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Dow, IBM sink on profit warning

Big Blue's quarterly earnings meet estimates, but a profit warning and analyst downgrades send its stock plummeting.

Stocks fell today following IBM's warning that Year 2000 bug concerns will put the damper on its next two quarters.

Shares of IBM plummeted this morning by 20 percent after two influential Wall Street analysts downgraded the stock. The company was the most heavily traded issue on the New York Stock Exchange today, with 69.3 million shares changing hands by markets' close.

IBM stock closed down 15.63 at 91.38.

The Dow Jones Industrial Average slumped 94.7 to close at 10,297.6, after plunging 214 points in the session's first 13 minutes. IBM, which represents 5.5 percent of the Dow average, accounted for 113 points of the decline. The technology-laden Nasdaq Composite Index, after a morning slump, rose 13.82 to 2,801.95.

Merrill Lynch's Steven Milunovich today downgraded IBM to "Neutral/Buy" from "Buy/Buy."

Yesterday, Big Blue said that first-quarter earnings of fiscal 2000 would be flat or slightly below the first quarter of 1999.

The company attributed the problem to a slowdown in mainframe computer sales related to Y2K bug. The bug is a programming glitch that could cause some computers to mistake the year 2000 for 1900, possibly affecting the functioning of the computer or related systems.

For its third quarter, the news was mixed. Big Blue earned $1.8 billion, or 93 cents a share, compared to $1.5 billion, or 78 cents a share, a year earlier. The total included a tax benefit of $63 million resulting from the sale of the IBM Global Network to AT&T, among other factors.

Without the special gain, earnings came to 90 cents a share, the same predicted by a poll of analysts on First Call.

Revenue grew 5 percent to $21.5 billion during the third quarter, which ended September 30. Revenue in the Americas region increased 1 percent from a year earlier to $9.6 billion. The Europe, Middle East, and Africa region had revenue of $5.8 billion, down 2 percent from the third quarter of 1998. Asia-Pacific revenue increased 28 percent to $3.7 billion. Revenue for S/390 server computers declined by 40 percent and for AS/400 servers by 30 percent.

The company had anticipated some slowdown in the server segment as large customers locked down their networks to assess the effect of the date change. But the rapid decline in mainframe sales surprised IBM, which had seen four consecutive quarters of high sales in this market.

"The [surge] in S/390 over the last year was buy-ahead purchases for Year 2000, and suddenly those funds are cut off," said Technology Business Research analyst Joe Ferlazzo. "The business is on track, but they should have known this earlier than they did."

Following slower S/390 server sales during the third quarter, IBM concluded customers had bought ahead for Year 2000, and mainframe sales would remain slow through the first quarter.

"As we look to the fourth quarter, the slowdown in high servers, which is unique to IBM, remains an issue," said Douglas Maine, IBM's chief financial officer.

Demand for servers has typically been 50 percent larger in the fourth quarter than the third, but not this year, said Maine.

About half of IBM's mainframe revenue comes from the finance and insurance sectors, which have been ahead of other industries attacking the Y2K problem. "They are slowing the rate of ramp up from pilot to production on the System 390s until after the beginning of the new year," said Maine.

"Once we get past these lingering Year 2000 effects, we should see an acceleration of demand as customers resume normal buying patterns," Maine told financial analysts.

Growth areas
IBM's strongest growth areas were in services, software, and technology. Services revenue increased 12 percent to $7.9 billion. Big Blue signed $9.2 billion in services contracts during the third quarter.

Services has been a particular focus for IBM over the past few years. Although margins for the service division are often lower than other IBM businesses, the company has experienced stronger growth rates in this area in past years.

Software revenues totaled $3 billion, a 7 percent increase over a year earlier. Hardware revenue took a 1 percent hit, at $8.8 billion, because of slower sales of servers.

IBM saw a decline in desktop PC sales, with Netfinity servers and ThinkPad notebooks driving systems growth. Together they represent about half of IBM's PC hardware revenue and grew revenue 37 percent in the third quarter.

"Even though we were pleased with our ThinkPad results, sales were constrained by short supplies of flat panel displays," said Maine. "We had mentioned this in the second quarter, but it worsened in the third quarter and shows no sign of improving in the fourth quarter."

Big Blue is trying to correct problems in the sale of personal systems by reducing staff by 5 percent to 10 percent and by taking consumer sales direct over the Web. The company also is refining its small and midsize business focus with services.

Direct sales also played an important role in IBM's commercial systems business. The company increased to 300 the number of large customers it services directly. Direct sales volume topped 10 percent for the first time.

The earthquake in Taiwan had a minor impact on IBM's third-quarter results, and although the company expects no problems next quarter, it warned it had not completed a supply-chain assessment.

The recent rise in DRAM prices also hurt Big Blue more than it helped it. DRAM sales, which make up about 10 percent of IBM's microelectronics revenue, grew moderately. But because the company buys about twice as much memory as it sells, rises in spot prices negatively affected revenue.

Overall gross margins for the quarter was 35.8 percent. Software gross margin was highest, at 81.2 percent, followed by global financing at 56.7 percent. Hardware and services had, respectively, a gross margin of 25.2 percent and 27.6 percent.

"It was a decidedly mixed quarter," IBM chief executive Louis Gerstner said in a statement. "On the negative side, we saw a Y2K slowdown toward the end of the quarter, particularly in our large servers, and to a lesser extent in services and operating systems software."