Hardware Sales, China Market Drag IBM Revenue South 4 Percent

Mark Loughridge

Despite solid profit growth, IBM's 4-percent year-over-year revenue decline for its third fiscal quarter disappointed investors Wednesday, prompting them to drive down the company's shares nearly 5 percent in after-hours trading.

IBM laid the blame for its third fiscal quarter revenue shortfall clearly on the China market and on a very disappointing double-digit fall in hardware sales.

"Obviously, this was a tough quarter for us," said Mark Loughridge, IBM senior vice president and CFO.

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IBM on Wednesday reported revenue for its third fiscal quarter, which ended Sept. 30, of $23.7 billion, down 4 percent from the $24.7 billion IBM reported in its third fiscal 2012 quarter.

Third-quarter income was $4 billion on a GAAP basis, compared with $3.8 billion in the third-quarter of 2012, an increase of 6 percent. IBM reported earnings per share of $3.33, up 11 percent. Non-GAAP income was $4.4 billion, or $3.62 per share, compared to last year's $4.2 billion. A 9-percent drop in revenue from growth markets led the revenue decline, Loughridge said. That, in turn, was led by a 22-percent fall in revenue from China, which Loughridge said was caused by that country's transitioning to a new economic development plan that is expected to impact IBM's business there for another couple quarters.

The U.S. market, on the other hand, was nearly flat, with a revenue drop of about 1 percent, while other "major" or non-growth market did well, he said.

"This is the best major market performance since the first quarter of 2012. ... Clearly, we need to improve our business, particularly in the growth markets," he said.

One bright spot from the falling revenue was a lowering of the amount in performance pay IBM recorded for the third quarter of $175 million, Loughridge said. "IBM has a pay-for-performance culture," he said.

IBM did well in all its major businesses except hardware, where the company's Systems and Technology Group reported a 17-percent drop in revenue to $3.2 billion. Loughridge said growth markets accounted for about two-thirds of that drop. Half the drop was attributed to the Chinese market, where hardware sales fell 40 percent excluding mainframe sales compared to last year, he said.

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For hardware, only IBM's System z mainframe business saw solid growth, with revenue up 6 percent over last year. The company's microelectronics OEM business was nearly flat with a 1-percent growth.

Power Systems server revenue, on the other hand, fell 37 percent year-over-year, while System x server revenue fell 18 percent and storage revenue fell 11 percent.

IBM plans to boost its Power server business by focusing it more on Linux going forward, IBM's Loughridge said.

"Linux is now a larger market than Unix, and is growing exponentially," he said.

IBM also saw double-digit growth in its Storwize storage business and strong growth in its flash storage business, he said.

IBM's software revenue rose 1 percent over last year to $5.8 billion, led by a 14-percent growth in its social workforce solutions and a 12-percent rise in its Rational branded software sales. Information management and Tivoli-branded software sales both rose by 2 percent over last year, while sales of WebSphere software were flat.

On the services side, IBM's Global Technology Services (GTS) revenue fell 4 percent to $9.5 billion, while its Global Business Services (GBS) revenue was flat at $4.6 billion.

However, Loughridge said, IBM's services backlog grew 2 percent over last year.

IBM's cloud revenue is up over 70 percent year-to-date compared to last year to about $1 billion. IBM reported about $460 million in revenue from cloud services.

The Federal shutdown so far has had no impact on IBM, Loughridge said.

Federal business accounts for less than 3 percent of IBM's total revenue, he said. "It turns out the bulk of our federal business is not exposed, or if it is exposed, it's deemed essential," he said.

Should the shutdown last through October, IBM expects no meaningful impact to its overall business, Loughridge said. A shutdown through November could start to have a meaningful impact, while one lasting through December could cause earnings-per-share to fall 5 cents, he said.

The biggest impact of a federal spending slowdown is on IBM's global business services business, he said.

Looking ahead, Loughridge said IBM is maintaining its full-year non-GAAP earnings-per-share expectations of at least $16.25, with $20 per share still being projected for fiscal year 2015. Full-year GAAP earnings-per-share is slated to be at least $15.01.