Reading Between the Lines of IBM's Third-Quarter Report

Analysis of News Events
  • Smaller Small Medium Big Bigger
  • Default Helvetica Segoe Georgia Times

Though reported revenues of older System i servers are down, the replacement Power Systems servers are doing well.


IBM announced new hardware and software offerings this month just before it released its third-quarter financial results. On all fronts, the company appears to be doing well, but there continues to be a question regarding sales of servers running IBM i, or the good old AS/400 to industry vets.


Just to recap, the company's total revenues for the quarter were up 5 percent over the same period last year to $25.3 billion. After you factor in the declining U.S. dollar, however, the actual increase was only 2 percent. Statistically, 2 percent is considered insignificant. So basically, the company brought in this year about the same amount of money it did last year during the same period. What's interesting, however, is that on that revenue, net income was up 20 percent. Now, that's pretty good--actually very good--and it means someone is figuring out how to work smarter instead of harder. Sam Palmisano, IBM chairman, president, and CEO, attributed the performance to "our strategy to manage for productivity in major markets and to invest for growth in emerging countries." That strategy, along with IBM's "steady base of recurring revenue and profits" and a "range of products and services that deliver value to clients" kept the company in good shape despite a worsening world economic climate and what is now an officially declared U.S. recession. Even under these conditions, here is a company that has a gross profit margin of better than 43 percent during the quarter. Someone deserves a major pat on the back here.


One of the brighter spots on IBM's ledger sheet is its services business, which ended the third quarter with a backlog of $114 billion, or the equivalent of slightly more than a year's total revenue for the entire company. The software segment also did well, showing an increase of 12 percent (8 percent adjusting for currency) over the same period last year to $5.2 billion. Geographically, the growth clearly is coming from Europe/Middle East/Africa, which showed increased revenues of 10 percent (4 percent after currency adjustments), and Asia-Pacific, where revenues increased 6 percent (1 percent after currency adjustments). While there was more business done in the Americas overall than in either of the other two reported regions, there was almost no growth--2 percent after currency adjustments. I say "almost" no growth, but 2 percent is growth and, as my former football coach used to say, "If you can gain three yards every play, you can beat the Green Bay Packers."


The part of the earnings report that was a little disappointing came from the Systems and Technology "segment," which presumably is the same thing as the Systems and Technology Group. While it earned $4.4 billion, or nearly 20 percent of the company's total revenues, the figure was down 10 percent (11 percent adjusted for currency) from the same period last year. This is a number that is quite significant. If your revenues drop 10 percent every year for five years, someone is going to want to rename your division General Motors. It's just not sustainable for the long term.


Within the Systems and Technology segment of course are the various server lines: System i, System p, System x, and System z. Unfortunately, the finance department apparently wants to compare apples to apples for the whole year, so there is no reporting for Power Systems--yet. We're hoping that changes next year, because IBM Business Partners have made it clear they very much want to see greater transparency (read: specificity) in reporting on the various server lines, according to Scott Handy, vice president of worldwide marketing and strategy, IBM Power Systems. I asked Handy during a pre-briefing for journalists whether or not IBM would separate the IBM i-related server revenues from the other reported figures. He said that the company was well aware of the desire by partners to have more information on this, but he didn't indicate that it would be forthcoming, citing the difficulty of separating out these figures when you have a single hardware line such as with the Power Systems moniker.


The financial report does give some indication of what's going on, however, in that it breaks out System z revenues as doing quite well, showing a 25 percent increase over last year. I think it's worth pointing out that one major reason for this is that IBM came out with an entirely revamped line of System z servers this year that breathed new life into the IBM mainframe. Larger companies can consolidate hundreds, if not thousands, of existing servers onto the System z and save lots of money on energy costs, reduce floor space, and simplify administration.


Reporting for the System x is fairly straightforward, too, but unfortunately, revenues for this server line decreased by 18 percent over the same period last year. The fact is, there is a lot of very stiff competition out there in the Intel market, particularly from Dell, which gives customers custom configurations, fast service, and low prices on Wintel servers, with HP not far behind.


Then we get into the murky midrange area, which is what everyone wants to know more about. The financial report says that the "converged System p server products" had revenues that were 7 percent higher than the same period last year. This is good, though it's a bit confusing. While System p would traditionally imply a server running the AIX operating system, the word "converged" suggests this is actually the new Power Systems brand, supporting AIX, Linux, and IBM i. But we're not told which operating system or systems buyers purchased when they bought the Power Systems hardware. We also have to assume that these servers are anything running a POWER6 processor. Why? Because the next line in the report says that revenues from System i servers decreased by 82 percent from the same period last year. Well, we believe there are three things to take into account here when reading this number. The first is that, based on past discussions with Ross Mauri, general manager of Power Systems, this figure is a reflection of only servers still running the POWER5 and POWER5+ chips, which are your smaller servers like the 515 and 525, where cost is a primary consideration.


In an open letter to IBM i users posted recently on the IBM Web site, Mauri says that during the third quarter, the majority of shipments will be Power6 processor-based Power Systems servers and that the "older System i servers based on the POWER5+ technology are gradually being withdrawn." He says the transition to the new Power Systems servers should be complete by year-end. One would think that once that happens, then there will not be any results posted at all reflecting System i revenues; there won't be any System i sales, just Power Systems sales. Presumably, the company will then likely drop the term "converged System p."


The second thing to consider when evaluating that 82 percent reported decline in System i server revenues is the stated commitment IBM has in protecting users' investment in their existing systems. Not only did we just get a new version of the operating system this spring with 6.1, but according to Mauri, another release is scheduled for 2010. Granted, this is not the same back-to-back series of releases the AS/400 world knew five or ten years ago, but it is ongoing, consistent support.


The third thing to consider is that there is a wave of consolidations going on among users of HP-UX and Sun Solaris, who are porting their applications over to IBM's AIX. These companies are looking to save money and get on a highly reliable platform that has a stable and predictable future. In short, AIX is coming into its own, and when the name of the game is consolidation, this is the platform where a lot of people are ending up. So IBM i, while it's a very good platform, is not your destination resort when you're consolidating your UNIX servers, which is where the action is right now.


While a few companies are moving off the i platform for whatever reason--they can't find skilled programmers or operators, or whatever--most of the companies running IBM i don't want to leave; they just want to modernize the user interface a bit. Think of it like being married. They don't want to go through the trauma of getting divorced; they just want their trusted and faithful spouse to lose a few pounds. The younger generation may look at their parents and make different choices, but mom and dad still hold the keys to the house, the car, and the 401K.


This i community is still a large and well-connected family, and it's going to remain that way for quite some time to come, regardless of who the kids bring home for dinner.