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Big Blue Stays Cautious on Second-Half Projections

Updated from 4:17 p.m. EDT:

Technology juggernaut IBM (IBM - Get Report) Wednesday evening posted in-line second-quarter earnings on softer-than-expected sales.

For the quarter, the Armonk, N.Y.-based company reported net income of $2 billion, or $1.15 a share, matching the consensus earnings estimate of analysts polled by Thomson Financial/First Call. Year-ago earnings were $1.06 a share.

Revenue growth slows at Big Blue
Source: The company.

Revenue, meanwhile, came in light. It totaled $21.6 billion, about $1 billion below expectations and roughly flat with the year-ago period.

IBM wasn't bullish about the second half, saying ongoing weakness in PCs and hard disk drives will continue to hurt results. Additionally, IBM said it is now seeing signs of slowing in its microelectronics business as OEM customers reduce purchases.

IBM has risen more than 20% this year, as investors have embraced the very thing for which critics attacked the company during the last years of the hyper-bull market: its diversity and its large exposure to the mainframe business. IBM holds a virtual lock on that business, which produces a stable stream of recurring maintenance and service revenue. Such annuities make up about 40% of IBM's sales.

Serve and Protect

In general, and as one may have expected, business was not brisk. IBM posted year-over-year declines in its hardware and software segments. Sales of personal computers and hard disk drives were particularly weak.

But without doubt, the company's best-performing segment was services, where revenue rose 6.8% in the second quarter. IBM's Global Services division racked up about $16 billion of new signings, bringing the company's backlog up to a staggering $95 billion. The exact schedule by which that backlog will be converted into revenue isn't clear. Nor is it known how profitable deals signed today will be 10 or 15 years down the road. But IBM's services backlog seems to be providing the company a sort of stability that tech outfits like EMC (EMC) and Veritas (VRTS) lack.

Even so, the second-half outlook CFO John Joyce gave on the conference call following the earnings release wasn't encouraging. Like many other tech execs before him, Joyce pointed to the weakness in Europe, where a strong dollar is making U.S. products more expensive for consumers and corporations. The strong dollar is hardly a new phenomenon. It's been a matter of U.S. policy for several years, and Joyce himself noted on the conference call that IBM hasn't been helped by currency exchange fluctuations since 1995. But even so, he said, the dollar could take its toll on IBM's results in the second half of 2001.

No Predictions

"If the dollar continues to be strong, the year-to-year hit to our earnings in the second half could be 14 cents," Joyce said. "We're making no prediction here. We're simply giving you the facts, making the assumption that the dollar remains at today's strong levels."

IBM said that it's been able to absorb the negative effects of the strong dollar thus far. But it warned that could end if business doesn't turn around in its microelectronics business, where sales could decline by about 15% in the second half of the year.

"If demand in microelectronics picks up in the third quarter and continues to expand in the fourth quarter, we will be encouraged," said Joyce. "But if our major microelectronics customers do not start growing their businesses in the third quarter, our ability to cover these nonoperating items could be problematic, and could cost us a few cents more." IBM's microelectronics business includes a wide swath of semiconductor and networking products.

Joyce also told analysts that it would be reasonable to assume equity writedowns of $100 million to $125 million in the second half of the year. That would work out to about 5 cents a share, Joyce said.

IBM fell $4.25 Wednesday to close at $104.28. In after-hours trading on Island, IBM dropped $2 to $101.81.

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