International Business Machines Corporation (IBM)

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International Business Machines Corp. (IBM)

Q3 2009 Earnings Call

October 15, 2009 4:30 pm ET

Executives

Patricia Murphy - Vice President of Investor Relations

Mark Loughridge - Chief Financial Officer, Senior Vice President

Analysts

David Grossman - Thomas Weisel Partners

Toni Sacconaghi - Sanford C. Bernstein

Keith Bachman - BMO Capital Markets

Ben Reitzes - Barclays Capital

Bill Shope - Credit Suisse

Moshe Katri - Cowen & Company

Richard Gardner - Citigroup

Robert Cihra - Caris & Company

David Bailey - Goldman Sachs

Chris Whitmore - Deutsche Bank

Presentation

Operator

Welcome and thank you for standing by. (Operator Instructions) Now I would like to turn the meeting over to Ms. Patricia Murphy, Vice President of Investor Relations. Madam, you may begin.

Patricia Murphy

Thank you. This is Patricia Murphy, Vice President of Investor Relations for IBM. I’m here with Mark Loughridge, IBM’s Senior Vice President and Chief Financial Officer. Thank you for joining our third quarter earnings presentation. 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.

Our 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 submitted to the SEC.

Let me remind you that 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 web site, or from us in Investor Relations.

Now, I’ll turn the call over to Mark Loughridge.

Mark Loughridge

Thank you for joining us today. We just finished another great quarter, driven by strong profit performance in software and services, and share gains in both hardware and software.

This quarter our revenue was up sequentially and our growth rate improved versus second quarter. We expanded gross margin by almost 2 points and pre-tax margin by over 3 points year to year. Our earnings per share is up 18% to $2.40. In addition, we generated $3.4 billion of free cash flow, up almost $1.3 billion year to year, and ended the quarter with $11.5 billion of cash on hand, while reducing our debt by $4 billion since June. We now expect to deliver at least $9.85 per share for the year, up $0.15 from our previous view of at least $9.70.

When you look at the third quarter as compared to the second quarter, though earnings per share growth is the same, both up 18%, we extended our share gains this quarter. For instance, in software we gained almost 3 points of share in WebSphere, where we compete head-to-head with Oracle. We also gained share in Information Management, Tivoli, and Rational. These share gains drove 5 points of constant currency growth in branded middleware revenue.

In hardware, we gained 5 points of share in System p, and 2 points of share in System x. That’s lot of share and we’re taking it from both Sun and HP. These share gains drove the improvement in our hardware revenue growth rate, which is 11 points better than last quarter.

Revenue growth from our services business was fairly consistent with second quarter, but the real story here was our ability to deliver double-digit profit growth by continually expanding margins. This quarter our services pre-tax margin was almost 15%. On a comparable basis our services margin is better than any of our key competitors. And believe me, we’re not done. Overall, with an improving trend in revenue performance, we’ve continued to generate profit growth through margin expansion.

Over the last several years, we have been shifting to higher value areas, and significantly changing our mix of business. At the same time, our ongoing focus on driving productivity in all areas of the business is reducing our fixed cost base and improving the operational balance point.

We continue to expect about $3.5 billion of cost and expense savings this year from the structural actions we’ve taken. And remember, we’ve got a spend base of almost $90 billion to work, so we’ve got a lot of opportunity to continue to reduce structure and make our business more efficient.

The impact of our transformation on this quarter’s profitability is clear and compelling. Our combined services segment pre-tax margin was up 2.4 points year to year, and in software, we grew segment pre-tax profit by over 20%, and margin by over 6 points. For the year, we continue to expect to generate about $8 billion of profit in software, and $8 billion in services.

We’re using this strong profit and cash generation to invest in capabilities that differentiate IBM and accelerate the development of new market opportunities, areas we’ve discussed in the past, like business analytics, and Smarter Planet, and cloud computing. Now we’ve just closed a strong third quarter consistent with the momentum in our business throughout 2009, and we’re well-equipped going into the fourth quarter.

Now, let’s get into the details of the third. Our revenue was $23.6 billion, down 7% as reported, and 5% at constant currency. Despite the revenue decline, we increased pre-tax income by 12% and net income by 14%, with outstanding margin performance. Gross margin expanded 1.8 points, due to better margins in services and software and a more profitable mix of business.

Our expense was better by 11% year to year, driven by actions we’ve taken to continue to transform and globalize the business, and focused expense management in a tough environment. Pre-tax margin was up over 3 points year to year to 18.6%, and IBM’s Net Income margin was up 2.5 points to 13.6%.

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