IBM Revenues Hurt By Server Transitions and Currency in Q2

July 26, 2010 Timothy Prickett Morgan

Wall Street just can’t get used to the fact that IBM doesn’t care all that much about revenues or bookings or other indicators of business so long as it hits its revenue targets for the quarter and is on track for whatever this year’s earnings per share goals are. That’s how the top brass at Big Blue get their compensation and bonuses, after all. Still, Wall Street was expecting IBM to do better than $23.7 billion in sales in the second quarter, up 2 percent, and $3.39 billion in net income, up 9.1 percent.

It’s hard to imagine how Big Blue could have done better, given the tough economic conditions in a lot of countries around the globe. And where there is growth in the IT sector, IBM has been fast to move there and capitalize on it. This is how IBM did not crash as hard as other big IT players during the economic meltdown of 2008 and 2009. I am not an apologist for IBM and its financial engineering, which I detest, but Wall Street’s expectations are sometimes silly.

The fact is, IBM is dependent, perhaps more than any time in its history, on high-end server sales to drive its hardware business, and both its Power Systems and System z lines have been waiting to be refreshed since late last year. And the declining revenue numbers for both systems over the past six months, which The Four Hundred has walked you through in great detail, are the predictable result of many customers putting off buying decisions for as long as possible to get a look at the new Power7-based machines or the System z11 mainframes, which were announced last week and which are officially called the System zEnterprise 196. Every new system refresh is a chance to get capacity for less money, and all customers know this. For Power7 hardware thus far, IBM is offering about twice the oomph for base hardware for the same money, so only a fool wouldn’t wait or get a 50 percent discount.

Despite the transitions, IBM’s Systems and Technology Group was able to bring in just under $4 billion in revenue, up 3 percent compared to the year ago quarter. Mainframes were not much help, with System z MIPS shipments down 14 percent and revenues down 24 percent. Power Systems machines were off 10 percent in the second quarter–and last year’s second quarter was not great either, being down 13 percent itself. But there was some light at the end of the Power7 tunnel. IBM launched the Power 750 midrange and Power 770 and 780 enterprise servers in February and started shipping them in March, and these machines help push up sales of Power-based midrange machines at IBM by 10 percent.

In a conference call with Wall Street analysts, Mark Loughridge, IBM’s chief financial officer, said that sales of Power-based blade servers rocketed up by 65 percent in the quarter, following the announcement of the PS700, PS701, and PS702 blade servers in April. For all I know, Power-based blade server sales were just awful in Q2 2009, so it might have been a ridiculously easy compare. (Like this quarter’s mainframe sales were, and still the revenues were awful.) Loughridge added that IBM’s Migration Factory was able to do 225 competitive Unix replacements in the quarter, bringing in $225 million in revenues for various IBM groups. About two-thirds of those deals were displacing Oracle Solaris iron, and in the past six months IBM has, said Loughridge, made nearly $650 million on 620 Sun takeouts.

Loughridge said that the rollout of the remaining Power7 machines and the zEnterprise 196 mainframes would help Systems and Technology Group build some momentum in the third quarter and push sales up in the fourth.

IBM’s System x and BladeCenter business has recovered nicely from its malaise, with sales up 30 percent in Q2. The volume business must have grown even faster than this, since Loughridge said that blade revenues were up 16 percent and high-end System x boxes (by which I presume he means those with four or more processor sockets) were up by 17 percent. IBM’s System x and BladeCenter profit margins improved as bigger boxes went out the door.

IBM’s storage revenues rose by 5 percent, with disk storage rising 12 percent. (That means tape storage tanked in the quarter.) Loughridge said that IBM added over new 130 customers for its XIV clustered disk arrays in Q2 and that revenues more than doubled compared to last year’s second quarter.

IBM’s Global Services monstrosity accounted for $13.7 billion in revenues, up 2 percent, in the second quarter. One of the things that made Wall Street jumpy about IBM’s Q2 2010 is that total new signings for services contracts were down 12 percent. IBM’s outsourcing business was hit particularly hard, with signings down 19 percent. Even though Loughridge explained that, given the nature of the outsourcing contracts, in the near term IBM would generate more money from the lower rate of outsourcing signings in Q2 2010 than it did for Q2 2009, Wall Street was not buying it and gave Big Blue’s stock a 2.5 percent haircut, to $126.55 per share. (Getting that stock split is going to take some more time, it looks like.)

IBM’s Global Business Services unit, which does business process re-engineering and outsourcing, posted $4.5 billion in revenues, up 3 percent, while Global Technology Services, which does traditional outsourcing, systems integration, and maintenance, posted sales of $9.2 billion, up only 1 percent. Total new services signings in the quarter were $12.3 billion, down 12 percent. IBM had a services backlog of $129 billion as it exited the quarter, up $1 billion from a year ago.

IBM likes to pretend that its software business is somehow not related to its own iron, that it is a big player outside of the System z, Power Systems, and System x platforms. But readers of The Four Hundred know intuitively that this is stretching the truth a bit. There is a cause-effect-cause relationship between IBM’s hardware and software, even after 15 years of trying to divorce the two and make IBM a bigger player on other platforms. What can be said is that when IBM’s platforms are in transition, the fact that its development tools, middleware, and databases run on other platforms helps cushion the company. And when IBM’s own systems are firing on all cylinders, there is usually some other transition in the market that somehow keeps that key branded middleware–WebSphere, Information Management, Tivoli, Lotus, and Rational–from getting too big for its britches.

In the second quarter, Software Group booked $5.28 billion in sales, up 2 percent; if you take into account the product lifecycle management divestiture to Dassault Systemes and knock out the lacking PLM compare from Q2 2009, then Software Group’s sales would have risen by 6 percent. WebSphere middleware posted a 17 percent revenue increase in the quarter; application servers, the core product here, rose 32 percent. Tivoli systems management tools did a little bit better, with 18 percent growth. IBM’s DB2, IMS, and other database sales were up 7 percent in Q2, while Rational development tools only eked out a 1 percent boost and Lotus took a 6 percent fall.

IBM’s business in the United States was up 1 percent, the first time in seven quarters it has risen, and the Americas region overall had 3 percent growth, to $10.2 billion. The EMEA region has issues thanks to Portugal, Italy, Ireland, Greece, and Spain and the crash in the euro, and sales were down 6 percent as reported in U.S. dollars, to $7.4 billion. (The United Kingdom bucked the trend, rising 11 percent.) IBM’s major markets–you know the ones, which are the countries that most of you reading this newsletter live in–had a 1 percent decline in revenues, which growth markets had a 14 percent bump and the BRIC countries–Brazil, Russia, India, and China–had a 22 percent spike. For the first time in IBM’s history, the growth markets taken as a whole brought in as much money to Big Blue as the Euro zone did. And it won’t be long before the growth markets are considerably larger if current trends persist.

Remember, people, it’s International Business Machines. This is business, nothing personal. And business is so good that IBM raised its earnings per share targets for 2010 to $11.25, up a nickel from April and up 25 cents since January. If the Power7 and z196 mainframe transitions take off, don’t be surprised if this gets raised again. In fact, I think that is part of the plan. As will be more layoffs to help pay for it.

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