Welcome and thank you for standing by. At this time, all participants are in a listen-only mode. Today's conference is being recorded. If you have any objections, you may disconnect at this time. Now I will turn the meeting over to Ms. Patricia Murphy, Vice President of Investor Relations. Ma'am, you may begin.

Thank you. This is Patricia Murphy, Vice President of Investor Relations for IBM. I'm here today with Martin Schroeter, IBM's Senior Vice President and Chief Financial Officer. I'd like to welcome you to our second quarter earnings presentation. The prepared remarks will be available within a couple of hours and a replay of the webcast will be posted by this time tomorrow. I'll 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. Our presentation also includes certain non-GAAP financial measures in an effort to provide additional information to investors. All non-GAAP measures have been reconciled to the related GAAP measures in accordance with SEC rules. You will find reconciliation charts at the end of the presentation and in the Form 8-K submitted to the SEC. Now, I will turn the call over to Martin Schroeter.

Thanks, Patricia. In the second quarter, we delivered 20.8 billion of revenue and operating EPS of $3.84. With that, our revenue for the first half was over $40 billion. Operating net income was 6.7 billion and operating EPS was $6.75. Our revenue was down less than 1% in the quarter and essentially flat for the first half excluding the impact of currency and the divested businesses. Our overall revenue performance includes the continued translation impact from a strong dollar and the impact of divested businesses. Together, these reduced our reported revenue growth by 12 to 13 points, both for the quarter and the half. I will focus on our revenue performance excluding the impact of currency and divestitures for the balance of the presentation. Let me give you a quick overview of different parts of our business. Revenue in our strategic imperatives, those that address the market trends in data, cloud and engagement is again up more than 30% in the second quarter and so up over 30% for the first half. This is an acceleration from roughly 20% growth last year. As we’ve said before, we are able to grow at a rate significantly faster than the market because of the industry perspective and deep insight we have from working with our clients on their core businesses to help move them to the strategic areas. We are clearing seeing this in analytics where our revenue is up more than 20% in the first half, well above market rates. This is terrific growth on a large revenue base. Recall we generated $17 billion of analytics revenue last year. The growth is led by GBS and by systems hardware, reflecting the new z13 and POWER8 systems where they specifically address analytics workloads. And we are developing new markets with the advanced…

Thank you, Martin. Before we begin the Q&A I’d like to mention a couple of items. First, we have supplemental charts at the end of the slide deck that provide additional information on the quarter. And second, I’d ask you to refrain from multi-part questions. Operator, can you please open it up for questions.

Thank you. [Operator Instructions]. The first question comes from Toni Sacconaghi with Bernstein. You may ask your question.

I was wondering if you could talk a little bit about software, the business was down 3% at constant currency, I think other than the financial crisis in '09 that's the lowest software growth rate in the last 15 years. You also had a significant pressure, accompanying pressure on margins. And I am wondering if you can kind of step back. At the beginning of the year you were hoping for an improvement and talking about the guidance, it looked like perhaps you are not as confident, you were saying we could end up at the low end of the range if we don’t improve, maybe we'll do better than that if we do improve. But I am wondering if you can kind of step back now that you are half way through the year. The results seem to suggest that there is something structural impacting your software business. Now whether that’s the decline that we've seen in UNIX over the last couple of years or whether it's the migration to as a service, there seems to be an inflection point over the last four quarters in your software business for the worst. And I am wondering if you can step back and tell us if you agree with that and what you think is driving this and do you have confidence like the same level of confidence as you did six months ago that the software business will improve throughout the year?

A few comments I think on software and some of these themes are going to be consistent with what we've talked about and then some of them will be I guess observations and we go through the year. So relative to, first relative to guidance as we said since the beginning, the difference, the primary difference in our guidance range for the year is driven by the trajectory of software. And so when we went through in the prepared remarks and pegged third quarter to the low end I wasn’t suggesting that we don’t see that difference still, in fact we do still see software driving the difference between the low and the high end but we do have to when you have a range you do have to pick one side to anchor your analysis. So we chose in this case to anchor to the low side. With regard to software there are some consistent themes here that we've been observing now for a while. We do still have in our overall growth rate a headwind from the operating system element of our business, so it was about a point. Additionally, what we saw in the BRIC countries' impact on IBM and I mentioned this in my prepared remarks even though the BRICs are relatively small, only about 7% of our revenue, they had a two point impact on the growth. That same phenomena translated into key branded middleware. So ex the BRICs our key branded middleware segment, software segment would have had 2 points of growth as well. So when we look underneath that I think the consistency here is that we have two phenomena. Within our top 250 clients and we've talked about the substantial both investment and commitment those clients made to the software platform, within that client base we continue to offer and they continue to utilize flexibility so that they can fully deploy middleware across their environments. And that phenomena hasn’t changed. Now outside of that top 250 clients we do see growth. We have seen growth, we have been growing there and we continue to grow. So it really is this flexibility that we are providing to our clients which we still think for the long-term as the right thing to do as they commit to the platform.

The next question comes from Tien-tsin Huang with JPMC. You may ask your question.

Just on the strategic imperatives I guess up 30% again, so up 30% I guess for the first half. I am curious if that growth rate is sustainable into the second half. Martin I know you suggested it could come down to the 20% level of last year, but checking to see if that's still the case for the second half of the year?

So it was quite a good acceleration as we mentioned in the last call from the fourth into the first and as you note and as we just talked about in our prepared remarks, we were able to maintain that trajectory into the second quarter. So we finished first half in a very strong position in strategic imperatives. And given our growth rates and where we think that market growth rate is, as I mentioned in my prepared remarks, I think we're growing share across that space as well. When we look forward in those strategic imperatives and we look forward at the overall revenue trajectory of IBM, we don’t have assumed, we have not assumed a dramatic improvement if you will in the overall revenue trajectory at the low end of our guidance. At the high end obviously as we just talked about in the last question and in prepared remarks, the high end we assume an improvement in the software trajectory, some of which will be in the strategic imperatives obviously. In fact the weighting of our software business and strategic imperatives is larger than the overall business. So I would expect that we would see an improvement in that. But again our current guidance at the low end does not assume a dramatic improvement in the overall revenue trajectory. And so within that the mix between the strategic imperatives again which has a lot of momentum versus the core, we're not suggesting that we have to grow or we have to change the trajectory at the low end.

Christine, can we take the next question please?

Next question comes from David Grossman with Stifel. You may ask your question.

Last quarter Martin we discussed cash taxes as a tailwind this year but offset by other headwinds. And then as of April it appeared the cash taxes would be actually free cash flow headwind in 2016. Is that still the case and if so are there known tailwinds next year that would offset that and allow the free cash flow conversion rate to remain in that 90% plus range that you've talked about for this year.

A few things, so and there are a number of metrics here I want to make sure that we triangulate to the right answer and that we don't confuse or we don't mix some of the data points, so cash taxes as you know last year were substantial year-over-year headwind and this year they're not a year-to-year headwind and the amount of cash tax tailwind that we're getting this year is the same as we thought it was going to be at the beginning there, so no change to that. Now let's switch for a second to the realization metrics, so cash taxes were about a 10-point headwind to realization to last year, very dramatic headwind to our realization. This year they're still a headwind although much reduced, so the realization impact is only about a point or two, so when you think about the relationship of what's going on our cash tax rate will still be a little hit higher than our book rate although not as high as it was last year. So this year cash taxes will be a little bit higher than the book rates so there still a realization impact but there is a year-to-year tailwind in terms of payments. Now next year we still have a lot of work to do and a lot of planning to do and while we have a small headwind in realization this year, we do see a headwind in realization next year and how that translates to a year-to-year I think we have to spend the next six months trying to figure that out and then we'll have more guidance in January for you, but again there are different elements here. So from the realization cash taxes are still a headwind this year although smaller than last year and next year we expect them to be a headwind but we'll have to translate as we get closer and to what that means on a year-to-year base for 2016, but as we just mentioned in our prepared remarks we do see now a modest improvement in free cash flow for this year.

Can we go to the next question please?

The next question comes from Lou Miscioscia with CLSA. You may ask your question.

So can we step a back to the services side in the sense that consulting system integration was weak again and you had talked about having to shift some of your resources maybe you can go in and say the cloud or ERP deployments are going down or being replaced by SaaS developments maybe you're not winning as many products they're giving that others are growing actually consulting pretty well here in beginning of 2015?

So a few things, our GBS and when we talk about consulting systems integration, I'll just focus the answer on our global business services segment. GBS was as you noted down again in the quarter although quarter-to-quarter we had about 1 point improvement in the trajectory still down but a bit better than the first and the dynamics within that I think are similar to what we saw in the first which is the shift that we're undertaking and what you've noted in your question, the shift that we're undertaking is pretty dramatic and we're seeing very strong double-digit revenue growth within the strategic imperatives within the GBS business alone. Now that we also have a pretty substantial -- think about it as a traditional ERP implementation kind of consulting business and the net of the shift to the shift of those strategic imperatives and obviously the reduction in our resources applied to those larger implementations the engineered shift is not yet at the point where the revenue growth coming from those imperative is offsetting if you will our reduction in those the areas that address those traditional ERP. So the course is still the largest part of the portfolio that was traditional parts of ERP implementations and while we engineer that shift we're going to see declines in that part of the business, but as I mentioned that shift is driving growth in the strategic imperatives we just have to continue to be as fast as we can to get those areas so we can see growth overall for the GBS business.

Could we take the next question please, Christine?

The next question comes from Steve Milunovich with UBS. You may ask your question.

A couple of non-operating items, Martin, last quarter you suggested currency could hit EPS about $0.80 for the year I was curious if that's still the number and it looks like your expectations for the next few quarters on currency at similar to a little worse than in the April quarter and I am little surprise given the move in the Euro than also was curious about the 17% tax rate, should we carry that forward does that go back to 20?

Sure, thanks, Steve. Few things so first on tax, we'll start at the back on tax. So we still see a 20% rate for IBM that's the right operating rate if you will for us, we did have as I noted in the call a couple of discrete items in the quarter but those were discretes in the quarter. Now we do have discrete throughout the year but 20% is the right number for tax. On currency impacts, I'll come back to earnings in a moment the first part of the question, currency impact is now a little bit worse for the year relative to what we expected just 90 days ago. So you may remember we include as we always do we include a supplemental chart on the impact of currency and we had on that chart in April that the third quarter would be about an 8-point impact and the fourth quarter would be about 5 year-to-year and now we see 8 to 9 and 5 to 6 in terms of the currency impact and that data again is in the supplemental chart. And so we are seeing an increased -- a slight increased currency impact for the second half of the year. Now our view of currency and its impact on profit is and can be, as you would imagine the translation impact can be quiet substantial. So we did say that the impact to earnings would be about $0.80 for the year and we still see, while it's gotten a little bit worse we still think that’s probably little bit worse as well, but we can hold that within the guidance we’ve given. So, yes the impact to EPS is probably a little bit worse than what we had assumed. We do have actions underway to try to navigate through whatever currency environment we’re in, but the year-to-year impact is still fairly substantial in our guidance. Now of notes -- of note is that the guidance as you know reflects a EPS of flat to downsize and the currency impact is five points, roughly in terms of earnings. So if we were in benign currency environment, we’ll discard the idea of it being an actual tailwind at some point. But if we were in a benign currency environment, our guidance would reflect flat to up five and that’s the kind of impact I think that you would expect to see in a company that has more than 60% of its revenues, and cash flows and profits, dramatic part of this profits operating in currencies other than the dollar. So the short answers to your questions tax 20 is still the right thing in terms of operating, the currency impact is a little worse than what we assumed from 90 days ago and it is a dramatic year-to-year impact on our profitability.

Let's go to the next question please Christine.

The next question comes from Brian White with Cantor Fitzgerald. You may ask your question.

Martin it sounds like services you got from bigger deals in the quarter, minor services in aggregate beat our number. When can we start to see margins improve back to levels that we saw two, three years ago in the services business?

Yes, we did see as you saw a very strong signings quarter which as we noted in the prepared remarks drove our backlog to 1%, ex-currency is the first time we’ve had backlog both in a couple of year. So obviously very encouraging to get the services backlog growing, so we can start to see a more consistent delivery of revenue growth. Obviously within that revenue growth in that business does drive profit leverage, but keep in mind that we continue to invest quite heavily as well in order to make sure we’re building the right cloud platforms, the right skills around that services business. So while the single largest impact year-to-year and our services profitability not on margins, but services profitability is the translation of those profits back to dollars given the dollar strength. We do see an opportunity to continue to invest quite heavily in our services business. We do see opportunities to continue to move not only the GTS business, but the GBS business to higher value and over time that will drive margin improvements. But for now, we’re not relying on margin improvements in our guidance for this year. But again the single largest impact on a year-to-year basis is currency. So as we continue to invest while that revenue grow -- if we were to grow we continue to grow revenue in GTS for instance that will drive some leverage in the profit model, we’re going to continue to invest pretty heavily going forward.

Can we take the next question please?

The next question comes from Keith Bachman with Bank of Montreal. You may ask your question.

Martin, I want to follow-up on that last point, I understand currency impact on the Services segment. But as you look out beyond the next quarter or two. Won't you need to A: continue to invest in these businesses on both GBS and GTS? And B: as you make that adjustment to the higher growth areas is there a mix impact that will continue to weigh in on margins even as you look out a bit further than the near-term quarter. So both the investment side and the mix side as you think about both sides of services please?

So couple of things Keith; first, we will continue to invest. So let's assume we’ll get through at some point, the year-to-year impact of currency and we’ll just take currency out of the equation for a second. When we look at our model, we see a few elements that will continue to drive profit growth within services while at the same time continuing to invest. So first we will continue to drive capacity utilization into our cloud business, so remember we’re investing pretty heavily in cloud and I would say that those businesses are not yet at scale. So as we get those and utilize that capacity and get to scale then we’ll see margin improvements in the services business. Secondly we continue to shift that overall portfolio to the most contemporary highest value offerings that our clients are demanding and I think you can see that both in the signings we had for instance in our services business and the backlog growth you can see it and the strategic imperative performance within GBS. So we continue to shift those offerings to higher value. And then underpinning that the delivery side of this, the delivery elements of this including much broader deployment of intellectual property leveraging our software and research ability to put automation into our delivery content. So, we do still see opportunities to keep a balance between we’ll keep investing but we’ll also be able to drive a more efficient delivery platform as we go through -- as we get out of this currency environment. And then finally, I think it’s important to note that while we do make use pretty heavy use in some countries like the U.S. we have a pretty good global delivery platform within the U.S. that’s not the same everywhere in the world. So, in some regions in the world our use of global delivery is still under 30%, so we still have opportunities in those regions to move more of our delivery into a global delivery format. So I still see between the shift to higher value between getting cloud to scale and the move to automation and getting more of our regions into the global delivery environment. We still have room to improve margins and services.

Christine can we please take the next question.

The next question comes from Jim Suva with Citibank. You may ask your question.

In your prepared comments you mentioned a little bit about operating expenses as a percent of sales have increased due to the mix shift and my belief is understandable and I assume you’re referring to the mix shift in more strategic imperatives and it can’t -- and so that manifesting itself a nice growth I think you said up 30% year-over-year which is good. Can you help us understand the timeframe or the milestones for judging and assessing the strategic imperatives and the investment in them of when we start to really start to see leverage to the model of leveraging that growth into a lot more profitability? Or in other words how much longer do you have to keep really investing a lot more ahead of all that?

So a few things, in the prepared remarks on expense what we talked about was a slightly higher E to R in the quarter and we wanted to go through make sure everyone understood that the 9% year-to-year improvement in expense was driven heavily by just the translation the currency impact which is actually 11 points a year so currency obviously has an impact on the expense side as well. We also talked a bit about the impact of having the expense from our system ex-divestiture now out of our run rate so that was a couple of points. So we wanted to make sure that everyone understood, our investors understood that we continue to invest and that’s why E to R is up in terms of the second quarter. Now when do we get through that? Boy, we see an industry where innovation where industry skills and knowledge are the differentiators in many of our engagements. And so a lot our investments are focused on yes the strategic imperatives as you said which is a combination of shifting out of things that we were doing into new things it's also part of growing that overall investment pool but within those investments yes there’re strategic imperatives but it’s also a lot of investments around building industry skills, industry talent because more and more our clients are looking for that industry point of view. So I don’t know that we get through if you will the bow to shift through the wave in terms of expense in terms of investments when do they slow-down. Now I do think they’re paying off. We had tremendous growth in cloud again we have tremendous growth all across the strategic imperatives. So, shifting this expense as we’ve talked about in the beginning of the year is absolutely the right thing for us to do for the long-term. We can see that pay off in terms of the market share we’re growing in those strategic imperatives. Now those will continue to pay dividends for a long-long time within that as you know we’re building a number of as a services businesses including Watson, so I think that those investment levels are important I think we’ll continue to maintain those investments because we’re building some very appealing businesses underneath those strategic imperatives.

Christine can we please take the next question?

The next question comes from Joseph Foresi with Janney Montgomery Scott. You may ask your question.

I was wondering if we could get some sense of what percentage of revenue the strategic imperatives are and how do they impact your visibility on the business? And then just one last one have we had a positive inflection point on the services backlog?

Sure. So a couple of things that we hit a positive inflection on the services backlog we’ll start with that. So, the backlog is $120 billion plus, so it’s hard to make it move if you will. We had a very good signings quarter as we talked about 22 deals greater than 100 million we still see a lot of opportunity in terms of additional services opportunity. But getting that substantial backlog to move it takes a lot of services, signings of our consistent period of time. So while we see very good demand it’s tough to predict on a 90 day basis where the backlog is going to be again given it’s a 122 billion that we’re trying to move. Now as a percentage of revenue we've talked about last year in Investor Day we talked about it on a full year basis had about 27% and we said in Investor Day that we’re going to grow that to about 40, be more than 40 billion about 40% of our revenue by 2018. Now I think even there is seasonality in this number I would say we are certainly ahead of the 27 given the growth and we're making tremendous progress toward that 2018 goal of 40% of our business but given the seasonality I'm not sure that whether where we are within that range is all that insightful. We will take our temperature again on this at the end of the year so that get a data point without much seasonality or that any seasonality but again from 27 last year we are on our way to 40 and I'd say the two data points that we have of 30 plus first quarter and second quarter are in very good shape remember that we showed at Investor Day we show the chart that said these have been growing at about 19% fairly consistently over the last few year. So you should assume and I think we're comfortable that we are making very good progress on that longer term goal.

Christine, can we please take one last question.

The last question comes from Amit Daryanani with RBC Capital Markets. You may ask your question.

Just wanted to get back to the software segment. Can you just talk about -- do you think the business performed in the June quarter inline to your plan or was it ahead of the low and then when you look at the PTI margin decline you saw in software is that reflects to the flexibility you are providing to your customer when they move to strategic imperative and it should get back to more normalize level once you get beyond that I guess initial transition or does that really reflect more of the reality that some of these strategic imperative revenues maybe at a lower margin than your legacy revenues are?

Sure. You made a couple of things. So, in terms of in line with the plan we've said since the beginning of the of the year that the at the low end of guidance we don’t assume a change in trajectory and at the high end we do and that's to by the way to over simplify up nearly 100 billion corporation but will over simplify for the purpose for this question and right now given that the change the trajectory in software has not changed I'd say that we are right in line with our plan but we are right in line with that low end of guidance. I don’t think that would surprise anybody. With regard to the margin a couple of things one software is very high margin element and can continue to be a very high margin component of our overall mix. Now when we look at margin if I think there are two things I would disaggregate on a gross profit level margin the only real shift we see is a slight shift to our SaaS properties. And so while they are coming at slightly lower margins than our traditional on plunders business they are still highly accretive to the overall IBM model because bear in mind these are new spaces for us were not taking and converting the non-prem business to it and as a service business we are building new revenue streams and spaces where in spaces where we are not today. So slightly lower gross margins on the SaaS business but all accretive to the IBM model and then the net margin in our software business reflect a lot of the investments that we've talked about both in strategic imperatives and remember we continue to invest in our core businesses because as we talked about it at Investor Day in other venues that contemporary nature of those while they are products that have been in our client sites for many-many years and they are committed to this products those products evolve into the latest most contemporary needs as well. So those products now have to live in and support our clients in a mobile world in a social world and they have to have analytics capabilities as well so the old products are also part of that investment and so. From an investment standpoint I would say that you're seeing the investments in our software business on the net margin line.

So let me take a few minutes to wrap up the call. We're half way through now of transformation here and you can see in our results that the investments and of course the shift in our business we're seeing good progress as we move more of our business into the strategic imperatives, we've been very active in reinventing our hardware business and I think that's paying off and the investments and the added focus we've put on the solutions areas are contributing to some pretty strong growth in those strategic imperatives. So, with six months behind us we've maintained our full year of EPS even though as I mentioned in the remarks and in the Q&A that currency is probably little worse than it was at the beginning of the year but will maintain our EPS guidance and as we talked about in the prepared remarks we've taken up our view of our free cash flow modestly, so modest growth free cash flow for the year. We said from the beginning that this will take some time, we continue to manage the business for the long-term and we're confident that we're on track to that longer term trajectory. So thanks very much everyone for joining us today.

Christine we'll turn it back to you to close out the call.

Thank you for participating on today's call. The conference has now ended. You may disconnect at this time.