IBM 3Q Earnings Beat Street Forecast

Because of a hiccup in its hardware unit, IBM Corp. stock took a hit even though the technology bellwether reported a 6 percent rise in earnings and exceeded Wall Street forecasts. Investors were also sorting out how much IBM is exposed to woes in the financial industry.

IBM shares fell 1.7 percent at the open of trading Wednesday after the company reported late Tuesday that its third-quarter profit was $2.36 billion, or $1.68 per share. That surpassed the profit of $2.22 billion and $1.45 per share that IBM posted in the same quarter of 2006.

Revenue rose 7 percent to $24.1 billion from $22.6 billion a year ago, though that growth would have been just 3 percent if not for the weak dollar. With dips in the greenback, deals done in other currencies translate into more dollars for big exporters like IBM.

Analysts' consensus forecast was for earnings of $1.67 per share on a shade under $24.1 billion in revenue, according to Thomson Financial.

As in several previous quarters, IBM leveraged stock repurchases to achieve hefty gains in earnings per share even with revenue growth in single-digit percentages. In a conference call with analysts, Chief Financial Officer Mark Loughridge noted that earnings per share have risen 16 percent this year, which puts the company ahead of its previous guidance of a 14 percent to 15 percent rise in 2007.

The brightest spot this time was IBM's services division, where IBM has worked hard to lower expenses in what has traditionally been a labor-intensive field.

Services revenue booked in the third quarter rose 14 percent to $13.7 billion, the best such gain in four years. The increase would have been 10 percent if not for the weak dollar. Most importantly, services posted a 27 percent increase in pretax profits.

IBM also signed $11.8 billion in services contracts in the third quarter, up from $10.5 billion a year ago. That revenue will flow into IBM over the next few years.

Where investors found signs of trouble was in hardware, where revenue fell 10 percent to $4.9 billion. That drop would have been 13 percent without the benefit of currency fluctuations.

Part of the decline could be attributed to IBM's recent sell-off of its printing division. But other key segments showed declines, and the group's overall profit fell 14 percent. Mainframe revenue -- a vital category for IBM because those huge computers require lots of specialized software and services -- was down 31 percent, and chip sales were off 15 percent.

Loughridge blamed the mainframes' steep drop on an unusually strong quarter a year ago, when IBM had recently released a new model. Loughridge said IBM expected the hardware group to return to growth in the first quarter of 2008.

Software, IBM's most profitable segment, grew its revenue 7 percent to $4.7 billion. The increase would have been 3 percent without shifts in the dollar. Pretax profit in software slipped 1 percent, largely because of the costs of acquisitions, Loughridge said.

Before the report, some analysts had worried that recent problems in credit markets would hurt IBM, because the financial services industry is IBM's largest customer segment. Financial companies account for half of all mainframe sales.

Indeed, Loughridge indicated that those troubles may be to blame for hardware and software deals that IBM failed to seal in the third quarter and saw slip into the current quarter. IBM's sales to financial services companies rose 5 percent -- but that would have been 1 percent in constant dollar values.

Annex Research analyst Bob Djurdjevic said the fourth quarter -- traditionally IBM's best -- will be especially important now because it will reveal whether the credit crunch's effect on IBM "was a blip or a longer trend."

In the first nine months of the year, IBM earned $6.47 billion, or $4.42 per share, with revenue of $69.9 billion. Those figures all rose from the first three quarters of 2007, when IBM made $5.95 billion, or $3.81 per share, on revenue of $65.2 billion.

IBM announced its results after markets closed Tuesday. IBM shares fell $2.07 to $117.53 at the open of trading Wednesday.