IBM beats estimates

July 19, 2000: 6:55 p.m. ET

Computer giant booked $20 billion of new services business in 2Q
By Staff Writer David Kleinbard

NEW YORK (CNNfn) - Computer hardware, software, and services giant IBM reported second-quarter net income that was slightly ahead of analyst estimates, even though its revenue slipped again.

The Armonk, N.Y.-based company reported after the market closed Wednesday that its second-quarter net income declined to $1.94 billion, or $1.06 per share, from $2.39 billion, or $1.28 per share, in the same period last year. Without a one-time gain associated with the sale of IBM's Global Network business to AT&T, the 1999 results would have been 91 cents per share.

Analysts had expected the company to earn $1.00 per share, according to First Call. Revenue declined 1 percent to $21.7 billion from $21.9 billion. Revenue was flat with last year's quarter when measured in constant currency terms. IBM's first-quarter 2000 earnings had declined 5 percent from the same period in 1999.

A second-half story

"Our second-quarter results are right in line with our expectations and with the view we've been expressing since last October," Louis Gerstner, Jr., IBM's chairman and chief executive officer, said in a news release. "Essentially, we've had three quarters of slow revenue growth, driven by a combination of the Y2K slowdown and a series of actions we've taken to improve our business portfolio. During that time, however, we have been able to produce satisfactory earnings growth."

"We are looking forward to a strong second half," said IBM's CFO, John Joyce. "We still agree that IBM is a second half story. We are comfortable with current earnings per share estimates for the full year 2000."

The consensus estimate for IBM's (IBM: Research, Estimates) full-year 2000 earnings is $4.36, according to First Call. IBM stock jumped 5-9/16 to 108-7/8 in after-hours trading.

"I think they fared according to the script they had before," said Sam Albert, president of the consulting company Sam Albert Associates in Scarsdale, N.Y. Albert used to be an executive at IBM. "Gerstner has transformed IBM from a hardware company to a software and services company, and the progress they made in services in the quarter was stellar."

Avoiding a slowdown in services

IBM appears to have avoided the slowdown in its computer services business that has hit several of its competitors, including EDS and Unisys. In fact, new contract signings in the services side of IBM totaled $20 billion in the second quarter, a record for the company. IBM also benefited from an improvement in its server business, particularly Web servers - where revenue increased almost 30 percent. Its high-end disk drive revenue, led by its advanced Shark product, also rose 30 percent.

On the flip side, IBM's second-quarter results were hurt by revenue declines from its System/390 and AS/400 servers, personal computers, and hard disk drives.

Hardware revenue was $9.2 billion in the second quarter, a decrease of 5 percent from last year's second quarter. IBM's personal computer business continues to lose money, although the company's management said on a conference call that they aim to make that business profitable by the end of this year.

Revenue from IBM's Global Services business, including maintenance, grew 2 percent to $8.2 billion. After adjusting for the sale of IBM's Global Network business to AT&T and a year-over-year decline in Y2K services business, Global Services revenue, excluding maintenance, increased 10 percent. IBM ended the quarter with a total services contract backlog of about $75 billion.

"Services is the future for IBM, because we are heading for an era when 75 percent of corporate IT work will be outsourced," Albert said. "Companies will go back to their core businesses and leave IT to an outside company. Having enough skilled people is the only limiter to growth in the services business."

Middleware and database software grow strongly

IBM's software revenue increased 2 percent in the second quarter to $3.2 billion. Software sales are important to the company's bottom line because its gross margin in software is 80 percent, versus 27.4 percent for hardware and 25.9 percent for Global Services.

Revenue from the company's middleware products rose 11 percent, while sales of its database software jumped 60 percent. Middleware is software that connects different parts of an application, enabling computer users to access data from multiple sources and across different platforms. During the quarter, IBM announced that it would invest more than $1 billion over the next several years to market and develop its Web management product, WebSphere.

However, IBM's sales of operating systems software declined 10 percent, primarily as a result of a decrease in mainframe software revenue. Competitors BMC and Computer Associates also have experienced declines in mainframe software sales.

Revenue from Global Financing increased 10 percent in the second quarter to $819 million.