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IBM continues to squeeze blue blood from IT stones

Mainframe boost more than covers Power dive

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As has been the case for so many quarters that it has become normal, IBM has managed to boost its profits even as its revenues were down a smidgen in the fourth quarter ended in December.

Sales across IBM's vast portfolio of IT hard and softwares was off six-tenths of a point, to $29.3bn. But thanks to Big Blue's constant restructuring and penny pinching and a shift to higher margin systems, software, and services – particularly in growth markets – the company was able to wring $5.83bn in net income out of the company, an increase of 6.3 per cent compared to the year ago period.

In a conference call with Wall Street analysts after the markets closed on Tuesday, IBM CFO Mark Loughridge attributed the stabilization of revenues and the increase in profits to a rebound in System z mainframe sales and the steady growth in software sales both related directly to IBM system software as well as running on competitive gear or further up the stack.

IBM does not report its server revenues in dollar amounts, but Loughridge did say that System z mainframe sales spiked 56 per cent in the final quarter of 2012. He added that that the aggregate amount of processing capacity shipped, as measured in aggregate MIPS (that's millions of instructions per second, and only loosely based on actual instruction-chewing capacity relative to prior mainframes), had risen by 66 per cent in the quarter, which was the biggest bump in capacity in the history of IBM's mainframe line.

Of course, that is probably a more accurate measure of how weak demand was for the System z11 machines, which came out in the summer of 2010 and which were a bit long in the tooth by last summer when the high-end Enterprise Class variants of the System z12 machines debuted.

Specialty mainframe engines, which are what IBM calls a regular mainframe engine that is only allowed to run Linux or algorithsm that accelerate Java or DB2 rather than the full-on z/OS mainframe operating system and which has a substantially lower price (like 75 to 80 per cent lower), accounted for about half of the MIPS shipped in the December quarter.

Mainframe growth was higher in the 30 growth markets where mainframes are not common, rising 65 per cent year-on-year, versus the 50 per cent revenue growth in the established markets of North America, Western Europe, Japan, and so on. This may be more of a reflection of the relative strength of the economies, of course, and not because mainframes are winning more server beauty contests.

IBM's Power Systems line, which has only just begun its transition to eight-core Power7+ processors, took it on the chin a bit, with revenues dropping 19 per cent compared to a year ago. Loughridge said that IBM nonetheless did 350 competitive replacements of Unix boxes from Oracle and Hewlett-Packard and that these deals brought in over $335m in hardware, software, and services revenues.

The rest of the Power Systems line will come out during the first half of 2013, according to Loughridge, and volumes for the already-launched Power7+ machines will start ramping in the second quarter. Whether IBM can get revenues back on track, given the competitive pressures from x86 iron based on Intel and Advanced Micro Devices chips, neither of which are slouches, remains to be seen.

IBM's System x and BladeCenter server business was off 2 per cent in the quarter, and its tape and disk storage businesses fell by 5 per cent. Disk sales were flat, and it was tape that took the dive. Loughridge added that the high-end DS8870 array that started shipping in October was sold out in Q4. IBM's external chip sales were up 4 per cent.

Add it all up, the Systems and Technology Group had $5.76bn in sales, down seven-tenths of a per cent. But if you back out the Retail Store Systems revenues that were in the year-ago period and that are no longer on the books because Big Blue sold that biz to Toshiba last year, then IBM's server, storage, and chip unit posted a 4 per cent revenue gain. Pretax income was up 23.2 per cent to $974m. Mainframes were pulling their weight for the first time in about a year or so.

Services: lots of heat but not enough light

The Global Services behemoth, which is the cornerstone of the Louis Gerstner era of IBM two decades ago and that largely saved IBM from itself if not oblivion, continues to generate a lot of revenues but not enough profits considering how many people it takes to provide services.

Global Services had just a hair over $15bn in revenues in the December quarter, down 2.1 per cent, which was the bad news. But the services backlog was up by $1bn at constant currency (flat as reported) to $140bn. Margins were expanding as Big Blue was rejiggering some low-margin deals and chasing higher margin services, such as "smarter planet" and big data engagements.

IBM's system outsourcing business generated just over $6bn in sales (down 3 per cent), while maintenance on hardware and software brought in $1.8bn (down 2 per cent). Application and process outsourcing, brought in a little more than $1bn (down 4 points), while consulting and systems integration raked in $3.6bn (down 3 per cent).

Integrated Technology Services, which even IBM cannot explain well, accounted for the remaining $2.55bn and was up 2 percent. (El Reg is no longer interested in the fake distinction between the Global Technology Services and Global Business Services divisions of IBM Global Services.

What you need to know is that the combined units as one beast had $2.8bn in pretax income, which was up 3.5 per cent. There's that margin expansion, and Loughridge said to expect more as 2013 keeps rolling.

Software Group is the real profit engine at Big Blue – and is about half useless without its systems business, but don't tell anyone. IBM's software biz has the steady monthly rental of mainframe software as its foundation, and on that builds the popularity of WebSphere middleware and the use of DB2, Lotus, and Rational wares by many shops on their systems, whether or not they have the IBM logo on them.

Big Blue has also done $12bn in acquisitions in the past decade, and this is what has helped transform Software Group from a $2.4bn business in 2000 to a $25.4bn in 2012.

Anyway, the take at Software Group was $7.92bn in the fourth quarter, up 3.5 per cent. Operating systems, which includes IBM's own z/OS, AIX, and IBM i as well as resold Linux and Windows, accounted for $709m in the quarter, flat from the year-ago quarter.

The key branded middleware that spans multiple platforms – WebSphere middleware; DB2, Informix, and other databases; Tivoli security, storage, and systems management tools; Lotus groupware and now social media software; and Rational development tools – accounted for $5.5bn in sales in the quarter, up 5 per cent.

WebSphere grew 11 per cent, Rational was up 12 per cent, and Lotus managed 9 per cent growth. The other middleware software – mostly all that stuff running on mainframes and some AIX and IBM i stuff – added up to $1.2bn. Software Group had a pretax income of $4bn.

This is considerably more than Systems and Technology Group and Global Services added together. But again, these distinctions are mostly arbitrary. The much more interesting set of numbers to see would be sales where companies buy the whole stack of hardware, software, and services from Big Blue and how that has changed and what kind of margin there is compared to those who buy only some part of their IT system from the company.

For the full year, IBM's sales were down 2.3 per cent to $104.5bn, but net income rose 4.7 per cent to $16.6bn. IBM generated $18.2bn in free cash flow in all of 2012 and spent $18bn on acquisitions, share repurchases, and dividends.

The company had $11.1bn in cash as the year ended, had $8.8bn in debts not related to its Global Financing asset portfolio, and says that its pensions are well funded and it is on its way to generate at least $16.70 in operating earnings per share in 2013. IBM did not forecast revenues, as it has not done for years. And that is because IBM doesn't care about revenues so long as profits are growing and it is moving from low-margin to high-margin businesses. ®

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