IBM Q4 2005 Earnings Conference Call Transcript (IBM)

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IBM - International Business Machines (NYSE:IBM) Q4 2005 Earnings Conference Call January 17, 2006 4:30 PM ET

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Mark Loughridge, Senior Vice President and CFO

Patricia Murphy, Vice President of IR


Tony Sacconaghi, Sanford Bernstein

Bill Shope, JP Morgan

Lora Canablerio, Goldman Sax

Steven Fortuna, Prudential Equity Group

Richard Gardner, Citigroup

Ben Reitzes, UBS

Shilly Shaw, Morn Cadet

Chris Wetmorn, Deutsche Bank

Rebecca Ronko

David Grossman, Clements Partners

Richard Farmer, Merryl Lynch

Patricia Murphy, VP of IR

This is Patricia Murphy, Vice President of Investor Relations for IBM. Here with me today is Mark Loughridge, IBM's Senior Vice President and Chief Financial Officer. Thank you for joining our fourth quarter earnings presentation.

By now the opening page of the presentation should have automatically loaded and you should be on the title page, chart 1. The charts will automatically advance as we move through the presentation. However if you prefer to manually control the charts, at anytime you can uncheck the synchronize button on the left of the presentation.

As always, the prepared remarks will be available in roughly an hour and a replay of this web-cast will be posted to our investor relations web site by this time tomorrow.

This 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'll find reconciliation charts at the end, and in the Form 8-K to be submitted with SEC.

For those of you, who are manually controlling the charts, please click on the next button for chart 2. 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 at the Company's filings with the SEC. Copies are available from the SEC, from the IBM web site or from us at investor relations.

Now let's go to chart 3, and I will turn the call over to Mark Loughridge.


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Mark Loughridge, Senior Vice President and Chief Financial Officer

Thanks Patricia. In the fourth quarter we delivered $24.4 billion in revenue which was down 12% as reported. Without PC’s in the impact of currency revenue was up 3%. Our pre-tax income was $4.6 billion this includes about $180 million of gain from certain real estate transactions as compared to the $75 million previously estimated. And we delivered $2.1 of earnings pre share up 20% year-to-year. This quarter we have one Non-recurring item. On January 5th we have announced changes to our US pension plan. We recorded one time pre-tax charge of $267 million in the fourth quarter for the curtailment of these plans.

When you exclude the non-recurring charge, IBM pre-tax profit was $4.8 billion and we delivered $2.11 of earnings pre share up 26% over the last years fourth quarter. But the most appropriate comparison is to last year's fourth quarter without the divested PC business as this view best reflex our ongoing performance. The details and description at the PC results are included in our supplemental charts.

On this comparable basis, revenue was down 1% as reported but up 3% at constant currency. Our pre-tax income was up 22% and earnings per share were up 29%. Looking at our results by business in hardware we had strong performance in storage, microelectronics, and bSerious and pSerious servers.

In software, performance is led by our key branded middleware products, especially information management and Tivole. Our services business had improved margin performance, driven primarily by benefits from our productivity initiatives. And across geographies the strongest results were posted by the America’s, which executed well on a solid demand environment. These results once again reflect the strength of our business model, the global scope of our enterprise and the ability of our broad portfolio to consistently generate earnings in cash.

Let's move on to our full year performance with chart 4. In 2005 our reported results included PC’s results for 4 months and non-recurring items. As reported we delivered $91.1 billion of revenue down 5% year-to-year. Pre-tax earnings were $12.2 billion up 15% and earnings per share were $4.91 up 12%.

Without the non-recurring items in 2004 and 2005. Our per-tax earnings were $12.4 billion up 12% and earnings pre share were $5.32 up 18%. To view the best represents on going operational performance IBM results without Non-recurring items in divested PC business. On this basis we delivered $88.3 billion at revenue up 3% as reported in a constant currency.

Pre-tax earnings were 12.5 billion up 15% year-to-year with solid growth and contribution from hardware, software and services. And earnings per share were $5.36 up 21%. Net cash from operation excluding global financing receivables was $13.1 billion up $200 million year-to-year. We had record returns to share holders from the share buybacks and dividends of $9 billion. We ended the year with $13.7 billion of cash on hand and low debt levels for Non- financing business. In 2005 our return on invested capital was 24% excluding our global financing business in the Non-recurring charges.

Earlier in the year we said we would deliver a profit more to cost expense performance than revenue. Throughout the year we leveraged our productivity initiatives to drive or pre share growth in excess of longer terms financial model objectives. We will continued to leveraged the cost efficiency of our model to drive profit growth as we move to 2006

And now let's get into the detail of the fourth quarter starting with the revenue chart 5. Total revenue in the fourth quarter was down 12% year-to-year as reported. Without the PC business revenue was down 1%. Currency negatively impacted our growth by 4 points, 1 point more than our estimates based on spot rates in mid-October. Without the impact of currency our revenue was up 3%. Global services was down 5% year-to-year as reported and down 1% at constant currency. The decline was driven primarily by our short term signing performance and by decline strategic out sourcing revenue. We’ll get into the service revenue dynamic when we discuss the services business. Hardware revenue was down 27% as reported. Without the PC business hardware was up 6% and up 9% at constant currency. We had strong double digit growth from our storage products and our microelectronics, OEM business. Software revenue was flat as reported and up 3% at constant currency. Our key middleware brands contributed high single digit growth at constant currency offset by declines in operating systems in other middle-ware products. Global financing revenue was down 8% as reported or 6% at constant currency driven by continued declined in the asset basis and lower level of used equipment sales.

Now lets turn to revenue by geography, chart 6. To provide the best view of our ongoing geographic performance I’ll focus my comments on the results without PC at constant currency. Looking at the major geography America’s performance was again driven by solid execution. The performance was broad based with growth across all key brands and all regions. Overall demand remains good as clients invest to improve competent of their infrastructure and to provide differentiated advantage in the market place.

Performance in Europe remain mixed. Revenue in Spain and Nordux was up. And France grew for the second consecutive quarter. Well, Germany’s growth rate improved Germany and Italy continue to decline. Although in these countries and in fact across all regions in Europe. We had good growth in hardware. After successful execution of their re-structuring action our new operating model with the more stream line management system in now in placed. Well hours to compete more effectively in these markets.

Asia pacific revenue decline this quarter. Japan which represents about 60% of the Asia pacific revenue based once again declined at constant currency. We continue to driver action to improve execution and as they take hold in the first quarter we expect improved performance. Medicating that clients in Japan, china grew and again goes to strong results lead by India.

China and India together with Brazil and Russia comprise the emerging countries that we discussed in the past quarter. For the year these emerging countries delivered 3.8 billion of revenue without PC and grew 14% at constant currency. Year-to-year growth was lead by India at 55%, while China grew 8%, Brazil 7%, and Russia 29%. We’ll continued to shift investment to these high growth markets.

Finally Our OEM growth was 35% in fourth quarter driven by the ramp up in our game chip processors. Now we’ll move on to gross profit chart 7.

Gross profit margins in the fourth quarter was 44.1% up 5.3 point year-to-year. Without the improvement from divesting the low margins PC business margin was up 2.2points Global services gross profit margin was up 3.1 point year-to-year as in the third quarter we had good yield from our productivity initiatives and a better contract profile.

Hardware gross profit margin improved over 9 point year-to-year driven by the divestitures the PC business. Without PC the hardware gross profit margin was flat. Software gross profit margin improves slightly. Global financing gross profit margin was down 2.3 point as we discussed in the past this business is more appropriately measured on return on equity. For the full year global financing return on equity was 33%. And now lets turn to expense chart 8.

Total Expenses in other income declined 7% in the fourth quarter as reported. Excluding the $267 million one time curtailment charge for a US pension plan change, expenses would be down 11%. Without the PC results in 2004 and pension charge, expenses in other income was better by 7%. On this basis expenses to revenue improved 1.7 points year-to-year and we improved our SG&A expenses to revenue ratio about half a point, down to 20.4%. Benefits from our second quarter productivity initiatives drove the year-to-year improvement.

By the end of the year essentially all of the impacted resources had excesses in the business. These are postures grew by a high level of saving in the fourth quarter yielding a large benefits cost expenses in the period. As in the third quarter most of the cost reduction went to the bottom line. Over the longer term these actions give us competitive cost structure more pricing flexibility and allow us to better manage escalating labor cost. Turning to our road map of item, that materially impacted earning growth, let me start with a two items that negatively impacted our growth. Retirement related plans both pension and health, were year-to-year of $522 million as reported including the one time curtailment charge. Excluding the curtailment charge, retirement related plans were heard, of $255 million. For the full year excluding charges in both years, retirement related cost was up approximately $ 1 billion, inline with our estimate as the beginning of 2005.

In spite of the fact that our pension plan changes will save us between $450 million and $500 million in 2006. Retirement related expense was still increase another $400 million to $500 million year-to-year. Excluding the impact of the 2005 one time charges. Additional details on our pension assumption and plan changes were posted to our investor website on January, 5th. Our profit growth was also impacted by a decline in IP income. Down about $70 million year-to-year. They were a couple of items that materially helped our earnings growth. Total equity compensation including the cost for restricted stock units and performance based awards, was down about a $140 million year-to-year.

We’ve included additional information on our equity compensation in the supplemental charge. Gains on real estate transaction were up almost a $160 million is year-to-year, this is reported in other income and expense. You recall the last quarter I told you we had some real estate transactions in process, and at the time our best assessments was that we would record a pre-tax gain of $75 million in the fourth quarter.

Our actual fourth quarter results include a pre-tax gain of a $182 million. Primarily comprised at the gain on the sale of an office building in Japan, partially offset by a charge to write down the building in the US.

The additional gain of a $107 million over our original estimate of $75 million was not offset as we had expected, by a loss in the sale of another building in Japan. We’re unable to reach agreement with the buyer, and the building remains in service for the company. When we comment on 2006 at the end of this presentation, there is a $107 million over achievement should be excluded. Turning to currency, US dollar had generally strengthened since year end 2004, especially against the European currencies.

IBM hedges its major cross border cash flows, and as a result, medicates the effects of currency volatility in the year-over-year results.

The impact of these hedging programs it’s principally reflected in other income and expense as well as cost a good sold. This quarter hedging program accounts for approximately, $150 million of the improvement in other income and expense. I’m not going to predict future currency moves, but our current spot rates currency were heard revenue growth in the next few quarters. Over an extended period of time, a strong US dollar negatively impacts IBM’s revenue in their earnings.

The supplement chart at the end of the presentation benchmarks currency potential future impact on revenue. Assuming Friday’s exchange rate, you’ll see that they found these rates we would expect a 3 to 4 point impact to revenue growth in the first quarter without PC’s, and a 2 point impact in the second quarter but for moderating in the second half.

Now let’s turn to cash flow chart 9. We had another outstanding year in cash generation, this cash flow analysis chart as one primary difference from the past 95 format.

It considers our global financing receivables as an investment to generate profit, not as working capital that should be minimize for efficiency. For 2005 net cash provided from operations excluding the change in global financing receivables was $13.1 billion and increase of over $200 million from last year. Our cash performance was driven primarily by our net income growth and our continued focus on working capital and supply chain management.

Within working capital adjusted for the sale of the PC business receivables collections continue to improve. Inventory decreased over $450 million year-to-year adjusted for the sale of the PC business inventory was down over $250 million and we receive $775 million in the third quarter from a settlement with Microsoft. We paid out $1.3 billion in re-structuring cash payments and funded $1.7 billion contribution to the US pension fund in the first quarter of 2005. $1 billion is more than was funded in 2004.

Turning to our use of cash for investments Net Capital Expenditures were approximately $3.5 billion. A decrease of approximately $200 million year-to-year. Let me make a sub-total here since many investors look at cash flow after capital expenditures. We generating cash flow of $9.6 billion about 400 million more than last year. Without the $1 billion of additional contribution to the US pension plan we generated $1.4 billion more cash flow this year. Next our global financing receivable net of changes in global financing debt were source of $1.3 billion due to continued decline in income generating assets.

We spend approximately $1.5 billion on acquisition in 2005 almost half of that was for the second quarter acquisition of essential. And we had net proceeds from divestitures of over 650 million driven by the sale of the PC business and about $270 million as the final settlement of the HTD divestitures. We turned a record $9 billion to investors this year and increase of over $650 million year-to-year. $7.7 billion of this was to share re-purchase. We bought back over 90 million shares and averages diluted share were at $1.6 billion down 4.7 % from a year ago. We have approximately $5 billion remaining at the end of December from our last ford authorization and we paid out over 1.2 billion in dividend

This year between our share re-purchase and dividend we were able to pay out to our share holders of a 100% of our net earnings. Even after investing $10 billion in R&D capital expenditures and acquisition. Moving on to chart 10, we will discuss the balance sheet. Our cash on hand was $13.7 billion over 90% of our total depth of $22.6 billion was driven by global financing business and global financing was leveraged that an appropriate 6.701

The remaining non-financing debt level was about $2.1 billion and debt capital was 6.7%. Majority of the debt increase was to facilitate the Homeland Repatriation and it expected to be significantly reduced by the end of 2006. Under this provision of the US tax law we were patriated $9.5 billion this year consistent with what we told you in October. Our balance sheet remain very strong and we are well positioned to capitalize on future opportunities and meet our cash needs. Now let’s turn to our three key business starting with global services chart 11. Global services delivered revenue of $12 billion declining 5% has reported and 1% constant currency.

The segment profit was up 18.5% year-to-year and the pre-tax margin improved to 11.9%. Signings for services this quarter were $12 billion at stock rate and a $11.5 billion at constant currency. This includes $5.3 billion of short term signings which were down 4% and $6.2 billion of long term signings. We signed 8 deals larger than a $100 million this quarter. Our backlog is estimate at a $111 billion as same as the year ago. Before turning to the three major business let me comment on services revenue dynamics. Revenue growth in a quarter is influenced by short term signings in the current entire quarter. Our short term businesses include integrated technology services, and the commercial content of consulting instance integration. As I said short turn signings were down 4% and we are essentially flat in the third quarter. Our long term business include strategic outsourcing, business transformation outsourcing and the federal content of consulting instance integration. Growth in these businesses have influenced by several factors. Including the accumulative effect of signings. Contract duration, extension and change in backlog overtime.

Turning to the three major segments, strategic outsourcing is declining 32% this quarter. Revenue was down 5% as reported and down 2% at constant currency. Strategic outsourcing revenue growth continue to be impacted by the high levels of backlog erosion, we experience in 2004 and the accumulative effect of lower signings starting in 2004, through the first quarter of 2005. integrated technology services excluding maintenance was down 5% year-to-year as reported and down 2% at constant currency. ITS signings this quarter were down 10%.

In 3Q I told you that we are in the process of making the necessary to alterative business to growth. The initial portfolio were balancing work is complete, for having business development skills and the sales coverage is lying to the revised portfolio. These changes will be operational in the first quarter. Business consulting services was down 6% as reported and down 1% at constant currency. This was driven by double digit declines in Asia pacific and Italy follow America’s grew. Business consulting services signing to were up 23% driven by 144% increase in the long-term business transformation outsourcing signings. Signings growth was driven by the America’s and Europe. Consulting insistence integration signings were up 4%. Driven by growth in our longer term US federal business. Strengths this quarter were in the strategy change and supply team management practices within CNSI, as well as overall strength in the financial services sector SMB and the America’s. We are taking actions to improve our growth in consulting insistence integration. I will mention just a few. We are increasing the level of dedicated sales resource to drive our business and web services and that’s a way solutions.

Further investing and resource to address as mid market opportunity increasing the level of brand resource in Asia Pacific, and leveraging our global and designs build and run capability. Our business transformation outsourcing business continued at strong year-to-year growth. ETO is an important offering to address the business performance transformation services opportunity. Other element include the strategy in change practice. Engineering and technology services and business performance software. For the year BPTS revenue was $4 billion up 28% year-to-year. Turning to margin global services growth margin improved 3.1 points year-to-year. Pre-tax margin was 11.9% and improvement of 2.4 points year-to-year. The year-to-year improvement in pre-tax margin was primarily driven by benefits from our restructuring action. CNSI utilization improvements and a better contract profile. Offset by IT investments and pension increases. The margin also benefited from a portion of the real estate gain, which contributed approximately the same amount from margin as the gain from a divestiture in the fourth quarter of last year.

So to wrap up the year, we improved our margin performance year-to-year for making our services business more cost competitive. Productivity initiatives such as professional market place began to take whole, this helps price to improve utilization and will be one of the drivers of margin expansion going forward. We increased our global delivery capabilities by adding over 15,000 resources to our global delivery resource centers. We grew long-term signings 19% for the year. These signings provide benefits over longer periods of time with little immediate impact revenue growth. Backlog will be stable with increased signing to less erosion than 2004. We did however fall short of our revenue expectations for the year primarily in our short-term businesses.

Looking forward our pipeline for the first quarter is up year-to-year with particular strength in our long term businesses. As always we need to execute to convert the pipeline designing. We expect improvements in our short-term businesses. Actions we are taking in integrated technology services, and consulting and systems integration should yield benefits over the course of the year. Our business transformation outsourcing business remained strong. Based on this we expect services revenue growth to accelerate throughout 2006 to achieve mid single digit revenue growth in the second half. And we will continue to focus on driving higher margins with more competitive cost structure.

Now I will move on to systems and technology group chart 12. Systems and technology group revenue at $6.8 billion grew 6% year-to-year and 10% at constant currency on the continued strength of the zSeries and pSeries servers, storage in our microelectronics business. zSeries revenue grew 5% year-to-year and 10% at constant currency. MIPS grew 28% year-to-year, this is our largest quarter of MIPS shipments on record and our highest revenue since fourth quarter 1998. Today over 50% of our revenue is driven by new workload such as Linux and Java, compared to only 15% at the end of 1998. This increased adoption of new workload by our customers highlights the broader applicability of the platform, enhanced customer benefits of our latest system z9. iSeries revenue declined 18% at the quarter as we wrapped around our high and POWER5 introduction in late 2004. We saw late quarter fall off as customers anticipated the first quarter announcement of new POWER5+-based products. For the full year iSeries grew 1% year-to-year. In 2005 iSeries added over 2500 new customers reflecting a continued commitment to the platforms from ISVs, resellers and customers.

pSeries unit servers grew 4% year-to-year and 7% at constant currency in what we believe is a flat market. We saw additional demand in quarter in the public sector which had an impact to our margin. The full year performance is extraordinary with 15% year-to-year growth, double-digit growth in all geography. We expect this will be the fourth consecutive year of pSeries share gain. The refresh of our POWER5 product line began in the fourth quarter and additional rollouts are coming in 2006.

xSeries service revenue was flat year-to-year and up 3% at constant currency. xSeries volumes were up 13%, however we saw strong competitive pressures drive lower pricing. We expect to maintain our leadership position in Blade center with fourth quarter revenue growth of 41% and full year growth of 65%. Total storage delivered year-to-year growth of 24% driven by strength in both Enterprise and mid range disk. Total disk grew 32%, with Enterprise disk at 46% and midrange disk growing 40%. Tape also turned in a strong performance growing 8%. We believe we have gained significant share in external disk and extended our share leadership in tape.

Our storage virtualization momentum, continued in the fourth quarter with growth of almost 40%. Total storage margin improved quarter-to-quarter always down year-to-year driven by intensified competition on price. And the mix impact of our midrange growth in both disc and tape. Microelectronics fourth quarter revenue grew 48% year-to-year. Revenue from our 300 millimeter products grew over 250%. Yields in our gain processor continue to exceed expectations this quarter, with our first full quarter of production shipments. In addition to the AMD Commitment announced in the fourth quarter last week we announced that Sony and Toshiba signed 5 year extension in our development partnership. We believe collaborative relationships like these also enable us to leverage IBM technology in the Jason market. Engineering in technology services grew 7% as reported and 14% at constant currency. Bringing full year growth to about 40%. EMPS enables customer to leverage our design skills know how and technical capabilities to meet their needs and its part of the high growth business performance transformation services opportunity. I will move on to software chart 13.

Software revenue was $4.6 billion in the quarter, flat year over year as reported but up 3% at constant currency. For the full year software grew 4% both as reported and at constant currency. Key branded middleware grew 3% as reported, and 7% at constant currency in the fourth quarter. This concluded a solid year with key branded middleware growing 9% year-to-year as reported and at constant currency. Driven by double digit growth in WebShphere, Tivoli and Lotus. Operating expenses were down 6% as reported. And down 3% at constant currency. For the full year operating expenses were down 2% as reported and down 3% at constant currency. The software market remains highly competitive. And our fourth quarter results for mix by geography: We saw double digit growth in the Americas where we believe we gained market share in both the fourth quarter and full year. This is partially offset by weaker results in Europe. The WebSphere family of software grew 4% as reported and 7% at constant currency. For the full year, WebSphere grew 10% both as reported and at constant currency. The WebSphere family of software provides the foundation technologies for customers implementing business processes and application and its services oriented architecture. As the customers interest in SOA has increased so has the demand for highly scalable robust infrastructure platforms, such as WebSphere.

In 2005 we saw particular strength in WebSphere application service and portal which grew 15% and 12% respectively. The WebSphere application service did particularly well in the fourth quarter growing 16%. In October we completed the acquisition of data power technology, which combines hardware and software technology in an appliance that helps simplify accelerate and increase the security of SOA deployments. Information management software grew 4% year-to-year as reported and 8% at constant currency. For the year information management grew 8%. In 2005 we saw growth in our information management distributed software, fuel by our content management and information integration product steps.

Ascential continues to exceed our expectation. Lotus revenue grew 2% year-to-year as reported and 7% at constant currency for the fourth quarter, completing a good year of 10% growth. Lotus continues to enjoy strong customer response for the Domino version 7.0 product line, as well as very high interest in workplace software. Workplace more than doubled both year-over-year and sequentially. Rational Software declined 2% as reported and grew 2% at constant currency in the fourth quarter. For the full year, Rational grew 4%. In the fourth quarter the Rational products that had good performance in both Asia and Europe, in the America a small number of customers delayed their buying decisions.

Tivoli grew 3% as reported and 7% at constant currency in the quarter. Full year growth was at 11%. Tivoli storage software products grew 17% of the quarter and 24% for the year as customer adoption of our virtualization technologies continue to gain traction. And the fourth quarter we announced our intention to acquire Micromuse. This software helps the customers manage the complex IT networks that support data, voice and video traffic. Micromuse is well positioned to participate in the growing demand for a variety of voice, audio and video services delivered over the Internet.

Overall our software businesses were solid in 2005. We believe we gain share in all 5 key middleware brands in the 2005 and held share in total middleware. The profitability of our software portfolio, improved as well, with pre-tax income margin growing by 3 points in 2005. Now I will wrap up chart 14.

We accomplished a lot in 2005, with solid growth and earnings in cash generation balanced across our portfolio. IBM delivered earnings per share growth of 12% as reported, 18% without non-recurring item and 21% without the non-recurring item and our divested PC business. This profit performance is driven by a combination of unit performance, portfolio actions and execution of our productivity initiatives. This year we have taken a number of very important action. To improve productivity and reallocate resources to the faster growing areas of the business. We completed the sale of our PC business to Anova.

The transition was smooth and to our relationship with Anova we are better positioned in China’s fast growing market. We continue to invest in acquisitions to strengthen our on demand capability. In 2005 we completed 16 acquisitions primarily in software and services at an aggregate cost of $2 billion. We further extended our commitment innovation and open standards. We successfully implemented a large restructuring action to improve that competitiveness of our cost structure. We changed our operating model in Europe, driving resources and decision making closer to the customer to improve speed and responsiveness. We redesigned our US pension plan and we are taking actions in other countries as well.

Over the longer term, these changes will result in less for utility and a more comparative cost structure. These actions contributed to our strong earnings in cash performance in 2005. And strengthen our capabilities as a globally integrated company. Now let’s move to chart 15.

Before wrapping up, I would like to spend a minute discussing the structure of our business. Often time to think about IBM only in terms of revenue mix. I would like to instead focus this discussion on profit mix, which is a source of our strong cash flow. We would do this in a very straight-forward way by discussing the profit generation of our software business, our hardware business and our services business. Based on 2005 segment pre-tax profit, excluding second quarter restructuring charges in PCs, approximately 37% of our 2005 total segments profit was generated from software. Another 28% from hardware and financing and 35% from services. Strategically, we have exceeded low margin commoditized businesses and created a more balanced portfolio. We integrated package across our segment to create solution offerings for global customer base driving profit in cash over the long term. We can look at this past quarter as an example, we’ve showed strong hardware growth of 9% at constant currency with particular strength in storage, microelectronics, zSeries and pSeries Servers.

Software revenue grew 3% at constant currency. Our key middleware brands now over 50% of our total software revenue grew 7%, while our operating systems and other middleware operating give a solid profit in cash generation, and in services revenue decline 1% despite the varying revenue dynamics some hardware, software and services each segment contributed solid profit growth.

Now let me digress for a moment on the contribution of long term signing to our near term profit, large long term deals are good for the business to be sure, but the yield to revenue from long term signing within a given year is typically only 8% to 10% of the total long term signing demand. This means that the contribution from $1 billion of long term signing within the year at average gross margins. Well at most provide IBM with $28 to $ 30 million as a profit in the year, a small amount as compared to 2006 pre-tax earnings base of roughly $12 billion. These signings provide more significant benefits to revenue and profit over the longer term. The strength of the IBM business model is not in any single component it is in our ability to generate consistently strong cash and earnings with balance contribution across our broad portfolio of the industry leading business segments.

So what this is all mean for 2006, we are position to continued to drive margin improvements with more competitive cost structure across the portfolio about 2/3rd of our profits will come from hardware and software with continuing growth from our strong product line. We expect to grow service signing in first quarter by improving execution on short term signings and driving closure on key long term deals, which will help provide a stable base business for years to come. And as always we have headwinds to work driven 2006 such as continued year-to-year increase in pension cost and the impact of our business from the strengthening as a dollar.

Turning to the average of the analyst earnings per share estimates for 2006, based on what we known now and the study economic environment it would be reasonable to roll through the fourth quarter operational over achievement excluding the real estate over achievement and as always we remain committed to deliver double digit earnings per share growth over the long term.

During the intergraded portfolio of hardware, software and services. Now Participants I would take your questions.

Patricia Murphy, VP of IR

Thanks Mark before we begin the Q&A let me comment on two items. First is always we have a few supplemental charge of the backend of the deck, but complement marks prepared remarks. Second as always please reframe from multi part question which will allow us to take questions from our callers. Okay operator lets open it up for questions.

Questions and Answer


Operator Instructions. Our first question is from Tony Sacconaghi, with Sanford Bernstein you may begin sir.

Q - Tony Sacconaghi

Yes thank you, sorry I can resist but I did have a clarification in the question. You had mentioned Mark to roll through the over achievement just to be specific on that you beat consensus estimates by $0.17 this quarter your over achievement from extra real estate was about $0.4.5 to $0.5 so you are suggesting that consensus analyst estimate should go up by 12% such as one as to clarify that. And then second for 2006 and then secondly I wanted to just give us a sense of your productivity initiatives when you talked about last year you are expecting a yield on your workforce reduction of 3 million to 500 million in second half of 2005 and the yield of 2 to 3 expect in 2006. Is that still in line with your expectations or did you actually get a bit more than you thought in the second half and how should you will be thinking about 2006 thank you.

A - Mark Loughridge

Yes Tony, for your first question you are quite current we would view the operational over achievement in the fourth quarter at that $0.12 range in excluding the $0.5 the real estate that we have achieved. And your second question we got about what we have thought in 2005 at 500 million, and that was spilled about 200 million in the third and 300 million in the fourth. So if you look for 2006 consistent with what we said earlier we think the cost expense saving for the restructure remains at 1.3 billion or 800 million year-to-year. Now I would keep in mind that these actions are designs to drive more competitive business especially in services, and over the longer term these action give us a more competitive cost structure more pricing flexibility and allows the better manage excluding labor cost.

Patricia Murphy, VP of IR

Thanks Tony lets go to the next question please.


Next question is from Bill Shope, with JP Morgan you may begin.

Q - Bill Shope

Okay great thanks looking at microelectronics business when you combine with strength and the 300 millimeter business with the declines in the legacy business, can you give us read on what the overall margin impacts from the business for data, quantitative or qualitative, given that 200 million to decline, could you just see a benefits on our rigorous margin.

A - Mark Loughridge

Yeah let me first startup let say we are pretty pleased with the growth that we saw in our 300 millimeter, and we are very pleased as we move into 2006 with that momentum. We did have a very good quarter microelectronics and we have made a lot of progress, the primary focus from investment side our mind is in technology in the 300 millimeter fab is to drive leadership in our systems business. So the game chips that’s drove volume buying this quarter benefit from the same technology in fact the quarter the IBM system but what I would like as also remember that the power base unique serves have been gaining shares since IBM, that were introduced the technology years ago and POWER5 has also had a strong impact on high in storage, we had 46% growth in the quarter and now we are starting introduce our POWER5+ into our service line. So I would say yes and its okay as you look at it to look at those trends in expect those continued that kind of momentum as we go into ’06.

Patricia Murphy, VP of IR

Okay thanks, so let’s go to the next question please.


Yes our next question is from Lora Canablerio (ph) with Goldman Fax, you may begin.

Q - Lora Canablerio

Yes on the services side. If you, others have suggested that outsourcing growth is going to be slower in ’06 which could be your obviously real problems in outsourcing to about 70% your bookings also its pretty well in the side you got more than the normal amount of business offering new in ‘06, so with that opens up the possibilities even more unpredictability and of course signings have been pretty erotic based on what you expected this quarter and what didn’t happen, so how can you be confident under the circumstances that you will be able to pull through the kind of services growth that you are anticipating, what for example can you tell us about on specific pipelines or having been down selected or anything that gives us more specifiticity so that it adds your confidence level?

A - Mark Loughridge

Well first of all I will let start very good question, lets start with from our demand prospective as we look at SOA the out sort of market in huge and there is a plenty of opportunity out there we frankly like the way we are positioned, we are the market share leader which will we believe we will maintain and on longer term signings for the year of which SOA is the major component I mean, the longer term contempt was up 19% for 2005, now those are just by nature the signing is going to be a lumpier in nature but as we look at both our pipeline and the deal less for our long term signing is going into the first quarter, we are quite optimistic. So I think we actually tough you are correct at the long term signings are lumpier in nature if you look at the full year performance in long term I actually think its pretty good and we are quite confident on a long term basis as we enter the first quarter.

Patricia Murphy, VP of IR

Thanks Lora lets go to the next question please


Next question from Steven Fortuna with Prudential Equity Group, you may began.

Q - Steven Fortuna

Yes there is one question Mark group xSeries basically flat year-over-year, how much of that is increased competition from herewith ,are they are much more formidable portion in the market place over the past say three months, six months versus the year ago.

A - Mark Loughridge

Well let’s say let’s look at this way as we first of all we posted at our higher volumes in xSeries history and our growing double digit of 13%, so we gain volumes share for the third consecutive quarter however our revenue per unit has declined year-over-year resulting 4% growth of constant currency. So if you look at the reason behind it I put it in three category, number one we've grown our volumes 31% in high in space driven by very solid full way rack performance and we gain share in the four way space so we seen our revenue per unit row driven by competitive price pressures. Number two, we have experience competitive price pressures in Asia, Pacific and Europe particularly in our main stream one and two way products which still represent large part of the market in these regions of the world and last I told that we have also faced some operation execution issue as we transition some models when the call demand on some of our products in the fourth quarter and we are not able to still supply to satisfy this damdnd but I go back to the top number one volume did improve, we did have price pressure and we are very confidence momentum in our place.

Patricia Murphy, VP of IR

Thanks Steve let’s go to the next question please


Next question is from Richard Gardner with Citigroup, you may begin sir

Q - Richard Gardner

Okay thank you, Mark a simple question. Q4 was the first quarter in five and what’s your experience significantly comparative backlog in services its look like it was about $1.5 billion. Could you just talk about what was the cost of that and may be expectations for backlog we gets on go forward basis here as we go into 2006? Thank you

A - Mark Loughridge

Yeah, that’s a good question. First of all as I look at the erosion in the fourth quarter was higher than previous quarter but for the full year erosion was down really quiet significantly and if you looking at the level of erosion in 2005 was frankly down 40% from 2004 and even if you exclude JPMC from 2004 erosion in 2005 was still down nearly 20% and in fact the erosion at 2005 was the lowest level we’ve had in four years. So I don’t think for data really suggest as a problem in erosion although erosion in a way like long term signings can be lumpier as distributed to your quarterly performance, so I would look at longer term trends.

Patricia Murphy, VP of IR

Thanks let’s go to the next question please


Our next question is from Ben Reitzes with UBS. You may begin.

Q - Ben Reitzes

Yeah Good afternoon, could you talk about the Mainframe and perhaps pSeries, you talked about the zSeries, I believe 5% growth, can you just talk about this new cycle what’s different should we expect an acceleration throughout the year and then also with pSeries with a slower growth in other quarters may be you for shadowing your some new product cycle. Can you talk about those two big areas in hardware and how will you look at those in ’06 thanks

A - Mark Loughridge

You Ben, we do as you look the zSeries cycle its you can’t really project with any level of position but I will say that we expect to see continued growth to the first half of 2006 continue in the momentum that we’ve seen in the fourth quarter, we do expect to see moderate in the growth in the second half of ’06 as we begin to wrap around our initial z9 shipments towards the end of year. If you look at your second question pSeries, pSeries grew 15% for the full year which I think demonstrates our technology leadership in the UNIX market. We’ve grown market share consistently for four years in this brand, the higher growth rates early in the year was still by a fully refreshed POWER5 product versus the POWER4 in prior year and I think fourth quarter conference tends to growth of 8% is roughly in line with our future expectation which is to grow above the units market share in the continued gain share. To resourcing our growth both on competitive displacements and from expanding work load with our existing customers.

Patricia Murphy, VP of IR

Thanks Ben, lets go to the next question please.


The next question is from Shilly Shaw with Morn Cadet (ph)

Q - Shilly Shaw

Thanks I wanted to ask you about offshore, what I am hearing from the industry contacts with IBM is now fully price competent and capable against the offshore prepaid in my question is, are we going to see IBM turn around to take to offensive offshore now and how my fully price competitive capability affect in a contract renewals that might be coming up?

A - Mark Loughridge

We were continually adjusting our resources investment in response to the market place and I would step back and say we think we have a very competitive position with the global solution capabilities we developed and continued to increase the volume work with our clients so we have grown resources in our global delivery centers is over 15,000 this year alone but I want to re-emphasize that this is not a labor arbitraries elements of the strategy its really developing extensive capability in both application services SO, BTO services delivery and technical support so it’s a broad skill based a good distribution on a global basis and I think it puts us in good shape as we enter 2006.

Patricia Murphy, VP of IR

Thanks Cindy let go to the next question please.


The next question is from Chris Wetmorn with Douche Bank, you may began

Q - Chris Wetmorn

Thanks just following up on that last question how does IBM and how is IBM currently viewing the trade of between pricing and taking prices lower in services and profitability in that segment as some of these re-structuring benefits come through and intend to that what percentage of the incremental cost savings does the IBM expect as fall of the bottom line in ’06

A - Mark Loughridge

Well you known its very difficult to tell the percentage of those cost savings that fall the bottom line and if you look at it as I said earlier on the Tony's question we did achieve our cost savings objective this year on both the third and fourth quarter and aggregate that was 500 million and we look for another 800 million year-to-year but I said from a price stand point and services, price pressures were really increase stable on the quarter but it is of course a very competitive segment in both SO and ITS prices pressures remain fairly constant that the world wide level. Well in CNSI pricing trend to pretty stable or if anything improving a bit.

Patricia Murphy, VP of IR

Thanks Chris lets go to the next question please


Thank you our next question is from Rebecca Ronko you may begin

Q - Rebecca

Hi great just a follow on to that market as well as relates to hardware you commented a couple of times in your prepared marks about increasing pressures on servers and storage competitive place begin Does what we haven’t see it take some of the re-structuring down into the pricing side of the pressures when you got to drop to the bottom line but why, when do we see you get more aggressive and hardware given the competitive dynamics if on the first quarter

A - Mark Loughridge

Well let me describe the hardware dynamics first of all were as you would expect quite pleased with our hardware revenue growth in the quarter I would argue that were obviously priced pretty effectively has it is but I’ll give you some flavor underneath that into these serious we see a continuation of the trend of moderate price declines as we move more new work load under the platform and units we didn’t experienced some more aggressive price competition at the low end of the product line but really more stable at the high end In xSeries I would say that were fine in both AP and mere to be particularly competitive environments right now so very focused on achieving cost reduction to maintain margins here and in storage price pressures pretty high most notably in the mid range basis and also in Europe and Japan

Patricia Murphy, VP of IR

Okay, lets go to the next question please


Next question is from David Grossman with Clements Partners you may begin

Q - David Grossman

Thank you, Mark could you put up somewhat in little more details on the actions that you intend to take care to accelerate the gross in your short-term services business and also if you could just clarify your comment of your growth was that in a single digits for the year or was that in a single digit for the second half of the year in ’06

A - Mark Loughridge

My comments are really for the second half, at an ’06, accelerating up to the our first half of that objective, but as far as the actions were taking if you look at it first of all, on an ITS basis we’ve think that there is more work under way to drive more focused place I would say on higher growth areas, the initial portfolio balancing work is complete for focus on a high growth area such as security, infrastructure management, ITS optimization, and adding business development skills and sales coverage that aligned to advice portfolio. These changes we believe we will be operational and in the first quarter so we expect the traction as we enter ’06, if you look at the BCS some of the actions were taking including, first of all increasing the level of dedicated sales resource to drive solutions such as business at web services and SOA on investing in resources to address mid market opportunities, increasing the level of the brand resources and Asia Pacific, and leveraging our global and divine build and run capability, so very strong action across both the BCS and ITS portfolio, that we believe we will pay off and improve performance in that signing base as we enter ’06.

Patricia Murphy, VP of IR

Thanks David, operator lets take one more question please.


Our next question is from, Richard Farmer (ph) with Merry Lynch, you may begin

Q - Richard Farmer

Thank you, Mark now that the PC investor is well behind the company, I wonder if you capturing the expected none of the services business on the PC’s that when all goes selling, and I guess more generally, are the dynamic side you are seeing in the customer accounts but previously, had a PC component for them, how are those turning out of those more or less favorable without that element of your portfolio?

A - Mark Loughridge

I think first of all the transaction as we’ve completed it with a Anova has gone very, very well, I mean the level of partnership between the two organization is quite impressive. And we had very little problems as we ran to that transition so really the business plans following that both our elements that we would provide, fully Anova and the level of teamwork and integration, I think its going quite well.

Patricia Murphy, VP of IR

Thanks Richard, I want to thank you of joining us tonight, have a great night.


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