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IBM reports earnings in line; sales sag

Big Blue meets analysts' expectations for the third quarter, despite reporting nominal revenue growth.

Technology giant IBM today reported third-quarter earnings in line with expectations, despite nominal revenue growth.

Armonk, N.Y.-based IBM earned $2 billion, or $1.08 a share, matching consensus estimates from FirstCall/Thomson Financial. The company earned $1.70 billion, or 90 cents per share, a year ago.

Sales rose 3 percent to $21.8 billion, compared with $21.1 billion a year ago. Analysts had predicted sales growth of 6 percent or more.

Although the company met earnings expectations, revenue numbers show IBM still has a ways to go to recover sales momentum after three difficult quarters.

Hardware revenue rose 4 percent to $9.5 billion from year-ago levels. Hard drive sales declined. Software sales fell 3 percent to $2.9 billion for the quarter, while revenue from IBM Global Services rose 4 percent to $8.2 billion, on continued strength in Asia.

John Joyce, IBM's chief financial officer, tried to downplay disappointing sales in a conference call with analysts by focusing on earnings per share, which he said rose "20 percent over last year's third quarter."

Joyce acknowledged revenue growth "was not at the pace that we wanted."

IBM
Stock price from October 1999 to present.  
Source: Prophet Finance
"Three issues held us back from stronger revenue growth," he said. Supply problems affecting the ceramics used in chips led to shortages of RS/6000 and AS/400 servers and components sold to third-party manufacturers.

With adequate supplies in the third quarter, IBM could have generated two more points of revenue growth, Joyce said.

Another factor hurting the quarter was a slowdown in mainframe sales, resulting from the launch of the new eServer line. IBM unveiled the first eServer Oct. 3 and on Monday added new models replacing the RS/6000.

IBM also saw problems in its software business, with revenue down 3 percent year over year.

"Our software sales teams did not execute, did not close the business in the pipeline at the end of the quarter," Joyce said. He said growth in Tivoli storage management software "was particularly disappointing."

Today's announcement is the first test of new management put in place near the beginning of the quarter. In July, Big Blue named veterans Sam Palmisano as president and chief operating officer and John M. Thompson as vice chairman.

"The recent manager changes are key," said Technology Business Research analyst Bob Sutherland. "And it will be interesting to see how well they execute with these changes given to them. The new management is under the watchful eye for execution going into the fourth quarter."

IBM's money-losing PC group returned to profitability this quarter, earning $65 million. The division, which lost nearly $1 billion in 1998, has been cutting costs and cleaning up its manufacturing and distribution operations.

Revenue for the PC division rose 16 percent, unit shipments of PC servers were up 40 percent and portables increased 30 percent.

The shift away from retail had a major impact on the PC division, where "nearly one out of every two sales is direct," Joyce said. But he cautioned this is "only one quarter of profitability" and that "this is a volatile industry that can change quickly."

IBM posted overall hardware revenue of $9.5 billion, up 4 percent year over year, with strong gains in desktop systems, portables, PC servers and Web servers. Demand for some RS/6000 models exceeded supply, and AS/400 revenues declined 6 percent because of shortages. The transition to the z900 eServer line sapped S/390 sales, with revenue down 24 percent.

Joyce said the transition to z900 servers gave "more of a pause than we expected."

"The pipeline started to slow, and some existing orders were even deferred," he said.

IBM expects to begin shipping the first z900 servers in mid-December.

Web server revenues rose 15 percent, even though IBM could not deliver as many RS/6000 models as ordered. IBM shed some of the effects of a misstep moving to 10,000-rpm hard drives, which sapped sales to third-party manufacturers in the first half. Despite gains, hard drive revenues declined $100 million during the quarter.

Software revenue declined 3 percent to $2.9 billion. Global services revenue grew 4 percent to $8.2 billion, in part because of outsourcing contracts in the Asia-Pacific region.

Geographically, Americas revenue was $9.7 billion, an increase of 1 percent year over year. Europe, Middle East and Africa declined 3 percent to $5.6 billion. Asia-Pacific grew 18 percent to $2.1 billion.

"America's results were disappointing," Joyce said. "It's fair to say that our exit from the PC consumer channel and the effects of Y2K impacted the Americas more than other geographies."

While these issues hurt other geographies by one point in the third quarter, the Americas took a three-point hit. Sales of S/390 mainframes and software were particularly disappointing for the region.

The dollar's strengthening against the euro and yen hurt revenue three points during the second quarter, up from one point a quarter earlier.

"If the dollar remains at current levels for the fourth quarter, the currency situation will only get worse," Joyce said.

Gross margins declined six-tenths of a point year over year and about 1 percent from the second quarter to 35.80 percent. Hardware margins were 27.90 percent, global services 26.60 percent and software 81.20 percent.

"Improvement in hardware gross profit was offset by a mix away from software and declines in global services and global financing gross profits," Joyce said.

Joyce remained somewhat optimistic about the fourth quarter, predicting gains over the third quarter, "although we are in a volatile and demanding business environment."

Joyce emphasized how IBM was improving on profitability by cutting costs and improving efficiency using the Net. "Year to date, we've sold about $15 billion over the Net, up 50 percent over last year." he said. IBM has "procured $28 billion in goods and services electronically this year, more than double last year."

The IBM executive said these changes "will be key to delivering earnings in 2001."