Power Systems Sales Power Down In The Fourth Quarter

January 27, 2014 Timothy Prickett Morgan

Taking over the helm of a giant such as IBM is never easy, and like many company leaders, Ginni Rometty, who has been in charge of Big Blue for the past two years, took over just as massive change was sweeping the industry. The way infrastructure is built, bought, and sold is changing, and IBM is taking more than its share of hits at the moment. That could mean IBM is a canary in the coal mine, being affected by change ahead of its peers. Or that its strategy and products are misaligned to the market.

I don’t have enough data to be sure what issues are keeping IBM from doing as well as it should be peddling servers, storage, and networking based on the technical specs of its iron and software. What we can all see from the quarterly financial results is that IBM’s hardware business is under great pressure and even product refreshes are not helping.

In the fourth quarter of 2013, IBM had sales of $27.7 billion, down 5.5 percent, with net income of $6.19 billion, up 6 percent. Net income would have fallen by the same amount that Systems and Technology pre-tax income fell had it not been for some income tax bennies IBM was able to book in the quarter. For the full 2013 year, IBM’s profits were off nearly a point to $16.5 billion on revenues down 4.6 percent to $99.75 billion.

For the quarter, IBM’s Power Systems line had another severely down quarter, with sales off 31 percent compared to the year-ago period. A year ago, in the wake of the Power7+ launch for Power 770+ and Power 780+ machines and the anticipation that the entry and midrange would be refreshed with Power7+ chips in early spring 2013, Power Systems sales were down 19 percent. So Q4 2013 was a relatively easy compare, and it went from bad to worse. IBM’s new chief financial officer, Martin Schroeter, was not specific about how much of the Power Systems decline was caused by a slump in sales of Power-based iron in China, but presumably that is a big part of the issue as it was in the third quarter of last year. The Chinese government is busy putting together its next five-year plan, and spending on IT by provincial governments and state-owned corporations has been curtailed. Big RISC systems get hit harder by such curtailed spending because X86 iron is still necessary for the massive telecom and cloud build out in the Middle Kingdom.

“Hardware continued to impact our overall performance,” Schroeter said on a conference call with Wall Street analysts after the markets closed on Tuesday last week. “We’re dealing with some challenges in our hardware business models specific to Power, storage, and X86. As expected, in System z we are impacted by the product cycle, as we wrapped on very strong performance from a year ago. Together, these dynamics significantly impacted our revenue growth, and profit.”

In the year-ago period, IBM had $5.76 billion in sales at the Systems and Technology Group, and thanks to the peak in the System z mainframe cycle (sales were up 56 percent), the company was able to book $4.1 billion in server sales and had a pre-tax income of $974 million. Fast forward four quarters, and Systems and Technology Group’s revenues have declined by 26.1 percent to $4.26 billion, server sales within this across all brands is down 28.2 percent to $2.94 billion. Pre-tax income for IBM’s hardware group was down 78.8 percent to $206 million. About half of that pre-tax income decline was due to a 37 percent decline in System z mainframe revenues. Even though System z mainframe sales are down, most of the action at this part of the product cycle is for upgrades, where customers are just activating cores and memory. So each deal IBM is doing is more profitable.

IBM’s System x server business has been in a slump since rumors that it might be trying to sell it off to Lenovo Group first appeared at the end of April last year. As we report elsewhere in this issue, Dell and Fujitsu were interested in acquiring the System x business, but in the end, Lenovo did.

IBM’s System x server business was down 16 percent in the quarter, which is less of a decline than either the Power Systems or System z products had, so this is not exactly the end of the world. And if enterprise spending is taking off a little bit more slowly, as Intel said that it was in its fourth quarter report a week ago, then it is no surprise at all to me that the X86 server sales at IBM would go down more dramatically than at HP or Dell. Those two companies peddle a lot of their iron to small and midrange businesses, while IBM is focused on enterprise customers.

That said, none of this is good for IBM’s top brass, many of whom come from the services and software side of the business and who are not as enamored of hardware as they might otherwise be. To which I would say this: Be very careful, International Business Machines. It still takes hardware to sell all that software. Maybe IBM will just sell off everything, including its fabs and server lines, and just become a reseller of Dell or Lenovo iron. Maybe that is what it craves, to just be out of the hardware business, which is a very tough business indeed. But it doesn’t have to be. People will pay a premium for a premium product, and that is an engineering and manufacturing issue to think of that product and make it profitably.

That is all philosophy. The reality is that IBM will be doing another round of layoffs in the first quarter, and it looks like Power Systems will take the brunt of the hit. Even after all the of things that IBM has done to boost Power–PowerLinux servers and Power IFL partitions with low prices, data analytics tuning for Power, Watson running on Power, and a promise of better Linux support with the future Power8 machines–IBM is facing reality.

“Even with these additional capabilities, we recognize that the size of the Power platform will not return to prior revenue levels. We will take action in this business to reflect the new business model,” Schroeter said. He did not elaborate on the number of employees that would be let go across IBM to get expenses and revenues back into line, but he did say IBM intended to take a charge of $1 billion, plus or minus $100 million, to cover “workforce rebalancings.”

Over at Software Group, everything is hunky dory after a bump or two earlier in 2013. The five key software brands–WebSphere, Information Management, Tivoli, Social Workforce Solutions (formerly Lotus), and Rational–accounted for $5.78 billion in revenues, with operating systems making up $733 million in sales and other middleware (mostly for mainframes, including CICS, DB2, IMS, and so forth) making $1.14 billion. All told, Software Group had $8.14 billion in sales (up 2.8 percent) and a pretax income of $4.24 billion.

I would venture that more than half of that income was just from mainframe systems software. If IBM sold mainframes much more cheaply and ramped up its product cycle to a new and substantial product every year, the business might look very different. Ditto for Power Systems, by the way.

Global Services had a backlog of $143 billion in contracts as 2013 came to a close, and this revenue-generating portion of IBM posted $14.7 billion in revenues, down 2.3 percent. Pre-tax income was $2.93 billion, up a smidgen from a year ago, so those layoffs from the second quarter of 2013 are paying off here. IBM’s technology outsourcing business accounted for $5.72 billion in the quarter (down 4 percent), while application outsourcing brought in just over $1 billion (down 7 percent). IBM has been backing away from this latter unit and pushing more of its own apps on its own cloud. Maintenance for hardware and software combined accounted for $1.76 billion (down 2 percent), while consulting and systems integration brought in $3.67 billion (up 3 percent). Integrated technology services–and after all of these years, I still have no idea what this really is, which I think is funny–brought in $2.49 billion (down 3 percent).