AS/400 Makes it Three in a Row

At first glance, IBM’s reported second-quarter earnings for 1998 do not exactly inspire backflips out of the company or its customers. Upon closer examination, however, the AS/400 Brand performed extremely well, offsetting several other problem areas IBM faced over the past several months.

This is the third straight quarter of double-digit growth for the AS/400, according to Tom Jarosh, general manager of the AS/400 Brand. Shipments of the midrange server were up 25 percent during the second quarter.

"Twenty-five percent of IBM’s AS/400 revenue comes from new customers, showing that the AS/400’s values of reliability, security and scalability are important now more than ever, especially for a 10-year-old machine," Jarosh says. "Forty percent of IBM’s customized AS/400s are being placed to customers new to the machine and to the individual software vendor."

One industry analyst likens the AS/400 to a popular dessert item at this point in its history. "The AS/400 is the chocolate chip cookie of servers – it’s not sexy, but it’s still so good," says Thomas Kraemer, an analyst with Morgan Stanley Dean Witter (New York). "We believe that the AS/400 is a critical platform for IBM, as we estimate that the associated hardware and software accounts for 10 percent of total IBM gross margin."

The outlook for the AS/400 is equally appealing. "We continue to think that the AS/400 is in the newest sweet spot of a major upgrade cycle and that positive growth rates will continue throughout 1998," Kraemer says.

Such growth rates will be challenged by the maturing NT platform, however, Kraemer adds, if IBM does not provide "clear fields of fire" for its AS/400, RS/6000 and other server lines.

IBM Chairman and CEO Lou Gerstner is optimistic. "Our second quarter and first half results clearly indicate, perhaps more so than at any other time in recent years, the value and strength of IBM’s portfolio of businesses." IBM’s diversity has been instrumental in keeping the company moving forward, despite facing what Gerstner refers to as "three major hits that affected the industry: intense price competition and excess inventory in the PC channel, continued severe price erosion in DRAM chips, and the impact of the Asian crisis."

Gerstner points out that, despite another strong performance from the AS/400 Brand, second-quarter results were mixed. Hardware revenues were down, attributed primarily due to the weakness in PCs. Additionally, a "major product transition" slowed System/390 business during the quarter.

IBM plans to address problem areas by reducing PC dealer inventory. Also, IBM is putting much faith in the new S/390 servers, scheduled for availability this month.

Services continued to demonstrate profitability, growing in revenue by nearly $1 billion – "a major contribution to the company’s earnings," Gerstner says. The software business has also treated IBM well, improving its gross margin for the fifth consecutive quarter.

Overall IBM’s North American revenues totaled $9 billion, an increase of 5 percent compared with the same period last year. Total hardware sales were $7.5 billion in the second quarter, a decline of 13 percent compared with the second quarter of last year. PC, RS/6000 and S/390 revenues all declined during this period. Storage revenues increased, however, primarily as a result of continued OEM shipments of hard disk drives.

Services revenues were the big winner during the second quarter, up 22 percent to $5.6 billion, the third consecutive quarter in which services revenues exceeded $5 billion. Software revenues rose 5 percent to $3.2 billion, with particularly strong performance in AS/400 software, DB2 database software and Tivoli systems management software.

Maintenance revenues dropped 9 percent during the second quarter to $1.5 billion, while revenues from rentals and financing increased 7 percent to nearly $1 billion.

IBM’s net earnings – or bottom line – for the six months ended June 30, 1998 were $2.5 billion while revenues were $36.4 billion compared with net earnings of $2.6 billion and revenues of $36.2 billion for the first six months of 1997. Net earnings represent the company’s total revenue, less total expenses.

Numbers alone have not impressed the market as much as IBM’s ability to make money in the midst of a turbulent couple of months. Stockholders showed their appreciation of IBM’s resiliency, as IBM stock went as high as $131 the day after second quarter earnings were announced. IBM stock had been as low as $106 in June in anticipation of a poor earnings report for the quarter.

One analyst firm predicts accelerated growth for IBM during the second half of 1998. This sunny forecast can be attributed largely to IBM’s cutting of PC inventories and anticipation of a new line of mainframes. Another firm predicts IBM shares will rise to $150 within a year, as hardware sales pick up and software and services continue their success.