Hardware makers to get hit further over Y2K

A year ago, hardware executives predicted that the millennium bug would reverse the year's normal business cycle. In other words, sales of personal and server computers would be hot in the first half of 1999, driven by Y2K issues, and then slow to a crawl in the second half as corporations entered "lockdown" mode.

But, as IBM indicated in a fourth-quarter profit warning issued yesterday, the effects are more selective: Computer makers focusing on back-end systems are taking a hit, while those selling personal computers are seeing an upturn in sales.

The Y2K bug is a programming glitch that could cause some ill-prepared computers to mistake the year 2000 for 1900, possibly affecting operations and output. Countless hours and dollars have already been spent in preparing business and government systems for the glitch, but IBM's warning was one of the first tangible signs of economic loss.

In reporting its third-quarter earnings, IBM told financial analysts its fourth-quarter results would be 15 to 20 cents off their expectations of $1.33 a share. Big Blue attributed the problem to slowing mainframe computer sales, down 40 percent for the S/390 line and 30 percent for AS/400 machines in the third quarter, after four straight quarters of record growth.

Big Blue wasn't the first to surprise analysts. Unisys, a computer services company, tipped off the trouble that lay ahead for mainframe makers when the company announced third-quarter results a week ago, warning hardware sales would be down 15 to 20 percent in the fourth quarter.

"Their hardware sales are almost all mainframes," said Technology Business Research analyst Joe Ferlazzo. "We all should have seen it coming and been prepared for IBM's warning."

But IBM's caution caught almost everyone by surprise, particularly Wall Street, which today bathed Big Blue in red. IBM lost 16 points in unusually high trading.

Moreover, Merrill Lynch's influential Steven Milunovich downgraded Big Blue to "Neutral/Buy" from "Buy/Buy."

BancBoston Robertson Stephens analyst Dan Niles appeared to second the move. "Look at it this way: You've got a company that does $20 billion in revenue a quarter, and they just missed by a billion and a half dollars, and there are a lot of other things that go with it."

Goldman Sach's Laura Conigliaro said that the worst is not over. She expects IBM's overall hardware business to be off 5 percent in the fourth quarter and 4 percent during the first quarter.

Douglas Maine, IBM's chief financial officer, yesterday told financial analysts this slowdown "is unique to IBM." He made this point several times in his conference call with them.

In many ways that is true, analysts said, pointing out that 70 percent of data center information resides on IBM mainframes. The slowdown in purchasing appears to stem from companies with large data centers that don't want to risk loss of data or interruption of their business because of the Y2K bug.

But analysts now predict other mainframe vendors, mainly Fujitsu, Hitachi, and Unisys, will also see slower sales over the next two quarters.

Several computer manufacturers, who asked not to be identified, said they expect slower server sales and that customers are already curtailing purchases as they prepare for the possible effects of the Y2K bug.

In a related matter, Intel is expected to announce new Pentium III processors on Monday as well as a new chipset boosting overall system performance. But Compaq Computer, Hewlett-Packard, and IBM, among others, do not plan to announce new servers; instead they will mostly upgrade existing models with the new "Coppermine" chips.

Tom Lattig, Compaq's director of corporate server marketing, explained why. "This transition is coming at a pretty difficult point--changing the architecture of the server--and doing that at the end of the year when a lot of our large accounts are completing annual roll-outs and preparing for the effects of Y2K," he explained.

"The feedback we're getting back from our customers is the next two months is about stability," said Lattig.

By contrast, most analysts expect PC sales to remain strong, with International Data Corporation forecasting as much as 28 percent year-to-year growth in the fourth quarter. If there is a slowdown, they said, it would be related to other factors, such as component shortages caused by the recent earthquake in Taiwan.

"Our assessment was based on the fact that Y2K spending had been declining since the middle of 1997 and many projects were wrapped up by the beginning of 1999," said IDC analyst Roger Kay. "Therefore, they would not pull budget from PC purchases."

Two factors account for strong PC growth: free and low-cost PCs and last-minute purchasing by smaller businesses.

"As the end of the year approaches, you have all these small- and medium-size businesses realizing they've got older PCs that are not ready for Year 2000," said Aberdeen analyst James Gruener. These companies either did not take the Y2K bug seriously or put off purchases until later in the year, he said.

If there is a slowdown in PC sales it would come in January and continue for another month as companies assess the impact of the Y2K bug, Kay said.

Several analysts said privately today they wondered how so many people looked at strong PC sales and missed the danger signals. Slowing sales by companies such as Baan and SAP, which sell software used in data centers, should have warned of trouble ahead.

Niles said he expects still bigger storms ahead.

"Everybody went into the fourth quarter thinking Y2K was not a problem, including IBM 90 days ago," said Niles. "Now they've come back and said, 'Guess what? Y2K is going to affect us for the next nine months.' If IBM can't get it right, which deals with all the top companies out there, what makes other computer companies think they can get it right?"

He predicted PC companies with businesses similar to IBM that have not announced earnings, such as Compaq and Hewlett-Packard, may have similar forecasts for the next two quarters.