IBM posts across-the-board Q1 declines

After resetting expectations with an earnings warning that rocked Wall Street, IBM hit its revised numbers for a quarter it called disappointing, posting a 12 percent revenue drop and 32 percent net income decline over the year-ago period.

IBM recorded revenue of US$18.6 billion and net income of $1.19 billion for its first quarter of 2002, which ended March 31. Earnings per share were $0.68, in line with the revised estimate of analysts polled by Thomson Financial/First Call. The analysts' initial consensus forecast was for $0.85 earnings per share, a number drastically curtailed after IBM's earnings warning last week.

IBM's product lines showed across-the-board revenue declines, with its hardware offerings showing the biggest drops. Big Blue remains confident that despite weak revenue it gained or held share in the "high-priority segments" of services, software, servers and advanced storage products, said IBM's new Chief Executive Officer Sam Palmisano in a prepared statement.

The shortfall between IBM's expected and actual revenue occurred "very late" in the quarter, leaving a gap that even a strong finish in the last week couldn't close, said Chief Financial Officer John Joyce during a conference call with analysts and reporters following the earnings release.

IBM's "annuity-like" stream of sales from predictable operations such as outsourcing, maintenance, host-based software and global financing means IBM enters each year with roughly a third of its revenue already under contract, Joyce said. That steady income, along with IBM's business model and product leadership, set it up well to take advantage of the IT industry's eventual recovery, he said.

Joyce made no predictions about the timing or intensity of the recovery.

"Our crystal ball obviously has been no better than anyone else's in the industry," he said.

IBM's OEM (original equipment manufacture) business was particularly hard hit during the quarter, with revenue declining 37 percent to $1.3 billion. IBM's Technology group lost $276 million, $75 million more than IBM estimated in its warning last week. The loss represented $0.11 earnings per share, more than half of IBM's year-over-year decline, Joyce said.

Hardware revenue decreased 25 percent to $6.4 billion, with IBM's zSeries mainframes, pSeries, iSeries and storage product lines all showing revenue declines. IBM attributed the enterprise hardware plummets to deferred purchasing decisions, price pressures and product transitions.

Revenue from IBM's hard-disk-drive (HDD) manufacturing operations dropped 29 percent from last year's first quarter, which Joyce attributed to pricing and demand pressures in the components market. IBM hopes to steady its HDD line through a joint venture with Hitachi Ltd., announced Tuesday, under which the companies will combine their HDD businesses into a new, stand-alone company which will be majority owned by Hitachi.

PC revenue also declined, which IBM attributed to continuing reduced demand. IBM is limiting its financial dependence on the PC market and has exited the consumer retail channel, Joyce said. Outsourcing is one method by which IBM is pulling back from the depressed sector. In January, it contracted with Sanmina-SCI Corp. to take over most of the manufacturing of IBM's NetVista desktop line.

IBM's vaunted Global Services organization was also affected by the downturn. Services revenue dropped 3 percent over the year-ago quarter, to $8.2 billion. New contract signings jumped 50 percent, however, to $15 billion. While IBM's pipeline for new deals remains strong, new signings generally take two to three quarters to affect earnings, Joyce said.

Software revenue dropped 1 percent to $2.9 billion. IBM noted that revenue from its key middleware product, WebSphere, grew 53 percent year-over-year. Middleware accounts for 80 percent of IBM's software revenue, Joyce said. DB2 and Tivoli also showed revenue gains, while Lotus' revenue declined slightly.

IBM's research and development expenses for the quarter dropped 6 percent. Discretionary expense cuts and the integration of Tivoli and Lotus into IBM's software group drove the decline, Joyce said.

Several times during the call Joyce defended IBM's accounting practices, which have come under fire recently. IBM is "astounded over the kinds of things we've read" about the company during the last few months, and "very proud" of the way it handles its books, he said.

Still, IBM made a few concessions to analyst demands for greater disclosure, including adding a line for "Intellectual Property and Custom Development Income" to its financial breakdowns. The change, first reflected in IBM's recently issued 2001 annual report, stems from charges that IBM did not properly disclose gains from selling its optical transceiver business to JDS Uniphase Corp. in late 2001.

Joyce fought back against criticisms that IBM had improperly classified such asset sales as operating income, rather than one-time gains.

"Let me be very direct. It is absurd to characterize our Intellectual Property and Custom Development Income as 'non-operational,' as has been done in a number of reports and articles. The simple fact is that generating intellectual property and deriving value from it is absolutely fundamental to IBM," Joyce said. "We set targets each quarter for IP income, just as we do for the product sales in the rest of the business."

In advance of the earnings release, IBM (IBM) shares closed down 1.6 percent, at $84.81 in trading Wednesday on the New York Stock Exchange.

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Stacy Cowley

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