Power Systems Down A Bit in IBM’s First Quarter

April 27, 2009 Timothy Prickett Morgan

IBM‘s Power Systems division, which sells what were formerly known as System i and System p servers and which are simply called Power Systems these days, was a relative bright spot among its various server lines in the company’s financial report for the first quarter of 2009. But even the popularity of IBM’s high-end Power boxes could not defy the same pressures that all of IBM’s other groups are feeling thanks to the economic meltdown.

For the first quarter, IBM’s revenues fell across all of its major product groups–some more than others–and profits took a slight haircut, too. But, thanks to the magic of share buybacks, which the company shelled out some $1.8 billion in cashish to do, Big Blue was able to show an increase in earnings per share, which is what IBM has taught Wall Street to believe is what really matters over the past 16 years since Louis Gerstner came in from RJR Nabisco to take over. Sam Palmisano, IBM’s current president, chief executive officer, and chairman has continued using the same playbook, which Gerstner scribbled in the blank pages for some IBM ivory letters relating to AS/400 F Series announcements, if I am not mistaken. (The pages have yellowed considerably in the ensuing years, I suspect.)

Let’s talk numbers, then. In the first quarter, IBM’s revenues fell by 11.4 per cent to $21.7 billion, and gross profits fell by 7.2 percent–because of pricing pressure, I presume, as IBM tried to close deals in this troublesome (some say rotten) economy. Even after IBM’s secretive layoffs last summer and fall and other cost cutting maneuvers, like trimming back on research and development, IBM was only able to bring $2.3 billion to the bottom line, down 1 percent from the year-ago quarter. Thanks to those share buybacks, earnings per share came in at $1.70, up 3.7 percent.

IBM’s Systems and Technology Group, which is where the Power System i platform lives, had a 23.5 percent decline in first quarter sales, to $3.23 billion, and stunningly, pretax income for the group was down 80.7 percent to $28 million (yes, I said “million”). I guess IBM slashed server and storage prices a whole lot even to get the shellacking it got in the first quarter. The Power Systems platform, which includes sales of machines that support i, AIX, and/or Linux, had only a 2 percent decline in sales, according to Mark Loughridge, IBM’s chief financial officer, who spoke to analysts about the numbers after the market closed last Monday (April 20). When Power Systems sales are measured in the local currencies where the deals were done instead of being translated back into U.S. dollars, sales for Power-based machines actually rose by 5 percent. This was the only part of Systems and Technology Group that had real growth when measured in constant currency. All other divisions within STG saw double-digit declines, and some of them quite steep indeed.

Loughridge said that high-end Power Systems sales (by which I expect he means Power 570 and Power 595 machines) increased by 35 percent in the quarter, and he said that IBM believes that it gained 4 points of market share, presumably he meant in the Unix market and presumably counting i boxes as Unix machines. (To be fair, OS/400 had all but a few supercomputing APIs of the Unix API set, and might as well be considered Unix with this whole other OS/400 environment to play with.)

On the mainframe front, revenues were down 19 percent while MIPS shipment rose by 18 percent. MIPS shipments for specialty engines, which support Linux or WebSphere or do DB2 acceleration, rose by 20 percent, with Linux-related MIPS shipments up 50 percent. The shift to these low-cost mainframe engines is what is helping keep the mainframe alive, but z/OS engine sales are clearly stagnant or falling, driving down sales.

IBM’s System x server line, which includes BladeCenter blade servers and which use X64 processors from Intel and Advanced Micro Devices, had a third bad quarter, with sales off 27 percent compared to the year-ago quarter. Loughridge tried to blame the X64 server decline at IBM on a soft market and the virtualization effect, and I don’t doubt that these are contributing to IBM’s woes, but I think something else is going on with IBM’s X64 server business, too. Storage sales were down 20 percent in the quarter, with double-digit declines in both disk and tape storage.

Even Software Group had a tough quarter, with sales down 6.3 percent to $4.54 billion, but rose by 2 percent at constant currency, showing you just how much stronger the dollar is compared to other currencies for reasons that I doubt Ben Bernanke can explain. WebSphere middleware sales rose by 5 percent, and Rational development tool sales were up 9 percent, bucking the trends at IBM for Q1. But the Information Management segment, by which IBM means databases and related tools, saw an 8 percent dip, Tivoli systems management tools fell by 1 percent, and Lotus groupware dropped by 12 percent.

Global Servers, which puts about half of IBM’s numbers on the board these days, put $13.15 billion in sales–or 60.6 percent of the revenue IBM booked in the quarter–on the books. The Global Technology Services piece of the services behemoth accounted for $8.75 billion in sales, down 9.5 percent; this is the part of IBM that does strategic outsourcing, product maintenance, and integrated technology services. Global Business Services saw sales slip by 10.5 percent to $4.4 billion; this part of IBM does consulting, systems integration, and application outsourcing. The outsourcing business over at GTS had $5.6 billion in new contract signings in the quarter, up 8 percent, while the application outsourcing business that is over at GBS saw a 44 percent rise in signings, to $1.4 billion. I guess people are getting sick of buying infrastructure, eh? Anyway, IBM had a total of $12.5 billion in services contracts inked in the quarter, and now has $126 billion in its services backlog. That’s not quite money in the bank, but it is as close as it gets, and it is a big pile of dough.

Which is probably why IBM is so chipper. The fact that IBM reckons, according to Loughridge, that the governments of the world have printed up $5 trillion in stimulus funds and that some $3 trillion of that can be chased (but certainly not captured) by products and services made by Big Blue, isn’t hurting the mood at the company, either. Unless you happen to be one of the IBMers who is getting sacked on the QT, of course. Palmisano is certainly pretty peppy, considering all of the negative signs in IBM’s financial report for Q1.

“IBM continued to perform well in a very difficult economic environment,” Palmisano said in his traditional quarterly statement accompanying the financial results; he did not join the Wall Street conference call, which he should do some time. “This was due to our long-term strategic focus: shifting into software and services, divesting of commodity businesses, and creating solutions that help clients reduce cost and conserve capital. At the same time we have a disciplined approach to cost and expense management giving us a strong financial position. We are well-positioned to continue to move aggressively and leverage our strong cash performance to make the most of the opportunities that arise, including smarter planet initiatives and other strategic options. We remain ahead of pace for our 2010 roadmap of $10 to $11 per share.”

Palmisano was referring to earnings per share for the full year, which IBM might have to buy with its cash hoard if the economy doesn’t improve. IBM has $12.3 billion in cash, but also has $7.6 billion on debts not related to its Global Financing arm, which finances IT products for resellers and customers. Global Financing has $30.5 billion in assets, but also has $23.4 billion in debts.

Palmisano did not say anything about the rumors that IBM was trying to buy Sun since mid-March, and on the call, Loughridge spent about as much time as it takes you to read a period on the subject of Sun and Oracle’s proposed acquisition earlier in the day. He said that Sun and Oracle have been partners for 20 years and still, somehow, IBM has managed to gain market share. “We have been competing with Sun, and we know Oracle inside and out, and now they have the same address and the same mailbox,” Loughridge added with just a touch of disdain. He brushed off a question about Cisco Systems entering the server space with such brevity and vagueness my brain buffers could not remember what he said and so I didn’t write it down to share with you.

IBM is apparently not worried. And that is pretty foolish. And maybe, just maybe, letting Sun fall into the hands of Oracle will prove to be a very bad thing for IBM’s business in the long term. We shall see.

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