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Slower times ahead, IBM says

Big Blue handily beats analysts' expectations for the second quarter, but foresees restructuring and single-digit growth in the near future.

IBM (IBM) today handily beat analyst's expectations for the second quarter, citing continued growth in professional services sales and response to its new System 390 servers.

However, slower times may be ahead. Lawrence Ricciardi, IBM's senior vice president, said that the company foresees "high single-digit revenue growth," noting that restructuring is also likely.

"We've got too much infrastructure in this company," he said.

IBM, which announced its results after the market's close, ended the day at 103-11/16 a share. Big Blue's shares fell to 101 in light after-hours trading, which was halted late in the after-hours session.

IBM posted $1.4 billion, or $1.46 a share, in earnings for the second quarter, off of $18.9 billion in revenues. This represented an increase over earnings of $1.3 billion, or $1.26 per share adjusted for a 2-for-1 split, on revenues of $18.2 billion a year ago.

Analysts, on average, estimated that IBM would post earnings per share of $1.42 for the three months ending June 30, although many thought the company would come in above that mark. John Jones, an analyst at Salomon Brothers, had predicted earnings of $1.45 but said IBM would hit his estimate or even "beat it by a nickel or so."

Professional services, which chief executive Lou Gerstner has placed at the center of IBM's strategy, fueled profits in the quarter. Services grew approximately 24 percent in the quarter to $4.6 billion, faster than the company's overall growth but down from its first-quarter growth of 28 percent.

"We saw very good customer response to our new System 390 servers and continuing strength in services and hard disk drives. There was substantial year-over-year improvement in our semiconductor business. Our PC commercial and PC server results were good," Gerstner said, in a statement. "Results from these areas more than offset revenue declines in some other segments, most notably our consumer PC business and our AS/400 and RS/600 server lines."

But there were some slow spots in the quarter.

Hardware, for example, stayed flat. Large inventories led IBM to offer discounts and rebates to distributors and resellers in both the first and second quarters to push product through the channel, a number of sources said. The programs, however, were executed in a more orderly fashion in the second quarter. As a result, IBM was able to increase sales in the last few weeks of the quarter.

"There was a lot out there. Inventory came down from Q2 to Q1," said Ian Morton, an analyst at Hambrecht & Quist, prior to the announcement.

On the other hand, mainframes, workstations, and minicomputers were weak spots, said analysts.

And although Ricciardi said that the company was on track for 1997, the future will involve cost-cutting to sustain growth. Gross margins are expected to drop close to 1 percent a year due to lower margins, especially in hardware.

"Changing mix in business should tend to drag gross profit margins down 1 point per year," he said. To make up the difference, IBM will work to cut internal costs and be aggressive on taxes, he said.

The company will also look into reducing costs by increasing its channel assembly program and creating a "build-to-order" program similar to Compaq's released earlier this year.

In the PC realm, the second quarter was not a banner one for the company. Retail sales were down and "Compaq grew faster than we did in unit growth and revenue," Ricciardi said. Sales of AS400 and RS/6000 servers were also down.

Meanwhile, as geographic sectors go, demand continued to increase in North America and Asia-Pacific, while shrinking in Europe.

On the product side, IBM added a new line of ultraportable 560 series notebooks with MMX processors and introduced a new high-end 765 notebook during the quarter. The 560e was the latest addition to the highly successful thin-and-wide 560 series of ultraportable notebooks. The 560e is offered with either a 150- or 166-MHz MMX Pentium. Just after the quarter ended, IBM also steeply discounted its ThinkPads to keep up with declining prices elsewhere in the industry.

Workstations based on the Microsoft-Intel platform were released just after the quarter ended. On the low end, the company committed to come out with a NetPC later in the year during the NetPC extravaganza at PC Expo in June.

Reuters contributed to this story.