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Executives

Patricia Murphy – Vice President, Investor Relations

Mark Loughridge – Senior Vice President, Chief Financial Officer

Analysts

David Grossman – Thomas Weisel Partners

Toni Sacconaghi – Sanford Bernstein

David Bailey – Goldman Sachs

Ben Reitzes – Barclays Capital

Chris Whitmore – Deutsche Bank

Richard Gardner – Citigroup

Keith Bachman – Bank of Montreal

Mark Moskowitz – JP Morgan

Peter Misek – Canaccord Adams

Katie Huberty – Morgan Stanley

International Business Machines Corporation (IBM) Q1 2009 Earnings Call April 20, 2009 4:30 PM ET

Operator

Welcome and thank you for standing by. At this time, all participants are in a listen only mode. Today’s conference is being recorded. If you have any objections, you may disconnect at this time.

Now, I will turn the meeting over to Ms. Patricia Murphy, Vice President of Investor Relations. Ma’am, you may begin.

Patricia Murphy

Thank you. This is Patricia Murphy, Vice President of Investor Relations for IBM. I’m here with Mark Loughridge, IBM’s Senior Vice President and Chief Financial Officer. Thank you for joining our First Quarter Earnings Presentation.

The prepared remarks will be available in roughly an hour and a replay of this web cast will be posted to our Investor Relations website by this time tomorrow. Our presentation includes certain non-GAAP financial measures in an effort to provide additional information to investors. All non-GAAP measures have been reconciled to their related GAAP measures in accordance with SEC rules. You will find reconciliation charts at the end and in the Form 8K submitted to the SEC.

Let me remind you that certain comments made in this presentation may be characterized as forward-looking under the Private Securities Litigation Reform Act of 1995. Those statements involve a number of factors that could cause actual results to differ materially. Additional information concerning these factors is contained in the company’s filings with the SEC. Copies are available from the SEC, from the IBM web site or from us in Investor Relations.

Now, I will turn the call over to Mark Loughridge.

Mark Loughridge

Thank you for joining us today. This quarter we delivered $1.70 of earnings per share, which was up 4% year-to-year. This positions us well to achieve our objective of at least $9.20 of earnings per share for the year. We generated $1 billion of free cash flow, up $450 million. We ended the quarter with over $12 billion of cash on hand and we reduced total debt by $3 billion. We returned another $2.5 billion to shareholders with $700 million in dividends and $1.8 billion of share repurchases.

We have done a lot of work over the last decade to transform the company, shifting

to higher value areas, globalizing our business and constantly working to improve efficiency. I will give you a few examples of how the changes that we have made have positioned us to deliver this performance in a challenging economic environment.

First, with a focus on higher value offerings and strong services capabilities, we can adapt our offerings to deliver what clients are looking for. Today, clients remained focused on trying to save costs and conserve capital. Our services signings reflect our ability to meet these needs. Total signings were up 10% at constant currency with 27% constant currency growth in our longer-term categories.

Second, the actions we have taken have dramatically shifted the mix of our business and our profit model has less dependence on hardware which is more vulnerable to economic conditions. In fact, this quarter effectively all of our pre-tax profit came from software, services and financing. The annuity nature of these businesses provides a solid base of revenue, profit and cash.

Third, we have been investing to capture the opportunity in the growth markets. Our constant currency revenue growth in these markets remained about eight points higher than in major markets.

Finally, We have had an ongoing focus on driving productivity in all parts of the business, from sales efficiency to supply chain management to service delivery to global support functions. The result of this work is to reduce our fixed cost base and therefore improve the operational balance points. Bottom line, we have built a more resilient business model and one that generates more profit from each dollar of revenue.

IBM’s transformation positions us well for 2009 but more importantly, our model provides the cash we need to invest in new areas that will help drive the next growth cycle for our clients. In addition to our growth markets investments, we have three other key initiatives.

First, is our Smarter Planet strategy where governments, utilities and businesses are applying intelligence to the key processes of the world. This allows clients to create more value and long term economic growth from their infrastructure investments. The second new opportunity is Business Analytics which leverages our broad capabilities to optimize our clients’ business performance by applying analytics to their business processes.

We are already working on advanced analytics projects with a diverse set of clients including TD Bank, MTN South Africa, The New York State Department of Tax and The Sentinel Group. Third is Cloud Computing, an emerging model for delivering and consuming IT enabled services.

Each of these three opportunities requires enterprise software, deep industry process knowledge and solution integration capabilities where IBM is very strong. We will leverage our cash position to be opportunistic to accelerate our progress in the areas we believe will fuel growth and competitive differentiation in the future. We will spend more time on these initiatives in our investor briefing in the middle of May but for now, I will get back to our first quarter performance.

Looking at our income statement for the quarter, our revenue was $21.7 billion, down 11% as reported, and 4% at constant currency. As I mentioned, we had outstanding margin performance. Gross margin expanded almost two points driven by improving margin in services and software and the mix to higher value businesses such as software.

Our expense was better by 9%, with continued focus on expense management and the benefit from a stronger dollar. Pre-tax margin expanded 1.3 points and net income margin expanded 1.1 points. Finally our ongoing share repurchase activity drove a lower share count. So bottom line, we delivered $1.70 of earnings per share up 4% year-to-year.

So let me get into the first quarter details, starting with revenue by segment.

Our revenue performance was impacted by currency and the economic environment but also reflects our broad business capabilities and the contribution of our annuity content. Service revenue was driven by a strong annuity base, though it was impacted by a slowdown in small, faster yielding projects and declines in longer-term signings in 2008.

Software revenue growth was driven by demand for mission critical software. Systems and Technology performance reflects the challenges that transaction based business are facing today. Within the segment, our UNIX servers performed well. In Global Financing, excluding currency impacts, both financing revenue and the sales of used equipment were essentially flat.

Our total geographic revenue was down 11% as reported and 3% at constant currency with consistent performance across the geographies. As always, I will focus my comments on the constant currency growth.

Globally, the major markets declined 4%. Our growth markets unit grew eight points faster, up 4% and we continue to out perform in these countries. Revenue from the growth markets represented 17% of IBM’s geographic revenue in the quarter. As these countries build out their public and private infrastructures in this environment they are also focused on cost savings. We have also been delivering these capabilities to clients in the major markets and so we are well-positioned to address these needs.

Our growth markets performance reflects the diversity of the regions. While some of these areas are clearly more challenging like Central and Eastern Europe and a few of the smaller Asia Pacific countries, several of the larger countries are showing resiliency and good growth. For example, India grew 12% and China grew 11%.

In India, we again were named the Number One IT service provider in the domestic market. In China, in addition to continued strong demand for our banking infrastructure offerings, our Smarter Planet solutions are gaining traction with clients. Across all of the growth markets we will continue to target our investments to profitable growth areas and capture opportunities in these strategically important markets.

When you look at revenue performance by sector, I think you will find it is what you would expect in the current environment. Public sector was the fastest growing sector again this quarter with growth at constant currency in all industries. In addition to solid revenue growth, we also had good signings in the public sector, up almost 50% worldwide at constant currency and over 200% in the U.S.

Government and education clients at the federal level are focusing on investments to drive job creation while state and local agencies are looking for cost reductions through infrastructure and process transformation. Healthcare clients are focused on cost reductions with strong demand for outsourcing and transformational offerings.

Now I will briefly comment on the other sectors.

For Financial Services clients, IBM’s value proposition around cost reduction and risk and compliance remain priorities. Market consolidation is driving demand for integration projects. In Communications, clients are also looking for operating efficiencies and cost reduction and IBM’s offerings on Intelligent Utility Network put IBM in a leadership position for Smart Grid technology.

While the Distribution sector remains challenging in the major markets, in the growth markets we have strong double-digit growth at constant currency in all industries as infrastructure for expansion drives investment. Industrial sector remains the most challenging in all industries as these clients are conserving cash and reducing capital spending to position for recovery and drive long term viability.

Now, I will move on to a discussion on expense. This quarter, our total expense and other income was down 9%. Currency drove nine points of decline year-to-year and reflects both translation of non-dollar based expenses and the impact of the hedging programs that flow to expense. We estimate that acquisitions contributed about three points of growth and our operational expense improved four points year-to-year. We have been executing an operational plan to increase efficiency and drive productivity across the business. Over the last several quarters I have highlighted a number of initiatives we are working on to reduce our structure and make it more variable.

This lower level of fixed cost improves our balance point so every dollar of revenue yields more profit. The changes we have made allowed us to deliver margin improvement this quarter in a tough environment, but we will also see additional benefit as we go forward as our current actions start to yield. I will comment on three actions we have taken that impact this quarter but also substantially improve our position going forward.

First, in March we completed the transaction to outsource our internal logistics process to Geodis and we booked a gain of $298 million net of a related charge for real estate. In our call in January I mentioned that we would complete the outsourcing arrangement in the first quarter and that the gain would be relatively offset by a higher level of restructuring in the first part of the year.

So second, this quarter our workforce rebalancing charges were about $265 million, most of which was for our services business. We expect to spend between $300-400 million globally for the full year which is a typical level of restructuring for us and as we said a lot of this was skewed to the first part of the year. Since most of this is behind us, the benefits of these actions will start to come through in the second quarter.

Third, we took additional specific reserves against our accounts receivable balance. This contributed to a year-to-year increase in AR provisions of about $100 million. Our reserve coverage on accounts receivable is now 2.4%, up 80 basis points from a year ago and up 40 basis points from year end. We believe the increase in reserves is appropriate given the current economic environment.

A few other items that I will mention had year-to-year impact to our profit. We had a year-to-year impact of $80 million from investment transactions primarily driven by the sale of Lenovo shares in the first quarter of last year. Within other income and expense, interest income was down about $110 million reflecting the current interest rate environment. As you would expect, we have a year-to-year benefit from our hedge of cash flow programs reflected in other income and expense, SG&A and cost of goods sold. The year-to-year benefit is about $380 million in total with about half in other income and expense. Of course this mitigates the impact of the stronger dollar throughout the income statement.

Finally, though it is not a significant year-to-year impact, we absorbed about $430 million of cost and expense for our retirement related plans in the quarter. We now expect about $1.4 billion of cost and expense for the year, about flat year-to-year. That is an improvement from our previous view.

Before getting into the segments, I will quickly show you our margin performance by segment. This is the 18th quarter of the last 19 that we have expanded our gross margin with about ¾ of this quarter’s improvement coming from our better margins in services and software and the balance from a mix shift to our software business. With the expense performance I just took you through, we expanded total pre-tax margin by 1.3 points. I will get into some of the drivers within the segment discussion but bottom line, our margins reflect the shift of our business to higher value areas and our constant focus on improving productivity.

So now I will turn to our segment performance, starting with services.

Our two Global Services segments delivered strong signings and profit margin performance this quarter. Total signings were up 10% at constant currency and total longer-term signings were up 27% at constant currency. Total pre-tax margin was up 1.6 points driving our services profit growth. We understood the challenges we would face as we entered 2009 and we continued to execute on cost and expense actions consistent with the transformation of our business model. We will see the benefit from our first quarter actions in margin improvement for the remainder of the year.

The combined segments delivered $13.2 billion of revenue in the quarter, down 10% as reported and down 2% at constant currency. Combined gross margins were up 2.2 points and we delivered $1.6 billion in pre-tax profit at a margin of 11.8%. Signings were $12.5 billion at actual currency rates, down 1% but up 10% at constant currency. Signings in our longer-term outsourcing businesses were $7 billion, up 14% at actual currency rates and up 27% at constant currency.

Shorter-terms signings, which include Consulting and Systems Integration and Integrated Technology Services, were $5.5 billion, down 14% at actual rates and 5% at constant currency. We signed 16 deals larger than $100 million and that is on top of the 24 deals larger than $100 million that we signed in the fourth quarter last year.

Backlog at the end of the quarter was an estimated $126 billion. As a reminder, we are now reporting backlog at actual currency rates. Excluding the impact of currency, backlog was flat quarter-to-quarter and up $1 billion year-to-year.

Now I will turn to the key drivers of performance in the two services segments.

Global Technology Services executed very well in a challenging environment. Total signings were up 13% at constant currency and longer-term outsourcing signings were up 22% at constant currency. Pre-tax profit was up 12% and margin was up 2.3 points. Revenue was down 10% as reported and down 1% at constant currency.

Strategic Outsourcing revenue was down 9% as reported and down 1% at constant currency. We had a strong quarter in SO signings, up 23% at constant currency. This was led by good growth in North America and the growth markets. Within North America, Canada was particularly strong. We have talked in the past about the compelling value proposition Strategic Outsourcing provides to our clients as it gives them a lower cost base and better variability over the contract period.

We have had two strong quarters of SO signings and expect double-digit growth again in the second quarter. With this signings performance we expect revenue to return to growth in the second half of the year. Integrated Technology Services revenue was down 7% as reported and up 1% at constant currency. Integrated Technology Services signings, or the shorter-term GTS signings, were down 7% at constant currency.

Although we continue to get good results in efficiency plays such as optimization and managed services, we are seeing declines in large end-user roll outs with high OEM capital content. We have been shifting our portfolio to higher value offerings and away from OEM content. So while this quarter we had lower signings and revenue the mix away from OEM gives us better gross profit performance.

Global Technology Services pre-tax profit was up 12% and margin improved 2.3 points year-to-year to 12.1%. This was the seventh consecutive quarter of double-digit, pre-tax profit growth and again we had gross margin expansion in all lines of business. Margin improvements were driven by a combination of greater mix to higher value offerings, particularly in Integrated Technology Services where the key plays are becoming a larger portion of the portfolio and cost and expense management driven by our initiatives in standardization, global integration and improved efficiency.

The work we have done to improve efficiency not only drives our margin improvement but gives us the flexibility and capability needed to quickly address rapidly changing environments and really positions us for when the economy turns.

Turning to Global Business Services, total signings were up 6% at constant currency. Pre-tax profit was down 10% or about $60 million year-to-year with margin essentially flat. Revenue was down 10% as reported and down 4% at constant currency. Looking at revenue from a geographic perspective, we had good results in the growth markets where revenue growth accelerated from the second half of 2008. However, in the major markets revenue was impacted by lower longer-term outsourcing signings last year and a deferral of some projects.

Turning to GBS signings, our longer-term application outsourcing signings were up almost 50% at constant currency with good growth in both the major and growth markets. Within the major markets, clients continue to be primarily motivated by cost savings opportunities but in the growth markets we still see a balance between cost savings and infrastructure build-out initiatives.

In our shorter-term category of Consulting and Systems Integration, signings were down 4% at constant currency. Within that, declines in the very small contracts, the ones that impact near-term revenue yield, were most pronounced. From a sector perspective, we had good growth in Public and Communications sectors but not enough to offset declines in Industrial and General Business. We still see over 70% of the deals coming from cost savings and efficiency offerings.

We will continue to evolve and adapt our offerings to meet the changing needs of our clients. As an example, we just announced the launch of our new Business Analytics and Optimization service line. This practice will draw on the full breadth of IBM’s capabilities including deep industry expertise, research and software capabilities. We think this is going to have an immediate impact on our clients’ ability to improve speed and quality of business decisions.

As we look forward, we will see the benefits of our recent workforce rebalancing actions over the remainder of the year. We have got the management and delivery structure in place in both services segments to continue to expand margin. In fact, we expect double-digit profit growth in the second quarter.

Moving on to software, the $4.5 billion of revenue was down 6% year-to-year and up 2% at constant currency. Software pre-tax income was up 5% and we expanded pre-tax margin by almost three points. This was a solid quarter in a tough economic environment. Customers continue to purchase mission critical software to run their businesses and demand was strong for software that delivers fast returns on investment while adoption of software for transformational projects slowed and non-essential purchases were heavily scrutinized.

Let me give you some insight into our branded middleware performance, which was up 5% at constant currency. WebSphere products grew 5%, or 14% at constant currency and gained share. Application Servers allow customers to build, run and integrate their mission critical business applications. They were up 1%, or 10% at constant currency. iLog, which was acquired in December, did very well this quarter and helped drive our WebSphere Business Integration segment to double-digit growth. Information Management software declined 8%, or up 1% at constant currency.

Distributed Relational Database continued to perform well, up 2% and double-digit at constant currency. Going forward, our information management software is a key component of our new Business Analytics and Optimization service line. Tivoli software was down 1%, up 8% at constant currency and we gained share. We had strong constant currency growth in all three of Tivoli’s product sets: Security, systems management, and storage software.

Customers utilized Tivoli software to improve control and automation of their infrastructure. This lowers costs and drives efficiency. Storage management software grew 3%, or 13% at constant currency, as customers optimized their storage infrastructure. Lotus was down 12%, but Rational had a very strong quarter and gained share with revenue growth of 9%, or 19% at constant currency.

This performance was driven by strength in our Performance and Security testing offerings which deliver near-term return on investment benefits to our customers. Across all software brands, we have strong recurring revenue. In fact, annuity content represents 2/3 of our software business. This provides a good base of profit and helped our software business to deliver solid performance in this tough environment.

Systems and Technology revenue of $3.2 billion was down 23% year-to-year, or 18% at constant currency. We continued to have strength in the high end of our servers driven by virtualization, increased efficiency and good returns on investment. First quarter was the fifth consecutive quarter of double-digit MIPS growth on mainframe servers and we had double-digit revenue growth in the high-end of POWER servers.

This quarter our systems business held share. Focusing on the brands, System z revenue declined 19% year-to-year, or 12% at constant currency, while MIPS grew 18%. MIPS from specialty engines were up nearly 20%, driven by over 50% growth in Linux MIPS. Our global reach was clearly an advantage. System z revenue grew 37% in our growth markets, which is up 60% at constant currency. Major markets were weak, particularly in Europe as we wrapped around on a strong compare. Converged System P was down 2% but up 5% at constant currency, gaining 4 points of share. Revenue from our high end converged System P continued to be very strong. Revenue was up 35%. We had 62 UNIX competitive displacements this quarter with half of the transactions over $1 million.

System x server revenue declined 27% year-to-year. The demand for x86 solutions continues to soften as customers virtualize workloads and consolidate onto more efficient platforms. Storage revenue declined 20% year-to-year, with double-digit declines in both disk and tape. Our tape performance was in line with the market. Keep in mind these storage results reflect the hardware performance only which is a subset of our broader storage solutions. But more of the value of the storage solution is shifting to software and services and as I mentioned, our Tivoli storage software had a very good quarter. Overall, Systems and Technology results reflect the challenge of this economic environment.

Turning to IBM’s cash performance, we generated $1 billion of free cash flow in the quarter, up $450 million year-to-year. The year-to-year improvement was driven by lower capital expenditures. We also had improved sales cycle working capital offset by a higher level of pension funding for our non-U.S. plans.

Looking at the uses of cash, we reduced debt by $3 billion and we also returned nearly $2.5 billion to our shareholders. $700 million of the shareholder return was through dividends and $1.8 billion was share repurchase. We bought back 22 million shares in the quarter and our average diluted shares were down 4%. At the end of March, we had $3.7 billion remaining from our last Board authorization.

Turning to the balance sheet, we ended the first quarter with a cash balance of nearly $12.3 billion with 2/3 of our cash in the U.S. The remaining asset decline was driven by normal seasonal decline in global financing assets and a stronger dollar.

Turning to debt, as I mentioned earlier we reduced debt by $3 billion in the first quarter. We have $5.8 billion of term debt maturities to go this year and we are comfortable with that level given our cash balance, continued cash generation and experience in the capital markets. We ended the quarter with commercial paper of about $800 million, which is up slightly from year end but still very low as compared to history. Our experience in the CP markets remains positive and we have substantial flexibility in the market. Of our $31 billion of total debt at the end of the quarter, $23 billion supports our global financing segment leveraged at 7:1. Once again we have put some information on our global financing business in the supplemental charts.

You will see that 60% of this portfolio is investment grade and while our reserves have increased, consistent with the economic environment, this business still provides a very strong 28% return on equity. I would take that any day. Our remaining debt, the non-financing debt was $7.6 billion, down $2 billion from year end and non-financing debt-to-cap was 42%. Our strong cash flow and significant cash position allow us to continue to invest and deploy capital to where we see the best long term opportunities.

Now I will start to wrap up with a brief discussion of the drivers of our earnings per share growth. This chart demonstrates that our first quarter results are consistent with the profile we laid out in January. We had a decline in revenue at actual rates which impacted EPS growth by $0.19. Our improved mix and ongoing actions to drive productivity yielded a significant amount of margin expansion which resulted in relatively flat pre-tax profit and with our ongoing share repurchase activity we delivered 4% growth in earnings per share.

We are executing a plan that is right for this environment and keeps us well positioned for the future. We have been transforming our business for a decade, shifting to higher value areas, globalizing our operations and adapting our offerings to deliver value to our clients. As we saw the environment deteriorate we increased our focus on cost reduction and operational efficiencies to improve our balance point. All of this positioned us to deliver strong profit and cash flow in this challenging environment and also come out stronger when the economy starts to improve.

Our strong financial position gives us investment flexibility, so we are very focused on the future. We see a real opportunity in Smarter Planet initiatives, business analytics and new compute models such as cloud computing as well as our ongoing focus to capture the opportunity in the growth markets. Our great cash position and strong cash flow allow us to be opportunistic in our investments and deploy capital to where we see the best long term returns whether that be our growth initiatives, acquisitions or returning value to shareholders.

So now with one quarter of 2009 behind us we continue to expect earnings per share of at least $9.20 for the year. It will come more from margin improvement, just as it did in the first quarter and we will continue to execute our strategy and maintain our focus on delivering profit and cash over the longer term. Though it is early in 2009 we remain ahead of pace for our 2010 roadmap.

Now Patricia and I will take your questions.

Patricia Murphy

Thank you Mark. Before we begin the Q&A, I would like to remind you of a couple of items. First, we have supplemental charts at the end of the deck that complement Mark’s prepared remarks. Second, I would ask you to refrain from multi-part questions. When we conclude the Q&A, I will turn the call back to Mark for some final remarks.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of David Grossman – Thomas Weisel Partners.

David Grossman – Thomas Weisel Partners

To hit the $9.20 on lower revenues it implies you are going to see a fairly substantial increase in year-over-year and pre-tax margin. So should we think of this new level as a level that IBM can sustain if internal growth accelerates in an improving economy and is it that margin strength that underlies your statement that you are ahead of your 2010 roadmap of $10 to $11 per share?

Mark Loughridge

Let me give some color behind that. First of all, as you pointed out there was very strong margin performance in the quarter and certainly margin carried the day in these results. Why do we feel confident? First of all, to start the year out with such a strong margin performance bodes well for the balance of the year to begin with.

Secondly, I would add that we did a lot to improve our own structural position. As I pointed out in my last call, the structural actions we took in the fourth quarter improved our spend base in 2009 by $1 billion. If you look at the actions we took in 2008 it improved our spend base by $1.5 billion. If you look at the actions we took in the first quarter, they will improve our spend base by another $0.5 billion, so now we are up to $2 billion and if you look at all the ongoing productivity efficiency initiatives we are driving that adds another $1 billion. So we are now up to $3 billion of spend base improvement year-over-year that we believe should drop to the bottom line.

Now it is also important as you look at this to realize the bulk of these actions are behind us and the bulk of the benefit is in front of us. So we finished most of the work here. Certainly in the U.S. but a lot of the benefit we see in front of us now coming off a very strong margin performance in the first quarter to begin with. So I think we have a strong action plan, a strong base of business and it even makes us more confident in our statement that we should be able to achieve at least $9.20 for 2009.

I would also agree with your last point, from my perspective we are well ahead of pace on our roadmap to 2010.

Operator

The next question comes from Toni Sacconaghi – Sanford Bernstein.

Toni Sacconaghi – Sanford Bernstein

I would like you to elaborate on the thinking behind your statement that you are well ahead of pace for your 2010 roadmap. You said ahead of pace just in response to that last question and you said well ahead of pace. If I take the mid point of your range for 2010 at $10.50 that implies earnings growth of over 14% for 2010 versus 2009 or significant upside for your 9.8 estimates for this year. Could you elaborate on what you mean by ahead of pace and where that conviction is coming from?

Mark Loughridge

By ahead of pace I am just talking about the compound growth rate in EPS starting in 2006. If you look at that, we have been growing on that compounded basis for that period through 2009 at pretty good pace of double-digit EPS. Given that range of $10-11, off even the minimum point of $9.20 we only need another $0.80 so it would be less than our cumulative pace today. I’m just saying if you look at the balance we have to achieve we have certainly done a good job of outpacing that so far.

Secondly, I will say as we go in to next year remember by the time we get to the back half of the year you will see some of the actions we have taken improving our overall revenue performance. We will now have had three quarters of double-digit SO signings performance that should improve our position as we go into the back half of the year. You will also see the effusion of this global stimulus which is now well over $5 trillion and the addressable portion for IBM is going to be almost $3 trillion which I think will substantially airlift overall spend patterns in the back half of the year as we go into 2010.

So again just to answer your question by ahead of pace if you look at our compound growth rate of EPS from 2006 to 2009 that is a growth rate of 15% and to me based on what we have yet to achieve that puts us well ahead of pace.

Operator

The next question comes from David Bailey – Goldman Sachs.

David Bailey – Goldman Sachs

What gives you the confidence you are going to see revenue growth in services in the second half given the weakness in short-term signings that you are seeing now particularly in the small, faster turn engagements?

Mark Loughridge

I was talking about our overall outsourcing performance. When we look at it, first of all SO signings grew 23% in the fourth quarter. In the first quarter we have had another growth of 23%. As I look into the second quarter we see another quarter of double-digit growth in our outsourcing businesses. I think that is going to help propel our longer term businesses as we go into the second half of the year. So off of this first half base I think third quarter for SO should be roughly flat. We should see growth as we go into the second half of the year.

All of that in addition to the substantial margin performance we have seen and the spend efficiencies that we see ahead of us, putting all those together I feel pretty confident about our position.

Operator

The next question comes from Ben Reitzes – Barclays Capital.

Ben Reitzes – Barclays Capital

I can’t believe it hasn’t been asked yet, so I will go ahead. Everybody on this call believes you are within a whisker of acquiring Sun Microsystems and obviously we saw the announcement today. Do you have any reaction to that? Would you just mind discussing IBM’s acquisition strategy in this environment where we are consolidating and what you are looking to do long-term with your business if in fact that is impacting you at all or maybe it is just a good time to reiterate what IBM is doing so people focus on that?

Mark Loughridge

I think that is a very fair question. First of all I’m not going to comment on the particulars here but we run a very disciplined process. We look at a lot of things but when we run a disciplined process we get good results. If you look at the specific performance in this space, our P series business picked up four points of share in the quarter. The high end of our business was up 35%. 62 enterprise customers migrated to POWER systems platform in the first quarter alone so it is a very strong base of performance. As far as your question about the combination, Oracle and Sun have been partnering for two decades. What is the result? The result is we have picked up 14 points of share since 2000 and now have 32 points. As I look at this and ask myself what has really changed I think nothing. We have been competing with Sun. We know Oracle inside out. They now have the same address and the same mailbox but we are talking about the same team we have been competing against for some time and winning on the field.

As far as acquisitions are concerned we have a very strong base. Our cash is well over $12 billion. We generate substantial free cash flow and we have a lot of flexibility as we go into the balance of 2009 to spend on our internal investments, our own dividends and share buyback program and a substantial opportunity that we see in the market place.

Remember that since 2000 we have done over 100 acquisitions and spent $20 billion and those have yielded substantial benefit to IBM largely as a result of our strong and very disciplined process.

Operator

The next question comes from Chris Whitmore – Deutsche Bank.

Chris Whitmore – Deutsche Bank

Getting back to organic growth I am curious about what is implied in your guidance of at least $9.20 per share. I think previously you talked about holding organic growth x currency growth flat. Do you still expect that target? If not, what is the new target?

Mark Loughridge

As you know we don’t give revenue guidance. We give our view of EPS. As I look at our view of EPS on an at least $9.20 basis for the year again I feel quite confident in that because even at more modest revenue performance not even flat on a year-over-year basis we feel quite confident about this given all the spend efficiencies, margin efficiencies and the value that we are delivering to our customers especially in the areas of the business where we think we can continue to take cost out of their systems and help them conserve cash and manage their business equation to help transform their businesses.

So, I don’t think we are giving an update on revenue today. What I do want to do is firmly reaffirm our view that we should be able to achieve at least $9.20 for the year and if anything I feel more confident about that today than I did a quarter ago.

Operator

The next question comes from Richard Gardner – Citigroup.

Richard Gardner – Citigroup

Mark you mentioned $1 billion in additional expense reductions coming I believe you said this year. Can you give us a sense of what exactly that encompasses and what types of areas you see the opportunity in? Also if you could just briefly address why the pension expense view changed for the full year?

Mark Loughridge

If you look at just to recap I see $3 billion of spending improvements on a year-over-year basis, $2 billion of that from the structural actions we have taken in 2008 in the first quarter which the benefit is largely ahead of us and we see another $1 billion from all of the work we have done on our integrated support functions. This has been an overall structural level of productivity that we have been driving for years now. This is just a continuation of that. We will see that not only this year but we will see that into next year as well. So I clearly see an additional $3 billion to buttress our margin performance as we go through the year.

Then as far as pension expense it is simply a function of the overall change in headcount. Of course it is dynamic. This isn’t a big change. It is $100 million and we will keep you updated as we go through the year.

Operator

The next question comes from Keith Bachman – Bank of Montreal.

Keith Bachman – Bank of Montreal

I was wondering if you could offer up some views on free cash flow, you suggested $9.20 or greater in 2009 on a net income basis or EPS basis and your cash flow is fairly healthy in the first quarter. I was just wondering if you could provide some views on free cash flow including some comments on the CapEx side?

Mark Loughridge

I feel pretty confident in our free cash flow performance as we go through the year much like expense. We have also been fairly tough minded about our capital expense structure and I think we will have good performance on that CapEx base as we go through the year. I think we will continue to have good cash from ops resulting from our strong margin performance and I would also add if you look at this other element underneath it, DSO has also performed very, very well again in the first quarter.

We are working on all those elements of cash flow and as I look forward I think we should have a pretty good year on that base as well.

Keith Bachman – Bank of Montreal

Just to push you, pretty good performance, does that mean growth in free cash flow?

Mark Loughridge

Yes.

Operator

The next question comes from Mark Moskowitz – JP Morgan.

Mark Moskowitz – JP Morgan

Kind of along the lines of that last question in terms of cash flow power, you mentioned during the call that you have about a 2/3 annuity stream in the software. Can you help us understand how much of that 2/3 is up for renewal this year and of the renewals that have come up anything in terms of re-scoping or are you having a greater leverage with your customer because of your service delivery improvements or your overall software stack? Any color there would be greatly appreciated.

Mark Loughridge

I think if you look at our software performance and you kind of break it down by the elements of the brand performance I don’t think I would break it down into how much is up for renewal or not up for renewal or the scope. I would go down by the overall business element. So first of all, if you look at our overall performance in our WebSphere content we were up 14% with very strong performance. If you look at our performance in our Tivoli content we are up 8%. Underneath that 8% our storage software is up 13%.

If you look at our overall tools content we are up 19%. I feel pretty confident in that overall performance. I don’t think it is going to be characterized so much by how much is up for renewal and I think we have a good base of business as we go forward. A lot of that as we look at those individual elements is a function of how much value we are able to generate for our customers and I think we have shown some pretty good performance in the first quarter.

Operator

The next question comes from Peter Misek – Canaccord Adams.

Peter Misek – Canaccord Adams

I had a question on servers and storage, on the servers and storage side can you elaborate what kind of competitive plans you have to deal with the entry of Cisco into the market especially on the server side? Just walking through obviously the performance there was impacted by macro events. What actions do you think you can take there to help improve things in the second half?

Mark Loughridge

I’m not going to comment specifically on what Cisco’s plans are. This is a pretty competitive space so you have to get your lift pass, go to the top and we will see you at the bottom of the hill here. As far as our plans, we are going to continue to drive for real value creation and if you look at our performance at the high end I think it backs that up. Our P series again was up 5%. Our high end P series was up 35%. We took four points of share in the quarter. We migrated 62 customers. Our z series content MIPS are up 18%. Specialty MIPS up 19%. Linux MIPS up 50%. Z series in the growth markets was up 60%.

I think we are going to continue to run our play. Our play in this kind of arena favors the efficiency of these higher end server platforms. You can utilize the z series to 100% of its capacity. A P series you can utilize to 50-70% of capacity and that compares with an x series which is typically at 20% or less. So that is going to be our play as we go through the year.

Operator

The next question comes from Katie Huberty – Morgan Stanley.

Katie Huberty – Morgan Stanley

Can you characterize the tone of business exiting the first quarter and specifically did you see any signs of demand improvement or deterioration in large deals or the transactional based revenue streams in the month of March?

Mark Loughridge

I think what you can really see is how important in this environment it is to be able to generate and listen to your customer’s challenges to improve their costs, improve their productivity to help them deal with risk and compliance to drive solutions that improve their cash position. If you look at the elements of our solutions that have satisfied those needs that is a big component in the strength we have had in our SO signings, in the first quarter of what we see going into the second quarter and so those are very powerful.

One area that I think is kind of emblematic of that, if you look at the Financial Services sector, an area that has been under a lot of pressure as we all know, the overall record performance for FSS compared to the balance of IBM was on par to the balance of our business but if you look at the signings performance in FSS, short-term signings were up 7% for the [sixth] consecutive quarter while long-term signings in FSS were up 50%.

Why is that? Because we are able to partner with our clients and help them solve their business problems in this challenging environment and we see that as an ongoing thing. We also see that as a larger proportion of the demand environment even in the growth markets. So in addition to the infrastructure build up priorities that we saw, we also see them now focused on that ability to partner with them and solve their business problems.

So let me say a couple of things in closing. I think IBM performed well in this very difficult environment. We saw a clear benefit of our transformation towards higher value software and services. Our software revenue grew and we continued to drive double-digit services signings and we have expanded margins significantly, a play that we have been running for some time now. As a result, we grew earnings and free cash flow. We remain on target for our goal of at least $9.20 EPS for 2009 and if anything I feel more confident in that objective.

As I pointed out in the discussion with Tony, based on our ability so far even at $9.20 the generally 15% compounded EPS growth since 2006, I would say we are ahead of pace on our 2010 roadmap.

On the spend side we are very disciplined in managing our costs. Much of this restructuring activity was front end loaded in the year as I said in our last call. We have that largely behind us especially in the U.S. The benefit is largely ahead of us. So we will realize that positive expense savings throughout the rest of the year. Perhaps the most important part of IBM model is our foundation builds on high value capabilities. So even in this uncertain environment we will continue to invest heavily in R&D to strengthen our business, we are committed to leveraging our strong cash position to take advantage of these opportunities and we will fund investments that will accelerate our initiatives like Smarter Planet, Business Analytics and Optimization and Cloud Computing that will help drive the next cycle of growth and productivity for our clients.

Thank you very much for the call today. We hope to see you at our May investor meeting. For now, as always it is back to work.

Operator

Thank you for participating on today’s call. The conference has now ended. You may disconnect at this time.

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Source: International Business Machines Corporation Q1 2009 Earnings Call Transcript
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