Analyst Conference Summary

conference date: July 18, 2007 @ 1:30 PM Pacific Time
for quarter ending: June 30, 2007 (2nd quarter)

Forward-looking statements

Overview: Great quarter.

Basic data:

Revenues were $23.8 billion, up 9% from year-earlier.

Net income from continuing operations was $2.3 billion, up 15% from $2.0 billion year-earlier.

Earnings of $1.55 per share from continuing operations, up 19%

Guidance:

14 to 15% EPS growth expected for full 2007.

Conference Highlights:

Strong quarter, close to firing on all cylinders. Led by Asia. Americas had best improvement, led by U.S. Japan grew for 3rd consecutive quarter.

Software revenue was up 13%.

Sale of Printing Systems Division (PSD) resulted in pre-tax gain of $81 million, adding $0.05 per share to EPS (to reach $1.55).

By geography, Americas revenues were $10.1 billion (up 10%). EMEA revenues $8.2 billion (up 13%). Asia-Pacific $6.4 billion (up 10%). OEM revenues were $852 million, down 9% from year earlier.

Global Services (GBS) revenue ($13.1 billion) benefited from strong demand for SOA. Global Business Services revenue grew 10% to $4.3 billion. Global Technology Services (GTS) revenue grew 10% to $8.8 billion. Service contracts were signed for $11.7. In India beating local competitors.

Systems and Technology segment revenue was $5.1 billion, up 2% y/y. System i declined sharply, as did microelectronics (due to game processor weakness), and printer systems due to divestment. System x Servers grew 16%, Retail store solutions grew 18%, and storage grew 6%. System z was up 4%.

Software segment grew 13% to $4.8 billion. Best growth was from Tivoli (33%), WebSphere (28%), information management (21%), Lotus (12%), and Rational (11%). Operating system revenues grew only 2%. Branded Middleware is now 53% of software revenue.

Gross margin was 41.8%, up .6% from year-earlier, driven by higher sales and mix shifts.

Tax rate was 28%.

Dividend has now doubled in last 2 years.

Total expense and other income was $6.8 billion. SG&A was $5.6 billion, RD&E $1.5 billion.

Cash flow was outstanding. Net cash from continuing operations was $4.8 billion. Free cash flow was $2.5 billion. $1 billion was paid in dividends, $18.2 billion was spent on share repurchases. Capital expenditures were $2.2 billion. The net change in cash and equivalents were negative $0.5 billion, ending at $10.2 billion. Debt increased to $34.7 billion.

2010 goals include reducing shares by 3% per year; revenue growth of 3 to 8%, and margin expansion. Looking for 10 to 16% EPS growth per year.

Q&A:

Operating expense rapid expansion? Components of expense growth included 3% from currency changes, 5% from operations, 3% for acquisitions and investment. Will continue acquisitions, but pace will slow and internal investment will slow too. Expects net margin improvement in second half.

U.S. revenue gains? Saw relatively improving economy. Took some time to get new sales resources productive. Higher level of services signings, with existing customers buying new products.

Signings weak? Have a good deal list going into Q3. Confident in signings growth, but need more momentum for Q4. Full year signings growth will be a challenge.

New server and storage products? Looking at 4 to 5% annual long term revenue growth. Great margin improvement. Virtualization gives customers reason to buy in to high end. For storage did 19% increase with tape, but disk was flat. New Power 6 technology had some impact on P series midrange.

Interest rates effects? Don't want to try to project that until January 2008.

Margin improvement through mix, like India services? Labor based businesses have seasonal effects in Europe, but global revenue growth should continue in second side of year. GBS has expanded margin over last 2 years. Very confident for 2nd half, despite challenging compares.

Challenges to reaching goals? Over-achieved on revenue in Q2. Margin expansion missed goals this quarter, because GTS investments needed. Share repurchases on track. Growth initiatives and acquisitions were on track this quarter. Rapid uptake on retirement related costs. So on track for everything in Q2.

Mainframe cycle? 8 consecutive quarters of growth. Longer cycle because of virtualization benefits. Box saves a lot of money for clients. Also moving into newer markets.

Softness in technology business? Gives leadership technology to server brand, gives strong return on invested capital. Helps fill out capacity with merchant business. Q2 had falloff in game chip area, which is only 1% of total gross profits. No point to ramping up fab capacity to get larger share in chip business. P6 is a good example of helping with server leadership.

2008 margin expansion? About .4%. Driven through investment in software business, in particular branded middleware, which has high margins. In each business unit looking for some improvement.

Economy going forward? Asia doing great, also seeing improvement in Europe. In Americas there was a falloff in March, but Q2 was well-balanced. In U.S. only automotive industry showed weekness.

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