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IBM Stock Sinks Despite Profit Leap

International Business Machines Corp. rode cost cuts and software acquisitions to healthy fourth-quarter profits, and the company posted a blockbuster number for contract signings. But investors found reasons to be disappointed, sending IBM stock down sharply Friday.

IBM's earnings report, released after the market closed Thursday, showed an 11 percent gain in net profit, to $3.54 billion, or $2.31 per share, on revenue of $26.3 billion.

Five cents per share of profit came from gains related to discontinued lines of business, so continuing operations earned $2.26 per share.

That was well above the $2.19 per share and $25.7 billion in revenue expected by analysts surveyed by Thomson Financial. But investors apparently wanted even more. Six cents of the earnings upside stemmed from beneficial changes in the company's tax rates.

Shares of Armonk, N.Y.-based IBM were down $4.55, or 4.6 percent, at $94.90 in Friday morning trading on the New York Stock Exchange.

The quarterly figures all surpassed results from a year earlier, when profit was $3.19 billion, or $1.99 per share, and revenue was $24.4 billion. However, profit in that comparison quarter was dragged down about $200 million after taxes, or 12 cents per share, by a one-time accounting charge and costs IBM incurred in freezing its pension plan.

By increasing revenue 7 percent in the fourth quarter, IBM grew faster in that period than it did in the rest of 2006. However, without currency fluctuations, the revenue rise would have been a modest 4 percent.

"We had a very strong finish to the year," Chief Financial Officer Mark Loughridge said on a conference call with analysts. He said he expects 2007 earnings to be in line with current forecasts -- a typically conservative appraisal but nonetheless one that also may have worried some investors.

One closely followed measure of IBM's business is services signings because that division accounts for more than half of the company's revenue. In the fourth quarter, the company closed $17.8 billion in services contracts, a hefty leap from $10.5 billion in the prior quarter and $11.5 billion a year ago.

Revenue from those services signings -- including a $4 billion-plus deal recently sealed with the German government -- will be booked over the course of several years. In the fourth quarter itself, IBM's services division posted revenue of $12.8 billion, up 6 percent from the prior year. Without currency fluctuations, however, the rise would have been 3 percent.

Improving that division's profitability has become a huge effort. IBM is trying to lower the costs of its services projects by relying less on consultant labor and more on software and other "repeatable assets."

The services unit's gross profit margin rose to 27.9 percent from 27.4 percent, the eighth straight quarterly increase. Annex Research analyst Bob Djurdjevic said the figure was "pretty impressive ... compared to other players in the industry that are struggling to make it into the 20s."

IBM's next-largest division, the hardware-focused systems and technology group, saw a 3 percent revenue rise, to $7.1 billion, but would have been flat at constant currency.

Meanwhile, software, IBM's most profitable unit, had a revenue gain of $5.6 billion, an increase of 14 percent -- though it would have been 11 percent without fluctuations in the dollar. Loughridge called it software's best growth in five years.

For all of 2006, IBM earned $9.49 billion, or $6.11 per share, on revenue of $91.4 billion. That marked a 20 percent increase in net profit from 2005, when IBM earned $7.93 billion, or $4.87 per share, on revenue of $91.1 billion. The increase in earnings per share was even higher than the net profit figure because IBM spent $8 billion buying back its stock in 2006, reducing the number of shares on the market.