many layoffs have taken place since then, sources put the figure at between 8,000 and 15,000.

IBM said pretax charges related to what it called productivity and other restructuring efforts amounted to $1.68 billion in the quarter, reducing earnings per share by 64 cents. Including expected losses on the sale to Hitachi, total restructuring charges in the quarter were $2.05 billion.

While IBM officials had previously expressed optimism that IT spending could rebound in the second half of 2002, customers continue to hold back, said Senior Vice President and CFO John R. Joyce. "Customers are giving orders a thorough review before signing, and the focus remains on fast payback on investments and new issues such as security and backup and recovery," said Joyce.

The slow rate of IT spending hit the companys services businesses particularly hard during the quarter. While Joyce 90 days ago said IBM expected new order bookings for services in the second quarter to be between $14 billion and $15 billion, bookings ended up being $10.6 billion. Overall, IBM Global Services revenue fell two per cent for the quarter to $8.7 billion.

Hardest hit were Global Services consulting and systems integration businesses. Sales there fell 11 percent during the quarter. IBM Global Services was also hurt by customers delaying signing large new outsourcing deals and, in some cases, scaling back existing outsourcing contracts, Joyce said.

Joyce said IBM failed to close three large outsourcing deals that, combined, would have lifted Global Services to the $14 billion level in new signings. In addition, said Joyce, many of the customers scaling back existing outsourcing deals were in the hard-hit telecommunications industry. Joyce said the company expects to see some additional downsizing of existing outsourcing deals.

Persistent weakness in the services business, which has been a significant source of growth for IBM in recent years, would pose a particular problem for IBM, said Bob Djurdjevic, president of Annex Research in Phoenix. "Not too long ago, services was the crown jewel in IBMs portfolio," he said. "Now its seen its second consecutive declining quarter."

Joyce hinted that, because of ongoing weakness in the services business, more restructuring--including layoffs--could be required. "Skills rebalancing is an ongoing requirement of our services business," he told analysts.

Also hard hit were IBMs server and storage businesses. Revenue for that segment, at $2.9 billion, was down 17 percent compared to the second quarter of 2001. That rate of revenue decline was actually slower than the 25-percent rate the company reported in the first quarter of this year.

Overall storage revenues dropped 23 percent, while server revenues were down 16 percent. Sales of IBMs iSeries servers was down 26 percent, while sales of its RISC-based pSeries Unix servers fell 27 percent. Low-end pSeries servers were particularly hard hit by competition from Intel-based PC servers, Joyce said.

Sales of IBMs personal computers PC printing systems, at $2.8 billion, was down 10 per cent for the quarter. And sales of OEM products like microprocessors fell 30 per cent to $800 million.

The bright spot for IBM was software where total revenues grew by seven percent to $3.3 billion. While sales of operating system software fell by four percent, sales of middleware such as database and WebSphere application server software were up 10 percent.

Despite continued slow IT spending, Joyce said IBM still expects to report earnings per share from operations for the year of about $4.

It was clear, however, that restructuring expenses will continue into the third quarter. Joyce said total restructuring expenses could grow to between $2.5 billion and $3 billion, with much of the additional expenses related to the sale of IBMs hard disk drive business to Hitachi.

Joyce said Hitachi is carefully deciding which hard drive business assets it wants as part of the sale. Annexs Djurdjevic said he believes that process is resulting in higher-than-expected expenses for IBM and could, ultimately, threaten the deal. Joyce said he could not predict when the sale of the hard drive business to Hitachi would be completed.