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IBM Posts 5 Percent Revenue Gain

With its crucial computer services business coming up short again, IBM managed to wow investors with impressive third-quarter sales in its highly profitable hardware and software lines, including mainframes and Web applications.

The quarterly profit of $2.22 billion reported Tuesday by International Business Machines Corp. blew past Wall Street projections.

Net earnings for the three months ended Sept. 30 amounted to $1.45 per share. In the same period last year, IBM earned $1.52 billion, or 94 cents a share, as the company absorbed a $525 million tax expense on foreign earnings that were repatriated to the United States.

Wall Street analysts expected a per share profit of $1.35, according to a survey by Thomson Financial, and IBM's share price rose to a 52-week high following the report, which came after the close of Tuesday's regular session.

IBM shares rose $2.87, or 3.3 percent, to close at $89.82 Wednesday on the New York Stock Exchange.

Third-quarter revenue rose 5 percent to $22.62 billion, up from $21.53 billion a year earlier. Services accounted for $12.02 billion of the tally, an increase of just 2.7 percent.

But hardware sales improved 8.9 percent to $5.58 billion, driven by a 25 percent gain in high-end mainframe computers, which typically accounts for roughly a fifth of the total. Revenue from the software operation, IBM's most profitable unit, rose 8.5 percent to $4.41 billion.

IBM also said its overall gross profit margin improved a notch to 42 percent, up from 40.6 percent in last year's third quarter. Likewise, profitability in software improved to 85.3 percent from a year-ago level of 84.9 percent, while hardware margins were 37.7 percent, up from 37.1 percent.

"The mainframe revival is especially impressive," said Bob Djurdjevic, an industry analyst with Annex Research.

Despite the better-than-expected showing, analysts peppered the company's chief financial officer with questions about another disappointing performance for the services business, which accounts for more than half of IBM's revenue.

Profit margins from the services business improved to 27.8 percent from 26.1 percent in the year-ago period. But adding to the concerns voiced by analysts, IBM reported that the unit had signed $10.5 billion in new contracts, down 29 percent from the year-ago period and the second straight disappointing quarter for that indicator of future revenues.

The tally marked an improvement from this year's second quarter, when there were $9.6 billion in new contracts, but CFO Mark Loughridge acknowledged that a number of major deals expected to be finalized by the end of September "slipped out of the quarter."

"We fully expected to grow our signings more. We just didn't get the deals closed," Loughridge said in a conference call after the report, noting that the current quarter's signings should benefit from the delay.

"I want to point out that although revenue growth for services was not at our objective, it was an improvement from the second quarter to the third quarter," he said. "We need to continue that momentum."

Djurdjevic said that although the overall backlog of $109 billion in contracts for future services is down 4 percent from a year ago, "the situation is actually stabilizing. IBM seems to be losing less business than before, so the sales shortfall isn't as painful as it had been."

In the first nine months of 2006, IBM earned $5.95 billion, or $3.81 per share. In the same period last year, earnings totaled $4.75 billion, or $2.90 per share, a number that also reflects the big tax expense. Revenue so far in 2006 has totaled $65.17 billion. That's down 2.3 percent from $66.71 billion in the year-ago period, which included sales from the personal computer business that was sold to China's Lenovo Group Ltd. during last year's second quarter.

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