International Business Machines Corp (IBM) 2005 Q4 法說會逐字稿

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Today's conference is being recorded.

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Now we will turn the meeting over to Ms. Patricia Murphy, Vice President of Investor Relations.

Ma'am, you may begin.

This is Patricia Murphy, Vice President of Investor Relations for IBM.

Here with me today is Mark Loughridge, IBM's Senior Vice President and Chief Financial Officer.

Thank you for joining our fourth quarter earnings presentation.

By now the opening page of the presentation should have automatically loaded and you should be on the title page, chart one.

The charts will automatically advance as we move through the presentation.

However, if you prefer to manually control the charts at any time, you can uncheck the synchronize button on the left of the presentation.

As always, the prepared remarks will be available in roughly one hour, and a replay of this webcast will be posted to our Investor Relations website by this time tomorrow.

This presentation includes certain non-GAAP financial measures in an effort to provide additional information to investors.

All non-GAAP measures have been reconciled to their related GAAP measures in accordance with SEC rules.

You will find reconciliation charts at the end and in the Form 8-K to be submitted to the SEC.

For those of you who are manually controlling the charts, please click on the next button for chart 2.

Certain comments made in this presentation may be characterized as forward-looking under the Private Securities Litigation Reform Act of 1995.

Those statements involve a number of factors that could cause actual results to differ materially.

Additional information concerning these factors is contained in the Company's filings with the SEC.

Copies are available from the SEC, from the IBM Website, or from us in Investor Relations.

Now let's go to chart 3.

And I will turn the call over to Mark Loughridge.

In the fourth quarter we delivered $24.4 billion in revenue, which was down 12% as reported.

Without PCs and the impact of currency, revenue was up 3%.

Our pretax income was $4.6 billion.

This includes about $180 million of gains from certain real estate transactions as compared to the $75 million previously estimated.

And we delivered $2.01 of earnings per share, up 20% year to year.

This quarter we had one non-recurring item.

On January 5 we announced changes to our US pension plan.

We recorded a onetime pretax charge of $267 million in the fourth quarter for the curtailment of these plans.

When you exclude the non-recurring charge, IBM's pretax profit was $4.8 billion, and we delivered $2.11 of earnings per share, up 26% over last year's fourth quarter.

But the most appropriate comparison is to last year's fourth quarter without the divested PC business, as this view best reflects our ongoing performance.

The details and description of the PC results are included in our supplemental charts.

On this comparable basis revenue was down 1% as reported, but up 3% at constant currency.

Our pretax income was up 22%, and earnings per share were up 29%.

Looking at our results by business, in Hardware we had strong performance in storage, microelectronics and our zSeries and pSeries servers.

In Software performance was led by our key branded middleware products, especially information management and Tivoli.

Our Services business had improved margin performance, driven primarily by benefits from our productivity initiatives.

And across our geographies the strongest results were posted by the Americas, which executed well in a solid demand environment.

These results once again reflect the strength of our business model, the global scope of our enterprise, and the ability of our broad portfolio to consistently generate earnings and cash.

Let's move on to our full year performance with chart 4.

In 2005 our reported results included PC results for four months and non-recurring items.

As reported, we delivered $91.1 billion of revenue, down 5% year to year.

Pretax earnings were $12.2 billion, up 15%, and earnings per share were $4.91, up 12%.

Without the non-recurring items in 2004 and 2005, our pretax earnings were $12.4 billion, up 12%.

And earnings per share were $5.32, up 18%.

The view that best represents our ongoing operational performance is IBM's results without non-recurring items and the divested PC business.

On this basis we delivered $88.3 billion of revenue, up 3% as reported and at constant currency.

Pretax earnings were $12.5 billion, up 15% year to year, with solid growth and contribution from Hardware, Software and Services.

And earnings per share were $5.36, up 21%.

Net cash from operations, excluding Global Financing receivables, was $13.1 billion, up $200 million year to year.

We had record returns to shareholders through share buyback and dividends of $9 billion.

We ended the year with $13.7 billion of cash on hand, and low debt levels for our non-financing business.

In 2005 our return on invested capital was 24%, excluding our global financing business and the non-recurring charges.

Early in the year we said we would deliver our profit more through cost and expense performance than revenue.

Throughout the year we leveraged our productivity initiatives to drive earnings per share growth in excess of our longer-term financial model objectives.

We will continue to leverage the cost efficiency of our model to drive profit growth as we move to 2006.

Now let's get into the details of the fourth quarter starting with revenue, chart 5.

Total revenue in the fourth quarter was down 12% year to year as reported.

Without the PC business, revenue was down 1%.

Currency negatively impacted our growth by 4 points, one point more than our estimate based on spot rates in mid-October.

Without the impact of currency, our revenue was up 3%.

Global Services was down 5% year to year as reported, and down 1% at constant currency.

The decline was driven primarily by our short-term signings performance and by a decline in strategic outsourcing revenue.

We will get into the Services revenue dynamics when we discuss the Services business.

Hardware revenue was down 27% as reported.

Without the PC business, Hardware was up 6% and up 9% at constant currency.

We had strong double-digit growth from our storage products and our microelectronics OEM business.

Software revenue was flat as reported, and up 3% at constant currency.

Our key middleware brands contributed high single digit growth at constant currency, offset by declines in operating systems and other middleware products.

Global Financing revenue was down 8% as reported, or 6% at constant currency, driven by a continued decline in the asset base and a lower level of used equipment sales.

Now let's turn to revenue by geography, chart 6.

To provide the best view of our ongoing geographic performance, I will focus my comments on the results without PCs at constant currency.

Looking at the major geographies, America's performance was again driven by solid execution.

The performance was broad based, with growth across all key brands and all regions.

Overall, demand remains good as clients invest to improve the competitiveness of their infrastructure, and to provide differentiated advantage in the marketplace.

Performance in Europe remained mixed.

Revenue in Spain and the Nordics was up, and France grew for the second consecutive quarter.

While Germany's growth rate improved, Germany and Italy continued to decline, although in these countries, and in fact across all regions in Europe, we had good growth in Hardware.

After successful execution of the restructuring actions, our new operating model with a more streamlined management system is now in place.

It will allow us to compete more effectively in these markets.

Asia-Pacific revenue declined this quarter.

Japan, which represents about 60% of the Asia-Pacific revenue base, once again declined at constant currency.

We continue to drive our actions to improve execution.

And as they take hold in the first quarter we expect improved performance.

Mitigating declines in Japan, China grew, and ASEAN again posted strong results lead by India.

China and India, together with Brazil and Russia, comprised the emerging countries that we discussed in past quarters.

For the year these emerging countries delivered $3.8 billion of revenue without PCs, and grew 14% at constant currency.

Year to year growth was lead by India at 55%, while China grew 8%, Brazil 7%, and Russia 29%.

We will continue to shift investments to these high growth markets.

Finally, our OEM growth was 35% in fourth quarter, driven by the ramp up in our game chip processors.

Now we will move on to gross profit, chart 7.

Gross profit margin in the fourth quarter was 44.1% up 5.3 points year to year.

Without the improvement from the divesting the low margin PC business, margin was up 2.2 points.

Global Services gross profit margin was up 3.1 points year to year.

As in the third quarter we had good yields from our productivity initiatives and a better contract profile.

Hardware gross profit margin improved over 9 points year to year, driven by the divestiture of the PC business.

Without PCs the Hardware gross profit margin was flat.

Software gross profit margin improved slightly.

Global Financing gross profit margin was down 2.3 points.

As we have discussed in the past, this business is more approximately measured on return on equity.

For the full year Global Financing's return on equity was 33%.

Now let's turn to expense, chart 8.

Total expense and other income declined 7% in the fourth quarter as reported.

Excluding the $267 million onetime curtailment charge for our US pension plan change, expenses would be down 11%.

Without the PC results in 2004 and the pension charge, expense and other income was better by 7%.

On this basis, expense to revenue improved 1.7 points year to year.

And we improved our SG&A expense to revenue ratio about .5 point down 20.4%

Benefits from our second quarter productivity initiative drove the year to year improvement.

By the end of the year essentially all of the impacted resources had exited the business.

These departures drove a high level of savings in the fourth quarter, yielding a large benefit to cost and expense in the period, as in the third quarter most of the cost reduction went to the bottom line.

Over the longer term these actions give us a more competitive cost structure, more pricing flexibility, and allow us to better manage escalating labor costs.

Turning to our roadmap of items that materially impacted earnings growth, let me start with the two items that negatively impacted out growth.

Retirement related plans, both pension and heath, were a year to year hurt of $522 million as reported, including the onetime curtailment charge.

Excluding the curtailment charge, retirement related plans were hurt of $255 million.

For the full year, excluding charges in both years, retirement related costs was up approximately $1 billion, in line with our estimate at the beginning of 2005.

In spite of the fact that our pension plan changes will save us between 450 and $500 million in 2006, retirement related expense will still increase another 400 to $500 million year to year, excluding the impact of the 2005 onetime charges.

Addition details on our pension assumptions and plan changes were posted to our Investor website on January 5.

Our profit growth was also impacted by a decline in IT income, down about $70 million year to year.

There were a couple of items that materially helped our earnings growth.

Total equity compensation, including the cost for restricted stock units and performance-based rewards, was down about $140 million year to year.

We have included additional information on our equity compensation in the supplemental charts.

Gains on real estate transactions were up almost $160 million year to year.

This is reported in Other Income and Expense.

You recall that last quarter I had told you we had some real estate transactions in process.

And at the time our best assessment was that we would record a pretax gain of $75 million in the fourth quarter.

Our actual fourth quarter results include a pretax gain of $182 million, primarily comprised of a gain on the sale of an office building in Japan partially offset by a charge to write down a building in the U.S.

The additional gain of $107 million over our original estimate of $75 million was not offset as we had expected by a loss on the sale of another building in Japan.

We are unable to reach an agreement with the buyer and the building remains in service for the company.

When we comment on 200 at the end of this presentation, there is $107 million over-achievement should be excluded.

Turning to currency, the U.S. dollar has generally strengthened since year end 2004 especially against the European currencies.

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

The impact of these hedging programs is principally reflected in other Income and expense, as well as COGS.

This quarter, hedging programs account for approximately $150m of the improvement in other income and expense.

I am not going to predict future currency moves but at current spot rates, currency will hurt revenue growth in the next few quarters.

Over an extended period of time, a stronger US dollar negatively impacts IBM's revenue and earnings.

The supplemental chart at the end of the presentation benchmarks currency’s potential future impact on revenue.

Assuming Friday's exchange rates, you will see that based on these rates, we would expect a 3 to 4 point impact to revenue growth in the first quarter without PCs, and a 2 point impact in the second quarter, before moderating in the second half.

Now let’s turn to cash flow, chart 9.

We had another outstanding year in cash generation.

This cash flow analysis chart has one primary difference from the FAS 95 format.

It considers our Global Financing receivables as an investment to generate profit, not as working capital that should be minimized for efficiency.

For 2005 net cash provided from operations excluding the change in Global Financing receivables was $13.1 billion, an increase of over $200 million from last year.

Our cash performance was driven primarily by our net income growth and our continued focus on working capital and supply chain management.

Within working capital, adjusted for the sale of the PC business, receivables collections continued to improve.

Inventory decreased over $450 million year to year.

Adjusted for the sale of the PC business, inventory was down over $250 million.

And we received $775 million in the third quarter from a settlement with Microsoft.

We paid out $1.3 billion in restructuring cash payments, and funded a $1.7 billion contribution to the US pension fund in the first quarter of 2005, $1 billion more than was funded in 2004.

Turning to our use of cash for investments, net capital expenditures were approximately $3.5 billion, a decrease of approximately $200 million year to year.

Let me make a subtotal here since many investors look at cash flow after capital expenditures.

We generated cash flow of $9.6 billion, about 400 million more than last year.

Without the $1 billion of additional contribution to the US pension plan, we generated $1.4 billion more cash flow this year.

Next, our Global Financing receivables, net of changes in Global Financing debt, were a source $1.3 billion due to continued decline in income generating assets.

We spent approximately $1.5 billion on acquisitions in 2005.

Almost half of that was for the second quarter acquisition of Ascential.

And we had net proceeds from divestitures of over $650 million, driven by the sale of the PC business, and about $270 million as a final settlement of the HDD divestiture.

We returned a record $9 billion to investors this year, an increase of over $650 million year to year. $7.7 billion of this was through share repurchase.

We bought back over 90 million shares, and average diluted shares were at 1.6 billion, down 4.7% from a year ago.

We have approximately $5 billion remaining at the end of December from our last Board authorization.

And we paid out over $1.2 billion in dividends.

This year between our share repurchase and dividends we were able to pay out to our shareholders over 100% of our net earnings, even after investing $10 billion in R&D, capital expenditures and acquisitions.

Moving on to chart 10, we will discuss the balance sheet.

Our cash on hand was $13.7 billion.

Over 90% of our total debt of $22.6 billion was driven by our Global Financing business, and Global Financing was leveraged at an appropriate 6.7 to 1.

The remaining nonfinancing debt level was about $2.1 billion, and debt to capital was 6.7%.

The majority of the debt increase was to facilitate the Homeland Repatriation, and is expected to be significantly reduced by the end of 2006.

Under this provision of the U.S. tax law we repatriated $9.5 billion this year, consistent with what we told you in October.

Our balance sheet remains very strong, and we are well-positioned to capitalize on future opportunities and meet our cash needs.

Now let's turn toward three key businesses starting with Global Services, chart 11.

Global Services delivered revenue of $12 billion, declining 5% as reported and 1% at constant currency.

The segment profit was up 18.5% year to year, and the pretax margin improved to 11.9%.

Signings for Services this quarter were $12 billion at the spot rate and $11.5 billion at constant currency.

This includes $5.3 billion of short-term signings, which were down 4%, and $6.2 billion of long-term signings.

We signed eight deals larger than $100 million this quarter.

Our backlog is estimated at $111 billion, the same as a year ago.

Before turning to the three major businesses, let me comment on Services' revenue dynamics.

Revenue growth in the quarter is influenced by short-term signings in the current and prior quarter.

Our short-term businesses include Integrated Technology Services and the commercial content of Consulting and Systems Integration.

As I said, short-term signings were down 4% and were essentially flat in the third quarter.

Our long-term business includes strategic outsourcing, business transformation outsourcing, and the federal content of Consulting and Systems Integration.

Growth in these businesses is influenced by several factors, including the cumulative effect of signings, contract duration, extensions and change in backlog over time.

Turning to the three major segments, Strategic Outsourcing signings declined 32% this quarter.

Revenue was down 5% as reported, and down 2% at constant currency.

Strategic Outsourcing revenue growth continued to be impacted by the high levels of backlog erosion we experienced in 2004, and the cumulative effect of lower signings starting in 2004 through the first quarter of 2005.

Integrated Technology Services, excluding maintenance, was down 5% year to year as reported, and down 2% at constant currency.

ITS signings this quarter were down 10%.

In 3Q I told you that we are in the process of making the necessary changes to return this business to growth.

The initial portfolio rebalancing work is complete.

We're adding business development skills, and the sales coverage is aligned to the revised portfolio.

These changes will be operational in the first quarter.

Business Consulting Services was down 6% as reported and down 1% at constant currency.

This was driven by double-digit declines in Asia-Pacific and Italy while America's grew.

Business Consulting Services signings were up 23%, driven by 144% increase in long-term business transformation outsourcing signings.

Sightings growth was driven by the Americas and Europe.

Consulting and Systems Integration signings were up 4%, driven by growth in our longer-term U.S. federal business.

Strength this quarter were in the Strategy and Change and Supply Chain Management practices within CNSI, as well as overall strength in the financial services sector, SMB and the Americas.

We're taking actions to improve our growth in Consulting and Systems Integration.

I will mention just a few.

We are increasing level of dedicated sales resource to drive our business and web services and SOA solutions, further investing in resource to address midmarket opportunities, increasing the level of brand resource in Asia-Pacific, and leveraging our global end-to-end design, build and run capabilities.

Our Business Transformation Outsourcing business continued its strong year to year growth.

BTO is an important offering to address the Business Performance Transformation services opportunity.

Other elements include the Strategy and Change Practice, Engineering and Technology Services and Business Performance software.

For the year BPTS revenue $4 billion, up 28% year to year.

Turning to margins, Global Services' gross margin improved 3.1 points year to year.

Pretax margin was 11.9%, an improvement of 2.4 points year to year.

The year to year improvement in pretax margin was primarily driven by benefits from our restructuring action, CNSI utilization improvement, and a better contract profile, offset by IT investments and pension increases.

The margin also benefited from a portion of the real estate gains, which contributed approximately the same amount to margins as the gain from the divestiture in the fourth quarter of last year.

So to wrap up the year, we improved our margin performance year to year, while making our Services business more cost competitive.

Productivity initiatives such as Professional Marketplace began to take hold.

This helped drive improved utilization, and will be one of the drivers of margin expansion going forward.

We increased our global delivery capabilities by adding over 15,000 resources to our global delivery resource centers.

We grew long-term signings 19% for the year.

These signings provide benefits over longer periods of time with little immediate impact to revenue growth.

Backlog was stable with increased signings and less erosion than 2004.

We did however, fall short of our revenue expectations for the year, primarily in our short-term businesses.

Looking forward, our pipeline for the first quarter is up year to year with particular strength in our long-term businesses.

As always, we need to execute to convert the pipeline to signings.

We expect improvements in our short-term businesses.

Actions we are taking in Integrated Technology Services and Consulting and Systems Integration should yield benefits over the course of the year.

Our Business Transformation Outsourcing business remains strong.

Based on this, we expect Services revenue growth to accelerate throughout 2006, to achieve mid single digit revenue growth in the second half.

And we will continue to focus on driving higher margins with more competitive cost structure.

Now I'll move on to Systems and Technology Group, chart 12.

Systems and Technology Group revenue of $6.8 billion grew 6% year to year and 10% at constant currency on the continued strength of the zSeries and pSeries servers, storage and our microelectronics business. zSeries revenue grew 5% year to year and 10% at constant currency.

MIPS grew 28% year to year.

This was our largest quarter of MIPS shipments on record and our highest revenues since fourth quarter of 1998.

Today date over 60% of our revenue is driven by new workloads such as Linux and Java, compared to only 15% at the end of 1998.

This increased adoption of new workloads by our customers highlights the broader applicability of the platforms, enhanced customer benefits of our latest System z9. iSeries revenue declined 18% in the quarter as we wrapped around our high-end POWER5 introduction in late 2004.

We saw late quarter fall off as customers anticipated the first quarter announcement of new POWER5 Plus-based products.

For the full year iSeries grew 1% year to year.

In 2005 iSeries added over 2,500 new customers, reflecting a continued commitment to the platform from ISPs, resellers and customers. pSeries UNIX servers grew 4% year to year and 7% at constant currency in what we believe is a flat market.

We saw additional demand in the quarter in the public sector which had an impact to our margins.

The full year performance is extraordinary.

With 15% year to year growth, double-digit growth in all geographies we expect this will be the fourth consecutive year of pSeries share gain.

The refresh of our POWER5 product line began in the fourth quarter, and additional roll outs are coming in 2006.

xSeries service revenue was flat year to year and up 3% at constant currency. xSeries volumes were up 13%; however, we saw strong competitive pressures drive lower pricing.

We expect to maintain our leadership position in Blade Center with fourth quarter revenue growth of 41%, and full year growth of 65%.

Total Storage delivered year to year growth of 24% driven by strength in both enterprise and midrange disk.

Total disk grew 32%, with enterprise disk at 46%, and midrange disks growing 40%.

Tape also turned in a strong performance growing 8%.

Believe we have gained significant share in external disks and extended our share leadership in tape.

Our storage virtualization momentum continued in the fourth quarter with growth of almost 40%.

Total Storage margin improved quarter to quarter, but was down year to year driven by intensified competition on price, and the mix impact of our midrange growth in both disk and tape.

Microelectronics' fourth quarter revenue grew 48% year to year.

Revenue from our 300 mm products grew over 250%.

Yields on our game processors continued to exceed expectations this quarter with our first full quarter of production shipments.

In addition to the AMD commitment announced in the fourth quarter, last week we announced that Sony and Toshiba signed five-year extensions in our development partnerships.

We believe collaborative relationships like these also enable us to leverage IBM technology in adjacent markets.

Engineering and Technology Services grew 7% as reported and 14% at constant currency, bringing full year growth to about 40%.

E&TS enabled customers to leverage our design skills, know-how and technical capabilities to meet their needs, and is part of the high-growth Business Performance Transformation Services opportunity.

I will move on to Software, chart 13.

Software revenue was $4.6 billion in the quarter, flat year to year as reported, but up 3% at constant currency.

For the full year Software grew 4%, both as reported and at constant currency.

Key branded middleware grew 3% as reported and 7% at constant currency in the fourth quarter.

This concluded a solid year with key branded middleware growing 9% year to year as reported and at constant currency, driven by double-digit growth in WebSphere, Tivoli and Lotus.

Operating Systems were down 6% as reported and down 3% at constant currency.

For the full year Operating Systems were down 2% as reported and down 3% at constant frenzy.

The software market remains highly competitive, and our fourth quarter results were mixed by geography.

We saw double-digit growth in the Americas where we believe we gained market share in both the fourth quarter and full year.

This was partially offset by weaker results in Europe.

The WebSphere family of software grew 4% as reported and 7% at constant currency.

For the full year WebSphere grew 10% both as reported and at constant currency.

The WebSphere family of software provides the foundation technology for customers implementing business processes and applications and of services oriented architecture.

As customers’ interest in SOA has increased, so has the demand for highly scalable robust infrastructure platforms such as WebSphere.

In 2005 we saw particular strength in WebSphere application servers and portals, which grew 15% and 12% respectively.

The WebSphere application server did particularly well in the fourth quarter, growing 16%.

In October we completed the acquisition of Data Power Technology, which combined hardware and software technology in an appliance that helps simplify, accelerate and increase the security of SOA deployments.

Information Management software grew 4% year to year as reported and 8% at constant currency.

For the year Information Management grew 8%.

In 2005 we saw growth in our Information Management distributed software, fueled by our content management and information integration product sets.

Ascential continues to exceed our expectations.

Lotus revenue grew 2% year to year as reported and 7% at constant currency for the fourth quarter, completing a good year of 10% growth.

Lotus continues to enjoy strong customer response to the Domino Version 7 product line, as well as very high interest in Workplace software.

Workplace more than doubled both year-over-year and sequentially.

Rational software declined 2% as reported and grew 2% at constant currency in the fourth quarter.

For the full year Rational grew 4%.

In the fourth quarter the Rational product set had good performance in both Asia and Europe.

In the Americas a small number of customers delayed their buying decisions.

Tivoli grew 3% as reported and 7% at constant currency in the quarter.

Full year growth was 11%.

Tivoli storage software products grew 17% in the quarter and 24% for the year, as customer adoption of our virtualization technologies continued to gain traction.

In the fourth quarter we announced our intention to acquire Micromuse.

This software helps customers manage the complex IT networks that support data, voice and video traffic.

Micromuse is well-positioned to participate in the growing demand for voice over IP, audio and video services delivered over the Internet.

Overall, our Software business was solid in 2005.

We believe we gained share in all five key middleware brands in 2005, and held share in total middleware.

The profitability of our software portfolio improved as well with pretax income margin growing by 3 points in 2005.

Now I will wrap up chart 14.

We accomplished a lot in 2005, with solid growth in earnings and cash generation balanced across our portfolio.

IBM delivered earnings per share growth of 12% as reported, 18% without non-recurring items, and 21% without the non-recurring items and our divested PC business.

This profit performance is driven by a combination of unit performance, portfolio actions and execution of our productivity initiatives.

This year we have taken a number of very important actions to improve productivity and reallocate resources to the faster growing areas of the business.

We completed the sale of our PC business to Lenovo.

The transition was smooth, and through our relationship with Lenovo we're better positioned in China's fast-growing market.

We continued to invest in acquisitions to strengthen our On Demand capabilities.

In 2005 we completed 16 acquisitions, primarily in Software and Services, at an aggregate cost of $2 billion.

We further extended our commitment to innovation and open standards.

We successfully implemented a large restructuring action to improve the competitiveness of our cost structure.

We changed our operating model in Europe, driving resources and decision-making closer to the customer to improve speed and responsiveness.

We redesigned our US pension plan and are taking actions in other countries as well.

Over the longer-term these changes will result in less volatility and a more competitive cost structure.

These actions contributed to our strong earnings and cash performance in 2005, and strengthened our capabilities as a globally integrated Company.

Now let's move on to chart 15.

Before wrapping up, I would like to spend a minute discussing the structure of our business.

Oftentimes we think about IBM only in terms of revenue mix.

I would like to instead focus this discussion on product mix, which is the source of our strong cash flow.

We will do this in a very straightforward way by discussing the profit generation of our Software business, our Hardware business, and our Services business.

Based on 2005 segment pretax profit, excluding second quarter restructuring charges and PCs, approximately 37% of our 2005 total segments profit was generated from Software, another 28% from Hardware and Financing, and 35% from Services.

Strategically we have exited low margin commoditized businesses and created a more balanced portfolio.

We integrate and package across our segment to create solution offerings for our global customer base, driving profit and cash over the long term.

We can look at this past quarter as an example.

We showed strong hardware growth of 9% at constant currency, with particular strength in Storage, microelectronics, zSeries and pSeries servers.

Software revenue grew 3% at constant currency.

Our key middleware brands, now over 50% of our total Software revenue, grew 7%, while our operating systems and other middleware offerings drove solid profit and cash generation.

And in Services revenue declined 1%.

Despite the varying revenue dynamics of Hardware, Software and Services each segment contributed solid profit growth.

Now let me digress for a moment on the contribution of long-term signings to our near-term profit.

Large long-term deals are good for the business to be sure, but the yield to revenue from long-term sightings within a given year is typically only 8 to 10% of the total long-term signings' amount.

This means that the contribution from $1 billion of long-term signings within the year at average gross margins will at most provide IBM with 20 to $30 million of profit in the year, a small amount as compared to a 2005 pretax earnings base of roughly $12 billion.

These signings provide more significant benefits to revenue and profit over the longer term.

The strength of the IBM business model is not in any single component.

It is in our ability to generate consistently strong cash and earnings, with balanced contributions across our broad portfolio of industry-leading business segments.

So what does this all mean for 2006?

We are positioned to continue to drive margin improvements with more competitive cost structure across the portfolio.

About two-thirds of our profit will come from Hardware and Software, with continuing growth from our strong product lines.

We expect to grow Services signings in first quarter by improving execution on short-term signings and driving closure on key long-term deals, which will help provide a stable base of business for years to come.

And as always, we have headwinds to work through in 2006, such as continued year to year increase in pension costs, and the impact of our business from the strengthening of the dollar.

Turning to the average of analysts earnings per share estimates for 2006, based on what we know now and a steady economic environment, it would be reasonable to roll through the fourth quarter operational over achievement excluding the real estate over achievement.

As always, we remain committed to deliver double-digit earnings per share growth over the long term through an integrated portfolio of Hardware, Software and Services.

Now Patricia and I will take your questions.

Before we began the Q&A, let me comment on two items.

First as always, we have a few supplemental charts at the back end of deck that that complement Mark's compared remarks.

Second, as always, please refrain from multipart questions.

This will allow us to take questions from more callers.

Okay, operator, let's open it up for questions.

(OPERATOR INSTRUCTIONS).

Tony Sacconaghi with Sanford Bernstein.

I can't resist, but I do have a clarification and a question.

You had mentioned, Mark, to roll through the over achievement, just to be specific on that.

You beat consensus estimates by $0.17 this quarter.

Your over achievement from extra real estate was about $0.045, $0.05, so you are suggesting that consensus analyst estimates should go up by $0.12.

I just wanted to clarify that.

And then second for 2006, -- and then secondly I wanted to just get a sense of your productivity initiatives.

When you talked about them last year you were expecting a yield on your workforce reductions of 3 to 500 million in the second half of 2005, and a yield of 2 to 3 X that in 2006.

Is that still in line with your expectations, or did you actually get a bit more than you thought in the second half?

And how we would be thinking about 2006?

Thank you.

For your first question, you are quite correct.

We would view the operational over achievement in the fourth quarter at that $0.12 range, excluding the $0.05 for real estate that we over achieved.

And to your second question, we got about what we thought in 2005 at 500 million.

And that was split about 200 million in the third and 300 million in the fourth.

So if you look at 2006 consistent with what we said earlier, we think the cost expense savings for the restructure remains at 1.3 billion, or 800 million year to year.

Now I would keep in mind that these actions are designed to drive a more competitive business, especially in Services.

And over the longer-term these actions give us a more competitive cost structure, more pricing flexibility, and allow us to better manage escalating labor costs.

Let's go to the next question please.

Bill Shope with JP Morgan.

Looking at the microelectronics business, when you combine the strength in the 300 mm business with the declines in the legacy business, can you give us a read on what the overall margin impact from the business would be either quantitative or qualitative?

Given the 200 million of declines do you still see a benefit to Hardware gross margins?

Let me first start out by saying we're pretty pleased with the growth that we saw in our 300 mm.

And we're very pleased as we move into 2006 with that momentum.

We did have a very good quarter in microelectronics, and we have made a lot of progress.

The primary purpose for our investments I would remind you in technology and the 300 mm fab is to drive leadership in our Systems business.

So the game chip that drove OEM volumes this quarter benefit from the same technology and fab support as our IBM systems, but what I would like both to remember is that the Power-based UNIX servers have been gaining share since IBM -- that were introduced -- the technology years ago.

And the POWER5 has also had a strong impact on high-end Storage.

We had 46% growth in the quarter, and now we're starting to introduce POWER5 Plus into our server line.

I would say, yes, and it is okay as you look at it to look at those trends and expect us to continue that kind of momentum as we go into '06.

Let's go to the next question please.

Laura Conigliaro with Goldman Sachs.

On the Services side, DPI and others have suggested that outsourcing growth is going to be slower in '06, which could be obviously a real problem since outsourcing is about 70% of your bookings.

Also, it is pretty well understood that you've got more than the normal amount of business up for renewal in '06, so that opens up the possibilities for even more unpredictability.

And of course, signings have been pretty erratic based on what you expected this quarter and what didn't happen.

How can you be confident under these circumstances that you will be able to pull through the kind of Services growth that you are anticipating?

What, for example, can you tell us about some specific pipelines, or having been down selected, or anything that gives us more specificity so that it adds to your confidence level?

First of all, let's start -- a very good question -- let's start from a demand perspective.

As we look at SO, the outsourcing market is huge, and there is plenty of opportunity out there.

We frankly like the way we are positioned.

We are the market share leader, which we believe we will maintain.

And on longer-term signings for the year, of which SL is the major component, I mean the longer-term content was up 19% for 2005.

Those are just by nature the signing is going to be lumpier in nature.

But as we look at both the pipeline and the deal list for our long-term signings going into the first quarter, we're quite optimistic.

I think we actually -- though you were correct, the long-term signings are lumpier in nature -- if you look at the full year performance in the long term, I actually think it is pretty good.

And we're quite confident on our long-term base as we entered first quarter.

Let's go to the next question please.

Steven Fortuna with Prudential Equity Group.

Just one question, Mark.

You grew xSeries basically flat year-over-year.

How much of that is increased competition from [Gilbert]?

Are they a much more formidable force in the marketplace over the past say three months, six months versus a year ago?

Let's look at it this way.

First of all, we posted our highest volumes in xSeries' history, and are growing double-digit at 13%.

We have gained volume share for the third consecutive quarter.

However, our revenue per unit has declined year to year resulting in 4% growth at constant currency.

So if you look at the reasons behind that, I would put it in three categories.

Number one, we have grown our volumes 31% in high-end space driven by very solid four-way rack performance.

And we have gained share in the four-way space, but we have seen our revenue per unit erode, given by competitive price pressures.

Number two, we are experiencing competitive price pressures in Asia-Pacific and Europe, particularly in our mainstream one and two-way products which still represent a large part of the market in these regions of the world.

And last I would close, we have also faced some operational execution issues as we transition some models.

We under called demand on some of the products in the fourth quarter, and were not able to secure supply to satisfy this demand.

But I would go back to the top.

Number one, volumes did improve.

We did have price pressure, and we're very confident on the momentum in Blade.

Let's go to the next question.

Richard Gardner with Citigroup.

A simple question.

Q4 was the first quarter in '05 in which you experienced significant leakage out of the backlog.

In Services it looked like it was about 1.5 billion.

Could you just talk about what was the cause of that, and maybe expectations for backlog leakage on a go forward basis here as we go into 2006?

That is a good question.

First of all as I look at it, erosion in the fourth quarter was higher than previous quarters, but for the full year erosion was down really quite significantly.

If you look at it the level of erosion in 2005 was frankly down 40% from 2004.

Now even if you exclude JPMC from 2004, the erosion in 2005 was still down nearly 20%.

And in fact, the erosion in 2005 was the lowest level we have had in four years.

I don't think the data really suggest there's a problem in erosion, although erosion in a way, like long-term signings, can be lumpy as it is distributed through your quarterly performance, so I would look at longer-term trends.

Let's go to the next question please.

Ben Reitzes with UBS.

Could you talk about the mainframe and perhaps pSeries?

You talked about the zSeries -- or I believe 5% growth.

Could you just talk about this new cycle?

What is different?

Should we expect an acceleration throughout the year?

And then also with pSeries a little slower growth than in other quarters.

Maybe you are foreshadowing here some new product cycle.

Can you talk about those two big areas in Hardware, and how we look at those in '06?

You bet.

We do -- as you look at the zSeries cycle, it is -- you can't really predict with any level of precision, but I will say that we expect to see continued growth through the first half of 2006, continuing the momentum that we have seen in the fourth quarter.

We do expect to see moderated growth in the second half '06 as we begin to wraparound our initial z9 shipments towards the end of the year.

If you look at your second question, pSeries, pSeries grew 15% for the full year, which I think demonstrates our technology leadership in the UNIX market.

We have grown market share consistently for four years in this brand.

The higher growth rates early in the year were fueled by a fully refreshed POWER5 product versus the POWER4 in prior years.

And I think fourth quarter constant currency growth of 8% is roughly in line with our future expectations, which is to grow above the UNIX market share and to continue to gain share.

So we are sourcing our growth both from competitive displacement and from expanding workload with our existing customers.

Let's go to the next question please.

Cindy Shaw with Moore & Cabot.

I wanted to ask you about offshore.

What I am hearing from my industry contacts is IBM is now fully price competitive and capable against the offshore pure plays.

And my question is are we going to see IBM turnaround and take the offensive on offshore now?

And how might fully price competitive capability affect any contract renewals that might be coming up?

We're continually adjusting our resources investments in response to the marketplace.

I would step back and say we think we have a very competitive position with the global solution capabilities we have developed, and continue to increase the volume work with our clients.

So we have grown resources in our global delivery centers, over 15,000 this year alone.

But I want to reemphasize that this is not a labor arbitrage element of the strategy.

It is really developing an extensive capability in both application services, SO, BTO service delivery and technical support.

It is a broad skill base, a good distribution on a global basis, and I think it puts us in good shape as we enter 2006.

Let's go to the next question please.

Chris Whitmore with Deutsche Bank.

Just following up on that last question.

How does IBM -- or how is IBM currently viewing the trade-off between pricing and taking prices lower in Services and profitability in that segment as some of these restructuring benefits come through?

And tied to that, what percentage of the incremental cost savings does IBM expect to fall to the bottom line in '06?

It is very difficult to tell the percentage of those cost savings that fall to the bottom line.

If you look at it, as I said earlier on Tony's question, we did achieve our cost savings objective this year in both the third and the fourth quarter; in aggregate that was 500 million.

And we look for another 800 million year to year.

But I would say from a price standpoint in Services, price pressures were really pretty stable in the quarter, but it is of course a very competitive segment.

And both SO and ITS price pressures remain fairly constant at a worldwide level, while in CNSI pricing trends are pretty stable, or if anything, improving a bit.

Let's go to the next question please.

Rebecca Runkle.

Just a follow on to that is while as it relates to Hardware, you commented a couple of times in your prepared remarks about increasing pressure on servers and storage competitively speaking.

Those far we haven't seen you take some of the restructuring down into the pricing side of the equation.

You have let it drop to the bottom line.

But why won't we see you get more aggressive in Hardware given the competitive dynamics you saw in the fourth quarter?

Let me describe the Hardware dynamics.

First of all we are, as you would expect, quite pleased with our Hardware revenue growth in the quarter.

I would argue that we are obviously priced pretty effectively as it is.

But I will give you some flavor underneath that.

In zSeries we see a continuation of the trend of moderate price to clients as we move more new workload onto the platform.

In UNIX we did experience some more aggressive price competition at the low end of the product line, but really more stable at the high end.

In xSeries I would say that we're finding both AP and EMEA to be particularly competitive environments right now.

So we're very focused on achieving cost reductions to maintain margins here.

And in Storage, price pressure is pretty high, most notably in the mid range space and also in Europe and Japan.

Let's go to the next question please.

David Grossman with Thomas Weisel Partners.

Could you perhaps provide a few more details on the actions that you intend to take here to accelerate the growth in your short-term Services business?

And also if you could just clarify your comments about growth.

Would that mid single digits for the year or was that mid single digits for the second half of the year in '06?

My comments were really for the second half in '06 accelerating through the first half for that objective.

But as far as the actions we're taking, if you look at it, first of all on an ITS basis we think that there is more work under way to drive more focused plays I would say in higher growth areas.

The initial portfolio balancing work is complete.

We are focused in high growth areas such as security, infrastructure management and ITS optimization.

And adding business development skills and sales coverage that is aligned to revised portfolio.

These changes we believe will be operational in the first quarter.

We expect to see traction as we enter '06.

If you look at BCS, some of the actions we're taking include -- we are first of all increasing the level of dedicated sales resource to drive solutions, such as business at Web Services and SOA.

We're investing in resources to address midmarket opportunities, increasing the level of brand resources in Asia-Pacific, and leveraging our global end-to-end design build and run capability.

So very strong actions across both the VCS and the ITS portfolio that we believe will pay off in improved performance in that signing base as we enter '06.

Operator, let's take one more question please.

Richard Farmer with Merrill Lynch.

Now that the PC divestiture is well behind the Company, I wonder if you're capturing the expected amount of Services business on the PCs that Lenovo is selling.

I guess more generally, are the dynamics that you're seeing in the customer accounts that previously had a PC component to them, how are those turning out?

Are those more or less favorable without that element of your portfolio?

I think, first of all the transaction as we have completed it with Lenovo has gone very, very well.

The level of partnership between the two organizations is quite impressive.

We had very little problems as we ran through that transition.

So really the business plans following that, both our elements that we would provide to Lenovo and the level of teamwork and integration, I think is going quite well.

I want to thank you all for joining us tonight.

And have a great night.

Thank you for participating on today's call.

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