IBM: A Tight Ship in Rough Seas

The company's recent financial result demonstrate that running a lean operation can produce a profit even against a headwind.

A number of tech firms are managing to squeeze out profitability in the midst of falling revenues by driving efficiency and streamlined operations. Intel (NASDAQ: INTC) has been on an operational efficiency charge for a while that has yielded great results, but IBM has managed to make Intel look like a self-indulgent 1999-era Dot Com company by comparison.

Despite year-over-year quarterly revenue declining for the fourth quarter in a row, IBM (NYSE: IBM) managed to pull out a healthy net profit thanks to an emphasis on operations, global business alignment and shifting to higher margin businesses.

As such, IBM was able to report second quarter earnings of $3.1 billion, or $2.32 per share, an 18 percent increase over diluted earnings of $1.97 per share in the second quarter of 2008. The earnings per share results were the highest for any first, second or third quarter in the company’s history, adjusted for stock splits.

And that comes on a down quarter. Total revenues for the second quarter were $23.3 billion, a decreased 13 percent (seven percent when adjusted for currency) from the second quarter of 2008.

As such, IBM raised its third quarter and full year 2009 estimates. It now expects full year earnings per share of $9.70, up from $9.20.

Mark Loughridge, senior vice president and chief financial officer of IBM, told a conference call of investors and analysts that IBM has essentially cut its way to profitability. "Margins are fueling profit growth," he said. "Our model delivers improved margins even when revenue growth is a headwind. So when revenue growth becomes a tailwind, the model we've created will become an advantage."

IBM raised its gross profit margin from 43.2 percent in the second quarter of 2008 to 45.5 percent this year thanks to what Loughridge called "rebalancing" the workforce. Mostly that meant distributing work across the globe and relying more on local employees, but there were some layoffs in the process. More than 9,000 people have been dropped from IBM's payrolls this year.

"This didn't just happen overnight. We've been working on this for a decade," Loughridge explained. "Looking at IBM's performance for the last several years, we have continuously generated strong growth. Since the Dot Com era, we have been executing a strategy aimed at higher value segments, global integration, higher efficiency and shifting to higher margin growth markets."

Scoring deals in a down quarter

It was still tough across the board for IBM. It said business in the Americas were down 9 percent, Europe, Middle East and Africa (EMEA) sales were down 20 percent and Asia-Pacific sales were down seven percent. However, it still managed to score 17 services deals worth $100 million or more.

The hardware business was down by double digits in the quarter, but looking forward, IBM expects that rate of decline to be cut in half in Q3 and cut in half again in Q4. "We're confident we have a good hardware play going forward. It should generate positive profit growth going into the fourth quarter," said Loughridge.

Software "had a terrific quarter and we expect to see about the same revenue performance in the third quarter," he said, also noting that middleware now makes up 58 percent of total software products.

Short-term signings for services were down seven percent, driven by customers being particularly careful about spending the discretionary element of budgets. Going forward, Loughlin expects "there will still be budget pressure. On the other hand, we think as stimulus starts to roll out that customer adoption should improve."

While IBM is still not making revenue projections, Loughridge felt IBM was very well positioned for 2010 to meet the projected earnings of between $10 and $11 per share.

"That was a long range forecast we built and it was built on the contribution from revenue and margin and share repurchase and acquisitions. We're ahead of that pace, with a solid base and structural improvements. Like every year, we will update our view in January," he said.

Article courtesy of

Tags: middleware, services, software, IBM, Intel

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