Software, Unix and Mainframe Servers Boost IBM’s Profits in Q3

The effect of changes in its hardware, software, and services product lines in the past year and layoffs last summer helped IT juggernaut IBM post a 5 percent increase in sales in the third quarter, hitting $22.6 billion in sales, and pumping up profits by 46.5 percent to $2.2 billion. Sales of software across its brands, exploding growth in emerging markets, and a resurgent market for mainframes and Unix servers were the key drivers in the quarter.

IBM’s chairman and chief executive officer, Sam Palmisano, last week gave the traditional statement in the traditional IBM press release accompanying the numbers. “Our strong performance is the result of excellent execution and the repositioning of IBM’s business model to capture the growth and profit areas of a rapidly changing IT industry,” Palmisano said. Unlike Mark Hurd, his counterpart over at Hewlett-Packard, Palmisano doesn’t get on conference calls or answer questions of Wall Street analysts. (And Palmisano probably didn’t actually say or type those words in the press release, either.)

Mark Loughridge, IBM’s chief financial officer, does talk to Wall Street after the financial results come out, though. And he said that the company’s Software Group contributed the most to the bottom line in the quarter. Software Group posted sales of $4.4 billion, up 9 percent, with only operating systems and non branded middleware (meaning programs that run largely on System z mainframes and System i5 servers) having declining sales in the quarter. WebSphere middleware sales increased 30 percent in the quarter, and Tivoli systems management tools showed a big recovery, with sales up 44 percent. (It wasn’t that long ago when Tivoli sales were very poor, and IBM started to focus on provisioning and security to turn this line around.) Sales of its information management products–DB2 and IMS databases and related tools–increased by 12 percent in the quarter. Lotus groupware and collaboration product sales were up 8 percent in the quarter, even with intense competition from Microsoft Exchange and myriad open source alternatives. Rational development tool sales were more muted, up only 2 percent. But these key branded software products grew in aggregate at 20 percent and accounted for 52 percent of IBM’s software sales in the third quarter.

Other middleware products–such as the CICS transaction monitor and various tools that run on the System i5 platform–accounted for 25 percent of IBM’s software sales in the third quarter, and actually declined by 1 percent. Operating systems declined in the quarter, mainly because of price cuts on System z mainframe software and disappointing sales volumes with the System i5 i5/OS-based server line, which is based on IBM’s Power5+ processors.

On the hardware front, IBM doesn’t sell PCs any more, so it doesn’t have to explain why it cannot make money in the PC business. That has to be something of a relief to Big Blue’s executives. And while IBM’s hardware business is no longer the revenue and profit engine that it was in decades gone by, without that hardware business, there would be no software business to crow about. IBM’s Systems and Technology Group had sales of $5.5 billion, up 10 percent.

The big news on the hardware front is that revenues for the System z mainframe line were up 25 percent, with MIPS shipments up 16 percent. IBM has recently revamped its System z lines with smaller, cheaper mainframes, the System z9 BC machines, and is getting more traction with its larger EC class boxes. IBM is seeing a resurgence in mainframe sales in Russia, China, India, and Brazil, and is doing all that it can to make mainframes easier to use for fast-growing companies that have not been able to computerize on a large scale before. Loughridge singled out Belarus Bank, which is a new mainframe customer and the first bank in the former Soviet Union to install a complete SAP banking solution–and it chose IBM mainframes to host that application.

In an interesting statistical aside, Loughridge mentioned that the installed base of mainframe MIPS worldwide had broken through 10 million MIPS for the first time in IBM’s history. That may sound like a lot, but if 200 MIPS is the average engine power, then that would be 50,000 engines, and maybe somewhere between 15,000 to 20,000 footprints. Still, more MIPS is better, and when you consider that IBM can command a few thousand dollars per MIPS for mainframe servers, that works out to an installed base of mainframes that could be worth approximately $20 billion. Not exactly small potatoes.

IBM is also firing on most of its cylinders in the Unix server market after a few disappointing quarters, and according to its statement System p5 server sales (which are mostly running IBM’s AIX Unix variant) were up 10 percent in the third quarter. Sales were driven by the transition to Power5+ processors. The Power5+ chip is also used in the System i5 line, which was revamped at the end of January, but sales declined by 22 percent. The System i5 line did, however, have a tough compare, since sales were up 25 percent in the year ago quarter.

IBM’s X64-based server business, which peddles Xeon and Opteron machines, grew by 4 percent. Loughridge said that System x blade server sales, which are sold under the BladeCenter brand, increased by 24 percent, and including Power-based blades based on the PowerPC 970MP and Cell chips, blade server sales were up over 30 percent. Blades are still, however, a relatively small part of IBM’s business.

Overall storage sales, including various disk and tape products, increased 12 percent, with disk array sales up 14 percent. The high-end DS8000 disk arrays, which were recently upgraded to use the Power5+ processors, were up nearly 30 percent in the quarter. Tape sales were up 8 percent, and Loughridge said the market was keen on the encryption technologies IBM has put into its tape products. IBM’s Microelectronics unit had revenue growth of 29 percent in the quarter, driven primarily by sales of Power chips to game console makers.

The Global Services group, which drove more than half of Big Blue’s sales in the quarter, posted revenues of $12 billion, up only 3 percent. Global Services has been a problem for IBM for more than a year, as companies are doing fewer big, long-term contracts and more smaller, short-term contracts. Loughridge said that short-term signings hit IBM’s targets, with $5.1 billion, but that long-term signings missed targets with only $5.4 billion in revenue. IBM’s total services deal backlog is estimated to be around $109 billion.

IBM split the Global Services business in two last year, creating the Global Technology Services (GTS) and Global Business Services (GBS) units. The GTS unit is the workhorse, with $8.1 billion in revenue booked during the quarter and a total of $6.4 billion in new signings; about 70 percent of the future revenue represented in those deals were in long-term contracts. GTS includes strategic outsourcing, which had a revenue increase of 6 percent, but a signings decline of 29 percent as a number of big deals slipped into the fourth quarter, according to Loughridge. Business transformation outsourcing sales were up 5 percent in the quarter, but bookings increased a staggering 150 percent. Loughridge said that short-term signings for the GBS unit increased by 11 percent and that revenue booked during the quarter rose by 1 percent.

On a geographical basis, IBM’s sales in the Americas region drove the largest part of the company’s sales in the third quarter, with $9.8 billion. But sales in the Americas only increased by 3 percent. IBM’s revenues from the Europe, Middle East, and Africa region, as reported by at headquarters in U.S. dollars, grew by 6 percent to $7.3 billion in the quarter. Sales in the Asia/Pacific region increased by 4 percent to hit $4.5 billion. OEM sales–mostly Power chips and not reconciled to any geography–accounted for $1 billion in the quarter, up 24 percent.