IBM Profits On Smart Software Plays

IBM's fourth-quarter 2012 results cap tenth straight year of earnings growth fueled by high-margin software sales.
IBM is treading water from a revenue perspective, but it keeps eking out more profit, year after year, by seeking out higher-margin software and hardware deployments backed by consulting services.

The focus on profits was the constant on Tuesday as IBM reported its financial results for the fourth quarter and year ended December 31. Quarterly revenues of $29.3 billion were down 1% year-over-year, though the result was flat adjusting for currency fluctuations and up 1% excluding the results of IBM's Retail Store Solutions business, which was sold to Toshiba last year.

Despite modest revenue growth, IBM's quarterly net income was $5.8 billion, up 6% year-over-year and yielding a gross profit margin of 51.8%, up 1.8 points from a year earlier. The story was much the same for the full year, with flat revenues of $104.5 billion accompanied by a 5% year-over-year increase in net income to $16.1 billion. Most impressively, earnings per share were $14.37, a 10% increase that marked the 10th consecutive year of double-digit EPS growth.

"Our performance in the fourth quarter and for the full year was driven by our strategic growth initiatives -- growth markets, analytics, cloud computing, Smarter Planet solutions -- which support our continued shift to higher-value businesses," said Ginni Rometty, IBM chairman, president and chief executive officer, in a prepared statement.

[ Want more on smart moves by Big Blue? Read IBM Gets $4.5 Million Tax Break On Analytics Center. ]

IBM's biggest growth area for more than 10 years has been its software business, a fact highlighted by Mark Loughridge, senior VP and CFO, in a conference call with financial analysts after the close of the financial markets on Tuesday.

"Since 2000 we've gone from $2.4 billion annually in software to, in 2012, $4.0 billion in the fourth quarter alone and $11 billion on the year," Loughridge said. Software revenues grew 3% in the fourth quarter and it was also IBM's most profitable business with 90.6% gross profit margin, more than twice the margin of the next-most-profitable segment, Systems & Technology (server and storage hardware).

Acquisitions have driven the vast majority of IBM's software growth through that period, and 2012 was no exception. IBM spent $3.7 billion last year to acquire 11 companies, including Worklight, Vivisimo, Varicent Software, Tealeaf Technologies and Kenexa.

IBM often acquires lesser-known companies in hot categories and then sells the technology broadly across its vast customer base. In the case of Worklight, for example, Loughridge said IBM grew that mobile security unit's revenue from about $1 million before the acquisition to "tens of millions" under IBM.

The bright spot in IBM's Systems & Technology segment 2012 was the System Z mainframe business. A late-year new-model introduction drove a 56% increase in that business while Power Systems servers suffered a 19% decline in revenue in the fourth quarter. Despite the decline, Loughridge insisted that the Power line is gaining share over Oracle/Sun and HP, and he predicted that new models would boost sales by the second quarter of 2013.

IBM's Global Technology Services and Global Business Services (GBS) units suffered 2% and 3% declines in revenue in the fourth quarter, but they still posted higher profits. GBS has renegotiated low-margin outsourcing contracts and is shifting its focus to more complex consulting work involving high-margin software and hardware, Loughridge said. IBM initiatives such as analytics, Smarter Commerce and Smarter Cities are tailor-made to fuel such growth.

Setting expectations for 2013, IBM focused once again on profitability, promising earnings per share of at least $16.70. It also reiterated its goal of reaching earnings of $20 per share by 2015.

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