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IBM says net income, revenue flat

update Big Blue edges ahead of analyst expectations for its most recent quarter with net income of $1.7 billion.

update Excluding its money-losing hard-drive business, IBM on Wednesday reported flat net income of $1.7 billion on revenue of $19.8 billion for its most recent quarter, edging ahead of analyst expectations.

On a per-share basis, the computing and services giant earned 99 cents. Analysts surveyed by First Call had expected net income of 96 cents per share.

Including the impact of discontinued operations during the third quarter, Big Blue had net income of 76 cents per share, or $1.3 billion, a drop of 18 percent from $1.5 billion in the year-ago quarter.

IBM is selling its hard-drive manufacturing operation to Hitachi. The drive business, which has cost IBM hundreds of millions in profits, reduced net income by $381 million for the most recent quarter.

IBM has ducked some of the worst effects of the information technology spending slowdown that have hammered rivals such as server maker Sun Microsystems, storage specialist EMC and services company EDS, but the sour climate still is putting pressure on Big Blue. To cope, Chief Financial Officer John Joyce said in a conference call, IBM is putting more emphasis on areas where customers can more easily see the benefit of their spending: software and services.

"The most profitable areas we believe will be in services and software, going forward," Joyce said, so increasing the company's market share in those sectors is "at the top of our list."

Services revenue, which accounted for 45 percent of IBM's total, grew slightly after quarters of declines, but customers are taking longer to commit to deals, Joyce said.

Despite new costs with its pension fund, IBM expects earnings to grow at more than 10 percent from the third quarter to the fourth quarter of 2002, Joyce said. "We are comfortable with something in the range of 12 percent," Joyce said, noting that the growth rate historically has ranged from 12 percent to 18 percent.

First Call analysts expect earnings of $1.35 per share for the fourth quarter, not including the effects of IBM's acquisition of PwC Consulting, on revenue of $22 billion.

The PwC acquisition is expected to decrease earnings per share by about 30 cents, IBM said, but will increase earnings per share in the second half of 2003. The acquisition will add about $1 billion to fourth-quarter revenue, Joyce said.

Revenue was flat compared to the same period a year ago, when IBM also garnered $19.8 billion, the company said. Various analysts had expected revenue in the range of $19.3 billion to $19.8 billion.

Services fills revenue gaps
The company's hardware and software revenue declined, with gains in services, storage and some servers filling the void, IBM said.

Overall hardware revenue from continuing operations declined 1 percent to $6.8 billion. IBM's hardware losses, however, were less severe than earlier this year. Hardware revenues dropped 25 percent in the first quarter and 16 percent in the second.

Sales of mainframe zSeries servers dropped 8 percent, and those of midrange iSeries servers plunged 20 percent. But sales of pSeries Unix servers increased 1 percent, and xSeries Intel servers increased 15 percent. In mainframes, sales of new computing capacity increased 7 percent, 45 percent of that driven by customers using the Linux operating system, IBM said.

Services revenue increased 2 percent to $8.9 billion. The company signed $9 billion in services contracts in the quarter, a figure that will come under scrutiny given the revenue warning in September from EDS, which is in a similar market.

The $9 billion figure is a decrease from the previous quarter because sales are taking longer as chief financial officers, chief executive officers and even company boards review purchases to make sure they'll pay off, Joyce said. IBM signed nine services deals worth more than $100 million, with one of them worth more than $1 billion, but customers deferred 11 deals worth more than $250 million, several of those worth more than $1 billion.

In the "extremely difficult" software market, customers are taking even longer to close deals and are moving toward less-expensive contracts, Joyce said. Software revenue decreased 3 percent to $3.1 billion.

Revenue from the WebSphere e-business software increased 27 percent, and DB2 database software grew 2 percent, but Tivoli management software decreased 16 percent and Lotus e-mail and calendar software decreased 15 percent.

Pension fund woes
Declines in the stock market will hurt the company's pension fund, the value of which is determined by the fund's rate of investment return, leading to a $700 million income drop in 2003.

IBM already had lowered the expected rate from 10 percent to 9.5 percent for 2002, but Wednesday the company said it expects to lower the predicted 2003 rate to 8 percent to 8.5 percent. To account for the shortfall, IBM plans to inject into the U.S. pension fund as much as $1.5 billion per year, beginning as early as the end of this year.

Joyce put the best light on the $700 million drop, saying the company had taken restructuring actions earlier in 2002 that collectively will save IBM $900 million.

IBM has been in the middle of major changes, including layoffs in the microelectronics division and the sale of the hard-drive business. Further major restructuring "is not in our current plans," Joyce said.

At the same time, the company bolstered its services group, completing in October its acquisition of PwC Consulting. The company's software group has been on a spending spree, acquiring Informix, CrossWorlds, Metamerge, Holosofx, Trellisoft and Access360.

The restructuring will lead to better results at the microelectronics division, Joyce said. A new plant to build chips from larger 300mm silicon wafers is producing prototype processors, and IBM has orders to keep the plant running at full capacity through mid-2003, Joyce said.