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IBM: A Work in Progress

By Steve Hamm For proof that IBM (IBM) is a company in transition, look no further than the computing giant's second-quarter earnings. The numbers it reported after the market close July 18 beat analysts' expectations through a combination of special charges and gains, and through business-unit results that ranged wildly from good to bad to mediocre.

On July 19, IBM stirred up the pot by announcing a reorganization of its 190,000-person global services unit. Division head John Joyce, a 30-year IBM veteran, is leaving the company and joining private equity firm Silverlake Partners. Meanwhile, the unit is being split among three executives who all report to Chairman and CEO Samuel J. Palmisano.

In its earnings announcement, IBM said that, excluding one month of sales from the PC unit, which IBM sold in May, revenues came in at $21.7 billion, up 6%, and net income was $1.9 billion. If you include the one month of PC sales but exclude nonrecurring items, net income was $1.8 billion, or $1.12 a share, up 11% from the previous year.

SOOTHING WORDS. The special items include a $775 million gain from the settlement of antitrust issues with Microsoft (MSFT), a $1.1 billion gain from the sale of the PC unit to China's Lenovo, and a $1.7 billion restructuring charge in connection with firing of 14,500 employees in slow-growth businesses and geographic markets.

IBM's business-unit sales results were all over the place. Mainframe sales were down 24% as the company readies new models to be announced July 26. Meanwhile, sales of Unix servers rose a very strong 36%. Global Services revenues saw another relatively weak quarter, up just 6% -- though the backlog of service-contract bookings rose for the first time in more than a year, by $3 billion, to $113 billion.

Chief Financial Officer Mark Loughridge seized on the improvement in an attempt to dismiss worries that were raised when the services unit reported poor first-quarter results. "Our backlog performance is in much better shape and shows the recovery we have been looking for," he said during a conference call with Wall Street analysts.

NEW HORIZONS. Since IBM's brush with death in the early 1990s, it has relied on the services business to drive overall revenue growth, and to rich profits from mainframes to boost its earnings. Now, both its services business and mainframes are in transition.

Services are shifting from traditional tech areas, such as IT outsourcing and systems-integration, to newer areas. These include business-transformation consulting and business-process outsourcing. At the same time, the mainframe operation is shifting to new applications, such as running Web sites and services.

"I think this quarter demonstrates how unsettled market conditions are," says Caris & Co. analyst Mark Stahlman. "The old IBM doesn't fit with the new markets. IBM understands this and is trying to move quickly to change itself. This elephant has been dancing on stilts."

In the services reorganization, Ginni Rometty, who had run business consulting since the 2002 acquisition of PricewaterhouseCoopers, will oversee a new unit called Enterprise Business Services, which includes consulting, business-process outsourcing, and research consulting.

Mike Daniels, who had run IBM sales in the Americas, will operate the traditional info-tech services businesses, including outsourcing. And Bob Moffat, who had run IBM's supply chain, will become senior vice-president for integrated operations, overseeing much of the staff that delivers services for Rometty and Daniels.

WAIT AND SEE. Analysts who participated in the earnings conference call seemed cheered by the results. So were investors. Big Blue's shares rose 4%, to $85 in afterhours trading. Before that hop, July had already seen the stock go up 10%, to about $82 per share. It hit nearly $100 late last year, but sank to a low of $72 in April after first-quarter earnings were announced.

While investor confidence seems to be returning, a close look at the results reveals continuing uncertainties in the services realm. IBM's Business Performance Transformation Services, which includes business-change consulting and business-process outsourcing, rose just 25% -- much slower than the 40% growth it achieved in 2004. Investors may have to wait another couple of quarters to see if IBM really is on track.

Hamm is a senior writer for BusinessWeek in New York

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