International Business Machines Corp (IBM) 2001 Q3 法說會逐字稿

Good afternoon and welcome to your IBM third quarter earnings conference call. 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. It is now my pleasure to hand the floor over to your host, Mr. [Harvey Park]. Sir, the floor is yours.

Thank you, [Mandy]. Good afternoon. This is [Harvey Park], Vice President of Investor Relations for IBM. Thank you all for joining us. Let me quickly give you a few pieces of information. At this time, the opening page of the presentation should have automatically loaded and you should be on chart 1 of the title page. After the last chart in the presentation, we will provide you an index to go back to specific slides during the Q&A. Or you can jump the index at any time by clicking on the index link located on the navigation bar on the left side of your screen. For printing, there are two alternatives. As in the previous quarter, there is a link on the index pages or you can download the entire set of charts for printing. Only if that is a link to the navigation bar, so you can download the chart at any time. In about 45 minutes, you will also be able to link to the prepared remarks of that same navigation bar. And finally, a replay of this webcast will be available on this website by this time tomorrow. 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 Reforms 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 filing with the SEC. Copies are available from the SEC from the IBM website, or from us in Investor Relations. And 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, [Harvey]. Good afternoon. We are pleased with our third quarter results, especially in this tough environment. One billion, six hundred million dollars in after-tax profit, $2 billion in free cash flow generated from over $20 billion in revenues. Our results continued to show strong resilience for the same two fundamental reasons as in prior quarters. First, we again gained share in key business areas, services, high-end servers, and software because we had the products and services. In other words, the solutions that customer's wanted in this environment. Second, we continue to benefit from the strength of our broad portfolio and our business model with its financial core of annuity-like businesses. And just as important, particularly, in this economy, our balance sheet remains very strong. Before I get into the details of our third quarter, let me describe how September 11th affected our results. Here is what we generally saw. For a third of our business that is the annuity-like and generated by ongoing operations, out sourcing, maintenance, host-based software, revenue was unaffected. In hardware and distributed software which is driven by new orders and new shipments of products, a significant amount of revenue comes in the last month of any given quarter. September business, therefore, is critical. As best we can measure, the falls were mainly in the US. The biggest impacts were to the storage subsystems, Business Innovation Services, and Intel-based servers.

Let me add, that we saw further slowing of already weak orders for PCs, associated HDDs, as well as our OEM microelectronics. On the other hand, our software and high-end servers remained very strong. The heaviest concentration of all of these deferrals was in the financial services and insurance sectors, as you would expect. And we are working with these customers as they deal with their priorities. While it is too early to know how much of this business will eventually be booked, in some areas like out sourcing, we see a very strong pipeline of opportunities. Clearly, this environment is putting more pressure on many technology companies, but is also providing the investment community a very useful tool for identifying long-term winners. We have said that history will not necessarily repeat itself and we continue to believe this. The next generation of e-business is about a powerful industry shift, the integration of computing and communication to achieve competitive advantage. It is not about just piece-parts. So, a major shift is underway in customer buying patterns in favor of powerful fully integrated servers, software, and services. This shift plays directly to the strength of IBM's products, services, and technology portfolio. Even though customers may have slowed their investments in IT in this economic environment, they remained focussed on this shift towards integration. We are still building an infrastructure that is scaleable, robust, and secure.

They are focussed on returns, on how best that they can get their cash back. But they also want to make sure the investments they make today are consistent with the long-term plan to tide front-end processes to back-end processes and to exploit the flow of information in between. As you have seen all year long, this customer shift clearly is helping us even during these difficult times in terms of revenue growth and market share gain in key segments. The important point is that we believe these trends will continue to accelerate in our favor once the economy begins to improve. So what does this mean for the fourth quarter? But I just told you about September can help set expectations for the fourth quarter. We will benefit from the steady flow of revenue and profit from our [annuity-like] services, host-based software, maintenance, and financing. We expect our customers to continue to prioritize hardware and software decisions towards products that yield sure paybacks. In these decisions, we expect to benefit in three ways. We now have product leadership over our piece-part competitors. Some of our competitors are going through significant changes borne on by increased competition in these difficult times. The business models are under pressure, so their product and support levels may have to change and finally, we have leadership in helping customers build total business solutions which means that the decisions they make with us today will fit into their business needs tomorrow. The fourth quarter will certainly be challenging. The cost consensus is that we will grow earnings per share by 50% over the third quarter and deliver well over two billion dollars in after-tax profits.

At the same time that some of our competitors will lose money. It is extremely difficult to make predictions in this environment. However, they spent everything. We know today, we believe the current earnings per share consensus for the fourth quarter is reasonable. We will address 2002 after our discussion of the third quarter results. So let's get started. Click on the next button for chart 4. Here is the financial overview of the third quarter. I have mentioned that revenue at 20.4 billion was down 3% at constant currency and 6% as reported. Obviously, currency's impact was 3 points. Let me just note here that based on current spot rates, the negative currency on revenue for the fourth quarter would be only about 1 point or sequentially from the third quarter, we are going to get a little help. Pretax income was down 19% principally due to the slowing demand in our technology-OEM businesses that we discussed back in July, but also reflecting business impact in September. Our tax rate was 29.5 down half a point from a year ago, but the same as last quarter. Our year-to-date tax rate remained at 29.6. Average diluted shares outstanding for the quarter were [1,768,000,000] down 2.3% from last year. And earnings per share were $0.90 down $0.18 or 17%.

In these results, we have absorbed currency, equity write-downs, and workload balancing initiatives. These three factors alone contributed about $0.13 to our year-to-year decline. Now, let's turn to revenue in the third quarter, starting with the geographic perspective. Click the next button for chart 5. Just over 90% of our revenue comes from sales to end-user customers, which we break into three geographic areas. Constant currency is the best measure of comparative business growth. The Americas has declined 5% at constant currency. As I have already mentioned, business in the US had the greatest disruption in September. Europe grew 4% in constant currency before the 3 points of currency impact, strong performance in services and software, cost at hardware declined. Asia-Pacific grew 5% in constant currency before the 10 points of currency impact. The deceleration in Asia-Pacific's growth from the second quarter is mostly due to the decline in PC revenue as we shift away from the less profitable consumer sector. Our OEM business, the other 10% of our revenues declined 27% in the third quarter. We indicated in July that we expected a substantial decline in our microelectronics business, based on the rapid deceleration in orders from our OEM customers that began in the second quarter. And in our hard disk drive business, we experienced sustained weakness in demand along with the rest of the industry due to decline in PC values.

Now, if you click on the next button for chart 6, I will touch on revenue by major line items. Let me start with Global Services, which at 41% of our revenue is our largest segment. Revenue was $8.7 billion growing 9% at constant currency. Services without maintenance grew at 11%. Hardware revenue in the third quarter was $7.5 billion, an 18% decline at constant currency. While we had strong growth in zSeries mainframes, in Shark stored subsystems, our OEM business, microelectronics, and hard disk drives as well as PC faced even weaker market conditions than anticipated. Let me add that the pool off in PC revenue has little impact on our profits. Software at $3.2 billion had strong growth at 14% of constant currency. We had terrific performance across all geographies and across all product lines. We gained share on key competitors even before the Informax acquisition with continued strong performance in our database and WebSphere application server businesses. Global financing revenue at $822 million declined 2% at constant currency. Income generating assets were flat from last year and financing originations were $8.8 billion in the quarter, but hardware re-marketing was down in the quarter driven principally by a falloff in the US. Now, let us review gross profit margin, chart 7. Total gross profit margin for the third quarter was 36.2% up 8/10th of a point from last year. Global Services gross profit margin improved nearly 2 points.

We benefitted from a cost reduction action in both services and maintenance as well as from improved productivity in our outsourcing contracts. Hardware gross profit margin declined nearly 4 points. As expected, the key drivers were lower volumes in our technology group and pricing pressures in PCs and hard disk drives. Software gross profit margin improved 3/10th of a point and our global financing gross profit margin improved 9 points, reflecting lower funding rates and lower used hardware sales. Now, let's turn to expense, chart 8. Total expense was $5.1 billion, up 5% from last year. So, the total expense to revenue increased by 2 1/2 points. However, both SG&A and R&D were flat year-to-year and down slightly from the second quarter. Again, a major factor impacting total expense was a $156 million write-down of certain equity investments, other than temporary market declines. Though SG&A is flat, there are many changes under the surface and these will continue. For example, at the beginning of the year, we targeted a $2 billion reduction in infrastructure expenses by the end of next year and we are already well on our way. As we reduce these expenses, we continue to increase investments in key areas where we can gain competitive advantage and prepare for 2002. For example, we spent more on direct sales, on technical sales support, on development, and yes, on information technology. And we put it where we are gaining share, service, storage subsystems, software, and Global Services.

We are also using technology to improve our efficiency. IBM e-procurement is one of the largest private exchanges in the world purchasing 98% of its goods and services electronically. That is over $40 billion on an annualized rate. IBM.com and e-care for customer support also continued to improve our productivity. Now, let us move to cash flow, chart 9. Cash generation for the third quarter was solid with free cash flow of $2 billion, the same as last year. And we expect it to remain strong through the rest of this year. Our ongoing focus, our working capital management was the key contributor. Capital expenditures were up slightly year-to-year with services being a key driver. Also, in the third quarter, we spent $1.8 billion to repurchase about 18 million shares. This left us with $1.8 billion under our last board authorization at the end of the third quarter. This continued strong cash flow even in a difficult economic environment gives us the flexibility to make necessary appropriate investments for the future of our business, for internal growth such as outsourcing services, for acquisitions, or for share repurchases. Now, let's look at the balance sheet, chart 10. The balance sheet remains very healthy. Total debt increased $800 million from the same time last year. Our $26.4 billion of Global Financing debt, which was 92% of IBM's debt, was leveraged at a comfortable 6.721. We increased our cash on hand and we funded the Informax acquisition while maintaining our core debt capital at a very comfortable 11%, the same level as last year.

As I have said in previous quarters, this is not the environment to have growing inventories or accounts receivable problems. Asset and debt levels continue to receive high focus and it shows in our results. But for some companies, focus on the balance sheet and cash flow has now become more fashionable. It has always been important to us and it pays in many ways. Since 1994, we put $50 billion of free cash flow to work after investing $38 billion in capital expenditures. We will consider that IBM reopened investment grade bond market in September with a heavily over-subscribed $1.5 billion bond issue. Now, let me turn to a discussion of some of our individual businesses, starting with Global Services, chart 11. Global Services at $8.7 billion was up 9% at constant currency. Services grew 11% and maintenance revenue was up 1%. $10 billion of signings grew our backlog of $97 billion. We did have delays in September signings particularly for Business Innovation Services in the America. But our out sourcing services pipeline going into the fourth quarter is as strong as we have ever seen. So, even in a challenging environment, we had seven deals greater than a $100 million, our sixth straight quarter of signing at $10 billion or more. And nearly $600 million of Web hosting signing, bringing our total Web hosting signings to $1.7 billion year-to-date. Now let me review the three major services segments.

First, out sourcing and e-sourcing; slightly more than 40% of Global Services this quarter grew a healthy 13% at constant currency. New businesses like e-sourcing, IBM's Web hosting, co-location, and managed application hosting continued to drive revenue growth. E-sourcing revenue was up 50% this quarter and was nearly three quarters of a billion dollars year-to-date. And finally, leveraging the scale and scope of our out sourcing business, cost management initiatives drove another point of margin improvement this quarter, extending our lead against the competition. Integrated technology services, which includes product support services and maintenance is about a third of Global Services. IT services, excluding maintenance was up 16%. We continue to see strength across all geography, driven by server and infrastructure consolidation. We also saw a slight uptake in business continuity and recovery services this quarter, which grew 14%. Next is Business Innovation Services, which includes consulting and systems integration. It is slightly less than a quarter of Global Services revenue and grew 6%. In America, VIS revenue dropped substantially, leading to a year-to-year decline in geography. The events of September 11 further impacted an already weak consulting and integration environment. In Europe and Asia, we had double-digit VIS growth and worldwide, we continue to see good growth in key e-business areas. Supply chain revenue grew more than 50% worldwide and e-business integration revenue more than double. Overall, this was a good quarter for Global Services. We have again gained share because our services capability provides compelling value for our customers by helping them drive efficiencies in their IT infrastructures and processes. As a result, out sourcing demand remained strong.

Server consolidations are driving a healthy IT as business and although Business Innovation Services in the US has weakened, many customers continue to integrate business applications across their enterprise. Our opportunity pipeline going into the fourth quarter is as strong as we have ever seen, giving us good visibility that signings will again accelerate, just as they did after Y2K. Click on the next button for chart 12 and I will discuss eServers and storage. Customers are shifting their priorities to high-end servers as they enhance their infrastructure. This strong momentum behind zSeries began a year ago and continued in the third quarter with mixed growth of more than 40%. Mainframe growth is driven by a number of factors. Customers are using mainframes for consolidation, adopting LINUX, centralized its first workloads like file, mail, or print serving and for new workloads like Web and e-commerce enabling and for greater reliability, security, workload management and reduced costs. In the UNIX server market, almost every competitor has pre-announced significant revenue shortfalls and we believe this market may be down as much as 35%. While pSeries revenue was down 9%, we will again gain share. Earlier this month, right on schedule, IBM had announced [Regatta]. This eServer [T690] is the first product to use powerful processors combining copper, silicon, and insulator and [Low-K Dylectric]. These are the most advanced chips ever offered. But the [P690] is more than just a hot chip.

While the competition chooses to provide reliability through expensive redundant hardware, the [P690] uses the mainframe's predictive technology to keep that locations up and running at a far less cost to the customers. The advanced architecture of the [P690], which gives customers 25% better performance at half the price. The iSeries or integrated server platforms grew 10% this quarter hosting gains in all geographies. In July, I told you about the release of the new operating system. It allows customers to leverage multiple environments, including JAVA, WebSphere, and LINUX. We added dynamic partitioning capabilities to the iSeries and this quarter, it won best of show at LINUX World. Recent reports by IDC and The [Gartner] Group highlighted the iSeries' ease of use, low cost of ownership, 64-bit capability, and high reliability; all attributes the customers have exploited the server consolidation. The Intel server market continues to be under intense pressure and our xSeries revenues were down 25% year to year in line with the market. We recently announced an advanced set of technologies from our high-end servers called [Summit] which will bring best degree availability, scaleability, and performance to the xSeries. So, the real world is made up of multiple server platforms and our customers recognize IBM's unique ability to offer the best server to meet customers' many different requirements.

Shark, our high-end disk storage device grew 14% and continued to gain share. We have seen strong customer demand for native [5-CON], which we announced this quarter and Shark remains the only enterprise storage device to offer this feature. We continue to see wide customer recognition of our competitive advantage. It was yesterday Wall Mart announced their decision to utilize z900 and Shark storage as the backbone of their worldwide data center. Complimenting our disk solutions, we offer our customers low-cost high-performance paid storage. It continues to do well and grew by more than 20%. Now, click on the next button for Personal Systems, chart 13. The PC industry slowdown and severe price pressures seen in the first half, intensified in the third quarter. Our PC revenue was down 29% year-to-year. From the second quarter, revenue was down 9% and we expect that when all the data is in, this will be in line with industry trends. We are fine-tuning our business model and have taken aggressive actions to bring our structure in line with these revenue levels. Plant inventories have been reduced 25% this year and channel inventories have been reduced 35%. Expenses have been reduced by leveraging the IBM.com sales channel and earlier this month, we refreshed the entire product line, bringing new wireless, security, and management capabilities to our Think Pads and desktops. Now, if you will move to chart 14, we will cover technology.

The semiconductor industry's severe downturn has led to competitors announcing year-to-year revenue declines ranging from 20%-50% and IBM microelectronics declined 30%. But we believe that third and fourth quarter will be the bottom. While we are disappointed with these results, we recognize that in any new business, growth does not happen in a straight line as we found out in the earlier years of Global Services. But you know that technology has always been a key part of this industry and as applications reach into new areas like pervasive computing and brand new customers sets, we will fully expect technology to maintain this vital role. With our leadership and custom logic, leverage by continued breakthroughs in IBM research and in expanding [packed] portfolios we will continue to make great progress over the long-term. So, we will leverage our leading-edge technologies based on [_____] including advances like [SLI] and [LO-K Dylectric]. For example, Regatta uses all of these and just last week, we took it a step further with the announcement of ultra-low power chips that can be exploited in portable devices. And we are accelerating our use of these technologies away from older technologies to meet our OEM customers' advancing requirements. Like Global Services and software, our microelectronics business is an integral part of our e-business strategy. Before I move on, let me touch on the OEM hard disk drive sector.

While we do expect to gain share in both desktop and mobile drives in the third quarter, our results reflect the same issues of low volume and price pressures as in the PC industry. Now, click on the next button for software, chart 15. Our software business at $3.2 billion was up 14% at constant currency. Operating system revenues, which make up about 20% of total software, were up 3% of constant currency, driven by server consolidation on to the z and iSeries platforms. Middleware, the majority of our software revenue at 80% of the total grew 18%. These results were broad-based success across our portfolio, across our operating platforms and across customer sets. Across the portfolio, our transaction processing leadership continued as WebSphere revenue grew 75% and MQSeries revenue more than a 100%. DB2 continued its success in the marketplace with 31% growth overall and even a higher 56% growth on UNIX and NT and these numbers are without [Informax]. Similarly, we turned the corner with continued sequential revenue growth, profitability improvements, and low [_____] the real-time collaboration software grew 18%. We also had success across platforms. Our middleware software grew 32% on UNIX and NT. Our host platforms' 14% middleware growth was led by our database tools business.

We are aggressively growing up to this market and should achieve about $400 million in revenue this year and we continued to have success across customer sets. We signed important new Middleware deals with existing customers and new customers like [ebay], with selective WebSphere as its technology foundation. As a result, we continued to gain share in key Middleware sectors. BEA systems, our largest competitor in application servers reportedly expects a flat and modest revenue growth this quarter versus a 75% growth in WebSphere. In September, [giga] projected that IBM WebSphere will more than double its market share to 34%. They projected that BEA is increasing share by only five points to 36%. We are now virtually tied with the lead in this market and expect to be number one shortly. In database, ORACLE had declining database revenues this quarter versus out 31% DB2 growth and our successful [Informax] database acquisition this quarter more than doubled our distributed database revenue, added 2500 skilled resources, strengthened our presence in small and midsize customer segments with the addition of a 1,00,000 customers, and in realtime web conferencing loaded same time lead with a 33% market share and almost three million corporate users according to a July IDC study. Finally, our ISV alliance's continued to drive revenue growth. More than $1 billion of IBM revenue was generated this quarter by 70 global strategic alliances. Our partnering strategy is paying off for our customers, our software partners, and us. We have talked to you a lot about IBM's key ability to integrate multi-platform e-business solutions for our customers. You can see this in our server results, in our services results, and here in our software results.

Now, if you hit the next button, let me summarize my remarks. Let me conclude by looking ahead to 2002. In many respects, this is an economic call. When does worldwide GDP bottom out and what is the timing and strength of the recovery? That is the call, I am going to review. In a weak economy, our recent results have demonstrated our ability to sustain strong profit, and we will leverage our strength, and continue to invest for the future. For example, we have recently acquired [Informax] to double our revenue on database software and on distributed platforms and mainframe to add their expertise to our consulting practice and while we are carefully controlling our total expense, we are also aggressively cutting infrastructure to enable increase investments in areas that can directly drive growth. When the economy picks up, the emerging changes in the competitive landscape will accelerate. We have already seen evidence of that even though some of our piece-part competitors are hoping that history will repeat itself. We have been consistently gaining share on our key piece-part competitors SUN, C, ORACLE, and BEA ... check out the industry reports. Our sustained track record for new patents, our rollout of new technology, and our timely use of that technology in new products means that our leadership has been widening ... check out the industry reports.

Open standards have been gaining momentum. IDC reported that LINUX was 27% of new operating system shipments last year even at this early-stage in its capabilities and they projected 24% compounded growth over the next five years. That compares to 17% for Windows NT. IBM revamped its strategy around open standards because its what our customers want. Our competitors have not, because it is not, what our competitors want. As customers get into more sophisticated applications of e-business, integration front to back they are turning IBM because of our experience, because of our ability to provide business solutions, and not just product solutions. Even some of our competitors are starting to recognize this and are trying to imitate us. IBM's business model has been building momentum over the past several years. Yet many of our competitors are facing major disruptions. They were reporting significant revenue and more importantly profit decline if not operating losses. As they adjust their business structure, they reflect the reality of competitive pricing. These are all metrics that point to IBM as the emerging leader and we continue to expect long-term growth in IT spending. As worldwide GDP growth settled out at 2-3%, many observers believe that IT spending should grow around 10%. From an economic perspective, information technology drives productivity, which drives earnings. Leading companies around the world understand the importance that is taking place in our industry as computers and telecommunications continue to converge [____] together and supported by powerful servers, sophisticated Middleware-software, and global services integration capabilities. That's exactly what our strategy has been build to address even during these challenging times, it's given us a competitive advantage. And when the economy recovers, we expect to be in an even stronger competitive position and return to our model of high single-digit revenue growth and low double-digit growth in earnings per share. In closing, IBM has managed through these tough times before. We benefit from our experience and we continue to feel good about our strategies, our products, and our services and the value we provide to our customers as the computing model continues to shift in our direction. We are very encouraged about our prospects. Now, [Harvey] and I will take your questions.

Thanks John. Before we take your questions, let me give you an update on our fall analyst's meeting. To minimize the scheduling conflict for many investors, we have moved this meeting ahead one-day to the afternoon of November 14. The additional details will be forthcoming. And now if you go to the next chart, you will find an index of all our slides that may be helpful during the Q&A. Before I turn the call over to the operator to give you polling instructions, let me make my usual request that you are refrain from multi part questions to give others sometime. As always, we are on a tight schedule. Okay [Mandy], lets get started.

Thank you. The floor is now open for question. If you have a question or a comment, please press 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 pound key. All questions will be taken in the order that they are received and we do ask all parties to please pick up their handsets for posing their question to ensure optimum sound quality. Again that is 1 followed by 4 on your touchtone telephone at this time for any questions or comments. Thank you. Our first question is coming from [John Jones] of Salomon Smith Barney. Please pose your question or comment.

Thank you. Just a clarification John. What did you say about Tivoli, you had some verbatim in your charts, but I did not hear the comments and the question that I would like to try to dig into is the sustainability of your operating margins and services. I mean your up dramatically over what we thought you could achieved and from the sounds of your comments, it looks like most of it is coming from your outsourcing business which clearly has some long-term implication, can you expand upon that and clarify the nature of it?

Thanks John. Let me take the second part of your question first. Our operating margin in services as you stated are being driven primarily from the outsourcing business. As we gain economies of scale in that business, our margins have been improving and so going forward I would say that we will be able to sustain those margins. Regarding Tivoli what I said was that Tivoli's revenues overall were basically flat year-to-year in the quarter, but we have been seeing significant declines in our Tivoli business over the last couple of quarters. So, we feel that it is bottomed out and its security product is doing quite well. So, flat year-to-year, but coming off some pretty weak quarters and we believe that it has bottomed out. I also mentioned that Tivoli's in profits have improved dramatically which they have and we think we have that business model where we want it and now we are looking forward for some revenue growth as we go forward from our Tivoli products.

Great. Thank you. Nice quarter.

Thank you John.

Thank you. Our next question is coming from [Gary Hameg] of Wit Sound view. Please pose your question or comment.

Yes. John ... September 11 you said caused some delay in bookings of your services contracts, and September 11 could have caused renewed interest or increased interest in outsourcing as a way to provide the recovery that people are now looking and the security which you are familiar with your centres. Have you seen any pick up of interest in outsourcing as a result of September 11?

Thanks [Gary]. What we have seen since September 11 is two things; first we have seen a pick up in our business recovery activity, which I mentioned in my prepared remarks, but when I meant by the slowdown in signings based of the September 11 is that there were a number of rather significant transactions that we were working on that these customers simply had other priorities versus closing the contract in the third quarter. We are working on those contracts in the fourth quarter. So, what I am saying is that a few contracts or other large contracts did pull out of the third into the fourth quarter and the uptake in outsourcing activity as I mentioned in the prepared remarks, is we are seeing a pipeline or backlog of contracts that is as large as we have ever seen.

Thank you very much.

Thanks [Gary].

Next question please?

Thank you. Our next question is coming from [Tony Sakanade] of Sanford Bernstein. Please pose your question or comment.

Yes. Good afternoon. John just a couple of clarifications. It sounds like the $156 million write-down was about $0.6 in EPS which you included above the line. Could you conform that and then in terms of confirmation for next quarter, what are your expectations for write-down that are built into your comps with consensus estimates for Q4? And, are you comfortable with consensus revenues as they are posed to now for Q4?

Okay Tony. First let me give you, it was $156 million of equity write-downs and what I will say about that relative to the fourth quarter is that it would be significantly less than that and it was $0.6 per share on a year-to-year basis because we had a slight gain last year ... it was less than $50 million last year. But, we are also impacted in the fourth quarter by $91 million of currency as well as we did take a small restructuring charge for our resource actions that was roughly $100 million or slightly less than $100 million. So, those two items the currency and restructuring were not included in the $156 million that I mentioned as it impacted the equity write offs.

And essentially, all of those will accordingly be much more benign in the Q4?

The comps as I mentioned will be less the equity write-downs will be hopefully significantly less, but the resource actions could be about the same

And then, in terms of your comfort with consensus revenue and expectations for Q4?

Well, let me explain how we analyzed the fourth quarter and I think that may help to answer your question. What we first looked at was our annuity revenue and our annuity profits, obviously and in the short-term over 50% of our profit in the fourth quarter are basically on the contracts and in addition to looking at the annuity revenue, we then obviously looked at our transactional revenue in the fourth quarter and we used the opportunity pipeline by product to analyze this, and if we apply the same closures rates to the current pipeline of our current hardware products and software products in the pipeline as we experienced or executed in the third quarter plus the introduction of [Regatta] ... the EPS estimates for the fourth quarter are reasonable and so that's why I made the statement that we made relative to the fourth quarter.

But, were you able to do the same pipeline kind of analysis on a revenue basis and come up with the same conclusion about consensus revenue expectations?

Well again I don't have that. I really focussed on the earnings per share in the fourth quarter.

Okay, and then just finally John. There was a pretty major erosion on operating profit as you reported on the segment basis in the enterprise systems business, which is somewhat surprising given the strength in your very high margin businesses namely mainframes and enterprise storage? Can you comment on what may have caused that erosion and again you know how we get comfortable that we see a nice rebound in that in the fourth quarter. I understand [Regatta] will play a force, but I would be surprised if your mainframes have the same kind of mixed growth in the fourth quarter?

When you look at the enterprise segments, the decline is driven solely by the decline in our xSeries margins. Our margins on our other products in that segments which is our UNIX products or zSeries products or iSeries products are all basically doing well year-to-year. They are the pSeries ... it is under some price pressure, but we are taking cost down along with price. So, the margins are holding up nicely. Our storage business also was seeing some price pressure, but we are also taking our costs down inline with prices. So again, we are maintaining our gross profit margins. In our zSeries, the gross profit margin is doing quite well. So, that leaves back to the xSeries. In the xSeries, we have been investing in order to gain share in that market place. It is a market place that's under tremendous pressure in the Intel-based server segment, but we are seeing some price pressure and we have been investing and that is what has caused the margin erosion in the segment.

Thank you very much.

Thank you Tony. Next question please.

Thank you. Our next question is coming from [Laura Conigliaro] of Goldman Sachs. Please pose your question or comment.

Yes. Just a couple of things. First of all pricing. You talked a lot about the fact that you are really focussed on the integrated solution that you are now providing to customers. To what extent have you actually re-looked at your pricing policies with that in mind and may be optimizing more for the solution that you are providing rather than for one area or another, particularly since you are in the process of pushing for market share gains? And then separately, as far as microelectronics, I guess you talked about the fourth quarter being roughly the same as the current quarter, where do you stand as far as inventory reductions?

Can you please repeat the second part of that question, Laura, please?

Where do you stand with inventory reductions on this group?

On which group?

Semi's.

Semi's. Okay, thanks. First on the pricing. Unfortunately many customers because of our competitors are all piece part players. When you are competing with, you know, in the market in many instances, the piece-part players will force the pricing engagement on each one of the parts of the solution. The real value Laura is the fact that we are then able to make it all work together and do our integration services plus the fact that we have been sure that our products work together you know in these package solutions that we often go to market with our ISVs Seibel and others and so this is something that we have worked on the way to look into our pricing policies and in some cases, we are pricing the value, but in many cases the procurement departments are still forcing some of the piece-part pricing engagement. So ...

That is the intention. So, I mean the intention is to get more and more of your pricing, as you say, the value basically solutions oriented.

Absolutely and I think that you will see us moving more and more in that direction as we go to 2002, but its going to take some time for us to get there. Now, on your question relative to the microelectronics inventory with our customers, I think that's what you meant what our customers are sitting on, that's the big earning ... is that correct?

Yes, but didn't you also indicate that you had something about a quarter of a billion dollars versus inventories?

Okay, that quarter of a billion dollars was inventory. The $215 million is the inventory that our microelectronics customers had on hand of our products.

Right exactly.

And, it is really a mixed bag Laura. It is the network players have worked a fair amount of that inventory and it has moved in the right direction that has declined. The pervasive customers ... the inventory is basically flat. Unfortunately, for the enterprise IT customers that inventory have actually gone up. So, we wrapped that all up. We are roughly back to $250 million, which is why I made the comment that we do not expect an uptake in microelectronics business in the fourth quarter, and we are not counting on that business up taking or doing much better on a quarter-to-quarter basis.

Thank you.

Thanks Laura. Next question, please.

Thank you. Our next question is coming from [Don Young] of UBS Warburg. Please pose your question or comment.

Thanks. Good evening John and [Harvey]. To followup on the 2002 outlook John, you sort of left is to us to talk about ... to us our own GDP assumptions. I was wondering, if you could share with us what you are preliminary thinking as of the IBM budget for next year? Are you likely to enter the year very conservatively positioned on expenses and effectively try to manage earnings despite the macro setting or should we look for something, although very back end loaded or will IBM be actually under some pressure or linear on the earning side?

Thanks Don. Well, if you look at our third quarter results our performance in most of our segments was pretty good except for PCs and our OEM segment, which were both down roughly 30% on a year-to-year basis. By the way that the combination of our PCs and technology OEM business costs us 7 points of revenue growth, and as I said in my prepared remarks, the impact on profit is not all that much because of it's variable nature in the PC business. So, we had a pretty good third quarter and if you can check other than those two segments, so if we carry that into 2002, and you know, we are well positioned competitively to continue to gain share in most segments and I will show you that we are working to execute better in both our PC and our OEM businesses. Like as we said, we have our annuity-based revenue and profit revenue and profit, which is you know roughly 50% of our profit and I believe that next year will be the opposite of this year with a stronger performance as you mentioned in the second half. We will grow profit's next year and I will share more with you when meet in January.

Thank you John.

Thanks. I know we have time for two more questions.

Thank you. Our next question is coming from [Stephen Weber] of S.G. Cowen. Please pose your question or comment.

Hi, John. I am interested in the fact that you said you didn't really see much change in the tempo of the business outside the US, despite all of that we read in the news about recession in Europe and even slower economic activity in Japan, etc. Could you just talk to us about what seems to be holding up your business on a comparative basis even though the economic backdrop is falling off?

Okay, Steve thanks. First, let me just touch on Japan and then, I will try to go into a broader discussion on Asia and demand. In Japan, our business has been growing double-digits ... [Harvey] wanted to check and see if that is in double-digits in this quarter, but through the first half, we were growing double-digits in a pretty tough economy. In fact, I was in Japan a couple of weeks ago, and you know, basically asking the same question Steve and the answer is that as these markets open up and as you know foreign competitors come into these markets, there is a need to be able to compete you know on a head-to-head basis and if you look at the percent of GDP that is invested in information technology, it is roughly 8% in US and it is about half of that in Asia and so, there is a need to catchup in the IT investments in the Asia-Pacific region. And, if you look at our results in Japan, we have been doing much better than GDP or the economy would suggest because of this need to use this technology to become more competitive, more productive, to drive earnings per share, and to reach more and more customers. So, that is just an overview of Japan.

Now, let me just go down our results by sector. Okay, sector being the different customer sectors that we focus on. The financial sector in Asia grew roughly 18%. These were on constant currency basis. The industrial sector grew 14%. Much of this growth has been coming through outsourcing contracts where customers realized that they needed to reduce their cost structure and you know outsourcing is one of the ways to reduce their spending on information technologies since we could do it a lot cheaper than they can do it for themselves. But at the same time, the communication sector was basically flat. Now, in almost every geography, we did see a weakest segment being small and medium business ... that was across the America, across India, and Asia-Pacific. Now in Europe, the industrial sector was up 17% and the public sector was up 18%. And so, what you are seeing [Steve] is certain sectors of these economies, you know, realizing that this is a productivity tool that can help them drive earnings and what we are doing ... we are doing quite well.

So, what you are saying is that you are implying that those are fundamental temple of your business in the key geographies outside the US is not really diminished even after September 11?

It is, as I said, the biggest impact was in the US. There were some contracts that you know fell out of the third quarter into the fourth quarter and, you know, let me stop there. I would only go on to say as I mentioned a moment ago that small and medium business was the one area that we did see a slowdown and the effect of September 11 on small and medium business is very hard to call and I am not going to take a shot at trying to call that.

Okay Steve. Thanks.

Yeah, its time for one last question.

Thank our last question is coming from [Daniel Confer] of J. P. Morgan. Please pose your question or comment.

Thank you. Just a one quick clarification question ... I just have a couple of items. The 40% software growth that is without the impact of the [Informax]? That is how you characterize the database management business?

On our services business, the [Informax] revenue was worth about 4 points growth. Okay and [Harvey] do you want to give him?

I will check that out and why don't you go on with your other question?

Okay sure.

On [Regatta] because John you made a statement that implies quite a bit of excitement as early as this quarter and I am wondering if we are getting may be a little bit more over excited whether we shouldn't rather expect the adoption period for [Regatta] to be somewhat more phased as customers gauge exactly how to use the technology which is so powerful? And how the comparative alternatives delay your mainframes or competitive offerings?

Well, we have been out, you know, working with customers in the third quarter on preparing them for [Regatta]. So, you know, there has been a quite a bit of activity on how much can we produce though I think that [Regatta] will certainly help our fourth quarter results.

Okay, and this is my second short question. You certainly recognize the possibility for the deterioration of the economic environment in the first half of 2002. I am wondering if that is leading you to at least think about stepping up to more direct [____] forms of asset control that might restrict your capital spending commitments next year particularly in microelectronics?

Absolutely Daniel. You know, we are slowing down a number of capital activities as we watch what happens to the economy and how quickly the economy might turn.

Okay that's it. Thank you.

Middle ware grew 18% ... as John said and that includes the [Informax] so it would be more like 14% without it.

Okay. Thank you.

Thank you all for joining us. Have a good evening.