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IBM falls short of estimates

IBM falls slightly short of analysts' expectations despite posting a 10 percent jump in earnings and record revenues of $23.7 billion.

Citing strong services, business, and database software sales, IBM (IBM) announced a 10 percent jump in fourth-quarter earnings today. But Big Blue's performance fell short of analysts' expectations, and the road ahead looks rocky.

IBM's current quarter faces a confluence of unusual events--the Asian currency crisis, smaller margins as its services business grows, the absorption of costs associated with the acquisition of Software Artistry, and IBM's sponsorship of the Nagano Winter Olympics, said interim CFO Lawrence Ricciardi. Earnings per share for the first quarter could end up roughly 10 cents to 15 cents lower than previous years, he predicted.

Looking beyond the first quarter, questions remain as to how long Asia's economic turmoil will cast trouble toward IBM, and how much pressure there will be on the company's margins from its services business. In the most recent quarter, services accounted for nearly 25 percent of Big Blue's revenue pie.

IBM reported earnings of $2.1 billion, or $2.11 per diluted share, for the fourth quarter just ended, compared with $2 billion, or $1.97 per share, reported a year ago. Wall Street had expected the company to post earnings of $2.15 per diluted share, according to First Call.

The shortfall partially can be attributed to the Asian financial crisis, Ricciardi said, noting that earnings per share would have been 18 cents a share higher were it not for Asia's negative impact.

IBM's fourth-quarter 1997 revenues increased to a record $23.7 billion, up 3 percent from the same period a year ago.

"We had a strong quarter that closed out a very good year," Louis V. Gerstner, Jr., IBM's chairman and chief executive officer, said in a statement. "Our strategic priorities were increasingly evident in our marketplace results."

Gerstner noted that the company's services business continued its growth rate of more than 20 percent for the year.

"The momentum of our software business grew throughout 1997, and we ended the year with an exceptionally strong performance from our Lotus Notes, Tivoli, and database software products," he added. "In addition, our strategy to exploit IBM's technological base continued to be successful, particularly in storage products, and in 1997 we repositioned our server product lines from top to bottom."

Services now total close to 25 percent of IBM's revenue. Contracts landed by IBM during the quarter include a contract to provide equipment and consulting service for pharmaceutical research to Monsanto, a manufacturer of biotechnology products, and a consulting agreement with Cathay Pacific Airways.

Ricciardi pointed out that, while IBM is growing, gross margins on high-end services are approximately 22.5 percent, lower than the 37 percent gross margin the company enjoys on hardware and much lower than the 70 percent margin it sees in software. Partially as a result, IBM's margins will continue to grow faster than the market as a whole, but may not maintain the growth rates seen recently.

"No tree grows to heaven," Ricciardi said. "I am not sure it will continue to grow at the historic rate."

Hardware presented a mixed bag for IBM's quarter as business desktops and servers, including electronic commerce packages based around the AS/400, met or exceeded expectations. Consumer sales, meanwhile, were lower than desired, said Ricciardi, noting that they nevertheless improved over the dismal sales reported for the third quarter.

Ricciardi warned that the current quarter will present financial challenges that inevitably will hurt IBM's bottom line. Expenses associated with the company's $200 million acquisition of Software Artistry will be accounted for during the quarter, and the company also will incur one-time charges from its sponsorship of the Winter Olympics, which will take place in Japan next month.

The currency situation in the Asia/Pacific region is expected to further drag down IBM's financial picture. The company will have to write off certain receivables that will go uncollected as a result of the crisis. Moreover, exchange fluctuations likely will depress results during the first half of the year.

"This is an unusual confluence of events in our traditionally smallest quarter," Ricciardi said.