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Hardware Sales Hold Back IBM

Sluggishness comes despite gains in technology services and consulting.

Updated from 4:40 p.m. EDT



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posted tepid third-quarter financial results as strong gains from technology services and consulting, its biggest unit, mixed with losses in hardware sales.

Net income rose to $2.36 billion, or $1.68 a share, from $2.22 billion, or $1.45 a share a year earlier. That beat analysts' consensus forecast by a penny, according to Thomson Financial.

Revenue rose 7% to $24.1 billion, in line with estimates, on the back of a 14% jump in total services revenue. IBM also signed $11.8 billion in service contracts during the quarter, ahead of most analysts' estimate of $11.5 billion.

"Our outstanding services results this quarter enabled us to stay on track toward our objective of accelerated earnings per share growth through 2010, while we work through a transition in our hardware business," said Chief Executive Sam Palmisano in a statement.

Factoring out currency exchange effects, revenue rose 3%. Software sales also grew 3% in constant currency terms, while hardware sales fell 13%.

In a conference call after the results were announced, Chief Financial Officer Mark Loughridge said the company is working through an awkward period in which customers are putting off hardware purchases as they await IBM's new servers with improved processors, and work through existing processing capacity.

Loughridge said the modest growth in software sales stemmed mostly from a failure to close large deals over $1 million in value.

"We could have done better," said Loughridge.

IBM is relying on increasing sales of software to improve its profitability and help reach its goal of earning $11 a share by 2010. The setback in sales caused the company's overall gross margin in the quarter to contract slightly to 41.3% from 42% a year earlier. But the gross margin remains slightly higher when comparing the first nine months of this year to the same period last year.

Loughridge shrugged off the notion that the demand for tech products and services was souring because of an economic slowdown. He said the weak sales were largely limited to financial services firms, predominantly in the U.S.

Financial services firms makes up IBM's largest customer segment, and are typically avid buyers of its System z servers, which saw sales fall 31%.

Looking toward the fourth quarter, Loughridge expects hardware sales growth to be flat, but forecast double-digit gains in software sales and profit. He reaffirmed the company's 14%-15% target range for growth in annual earnings-per-share. Year-to-date, earnings per share are growing at about 16%.

In the meantime, Loughridge said that the company is working off its debt burden and maintains ready access to affordable credit. In the quarter, IBM repaid $500 million of the more than $11 billion it borrowed earlier in the year to accelerate its stock buyback plans.

IBM's debt-to-capitalization ratio, excluding debt from its financing arm, fell to 40.3% from 46.7% at the end of the previous quarter.

Loughridge stressed that IBM maintains "good access to the credit markets," especially as investors turn to corporate debt with low default risk. The company can arrange short-term financing at 30 basis points below the London Interbank Offered Rate, or LIBOR, and its recent sale of $3 billion in 10-year bonds was twice oversubscribed.

In late trading, IBM shares were down $1.39, about 1.4%, to $118.21.