IBM Issues Surprise Warning, Shares Tumble

NEW YORK – International Business Machines Corp. (IBM) Monday warned of a huge first-quarter shortfall, which it blamed on businesses cutting technology purchases, spurring a sell-off in its shares.

Despite persistent rumors during recent quarters that Armonk, New York-based IBM would warn -- with the latest coming on Friday -- the news still caught the market by surprise, and initially sent stocks down around the globe.

Corporate technology spending has been dismal for the past year due to the economic downturn -- hampering earnings and revenue at most technology companies.

The news from No. 1 computer maker IBM made it clear that companies haven't started spending again, investors said.

"IBM is not immune to some of the same issues that are affecting everyone else," said Marty Shagrin, an analyst at Cleveland, Ohio-based Victory Capital Management.

But, Shagrin and some other analysts also said increased investor concerns about the aggressive accounting may have limited IBM's first-quarter earnings. In response to that scrutiny, IBM last month said it would provide more information on some items it typically includes in revenue and profit.

"I think in periods in the past, if IBM has had a revenue shortfall, they've been able to make up for it in other areas," he said. "But with the increased disclosure and increased scrutiny, it doesn't seem like they had that possibility this time."

IBM, which declined to comment beyond its written statement, said customers deferred capital spending due to the business environment, hitting IBM revenues across the board. In particular, the division which makes components for other companies to use in computers and other products was hurt.

It was the first time in more than a decade that IBM issued an earnings warning outside of a regularly scheduled event.

The warning from IBM was followed by word later Monday from No. 2 personal computer maker Compaq Computer Corp. that its first-quarter revenue would come in at $7.7 billion, $100 million higher than analysts expected.

Compaq's quarter was better than expected while IBM's was weaker because IBM sells everything from database software to large mainframe computers to computer services contracts, analysts said. That makes IBM a better gauge for technology spending overall, while Compaq's revenues largely reflect PC and computer server sales.

IBM, which in recent quarters has been criticized on Wall Street for its slowing revenue growth, said it expects first-quarter revenue to come in at $18.4 billion to $18.6 billion, more than $1 billion below analyst expectations.

Its shares closed down $9.84, or 10.1 percent, at $87.42 on the New York Stock Exchange.

WARNING COMES AMID CHANGE

This warning comes at a time when IBM is facing some of its biggest changes in several years.

Last month, Chief Executive Samuel Palmisano took the reins from long-time IBM head Louis Gerstner, who was credited with turning Big Blue around and making it profitable in the 1990s. Gerstner remains chairman through 2002.

In addition, IBM, which reports earnings on April 17, has been criticized as investors and analysts scrutinized the company's accounting methods and said the company wasn't providing enough information.

As a result, the company issued new information in its annual report, released in March, and said that it would break out more financial items for investors.

Like Victory's Shagrin, Merrill Lynch analyst Steven Milunovich said in a research note that the move could indicate a change in management style.

"One might speculate that new CEO Palmisano wants to lower the bar. Given increased accounting scrutiny, IBM's proclivity to stretch to make earnings on disappointing revenue was becoming a liability. The company downplays this view, indicating that demand late in the quarter disappointed and nothing more," Milunovich said.

IBM shares have fallen 28 percent this year due not only to Monday's warning and accounting concerns but also to worries about the company's ability to increase revenues, particularly in services, which contributes about 40 percent of revenues.

In the fourth quarter, services revenue dipped 1 percent and revenue overall fell 11 percent.

Tom Bittman, a research director at Gartner Inc., said that in addition to weak semiconductor and hard disk drive sales, he believes IBM's business suffered due to a declining PC business, weak sales of large mainframe computers, and low services revenue.

Large long-term services contracts are a good business, Bittman said, but IBM has nearly saturated the sector.

"The problem is can you grow it at the same rate? We don't think there are as many good deals out there," Bittman said.

TECH SLOWDOWN

IBM expectations for first-quarter revenue in the range of $18.4 billion to $18.6 billion is down from $21 billion a year ago. It said it anticipates earnings per share of 66 cents to 70 cents, down from 98 cents in the first quarter of 2001.

Prior to the warning, analysts saw earnings in the range of 80 cents to 88 cents per share, with a mean estimate of 85 cents, according to Thomson Financial/First Call. Revenue estimates ranged from $19.3 billion to $20.8 billion.

IBM attributed the shortfall in part to its technology group, which makes items such as microchips for other companies like Apple Computer Inc. . It said it expects that revenue to fall 35 percent, hitting its profit by $200 million before taxes, or 8 cents per share. The fall comes on the back of a 34 percent decline in revenues during the fourth quarter.

The news hit technology companies' stocks as investors worried about more earnings warnings from other companies but by the end of the day, some stocks had recovered. The Dow Jones Industrial Average fell 23 to 10,249 while the Nasdaq Composite Index was up 16 at 1786. The American Stock Exchange Computer Hardware Index fell 1.2 percent.