Patricia Murphy - IR Mark Loughridge - CFO

Toni Sacconaghi - Sanford Bernstein Richard Gardner - Citigroup Bill Shope – JP Morgan Laura Conigliaro - Goldman Sachs Richard Farmer - Merrill Lynch Harry Blount - Lehman Brothers Ben Reitzes - UBS Rebecca Runkle - Morgan Stanley David Grossman - Thomas Weisel Partners Keith Bachman - Banc of America Securities 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 fourth quarter earnings presentation. By now, the opening page of the presentation should have automatically loaded and you should be on the title page. The charts will automatically advance as we move through the presentation. If you prefer to manually control the charts, at any time you can un-check the synchronize button on the left of the 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. 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 web site, or from us in Investor Relations. Now, I’ll turn the call over to Mark Loughridge.

Mark Loughridge: Thanks Patricia. We had a very strong finish to the year. We delivered $26.3 billion in revenue, which was up 7% as reported and 4% at constant currency. Our pre-tax income was up 5% to $4.8 billion and we delivered $2.26 of earnings per share, including a $0.06 benefit from a lower tax rate. Our EPS was up 12% year-to-year. Excluding the one-time pension curtailment charge from the 2005 results, EPS was up 7%. This quarter, we had the best software revenue growth in over five years, with continued momentum in our strategic middleware, and additional benefit from our recent acquisitions. Our focus on building up our software capabilities is clearly paying off. The profile of our services business continued to improve. Revenue growth accelerated in the quarter, and we had exceptional signings performance, closing almost $18 billion of new business. From a geographic perspective, the Americas and Asia Pacific posted the strongest growth, with a solid recovery in Japan and good contribution from emerging countries. We are driving productivity initiatives across the business. At the same time, we’re ramping investments to drive future growth. And once again we had strong cash performance, with an increase in net cash from operations for the year of $2.2 billion, excluding Global Financing Receivables. Let’s move on to our full year performance with Chart 4. Our full year performance was the result of a series of actions we’ve taken over the last several years to improve our mix of businesses and globally integrate the company. We delivered $91.4 billion of revenue, pretax earnings of $13.3 billion, and earnings per share of $6.06. We expanded margins, had record cash performance, and provided record return to shareholders. In summary, we had a strong fourth quarter and 2006, and we feel good about the momentum of our business as we enter 2007. But before moving on, I’d like to add some perspective to our profit performance on the next chart. There are a few items in our operating results that many other companies, especially in the tech sector, exclude from the discussion of their earnings. For example: These items are part of any ongoing business, and we view them in the same way as any other element of cost or expense that impacts our financial statement. Now before getting into the details of the fourth quarter results, I’ll make a brief comment on the structure of our presentation. This quarter we completed the acquisition of Integrated Security Systems, a business that protects a clients’ IT infrastructure against intrusion through a combination of software and managed services. This is consistent with our strategy, which capitalizes on a trend toward the convergence of software and services. The long term value of ISS is in managed services, and ISS is now an integrated business within Global Technology Services – and reported in the Global Technology Services segment. But because some of the value is being delivered through software licenses, this activity will be classified as software sales on the income statement. Going forward, we will consistently focus our discussion on the segment view, as this is how we are managing our businesses, and the best reflection of our strategy. Let’s now turn to IBM’s external segment revenue. IBM’s fourth quarter revenue was up 7% as reported, 4% at constant currency. Performance was led by Software, reflecting strong demand for our industry-leading middleware portfolio. Revenue was up 14% as reported and up 11% at constant currency. Global Technology Services revenue grew 7% as reported and 4% at constant currency. The acceleration in growth was driven by Integrated Technology Services, with progress in the implementation of our new offerings, and contribution from the newly-acquired ISS business. Global Business Services grew 6% as reported and 3% at constant currency, led by solid performance in consulting. Systems and Technology revenue was up 3% as reported, and flat at constant currency. The best performance came from Storage, and Retail Store Systems. Our System z revenue improved year-to-year, and as anticipated, Microelectronics revenue declined as it wrapped around on a very strong fourth quarter of 2005. Global Financing revenue was up 3% as reported, and flat at constant currency, with a modest improvement in financing revenue due to an increase in assets. Overall, IBM’s gross profit margin improved a half a point, led by services, and a mix toward our higher margin software business. I’ll address the margin dynamics in the discussion of the segments. Looking at our revenue by geography, as always, I’ll focus my comments on the results at constant currency, to provide the best view of the underlying business performance. The Americas revenue grew 5%. From a product perspective, the Americas’ growth was again driven by software. By region, the best performance came from Latin America, with double-digit revenue growth. The U.S. also grew, while Canada had a modest decline. Europe’s revenue was up 3% year-to-year, an improvement from the growth rate in the third quarter. Of the major countries, Italy had the best performance, and the U.K. also improved year-to-year. Asia Pacific also delivered strong results with revenue up 5% in the quarter. The Asia Pacific economy remained strong, led by India and China. Our business in Japan returned to growth in the second half of the year. This is an important market for us, as Japan represents over half of the Asia Pacific revenue base – and is the second largest country globally in terms of revenue and profit. The emerging countries of China, India, Brazil and Russia together grew 18%. India and Russia both posted growth of over 30%. China grew 18%, and Brazil grew 9%. For the year, these four countries contributed $4.5 billion of revenue, up 16% year-to-year without the divested PC business in last year’s results. We continue to invest to build capabilities in these countries, to address the fast-growing domestic market opportunities, and to enhance IBM’s globally integrated operations. Finally, our OEM revenue was down 3%, after four consecutive quarters of very strong growth. Now we’ll move on to expense. I’m going to spend a little more time on expense this quarter, as it is important to understand the dynamics, and the investments that we are making. Total Expense and Other Income increased 16% in the quarter, excluding last year’s pension charge. Excluding currency impacts and the year-to-year impact from real estate transactions, total expense growth would have been 9%. SG&A was up 13%. Approximately four points of this growth is due to the impact of currency. We estimate that our investments in acquisitions drove four points of the growth in SG&A. While it can take some time for these investments to be fully accretive, we are encouraged by the accelerated pace with which we have integrated acquisitions and the contribution from the acquired businesses within the fourth quarter. The remaining 5 points of the SG&A growth was largely driven by investments we are making in our software and services business and emerging markets. Like the acquisitions, productivity of the sales resource improves over time. The returns on these investments are reflected in the momentum in our key middleware brands, growth in emerging markets, and strong signings performance. RD&E was up 9%. Acquisitions drove approximately half of this growth, with the remainder reflecting our ongoing commitments to maintain our technology leadership across our product portfolio. We expect a similar level of expense growth during the first half of 2007, driven by investments in strategic areas with some moderation of the growth rate in the second half. To help mitigate some of the impact, we expect to continue to expand gross margins, globalize our support functions, and rapidly integrate new acquisitions. I also want to highlight a couple of other items that significantly impacted our profit growth. We refer to these as our “roadmap” items. The first is gains on real estate transactions, which are recorded in Other Income and Expense. In the fourth quarter of last year, we had unusually high gains in the quarter due to a few large transactions. While we did have some real estate activity in the fourth quarter of this year, the gains were down $140 million year-to-year. Second, retirement-related plans generated about $600 million of cost and expense in the quarter. This is an increase of about $80 million year-to-year, excluding last year’s pension curtailment charge. The retirement-related plans cost over $2.4 billion for the full year, up about $325 million over the prior year, excluding the 2005 non-recurring charges. For 2007, the interest rate environment together with other factors such as actuarial assumptions will result in retirement-related expense of about $2.5 billion, an increase of less than $100 million year-to-year. I’ll comment on two other items, tax rate and currency. In the fourth quarter, we recorded an effective tax rate of 28%, down from the previous ongoing rate of 30%. For the full year 2006, IBM’s effective tax rate was 29.3%. Looking forward to 2007, we expect a rate in the range of 28.5%. The improved rate is the result of a more favorable mix of income in lower tax jurisdictions, and the ongoing benefit from the R&D credit passed by Congress in December. On currency, 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. I’m not going to predict future currency moves, but at current spot rates we would expect revenue growth to benefit from currency translation in the first half of 2007. Now let’s turn to Cash Flow. We had another outstanding year in cash generation. As you know, 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 2006, Net Cash Provided from Operations, excluding the year-to-year change in Global Financing Receivables, was $15.3 billion, an increase of $2.2 billion from last year, and the highest on record. Excluding the significant pension funding activity in the U.S. in 2005 and the U.K. in 2006, we generated $1.5 billion more cash from operations year-to-year. Our year-to-date cash performance was driven primarily by growth in Net Income, and continued focus on working capital. Turning to our investing activities, net capital expenditures were approximately $4.7 billion, an increase of approximately $1.2 billion year-to-year. The growth was driven by the unusually high level of real estate asset sales in 2005, and increased spending in support of strategic outsourcing contracts. Let me make a subtotal here since many investors look at cash flow after Capital Expenditures. We generated cash flow of $10.5 billion, up about $960 million compared to last year. We have increased cash flow in each of the past four years. Spending on Acquisitions was $3.8 billion, up $2.3 billion year-to-year. This activity increased in the fourth quarter as we completed acquisitions announced in the third quarter, including FileNet, MRO and ISS. We returned a record $9.8 billion to investors this year, an increase of almost $800 million year-to-year. $8.1 billion of this shareholder return was through share repurchase, an increase of about $350 million from our spending last year. We spent a record amount on share repurchase in 2006, buying back over 97 million shares. Average fully diluted shares were at 1.6 billion, down 4.6% from a year ago. We had approximately $5 billion remaining from our Board authorizations at the end of December. IBM has bought back over 1.2 billion shares on a split-adjusted basis, at an average price of about $62 per share since the inception of our share repurchase program in 1995. Turning to dividends, this year we paid out about $1.7 billion, which is an increase of about $430 million year-to-year, driven by a 50% dividend increase. We continued our long history of high returns to our shareholders. This year, between share repurchase and dividends we were able to pay out over 100% of our net earnings to our shareholders, even after investing over $14 billion in R&D, capital expenditures, and acquisitions. Turning to the Balance Sheet, our cash on hand was $10.7 billion. 98% of our total debt of $22.7 billion was driven by our Global Financing business, and Global Financing was leveraged at an appropriate 6.9 to 1. The remaining non-financing debt level was $395 million and debt-to-capital was 1.5%. As anticipated, Stockholder’s Equity was down $4.6 billion year-to-year, driven by a non-cash accounting charge of about $9.5 billion for FAS 158 pension accounting, implemented in the fourth quarter. We ended the year with almost $29 billion of stockholders’ equity. Our Balance Sheet remains very strong. Now, let me turn to the businesses, starting with Services. Our two services segments, Global Technology Services and Global Business Services together delivered external revenue of $12.8 billion, up 7% as reported and 3% at constant currency. Signings for services this quarter were $17.8 billion at constant currency, up 55% over last year. At spot rates, we signed $20.3 billion. Our shorter-term signings were $6.2 billion, up 16% year-to-year. Our longer-term signings were $11.6 billion, up 89% year-to-year. This quarter we signed 14 deals larger than $100 million, and our backlog has increased to an estimated $116 billion. This strong finish to the quarter allowed us to grow signings for the full year, for both short term and long term. Turning to the segments, Global Technology Services delivered revenue of $8.6 billion, up 7% as reported and 4% at constant currency. Strategic Outsourcing revenue was up 7% as reported and up 4% at constant currency. Signings doubled year-to-year, with strong growth in all geographies. Business Transformation Outsourcing revenue was up 8% as reported, and up 5% at constant currency. BTO signings were down 57% year-to-year. We continue to see opportunity within the BTO business, particularly in Finance and Accounting, Human Resources and Procurement. Integrated Technology Services revenue was up 8% as reported and up 6% at constant currency. We continue to see progress from the changes we’ve implemented to improve the Integrated Technology Services business, including streamlining our offerings and aligning skills, to address higher growth and higher value areas. The acquisition of Internet Security Systems added to our capabilities in security and intrusion protection, and contributed to the ITS growth. ITS signings were up 20% this quarter, with growth in all geographies. As in the third quarter, the strongest growth came from the regions where our transformational actions were implemented first. We’re encouraged by our progress in ITS. Turning to margin, Global Technology Services pre-tax margin was 9.3%, down year-to-year as compared to a particularly strong fourth quarter of 2005, but in line with full year margins adjusted for the impact of the ISS acquisition. We continue to make investments in sales, delivery and business development skills across our entire set of offerings, as well as invest in strategic outsourcing infrastructure and BTO capabilities. Looking forward, we will continue to optimize resources and processes to increase productivity, and improve flexibility and scalability. This activity may be skewed a bit more towards the first half of 2007. The goal of these actions is to drive labor cost savings and increased customer satisfaction within service delivery. Global Business Services delivered revenue of $4.2 billion, up 6% as reported and up 3% at constant currency. The constant currency growth represents a 7 point improvement since the growth rate at the end of the first half, as we’ve expanded our focus from Operational Transformation to a focus on Profitable Growth. Our signings this quarter reflect the strong demand for both our shorter-term and longer-term offerings. Shorter-term signings were up 14% year-to-year, where we saw strength in the larger higher value add engagements. Longer-term signings were up over 200% year-to-year, driven by our global delivery capabilities in the Application Management business. Longer-term signings were up 17% for the year. Global Business Services’ pre-tax profit was up over 30% year-to-year, and the fourth quarter pre-tax margin improved 2.3 points to 11.8%. Margin improvement was driven by improved utilization, strong contract management and delivery, and stable to improved pricing. Finally, I would like to talk about our signings this quarter, not the quantity or dollar value, but the quality of the deals we signed this quarter, and what they represent. The key to our success in Services will come from first, our ability to integrate our businesses globally, and to take advantage of our local and global skills; and second, from the use of the technology and industry skills required to create solutions that drive value and savings for our customers. We were successful on both fronts this quarter, we signed large Application Management deals at Vodafone and CMA CGM. The key differentiator for both of these is the ability to provide strong local expertise and industry skills coupled with the benefits of global delivery. We also signed large long term deals with the State of Indiana, the State of Texas, and the German Army. The value in these contracts came from our strong industry knowledge, and from the use of technology needed to drive cost savings and improve performance for our customers. These wins were driven by a strategy that puts technology at the forefront, and uses our scale and global capabilities to meet our customer’s diverse sets of requirements. We’ve done a lot to improve the profile of our Services business in 2006, and we are entering the year with a stronger services base. Now I’ll move on to Systems and Technology Group. Systems and Technology Group revenue of $7.1 billion grew 3% year-to-year, or flat at constant currency. For the full year, Systems and Technology grew 5%. System z revenue grew 5% year-to-year, 1% at constant currency. MIPS grew 6% against, what was, the quarter with the largest MIPS shipment on record. This was the sixth consecutive quarter of MIPS growth. System z performance reflected continued good sales execution and we believe we grew market share. The mainframe’s unique ability to deliver attractive economics, advanced security, and industry leading energy conservation, cooling and virtualization, play to the strength of the platform. System i revenue declined 10% year-to-year, 14% at constant currency. Sales of upgrades improved sequentially, however they remain down year-to-year as customers continue to leverage their existing capacity. We expect the upgrade activity to ramp during the year. System p revenue grew 4%, flat at constant currency. We believe we grew share in the quarter. System p had strong high-end sales extending our price/performance leadership position and raising margins. Customers are leveraging System p’s native virtualization to consolidate multiple smaller servers into high-end System p. System x servers grew 7% year-to-year, and 3% at constant currency. Blades were essentially flat year-to-year. We had good growth in both Europe and Asia Pacific, offset by a decline in the Americas. We expect we held share in System x in the quarter. Storage grew 9% year-to-year, 6% at constant currency. Disk rose 12%, with double-digit growth in both mid-range disk and SAN. DS8000 unit shipments grew over 14% year-to-year. We believe we gained share in Disk in the fourth quarter, and we extended our market leadership in tape. Tape was up 4% year-to-year on the continued strength of our new tape security offering. Together with IBM software and services, this solution provides for cost effective encryption and management of large volumes of digital information. When results are published, we believe we will retain our number one market share position in overall storage hardware. Microelectronics revenue declined 6% compared to a very strong fourth quarter last year. In this quarter, we met all customer demand for games processor volumes to support the launch of both Sony Playstation/3 and Nintendo Wii, while continuing to also supply Microsoft with its Xbox 360 processors. Our Retail Store Systems had double-digit growth rate every quarter this year, and grew about 20% for the year. Customers are replacing older technology in favor of integrated retail solutions. IBM is the market leader in this segment. Now, I’ll move on to Software. Software segment revenue was $5.6 billion in the quarter, up 14% year-to-year as reported, and 11% at constant currency. For the full year, software grew 8% as reported and 7% at constant currency. Customers are responding to the breadth of our software portfolio coupled with IBM’s unique ability to apply these technologies to their business needs. As a result, in the fourth quarter, key branded middleware delivered 25% growth as reported and 21% at constant currency, which is roughly double the market growth rate. This growth came from both organic sources and strategic acquisitions. In the fourth quarter all brands grew faster than the market with all of the five brands delivering double-digit growth as reported. Our major acquisitions for the year include Filenet, MRO and Micromuse which enhanced growth in the Information Management and Tivoli brands. The WebSphere family of software grew 22% as reported, and 18% at constant currency. WebSphere provides the foundation for web-enabled applications and is a key product set in deploying Services Oriented Architecture. We are continuing to invest in SOA technologies, which allow us to bring advanced industry-specific solutions to the market. As a result we are extending our leadership in SOA. Information Management software helps companies integrate, manage and gain value from their business information. For the quarter, revenue was up 28% year-to-year and 24% at constant currency. Our distributed relational database was particularly strong, growing 32%, far outpacing our next two competitors. Our Information on Demand portfolio was marked by the launch of the IBM Information Server on October 16th. This product is an industry-first, unified software platform that helps clients extract more value from complex information. Our IoD offerings were up 42% in the quarter. This quarter we concluded the acquisition of FileNet Corporation, an industry leader in enterprise content management. In Information Management, we grew faster than the market organically, and a strong performance from Filenet added to this growth. Tivoli software grew 25%, and 21% at constant currency. As in the third quarter, we again saw double-digit growth in each of our three key segments: Systems Management, Security and Storage. Systems Management grew as a result of major service providers choosing our Micromuse solutions over other competitors in the market. In the quarter we completed the acquisition of MRO software which added to our capabilities in enterprise and IT asset management. Lotus software grew 30%, and 24% at constant currency. Lotus benefited from strong momentum in its Notes/Domino family of collaboration products and broad adoption of its enhanced version of Sametime, which shipped in the third quarter of this year. Customer loyalty to our Lotus products remains strong as evidenced by nine consecutive quarters of growth. Rational software, which provides customers with tools that manage the business process of software and systems development, was up 12%, and 8% at constant currency. In a slower growing market, Rational gained share in the fourth quarter and full year 2006. Other Middleware was up 3%, and flat at constant currency. This segment includes more mature products which provide a stable flow of revenue and profit. Operating Systems were down, due to improved price performance in System z operating systems. Overall, our software business had another strong quarter with revenue growth of 14%. The pre-tax profit of over $2 billion is up 4% year-to-year, but the pre-tax margin declined as we integrated our new acquisitions. The full year pre-tax income of $5.5 billion is up nearly 15% year-to-year. We have been investing heavily in our Software business for some time, both internally and through our targeted acquisitions. This quarter’s strong results reflect those investments. Now, I’ll wrap up in the next four charts with a discussion on the full year performance. Over the last few years we have been steadily transforming the company. We’ve taken a series of actions – divesting of businesses that are commoditizing, while investing in targeted acquisitions to build capabilities in higher value areas. We’ve had a sharp focus on productivity, to expand margins and drive more efficiency in our business. And we have accelerated our move to a globally-integrated company. The actions we have taken have resulted in a more balanced mix of businesses, and a stronger, more competitive and sustainable global business. Our 2006 performance reflects this improved business model. In wrapping up 2006, I’d like to address the year from three perspectives: our business mix, our global reach, and our business model. First, our businesses. The largest profit contributor was our software business, with about 40% of segment pre-tax profit. This year, our leadership in technology and innovation has allowed us to continue to capitalize on industry trends, such as SOA and Information on Demand. Our Services revenue growth improved over the course of the year. We are getting traction in our short term businesses. Integrated Technology Services is recovering after rebalancing its offerings and resources. Global Business Services significantly improved profitability. With a great finish to the year in signings, we ended the year with a backlog of $116 billion, while maintaining our focus on strong profitability. In hardware, we are the leader in servers. Through continued investment in R&D, we introduced Power5+, extended virtualization capabilities, and provided leading technology for all three major game platforms. Our System z servers had a great year, and provide good profit generation across the business over time. We’re continuing to add to our capabilities. Over the years, we have built a targeted acquisition strategy, and we’ve developed the capability to rapidly acquire, integrate, and accelerate new product offerings. This year we spent almost $4 billion on 13 acquisitions, including nine in the software segment. And we are also continuously evaluating underperforming and less strategic areas of our portfolio. Our businesses are enabled by the global reach of IBM. IBM has tremendous global reach. We operate in 170 countries, with about 60% of our revenue generated outside the US. And about 65% of our employees are outside of the U.S., including 30% in Asia Pacific. This gives us access to markets, with local management teams who understand our clients and their business challenges. In the major countries, we are well-established. This year, we had continued solid contribution from the U.S., and improved performance in France and Italy. In the second half, our business in Japan recovered. In the emerging markets of China, India, Russia and Brazil we grew 16% in 2006. These are among the fastest growing IT markets in the world. Over the next four years, we expect them to grow at more than two times the worldwide rate, with an opportunity of over $150 billion by 2010. We’re investing to extend our leadership in emerging markets. At the same time, our global scale provides a base that enables us to leverage investments and infrastructure, and drive productivity and efficiency. From a sales perspective, ibm.com was our fastest growing channel in every geography. We delivered $10 billion of sales through the ibm.com telesales and web channels. In support of our clients, we expanded our global delivery centers, which is a more efficient model for services delivery. In 2006 we added capabilities to our centers in India, Brazil and Argentina, to provide the ability to seamlessly transfer workload. This year we added over 20,000 employees to our service delivery centers in low cost countries. We have continued the global integration of our internal support functions, such as supply chain, finance, and HR. We look for 10% to 15% productivity from the global support functions, and this year we achieved our goal. As a globally integrated company, we will continue to leverage the skills and capabilities of our global infrastructure and workforce. Finally, let’s look at IBM’s 2006 business model performance. In 2006, we had record profit, earnings per share, and cash performance. In the year, we grew pre-tax profit about $1 billion, and grew earnings per share by 14%, excluding last year’s non-recurring activity. Gross margins expanded for the third consecutive year. Our productivity actions and high profit levels allow us to reallocate resources and increase investment in more strategic areas of the business. Looking at the measures of capital efficiency, our Return on Invested Capital for the year was 34% for our core business, with a 30% Return on Equity for our financing business and we had record return to shareholders of $9.8 billion, including $8 billion for share repurchase. Our business model success will be measured over the long term, not any individual period. The strategies we have put in place, the investments we make, and the individual actions we take, are all with an objective of optimizing our long term performance. 2007 should be no different. We’ll continue to take actions to transform and improve our business. This means that any particular period may reflect the impact of those actions, as we buy and sell businesses, have gains and charges, and invest resource in some areas while moving resource out of others. So, while the timing of various activities can impact the individual quarters, at this point, it would be reasonable to assume an earnings per share distribution in 2007 similar to 2006. We do all of this in the context of managing the business for sustainability and with our long term objective in mind, to deliver 10% to 12% earnings per share growth over the long term. Taking all of this into consideration, and a steady economic environment, we would expect earnings per share for 2007 to again be in line with our long term model. This is also consistent with the growth in the current average estimate for earnings per share. Now, Patricia and I will take your questions. Patricia Murphy: Thanks, Mark. Before we begin the Q&A let me comment on two items. First, we have supplemental charts at the end of the deck that complement Mark’s prepared remarks. We have a few new charts this quarter, including a chart that bridges the software and services segment revenue to the income statement, and an estimate of retirement-related expenses based on year end 2006 assumptions. Also, as always, I’d ask you to refrain from multi-part questions to allow us to take questions from more callers. Operator, please open it up for questions.

(Operator Instructions) Your first question comes from Toni Sacconaghi - Sanford Bernstein. Toni Sacconaghi - Sanford Bernstein: Thank you. Profitability in your Global Technology Services group was lower than expected, and typically services profitability spikes up in the fourth quarter due to volume. Certainly it doesn’t appear on that side of the business that that happened this quarter. Can you go into a little more detail? You talked about increased infrastructure in sales as the reason behind it. You also talked about optimizing resources in the first half of ‘07. Is that a code word for saying that you will be taking out people and expense in the first half of '07 in your Global Technology Services business and we should see the benefits of that in the second half? Mark Loughridge: Thanks, Toni. Let me take that question and first, look at it from an overall total services prospective. The issue that I would like to highlight first of all, that total services margin improved sequentially and year-to-year in the fourth quarter and also improved on a full-year basis. So it was really the combined fourth quarter margins as you look at it, were the highest in the past three years but were down against a very difficult compare in fourth quarter 2005. If you look under total services, that difficult compare was predominantly in Global Technology Services. If you look at GBS, as you can see in the results, we had very strong margin performance in GBS again this quarter with most of improvement coming from improved utilization, improved contract management and delivery discipline. I expect that momentum in our margins to continue as we go into 2007. For GTS this quarter, as I had said, we had a very difficult compare from the fourth quarter of 2005. The fourth quarter margins would have been flat sequentially really, adjusted for the impact of acquisitions, and we do continue to make investments in sales resource in the ITS transition area, as well as in the infrastructure supporting our SO and BTO accounts. So we believe these investments are paying off. I think you can best see them in the performance that we had in ITS. It did show improving revenue performance. We certainly saw improved signings performance not only here but across our services organization, and I think as you look at the profitability in our Global Technology Services it is predominantly an issue of the earlier year compare. I think if you put that margin in context for the general quarterly improvement across the year, it is not out of line. In all, an element of our overall IBM margin that was, in fact for the full year, up a point. Patricia Murphy: Thanks, Toni. Let's take the next question, please.

Your next question comes from Richard Gardner - Citigroup. Richard Gardner - Citigroup: Thank you very much. Hello, Mark. I was hoping that you could talk a little bit about the microelectronics business. Obviously it was down year-over-year, but based on my math, it looks like it might have been down sequentially as well, which is a bit of a surprising outcome given that you are finally shipping chips to all three major game consoles. They are all shipping at volume this quarter, and we had actually picked up some strength in the networking portion of that business. Can you give us a sense of, in addition to a tough year-over-year compare, what happened to that business sequentially and what caused what looks to be a sequential decline? Mark Loughridge: Well you know, Richard, if you look the microelectronics business, it really experienced very strong growth through the first three quarters in advance of the fourth quarter launch of new game consoles from Nintendo and Sony as well as supplying Microsoft for the holiday season. So given the seasonality of the consumer segment, we anticipated demand will continue to moderate through the first half of '07 but should improve later in the year. In the fourth quarter, we did experience strong growth in our communications and electronics segments, contributing to an improved margin mix as game processors growth slowed. But if you look at it over the years, despite the revenue decline of 6% in the fourth, microelectronics did grow 22% for the full year. So, as I look at that performance, we had very strong micro performance in the game chip platform for the year. We supplied all three game platforms. This is, in many respects, a function of the holiday season on our shipments into that. We had very strong micro performance in other elements of our technology base, and I think the strongest element of our micro platform is supplying our base server business. Patricia Murphy: Thanks, Richard. Let me just correct Richard that, in fact, the revenue was up sequentially in microelectronics from third quarter to fourth quarter. Mark Loughridge: Right, good point, Patricia. Patricia Murphy: Let's go to the next question, please. Mark Loughridge: Your next question comes from Bill Shope – JP Morgan. Bill Shope - JP Morgan: Great, thanks. Obviously very impressive signings numbers, so congratulations on that. My question is: how much of this was largely seasonal or some perhaps one-time deals? Looking forward, how should we think about the pipeline for the first quarter? Did you pull business in? Do you feel like you still have a solid pipeline going forward for us to go ahead and model the run-rate here? Mark Loughridge: Very good question. We did have, as you all know, a very good quarter in signings, which enabled us to grow both short term 16% and long-term signings a pretty stellar 88% in the quarter, for a 55% signing growth for the quarter. In fact, if you look at it now for the full year, we have grown overall signings 4%, and we enter the year 2007 with a pretty strong backlog at $116 billion. So we have clearly made progress in our shorter-term business in the second half of the year, and looking at the opportunities out there in our pipeline, I expect the progress to continue into the first quarter. If you look at longer-term signings, they can be very inconsistent from quarter to quarter, and we certainly saw that in the third quarter of this year. So, as I look at it first from a long-term perspective, we're not going to replicate the fourth quarter performance, but we do see substantial opportunity there. If you take both the short-term trends and long-term together and look at our first quarter opportunity, we still see opportunity for growth in the first quarter.

Your next question comes from Laura Conigliaro - Goldman Sachs. Laura Conigliaro - Goldman Sachs: Thank you. For much of the year, you have actually struggled with your hardware growth, other than a quarter or two here or there in individual categories, as well as profitability here and there. Why should we think that this is going to change on a sustainable basis? Why, in fact, were blades flat? Then a clarification. Could you please just tell us what your software growth would have been excluding acquisitions? Mark Loughridge: Sure. Let me take those in sequence. So, first of all, if you look at overall S&TG and you look back at 2006, two really different stories from the first half to the second. In the first half, our 3% growth was on the strength of microelectronics, while servers declined 3% and storage grew 1%. During this time, we saw areas to improve our execution and facilitate in our client's progression into the mainframe z9 technology. Now if you look at the second half, it is a different perspective. In the second half, our actions in working with our clients on the z platform have continued to show strong results through the fourth quarter, providing 12% growth for the half and a substantial share gain for System z. In fact, System z in the quarter was the strongest mix growth on record. So, as I look at S&TG going into next year, I think we've done a lot to refine our System z sales cadence and our customer strategy with our clients. Storage had a lot of momentum as we went through the fourth quarter that I expect to extend in the first. As you know, we are the leader in server share. Secondly, if you look at overall organic growth for software, I would like to again take you back to the fourth quarter 2006. From an external basis, software revenue grew 14% as reported and 10.6 at constant currency. Underneath that, branded middleware grew 25% as reported and 21% at constant currency. Organically, at constant currency, branded middleware grew 10% for the quarter. So you can see about half of that was organic, and I think if you look at this performance that we had in software in the fourth quarter, it was really, really very powerful on the organic side, very powerful on the acquired side as we quickly integrated those businesses into our global reach.

Your next question comes from Richard Farmer - Merrill Lynch. Richard Farmer - Merrill Lynch: Mark, you mentioned the pension retirement assumptions, the actuarial assumptions might be changing. Would you mind just clarifying what are the changes in the return and the rate assumptions or other assumptions? What would be the going forward view of pension and retirement expense without those changes and assumptions? Mark Loughridge: Now I didn’t say that we are changing assumptions. Assumptions in our base return objectives have been 8% for quite awhile now; we are maintaining that at 8%. What has changed has been the interest rate environment. So all we are referencing is the change in the interest rate environment, especially at the long end of the curve and how that affects your long-term liability. So if you look at pension expense year-to-year, this year we expended about $2.4 billion, and we expect that to increase year-to-year by a little less than $100 million. So it will be in the range of 2.5 or a little less than that. But if you look at the supplemental, if you take those same end of year assumptions in the industry -- these are not our assumptions; they are, in fact, the interest rate that we use to calculate that long-term liability -- you can see how based on that interest rate environment, it will continue to improve, frankly, as we go into 2008 and 2009. I think the graphic that we provided is pretty clear there.

Your next question comes from Harry Blount - Lehman Brothers. Harry Blount - Lehman Brothers: Hi, Mark. A similar question on the retirement and a broad question on expenses in general. You do lay out fairly clearly on the supplemental side what your expectations are around that, and some of the earlier slides -- 5 and 8 I believe -- you laid out some of the individual expense items. But, as I look through your 10% to 12% earnings growth target, I'm trying to get a sense of why the earnings growth couldn’t actually be better in '08 and '09 given the significant ratchet down you guys might be looking for on the pension side of the equation? Mark Loughridge: Well, first of all, if you go back to my comments, pension expense is actually going to increase as we go into 2007. So again, pension expense for 2006 was $2.4 billion, and as we take the end of year interest rates and environment and we calculate that future liability, pension expense in 2007 should be slightly below $2.5 billion. So it is an increase year-to-year in pension expense of a little less than $100 million. So much less of an increase in 2007 than we have seen in the past. Nevertheless, still more expense in 2007. It does not really at current interest rates begin to ratchet down until we go into 2008 and 2009, and that is the point of the graphic at the end of the chart. So I think that as we go into next year, we certainly have the momentum and the structure to continue to meet our model expectations, even if you roll through the fourth quarter overachievement.

Your next question comes from Ben Reitzes - UBS. Ben Reitzes - UBS: Good afternoon, thanks. I guess a little more clarification on the guidance, Mark. Obviously you said The Street estimates look reasonable. That is 9% growth from your current 2006 of 606. So your IBM business model of 10% to 12%, the midpoint of that puts you at 673. So I was hoping you could clarify that and also talk about what kind of tax rate was implied in your guidance. Given that you had the R&D tax credit this quarter, do we go back to 30%? If you do think it is 9%, if you could please tell us why it would be a little below your model, that would be great. Mark Loughridge: I think my point was the growth rate in analyst estimates was reasonable and the original growth rate was about 10%. So even if you rolled through the overachievements that we saw in the fourth quarter and still maintained your 10% growth, that is a reasonable expectation. So it is above the 9% that you referenced, Ben. Is that clear? Patricia Murphy: And let me just add clarification on the tax rate for next year. As we said in the prepared remarks, Ben, that we expect the tax rate for next year to be in the range of about 28.5%. Let's go to the next question, please. Operator: Thank you. Your next question comes from Rebecca Runkle - Morgan Stanley. Rebecca Runkle - Morgan Stanley: Good evening, thanks Mark. Just looking at cash flow from ops, you spent about 25% of that on acquisitions in '06, which is a pretty big step up from what you have been running the last couple of years. I was just curious how you're thinking about acquisition rate in '07? Does that level of investment continue, or would you characterize '07 as more of an integration year, and you might see some moderation in the rate of acquisition activity? Mark Loughridge: Well, a very good question. I think what I would like to do as you look at acquisitions if you don't mind, is go back to the presentation that we made in India, and the presentation we showed in India is, we think there's a strong category of acquisition content out there that if we pick them correctly and they are highly scalable and have not yet globalized, basically IT-related, that we can rapidly scale those investments. If you remember, the IRR for those was in excess of 20%. So my view of that is: why wouldn't I continue to pursue that strategy? As we look at the investments that we made in acquisitions in 2006 and the performance on those investments in the fourth quarter, they are on a very, very steady track. So I think that the acquisition performance that you saw in this range of target acquisitions is a good indication of our direction as we head into 2007.

Your next question comes from David Grossman - Thomas Weisel Partners. David Grossman - Thomas Weisel Partners: Thanks. Mark, could you go back to the expenses? I know you made some comments in your prepared remarks on slide 8. But if I understood you correctly, you said that the higher expense levels would continue in the first half of '07. So if you could maybe just help us better understand what you mean by that and the underlying drivers? Secondly, when we apply that 10% year-over-year growth in '07 to the base EPS, are we using the $6.11 number including the $0.06 benefit from the lower tax rate in the fourth quarter? Mark Loughridge: First of all, let's start with expense. As we laid it out in the presentation, we tried to be very clear. If you look at that, the 16% expense growth adjusted for currency in last year's real estate gain, which we clearly laid out, is actually 9%. Underneath that 9%, about half of that was driven by our acquisitions, which are primarily in our software group and our GTS business. The remaining 4.5 points of growth is largely driven by investments we're making in our software and our services business in emerging markets. Against that organic investment, I point to the positive returns on these investments that are very encouraging. E-branded middleware is up 21%. We had 47% signings growth in our GTS business alone and our 14 emerging countries together grew 18%. So I think that is a substantial achievement given that 4.5% growth in our organic expense equation. I also want to step back a little bit as you look at that expense performance. I want to give you a feeling for the process that we are using here. We are being very surgical and very deliberate in our investment for 2007. First, our organic growth, we will continue to invest to drive our momentum in the software business, which has roughly 85% gross profit margin and performed well in the fourth quarter and throughout 2006. So we see a real increase in our momentum in that software business from our organic investments. Emerging countries at 21% for the year 16% constant currency, also very attractive margins as they continue to build their infrastructure. We invested to drive signings. I think the results speak for themselves, and we're investing in our channel growth like IBM.com. Now I will also tell you on the other side, we are working pretty hard to mitigate the impact of these investments with a tough-minded focus on spending on areas that are not clearly revenue generating, including reductions in support functions as we continue to globalize IBM in diverse centers of excellence and will continue our efforts to derive greater productivity in our operations through balancing and prioritizing resources in support of higher-yielding opportunities. In fact, if you just look of a microcosm of the finance organization, we have about 11,000 people currently in finance. If you look at our trajectory in globalization, by the end of 2008 we will have almost 40% of that resource in global centers of excellence. So that covers the organic investment. On the acquisition investment, as I said earlier, we are focused on strategic acquisitions that complement our product offerings that we can quickly integrate and accelerate through the IBM global structure. They are generally highly scalable, generally intellectual property-based and aligned with our growth opportunities. If you go back to the data that we reviewed in our analyst conference in India, you can see that of the 24 acquisitions in this strategic profile, the population almost doubled that revenue in two years, was accretive in year 2, and accretive without intangibles in year 1. So against this investment, again very tough-minded and a very disciplined approach. Patricia Murphy: Thanks. Let me just clarify that the earnings per share for 2006 for continuing operations is $6.06, and that would be the base that you would apply your growth assumptions to. Mark Loughridge: Right. So to be very specific, against that $6.06, we see 2007 and the opportunity to support both our model and your estimates at 10% growth. Operator: The last question will come from Keith Bachman - Banc of America Securities. Keith Bachman - Banc of America Securities: Hi guys, thanks for taking my questions, sneaking under the wire. I had a question going back to margins for a second. The Systems and Technology group margins were lower on a year-over-year basis and certainly a bit lower than we were anticipating. I was just hoping you could add a little color on that group. I wouldn’t think it would be implicated at all by any of the acquisitions you have done, so I'm not sure what is happening there. Mark Loughridge: Well, overall when you look at margins, I would look at margins in their broader scope for IBM. So first of all, if you look at IBM, the margin for '06 was up a point, and I thought that the fourth quarter, though down year-to-year, was in line with the other quarterly performance; it was predominantly down based on last year's real estate investment and the acquisitions that we have made. The difficult compare we saw was predominantly in GTS. GBS had spectacular margin performance as they continued to improve our utilization, contract management discipline driving 37% growth in their profitability for the year. Software, the software acquisitions were a real addition here to the overall performance of that unit. But if you look at the margin decline, more than two-thirds of that was driven by the acquisitions we made. S&TG margins did decline, driven largely by that same real estate deal and currency items that impacted our overall IBM margins. So actually, if you airlift those out, they did well operationally. Patricia Murphy: Thanks, Keith, and I want to thank you all for joining us today. Have a good evening.