Servers Slammed in IBM’s Second Quarter

July 20, 2009 Timothy Prickett Morgan

With the entire server market in the tank right now thanks to the poor economy just about everywhere, you can understand why IBM didn’t really want to talk all that much about systems when it announced its financial results for the second quarter last Thursday after the market closed. The irony is, even as bad as IBM’s server sales were in the second quarter, it probably gained share in the key RISC and X64 server rackets.

For the quarter ended on June 30, IBM’s overall sales worldwide dropped to $23.25 billion, down by 13.3 percent compared to the year-ago quarter when the U.S. economy had been in recession for more than a year but the global economy and a strengthening U.S. dollar was masking some of the recessional effects. Even though sales dropped, IBM’s layoffs and “workload rebalancing,” coupled with other cost cutting measures and consolidation of its supply chain and support operations, allowed the company to nonetheless report a net income of $3.1 billion, up 12.2 percent.

Neat trick, right? This kind of business transformation and financial engineering is a key reason why IBM’s Global Services group accounted for $13.4 billion in the quarter. The same thing IBM is doing to itself to make its own business more lean and mean is a prescription that it is peddling to the Global 20,000–and making good money on, apparently.

Sales in the System and Technology Group were $3.85 billion in the quarter, down an eye-opening 26 percent compared to a year ago as enterprise shops locked down server spending excepting on essential, mission-critical projects.

“We believe this performance is in line with the industry,” explained Mark Loughridge, IBM’s chief financial officer, in a conference call with Wall Street analysts. “Now remember, at this point in the first quarter, we also estimated in line performance, but after our competitors reported their results, based on industry reports we actually gained a point of share in the first quarter.”

As basically the only major supplier of mainframes, this can’t be true for the System z. (Yeah, I know Unisys, Bull, Siemens (now Fujitsu , and Hitachi still sell mainframes, but it is noise in the data. And to be fair with IBM, mainframes were up against a tough compare in the wake of the System z10 mainframes and their quad-core engines in March 2008, but even that doesn’t account for the 39 percent decline in mainframe revenues and 20 percent decline in mainframe MIPS shipments. (In the second quarter of 2008, mainframe MIPS shipments rose by 34 percent.)

Loughridge said that IBM believes that its Power Systems machines gained share in the Unix market during the quarter, even as Power Systems sales fell by 13 percent. IBM’s share gains were “most pronounced” in the midrange and high-end of the Unix racket, and the company had over 100 competitive replacements against Hewlett-Packard and Sun Microsystems Unix shops in the quarter. IBM has done approximately 150 Unix replacement deals in the first half of 2009, and they accounted for nearly $250 million in sales, according to Loughridge. IBM apparently will gain market share in Unix for the fifth quarter in a row. (Party in Austin, whoo whoo!)

IBM doesn’t talk about the i platform anymore. Which leaves you and me speaking for it, I guess. Presumably IBM sold some boxes with i 6.1 running on it. But Power Systems people are obsessed with crushing Sun and HP and not worrying about protecting the base of 200,000 i shops out there in the world and making them ecstatic. Keeping i shops in a perpetual state of dependence and annoyance seems to be the plan. But, i 6.1 does exist and it does run on modern iron, which is priced the same as the Unix equivalent (finally, after a decades of crabbing.) That’s better treatment that HP’s MPE customers got, and probably better treatment than Solaris customers can expect when Oracle takes over Sun. (If you prove me wrong about that, Larry Ellison, I still win. Get it?)

IBM’s System x tower, rack, and blade server business (wasn’t this supposed to be called Modular Systems, and why is IBM’s top brass still calling it “Converged System p” when it is Power Systems?) had a 22 percent decline in the quarter, and IBM thinks that it gained share for the second consecutive quarter in the X64 racket. “We believe the improved sales execution and strong performance from our new products will enable us to continue to gain market share through the second half,” Loughridge said about the System x line, adding that blade server sales only declined by 6 percent and that Big Blue might have gained share here, too.

Rounding out Systems and Technology Group, disk and tape storage products both had double-digit declines and overall, storage sales were off 20 percent. OEM chip and technology sales were down 23 percent, and retail store systems had a stunning 41 percent decline.

Global Services gets a lot of the airtime from IBM these days, but software–a lot of which is dependant on system sales–is still the profit engine. Software Group’s sales in the second quarter fell by 7.3 percent to $5.17 billion, but gross margins were up by 1.3 points to 85.9 percent and pretax margins were up by 8.3 points to 32 percent flat. WebSphere middleware sales rose by 8 percent in the quarter, but Tivoli system management and Rational software development tool sales both fell by 2 percent. Database and related transaction processing product sales (what IBM calls Information Management) fell by 4 percent, and Lotus groupware and messaging product sales fell by 14 percent because of a “difficult compare” and “customer consolidations and downsizing.”

On the services front, Global Technology Services (strategic outsourcing, integrated technology services, and business transformation outsourcing) had $9.1 billion in sales in Q2, down 9.8 percent, and Global Business Services (consulting, systems integration, and application outsourcing) had sales of $4.34 billion, down 15 percent. Signings across both divisions of Global Services came to $14 billion in the quarter, and IBM’s services backlog was at $132 billion as the quarter ended, the same as a year ago.

Plenty of customers are looking for ways to cut costs, and Global Services appears to have some answers that people are willing to shell out beaucoup bucks for, but it is equally true that even IBM is feeling the pinch. As an example, strategic outsourcing signings in the quarter were up 38 percent at constant currency across all geographies, and rose by 90 percent in North America; however, strategic outsourcing revenues were actually down because existing customers cut back to save money.

IBM generated over $4 billion in cash in the quarter, had $12.5 billion in cash and equivalents, but only $5.9 billion net cash after taking into account $6.6 billion in long-term debts (and not including $22.8 billion in debt that IBM has for financing equipment and software to resellers and its customers). IBM spent $1.7 billion to buy back 12.6 million of its own shares, thereby boosting its earnings per share numbers by a little more than 2 cents to $2.32 per share. IBM really, really, really wants to hit $10 to $11 in earnings per share for 2010, and Loughridge said last Thursday that IBM was raising guidance for 2009 from an expected floor of at least $9.20 per share to at least $9.70 per share. IBM is more confident that its cost cutting will yield better bang than it thought, and that it can continue to make money even if the IT market stays weak.

“Bottom line, the changes to the company have allowed us to deliver strong performance in a tough environment,” said Loughridge. “But more importantly, the transformation has positioned us to come out even stronger when the economy improves–with tremendous operating leverage and a much better business profile as we continue to mix to higher value businesses.”

I’ll try to give you the drilldown on Q2 server sales with actual revenue figures in the next issue. Where did I put that bottle of Advil. . . ?

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