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Big Blue misses Q1 targets big-time thanks to systems shortfall

$1bn in charges for "workload rebalancing" – aka layoffs – coming in Q2

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Big Blue did not turn in the numbers that it expected in the first quarter thanks to more than $400m in mainframe systems, related software, and intellectual property licensing deals that rolled over into the second quarter. In the quarter ended in March, revenues were off 5.1 per cent, to $23.41bn, and net income fell by 1.1 per cent to $3.03bn.

On a conference call with Wall Street analysts after the market closed on Thursday, IBM CFO Mark Loughridge discussed those deals, saying, "We should have closed on those rollover deals, and we thought we had right up to the end," Loughridge said.

Loughridge said there were a number of factors contributing to IBM's difficulties in the first quarter. The fact that the Easter holiday was in March didn't help matters, and in fact the last time that happened was back in 2005 and IBM had a revenue miss then, too.

He also said that IBM had misjudged the effect of the political power change in China, specifically relating to the ripple effects it has on spending in the provinces and the industries they control. The US Federal business was also down thanks to the budgeting issues that Uncle Sam is facing, and the Japanese devaluation of the Yen didn't help the quarter, either.

There were also sales-execution problems in growth markets, which should have been up in the mid-single digits but which only rose a point compared to the year-ago quarter. But Loughridge made no excuses, saying that those mainframe deals should have closed and that it was an execution problem.

IBM doesn't do formal layoffs, but rather what it calls "workload rebalancing", which is a continuous business and employee evaluation process that results in layoffs, usually at a level that is below the radar of state reporting requirements.

Loughridge said that IBM would be booking $1bn in charges relating to layoffs, which would occur mostly outside of the US, so it can make its numbers for the year and line up its employee ranks against the opportunities it sees in the months ahead. Most of that rebalancing charge will hit in the second quarter, and there might be a good reason for that timing if IBM is indeed selling off portions of its System x x86 server business to Chinese PC and server maker Lenovo. (We will cover that in a separate story.)

The Systems and Technology Group at IBM, which makes chips as well as servers, storage, and networking products, had $3.11bn in revenues to the outside world (it actually sells products to other IBM divisions, such as Software Group, for appliance and data warehousing systems). That was a 17 per cent drop compared to the year-ago period. Most alarmingly, even with adding in another $120m in internal sales, STG still posted a $405m pre-tax loss in the first quarter. In the year-ago period, IBM had $3.9bn in total server sales ($151m came from internal sales and $3.75bn to the channel and customers), and had a $105m pre-tax loss. This business was not moving in the right direction in the first quarter.

But, said Loughridge, IBM is expecting for System z mainframe revenues, which were off 7 per cent in the first quarter, to have double-digit revenue growth in the second quarter.

Power Systems sales in Q1 were adversely affected by the impending rollout of entry and midrange machines using Power7+ processors, which launched in early February. IBM's Power line stomached a 32 per cent revenue decline in the first quarter, and Loughridge said that "Power picked up share, but it doesn't mean much if you are declining double digits."

True that.

IBM's CFO said that the company was taking actions to try to make Linux more appealing on Power Systems iron and doing other things to try to get the Power-based system business back on track, and said that these efforts could take six to nine months to come to fruition.

IBM's System x server line declined 9 per cent and was a relative bright spot. Tape, disk, and flash storage products saw an 11 per cent drop, and IBM's OEM chip business was off 16 per cent.

Software Group, which is the profit engine for Big Blue, was down a smidgen to $5.57bn in sales in the first quarter. Including a whopping $831m in sales to other divisions, it was able to post a pre-tax income of just over $2bn.

The five key products in the IBM software portfolio – WebSphere middleware, database and database tools, Tivoli security and systems management, social workforce solutions (what used to be called Lotus), and Rational development tools – grew 1 per cent to $3.51bn in external sales. Operating systems brought in $578m, down 2 per cent, and other middleware, mostly running on proprietary systems, brought in $1.06bn and was off a bit.

The Global Services behemoth had $14.1bnn in sales, down 3.9 per cent, but pre-tax income, after a lot of rejiggering in the past year, was up 9.9 per cent to $2.29bn. IBM exited the quarter with a services backlog of $141bn, up one point from a year ago.

Global Financing, which provides leases for end-user customers as well as financing to the reseller channel, is tracked separately from Global Services, and had $499m in external revenues and over $1bn when you add in financing that it did internally at the company (this seems like weird bookkeeping to El Reg, but it could be for wafer-baking and other capital equipment). Global Financing had $538m in pre-tax income.

Which shows you IBM should just do financing for the commodity servers and let someone else build them, perhaps. And it will very likely be a deal something like that which will come out of whatever negotiations that IBM and Lenovo are doing now for all or parts of the x86 server business.

Despite all of the issues that they're wrestling with, IBM reaffirmed its expectation that it can still bring at least $16.70 in operating earnings per share for 2013, and that it is well on its way of hitting its goal of at least $20 in operating EPS by the end of 2015, according to its financial roadmap.

That plan is what many unhappy IBMers call the 2015 Roadkill, and with the layoffs that IBM hinted at on Thursday, you can expect more grousing. ®

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