International Business Machines Corporation (IBM) Q1 2006 Earnings Report, Transcript and Summary

Welcome and thank you for standing by. Now I will turn the meeting over to Patricia Murphy, Vice President of Investor Relations. You may begin. Patricia Murphy, Vice President of Investor Relations : Thank you. 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 Office. Thank you for joining our Q1 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 an 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 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 two. 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 three, and I’ll turn the call over to Mark Loughridge. Mark Loughridge, Senior Vice President and Chief Financial Officer : Thanks, Patricia. In Q1 we delivered $20.7 billion in revenue, which is down 10% as reported. Without PCs and the impact of currency, revenue was up 4%. Our pretax income was $2.4 billion, up 21%, and we delivered EPS of $1.08, up 27% YtoY. Remember that in 2005 our Q1 results included the PC business. On a comparable basis, without the now-divested PC business, revenue was slack, but up 4% at constant currency. Our pretax income was up 24% and EPS was up 30%. Our cash and balance sheet remains strong. Net cash from operations, excluding Global Financing receivables was $700 million, up $1.6 billion YtoY. We ended the quarter with $12.3 billion of cash on hand and low debt levels from our non financing business. Before getting into the details of our Q1 results, I want to spend a moment on a discussion of the structure of our business. We’ve done a lot to reposition our business model over the last couple of years to focus on higher-value solutions. We’ve exited commoditizing businesses such as hard disk drives, displays and most recently the PC business. At the same time, we’ve been a strategic acquirer of higher-value software and services capabilities. The result is a business structure and profit profile that is relatively balanced between services, hardware and software. The business mix varies by the quarter, based on the skew of our business throughout the year. In Q1, hardware and financing represented a smaller percentage, as is typical. The strength of the IBM business model is not in any single component, is it in our ability to integrate and package across our segments, to create solution offerings for our clients, and by executing that model we can generate more consistent cash and earnings over the long term, enabling investments for future growth and consistent returns of cash to shareholders in the form of dividends and share repurchase. At the same time, we’re working to create a truly globally integrated company. Let me give you a few examples. Last year, we restructured our European operation to create a more streamlined and efficient management system and more competitive cost structure. We have globalized our support functions and created global competencies in our services business, to leverage our scale, drive efficiency and increase responsiveness. We’re shifting resourced to utilize highly skilled talent in emerging countries. We saw the benefit of these actions in the second half of 2005 and it continued in Q1. As get into the details of the quarterly results, you’ll see that our performance once again reflects the strength of our business model, the global scope of our enterprise and the ability of our broad portfolio to consistently generate strong earnings in cash. Now let’s start with revenue, chart four. Total revenue in Q1 was down 10% YtoY as reported. Without the PC business, revenue was flat. Without the PC business and the impact of currency our revenue was up 4%. Global Services was down 1% YtoY as reported, but up 3% at constant currency. The cumulative effect of YtoY improvement in long-term signings over the last several quarters and an increase in short-term signings in the current quarter contributed to a sequential improvement in the revenue growth rate. Hardware revenue was down 32% as reported. Without the PC business in our 2005 results, hardware was up 3% and up 6% at constant currency. Our hardware results were mixed by brand, with good performance in microelectronics, System X servers and our storage business offset by weak sales in other server brands. Software revenue was up 2% and up 6% at constant currency. This performance was led by double-digit growth in our key middleware brands, with particular strength in WebSphere and Tivoli. Global Financing revenue was up 1% as reported and up 4% at constant currency, driven by the interest rate environment and customer financing originations, or signings, were up double digits. Now let’s turn to revenue by geography, chart 5. This provides the best view of our ongoing geographic performance. I’ll focus my comments on the results without PCs at constant currency. Looking at the geographies, at 6% the Americas delivered its best growth rate in six quarters, led by software and services performance. All regions grew, with continued solid performance in the United States. Growth in Europe accelerated to 3%. France and Spain showed solid growth and Italy returned to growth. The UK was also up, but Germany declined. While results remain mixed by country, overall our performance improved due to a combination of a slowly improving economic environment and better execution under our new management system. Asia-Pacific revenue declined 2% this quarter. The performance continued to be impacted by Japan, which represents about 60% of the Asia-Pacific revenue base. We’re continuing to implement actions to improve performance. While we saw modest improvements this quarter, revenues still declined. In all other Asia-Pacific regions growth improved. The strongest growth came from China and India. China and India, together with Brazil and Russia represent our key emerging countries. Together, these four countries grew 18%. YtoY growth was led by India, up 61% over Q1 last year while China grew 15%, Brazil grew 1% and Russia 48%. We’re building capability in these emerging countries, especially in India and China. In these two countries alone, we ended Q1 with 45,000 resources to support the local demand as well as global demand. But it’s not just about putting resources in low-cost countries. It’s about having access to the right skills in the right places, for the right tasks. It’s about bringing together the front-end capabilities with the back-end processes, to provide higher-value solutions. We’ll continue to shift investments to these high-growth markets. Finally, our OEM growth was 26% in Q1 driven by strong game chip performance in our microelectronics business. Now we’ll move on to our gross profit, chart six. Gross profit margin in Q1 was 39.1%, up 3.1 points YtoY. Without the improvements from divesting the low margin PC business, margin was up five-tenths of a point. Global Services gross profit margin was up 2.3 points YtoY. The trends we saw in the second half of last year continued, with the improvement achieved through good yield from our productivity initiative, and improved utilization. Hardware gross profit margin improved 3.6 points YtoY, driven by the divestiture of the PC business. Without PCs, the hardware gross profit margin was down 4.1 points. We’ll comment on margin dynamics when we get to the hardware section. Software gross profit margin improved four tenths, lifted by strong revenue performance off a relatively fixed cost base. Global Financing gross profit margin was down 1.3 points, due primarily to lower financing spreads. For the quarter, Global Financing’s return on equity was 34%. Now let’s turn to expense, chart seven. Total expense and other income declined 10% in Q1, as reported. Without the PC results in 2005, expense and other income were better by 6%. Expense to revenue was 27.3%, about flat as reported, but improved 1.7 points YtoY, adjusting for the divested PC business. Each quarter, to help investors understand the drivers of our operational performance, we highlight those items in cost and expense that significantly impacted our profit growth. We refer to this as our roadmap. In Q1, we had a couple of items that significantly helped our profit growth. We continued to benefit from our Q2 2005 productivity initiatives. These actions were designed to give us a more competitive cost structure and more pricing flexibility. As we discussed in the past, some of the benefit flows through the price, some is invested back in the business and some goes to the bottom line. Total equity compensation was down about $85 million YtoY, due primarily to lower grants over the last few years. Continued workforce rebalancing is a part of any vital company, with the amount in any quarter likely to vary. During Q1 these charges were down $65 million YtoY. In Q1, other income benefited from a $94 million YtoY increase through interest income, reflecting our strong cash balance and increasing interest rates. Turning to the items that hurt our YtoY profit growth, retirement-related plans, both pension and retiree medical, generated $623 million of cost and expense in the quarter, a YtoY hurt of $74 million. For the full year, we now expect these plans to cost us between $2.3-2.4 billion, a $200-300 million year over year impact, excluding last year’s one-time charges. This is less than the previously estimated $400-500 million range due to reductions in our non-US pension funds. Though we’re still facing a significant YtoY increase, we’re making progress in our efforts to mitigate the impact. Before moving on to cash flow performance, let me comment on currency. The US dollar has generally strengthened since Q1 2005. 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 cost of goods sold. This quarter, consistent with Q4, hedging programs account for approximately $150 million of an improvement in other income and expense. Keep in mind that this benefit offsets the negative impact of currency translation throughout our income statement. I’m not going to predict future currency moves, but at current spot rates we would expect a 1-2 point impact to revenue growth in Q2 before moderating in 2H06. 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 Monday’s exchange rate. Now let’s turn to cash flow, chart eight. In Q1 we had outstanding cash generation. Our cash from operations, excluding Global Financing receivables was the strongest Q1 we have seen in the last five years, driven by earnings in accounts receivable performance. This cash flow analysis chart has one primary difference from the FAS 95 format. It considers Global Financing receivables as an investment to generate profits, not as working capital that should be minimized for efficiency. In Q1, net cash provided from operations, excluding the change in Global Financing receivables, was over $700 million, an increase of over $1.6 billion from last year. Last year, in Q1 we contributed $1.7 billion to the US pension fund, while this year we made a $1 billion pension contribution to the UK pension fund. Excluding the pension funding from both years, we generated over $900 million more cash from operations YtoY. Our cash performance was driven primarily by growth in net income and our continued focus on working capital and supply chain management. Within working capital, receivables collections continued to improve. Inventory decreased over $450 million YtoY. Adjusted for the sale of the PC business, inventory was down over $275 million, primarily in microelectronics. Also in working capital, we paid out $250 million in restructuring cash payments, and funded a $1 billion contribution to the UK pension fund in Q1 2006. Turning to our use of cash for investments, net capital expenditures were $1 billion, consistent with last year’s activity. Let me make a subtotal here, since many investors look at cash flow after capital expenditures. Net of capital expenditures, we had a use of cash of less than $300 million, a net increase in cash flows of $1.6 billion YtoY. Without the pension contributions, we generated over $900 million more cash flow this year. Next, our Global Financing receivables, net of changes and Global Financing debt, were a source of $2.9 billion. This is almost $200 million less than last year. We spent approximately $700 million on acquisitions in Q1, driven primarily by the software acquisition of Micromuse. We continue to drive very strong returns to shareholders. We returned over $2.8 billion to investors in Q1. $2.5 billion of this was through share repurchase. We bought back over 31 million shares, and average diluted shares were at 1.6 billion, down 4.4% from a year ago. We have approximately $2.5 billion remaining at the end of March from our last board authorization. In Q1 we paid out over $300 million in dividends. Over the last 10 years, we have returned over $70 billion to our shareholders, through share buybacks and dividends. Moving on to chart nine, we’ll discuss the balance sheet. Our cash on hand was $12.3 billion. 94% of our total debt of $22.5 billion was driven by our Global Financing business, and Global Financing was leveraged at an appropriate 6.9:1. The remaining non-financing debt level was about $1.4 billion and debt to capital was 4.4%. Our balance sheet remains very strong, and we’re well positioned to capitalize on future opportunities and meet our cash needs. Now let’s turn to our business units, starting with Global Services, chart 10. Global Services delivered revenue of $11.6 billion, declining 1% as reported, and up 3% at constant currency. Signings for services this quarter were $11.4 billion at constant currency. Short-term signings were up 5%, and longer-term signings were up 20%. This quarter, we signed 13 deals larger than $100 million and our backlog remains stable, estimated at $111 billion. Before turning to our services businesses, let me remind you of the management system changes we made to last quarter. Global Services’ segment results will now be reported as two segments. Global Technology Services segment primarily reflects infrastructure services, delivering value to our global scale, standardization and automation. It includes our outsourcing businesses, both strategic and business transformation, Integrated Technology Services and maintenance. Global Business Services segment primarily reflects professional services, delivering business value and innovation to our clients through solutions which leverage industry and business process expertise. It includes consulting, systems integration and application management services. With these new segments, we’re providing additional information to help investors understand our services business, including revenue performance of our business transformation outsourcing business, and long and short-term signings for each of these segments. Let me get into each of the businesses. Global Technology Services delivered revenue of $7.7 billion, declining 1% as reported, but up 2% at constant currencies. For the segment, longer-term signings were up 40% YtoY and shorter-term signings were up 3%. We delivered double digit signings growth across all geographies in the quarter. Strategic outsourcing revenue was down 3% as reported and flat at constant currencies. Signings increased 50% YtoY, led by stronger growth in the Americas, with both Europe and Asia-Pacific also growing double digits. Business transformation outsourcing revenue was up 47% as reported and up 51% at constant currency. I should note that one large contract renegotiation drove 12 points of the growth. Our BTO revenue grew in all geographies, reflecting broad-based customer acceptance of our offerings. BTO signings were down 9% year to year, coming off a very strong growth in 2005. Like strategic outsourcing, BTO engagements are longer-term and so signings in any period can be lumpy. Integrated Technology Services revenue was down 6% as reported, and down 3% at constant currency. Revenue continued to be impacted by signings declined in Q3 and Q4 2005. We’re continuing to implement actions to improve the Integrated Technology Services business. We’ve added about one third more people into our business development and sales coverage roles. We’ll be focused on selling our infrastructure solutions and our traditional services. The infrastructure solutions that we’ve launched are gaining traction in the market as customers see the value created by leveraging IBM’s market-leading software and hardware. For example, we see strong interest in IT resources optimization, end user services and business continuity. While we still have work to do; we did see a reversal in the signings trend this quarter - up 3%. Turning to margins, Global Technology Services pre-tax margin was 10.3%, an improvement of 2.5 points YtoY. This was driven by the cost and expense benefit of last year’s productivity initiative, sales execution and operational improvements and better contract profiles. Global Business Services delivered $3.8 billion of revenue, declining 1% as reported but up 4% at constant currency. For the segment, shorter-term signings were up 5% YtoY and longer-term signings were down 27%. Revenue performance this quarter were driven by strong growth in our consulting offerings in the Americas and in our application management services offerings in the Americas and Europe. Overall, revenue growth however continues to be impacted by weakness in Asia-Pacific and in particular Japan. Last quarter I talked about some of the actions we were taking to improve growth in our consulting business. Let me give you a sense of how we are doing. We are continuing to increase the level of dedicated sales resource to drive our business and web services and SOA solutions. We invested in resource to address mid-market opportunities which contributed to double digit growth in small and medium business. We increased the level of services resource in Asia-Pacific. This quarter, shorter-term signings growth exceeded 20% but we still have more work to do to yield better results in this region. Turning to margin, Global Business Services pre-tax margin was 8.5%, an improvement of 4.7 points YtoY. This represents a substantial improvement in margin. The improvement came from increased utilization and operational improvements, and the cost and expense benefit from last year’s productivity initiative. (To wrap up?) Q1 for Global Services, we’re beginning to see the expected turnaround in our services business, driven by long-term signings growth over the past four quarters. We have improved growth in Global Business Services, indicating that we are beginning to get traction from the initiative we’ve implemented over the past two quarter. We improved margins in both service segments while making our services business more cost competitive. To improve performance going forward, we will continue to focus on actions to improve our Integrated Technology Services business and Global Business Services in Japan. Now I’ll move on to systems and technology growth, chart 11. Systems and Technology Group revenue of $4.4 billion grew 3% YtoY and 6% at constant currency. Growth was led by microelectronics, System X servers, storage and retail store solutions. While gross margin was up for hardware overall, excluding the PC business in 2005 it was down YtoY. Product mix negatively impacted systems and technology profit on two levels. First, we had strong growth in our lower-margin businesses, microelectronics and System X servers. Second, within most of our system brands, we had better performance in the low end of the product lines, which typically have lower margins. Turning to the brand, System Z revenue declined 6% YtoY at actual currency, down 2% at constant currency. MIPS grew 22% YtoY, driven by continued strong customer acceptance of specialty engines for Linux and Java workloads. Over 35% of the MIPS shipped were on these engines, the largest percentage of specialty engines in a quarter. These engines are priced aggressively to drive these workloads onto the platform. This is good for the longer term, but because the engines are priced aggressively, the MIPS impacted our revenue and margin in the quarter. We expect a more typical workload mix in the future. We continue to add capability to platform and later this month we will announce our new midrange System Z. The workload mix, together with new capabilities, will help to drive improved performance in Q2. System I revenue declined 22% and 19% at constant currency, as customers evaluated the refreshed System I products which became generally available in February. Revenue declines are not unusual in the quarter that we roll out a new product announcement. System I had strong volumes and revenue growth in its low end and express models, which target the small and medium business market space. We expect to see improvement in the midrange and high end of the product lines as the year progresses. System P Unix servers declined 9% in the quarter, down 6% at constant currency. System P volumes were up 9%, however revenue performance reflects a mix towards lower-end offerings. We expect more balance in the mix in Q2, as we’ll have our first full quarter of shipments of our new 570s, and QuadCore(?) 560 midrange models. System P will complete its transition to POWER5+ in Q3. System X servers grew 10% YtoY and 13% at constant currency, with growth in all geographies. Server volumes grew over 20%, reflecting continued strong performance in Blades, which grew over 45% in both volumes and revenue. We had strong customer acceptance of the new BladeCenter 8, the industry’s first high-speed chassis. We believe we gained share in System X servers, and maintained our leadership in Blade. Total storage grew 6%, 9% at constant currency. Total disks grew 6%, driven by strength in the midrange. Our storage virtualization momentum continued with strong growth in Q1. Tape grew 5% in the quarter. We believe we held share in both tape and disk storage. Microelectronics revenue grew 37% YtoY, based on strong client demand in the game processor business. The annex of our East Fishkill fab is now operation and supporting production of 90 nanometer product and 65 nanometer development. Engineering and technology services revenue declined 15% YtoY as we wrapped around on last year’s strong performance. We continue to leverage IBM’s advanced technologies with new customers in their innovative projects. For example, NTS leverages its system design capability to collaborate with St. Jude Medical in the design, development and manufacturing of a patient care management system for implantable cardiac devices. Physicians will use the system to more efficiently conduct tests, review stored data and program the implanted devices for optimal patient care. Earlier this year, we announced the technology collaboration solutions organization, which combines engineering and technology services, OEM microelectronics and other key capabilities including our IT portfolio. These capabilities help our clients leverage collaborative innovation, spanning the entire technology lifecycle from the conceptual design to production. Technology collaboration solutions will drive synergistic flows from IBM’s core technologies. Now let’s move on to software, chart 12. Software, at $3.9 billion, was up 2% YtoY and was up 6% at constant currency. This growth was driven by our key middleware products while operating systems and product lifecycle management software declined. Our key branded middleware products continued to benefit from investments in development, sales and marketing, capturing the emerging trends in the marketplace. Our strategic acquisitions also add to the breadth and depth of this portfolio. As a result, we are well-positioned in these fast-growing technologies and our Q1 results point to the progress we’ve made. Key branded middleware is made up of five key brands which provide an integrated suite for our customers. The WebSphere Family of software grew 26% and was up 30% at constant currency. WebSphere provides the foundation for web-enabled applications and is a key product set in deploying services-oriented architectures. We are the market leader in SOA and are seeing strong demand for our WebSphere products, including the application server, portal and our business integration products. We believe we gained share for the quarter. Information management software grew 6% and was up 10% at constant currency. We continue to enhance and expand our information management portfolio with products built around information on demand. We had particularly strong performance in our information integration product set, as essential products continue to build momentum. We believe we gained share in this market, and grew faster than our closest competitor. Lotus software was flat YtoY, up 5% at constant currency. Our Lotus products provide customers with collaborative solutions which enable the integration of people, data and business processes as part of IBM’s on demand and SOA strategies. In a mature market, our Domino products had competitive pressure. However, adoption of Lotus workplace software continues, more than doubling YtoY. Tivoli software was up 24% and up 28% at constant currency. Our growth was broad based, with systems management, security and storage software all delivering double digit revenue growth in the quarter. Our portfolio of storage software products have been embraced by our customers and business partners, due to their competitive price points and superior functionality. Midway through the first quarter, we completed the acquisition of Micromuse, which contributed profit in the quarter. Customers are quickly recognizing the value of the combined Micromuse and Tivoli product portfolios to help them manage their IT-based business service needs. We believe Tivoli gained share for the quarter. Rational software was down 8% and down 4% at constant currency in a slowing market. In total, our key branded middleware improved 11% YtoY and was up 14% at constant currency. Other middleware was down 1% as reported, but up 1% at constant currency. Other middleware includes legacy products which provide a stable base of profits but grow at more modest rates. Operating system software declined 12%, down 9% at constant currency. Operating systems are closely tied to our server products, and provide a sound, cost-effective platform for our middleware and solutions. Growth this quarter was impacted by new product introductions in our midrange servers. Product Lifecycle Management, or PLM software, is now included in the software segment. PLM software includes computer-aided design and manufacturing products typically used in automotive, aerospace and other industrial customers. In Q1 a number of automotive companies delayed purchases, resulting in a modest decline in revenue. Overall, our software business had another solid quarter. In 2005 we gained share in all five key brands and with double digit growth in key branded middleware this quarter, we believe we continued to take share overall in Q1. This revenue growth drove strong bottom line results. Software segment pretax margin grew 4.3 points YtoY to 23.1%. Now I’ll wrap up on chart 13. We have a balanced portfolio of businesses; hardware, software and services, designed to deliver our longer-term financial objective of double digit EPS growth. The strength and breadth of the model comes from it being able to bring these business together to consistently deliver solid overall profit performance. This quarter, we had improving fundamentals in our services business. Signings, both long-term and short-term were up YtoY. This translated to improved revenue growth and we again improved our margins. In hardware, we had good performance in microelectronics, storage and our System X servers, while our other server brands were impacted by new product introductions and mix. Our strong software performance was led by our key branded middleware products, especially WebSphere and Tivoli, reflecting strong demands for products deploying services-oriented architectures and the value of our systems management, security and storage offerings. For Q1 our profit performance was once again driven by a combination of unit performance, portfolio action and execution of our productivity initiatives. Our services, hardware and software businesses together drove revenue growth of 4%, profit growth of 21%, EPS growth of 27% and solid cash performance. Given our start for the year, we are on track to deliver EPS growth for 2006 in line with the IBM model. This is consistent with the average of your estimates for the year. Before going to Q&A, I wanted to mention our investor meeting later this quarter. As I stated up front, we are working to create at truly globally integrated company. One important element of our strategy is leveraging performance in emerging countries including India and China. We’d like to share our unique global capabilities and for that reason we’re hosting our investor meeting in India in June. We have a full two-day agenda planned. You’ll have an opportunity to attend a large employee event, to visit our facilities at Bangalore and to meet face to face with major business leaders from Asia. You can get more information on the event from Patricia, and our investor relations team. We’re excited about the program and I hope that you’ll join us on June 6th and 7th in Bangalore. Now Patricia and I will take your questions.

Thanks, Mark. Before we begin the Q&A, let me comment on two items. First, as always we have a few supplemental charts at the end of the deck that complement Mark’s prepared remarks. Second, I’d ask you to refrain from multipart questions. This will allow us to take questions from more callers. OK, Operator, let’s open it up for questions.

Thank you. That is *1 to ask a question. Our first question is from Tony Sacconaghi with Sanford Bernstein. You may begin. Q – Tony Sacconaghi, Sanford Bernstein: Yes, thank you. Mark, I realize that you typically do not provide specific guidance for investors, but you often do provide a qualitative assessment of the direction and your sentiment for the business looking forward. Specifically, can you comment on whether you are comfortable with current analyst EPS estimates for Q2 through Q4 as they now stand? Secondly, can you comment on the pipeline as it looks for services? Is it better, worse or the same as it was at the end of Q4? Thirdly, can you comment on whether you believe hardware or services has the biggest opportunity for improvement looking forward? A – Mark Loughridge: OK, Tony, thank you very much for that question. First of all, let’s talk about our view of guidance. Number one, on EPS base, I’ve got to admit we’ve just got through a first quarter and had very strong performance. I mean, earnings up 21%, EPS up 27%, revenue up 4%, so we’re running this business really for the long term and remain confident in our longer-term model. We deliver this through a combination of revenue growth, productivity and cash generation. I would say that in any particular quarter of the year, our performance can vary from the model, but as I look forward it would be difficult to leave the first quarter and not be quite confident as we go forward. As we said in the text, I think the analyst estimates and relatively the skew of that business estimate through the year looks reasonable. Your second question was on pipeline. First of all, if you look at the deals that we’re facing, we like the opportunities we see going into this second quarter. We’ll remind you that we had particularly strong signings in the second quarter last year, particularly in the long-term signings. If you look at Q1, we had really good momentum in our short-term business, and we think that should continue as we go through the second quarter. In addition, our long-term signings as we exited 2005 were up 19% and here we see now, our long-term signings up 20% and underneath that, SO up 50. All of that bodes well for that business as we go forward.

Thank you. Our next question is from Bill Shope with JP Morgan. Q – Bill Shope, JP Morgan: OK, great, thanks. Mark, you cited product transitions and mix as the primary factors behind the margin and potentially the high-end revenue pressures in the hardware division. Can you give me any color on whether you saw any incrementally aggressive pricing from competitors, or potentially some unexpected macro pressures on the segment, because we are seeing some signs of weakness in servers in general across the industry. Could you give us any color there? A – Mark Loughridge: Yes, let me give you a perspective. First of all, I don’t think that in general we saw increased pricing pressure in the quarter. Once again, I want to frame the hardware performance in the quarter and reiterate, this is a very light hardware quarter for us if you look to a normal distribution throughout the year. Returning to your question on pricing, in the Z series, the price at the product level was in line with our historical trends. We saw some accelerated decline and in our overall prices our mix shifted, but that’s because we were driving that through workloads typified by the specialty MIPS engines. System I, we did experience some price pressure in the midrange. On P series we’re finding select countries in Asia-Pacific and EMEA to be particularly competitive. On X series, our price pressure continued and our Q1 were more pronounced in the US than in Europe, and in storage really price pressure remains really high, most notably on enterprise disk and SAND(?) products.

Thanks Bill, let’s go to the next question please.

Thank you. Our next question is from Laura Conigliaro with Goldman Sachs. You may begin. Q – Laura Conigliaro, Goldman Sachs: Yes. Given the fact that you saw pretty solid services signings growth last year, and you had pretty good services signings this year, you’re still going to need to average maybe $12.5 billion per quarter for the remainder of the year to get to say a low single digit growth number for the year. With the deal sizes getting smaller, and several deals where IBM is the incumbent coming up for bid this year, where you’re presumably not going to win all of them, is there actually enough business out there for you to reasonably expect say 4-5%, or will single digits be low to mid single digits type growth for all of 2006? And I’m sorry to ask this, but could you please clarify ‘other income’, which was considerably higher this quarter than it was last year? A – Mark Loughridge: Let me first of all start with signings. Signings first of all I think has a lot of opportunity, and now we go back to the characteristics we saw in this quarter. I mean, long-term signings up 20% - that is real capability that will provide growth as in stability over time. Short-term signings are up 5%, so that’s low real performance on our near-term performance in the quarter, so we see good opportunities out there over the long term, consistent with our business model and frankly consistent with the long-term trends that we saw as we exited 2005. As far as other income, we had $150 million YtoY from hedges as we said. That was predominantly consistent with our Q4 performance where we were up $150 million as well. Now there are offsets in other parts of the P&L. So where we would have seen offsets and a relative revenue on cost in the other parts of the P&L, we saw some benefit in hedging. The other $94 million was driven by interest income, and that was basically a factor of our large cash balance that we have. I look at both of those in context of a very powerful quarter plus 27%. So with hedging $150 million consistent with Q4 performance, the other interest income off our large cash balance.

Thanks, Laura, let’s go to the next question please.

Thank you. Our next question is from Rebecca Runkle with Morgan Stanley. You may begin. Q – Rebecca Runkle, Morgan Stanley: Thanks. Good afternoon, Mark. Just following up and trying to understand some of the lower costs related to the retirement plans for the share, if I take a step back given the first quarter performance and some of the upbeat commentary that you’re providing, is it fair to say that IBM could hit its long-term growth model, axing out the retirement impact, because that lower cost of retirement plans for this year is pretty accretive to the bottom line and some might argue that that’s not quite purely operational in nature, and I’m just trying to understand from a pure operational stand point, do you look at IBM being able to hit that long-term target this year? A – Mark Loughridge: Sure. Let me talk about that a little. First of all, let’s put this in context. As we look at retirement-related expense, our January view was that the expense would be $2.5-2.6 billion. Currently, we’re viewing that at $2.3-2.4 billion. It is still a headwind of $200-300 million that we need to overcome as part of our business model. So I would not look at that change and necessarily make that additive, because right now what we need to do is to develop the execution plan and continue to overcome that pension impact on a YtoY basis. I will say, we’re very committed to our long-term business model and our objective of double digit EPS growth.

Thanks Rebecca, let’s go to the next question please.

Thank you. Our next question is from Harry Blount with Lehman Brothers. You may begin. Q – Harry Blount, Lehman Brothers: Great, thank you very much. The question is on margins. Starting next quarter, you start to anniversary on some of the productivity initiatives you’ve taken. As we look at the total opex, and given your comments about letting some flow through to the bottom line versus taking some into the business, I was wondering if you could maybe comment about the absolute level of operating expenses as they currently stand. Then also, related to the software business, trying to get some sense of how the middleware and total software may have looked, excluding the acquisitions and the revenue reclass. A – Mark Loughridge: OK. Well let’s take your first question. I think what you were really looking at was the yield off the restructuring as we see it throughout the year and how it played out in our business. So number one, you remember that we said that restructuring in the year would yield $1.3 billion in savings, and on a YtoY basis that would be about $800 million. If you look at $800 million, we’ll see that through the second and the third quarters and we’re probably 35-40% of our way through that yield. If you remember, we had said that that restructuring, about 70% of it, was oriented towards our services business. Let’s now talk about how that exhibits itself within services. If you assume that all of that went to the bottom line, which I personally think is an extreme assumption, but if you did assume that, that would be about one third of the improvement that we saw in our Global Technology Services, which was up 2.5 points YtoY. It was about 40% for Global Business Services, which was up 4.7 points. So there was a lot of margin improvement over and above the yield that we got out of that restructuring yield, and if you looked at it through the course of the year, we’re probably about one third to 40% of the way through that $800 million.

OK thanks, Harry, let’s go to the next question please.

Thank you, that’s Richard Farmer with Merrill Lynch. You may begin. Q – Richard Farmer, Merrill Lynch: First, a quick clarification on your comments on the P series transition. I think you said you expect it to be complete by Q3, that would seem to imply that we could still see some transition issues in the June quarter – is that correct? Then the real question is on middleware. You had a lot of strength in WebSphere and Tivoli which was a big reversal from desolidation(?) in those businesses last quarter. What was different this quarter, that enabled you to execute so much better in those software categories? A – Mark Loughridge: OK, well first of all let’s go back to your P series question. Number one, if you look at that product transition, we announced the POWER5+ on the midrange in February. We did experience extended sales cycle on a higher than normal weight at the (inaudible) out of the quarter, we should recapture that as we go into the second quarter. We did point out that the high end will move to POWER5+ technology in the third, which will complete its product transition, but in the second quarter we should see that midrange capitalize on the Q1 introduction. As far as software is concerned, I mean number one, I’m very impressed with software performance in the quarter. Granted, middleware as a category up 14% at constant currency, led by WebSphere that was up 30%, Tivoli up 28% and information management up 10%, so I think it was strong execution on the part of our software organization, real capability in product breadth and especially strength in SOA as we move forward.

Thanks, Richard, let’s go to the next question please.

Next question is from Keith Bachman with Bank of America. You may begin. Q – Keith Bachman, Bank of America: Hi, thanks. I wanted to go to the Asia-Pacific if we could for a second, in terms of - you mentioned it was a bit of an improvement, a modest improvement from last quarter in a year over year basis. What needs to happen in order for that to be less of a drag on your operations, or even run at the same rate as the rest of IBM? And is it primarily the services? If you give us a little more color on how Asia-Pacific and Japan specifically gets fixed. A – Mark Loughridge: First of all, when I look at Asia-Pacific, frankly I think they did pretty well on hardware and they did pretty well on software. If we then kind of did a view of the units, China group 15%, and Asia again posted strong results. India was up over 60% so a really strong performance in these emerging parts of our marketplace. So that really leaves Japan. We did see I think a more stable level of performance in Japan, but we do need to improve the execution as we go forward. That will probably exhibit itself more in the second half of the year, but I’ve got to say, when you look at Japan you’ve got to remember that though we’ve had some operational issues that have affected our growth on the margins, this is one of the largest and the most powerful businesses in Japan. Highly profitable, we’ve got a broad base of business based on strong customer relationships that take years to establish. You’re talking about what is fundamentally a very strong base of business to being with, we just need to exhibit growth as we go through the quarter on that base.

Thanks, Keith, let’s go to the next question please.

Thank you, that’s Ben Reitzes with UBS. You may begin. Q – Ben Reitzes, UBS Warburg: Good afternoon, thank you. Could you talk, Mark, about the gross margin a little bit more? And other income? As we go throughout the year with gross margin being a little below our expectations in hardware, just how does that progress and you fix it? Is it MIPS? And just a little more color – I know you said some things, but if you can clarify. Then with this other income dynamic, do we keep seeing these kinds of benefits from hedging or does that clearly go away in the second half and we start seeing a more normal other income number there when currency flattens out? A – Mark Loughridge: OK. First of all, on gross margin; I think we had really strong performance on gross margin in our services business. That was driven by real discipline and execution capability in those business. I think we should continue to see that level of performance as we go through the year. Software margins, again very, very strong. So that really leaves hardware, and hardware margins are really a function of the mix of businesses that we have and we need to recalibrate to emphasize the high end of those businesses and within the deep platform, drive more of our traditional workload as well as capitalize on the introduction of our new Z midrange product. So on a margin basis, I think we actually had a very strong quarter and I feel very good about our margins going forward throughout the balance of the year. Secondly, on your comment on currency, I mean if you look we gave you an example at current spot rates what the impact of currency would be. Q2 would be about a 1 to a 2 point impact and that would moderate as we go through the second half. Obviously as you do that, we will see less benefit from hedging on currencies but you’ll see more improvement in the balance or I&E. So generally, there is an offset within our hedging program. If hedges have more contribution, it’s because the balance of the I&E was impacted. If hedges have less contribution, it’s because the balance of the I&E has done relatively better.

OK, thanks, Ben. Operator, let’s take one last question.

Thank you. Our last question will be from Richard Gardner with Citigroup. You may begin. Q – Richard Gardner, Citigroup: Thanks very much. Mark, you talked about the negative mix shift of specialty engines in the quarter within the mainframe business. I was hoping you could talk about how much control you have over workload mix and that difference from quarter to quarter and what it is that gives you confidence that the mix will rebound back to your more traditional workloads in Q2 and beyond. Then maybe if you could also help us understand the implications of a workload shift to specialty engines for the services and software businesses? Thanks. A – Mark Loughridge: I think number one, I would look at the characteristics of the quarter. You know, Richard, number one this is a light quarter for hardware. I think it’s relatively difficult to interpret trends off a first quarter performance on a hardware base of business. Now, we did have a much higher mix of specialty engines but I don’t think that’s typical of our base of business going forward. It was a characteristic within the first quarter. Specialty engines are geared for very high growth opportunities that we see in the marketplace and we will see downstream benefits from those in other parts of our business, but I don’t think that’s necessarily a characteristic. As far as our control of our destiny, number one it’s really driven by our continued execution and as I said on the call, introduction of our new Z series platform for our midrange Z products.

Thanks Richard, and I want to thank you all for joining us this afternoon, and I hope to see you all in Bangalore in June.

Thank you for participating on today’s call, the conference has now ended, you may disconnect at this time.