Power Systems Sales Stalled–Again–By Power7+ Rollout

April 22, 2013 Timothy Prickett Morgan

The first quarter started out pretty good for IBM, according to the company’s chief financial officer, Mark Loughridge. But as it progressed, Big Blue had sales executions with some big mainframe and software deals that pushed out more than $400 million in revenues. And with the Power7+ entry and midrange Power Systems launched in February and not shipping until the end of the quarter, sales of these machines stalled for the second quarter, too. Pushing the Systems and Technology Group to report a substantially larger pre-tax loss than it did in last year’s first quarter.

In the March quarter, Big Blue brought in $23.41 billion in revenues, which was 5.1 percent lower than in the first quarter of 2012. But, as I have pointed out many times before, IBM is less concerned about revenue growth than operating earnings per share because its 2015 Roadmap–the plan that the top brass put together before CEO Sam Palmisano left–has the goal of the company delivering at least $20 per share EPS on an operating basis in the 2015 fiscal year. How IBM gets there is another matter entirely, and this was a rough quarter and not one to engender confidence that IBM can get there. But, the company insists, it is on track for this year’s EPS targets and for the 2015 target.

In a conference call with Wall Street analysts, Loughridge said that a number of factors had weighed in during the quarter, some relating to the mainframe and database software shortfall but others relating to other products or the business overall. The pumping of yen into the Japanese economy didn’t help, which decreases the value of the revenues IBM brings back from Japan, which is still one of the dominant markets for IBM. Loughridge added that the change in leadership in China, which happens every decade or so, also had an effect, and one that it was caught off guard by as states and provinces, which control local industry, put the damper on IT projects as they waited to see which way the wind was going to blow from Beijing. The US government was jittery in its IT spending plans as the budget crisis and sequester lingered, and the Easter holiday falling in March instead of April also hurt sales, just as it did in 2005 when IBM also had a big revenue miss.

Within Systems and Technology Group, mainframes were a high point, and clearly IBM was trying to time the entry and midrange Power7+ server launch during a quarter when mainframe sales would have been strong enough to mask the Power Systems weakness. But when the more than $400 million in mainframe and database software sales slipped out into the second quarter, what it really did was show how weak System x server sales were in terms of profitability, and that perhaps Power Systems machines based on older Power7 chips were also being sold at cut-throat prices. Transitions are always hard, which is why IBM has always staggered and interleaved its server launches. Otherwise you get a sawtoothing of revenues and profits that Wall Street just can’t tolerate. As it is, the fact that so much mainframe iron pushed out to the second quarter is sufficient to make people jumpy. But Loughridge was clear that IBM understood this was a sales execution problem. “We’re going to roll up our sleeves and get this back on track,” he said.

Aggregate mainframe MIPS shipped in the quarter were up 27 percent, and more than half of those were so-called specialty engines to speed up database and Java workloads or to run Linux. That represented a 65 percent increase in specialty engine MIPS shipped, and if you do a little math on that this means that regular mainframe MIPS shipped to run the z/OS operating system had to fall around 19.5 percent. MIPS shipped to support Linux nearly doubled, and specialty engines for accelerating Java (zAAPs) had a 70 percent bump in capacity over Q1 2012 and database accelerators (zIIPs) rose 24 percent in terms of MIPS shipped. IBM expects for mainframe sales to be up by double digits in the second quarter.

IBM did not do the usual bragging about how Power Systems had taken down hundreds of competitive takeout deals, but Loughridge did say that IBM pushed a lot of Power-based supercomputers in the first quarter of last year, which made for a tough compare. So did the impending launch of entry and midrange Power7+ machinery, which everyone expected in the quarter. So it is not really much of a shocker that Power Systems revenues were down 32 percent in the quarter. But there are still issues here.

“Power picked up share, but it doesn’t mean much if you are declining double digits,” Loughridge admitted in the conference call’s question and answer session, adding that IBM planned to do a better job of peddling Linux-based Power servers against X86 servers (neglecting the fact that Windows dominates on X86 iron and Windows does not, but certainly could, run on Power iron). Whatever IBM’s plan, he said it would take six to nine months for it to get back on track. I am going to noodle this a bit, but I would guess that Power 770+ and Power 780+ machines are not selling as well as Big Blue would like, and the fact that there is no Power 795+ is probably causing a slowdown in revenues at the high-end, too.

System x sales, which include BladeCenter iron and any x86-based PureSystems iron (presumably) was down 9 percent in the quarter. We’ll see if Hewlett-Packard, Dell, and other X86 server makers had similar declines in the coming weeks, but my guess is that IBM, being focused on large enterprises, will be hit a little bit harder in the X86 racket, if there is a slowdown ahead of the launches of new Xeon E5 and E7 processors from Intel that are expected in the second half of the year.

Toss in storage, both disk and tape products, which declined 11 percent in the first quarter, and it was a pretty disappointing three months for Systems and Technology Group, which saw external revenues (for chips, servers, networking gear, and storage sold to companies and resellers) fall by 17.2 percent to $3.11 billion. IBM had a total of $3.21 billion in STG sales in the quarter if you count iron that it sells to other IBM divisions and groups (such as appliances), then it was $3.23 billion. The trouble is that IBM’s pretax losses widened to $405 million in Q1 2013, compared to a loss of $105 million in the year-ago period.

It would have been better to have gotten Power7+ chips in the field at the end of 2011 or in early 2012, ahead of the System zEnterprise EC12 mainframe launch last summer, and this was more or less the plan (as expressed by those Power7′ or Power7 Prime machines). But it did not come together or was changed. IBM needs to get out in front of Intel, not follow it, and Power7+ followed Xeon E5 in the core two-socket workhorse server. (Power7+ in the Power 770+ and Power 780+ machines did better than the “Sandy Bridge-EX” Xeon E7, which never saw the light of day last year.)

Software Group posted revenues of $5.57 billion in the quarter, down a half-point from a year ago, and after peddling another $831 million on wares to other IBM divisions, it was able to book a pre-tax income of a shade over $2 billion in the quarter. The five key branded products–you know them by heart already, but it includes WebSphere, Tivoli, Rational, Information Management and now Social Workforce Solutions (formerly known as Lotus)–brought in $3.51 billion, up a point. Operating system sales came to $578 million and fell 2 points, and the other bits of the Software Group portfolio (which includes mainframe and IBM i add-ons) we down a tiny bit to $1.1 billion.

Sales at Global Services was down 3.9 percent to $14.1 billion, with $2.29 billion of pre-tax income. IBM has a backlog of $141 billion of services deals on the books, which is up a point from a year ago. All of its various units in Global Services–outsourcing, integrated technology services, maintenance, application outsourcing, and consulting and integration–were down in the quarter. Global Financing had $499 million in external revenues and twice that when you add in financing it did for other IBM divisions, and posted a $538 million pre-tax profit.

At some point, with IBM constantly shrinking, even with expanding profits, some people who think of IBM as a bellwhether are going to get freaked out and think something is messed up in the IT sector. Maybe there is something messed up. If IBM thought the transition from mainframe to client/server was bad, at least there was some profits left. The combination of commodity hardware, virtualization, and cloud computing is increasing efficiencies, and that is great, but it is also squeezing profits from the IT machine and every industry needs profits. IBM wanted to be in services, but it might have picked the wrong kind in the long run. The Google search engine and advertising empire is getting close to the same size as IBM itself, just to name one.