IBM's 3Q profit strong on global sales, cost cuts

Posted October 17, 2008 6:09 a.m. EDT
Updated October 17, 2008 11:12 a.m. EDT

— A big question hanging over IBM's third quarter was just how much new business it brought in during a period of economic strife.

Armonk, N.Y.-based IBM (NYSE: IBM) gets about half its revenue from annuity-like payments from contracts it signed months or even years ago. So IBM inking $12.7 billion in new services contracts during the July-September period as the U.S. economy was tottering was a relief to investors Thursday and another sign of IBM's global reach.

The figure was down 4 percent from last year, but short-term contract signings were up 13 percent to $6.1 billion, indicating that IBM was able to lure new business despite the economic turmoil. IBM ended the quarter with a backlog of $114 billion in services contracts that have been signed but haven't flowed to the company's balance sheet yet.

IBM said Thursday after the market closed that its third-quarter profit jumped nearly 20 percent, surpassing analysts' estimates, as the technology company overcame slumping hardware sales. The drop in hardware sales was caused by weakness in the low end of the server market, where IBM competes with Hewlett-Packard and Dell.

IBM, which employs some 11,000 people in Research Triangle Park, N.C., had released partial third-quarter results last week to try to reassure investors who had been driving down the company's stock price.

Profit came in 2 cents per share ahead of analysts' recently revised estimates.

IBM earned $2.82 billion, or $2.05 per share, in the three months ended Sept. 30. That compares with net income of $2.36 billion, or $1.68 per share, in the year-ago period.

Analysts surveyed by Thomson Reuters were expecting $2.03 per share.

IBM continues to get better at wringing out more costs to improve its profit margins. Gross profit margin, or the profit on each dollar of sales once manufacturing expenses are stripped out, rose from 41.3 percent of sales to 43.3 percent of sales.

Mark Loughridge, IBM's chief financial officer, said cost-cutting and shunning less-profitable deals were key reasons for the increase. Growth outside the U.S. is also central to IBM's strategy. Sales from so-called "growth markets" increased 13 percent while major markets were up just 5 percent.

Loughridge said economic deterioration would have to get substantially worse for IBM to miss its forecast for 2008. IBM reiterated its target of at least $8.75 per share in profit for the year.

"We'd have to see a dramatic slowdown in our emerging countries, but we don't see that," he said on a conference call with analysts. "Even in a weaker demand environment, we have put exceptional focus on cost, expense and margin management."

IBM's total sales fell short in the third quarter.

IBM's revenue grew 4.9 percent to $25.3 billion. Stripping out currency fluctuations, sales grew 2 percent. Analysts expected $25.9 billion.

Sales were hurt by a 9.5 percent decline in the hardware business, which includes mainframes and computer servers.

While mainframe sales were up 25 percent, helping IBM in a big way because of the mainframes' fat profit margins, a line of cheaper servers built with industry-standard x86 processors fell 18 percent, and IBM said it expects weakness in that area to continue.

That's potentially a troubling trend for other companies like HP and Dell that also compete in the x86 server market.

IBM was strong in its most lucrative areas.

Services revenue grew 8 percent to $14.76 billion. Software sales rose 12 percent to $5.25 billion. Together, the two segments make up nearly 80 percent of IBM's sales and nearly 90 percent of its pretax profit.

IBM shares gained $2.23, 2.4 percent, to $93.75 in extended trading after the company reported its results. The stock gained $3.23, 3.7 percent, to close at $91.52 during the regular trading session.