International Business Machines Corp (IBM) 2001 Q1 法說會逐字稿

1 IBM INC. CONFERENCE CALL

Good afternoon ladies and gentlemen and welcome to your IBM's first quarter earnings release. At this time, all participants have been placed on a listen-only mode and the floor will be open for questions and comments following the presentation. If you do have a question or a comment at any point throughout the presentation, please press 1 followed by 4 on your touch-tone telephone. At this time, it is my pleasure to turn the floor over to your host Mr. Hervey Parke, Vice President of Investor Relations for IBM. Sir, the floor is yours.

Thank you Mandy. Good afternoon. This is Hervey Parke. Thank you all for joining us today. Let me quickly give you a few pieces of information. First, at this time, the opening pages of presentation should have automatically loaded and you should be on Chart 1, the title page. After the last chart in the presentation, we will provide you an index to go back to the specific slides during the Q&A. Alternatively, you can jump to the index at anytime by clicking on the index link on the left 2 side of your screen. For printing the slide you still have 2 alternatives, on the index page there is a link so you can download the entire set of charts for printing or you can print the charts one by one during the presentation to take notes on them. While all of the charts will be available at the beginning of the presentation, printing them all they tie up your browser, so you may want to wait until the end of the presentation. A replay of this webcast will be available on this website by this time tomorrow, and we will make the text of our presentation available on this website in approximately 45 minutes. Second point, let me make sure you saw a note in the press release, starting with this first quarter, our results reflect 2 changes the company made in the organization of our business segments. The Intel-based xSeries servers were transferred from the Personal Systems Group to the Server Division of the Enterprise Systems Group. The Printing Systems Division was transferred from the Technology Group to the newly formed Personal and Printing Systems Group consisting of the realigned Personal Computer Division, Retail Store Solutions Division, and the Printing Systems Division. First quarter 3 2000 results have been reclassified to conform to the 2001 presentation. This affects the attached segment data. This does not affect the financial results statement

as this is all contained within hardware. Now please click on the next button and move to Chart 2. Certain comments made by John Joyce or myself during this call 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 website or from us in Industrial Relations. Now please click again on the next button for Chart 3, and at this time let me turn the call over to John Joyce, IBM's Senior Vice President and Chief Financial Officer.

Thanks Hervey. Good afternoon. We are pleased with our first quarter results. With $21 billion in revenues which is double-digit growth of 14% at constant currency and earnings per share of 98 cents, also double-digit growth of 18% over last year. Last 4 quarter, we said we were entering the year with some momentum. Our strategies were continuing to take hold, and the market place was moving in our direction, a direction that increasingly values solutions over point products. We saw increasing demand for our products and services driven by our growing technology leadership in both hardware and software and our team was executing well. All of those factors remain true in the first quarter. Our results also reflected several other factors that continue to differentiate IBM from our competitors, particularly our diversified worldwide portfolio of businesses and our strategic focus in key growth areas such as Services, Middleware, and Technology. We told you in January that we expected continued strength in these higher growth areas, and we executed well. At that time, we also recognized that we would feel demand and price pressures in PCs and hard disk drives. Our expectations here were right on track as well. In addition, we continued to make progress in the first quarter in key competitive areas such as Servers and Storage Subsystems.

We will talk in more detail about each of these areas later in the presentation. Before we get to that, however, let me answer the next 5 question on your mind; have we changed our expectations for 2001? We recognized that the US market remains volatile and uncertain, and it is likely that other regions of this global market are feeling some of the same pressures. We are certainly not immune to a major worldwide economic downturn. However, there are unique factors that set us apart from many other companies in the IT market place, and we have not changed our opinion of full-year 2001. So let me repeat what I said in January, based on our results and everything we know today about the coming year, we remain on track for your consensus earnings per share estimate for 2001 which is consistent with our longer-term business model. Now lets get into the details of the first quarter Chart 4. Here's a financial overview of the first quarter. Revenue at $21 billion was up 9% as reported. Currency's impact was five points, so revenue at constant currency grew 14%. I have another chart on currency later that may be helpful to you in considering its effect on the rest of 2001. Pretax income was up 15%, and once again we saw improving profitability both our gross profit margin and our total expense-to-revenue improved 6 three-tenths of a point over last year, as we continued to benefit

from our own investments in e-business to improve our productivity. The tax rate was 29.7 down three-tenths of a point from a year ago, but up two-tenths from the fourth quarter. Average diluted shares outstanding for the quarter were $1 billion $781 million down 2.7%, reflecting our stock buy back program, and earnings per share were 98 cents up 18%. Now, let's turn to revenue in the first quarter starting with the geographic perspective. Click the next button for Chart 5. Asia Pacific once again was the strongest region in the first quarter with 18% growth in constant currency. Our results in Japan continue to underscore the point that IT spending and most notably services can be a priority in a weak economy. Europe grew 11% in constant currency with the possible exception of Germany with the biggest issue is in the telecom sector, we are not seeing a slowdown in demand for e-business applications, and the Americas has picked up another 3 points of growth over the fourth quarter despite the tough economic environment and associated competitive pricing. Our OEM business grew 49% driven by our strong demand for our microelectronics. As I indicated last 7 quarter, this chart represents 2 important attributes of our portfolio, particularly in times like these, geographic diversity and a strong OEM technology business.

Now, if you'll click on the next button for Chart 6, I'll touch on currency. This chart shows our average exchange rate as well as a year-to-year comparison for the dollar against 3 currencies for the first quarter. A negative comparison indicates that the real growth in local currency revenue was hurt by the translation to dollars. In the quarter, each of these 3 currencies was weaker against the dollar on a year-to-year basis. So currency's impact was 5 points on reported growth, a point worse than spot rate indicated 3 months ago, and based on current spot rates, the negative effect of currency on revenue for the rest of the year has increased since January. As in prior quarters, we have provided current spot exchange rates as a way of gauging possible future impact from currency. This is by no means a prediction of what will happen? It simply shows the year-to-year effect if the dollar remained at current levels. For example: Back in January, the spot rates indicated that the impact of 8 currency on our reported revenue growth in this coming second quarter would be 2 points, at current rates it would be 4 to 5 points, it would be about the same difference for the third and fourth quarters. While only a couple of sell-side analysts have recently changed their models to reflect this trend, we do expect others will also address this as they adjust their models over the next few days.

Occasionally, an analyst will ask why we focus on revenue growth at constant currency? Let me give you 3 answers: First, if you are trying to get a feel for the real rate and pace of business on a worldwide basis, you need to take currency out of the equation, since companies have different mixes of geographic contribution. Second, and more importantly, revenue growth at constant currency has a closer relationship to the earnings growth since we typically hedge much of the effect of currency, and third, exchange rates, at any point in time have little or nothing to do with your success in a particular market. Now let's look at revenue by major line item Chart 7: First hardware, revenue was $8.5 billion in the first quarter growing 15% at constant currency. Global services, 40% of IBM's revenue in the first 9 quarter were $8.5 billion and grew 18% at constant currency. Services without maintenance was up 21%, software was $2.9 billion growing 5% at constant currency, WebSphere and Database on distributed platforms continued to have very strong growth. Global Financing Revenue also grew 5% at constant currency and was over $800 million. Income generating assets were up 7% over last year and financing originations were $9.6 billion in the quarter. Now lets review gross profit margin Chart 8:

Total gross profit margin for the first quarter was 36.1% up three-tenths of a point from last year. Hardware gross profit margin improved 2.8 points with improvement in all segments. Global services gross profit margin declined four-tenths of a point. Two factors were faster growth of services over maintenance and rebalancing to meet the demand for new e-business skills, software gross profit was up two-tenths of a point over last year, and our Global Financing gross profit margin improved 3.8 points principally due to better margins on our hardware remarketing. So, overall, a good showing for gross profit margin. Now, let's turn to expense, Chart 9: Total expense was $5.1 billion in the 10 first quarter, an increase of 7% from last year. Total expense-to-revenue improved by three-tenths of a point, but underneath this, was some very important dynamics. We continue to make excellent progress in our operating expenses where expense-to-revenue improved by a point and a half driven by our continued focus on productivity. SG&A expense-to-revenue improved 1.1 points. R&D improved four-tenths of a point; however, while interest expense was flat, other income was down over $200 million from last year.

The major factor was $116 million write-down of certain equity investments for other-than-temporary market declines, which we have absorbed in our reported results not in pro forma results as many others do. By the way, on that point, the negative effect of FAS 133, were also included in our results, although for IBM this was only $6 million. Now let's move to Chart 10: Free cash flow in the first quarter was negative $1.6 billion, the same as last year. As this chart indicates, the first quarter is historically, the weakest quarter for cash flow, a key difference from last year was an increase in capital expenditures, principally driven by the investment in microelectronics capacity that we initiated last fall. This was offset by 11 improvements in working capital. Trade receivables improved as we focused on both credit and collections and our day sales outstanding were flat year-to-year. Inventory was flat as turnover increased. Like many of our customers, we continue to invest in applications to further improve our inventory performance. We can now link 25,000 suppliers to our 25 worldwide manufacturing facilities over the Internet. I want to stress that accounts receivable and inventory are key focus items. This is not the economic environment to have growing inventories and accounts receivable problems.

Also in the first quarter, we spent $1.3 billion to repurchase about 13 million shares, this leave us with $1.4 billion in our last Board authorization, at the end of the quarter. While capital expenditures will increase this year, share repurchase remains an important part of our financial model, as does maintaining a strong balance sheet. Let's look at that next Chart 11: The balance sheet remains very healthy, our $27.1 billion of global financing debt which was 94% of IBM's debt was leveraged at a comfortable 6.8 to 1. Our $1.8 billion in core debt stands at 9% debt-to-capital, lower than last year's 12 13%. The cash on the balance sheet is $3.9 billion, an increase of $300 million over the first quarter of 2000. Now let's turn to a discussion of some of the individual businesses, starting with Global Services. Chart 12: This was another strong quarter for Global Services, with revenue was up 18% at constant currency. Services were grew 21% and maintenance was up 2. Double-digit growth across each of our services segments was again fueled by e-business and we continue to grow profits along with our revenue, aggressively pursuing new contracts, but unlike some of our competitors not at the expense of the bottom line or the balance sheet. We continue to walk away from bad deals.

Ten billion dollars of signings, further added to our backlog which now stands at $87 billion. A few comments on our signings; this was the largest first quarter for signings in our history, including 8 deals over $100 million, plus one over 1 billion, and we have yet to include huge NTT agreement since this complex contract is still being finalized. We have also had many competitive wins like the Bank of Nova Scotia and De Post, the Belgian Postal Service, and our pipeline remains strong. Now, let me address the three major segments of our services 13 offerings. First, Outsourcing and eSourcing which is about 40% of Global Services, grew 16% at constant currency. The Asia Pacific region once again led the way with strong growth in Outsourcing and four new mega-deals. In Web-hosting, our worldwide signings were up 160%. Next, is business innovation services, which is about a quarter of global services revenue, with growth of 26%, we have successfully made the transition from custom integration and Y2K remediation to our e-business offerings. We had good growth in supply chain management as well as the complex integration of our customers various e-business applications. This is the heavy lifting that IBM is best able to do. Next, Integrated Technology Services, which includes product support services and maintenance, is about a third of global services. Demand for our expertise in infrastructure services and enablement continue this quarter. ITS - excluding maintenance grew 29%. As I discussed in January, services will continue to drive IBM's growth.

Some analysts hold a view that IBM's revenue and profit are still driven by the mainframes. The mainframes drag along large 14 amounts of services, software, financing storage, and all sorts of things. Some others pay a lot of attention to our PC business. Let's look at the first quarter - in constant currency IBM's total revenue grew $2.6 billion a pretty impressive number all by itself. What's important is where that growth came from; $1.3 billion or half of that growth came from services, which is driven by customer's investments in new business solutions not hardware sales. Over $700 million of the growth came from microelectronics. Again, this is not driven by IBM products, but by other company's products. Software drove about $125 million of our growth. Half of this is software or mainframes. But since that revenue flows from a monthly license charge from the entire installed base of mainframes, the current quarter shipments have little to do with current revenue. This is more, annuity-like. These three; Services, Middleware, and Technology account for approximately 80% of our growth in the first quarter. Hardware is still very important to our growth. We got nearly $200 million from our pSeries or Unix Servers as we continue to gain share. Another 200 million from PCs.

Over 150 million from our storage 15 subsystems hardware, driven by Shark's new competitiveness. Almost 100 million from our xSeries, our PC-based server. And yes, approximately $125 million or about 5% of our growth came from our mainframes. Our growth is not driven by PCs or mainframes. We are a services-led company. What we really do is, integrate all of these complex technologies and protocols from hundreds of vendors and let our customers focus their core strength. Together, we solve their business problems and help them become more competitive and more profitable in their own markets. What has sustained IBM's services growth, when other services companies have fallen away, is the unique combination of deep business knowledge and broad IT skills. This is what enables us to do the heavy lifting to build and integrate these new business solutions. And so, we continue to invest in e-business skills for services. Last year, IBM Global Services hired more than 19,000 employees, and we will grow our headcount again this year. I would remind you that we will grow net headcount, net of attrition, and net of normal rebalancing of our workforce that goes on every year within all of our business units. Click on 16 the next button for Chart 13, and I will discuss software. Our software revenue at $2.9 billion grew 5% in constant currency.

Operating system revenues, which make up about 20% of total software, grew 2%. Middleware, which represents about 80% of our total software revenue, grew 6%. On distributed platforms, Unix and PC our middleware products continue to grow faster than the industry. MQ series grew 48%. Our DB2 database software grew 36% and WebSphere continue to gain momentum in the marketplace with another strong quarter of 53% growth. By the way, on the mainframe, where we have a substantial database software business, we've got an additional boost from our new database management tools introduced last fall. Two segments of our Middleware business Tivoli and Lotus continued portfolio transitions. Tivoli continued to expand its leadership in enterprise systems management with new offerings and storage management, security, and management of web solutions. For example, storage management software had another strong quarter with 67% growth on distributed platforms, and although total revenue fertility declined in the first quarter, their profitability improved. So, as I said in January, this transition will last 17 until the second half of the year. Lotus is going through a similar transition with the focus on profit and new growth areas like knowledge management where we were up 14% in the first quarter. One final point on software, we signed five new ISV alliances this quarter with companies like Lawson Software, Trilogy, and JD Edwards, who have committed to lead with IBM middleware, eServers, and services as we work with them to help our customers build applications.

This brings our total for these partnerships to 55. Now, click on the next button for Chart 14, Technology. Our microelectronics business grew triple digits. This outstanding performance was fuelled by our advanced technologies being utilized in three fast-growing industry segments, networking, pervasive, and enterprise IT. Also, we announced a key technology partnership with Toshiba and Sony to address the market segment, we believe has the potential for strong future growth. We remain significantly ahead in multiple technologies, one or two years in some cases. Even products that many now take for granted, like copper, are only produced in high yields by 18 IBM. Our unique technologies represent a relatively small, but fast growing percentage of our customers total semiconductor requirements. This allowed us to maintain momentum during a period when the industry slowed. We recognized that this industry is under pressure, and we do not expect to maintain triple-digit growth, but we have the fastest, most advanced technology available. So, we should continue to gain share and remain the industry's #1 ASIC supplier. Speaking of supply, this growth reflects the strong progress we have made bringing supply online, both internal and outsourced. I feel comfortable that we are well positioned and balanced in this volatile industry.

We are particularly proud of our Microelectronics Division's results. A business that came forward with a strategy, and executed against it, but they did not do it alone. These results are just one example of how we leverage our patent-leading research division to bring advanced technologies to market. Now, let me address OEM storage. While we haven't made as much progress as we wanted, HDDs did growth 12% year-to-year; our second consecutive quarter of growth during a period when the PC industry was under extreme pressure. Our volumes were up 39%. 19 We maintained our position as leading producer of mobile drives, and last month we extended our product leadership, announcing the fastest, largest, and quietest mobile drives available. Server revenue grew 42%, driven by our ten-thousand RPM discovery drive, and by the way, revenue for the IBM Microdrive more than doubled. Nevertheless, this remains the troubled segment of the industry. Now, let's turn to eServers and Storage, Chart 15. IBM's eServers followed their terrific fourth quarter performance, with yet another strong quarter. pSeries, our high performance Unix platform, and our largest performance server platform, grew 33%, gaining share in a very competitive environment. Our leadership technology utilizing copper and Silicon on Insulator is being delivered today, and Power 4 is up and running with customer delivery later this year.

Yesterday, we announced our new p620 and p660, midrange server offering extending our technology leadership to 6-way enterprise servers. We also announced AIX-5L, giving our customers the option to run their Linux applications under the award-winning AIX operating system. The build out of our 20 customers' e-infrastructure continues. The requirement to support end-to-end mission critical transactions plays to our strength. IBM eServers were designed to support these processing intensive, 24-by-7 applications that our customers increasingly rely on. In today's environment, with customers focusing on cost, our investment in delivering performance, affordability and reliability are starting to pay dividends. MIDS grew 40% this quarter, compared to a year ago, reflecting the continued strong demand for mainframes. Only a small portion of what we shipped is for replacement of older machines at this point. Customers are increasing capacity for web enablement as they extend the reach of existing applications over the net. Customers are also consolidating Unix Servers on the z900. We continue to see strong interest in Linux on the z900, especially, in the communications sector. Also, we started shipping our new operating system for the z900 at the end of March. z/OS is designed to meet the need of e-business application, and includes the intelligence resource director, which dynamically shifts processing power to applications as transactions rise and fall.

Dynamic scalability. Our xSeries Servers 21 grew 14%. Despite fierce pricing pressure, our customers recognized the value of our eServer brand. From PC servers to mainframes, our customers rely on our unique ability to support their various environments. Completing the eServer brand is the iSeries, integrated server platform. Following a strong fourth quarter, during which the iSeries grew 15%, we encountered a downturn as our customers anticipated the new offerings, which will be announced next week. The availability of the Linux on the iSeries; we do expect results to improve. As with our eServers, we had strong competitive performance in storage. Disk subsystem revenue grew 60%, driven by Shark growing 82%. There are now over 7000 terabytes of Shark storage installed, and many of our customers have installed the advanced functions we announced last December. The investment I told you we were making in our Storage sales force is paying off. We have penetrated nearly two thirds of the Fortune-100 companies, and we continue to focus aggressively on our competitors' accounts. Now, let me turn to Personal Systems, Chart 16. Strong ThinkPad and NetVista shipments helped drive our PPSG segment to 7% growth year-to-year. We continued 22 to do well in the selected segments we focused on.

The first quarter is typically light for us in PC's, making fixed cost absorption more challenging during this period. Due to this, and severe price pressure we did lose money in this segment, but we materially improved over last year's performance. We continued to focus on the end-to-end cost initiatives we've discussed before. The percentage of revenue, driven by our direct business is at 33%, up over 60% from a year ago. Despite the industry slowdown, we have reduced channel inventories by nearly one week. If not for this, our revenue growth would have been even higher. Finally, plant inventory has been reduced by 17% from our year-end position. We believe, we have identified, and are executing the right plans to drive continued improvement in this business. Now, if you'll hit the next button, let me summarize my remarks. As I said at the beginning of this presentation, we are pleased with our first quarter results. As we did in the fourth quarter, we generated double-digit growth in revenue and earnings per share, and we proved that our strategies are working despite a difficult economic environment. This chart shows our revenue growth at constant 23 currency and our growth in earnings per share for the last 9 quarters, as well as the full-year results for 1999 and 2000. If you focus on the quarterly data, you can clearly see the slowdown in our growth rate

as our customers approach Y2K, and then you could see the return to growth, once they shifted their focus and resources back to new e-business applications. If you focus on the annual data, you can see that despite this slowdown we were able to achieve our full-year objective for earnings per share in both 1999 and 2000. Let me make two points: First, our portfolio businesses designed to deliver steady annual results. We have been saying for sometime now that our longer-term financial objectives are to grow revenue in high single digits at constant currency, and to grow earnings per share in low double digits. Over the last 2 years, difficult Y2K affected years, we have achieved an average of 16% earnings per share. During this time, we also generated $14 billion in free cash flow. Let me remind you that we used this cash flow as a driver of earnings per share. By the way, if you go back to 1994, when we began transforming IBM into a Services, Middleware, and Technology 24 Company, on a constant currency basis, our revenues have grown by $32 billion, and we've generated $48 billion in free cash flow. Clearly, our large revenue base with its services, product, and geographic breadth, and our very strong free cash flow have been key to our delivering consistent, double-digit earnings per share growth.

While our results may vary from quarter-to-quarter, on a full-year basis, we've met our EPS objectives by focusing our productivity and by sticking with our strategy. The second point is that while many of our competitors who follow the dotcom mania are now trying to reinvent their strategy and are struggling with earning shortfalls. IBM has emerged from the past 2 years stronger than ever. We've made real progress in our key strategic growth areas of Services, Middleware, and Technology. As I said earlier, these three accounted for approximately 80% of our growth in the first quarter. We're also more competitive in key hardware areas like servers and storage. We have higher levels of productivity as reflected in our gross profit margins and our expense-to-revenue, resulting from our internal investments in e-business, and the IBM team is 25 executing. So now, we are starting to see the benefits. As the U.S. Economy started to cool back in the fourth quarter of last year, and even more so in the first quarter, our growth in revenue and, more importantly, in earnings maintained its pace. 2001 would be a challenging year, and as Lou Gerstner pointed out in our earnings press release, we're no better than other in predicting how the current economic uncertainty will unfold, but we have a strong start. We have our portfolio businesses that is more competitive and that can deliver steady results, and we have a heightened focus on operations, so as I said in my opening remarks,

and as I said back in January, based on our results and everything we know today about the coming year, we remain on track for your consensus earnings per share estimate for 2001 which is consistent with our longer-term business model. Now, Hervey and I will take your questions.

Thank-you. The floor is now open for questions.

If you'll go to the next chart, you will find an index of all our slides 26 that may be helpful during the Q&A. Now, before I turn the call over to the operator to give you polling instructions, let me make my usual request that you refrain from multi-part questions. That gives others some time, and we have a tight schedule as always. Okay Mandy, lets get started.

Thank-you. The floor is now open for questions. If you have a question or a comment, please press the numbers 1 followed by 4 on your touchtone telephone at this time. If at any point your question has been answered, you may remove yourself from the queue by pressing the # key. All questions will be taken in the order they are received, and we request all participants to please pick up their handsets while posing their questions to ensure optimum sound quality. Again that's 1 followed by 4 for questions or comments at this time. Thank-you. Our first question is coming from Laura Conigliaro Goldman Sachs. Please pose your question.

Yes, thank-you. Just really quick and that is the pattern of closing that you saw in individual businesses, especially in various parts of your hardware business, if 27 you could give us some observations on that, and secondly, you obviously feel pretty good about the consensus earnings per share. Apart from currency impact would you make any comments about how you think about the consensus revenue numbers, again apart from currency impact?

Thanks Laura. First on the closing, as we went through the quarter, obviously, we're pleased with our results and we produced $21 billion in revenue, and given the size of that revenue number, obviously, we've been dealing with hundreds of thousands of customers, and some of those customers did delay some decisions but others increased their purchases as they saw this is a time where they can distance themselves from their competitors and gain some competitive advantage. So it really, with the amount of customers and the amount of transactions that we deal with, we see a little of both. On your second question, on the revenue side, I, as you know, our model is high single-digit revenue growth over the long term and double-digit earnings per share growth, and I think from a revenue standpoint that's what I would look for on a constant currency basis, look for going forward. 28

Next question please.

Thank-you. Our next question is coming from Steve [_______________] of DKW. Please pose your question.

Just simple one, relative to your comments about the services offering. I was curious if you could give us any flavor for what percentage, of either the new contracts or the ongoing revenue streams involve IBM hardware and IBM software, in particular, the Middleware?

I'm sorry Steve, do you mean of the services revenue?

In the services revenue what percent of them, particularly new contracts from the last year or so involve IBM hardware and IBM Middleware?

Well.

In other words, you were talking about the drag along factors before. 29

First of all, the revenues in the services line are based on, for outsourcing contracts, include hardware delivery, if you will, to our customers; in other words, we will run our customers Data Center, which includes a hardware portion. But I will remind you that a lot of this hardware, when we take over Data Centers is not only IBM hardware, in Data Centers we have some competitive equipment as well.

I understand that part, John. I was thinking more about your comment about the heavy lifting complex integration, things of that sort, rather than just the straight out sourcing.

Oh, I see. Well, from the services standpoint, in that number there is no hardware, and as I said in my comments, the hardware portion of our business and its relationship to the services portion, there is not a strong linkage between those two. So off the top, I have to go take a look at that on the percentage that's in the services contract, I don't know, I'm looking at Hervey here, as to whether or not he could add anything to that. 30

No I don't think so, Steve. I think that it is more of a solutions plays here, and I think we have to have competitive products, as John said, they're getting more competitive all along, but I think that we're just finding that the customers are more focused, particularly the CEO is on the solution part of it and not too much on the point product aspect of it.

You know Steve; let me try it this way. Customers, when I talk about the heavy lifting, customers are increasingly asking us to give them the solution and whether or not its on Unix, or whether or not its on NT, and by the way, in many cases they need solutions that can operate in an environment that utilizes both NT and Unix and are zServer products, and so customers are saying IBM make all of this work together so that I can take my existing logistics applications or manufacturing applications and put them out on the Internet to get more efficient, and so when I talk about heavy lifting, it's making all of this work together, not only the IBM products, but making competitive products work so that the customers have solutions to make them much more competitive. 31

Okay, thank-you.

Next question please.

Thank-you. Our next question is coming from John Jones at Salomon Smith Barney. Please pose your question.

Thank-you, clarification, and then a question. John, the write-off that you identified near the income line 116 million. Could you expand upon what that was and confirm that, I guess it's about a nickel, a nickel of impact at the bottom line. The question I'd like to ask is regarding Microelectronics, you had a great quarter, but there has been some dramatic changes in a number of the outlooks for your customers in that business. Can you talk about what that business outlook looks like today, and can you talk about whether the margin pressure in your technology business, which shows up in your results is coming from that business or from the HDD business; we can't see under the total technology number that you put out?

Thanks John. First on the 116, equity investments that we have made over 32 the last several years, these are very slow investments, they are not speculative, but what we do is many times when we have a relationship with a smaller company, they will some equity involved. Given what's happened to the equity market for many, many companies where they have had dramatic downfall or declines, we have looked at this equity and determined that this is not a temporary decline and that it was prudent for us to take a $160 million write-off and write those assets down. Your second question on Micro, Micro grew over 100%, it was 117%. Clearly, we are not going to maintain triple-digit growth rates in Microelectronics. However, double-digit growth rates are certainly achievable and that's what I would expect going forward. From a margin standpoint, we see more margin pressure in HDDs, and as I said in my remarks, the 2 areas where we continue to see difficult segments going forward is in PCs and HDDs.

So, the decline in margin sequentially then came from an HDD business even though you saw it growing margin pressures really coming out of that side of the business?

Yes it is. 33

Okay, thank-you. Nice quarter.

Thank you. Next question please.

Thank-you. Our next question is coming from Lynette Donovan of Scudder. Please pose your question.

Hi, this is actually something that John asked, I didn't really hear the answer. With regards to your OEM business, it grew and Microelectronics you noted that networking grew 200% given the concerns in the communications segment right now and Cisco's recent inventory announcements, could you give us a little bit more color on what percentage of your total Microelectronics business is related to companies such as a Cisco? Thanks.

Well let me try it this way Lynette. As we look at the growth rate that we experienced here in the first quarter of plus 100%, we have looked at our customer set in Microelectronics going forward, and we have anticipated what we think those customers would be purchasing from us and that's why I gave the 34 double-digit revenue growth going forward which is what we would expect of Microelectronics over time growth rate out through the rest of the year.

Are you still investing in capacity the $3.5 billion, I think you announced before?

Well, we are doing 2 things. First, we are proceeding with our 300 millimeter investments, but I also have talked about investing in what we call outsourcing of certain manufacturing. We are cutting back a bit on that so that we keep the capacity in our manufacturing locations close to 100%, and so as we look forward there's one other point I would like to make, and that is that as we have the technology that many of these customers are looking for. We have, what nobody else really can manufacture, it's faster, it's cheaper, and they need this technology to improve their hand externally, and we have been designing, these are engineering design wins that we win, and once you win that design win going forward the chances of a change are small, and so looking at the customer set that you referenced looking at the number of design wins that we have achieved that's why I 35 give the guidance of double-digits going forward. Thank-you, next question please.

Thank-you. Our next question is coming from Toni Sacconaghi at Stanford Bernstein. Please pose your question.

Hi, gentlemen, had a very nice quarter. A couple of quick questions, if I may. Just to better understand your status in Microelectronics one more time versus last quarter, you talked about how you were supply constrained during the fourth quarter and first quarter of last year and this year, respectively, can you comment on whether you feel you are fully caught up with a demand for your Microelectronics business, and can you help us understand at what level of order backlog you felt you were going into the first quarter versus where you are going in the second quarter? And, then secondly, to appease the many people who still worry about mainframe MIPS, the 40% growth number was considerably lower than I expected, particularly given the new mainframe cycle and the EC compare versus last year. Did you see any push out of mainframe demand this quarter or as you alluded 36 to in your comments, are you seeing a lower retirement rate which perhaps made that number a little less robust than at least I expected?

Thanks Toni. First, on supply and demand balance in Micro. We, basically ran at about 100% in the first quarter, in the second quarter we will have a little bit more supply than demand, as many of our customers work off their inventories, but we think that that will be back in balance in the third quarter. But I will also mention that more supply comes on in the second quarter on a year-to-year basis. From the mainframe standpoint, as you pointed out, we are seeing less replacements of old MIS. Our MIP growth is becoming more and more related to web-enablement, which is customers taking mainframe applications and wanting to put those applications out on the web. We are seeing a significant interest in our Linux Applications, and last, and I think one of the more important mainframe opportunities is in server consolidation. Customers are increasingly taking Unix Forms if you will, and they are finding that it's cheaper and more reliable to put it on the mainframe. So the combination of those 3 things are basically what drove the 40%, 37 but back to my original point, the replacement products were a lot less than they were last year.

So your belief is that there haven't really been push outs attributable to some of the lower spending, and I guess the implication is will you see any MIPS growth over the next couple of quarters, accordingly?

I think you'll see MIPS growth over the next quarters and one last point, the pricing has eased back a little bit on the mainframe.

Just one observation Toni, obviously as we had a tremendous fourth quarter with the announcement of [Freeway], but I'm sure that your models got that factored in. Thanks Toni. Next question please.

Thank-you. Our next question is coming from Gary Helmig of Wit SoundView. Please pose your question.

Yes, John I have only one question and no clarifications. You have a competitor in Massachusetts in the storage area that had, kind of, a funky quarter and since 38 competition wasn't the issue on their pre-announcement call they said that one of their competitors wasn't big enough to be counted and wouldn't affect them. You talked about how you have 82% revenue growth, could you give us an idea of what the revenue dollars were for Shark?

Okay. Hold on one second.

Gary, its Hervey. As you know, we don't really break out the dollars that way, the only think that I can point to you is that, I think in our opening remarks John made the point that on a constant currency basis, we had a contribution on a constant currency basis in terms of the growth from our storage business is identical to $175 million, so you got something to work with there I think, but it gives you a rough feeling that that's all we are trying to do here.

And the 82% of constant currency, is that as reported?

Yeah that's constant currency, but that's Shark and 60%, Gary, for both Shark and the 7133.

An 82% in [reported] would 39 be something in the order of 70%?

You've got about, in a currency maybe you've got an average of about 5 points.

Okay, so 80 - 70 series has 87%.......

We're pretty proud of some of the wins we had in the quarter. Etna, City of Boston, which is an interesting one, and Fleet Bank. I think we also pointed out, that we now, in terms of the financial 100, we've got about two-thirds of those accounts with Sharks in ..

And as I said in my remarks, Gary, we are very focused on our major competitors top accounts, because we're finding that once we get a Shark installed, not only are we able to expand Sharks within the account, but we get a significant amount of upgrades.

Okay. Thank you, John.

Thanks Gary. Next question please.

Thank-you. Our next question is coming from Daniel Kunstler 40 of JP Morgan. Please pose your question.

Question has been asked and answered. Thank-you.

Thank-you. Next question please.

Thank-you. Our next question is coming from J. Stevens of Buckingham Research. Please pose your question.

Yes, thank-you. John, you had a blow-out, big, first quarter in revenue growth, in dollars and in constant currency, but in constant currency now, the growth is above that trend line number, that you'd mentioned of high single digits for revenue growth in topline revenue on a long-term basis. Now, if we use your long-term guidance for revenue growth in CC, and look at the first quarter in CC, it sort of implies a slowing in the rate of growth of topline revenues for the rest of the year. Would you want to put some color on that John?

Well, the first point is, the number that you have pointed out, and as I tried to point out in the chart, the last chart that I showed, it shows our revenue growth over 41 the last 9 quarters, we are going to have quarters where we have above single digits, and quarters where we will have, hopefully, high single digits, and in any given quarter, we will be above and below that mark. The high single digit, as I said, is a longer-term model..

Right.

And where we look at that as we make investments, and as we operate the company for efficiencies. Now, to your point: The next two quarters, as the analysts, and all of you have in your models, you do see the revenue coming down in the back half, maybe not coming down, but the tougher compares, and we're also taking into consideration this economy that we're dealing with, and we're trying to say "Listen we think we can hit our model for the year, even given the economy based on the fact that we've got a good start here."

Thanks Jay.

I think we have time for one more question.

Okay. Thank-you.

Thank-you. 42 Our last question is coming from Steven Weber of SG Cowen. Please pose your question.

Hi, John. In the first quarter, it looks to me, like you grew your operating expenses, SG&A and R&D, about 7%, year-over-year in constant currency terms. Do you think that's a good number for the year or will it slow down, and can you just give us some feel for, kind of, obviously everybody else is trimming their sales here and there because of the environment, what you might be doing to deal with all of the uncertainty?

Well, as I have said in the past, we are investing, Steve, as you know, the gain-share. We believe we are gaining share in Unix, we are gaining share in Services, we are gaining share in Microelectronics, we are gaining share in Storage, and we are gaining share in Middleware. And, so, therefore, we are investing. I talked about it the last time we spoke, that we are doubling, we've doubled our Storage sales force, and therefore we will continue to invest as long as we see the revenue growth coming in, and as if we see that revenue starts to stall, as we always do, and you know 43 this, we will pull back a little bit on that. But the important point is that we are investing for growth, and so you'll see this expense line, you know, on a constant currency basis, you'll see some growth.

Thanks Steve, and thank you all for your participation. Have a good evening.

Thank you for your participation. This does complete today's teleconference. You may disconnect your lines at this moment.