IBM Loses Money On Hardware In Q1

April 23, 2012 Timothy Prickett Morgan

IBM may have a new president and CEO, but you would be hard-pressed to find any difference between the numbers turned in by Ginni Rometty in her first quarter at the helm of Big Blue and those of her predecessor, chairman Sam Palmisano, in his last quarter standing at the wheel in the fourth quarter of 2011. To many, this makes IBM almost boring in its predictability, but if you are counting on rising earnings driving a rising stock price as well as dividends, this is probably the kind of hum-drum thing you like.

In the first quarter ended in March, IBM raked in $24.67 billion in sales across its hardware, software, and services groups, up a mere three-tenths of a percent compared to the year ago quarter and about $100 million shy of what Wall Street had been expecting. But profits were a bit higher than expected, with net income rising 7.1 percent, to $3.07 billion. Thanks to share buybacks, IBM was able to goose earnings per share by 13 percent to $2.61 a pop, and this is more or less how IBM’s top management grades itself and hands out bonuses and shares to itself, so you know the top brass at Big Blue were quite pleased with themselves.

As is often the case these days with IBM, the hardware business was not a stunner, but as the company’s chief financial officer, Mark Loughridge, pointed out while going over the numbers in a conference call with Wall Street analysts, the System z mainframe and Power Systems were both up against some tough compares in the first quarter. Still, absolute revenues are down as customers are expecting enhancements in both product lines in the second half of this year.

Systems and Technology Group, the part of IBM that makes servers, storage, and networking equipment as well as chips and other intellectual property that it sells to other companies, took a 6.7 percent revenue hit in Q1, to $3.75 billion. Gross margins fell by 3.6 points to 34.2 percent, and the unit had a pre-tax loss of $105 million. Loughridge said that server announcements in the second half of the year would get Systems and Technology Group back on track. He did not elaborate on what these announcements might be, but Loughridge did say that IBM expected for sales of new System x machines based on Intel’s new Xeon E5 chips as well as the PureSystems machines announced last week would start contributing to growth in the second half as well.

During the first quarter, sales of System z mainframes were down 25 percent, and MIPS shipments were off 5 percent. In the year-ago quarter, mainframe sales were up 40 percent, so this was a pretty tough compare. Loughridge said that IBM’s revenue at this point in the System zEnterprise product cycle was focused on customers firing up extra engines on existing machines, which are more profitable sales than the initial machine installs. Given this, you have to wonder where IBM is taking such big hits to its bottom line in hardware. Both Power Systems and System x/BladeCenter sales were flat in the quarter, and either one or both could be the culprit.

The fact that IBM did 250 competitive takeouts in the quarter with Power Systems iron, generating over $200 million in sales and about 20 percent lower than typical takeout deals over the past several years, suggests that Big Blue is having to cut prices to win against Hewlett-Packard and Oracle–especially when customers are expecting new Power7+ servers sometime this year. IBM’s X86-based server business is always under intense pressure, particularly from Dell these days, so this is nothing new and it could be feeling the profit pinch here, too.

Storage hardware sales were down 4 percent in the quarter, but storage software sales spiked 18 percent. As with servers, the revenue is shifting away from hardware and toward software. That doesn’t mean that hardware is not important or that the combined solution is less expensive. It just means vendors are putting the money into different pockets because all the competition is doing it, too.

This is one of the reasons why Software Group has been growing over the past two decades, by the way, but no one seems to want to say it. Everything has a price tag, where in the past new features and functions were integrated by default into IBM’s flagship OS/390 or OS/400 operating systems. IBM is also expanding out into selling application software again and getting more traction in database and analytics software, too, and has carved out the dominant position in application serving to its credit.

In the quarter, Software Group had $5.6 billion in sales, up 5.5 percent, and had gross profits of 87 percent and pre-tax income of $1.95 billion. The five key branded products–WebSphere, Information Management, Tivoli, Lotus, and Rational–accounted for $3.47 billion in revenues, with operating systems generating $616 million and other middleware bringing in a little more than $1 billion. (Most of that is mainframe systems software, with a smattering of IBM i stuff.) WebSphere tools had a 16 percent revenue bump in the first quarter, Tivoli security and systems management software sales were up 5 percent and so was database and related products in the Information Management division, Rational squeaked out one point of growth, and Lotus was flat.

The Global Services giant had $14.67 billion in sales, up only seven-tenths of a percent, and the company’s services backlog was down 2 percent to $139 billion. Global Business Services, which does system integration, consulting, and application hosting, shrank 1.5 percent, to $4.64 billion, while Global Technology Services, which does maintenance, outsourcing, and other services, grew 1.7 percent, to $10 billion. The combined divisions brought Global Services $2.08 billion in pre-tax income in the first quarter.

IBM didn’t say much more about the rest of 2012, but did boost its operating earnings per share target for the year to $15, up 15 cents.

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