Strong Dollar Hurts Power Systems Sales In Q2
July 27, 2015 Timothy Prickett Morgan
It is a story that every big multinational public organization is telling as they reveal their financial results for the second quarter of the year. Economic uncertainty in parts of Europe, South America, and Asia have pushed up the value of the U.S. dollar relative to the other currencies, which is great if you are an American traveling. But if you are an American corporation bringing a big chunk of your overseas sales back home for financial reporting, it is not so much fun.
Such is the case with IBM‘s Power Systems line during the quarter ended in June, and indeed for all of IBM’s product lines spanning hardware, software, and services. IBM posted sales of $20.81 billion in the second quarter, down 13.7 percent as reported but down less than 1 percent once currency effects and the divestiture of the sales of its IBM Microelectronics and System x divisions were taken out of the numbers. (This is not a sensible way to do things because those actions do have financial consequences and can’t be ignored, but taking them out and looking at the business as if currency were not such a headwind is a way of gauge the strength or weakness of the remaining IBM business.) IBM has had 13 quarters in a row when its revenues have declined–sometimes imposed by the market, sometimes by itself as it sells off assets–and everyone is trying to figure out if IBM can grow its business again not only in the social, mobile, cloud, and analytics areas (what IBM calls its strategic imperatives) but also with Power Systems and System z iron and software stacks.
Due to the divestiture of the chip and X86 server businesses, IBM’s Systems Hardware group saw revenues drop 31.7 percent to $2.06 billion. IBM distributed another $107 million in hardware to its other units, for a total of $2.17 billion in revenues for the quarter, and it brought in $255 million in pre-tax income from its hardware business, up 26 percent. So even if the hardware business is declining, profitability is on the rise and that is a good sign. That means as IBM grows revenues, more profits should fall to the bottom line. This is clearly what IBM hopes to do as it goes through the long System z13 upgrade cycle among its 6,000 mainframe customers and has the Power Systems line firing on all entry, midrange, and high-end cylinders.
IBM does not provide specific sales figures for its Power Systems and System z lines, but if you do a little math, you can figure out that its servers accounted for $1.45 billion in revenues in the second quarter. It is difficult to get comparative figured because of the System x numbers being in the year-ago figures, but what I can tell you is that IBM sold $1.21 billion in servers in the first quarter when it did not have System x in its lineup and $1.51 billion in the fourth quarter of 2014. IBM booked another $528 million in operating system sales, which include perpetual licenses for its own IBM i and AIX, plus reselling support contracts for various Linux distributors on its Power and System z platforms. So the core server business represented just under $2 billion in sales in the first quarter. To give you a sense of size, IBM’s systems business is roughly four times the same size as the Unified Computing System business at Cisco Systems, but Cisco could hit somewhere between $3 billion and $4 billion a year before its growth slows down to meet the overall market. (It helps to keep some perspective.)
As reported, Power Systems revenues were down 1 percent in the quarter, but were up 5 percent when measured at constant currency. This may seem like anemic growth, but the Power Systems business seems to have found a floor from which it can get up off of and start rising again. On a conference call with Wall Street analysts last week, Martin Schroeter, IBM’s chief financial officer, said on the call that Power Systems exhibited growth in both the first and second quarters (again, at constant currency), and added that this was “led by strong growth in scale-out systems, which are capturing both the Unix and Linux opportunity and a return to growth in the high-end.” Schroeter did not mention the just-announced Power E850 midrange, but we presume these helped a bit, too. As reported, IBM’s System z sales were up only 9 percent against a pretty east compare when the z12 systems had all but wound down last year. Aggregate compute capacity on mainframe shipments (including activations of z cores running on existing machines installed in the field) rose by 24 percent in the quarter compared to the year-ago period. At constant currency, those MIPS shipments boosted revenues by 15 percent for Q2, and Schroeter said that through the first half revenues increased by 50 percent for the System z line.
We have said before that anything that makes the Power Systems business stronger allows the IBM i platform to last longer, and we will add this: The strength of the System z business allows IBM to continue to invest in the Power platform, either for its own Power Systems or through the development of a broader ecosystem that is being steered by the OpenPower foundation. “I believe our Power results through the first half show that the Power strategy is working,” Schroeter said.
IBM’s storage business drove another $650 million in revenues, and the company has many of the same issues with peddling legacy storage arrays as all of the incumbents. IBM’s FlashSystem all-flash arrays are doing well and are gaining share in this lucrative and fast-growing market. But the adoption of expensive flash arrays is not happening fast enough to fill in the gap created by falling disk array and tape array and library sales. In any event, as reported, storage sales were off 10 percent in aggregate across the product lines, and taking out the effects of currency and the System x divestiture, it was down only 4 percent.
IBM’s Software Group had a 10.1 percent decline, to $5.83 billion, and with another $770 million in revenues internally to other IBM groups. Pre-tax income for Software Group came to $2.72 billion, or 34.4 percent of revenues–a healthy operating margin for any software company. At constant currency, the decline for Software Group was only 3 points. WebSphere middleware sales rose 5 percent, while database products were flat compared to the year-ago period. Tivoli security and systems management software had a 1 percent decline and Rational development tools had a 2 percent decline. IBM’s Workforce Solutions division, which includes Lotus and Domino software as well as a bunch of other collaboration and marketing tools, were down 3 percent in the quarter. Add it all up across those five brands, and sales were flat. Considering that IBM has sold off the System x division, which no doubt still drives a portion of its sales, this was not all that bad. The main effects that are hurting IBM are currency exchange.
The Global Services group, by far the largest piece of IBM, had $12.75 billion in sales, down 11.1 percent from Q2 2014. IBM’s consulting and integration business, which comprises about a quarter of the overall business, was down 4 percent at constant currency and a lot more than that as reported (IBM did not say how much). All other parts of the business–systems and application outsourcing, maintenance, and the mysterious Integrated Technology Services–had modest gains at constant currency. But again, the System x divestiture and the currency issues were the big factors in bringing revenues for Global Services down. Global Services had $1.9 billion in per-tax earnings in the quarter, down 29 percent from the $2.68 billion this group posted a year ago. We are hearing that IBM has begun another round of layoffs in Global Services as a consequence, but IBM does not discuss such things publicly.
Schroeter said that IBM’s cloud business–and it has not really defined what that is, but presumably it is systems used to build private clouds plus its SoftLayer public cloud and some aspects of Global Services outsourcing and hosting–grew by over 70 percent in the quarter and now has a run rate of $8.7 billion. That run rate is $1 billion higher than the annualized rate IBM experienced as it exited the first quarter of this year. IBM’s various software and infrastructure services running on its cloudy infrastructure hit an annualized run rate of $4.5 billion, or slightly more than half of all of its total cloud revenues.
IBM has been obsessed with growth markets–particularly Brazil, Russia, India, and China–for the past decade, but in the second quarter of this year, it was Canada, Germany, Italy, France, and Japan that provided the growth. Sales in the U.S. were down in the low single digits, said Schroeter, and across the major markets revenues were flat as a group. Brazil was off 16 percent (against 20 percent growth for Q2 2014) and China was off 25 percent. The “volatility of results” continued in Russia, as Schroeter put it, and India had modest growth.