International Business Machines Corp. Q1 2010 Earnings Call Transcript

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International Business Machines Corp. (NYSE:IBM)

Q1 2010 Earnings Call

April 19, 2010 4:30 pm ET


Patricia Murphy - Vice President of Investor Relations

Mark Loughridge - Chief Financial Officer, Senior Vice President


Toni Sacconaghi - Sanford C. Bernstein

Ben Reitzes - Barclays Capital

Katie Huberty – Morgan Stanley

David Grossman - Thomas Weisel Partners

Richard Gardner - Citigroup

Mark Moskowitz – JP Morgan

Keith Bachman – BMO Capital Markets

Bill Shope – Credit Suisse

David Bailey - Goldman Sachs

Chris Whitmore - Deutsche Bank


Welcome and thank you for standing by. (Operator Instructions) Now I will turn the meeting over to Ms. Patricia Murphy, Vice President of Investor Relations. Madam, you may begin.

Patricia Murphy

Thank you. This is Patricia Murphy, Vice President of Investor Relations for IBM. I am 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 webcast 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 8-K 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 $1.97 of earnings per share which was up 16% year-over-year. Our improving business mix and focus on driving productivity again delivered solid margin and profit performance.

We increased pre-tax margin by a point and both pre-tax and net income were up 13%. We had great cash performance, increasing free cash flow by $400 million to $1.4 billion. We returned another $4.7 billion to shareholders with $700 million in dividends and $4 billion of share repurchases. The balance sheet is solid and capital structure is well positioned to support our full-year objectives. Our liquidity position remains strong as we finished the quarter with $14 billion of cash on hand. This was a very good start to the year.

Our key investments are unique to the IBM strategy and are paying off. This quarter our growth markets were up 8% year-over-year at constant currency led by the BRIC countries which were up 14% as these countries build out and integrate their public and private infrastructures.

Business analytics is one of the fundamental drivers of our software performance. Software revenue was up 11%, or 5% at constant currency, with share gains in each of the five middleware brands. Across software and services our business analytics revenue was up double-digits. In Services an increasing portion of our consulting business is driven by our Smarter Planet engagements and business analytics. This quarter consulting signings were up 18% or 12% at constant currency with the strongest consulting performance in over three years. So our growth initiatives helped drive our first quarter revenue performance.

You may recall that in January we expected to improve our revenue growth rate from the fourth quarter to the first resulting in mid-single digit revenue growth at actual rates. Let me tell you how we did and give you a few highlights. Our first quarter revenue was up 5% year-over-year, though it was driven more by our business operations and less by currency. With a strengthening dollar, currency was less of a help, only contributing 5 points of growth versus the 6 to 7 points based on mid-January spot rates. This impacted revenue by about $250 million so our underlying business performance was better than expected.

The improvement in revenue growth from our fourth quarter was broad based with improvements across each of our major segments and geographies. In our segment performance, systems and technology improved 11 points, software 9 points, global business services 4 points and global technology services 3 points; all at constant currency. By geography, America’s revenue growth improved 6 points, EMEA 5 points and Asia 4 points. The major markets rate improved 5 points and the growth markets 6 points, led by the BRICs.

Keep in mind our solid annuity base, so our transactional growth rates drove these gains and so now, after a very good first quarter, we are increasing our earnings per share expectations for the year to at least $11.20 which is up $0.20 from our previous view of at least $11.

Now I will turn to the detailed financial results for the first quarter. As I just mentioned, our revenue was up 5% year-over-year to $22.9 billion. Gross margin expanded 20 basis points due to better margins in Services and Software and more favorable business mix. Our expense was up 2% year-over-year. Within this, our operational performance was better 5 points but was more than offset by a 7 point impact from currency and a point of acquisition expense. Pre-tax margin was up a point year-over-year to 15.4% and net income margin expanded nearly a point to 11.4%. With continued margin expansion we increased both pre-tax and net income by 13% year-over-year. Finally, our ongoing share repurchase activity drove a 2% reduction in our share count. So bottom line, we delivered $1.97 of earnings per share, up 16% from a year ago.

Now I will turn to the revenue details starting with a geographic view. In discussing the geographic results, as always, I will focus my comments on constant currency. As I just mentioned, the improvement in revenue growth was fairly consistent across our geographies, with Americas better by 6 points, Europe better by 5 points and Asia by 4 points. Driving the 5 point improvement in the major markets growth rate we had better performance in each of the G7 countries. The best growth again came from the UK, which was up 8% year-over-year.

In the growth markets, growth accelerated as market conditions improved in most countries. With 8% growth this quarter growth markets outpaced the majors by 10 points. The growth was led by the BRIC countries which represent about one-third of the growth markets. The BRIC year-to-year increase of 14% included strong double-digit growth in Brazil, India and Russia. Government spending and programs remains a tailwind in most countries and our strongest performance again came from the public sector. Within the growth markets, our biggest improvement from fourth quarter was in sales to our small and medium business clients driven by growth in Services, Power, Storage and System x.

We are having great success expanding our footprint in the growth markets which provides a base on which to build a software and services stack. Turning to revenue and gross margin by segment, our services revenue growth improved from the fourth quarter in total and in SO, BTO, ITS, Maintenance and GBS. This was driven by growth in outsourcing signings on a trailing 12-month basis and growth in core consulting signings this quarter.

Our software performance was excellent, up 11%. Targeted investments over the last several years have positioned us to capture growth in key areas like business analytics, storage management and business integration. This quarter our Systems and Technology business returned to growth, and we gained or held share in every brand. Turning to gross profit our improving business mix and productivity initiatives have yielded consistent improvement in our gross margin over time. This quarter, better margins in services and software and the relative strength of our software business resulted in gross margin expansion of 20 basis points.

Now let’s take a look below the gross profit line to our expense and spending profile. Our total expense and other income was up 2% and together with a 5% increase in revenue, our expense-to-revenue ratio improved eight-tenths of a point year-over-year. The operational expense improved 5 points year-over-year. But it was more than offset by currency which impacted expense growth by 7 points and acquisitions accounted for one point. We are continuing to execute initiatives to increase efficiency and drive productivity, leveraging scale and our global footprint. This strategy has worked well over the last five years and will continue to produce over the next five.

As always, I will lay out the roadmap of cost and expense items that had significant year-to-year impacts to our profit. First in March we completed the sale of our PLM operations to Dassault and we booked a gain of about $590 million. In our call in January I mentioned that the gain from this sale would be relatively offset by a charge for productivity actions. This quarter our workforce rebalancing charges were about $560 million. The majority of the spending was in Europe and Asia and we expect payback by the end of the year with most of the benefit in the second half.

If you recall in the first quarter of last year we had a gain of almost $300 million associated with outsourcing our logistics business to Geodis and this was effectively offset by our workforce rebalancing charges of $265 million. So a very similar dynamic, with a gain offsetting our workforce rebalancing charges. In fact, when you look at the combined impact of the two unique items last year and two this year there is no impact on IBM’s year-to-year performance in the first quarter. Our bad debt expense was less than $10 million in the current period, an improvement of about $90 million from last year reflecting the improving credit environment. Our accounts receivable reserve coverage of 2.1% is down 30 basis points from last year though it is up slightly from year end.

Finally, I will comment on the impact from currency. As you know, we hedge our major cross-border cash flows to mitigate the currency volatility in global cash planning. With the year-to-year change in currencies, this hedge of cash flow program generated a loss in the first quarter of this year as compared to a gain last year. The year-to-year impact in the first quarter was over $350 million which is roughly 60% in expense and 40% in cost of goods sold. Keep in mind that these hedging losses mitigate the translation gains elsewhere in the P&L. Though it is difficult to measure the currency contribution to the bottom line due to the impact of pricing and sourcing actions, we do not believe that currency, net of hedging activity, contributed to our profit growth in the quarter.

So now let’s turn to our segment pre-tax margins. This is a snapshot of our margins by segment. The combination of the four unique items I just mentioned has no year-to-year impact on IBM’s total results but they do impact the year-to-year performance of the segments. For example, the workforce rebalancing activity this year was incurred in every segment but the PLM gain was booked in software. We have provided here a normalized view of the profit and margin dynamics by removing the unique gains and charges in both years to give you a better view of the underlying operational performance of the segments.

Now let’s turn to the segments, starting with services. The two services segments delivered $13.7 billion in revenue, up 4% year-over-year and down 2% at constant currency. This is a 3 point improvement in growth rate at constant currency versus the fourth quarter. Total signings were $12.3 billion, down 2% at actual rates and 7% at constant currency. If you exclude application management services signings, signings would have been up 4%. I will talk about our AMS performance in a moment.

Total outsourcing signings were down 3% at actual rates and 8% at constant currency though strategic outsourcing signings were up 6%. As you know, outsourcing signings can be very uneven by quarter and it is important to look at the longer term trends. Total outsourcing signings on a trailing 12-months basis are up 5% at actual rates and up 4% at constant currency.

Total transactional signings, which include integrated technology services, consulting and AMS systems integration, were down 1% at actual rates and 6% at constant currency. In the quarter, we did see a shift in demand toward our consulting offerings with consulting signings up 18%. Overall, we signed 13 deals greater than $100 million and backlog at the end of the quarter was $134 billion, up $8 billion year-over-year or up $1 billion adjusting for currency. Within the backlog we saw improved stability in our base accounts, with backlog erosion at the lowest level in two years.

Now I will go into the key drivers of performance in the two services segments. In global technology services revenue in the quarter was $9.3 billion, up 6% year-over-year as reported and flat at constant currency. GTS outsourcing revenue improved in the quarter and returned to growth at constant currency reflecting demand for BTO and strategic outsourcing over the last 12 months. In integrated technology services the revenue growth rate also improved from the fourth quarter.

Total GTS signings were up 1% at actual rates, down 5% at constant currency. GTS outsourcing signings were up 1% at actual rates, down 4% at constant currency. Strategic outsourcing signings were up 6% at actual rates with strong growth in North America. Integrated technology services signings were flat at actual rates, down 5% at constant currency. The strongest performance was in the growth markets, up 29% year-over-year, and we had improvement in labor based services in North America.

Global technology services gross profit was up 8% year-over-year with margin up one-half point. Total pre-tax income was down 13% year-over-year as we absorbed a significant increase in workforce rebalancing charges. Looking at a normalized view of GTS margins, excluding the items I discussed earlier, PTI would be up 9% year-over-year with pre-tax margin expansion. This rebalancing activity will provide PTI benefit mainly in the second half of the year and with this activity behind us we expect that GTS will return to PTI growth and margin expansion over the remainder of the year.

Turning to global business services revenue was flat as reported, down 5% at constant currency. This improved revenue performance from fourth quarter was driven by strong growth in consulting signings which yield quickly in the quarter and revenue from application management services signings over the last 12 months. Total GBS signings were down 6% at actual rates, down 12% at constant currency. This quarter, I am going to describe our signings performance for GBS the way we manage it, as two distinct businesses; consulting and application management services which includes both application outsourcing and systems integration.

In consulting signings were up 18% at actual rates and 12% at constant currency. This is the first quarter we have had constant currency growth in consulting since the fourth quarter of 2008. We are starting to see a shift in customer buying patterns toward more transformational offerings which are reflected primarily in our consulting business. We have reengineered this business to align with the strategy around smarter planet and business analytics, making investments and adding significant talent. We are getting good traction from our growth initiatives. Consulting signings in growth markets were up 35% at constant currency and our smarter planet and business analytics offerings were 25% of total consulting signings.

Now turning to application management services signings were down 23% at actual rates and 27% at constant currency versus a strong first quarter of last year where we had a handful of large deals. This is where we came up short versus our expectations in the quarter. AMS signings were down $700 million compared to last year. Now AMS has grown on a trailing 12-month basis but obviously it had an impact on our signings performance this quarter. As I mentioned earlier, services signings excluding AMS would have been up 4%.

Global business services gross profit margin expanded 7/10 of a point this quarter to 27.3%. Pre-tax margin was down 1.6 points year-over-year. Adjusting for the unique items PTI margin was 12.4%, down one-half point year-over-year. To wrap up services, we had good improvement in revenue performance driven by outsourcing signings growth in both GTS and GBS over the past 12 months and a return to signings growth in consulting. This is important because consulting has been a good leading indicator and has the greatest impact on near term revenue performance. Both of these give us momentum going forward and we expect our services business to return to modest growth in the second quarter.

Software had a terrific quarter with revenue of $5 billion, up 11% year-over-year or 5% at constant currency. These results are a direct result of our sustained investment in this space. Organic investments complemented by strategic acquisitions have enabled us to deliver unique capabilities and tremendous value for our customers.

This quarter key branded middleware grew 13% or 8% at constant currency and gained share for the tenth straight quarter as we continue to extend our lead in the middleware market. Every one of the key brands gained share. We had very strong performance, especially in our business integration, analytics and storage management software. This contributed to great brand performance with WebSphere up 13%, information management up 11% and Tivoli up 23%.

The software segment pre-tax income grew 54% or 25% after normalizing for the unique items. Pre-tax margin was up 9.6 points year-over-year to 36%. Normalized, we improved pre-tax margin 2.8 points to 27%.

Now let me take you through some additional detail on the brands. WebSphere had another strong quarter. Business integration offerings which deliver value to customers by enabling them to make their processes more predictive, agile and collaborative grew over 20%. ILOG, which plays a key role in IBM’s Smarter Planet initiative by providing business rules management, did very well again this quarter growing over 30%.

Information management software had a great quarter. Business analytics continues to be a key growth area for us. Cognos which was our largest acquisition ever posted strong double-digit growth and gained share, providing a proof point on analytics demand in the market. Tivoli had an excellent quarter and gained share across all three market segments. Within systems management, enterprise asset management which includes Maximo products grew double digits.

This is a key component of our Smarter Planet strategy. Growth was broad based across geographies, most notably in the growth markets. Storage management software also grew double digits which complements the strong growth in storage hardware. We have had over 20 consecutive quarters of growth in Tivoli storage software. Finally, security had solid growth driven by strong sales across the portfolio.

Lotus revenue growth improved significantly from the fourth quarter driven by 31% year-to-year increase in advanced collaboration. This software improves our customers’ productivity by enabling the efficient sharing of information. Rational software had a solid quarter with revenue growing 7% year-over-year. Rational provides an integrated suite of products to manage the business process of software and systems delivery.

This quarter we completed the sale of our PLM operations where we have acted as a sales channel. Our participation in this business has been declining for some time and this transaction is in line with our strategy to divest of lower value businesses. The sale will have a positive effect on software margins immediately and improve our software revenue profile over time. Over the next year the loss of PLM revenue will impact our software revenue growth by 2-3 points. We will provide a view of our software revenue growth without PLM for the next four quarters to better reflect our ongoing business performance.

Software had a great quarter, reflecting the strength of the portfolio and the value it delivers to our customers. We expect to continue the same level of revenue performance in the second quarter, of course adjusting for the PLM transaction. Systems and technology revenue was $3.4 billion, up 5% year-over-year, 2% at constant currency. This is an 11 point sequential improvement in year-to-year growth rates at constant currency. We gained share in storage, both disk and tape, system x, which includes 55% growth in blades, retail store solutions and the mid-range of Power which was driven by the introduction of POWER 7. We held share in high-end servers.

Gross profit margins improved in storage, system x, retail stores and microelectronics OEM. In systems and technology we expect mid single-digit constant currency revenue growth in the second quarter and our new high-end products to help accelerate revenue growth through the second half, to double digits by the fourth quarter.

Now, let me take you through more details on the brands. Power Systems revenue declined 17% year-over-year and we held market share. We have been taking share in UNIX for years. In the first quarter our success with competitive UNIX displacements continued with over 170 competitive wins totaling over $125 million for the quarter. This quarter we took share in both low-end and mid-range systems. In the mid-range where we introduced POWER 7 in February, we gained better than 2 points of share year-over-year.

POWER 7 systems further extend our price performance advantage versus others competing in the UNIX space. We expect our share gains to continue in the high-end when we announce our new POWER 7 products later this year.

Storage revenue grew 11% year-over-year. Disk grew 18% and gained share with double-digit growth in enterprise, mid-range and low-end products. In the high-end, growth was driven by XIV where we added 75 new customers to our XIV platform in the first quarter. Tape declined 5% but we again gained share. Our hardware storage results complement the strong performance in storage software, our storage hardware and software together grew 14%. System x server revenue grew 36% year-over-year. This was our fifth consecutive quarter of share gain in x86.

Our improved sales model and enhanced product offerings are the key contributors to this performance. System x blades grew 55% year-over-year and gained 2 points of share. Gross profit margin expanded year-over-year driven by improvements in end-to-end operational efficiencies and the strong performance in blades. System z revenue declined 17% year-over-year. MIPS declined 19% in the first quarter after growing 18% a year ago.

This performance is consistent with what you would expect at this point in the product cycle. Later this year we are releasing the next generation System z. Microelectronics OEM revenue was up 16% year-over-year. Our 300 mm fab is at near full utilization and our 45 nm output was sold out again this quarter. Systems and technology returned to revenue growth this quarter with strong performance in System x, storage, microelectronics and retail store solutions. I expect this growth rate to accelerate through 2010.

Turning to cash flow, we generated $1.4 billion of free cash flow, up $400 million year-over-year. The growth was achieved off of a strong first quarter of 2009. The increase in free cash flow was driven by higher net income and improved cash from sales cycle working capital as collections remain strong. We delivered this $400 million increase in free cash flow even taking into account significantly higher tax payments, so this was quite an achievement.

Below the free cash flow line we received about $450 million from the PLM sale which is reflected in the investing section of our cash flow and on the line labeled “Other” in this chart. Looking at our uses we completed five acquisitions for $800 million which is a good start to the year and we returned $4.7 billion to shareholders. $700 million was in dividends and $4 billion was in share repurchases which helped drive a year-to-year reduction in average diluted shares of just over 2%. We have $2 billion remaining from our board authorization. Overall, this was a great quarter for cash flow, especially for a first quarter.

Now, let's turn to the balance sheet where we see the benefit of our strong cash performance. Even after funding investment and returning cash to investors we maintained a healthy cash balance of $14 billion which was flat from year-end and an increase of $1.7 billion from the first quarter of 2009. Total debt was $26.3 billion. Over $22 billion of debt is in support of our financing business which is leveraged at an appropriate 7:1 ratio. $4.1 billion is non-financing debt which is up $400 million from year end.

We continue to have a high degree of financial flexibility in our model. Non-financing debt-to-cap was 18%, up 2 points from year-end and down 25 points from a year ago. The balance sheet remains strong and positioned to support the business over the long term.

I will start to wrap up with a brief discussion of the drivers of our earnings per share performance. This quarter all categories positively contributed to our earnings growth. Starting with revenue, which contributed $0.09 of benefit, or about one-third of the total growth, this was the largest contribution we have had from revenue growth since the second quarter of 2008. Our ongoing work to improve our operating leverage resulted in gross margin expansion and expense productivity which together contributed $0.13. We also had a modest benefit from tax and share repurchase contributed another few cents. So our growth was delivered in a very balanced way, through revenue growth, profit expansion and an effective use of cash.

Our performance in the first quarter was driven by the investments we have made to capture growth opportunities and our ability to deliver value to our clients. We had broad based improvement in revenue growth, across our segments and across our geographies. This improvement, together with a shift to higher value businesses and focus on driving productivity, again delivered solid margin and profit performance.

We took actions in the first quarter to continue to transform the company; shifting to higher value areas and improving our structure. We completed five acquisitions in the first quarter, investing in key capabilities that support our growth initiatives. We divested of our PLM operations and after we get through the comparison in the next few quarters this will improve the revenue growth and margin of our software business. We introduced new mid-range Power offerings and will deliver high-end power and mainframe systems later in the year to drive share gains in the second half and we continued to increase the productivity of the business. These actions will improve our strategic position and our business model going forward.

Given what we see in the short term and our work with the business units we expect a return to revenue growth at constant currency in the second quarter, with services delivering modest revenue growth, hardware improving to mid-single digits and software continuing its strong performance. We are confident in our ability to continue to improve our revenue performance, leverage our business model to expand margin, grow profit, generate cash and return value to our shareholders. So consequently we are increasing our expectations for the year, to at least $11.20 of earnings per share

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 our 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 final comments.

Operator, please open it up for questions.

Question and Answer Session


(Operator Instructions) The first question comes from the line of Toni Sacconaghi - Sanford C. Bernstein.

Toni Sacconaghi - Sanford C. Bernstein

I was hoping you could comment a little bit on the IT spending environment and go over again what you said about revenue growth at the end of the call. On the IT spending side do you think we are back to a fairly normal IT spending environment? By that I mean normal sequential patterns in terms of market revenue growth. For IBM specifically on the revenue growth side perhaps you could just go through one more time your expectations for revenue growth. That is something new. You typically don’t comment on revenue growth for IBM. If we are in a more normal spending environment given that IBM historically has grown 3-4% a year at constant currency or call it 2-5%, in that range, should investors be expecting that IBM can grow in that range at constant currency for the remainder of this year?

Mark Loughridge

Let me start with your first question about the IT spending environment and revenue growth characterizing that compared to more normal IT spending levels. First of all, as we went through it we made it the second chart in the pack and you can see how our growth rates improved across our brands and across our geographies. So to me, STG up 11 points. Software up 9. GVS up 3. Very good, uniform performance on that content highly driven by the strength of our transactional performance and our STG and software business.

I think even more interesting to me as you look across the geographies look at how uniform that improvement in growth rate is going from the fourth quarter to first quarter. Americas up 6 points. EMEA up 5. Asia up 4. The major markets improving 5 points of growth. Growth markets up 6. Within that BRIC up 7 with IBM total revenue up 5. That is very consistent with the direction we gave when we posted fourth quarter. We talked about we ought to be seeing improved performance in our revenue growth rates both in actual and in constant currency going from the fourth to the first. Actually within that at the time we had assumed currency would be an assist of 6-7 points and actually it came out more like 5 points. Given that we actually exceeded our own objectives here we did much better on the operational performance to compensate for that currency effect.

The second thing I will say across the spend environment, we are seeing a transition in the kinds of deals and the IT spend mix that our customers are looking for. Specifically in this quarter you can see that transformational offerings especially within consulting were much more highly driven with consulting signings now up 18% or 12% in constant currency. That is very strong performance. We haven’t had that growth rate in the consulting business for over three years. I thought that was very encouraging in an area of the business that yields more quickly.

Now whether we are back to normal IT spend, that is a longer term view of the world. Obviously I would like to see this momentum continue but what I see within the IBM equation is we have a very strong play to improve our revenue performance now going into the second quarter with the services businesses now returning to modest growth, software continuing its very powerful performance up 11% in the first quarter. I thought that was very encouraging to see that kind of growth in our most profitable business continuing to fuel the remix in our business equation.

In hardware now taking advantage of improved transactional content within our transaction base and now moving into the second half we have substantial announcements coming up. I think it is all good and positive performance on that transactional side the way I see it now. There will be the offset with PLM and that is about a 2-3 point impact in software growth but we are normalized for that going forward. Generally if you look across the characteristics I feel like we have a good hand going into the second quarter.


The next question comes from the line of Ben Reitzes - Barclays Capital.

Ben Reitzes - Barclays Capital

Can you talk a little bit more about your raising of guidance? Just a few things that I had hoped you could highlight. If I use the lower than expected share count I think I get pretty close to the $11.20. I assume that is not what you want us to be changing. Can you talk about maybe the benefits of the cost cutting and other reasons why you raised the guidance? Maybe even highlight currency? The puts and takes.

Mark Loughridge

Sure, let me go through that. First of all when you look at that guidance to be 90-days into the New Year and take that guidance up $0.20 I think that is a pretty significant improvement in our view of the year. That improvement was really driven by the strength we see in the quarter, the strength in the operational performance. I covered a number of these points in the last question but much better signings performance in our consulting business. Software transactional performance in the first quarter up 28% at constant currency and 24% at actual. Hardware returning to growth with good announcements in the quarter but very exciting announcements as we move into the second half.

If you look at what accounts for the improvement going from $11 to $11.20, that improvement is based on our confidence as we now have closed I would say a very good first quarter. Now within that, there are a number of different mechanics under the hood we can talk about. First of all, one you had mentioned if you look at the workforce rebalancing work we did that was predominately in Europe and Asia. So it has a slightly longer payback. We said it pays back within the year. If you look at that it is about $550 million of benefit predominately in the second half of the year.

I would say that would yield about 2/3 because the balance of the third now that we are in more of a growth mode the balance of that third we can use now for investment to drive our revenue. So let’s say about 1/3 of that $550 million. That would be about $0.20. Now as I pointed out earlier that is partially offset by the $0.07 impact from PLM with the PLM impact starts in the second quarter. The benefit of the workforce rebalancing is really in the second half of the year. I think that gives you kind of a framework.

I also want to comment if you look at improving the guidance from $11 to $11.20 remember that when we were in the second quarter of 2007 we established a roadmap that we said just having completed a year at $6.05 we thought we had a very good chance to improve that to at least $9.00 by the time we got into 2010 with a potential range in 2010 to 2011 depending on the performance of our pension fund. Here we are talking about $11.20, well beyond that roadmap objective. So I think we have done pretty well especially having gone through a recession and within that recession recording earning per share growth every quarter at a fairly substantial rate. I feel good about the guidance. I feel good about the business as we exit the first quarter. The workforce rebalancing will have benefit but that will be predominately in the back half of the year.

Frankly when you look at your to-go increase based on our increase in our EPS guidance I reserve most of that to go increase for the back half of the year.


The next question comes from the line of Katie Huberty – Morgan Stanley.

Katie Huberty – Morgan Stanley

A follow-up on the margin question. Any reason we wouldn’t see a nice uplift and perhaps better than seasonal uplift in gross margins in the back half of this year in light of the high-end server cycle that kicks in in the second half and then the back end loaded cost savings?

Mark Loughridge

We certainly have as you point out, we have a strong base as we go into the second half of the year. First of all it is the savings out of workforce rebalancing that will be substantial. In addition as you pointed out new and exciting announcements on the high end of our server line which drives substantial margins and [inaudible] substantial margin in the business. So I think we have a very good base going into this second half of the year.


The next question comes from the line of David Grossman - Thomas Weisel Partners.

David Grossman - Thomas Weisel Partners

Could you help us better understand your divestiture strategy particularly the thought process around balancing mature free cash flow, [yielding businesses] and growth?

Mark Loughridge

Absolutely. Let’s link the discussion on divestitures with acquisitions because they are part and parcel partners in this strategy of ours. First of all, if you look at the ongoing strategy we have we want to move into intellectual property based businesses that are highly scalable and related to driving the solutions offerings we have; solution offerings like business analytics for example.

What we are doing on the [audio break] side, on the divestment side, is moving out of businesses that have lower growth prospects and lower margin prospects. If you look at the divestitures and the acquisitions in the quarter I think they are perfect examples of that strategy. The PLM business we remarketed their product. We didn’t own the intellectual property; they owned the intellectual properties and as we worked through this with the sale it made more sense for them to actually run that sales and marketing themselves rather than for us.

At the same time we invested in five very strong candidates that do have a lot of intellectual property and that intellectual property is aligned with the strategic objectives we have set for ourselves. So I think this is actually a perfect example; divesting of lower growth, lower margin commoditizing content and monetizing content and moving that investment base into higher growth, higher margin intellectual property that we think is highly scalable and aligned with our strategic trajectory.

David Grossman - Thomas Weisel Partners

Can you give us a sense of how much may still be out there in terms of things that would fall into the same category as PLM in terms of scale?

Mark Loughridge

I think that is a very fair question. We have had that question a number of times I would say over the last decade. Oftentimes we have had divestitures and our analysts look at them and say well that might be about it. We are looking at next year IBM’s centennial. We are investing and driving for another centennial. So this is going to go on all the time. This is going to be a constant process of regeneration and renewal and transforming our business base into new opportunities that we think have better margin and better growth prospects and I think there is no better example than looking at the profit mix of the software business from 2000 to 2008 and you can see how much that expanded. That was a strategic choice.


The next question comes from the line of Richard Gardner – Citigroup.

Richard Gardner - Citigroup

You made reference to the weakness in App management bookings. I was hoping you might be willing to give us a little bit more detail on the reasons for that? Maybe also a word on what you saw in the systems integration portion of that and generally your view of the services pipeline going into Q2, long-term versus short-term and what type of bookings growth expectation you have for the services business for the full-year this year?

Mark Loughridge

First of all if you look at the AMS, it was down about $700 million year-over-year. It faced a prior year where they grew signings 23% and they had a handful of very large deals. It was a challenging quarter for that business and that business did quite well last year. We grew signings 14% for the year. So a good double digit performance in 2009 and a particularly strong first quarter to compare to.

If you look at across the services base of business on a signings base, we do think that when we go into the second quarter we have a very good deal list with good odds so there is no reason we shouldn’t be growing signings at a reasonable level as we go into the second quarter. If you look at booking expectations I think that is going to be characterized quarter by quarter. Right now we see a pretty good pipeline going into the second quarter and as I said we will be returning to signings growth.


The next question comes from the line of Mark Moskowitz – JP Morgan.

Mark Moskowitz – JP Morgan

I want to come back to the transformation activity in terms of consulting services. Is this shift you are seeing, do you see this as a multi-quarter or multi-year shift? How should we think about the gross margin, operating margin profile? Could we see incremental leverage from this over the next year or two?

Mark Loughridge

Let’s look at first of all your question on transformation especially related to consulting services. If you look at the consulting performance as we pointed out signings were up 18%. Underneath that, underneath that performance it is interesting to note that North America was up 26% and GMU was up 35%. In fact we had growth in four of our five major IOCs in the consulting. A pretty broad based phenomenon with real strength not only in our major markets like North America but also in our growth markets, up 35%.

If you look at the content underneath consulting in our base of business it was about 25% of base of business that was business analytics and Smarter Planet so you can see the linkage that consulting momentum grew to other parts of our business. Business analytics where is its biggest component? It is obviously in software. We have reviewed with you the acquisitions and organic investments we have made in business analytics and software as well as the organic investments, mathematical expertise and research given we are now the largest private sector math department in the world.

All of those work together to help drive that equation and move that transformation through a number of our business units. Given the investment we have made in this obviously we are looking for a multi-quarter, multi-year growth in that business analytics opportunity. So, with that business analytics is a great example of moving into solution offerings with a big software base in the framework or the deliverable and that software base comes at very high margins. It is part of the mix shift that you have seen starting in 2000 driving much more of our profitability through that high margin business.


The next question comes from the line of Keith Bachman – BMO Capital Markets.

Keith Bachman – BMO Capital Markets

I wanted to go back to revenue growth if I could and how you are thinking about IBM in 2010. A different way, if you look at the EPS bridge for the first quarter of 2010 versus 2009 about 1/3 of your EPS growth was related to revenue at actual. If you think about what you provided of at least $11.20 for the year, how do you think the revenue growth will contribute to that? Is it more than 50%?

Mark Loughridge

Well I am not going to give specific percentages to break that down. We do think we are clearly, based on the improvement of revenue growth rates from fourth to first and then the comments we made working with our general management going from first to second, we believe we are in a better framework for revenue as we go through the year. When you look at the components underneath the $11.20 we run multiple scenarios. We run scenarios with higher revenue growth rates in geographies; higher revenue growth rates in GMU versus major markets, higher revenue growth rates with higher margin content along business analytics; we do alternatives if the growth rate comes in the more transactional content as opposed to the [inaudible] content and what is the impact in currency.

Just in currency alone if you just look at the 90-day change in spot rates, in a quarter, that alone has impacted the actual revenue growth by about $1.5-2 billion. There is not just one scenario we look at to drive our view of the year. We look at multiple scenarios. We look at our flexibility to drive that and what we are delivering I think is a view of the world is in that least number. To us and to me that is a high probability base looking forward.


The next question comes from the line of Bill Shope – Credit Suisse.

Bill Shope – Credit Suisse

In the past mainframe cycles have been a key driver, at least a key stimulus for IBM’s not [hardware] segment. Is that something we should anticipate in this coming cycle? Or has the direct link between mainframe and the services and software portfolios been diluted somewhat over the years?

Mark Loughridge

The thing I am always more impressed with is how dynamic the different plays and different solutions are in the corporation that cut across different product lines and avenues. We are certainly not dependent on any one set of announcements or strategies within the company. Now that said, this mainframe cycle looks typical to me and we have a very powerful announcement set up for the back half of the year so I am very optimistic in the upcoming announcements for both z series and our high end POWER 7 series.


The next question comes from the line of David Bailey - Goldman Sachs.

David Bailey - Goldman Sachs

Last quarter you had commented that you had a number of large software deals that didn’t close in Q4 and fell into Q1. I was wondering if you could help us understand how big a factor that was in your Q4 software result and did you see a return to more normal close rates this quarter?

Mark Loughridge

Great question. We did track those deals as they rolled from fourth to first. As you look at them we did close a number of them but really the closure rate was very similar to 2009. So, on a year-over-year basis they really didn’t have much contribution to our overall growth. Our growth in this quarter was really driven by the operational performance in the quarter by our software business driving that 11% growth rate.


The next question comes from the line of Chris Whitmore - Deutsche Bank.

Chris Whitmore - Deutsche Bank

You bought back about $2 billion more of stock than I expected during the quarter. Can you maybe update us as to what you expect to use your liquidity for going forward? Where do acquisitions sit versus buybacks? How are you thinking about that equation going forward?

Mark Loughridge

Good question. When you look at the acquisition base we had in the first quarter I thought we had a pretty darned good start. That is $1 billion of acquisitions spread across five very strong opportunities for us and demonstrates our commitment to acquisitions as an ongoing play. At the same time, we purchased $4 billion in the quarter. If you compare that to the prior year’s that does look like a large first quarter but I caution you really the prior year was impacted by the equity impact that we had in the business leaving 2008. So in other words when we had the big pension impact due to lower returns that in turn impacted our equity and our debt to cap went to about 48%.

So last year we had to be fairly careful about equity based transactions and the impact on that. We are not in that situation this year. We are not in that situation. If you look at our debt to cap now it is 18%. That is very conservative. We have $14 billion of cash. We just finished the quarter with $1 billion of growth acquisitions, $4 billion in share repurchase, $700 million in dividends. Now I would tell you as you all know this is a power reserved to the board and we have about $2 billion left in our authorization. I would think it would be more practical to compare this year’s acquisition opportunities and this year’s share repurchase opportunities especially on the latter base to what we saw in 2008 as opposed to 2009.

So thank you very much for your questions. Let me just wrap up here. We had a very good start to the year including real progress on the top line. Our best growth came from software which is our most profitable and highest value area. We had great growth in consulting signings which as you know tends to be a leading indicator. We started the introduction of our high-end servers which we will continue to roll out later in the year and drive hardware growth in the second half.

Overall we are encouraged by our performance in the first quarter and the position we are in for the rest of the year. That is why, just 90 days into the year we are taking up our EPS expectations for 2010. With at least $11.20 for the year we are well ahead of our 2010 roadmap objectives and we will talk to you again at our investor briefing on May 12th. But for now, as always, it is back to work.


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

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