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IBM edges past expectations, despite lower revenue

Big Blue squeezes past analyst projections with earnings per share of $1.06, but lagging revenue keeps a lid on any euphoria.

IBM squeezed past analyst projections today with earnings per share of $1.06, but lagging revenue kept a lid on any euphoria.

The company reported earnings of $1.9 billion, or $1.06 per share, for the second quarter, beating the lowered consensus estimate of $1 per share on First Call/Thomson Financial. The Armonk, N.Y.-based company posted 91 cents a share a year earlier, excluding extraordinary events, giving the company a 16 percent increase in profit.

Revenue, though, declined by 1 percent year-over-year to $21.7 billion. Second-quarter 2000 net income totaled $1.9 billion, compared with $1.7 billion--excluding one-time events--for the same period a year before.

Sales sluggishness caused by the Year 2000 glitch continued to sap IBM in the second quarter, following revenue hits in the two previous quarters. Hardware revenue declined 5 percent from a year earlier, to $9.2 billion. Web server revenue grew strongly, but revenue from sales of System/390 and AS/400 servers, which were affected by the earlier Y2K buildup, declined.

The sales malaise affected other divisions as well. Services, including maintenance, grew a modest 2 percent in the second quarter to $8.2 billion. Software revenue increased 2 percent to $3.2 billion. Hard drive revenue declined $250 million for the quarter.

"Our hard disk drive business, while improving quarter to quarter, is still a drag on our revenue growth," IBM chief executive Lou Gerstner said in a statement. "PCs, as well, improved quarter to quarter, but we're not satisfied with the results.

"Nevertheless, our outlook going forward is quite different from the one we faced in the last three quarters, and we continue to be very encouraged about the second half of this year."

In a conference call with financial analysts this afternoon, IBM chief financial officer John Joyce honed in on services, hard drives, mainframes and PCs. All of those areas posted disappointing results but show good growth potential for the second half, he said. He pointed out, for example, that IBM shipped 200,000 hard drives at the quarter's end and outlined services deals that would yield future revenue.

"Our general view of the second half remains unchanged," Joyce said. "We are comfortable with current consensus for earnings per share for full year 2000."

Overall, hardware systems fared badly during the quarter. While IBM had predicted mainframe sales to recover in the quarter, S/390 sales grew 1 percent year-over-year and AS/400 sales declined 23 percent. Joyce attributed some of the AS/400 drop to a normal slowdown before new models are released on July 28.

Sales of Web servers, however, emerged as a bright spot, growing 30 percent from a year earlier.

PC revenue declined $140 million year-to-year, but IBM's PC group cut its losses by about $100 million to $69 million from the first quarter. Gross margins grew 3 percent.

Increased direct sales added to the margin increase, up five points to 24 percent. IBM's goal is to have direct sales account for 35 percent of total sales by year's end.

"We are committed to a profitable PC business," Joyce said, acknowledging the company "has got more work to do, particularly in hard disk drives and PCs."

Still, a component shortage affecting ThinkPads and the new NetVista PC line could hurt sales throughout much of the quarter, Joyce said.

Middleware software revenues grew 11 percent, but operating system software declined 10 percent, in part because of slow AS/400 sales. IBM's WebSphere middleware jumped 200 percent during the quarter from a year earlier. Middleware, which accounts for two-thirds of IBM's software revenue, grew best on Unix and Windows NT, gaining 34 percent.

Gross profit margins declined nearly 1 percent to 36.7 percent year-over-year but up half a point from the first quarter. Hardware gross profit margins declined half a point, as revenue strength shifted from servers to microelectronics. Services margins dropped 1.3 percent and software nearly 1 percent.

Second-quarter revenue from the Americas decreased 3 percent to $9.7 billion from a year earlier. Europe, Middle East and Africa revenues were $5.9 billion, down 9 percent, while Asia-Pacific revenue grew 20 percent to $4.3 billion. Original equipment manufacturer (OEM) revenue declined 6 percent to $1.8 billion.

Signs IBM could be in trouble had been coming for weeks. Following the Independence Day holiday, BMC Software and Computer Associates stock plunged 40 percent and 42 percent, respectively, setting new 52-week lows.

Both companies reported poor earnings following slower-than-expected mainframe software sales. Gartner analyst Ray Paquet called the problem the "Y2K hangover," as large businesses put mainframes into service used in Y2K testing rather than investing in new systems and software.

IBM, whose products account for about 70 percent of mainframe sales, also makes software for large servers, meaning it could be doubly hurt by any trouble in the market.

Merrill Lynch analyst Steven Milunovich cut his second-quarter IBM growth estimate to 3 percent from 1 percent because of potential services weakness, also attributed to lingering Y2K effects.

Today's news crowns a less than stellar week for IBM's hardware business. On Monday, as first reported by CNET, IBM acknowledged it had a backlog of ThinkPad portables stretching into August. Of 108 configurations available, 79 were back-ordered.

Despite another difficult quarter, financial analysts remain optimistic IBM will reinvigorate growth in the second half.

"We expect that IBM will be generally positive about the second half, though we think there is some risk to our third-quarter revenue (growth) estimate of 9 percent," Milunovich said in a conference call last week. "We would have investors wait to see the quarter, but we do expect the stock will perform better in the second half."

Earlier, Milunovich predicted IBM's stock would gain 20 percent in the second half.