IBM Beat Buoys Hope

Updated from July 18

To the relief of tech investors, IBM ( IBM) beat earnings estimates by a penny and nailed its revenue expectations for the second quarter.

"The level of expectation on Wall Street was so low, in my mind, there was only one way to go afterward, and that was up," said Bob Djurdjevic, president of Annex Research, who owns Big Blue shares. "The absence of bad news was good news."

Djurdjevic said IBM's improvement in profitability in the software business was a positive, and mainframe revenue growth "was a pleasant surprise."

In early Wednesday trading, the stock was up 3%, gaining $2.20 to $76.46.

"We're really encouraged to see the overall gross margins continuing to increase," said Kim Caughey, a senior equity research analyst with Fort Pitt Capital Group, which holds IBM shares. She added that the company seems "pretty confident" that it has a pipeline of good deals, and it is not sacrificing closing the deals for lower margins.

The hardware and IT-services giant said net income rose to $2.02 billion, or $1.30 a share, a 14% improvement up from $1.83 billion, or $1.12 a share, a year earlier.

A Thomson First Call survey had expected the company to earn $1.29 a share.

Revenue tallied $21.89 billion, falling 2%, but up 1% when adjusted for the impact of the PC business. A year ago on the top line, IBM collected $22.27 billion, including $557 million for the last month of revenue from the PC business.

The top-line results were in line with analysts' anticipated sales of $21.89 billion.

The company's gross profit margin rose to 41.2% in the quarter from 39.4% last year, which includes the divested PC business. Excluding the PC business, last year's gross profit margin was 40.6%.

IBM said Global Services revenue, including maintenance, fell 1% to $11.9 billion in the second quarter. The company signed services contracts totaling $9.6 billion, which seemed to disappoint both the company and investors.

"The signings were weaker than we would have liked," Caughey said.

Djurdjevic agreed that IBM is still having trouble growing its services and said the reorganization of the division a year ago has not worked. He suggested that the company should break it into smaller segments to be more nimble.

In a conference call with analysts after the bell, IBM Chief Financial Officer Mark Loughridge admitted that services was not up to par.

"In services, our short-term business were weak," Loughridge said, adding that the integrated technology-services business has been in transition as it is rearranged to focus on higher-value and higher-growth segments. The transition has taken longer than expected, however.

"In global business services, though our business grew in the Americas, we underperformed in some key countries in Europe and Asia," he added.

Hardware revenue fell 7% (8%, adjusting for currency) to $5.1 billion, which includes revenue from the divested PC business. Hardware revenue without the PC business increased 3% (2%, adjusting for currency).

Software revenue rose 5% to $4.2 billion. The company said revenue from IBM's middleware brands, which include WebSphere, Information Management, Tivoli, Lotus and Rational products, were $3.2 billion, up 4% from a year earlier.

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