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IBM earnings bring market down

Big Blue beats Wall Street expectations with its fourth quarter earnings, though some issues continue to dog the computer giant.

IBM beat Wall Street expectations Thursday with its fourth quarter earnings, driven by strong North American sales and growth in its services business, though it still faces challenges in its chip business as well as in Latin America and Asia.

IBM traded at 196 in pre-open dealings Friday, down 11 from Thursday's close, after a big Wall Street firm cut its rating on the stock despite fourth-quarter IBM earnings that beat Wall Street expectations.

This morning, Morgan Stanley Dean Witter cut its rating on IBM to outperform from strong buy, but raised its target price on the stock to $210.

"IBM didn't help this market very much," said Thom Brown, managing director of Rutherford, Brown and Catherwood. "Brazil is going to be very troublesome until they are out of the woods...they sure aren't there yet," said Brown.

This morning the Dow Jones industrial average was down 134 points at 9131. IBM opened on the New York Stock Exchange at 184, down 13-1/16, and remained 13 points lower at mid-morning.

IBM reported earnings of $2.47 per share, or income of $2.3 billion for the quarter, compared to earnings of $2.11, or $2.1 billion for the same period in 1997.

Fourth quarter revenues grew by 6 percent to $25.1 billion, the company said. North American revenues accounted for $11.3 billion, up 8 percent, while revenues from Europe, the Middle East, and Africa were $8.7 billion, up 13 percent.

The company's revenues in Asia fell 3 percent, while Latin American business fell 22 percent, compared to the same quarter in 1997.

IBM reported declines in its total hardware sales, although revenues from the personal computer business increased. Service revenues jumped 20 percent to $7.1 billion, year over year. Software sales grew to $4.1 billion, up 9 percent.

IBM also reported year-end results for 1998, announcing earnings of $6.3 billion for the year, or $6.57 per share. The company earned $6.1 billion, or $6.01 per share in 1997.

Almost 60 percent gross profits come from software and its fast-growing services business, extending an ongoing shift at IBM away from hardware as the main source of business.

In a conference call Thursday, IBM cited positives including: 10 percent growth in pre-tax income, increasing shift from hardware to services which boosts profits, a revamped PC business model, and growth in its server computer business.

But it continues to struggle with its semiconductor business which makes memory chips, processors, and custom logic. IBM executives said that prices for DRAM memory chips were down "too far for any of us to make money."

Though the PowerPC processor--which is used in Apple's Macintosh computers--part of the semiconductor business saw growth, this was offset by the termination of a relationship with National Semiconductor. IBM made chips for National's Cyrix division and also sold Cyrix-design chips under its own name.

IBM said personal computers saw growth, but did not break down growth by sector. Most of the growth appears to be coming from PC servers, such as its Netfinity line. IBM executives said that all lines--desktops, mobile PCs, and servers--were profitable and overall saw a market share gain of one percent.

Executives did say that the old model of manufacturing and delivering PCs gave them trouble in the first half, but the new Advanced Fulfillment Initiative--referred to as AFI--is "contributing tremendously to health of the PC business" and helped the company in the fourth quarter. Previously, IBM said, there was "too much supply in the channel and we gave business partners unlimited price protection" which was a crippling burden.

On the up side, IBM cited gains in service saying that "backlog" grew $9 billion to $51 billion, an all time high. IBM executives said "growth is driven principally by services and software technology."

The $9 billion in new orders allowed revenues to increase 28 percent, IBM said, jumping 20 percent to $7.1 billion compared to the figure in the same quarter last year of $5.9 billion.

Software grew nine percent to $4.1 billion, though Asia and Latin America were flat. Middleware makes up about two-thirds of software revenue, according to IBM. Big Blue also said its database business on Unix and Windows NT grew faster than Oracle.

IBM also said there was a strong customer response to its large-scale 390 server based on more inexpensive "CMOS" chip technology, citing a market share gain of 10 points.

IBM tempered all of this, however, by saying that uncertainties in Asia, Brazil lie ahead, and the Y2K bug is always a potential negative.

Almost 60 percent gross profits come from software and its fast-growing services business, extending an ongoing shift at IBM away from hardware as the main source of business.

Quarterly sales of $25.1 billion rose 6 percent, with 1 point of the gain coming from currency fluctuations, a reversal from recent quarters where IBM's results were hurt by a strong dollar, which tends to erode the value of sales overseas.

Total hardware sales fell 2 percent to $11.3 billion, services revenues jumped 20 percent to $7.1 billion and software sales grew 9 percent to $4.1 billion, IBM said.

Sales in North America rose 8 percent to $11.3 billion in the quarter and 13 percent to $8.7 billion in Europe, the Middle East and Africa. But sales edged down 3 percent to $4.2 billion in the Asia-Pacific region and tumbled 22 percent to $929 million in Latin America.

IBM continued to fuel earnings per share growth through share repurchases, buying back $1.6 billion in stock during the fourth quarter. As a result, the company's earnings per share on a diluted basis rose 17.1 percent in the quarter, compared with a 12.1 percent rise in net income.

After the report, IBM Chief Financial Officer Doug Maine said the company had made "substantial" progress in picking up the pace of growth in its financial results during the second half of 1998 and was carrying that momentum into 1999.

For example, the latest quarter's 6 percent revenue growth compared favorably to the tepid 2.5 percent rate of growth seen in the same quarter of 1997. "We feel very good about the state of the company now," Maine told Wall Street analysts in a conference call after the release of IBM's fourth-quarter results late Thursday.

Despite ongoing concerns about Asia and Latin America and the impact of Year 2000 repair on computer spending, Maine said it was "reasonable" to expect industry technology spending to grow by 8 to 9 percent in 1999 as surveys have projected.

He said the computer maker's fast-growing computer services business, which grew 20 percent to $7.1 billion in the quarter, had $9 billion in new signings, pushing its backlog to $51 billion in the period.

Reuters contributed to this report.