International Business Machines Corp (IBM) 2002 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the IBM first quarter earnings release.

At this time, all participants have been placed on a listen-only mode, and the floor will be open for your questions and comments following the presentation.

It is now my pleasure to hand the floor over to your host, Mr.

. Sir, the floor is yours.

Thank you,

. Good afternoon.

This is

, Vice President of Investor Relations for IBM. Thank you all for joining us.

Let me quickly give you a few pieces of information.

A this point, the opening page of the presentation should have automatically loaded, and you should be on chart one, 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 just to 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 slides, there are two alternatives. As in the previous quarters, there is a link on the index pages, so you can download the entire set of slides for printing.

Or, there is a link on the navigation bar, so you can download the charts at any time.

In about 45 minutes, you will also be able to link to the prepared remarks off that same navigation bar.

And finally, a replay of this Webcast will be available on this Web site by this time tomorrow.

Now, please click on the next button and move to chart two.

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 Web site, or from us in investor relations.

Now please click again on the next button for chart three.

And at this time, let me turn the call over to John Joyce, IBM's Senior Vice President and Chief Financial Officer.

Thanks,

. Good afternoon.

Before I get into the details on our first quarter results, I'd like to briefly mention two other items.

First, as I'm sure you've seen by now, we announced plans for a strategic relationship with Hitachi to accelerate the delivery of advanced storage products and technologies.

At this point, we have a preliminary agreement with Hitachi to create a new, standalone company that will integrate various hard disk drive operations from research and development through sales and marketing.

And more than just focusing on HDDs, an additional initiative addresses our working together on a common architecture for future storage subsystems to improve interoperability and lower customer cost. I'll touch on this again later.

I'd also like to take a moment to comment on the various reports we've seen recently involving our accounting and disclosure practices.

We have been astounded over the kinds of things we've read about IBM in the last few months. We certainly have no interest in rehashing any of it. So let me just say once again that we're proud of our accounting and disclosure practices. We hope this issue is behind us, and we'd like to move on.

Now, let's turn to the first quarter results.

In this tough environment for IT spending, there are two major points I will make.

As I said in our press release last week, we saw a continued slowdown in customer buying decisions. They chose to reduce or defer capital spending decisions until they see a sustained improvement in their own businesses. The resulting effect on us was an across-the-board weakness in revenues, despite gaining or holding share in key areas.

And second, while no one can predict the timing of an IT recovery, discussions with our large customer base give us confidence that IT remains key to their future business strategies in that IBM will have an increasing role in those plans.

While uncertainties remain, here's what we do know. Our annuity-like stream of revenue and profit give us a higher safety net for our results than our competitors.

Our product leadership has become increasingly more evident. So whatever business opportunity is out there, we are going to get more than our historical share.

And our business model is already positioned to address our customers' changing requirements, and to address the most profitable growth segments of the industry.

While we must continue to make adjustments to our portfolio of businesses, we are not faced with the fundamental changes our competitors must make. We remain very confident in the IT sector in general and in IBM's prospects.

I will make a few comments on our outlook later in the presentation. But let's first assess our first quarter results, starting with revenue, chart four.

We're going to take three different views of revenue, starting with a geographic perspective. Over 90 percent of our revenue comes from sales to end-user customers, which we break into three geographic areas.

On a year-to-year basis at constant currency they were down six percent, about the same as in the fourth quarter. And there wasn't much change by major geography. The Americas declined eight percent, Europe declined four percent, and Asia-Pacific declined three percent.

Finally, our OEM business declined 37 percent, also about the same as in the fourth quarter.

Now, if you'll click on the next button for chart five, I'll touch on revenue by major line item. Again, these are in constant currency for comparison purposes. And I'll be brief, since we'll cover these businesses more thoroughly in a few minutes.

Let me start with global services. Revenue was up one percent, just as it was in the fourth quarter. So, with another quarter of strong signings growth, this business has stabilized. Our annuity-like outsourcing and maintenance businesses continue to do well. But we continue to feel the economic pressure in consulting and systems integration along with our competitors.

Hardware revenue in the first quarter declined 23 percent, two points more than in the fourth quarter. By segment, technology was down 37 percent. Enterprise, server plus storage was down 19 percent. And personal and printing systems was also down 19 percent.

Software grew three percent, while middleware grew six percent. Global financing revenue declined three percent, about the same as in the fourth quarter.

Income-generating assets were down from last year, and financing originations were $8 billion in the quarter.

Now let's take a third view of revenue, chart six.

A point that we've been emphasizing about our business model is the value of our annuity-like revenue. Not only does it fund our growth, but in tough economic times like these, it provides a safety net that is higher than most of our piece-part competitors.

As we enter the year, we know that about a third of our revenues for that year are already under contract. Key contributors are most of our outsourcing revenue, our maintenance revenue, our host-based software, our global financing, and then smaller portions of our other businesses.

For the shorter period of a quarter, the proportion is closer to 50 percent. So, the left chart depicts the relationship for the first quarter. The annuity-based revenue came in as expected, but the darker portion of the transaction-based revenue represents the shortfall.

The chart on the right shows the cumulative orders for a representative transaction-based product. It shows the historical pattern of how total orders build by week, accelerating at the end of the quarter.

Different product offerings have different patterns. Once again, the darkened portion shows the shortfall as it occurred very late in the quarter. We did have a strong finish in the final week, but not enough to close the gap.

As we and many of our competitors have stated, many of our customers chose to reduce or defer capital spending decisions until they see a sustained improvement in their businesses. So, we have an enviable annuity-like base.

Our pipeline of opportunity remains strong, but it is critical that we have a strong finish at the end of the quarter, as the chart indicates. I'll talk more about that later.

Now, let's review gross profit margin, chart seven.

Total gross profit margin for the first quarter was 34.7 percent, down 1.4 points from last year. As in the fourth quarter, gross profit margin improved year to year in each revenue segment except hardware, which declined by nearly nine points. Most significant was the continued weakness in demand for our OEM products.

Gross profit margin for our microelectronics division is down 35 points year to year, reflecting the fixed variable nature of this business. And for HDDs, they were down 16 points year to year.

However, for

products were pretty stable, as we offset price reductions with cost reductions. But within product lines, there was a mix towards the lower end.

Global services gross profit margin improved half a point. Software gross profit margin improved nearly a point. And our global financing gross profit margin improved more than nine points, reflecting a downward trend in interest rates.

Now, let's turn to expense, chart eight.

This chart reflects our enhanced breakout of data introduced with our annual report. Very briefly, we've added a line for intellectual property and custom development income. These were formerly recorded as reductions to SG&A and RD&E.

And second, we've reclassified a number of other transactions that were previously part of SG&A, adding them to the "other income" line. This new other income and expense line is now made up principally of interest income and gain or losses from equity method investments, marketable securities, currency exchange and real estate sales.

So, total expense and other income, which is all part of managing the breadth of our business, was $4.7 billion in the first quarter, down seven percent from the first quarter of 2001.

SG&A decreased two percent. There are a few key dynamics. As in recent quarters, we continued to cut discretionary spending. But also, we continue to make progress on improving productivity.

One of the objectives for 2002, we highlighted in our annual report. In the first quarter, we cut about a quarter of a billion dollars out of infrastructure, redirecting much of these savings to direct investments where we can leverage our leadership, like development and sales for software, services, servers and storage.

On the other hand, we also continue to increase receivable provisions, reflecting the weak economy, and to increase workforce rebalancing, reflective of the changing requirements for skills and of ongoing efforts to improve our productivity.

R&D decreased six percent, driven by focus on discretionary expense and by savings from the integration of Lotus and Tivoli into our software business.

IP and custom development income was $333 million. The total was up $56 million from a year ago. This income comes from dozens of deals, as happens every quarter. This quarter the largest was the Sony-Toshiba agreement, which combined was about $60 million. I'm going to show you some more details in a moment.

Next, other income and expense, which at $205 million, was about flat with the fourth quarter, but up $129 million from last year's first quarter. Year-to-year the key difference is the significant reduction in equity investment write-downs, as I had mentioned back in January, as well as the transaction with Sanmina-SCI for our desktop manufacturing.

Finally, interest expense associated with our small amount of core debt was $30 million, down $42 million due to a reduced level of debt and lower interest rates.

Now let me make a general point, again about expense.

In the roadmap section of the annual report, we noted that there were events and trends that can help or hurt earnings. This quarter was no exception, and I've noted some of the them.

Year-to-year on the hurt side were bad debt expense, up about $60 million, and continued workforce rebalancing costs, up $110 million. We also had lower pension income, about a $75 million hit, and lower interest income, down about $20 million.

But we got some help -- elimination of goodwill amortization, about $75 million. Less impact from equity transactions, about $90 million. Income from intellectual property, up $56 million. And about $90 million from the sale of the U.S. and European desktop PC manufacturing to Sanmina-SCI.

There are many other factors on a smaller scale. But when you add the pluses and minuses up, there was little net effect this quarter.

You must look at the combined effect. It may help or hurt in any given quarter, but we feel it's our job to deal with these events within the context of our business model over time.

Now, let me go back to intellectual property chart nine.

Let me be very direct. It is absurd to characterize our intellectual property and custom development income as non-operational, as has been done in a number of reports and articles.

The simple fact is that generating intellectual property and deriving value from it is absolutely fundamental to IBM. We invest a lot of money in R&D, about $5.5 billion, which is a great deal more than our competitors.

We have a portfolio of 37,000 patents worldwide, and we've been adding to that portfolio by generating more patents than any other company for nine consecutive years.

When Lou Gerstner joined IBM, one of his mandates was to dramatically shorten the time from research to final product. And today, you see that in the form of industry-leading technology and products. But not all R&D results in a mainstream IBM product.

However, you can monetize this IP in different ways for the benefit of our shareholders. Sometimes IP results in a product or offering that is not consistent with our strategic direction and is not growing as fast as it would in another company's hands.

As a result, we can get a good price for the IP even though very few assets or people are part of the deal. More typically, we have a portfolio of IP that we're looking to either license or sell depending on what the market will bear.

We have a separate organization that is responsible for identifying the opportunities and optimizing the returns over time. And we set targets each quarter for IP income, just as we do for the product sales, though investors used to question the value it got from our R&D investment.

The bar chart shows that since 1994, we have done a better job of getting the full value, not just in products and services. Deriving value from our intellectual property is an integral part of our ongoing business, and a competitive and financial advantage.

Now let's move to cash flow, chart 10.

We managed our cash flow well in a tough environment. Our cash flow is typically negative in the first quarter, in large part due to the payment of variable compensation to employees.

This year our cash flow in the first quarter was a negative $1 billion, but an improvement of $600 million over the first quarter of both 2001 and 2000.

While our net income was down $558 million, working capital improved by $1 billion. This strong performance enabled us to continue our investments. We put $1.3 billion into capital expenditures. We used $1.8 billion to buy back about 17 million shares, leaving us with $2.8 billion remaining in our last board authorization a the end of the quarter.

Notice that our global financing assets other than fixed assets generated an additional half-a-billion dollars in cash over the last year's quarter. Strong cash flow leads us to a strong balance sheet.

Let's look at that next, chart 11. And the balance sheet remained very healthy.

Cash on the balance sheet stands at $4 billion, just above a year ago. Total debt decreased to $3.9 billion from a year ago. Global financing debt was reduced by $2.7 billion, in line with a reduction in global financing assets.

Ninety-eight percent of IBM's debt was in support of global financing, and was leveraged at a comfortable 6.6 to one.

Core debt was reduced by an additional $1.2 billion year-to-year to $531 million, and stands at a three percent debt to capital. Asset debt and leverage levels continue to receive high focus, and it shows in our results.

There continues to be articles suggesting that IBM has leveraged its balance sheet in order to buy back stock. The simple fact is that a financing business is based on leveraging debt. We do that conservatively, and our debt is directly tied to our financing assets. It grows or shrinks as those assets do.

Excluding global financing, IBM has virtually no debt.

Now let me turn to a discussion of some of our individual businesses, starting with global services, chart 12.

Global services, at $8.2 billion, was up one percent at constant currency. In revenue, services was up one percent and maintenance was up three percent, similar to the fourth quarter.

In a record first quarter signings, with over $15 billion, up 50 percent, there were 10 deals over $100 million, of which two were over $1 billion. And our pipeline for new deals remains strong.

Despite the ongoing economic downturn, we continue to exercise financial discipline, demonstrated by year-to-year profit margin improvements for the quarter.

Now let me review the three major services segments.

Strategic outsourcing, which is 40 percent of global services, grew six percent at constant currency. Demand remains strong. The value proposition of strategic outsourcing is attractive to customers in both good and bad economies, as customers focus on cost reductions. We achieve the high success rate in converting our opportunity pipeline into signings.

Our hosting revenue grew 17 percent. This includes e-sourcing, a form of hosting on demand.

Integrated technology services, including product support services and maintenance, is a third of global services, and grew three percent at constant currency.

Management services, such as business recovery, technical support and infrastructure and systems management, continued to grow. But revenue growth has been moderating for hardware deployment and supporting services, as you would expect with the continued slowdown in PCs, telecommunications and networking equipment providers.

Finally, business innovation services, which includes consulting and systems integration, is slightly less than a quarter of global services revenue.

As we stated in last quarter's earnings announcement, this segment of services, which has short-term contracts, has been most impacted by the economy. BIS revenues declined seven percent year-to-year, about the same as the fourth quarter. And again, the rate of decline was most predominant in the Americas.

Yet, we did continue to see year-to-year growth in key e-business areas, as customers invested where they could optimize cost savings. E-business integration revenue again had strong growth, and ERP was up moderately.

Let me briefly address the relationship between signings and revenue growth. While we now have two consecutive quarters of strong signings growth, service revenue was only up one percent.

The graph at the bottom of this chart shows that revenue growth follows signings growth, but the effect is not immediate. It takes sustained movement in signings for two or three quarters to effect a change in revenue growth. The rate of growth is dependent upon several factors, including the mix of long-term versus short-term signings and any restructuring of existing customer engagements.

With our strong signings over the last two quarters combined with the opportunity in our healthy pipeline, services revenue could grow double digits by the end of the year. Based on our signings, we feel optimistic about

.

Now click on the next button for chart 13, and I'll discuss e-servers and storage. IBM e-server revenue is down 19 percent, but we expect we held share when the rest of the sector data is available.

In the server and storage sectors during the first quarter, we saw a longer customer decision process, and aggressive pricing by competitors. Although, as I said earlier, we matched our price reductions with cost reductions.

And customers also continue to look at the least expensive solution to their short-term need, as well as a quick return on their IT investment.

On the high end, our mainframe customers pushed processor utilization rates higher and deferred adding capacity. Utilization on mainframe is significantly higher than just six months ago.

The capacity requirements are directly related to our customers' business volumes. And we anticipate that as the rate and pace of the economy picks up, the business volumes will drive up capacity needs.

At the end of the server line, we see Linux on Intel moving in on the low end of the Unix space due to the strong price performance of commodity processors and the flexibility of an open-source operating system.

Our xSeries is doing better because we added performance and reliability advantages.

Our first quarter results reflect this environment. Mainframe MIPS declined four percent year to year, and revenue declined 20 percent at constant currency. However, Linux on mainframes grew at over 100 percent.

Our pSeries Unix servers were down 24 percent year to year, probably in line with the industry. And our p670 mid-range Regatta plus our lean channel inventory should contribute to our second quarter performance.

iSeries was down 35 percent, as customers deferred buying decisions pending the introduction of the Power 4 architecture. We will also be announcing new virtualization capabilities for Linux on iSeries at the end of the month. xSeries revenue declined three percent year to year, driven by the steep price erosion we have seen over the past year.

The eServer x440, which we announced last month, will bring a new measure of performance by enabling our customers to scale to 16 processors.

In storage, we continue to see customers focus on network-enabled products, as revenue from our emerging SAN fabric and NAS products more than doubled year-to-year.

Total disk storage was down 12 percent, but continued to gain share. Tape storage was down 18 percent and held share. Similar to servers, there was increasing price pressure and a longer customer decision process, resulting in some deferrals at the end of the quarter.

Despite this, product margins were down only slightly for all key disk and tape products, and remain strong.

Now click on the next button for personal and printing systems, chart 14.

Our segment reporting showed personal and printing systems business had a profit of $65 million in the first quarter. But this included the gain from the Sanmina-SCI transaction, offset by some resource rebalancing.

So, the tough marketplace conditions we saw through 2001, continued in the first quarter. Revenue was down 19 percent, which we believe was in line with the industry segments in which we compete.

We continued to execute on the strategies for our PCs we have discussed in the past. Our inventory was down nearly 40 percent year-to-year.

Channel inventory was also reduced by over $250 million from a year ago, and expenses were down more than 20 percent year-to-year, although the percent of business through our direct channel did not meet our expectations.

We also continued to bring innovative new function to our desktop PCs and ThinkPads, like the latest wireless and security offerings.

Now if you'll move to chart 15, we'll cover technology.

The technology segment lost $276 million this quarter, about $75 million more than the preliminary estimate in our press release last week. This loss equates to 11 cents of earnings per share in the quarter, and was more than half of our year-to-year decline.

Revenue from our microelectronics division was down 42 percent year-to-year at constant currency. Our customers' inventory of IBM components stabilized at the same level as last quarter, and seems to be about right for the inventory turnover going forward.

Our microelectronics division is positioned for the shift from standalone processors to the integration of multiple functions on a single chip, and that is shift to our strength.

Dataquest has reported that IBM is the industry leader in custom ASIC chips for three years in a row. A power PC has been combined with other features to make chips for everything from television set-top boxes to gain systems, to network routers.

Revenue from OEM hard disk drives was down 29 percent year-to-year, reflecting the continued pricing and demand pressures in the components market. All three of the new drives I told you about last quarter have ramped up strongly and are shipping in volume. These new products account for over 70 percent of the first quarter HDD revenue.

Also, as I stated in my opening remarks, we are working with Hitachi on a preliminary agreement involving our HDD business. As part of this, we will need to assess our capacity requirements.

Now click on the next button for software, chart 16.

Our software business, at $2.9 billion, grew two percent at constant currency. Operating system revenue declined seven percent, driven by lower volumes in pSeries and iSeries.

Middleware revenue, which represent 80 percent of total software, grew six percent. About two-thirds of our middleware revenue flows from host systems, which is annuity-like and based on monthly license charges. In the quarter, this grew three percent, driven principally by DB2 and WebSphere.

Middleware revenue on Unix and NT platforms grew 13 percent. The key factor was the addition of Informix to our database revenue stream. While delayed customer decisions in the last few weeks of the quarter was also a factor in software, particularly on Unix and NT platforms, we do expect to gain share against key competitors.

WebSphere, our leading infrastructure middleware for e-business, delivered another strong quarter, with 53 percent growth. This is WebSphere's 12th consecutive quarter of double-digit growth.

Meanwhile, the average Street expectation for our leading competitor is a revenue decline of over 13 percent.

The Giga Information Group reported that WebSphere more than doubled its market share from 1999 to 2001, while BEA lost share. Giga now views WebSphere in a deadlock with BEA for the industry lead.

In January, we closed the acquisition of CrossWorlds. This key integration software is now part of the WebSphere portfolio. We continue to introduce key e-business standards in to WebSphere.

Last week we announced the new Web services standard for security with Microsoft and VeriSign.

DN2, our leading database management software grew 12 percent, in sharp contrast to our leading competitor, which the Street expects to decline 15 percent, as database tools business grew 17 percent.

Our total management software business, with the addition of Informix, grew 28 percent.

Tivoli's turnaround continued with the seven percent year-to-year growth, fueled by strong demand for its security and systems management products.

Last week we launched Tivoli's entire product line, focusing on business impact management. In security software, Tivoli is number one in share in EMEA and Asia-Pacific, and number two worldwide according to IDC.

Lotus revenue declined slightly. Lotus Notes still maintained the number one position in this more mature segment. Lotus advanced collaboration software, including same-time encrypt

, grew seven percent.

And finally, we continue to expand our strategic ISV alliances, which are aimed at helping customers roll out new application and expand IBM's share.

We announced eight new alliances this quarter, with an emphasis on leading solutions in customer relationship management and product life management.

We now have a total of 82 alliances announced to-date. That gives us financial stability and competitive advantage, a strategy based on solutions, which leverages the breadth of IBM in a clear objective of gaining share in key business segments.

Now, please move to chart 17.

At this point, I'd like to take a few minutes to briefly respond to three concerns that some of you have brought up recently -- the drivers of our EPS growth in recent years, the actions we've taken to improve our growth, and our net profits compared with several of our key competitors.

If you look back five or six years, when IBM's e-business transformation was just beginning, it's true that a portion of our earnings growth came from such areas as share repurchases and improvements in our tax rate.

We don't view this as non-operational. We consider this good management.

IBM's tax rate used to be over 40 percent, substantially out of line with the rest of our industry. And many of our long-term shareholders have applauded our stock buyback program, recognizing that we have not spent the money chasing dot-com dreams like so many other companies.

It's also true that our over-funded pension plan has contributed to our reported results, following generally accepted accounting principles. In this environment, this is good news for our employees and retirees.

We are also mindful that we must manage a total compensation for our employees, offering them the right mix of salary, incentives and benefits to attract and retain the best people. The pension plan isn't the only factor.

In recent years, the net effect of factors such as taxes, share buybacks, pension gain and currency have become a smaller and smaller part of our earnings growth. In fact, this combination of items actually reduced our profit growth in 2001.

But here's a point on which I think we can all agree. Cash flow is the best impartial measure. It cuts through all of these issues, which is why we and other well-run companies put so much focus on it.

Go back eight years at IBM. Our cash flow was running dry. Since then, we've built it up substantially, first by strengthening our balance sheet, and then by improving our net income and operational cash management.

In each of the last two years, we've generated about $7.5 billion in free cash flow. Our focus on cash flow keeps us focused on good operational management.

We are not distracted by people who criticize our earnings by selectively picking one or two items, such as pension gains or tax rates, from our overall results. As we've said before, cash flow is the great equalizer.

Click on the next button for chart 18.

Now let's focus on revenue. This chart shows the impact on revenue of various actions we've taken in recent years to position ourselves for leadership in the post-PC era -- the network world of e-business.

As you can see, our revenue stream has been reduced by $3.6 billion, by exiting businesses that did not match our strategic direction, including such areas as DRAM memory chips, the IBM global network, and our network hardware business.

Exiting was bad for revenue, but was good for shareholders. We also been consistently reducing our exposure to the PC marketplace, including exiting the consumer retail channel. Again, bad for revenues, good for shareholders.

In addition, revenues from server and storage products have declined slightly due to the incredible price performance improvements that we've delivered year after year.

For example, since 1997, the price per MIP in our high-end server product has actually declined by 75 percent, and our price per terabyte of our storage has declined 90 percent, delivering industry-leading performance at ever-lower prices has been key to our being number one in servers, and to protect the annuity revenue that we derive from our large, growing install base.

The profits and cash generated by these businesses have also been key to funding new growth areas. And we've been making significant investments in strategically important areas of our industry, including services, software and microelectronics.

Since 1997, we have grown our services business by $11 billion. And as you know, we are by far the world's largest IT services company.

We've grown our software business by $2 billion, with major gains in middleware products that drive e-business.

And we've grown our custom chip business by $2 billion. And we're the world's number one custom chip vendor.

All of these actions are obviously good for revenues and good for shareholders. And these steps have helped position IBM for leadership in the rapidly evolving e-business world.

It's clear from this chart that our primary focus has not been on chasing profitless revenues. And, as you'll see in the next chart, the actions we've taken to transform IBM also have had a dramatic impact on our profitability compared with our top competitors.

Turn to chart 19. This chart shows IBM's net income compared with the net income of seven of our largest key competitors -- in services, database software, Unix servers, PC servers and storage products. Five years ago, these seven leading competitors made about $9 billion combined, while IBM made about $6 billion, giving us a 40 percent share of the net profits.

However, last year we generated more profit than all seven of these competitors combined. This is certainly an endorsement of our business model.

Some people have said that IBM did not fully participate in the IT boom of recent years. In fact, we did not chase the dot-come bubble, for leadership in the profitable segments of the industry.

So let me summarize these last few comments.

Our EPS growth has increasingly come from operations supported by cash flow. We have significantly transformed IBM to focus on the strategic growth segments of our industry, and we are continuing to move to the profitable segments in the industry.

Now, if you'll click on the next button, I'll wrap up.

Many of the earlier estimates for IBM and other technology companies called for a relatively rapid turnaround in the second half of this year. A number of broad economic indicators also are signaling some signs of improvement.

However, the IT industry is always hit hard during economic downturns, and capacity utilization in our industry remains low. In this volatile marketplace it is extremely difficult to make predictions. And our crystal ball, obviously, has been no better than anyone else in the industry.

However, we believe that the recent changes to the 2002 revenue and EPS estimates for IBM better reflect the current realities of the marketplace. Based on where we stand today, we should be able to make these estimates.

We expect to hold or gain share in key segments of our industry as we move through the rest of the year and beyond. We're also committed to continue to reduce our cost and expense structures.

And finally, we have the strength of our business model. We've just come through probably the toughest two or three quarters for the technology sector in a decade.

Before IBM's transition, we might have lost billions in such an environment. But even in our seasonally smallest quarter, in a period of weak demand, particularly in our OEM business, we still made $1.7 billion.

IBM remains very profitable, very well positioned for the future and continues to be the world's e-business leader.

Now,

and I will take your questions.

Thanks, John.

Now, if you'll all go to the next chart, you'll find an index of all of 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 refrain from multi-part questions, to give others some time. As always, we are on a tight schedule tonight.

OK,

, let's get started.

Thank you.

The floor is now open for questions. If you have a question or a comment, we ask you to please press one followed by four on your touch-tone telephone at this time.

If at any point you would like to remove yourself from the queue, you may do so by pressing the pound key.

And we do ask all parties to please pick up their handsets while posing their questions to ensure optimum sound quality.

Thank you.

Our first question is coming from

of

.

Yes, John. I guess you've had it with all these nitpickers with this presentation. You seem to be addressing them.

On the p600, its performance, is there any characterization of that performance between the high end and the mid range, low end?

No, Gary. We performed well in both the high end, OK. We performed better in the high end, not quite as good in the low end.

So there's not a meaningful difference in the rate of decline in those areas?

No.

Thank you.

Next question, please.

Thank you. The next question is coming from Don Young of UBS Warburg.

Yes. Thank you and good evening.

John, first, I think it's a great that you're -- what you're doing in the hard disk drives to reduce the exposure to what I think is a less attractive business. But I get the sense that the losses in technology are more coming from other areas than the hard drive.

And I'm wondering if that is accurate, and if there is the potential that IBM could go beyond the hard drive restructuring that's on the table and take other actions to reduce the exposure to the volatility in this sector?

Thanks, Don. Well first, the loss of $275 million is about 50-50 between the technology or the microelectronics division and our HDD business. But the reasons are quite different.

The semiconductor piece of this is based on the fixed variable nature of that business. And you go back a number of quarters when the demand for semiconductors was quite good, the returns were excellent in our

business, or semiconductor business.

And so what we need to do there is really work on the turnaround, get our cost and expenses down to a point where we could live through this semiconductor slowdown.

And based on some recent news, yesterday, it looks like things are beginning to pick up, and we think that, as get our costs in line, we'll be able to get back to a very, very important segment within the IBM company.

Now on the HDD side, it's a bit different, as you've pointed out. In HDDs, the PC industry had slowed down. And this -- and there's been quite a bit of price pressure. And it's no secret that we've had some trouble with our server drive over the last really 12, 18 months.

And so we think that this arrangement that we are working on with Hitachi will enable us to better A, scale, make us more competitive.

And, but we do believe that with our new

drive, which is our new server drive that is currently being qualified, that this business also could be a good business going forward, but not one that is part of our solutions and technology focus.

John, is the -- when you talked about the comfort with the earnings expectations, what were you basing that on as far as hard disk drives? That would be -- the drag would be in there all year? Or you'd see a significant scaling back of that because of the restructuring?

Or, you know, how does that go into your thinking on the earnings outlook?

Well, Don, first of all, I'm making that statement based on where we are today. No change to our current operations.

However, given the negotiations that we're participating in with Hitachi, that may change going forward, depending on how we come out of those negotiations.

So, but to answer your question, the comment I made on the going forward statement assumes business as usual.

Great. Thank you, John.

Thanks, Don. Next question, please.

Thank you. The next question is coming from Laura Conigliaro of Goldman Sachs.

Yeah. You -- back to outsourcing. Outsourcing, you said, I think you said it was 40 percent of your revenues.

What was it of your bookings? And I think you also had indicated maybe last quarter that it was much higher in bookings than it was in revenues. So if you can give us that this quarter, and then compare it to last year.

And what is the book value that you're carrying, your HDD business at at this point? And I guess if you can give us a sense as to whether or not we should see a gain or a loss on that.

Let me take the second part of your question first, Laura.

We are currently working with Hitachi on what might be the manufacturing strategy for the new venture. So I want to finish that negotiation first, and then I'll come back to you as to what may or may not happen.

And as we go through those negotiations, we will -- once we have news or once we finalize something, we will announce that.

On the first part of your question,

turning pages over here to get you the percentage. But before he gives you the percentage, let me make the following comments.

The strategic outsourcing part of our business is the business that seems to be doing -- that is doing, not seems to be doing -- that is doing the best in our services mix of businesses. And --- what,

, is that 50 percent?

The signings for outsourcing were about two-thirds.

Two-thirds. And when we were short, and where we missed in the quarter, was in our consulting or BIS signings.

And so, these -- the signings in strategic outsourcing, as you know, are longer-term contracts. So that was to the point I made in my prepared remarks, that when we do our math on feathering those signings in going out over the next couple of quarters, we believe that we could see double-digit growth by the end of the year.

Now, we are also assuming in that, in that statement, or in that outlook that we have a very good second quarter signings. Our backlog that we're working on -- and, Laura, that's the list of customers that we're in negotiations with to close in the second quarter -- is very, very strong.

So we think we could have -- we had a good fourth quarter on signings, roughly 15 plus billion, a good first quarter on signings, 15 plus billion, up 50 percent or so. And we're shooting to have a good second quarter signings. And therefore, we should have a good back end of the year in services.

Now, ...

John, ...

... the thing that we are, that we are working on is we need to get our BIS or consultant signings up. And that will bode even better for us going forward.

John.

Yes.

Just a question. As far as the good signings that you referred to in the June quarter, based on what you see in the pipeline, should we be expecting something that's flat with, more or less flattish with what we just saw this quarter?

Yeah, maybe up a little bit.

Thank you.

Next question, please.

Thank you. The next question is coming from Tony Sacconaghi of Sanford Bernstein.

Good afternoon.

John, just probing a little bit more on the technology group, you mentioned that about half of the operating profit loss was from HDDs and half was from microelectronics.

That business was down about 25 percent sequentially in revenues, and yet the operating profit was slightly improved. And intellectual property gains were also down sequentially.

So, A, can you help us understand why there was some improvement in that business? And was it HDDs or technologies that seemed to improve, despite the lower revenue base?

And then secondly, why over the course of the last week was the technology group's operating profit, you know, another $75 or $80 million lower than you had suggested last week?

OK. Thanks, Tony.

First, the improvement sequentially came primarily from storage technology, the technology group. And this goes back to what I said in our last call, Tony. That we had these three main drives that we needed to ship in volume. And as I mentioned in my remarks, you know, we did ship these new products.

However, we were short in volume in HDDs, but we did ship the new products and it did help improve the loss on a sequential basis from the fourth quarter of last year in storage technology.

And as far as technology group, it was a little bit better in the first quarter, based on some of the work we've been doing on trying to get costs out. But it was not -- it was not quite as good as we did in the HDD business, on a quarter-to-quarter basis.

Now, your second part of your question was what, Tony?

I was just inquiring on -- you had said it would be about $200 million, and it was about $75 million worse than you expected last week. I'm just curious if there was anything in there.

No, it was -- that was a very preliminary number. We saw the revenue shortfalls. We felt that we needed to go out and make the announcement that we made. And we were looking at where we saw ourselves coming up short. We came up short in the technology group, and at that time that's what we knew, and so that's what we announced.

Thanks, Tony.

Thank you.

Next question, please.

Thank you. The next question is coming from

Weber of SG Cowen.

Yes. I have a couple of questions.

One, you -- John, you said something about assessing your capacity depending on how this HDD deal works out. Does that imply that you're contemplating or at least there's a possibility of some significant write-off somewhere along the line?

And then my second question is, when I look at these numbers, it's sort of the seasonality and the year-over-year stuff. It would appear to me that the -- that your demand equation is sort of bumping along the bottom rather than getting worse.

Could you just give me your feeling on how it looks?

OK. On the capacity statement, as I mentioned a moment ago, we are still working with Hitachi, OK, on what the manufacturing strategy might look like, and what capacity will be required for the joint venture. And until we work through some of those issues, Steve, I need to kind of wait on that. And once we know something, we will let you know.

But what would be a timetable on concluding this deal, and when it might become effective?

Well, we were hoping to have definitive agreements by the end of the second quarter. So that's our goal.

You know, there's a lot to do between now and then. But we do have that as a goal. And depending on how the negotiations go will depend on whether or not we're able to get it done by the second quarter.

But it is not -- you know, we do have our discussion that we'll have on May 15th. And if there are any updates at that time, we will share them with you. If there's not, if we're still in the middle of negotiations, we'll have to wait until we get those concluded.

If you have a deal by the end of Q2, will you -- does that mean the joint venture starts? Or will there be another lag?

There could be another lag. This is going to take some kind to complete. It's a very complex deal. There are a lot of variables that we're dealing with.

I mean, this is important to us in that, A, that we are still going to be a participant, roughly 30 percent. We still need server drives and drives for our PC businesses. And this is very critical to our success going forward, so we need to make sure we work through all these things carefully.

And we're not going to try to just get it done by a given date. We're going to make sure we get the right agreement between Hitachi and ourselves.

But quite frankly, it's been going very well. You know the companies, we know each other well. They are a big supplier to us in our -- for components and whatnot. So the two companies know each other very well. And I think we will get this done as quickly as possible.

OK. The second part of my question, your feeling about the -- how you would characterize the demand equation?

Well, yes. I made the comment in my closing remarks that I feel that the current estimates better reflect what's happening in the information technology sector.

And so, I feel that, yes, there are a number of areas where we have seen the declines, they're not getting any worse, OK, that we are stabilizing.

And as I said in my closing remarks, you know, we think the second half of the year, given what we're seeing in consumer spending, given what we're seeing as we talk to our customers, could be a, you know, it could look like a pretty good second half.

Thank you. Next question.

Thank you very much.

Thank you. The next question is coming from Jay Stevens of Buckingham Research.

Yes, thank you.

John, could you put a little more color on backlog in services and how we should look at that? What goes into backlog?

Because the number is almost three times the annual run rate. And yet, services revenue has declined two quarters in a row. So help us understand backlog relative to revenue.

I'd ask you to go back to the chart that we put in the presentation, Jay. And I'll give a little bit more color to that.

We have -- there are a number of things that take place. It's the length of the contract, and back to Laura's question, you know, how much of our backlog are we adding strategic outsourcing, which have the longest length?

Now, we like those contracts, because it really builds our annuity stream, and they're long-term contracts, and that's good. But they are often longer in length.

The BIS contracts are shorter term. And they are the contracts that, where we're disappointed in the quarter in our signings.

We were very happy with our total signings, and pleased with our total signings, but we would have liked to have seen more consulting contract signing. So they are the things that you need to take into consideration as you look out and you try to track signings to revenue.

And I tried to help by making the comments that, based on what we know today, and based on what we think we're going to be able to do in the second quarter relative to signings, that we think we could get to double digits by the end of the year.

Thank you, Jay. I think we have time for one more question.

Thank you. Our last question is coming from Daniel Kunstler of J.P. Morgan.

Thanks. Good afternoon. Just a couple of little things.

In the press release you refer to some product transitions which may have weighed down on parts of the service business, but not necessarily including mainframe. And with the introduction of the z800, I was wondering if there had been some kind of a transition impact there.

And secondly, with regard to your improvements in market share, I was wondering if there's some specific data that you were referring to or are you tallying up the various announcements which have already been made by competitors, and the estimates of analysts for those who have not yet announced?

OK. Relative to the z800, yes. There was a product transition stall, and -- but it was primarily in Europe. We did quite well with the z800 in the U.S., but there was a stall in Europe. And we think that actually that could help our second quarter numbers for the mainframe.

Relative to the share statements, Daniel, we are -- we are basically using First Call numbers for many of the statements that we've made. And in some cases, some of our competitors have already announced or pre-announced. And so we're kind of using the summation of all that information to make the statements that we're making.

But quite frankly, as we look forward, I mean that is our number one goal in this difficult IT sector at this point in time, is to continue to gain share.

And then when things pick up, we think we are going to be very well positioned, given the fact that, you know, we're number one in services. We're number one in WebSphere. And we're number one in servers.

You know, we're fighting to be number one in database and number one in custom logic.

And given that position, and given the fact that we believe things will begin to pick up, as some of the estimates have suggested, with our strong cash flows and good earnings, we have the right strategy and we think going forward we're on the strategy. And now it's just a question of continuing to gain share, and we'll do quite well when this economy picks up.

OK. Thank you, Daniel. And thank you all for your participation.

That concludes our conference call.

Thank you for your participation.

This does conclude today's teleconference. You may disconnect your lines at this time, and have a wonderful day.

END