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For Big Blue, No Slack in Services

By Steve Hamm IBM delivered surprisingly strong fourth-quarter results when it announced earnings Jan. 18 -- perhaps putting to bed worries that had arisen on Wall Street about slacking demand in its services business. Revenues from continuing operations hit $27.7 billion, up 7% from the year-ago period, which had been a killer quarter. IBM's (IBM) net income increased 12%, to $3.1 billion, and earnings per share were $1.81, up 16%.

"We gained share in many key areas and continued to shift our business to high-value segments of enterprise computing," says Mark Loughridge, senior vice-president and chief financial officer.

He expects IBM's 2005 revenues to grow about 1% faster than analysts' current 6% consensus figure -- excluding the PC business. IBM last month agreed to sell that unit to China's Lenovo (LNVGY), a deal that's expected to close in the second quarter.

"LUMPY" PIPELINE. For the fourth quarter, Big Blue exceeded analysts' consensus earnings and revenue growth projections, potentially setting the stage for a stock-price rally. Analysts surveyed by Thomson First Call had forecast EPS of $1.76 on revenue of $27.4 billion. In trading Monday before the results were released, IBM's stock closed at $94.90, up 80 cents. It had traded as high as $99 in early January.

Revenues from services were the big story, rising 10%, to $12.6 billion. Consulting was up an impressive 12%. IBM signed services contracts totaling $12.7 billion and ended 2004 with a backlog of $111 billion. That was down 8% from 2003's backlog, due in part to a termination of a large contract with JP Morgan Chase. Gross profit margins in services were 25.1%, up 0.3%.

"This is stronger-than-expected demand," says analyst Mark Stahlman of Caris & Co. "There are still some concerns about the services pipeline, because it's so lumpy. But I think Wall Street should focus on profitability rather than bookings, since quarterly demand for services will always be variable."

STRIKING CHORDS. Revenues were good in most of IBM's businesses, with the exception of hardware, which had been the leading segment over the past few quarters. Hardware revenues came in at $9.5 billion, up just 4%. While sales of Windows servers increased 25% and Unix servers were 15% higher, mainframe revenues shrank 4%, and Personal Systems Group revenues increased just 2%.

Loughridge says the announcement of the PC division's sale to Lenovo slowed revenue growth. Hardware sales were also affected by product transitions in storage devices and the iSeries midrange servers.

IBM reported healthy demand for software -- with revenues up 7%, to $4.5 billion. Especially strong were the WebSphere product family, which includes Web application servers, rising 18%, and Tivoli products, which help corporations manage their computing system, 25% higher. These two businesses signal that IBM's "On Demand" strategy for managing complex data centers is striking chords with customers.

Each quarter, IBM usually has one weak segment. This time it was hardware. But with Big Blue's very competitive technology in the server business, don't expect that to become a trend. Hamm is senior writer for BusinessWeek in New York

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