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'll 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 their 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. So with that, I'll turn the call over to Martin Schroeter.

Thanks, Patricia. In the second quarter, we delivered $19.3 billion of revenue, operating pretax income of over $3 billion, operating earnings per share of $2.97, and free cash flow of over $2.5 billion. The quarter played out as we expected with continued solid growth in our strategic imperatives which now really reflects organic growth. We wrapped on the acquisitive content and we're at the stage where we can start to get some efficiency as a result of bringing them into IBM while we build on the new content. Our gross margin is up over 2.5 point sequentially and positions us for the continued improvement over the course of the year we talked about 90 days ago. And we had good free cash flow performance all again as we expected. In the second quarter we signed a number of large contracts in global technology services and again, grew our global business services signings, both of which will start to contribute in the second half. And since the quarter ended, we announced our new IBM Z system which will be available later this quarter. With all of this we expect improved performance in revenue and gross margin in the second half and we continue to expect at least $13.80 of operating EPS and free cash flow consistent with last year. I'll spend time on the first to second half dynamics a little later and you will see it's very similar to what we talked about in April. We've been focused on helping our enterprise clients transform their businesses to leverage their data for competitive advantage and to improve the efficiency and agility of their IT environments. Our strategic imperatives performance has been an indication of our progress in moving to these areas. As you know, our strategic imperatives are in separate businesses…

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, as always, I'd ask you to refrain from multi-part questions. So operator, lets please open it up for questions.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question is from Katy Huberty with Morgan Stanley. You may ask your question.

Yes, thank you, good afternoon. I appreciate the second half versus first half color but if you can comment more specifically on the third quarter because of the mainframe launch; consensus is modeling both better revenue and better EPS growth sequentially than last year. Are you comfortable with those boggies? And maybe in regard of that just talk about how you think this mainframe cycle will compare to past cycles? Thank you.

Sure Katy, thanks, and thanks for joining the call. I guess a couple of things, I'll start actually where you finished on mainframe because we have in the past said that the economics for the mainframe for us, what we're looking for is that the overall economic equation cycle-to-cycle kind of holds and we saw for the last four mainframes, including the one that we just finished and now we expect the overall economic equation to be fairly stable, that doesn't map to a calendar period of it because we announced them at different times but we would expect the overall economics of the mainframe to hold cycle-to-cycle the cycle amount to the fifth cycle, we could have gone back further but let's just say that mainframe is roughly consistent with the past. In terms of third and fourth quarter, I guess there are couple of things. I think you're interested in revenue and we'll talk about EPS as well and then where does the mainframe fit. On the revenue side of that typically we see about -- for seasonal reasons, we see about $1 billion 2Q to 3Q reduction for seasonality. Now we're only going to have a month or less of the new mainframe, we're going to have a month of some of these new contracts, not the full quarter, those will come in the fourth and so that typical $1 billion impact will be helped a little bit, $200 million to $300 million by mainframe or the services contract but that's about it for the third and then obviously the rest will be in the fourth. And then from an earnings perspective, given the power of the mainframe and the profit equation, how it helps mix plus our typical -- you know, typically we have a lot of our transaction business in the fourth. When you look at our EPS guidance, we're up a little bit for the year; we're up even less than the full year now through the first half. And then third quarter I wouldn't expect to drive much growth at all. I think most of the growth rate is going to be in the fourth, again, given the cycle dynamics and quite frankly, given the fact that the benefit really is only a month now and three months of the fourth. Thanks, Katy.

Thanks, Katy. Can we take the next question please?

Thank you. Next question is from Wamsi Mohan with Bank of America Merrill Lynch. You may ask your question.

Yes, thank you. Martin, your cognitive solutions, pretax margins were up nicely, both on a quarter-on-quarter and year-on-year basis despite some continued weakness on the transactional business. Can you address what the main drivers there were for cognitive margins and PTI specifically was at lower drag from M&A, better contribution from the SaaS assets and do you see that sustained continued sort of year-on-year improvement in the second half for cognitive PTI margins? Thanks.

Yes, thanks Wamsi. Well, you've kind of answered your question, so well done. No it is -- it really is a reflection of a few things. One is sequentially we've got a benefit from scale, now that's annual, that's year-to-year as well as sequential, but we're getting a benefit from scale as we build those service businesses. And then just like when we wrap on an acquisition and the revenue benefit, at the same time that allows us -- not allows us but what we start to do is we start to build the consolidation if you will and the efficiency in getting those acquisitions onto our own platform; so we get kind of local expense savings if you will from doing things once as opposed to a number of times around a unit. So better scale, ramping acquisitions, not only on the growth but then we get an opportunity to get a bit more productivity out of them. And yes, those -- I would expect that margins in cognitive solutions while on a year-to-year basis we still see -- because of mix we still see a year-to-year decline, sequentially we'll continue to improve on those things, the things I identified; the scale will last forever and then the wrap on the acquisitions will start to deteriorate in another three or four quarters.

Thanks, Wamsi. Can we please take the next question.

Our next question is from Steve Milunovich with UBS. You may ask your question.

Thank you. Martin you made a number of positive comments about the trajectory of services but the supplemental slides, the signings overall are down 14% year-over-year and the backlog is now down to 4% year-over-year. What's going on there and why do you think that's going to improve?

Yes, couple of things Steve. First, let's pull signings, we'll talk about backlog because the impact of signings on backlog, as you know we've talked about it is different when it's a renewal versus when it's new business and siginings, they don't playout as we said in the past on a 90-day period, obviously the longer you get, the more it looks like your backlog but you got to get over a pretty long timeframe in order to have the signings translate directly into backlog. So in the first half of this year we had one of the biggest new contract signings we've had for any six month period as big as it was; last year it was bigger than the year before. So what happens in our backlog is those new contracts come on once we go through the transition period, as I mentioned earlier and that for us it will start to be September, once you get through that transition period, all of that translates to revenue rather quickly, that's different from a backlog or signing that goes into backlog as an extension of a contract that's ten years old and is about to expire because that is not going to drive any incremental growth. So yes, on GTS the backlog is down, the new signings go in though at a rate that will drive revenue in the near-term and so the backlog being down is something we obviously have to work on a few years out because those contracts are going to come due and we have to get them renewed because it's not going to drive any growth but we need the backlog. And on GBS, we had second quarter in a row of good signings, performance, in fact an acceleration from the first and within their backlog now, as we noted in our prepared remarks, our consulting business now has gotten itself back to kind of a flat backlog which in the near-term that tends to yield pretty quickly as we deliver; so they were battling double-digit declines in backlog for a while, they worked their way out of that spiral; and so we'll see a near-term yield on the consulting side as well.

Thank you, Steve. Operator, can we please take the next question.

Thank you. Next question is from Ingin Wang with JPMorgan. You may ask your question.

Hi, thanks for the update. Just on the strategic comparative, it's up 7%; is high single digit a good proxy for organic growth and strategic comparative for the year because you hired the efficiency I think. Martin, [indiscernible] and the focus was due more towards maybe margin, then revenue acceleration within strategic comparatives?

Thanks, Ingin. A couple of things I think worth noting. Yes, we certainly ramped on the acquisitions and so this is a pretty good proxy for the organic piece and it is mostly as a service, right, so it's not going to drive the same impact on our big base of business as it would if you ramped on an on-prime business because it didn't have the same impact to begin with. Now -- by the way we're not out of the acquisition business, right, we're still active acquirers, we just happen to ramp on and are getting our feet under us on everything we did in the past 18 months but we are still active acquirer. So that will drive some of the growth but when we think about strategic imperatives, going forward I would expect that we get a bit of an acceleration from the new mainframe, power will drive a bit and quite frankly, the services contracts, particularly the new ones that we signed and we talked about, they are cloud contracts, they are to help our clients build and run clouds and move them onto the cloud. So just like we've encouraged everyone to look at the strategic imperatives on a trailing 12 month basis which they we're at 11% on a trailing 12 month basis; with the acceleration now through the back half of the year, when we get to the end of this year, I'd expect us to be still on that same trailing 12 months, so the whole calendar year I'd expect us to be in that 10% to 11% range on strategic imperatives as well.

Thank you, Ingin. Can we go to the next question, please.

Our next question is from Toni Sacconaghi with Bernstein. You may ask your question.

Yes, thank you. Martin, I was wondering if you could just quickly clarify, I think you said you didn't expect EPS growth in Q3. Consensus is looking for $0.09 year-over-year improvement in Q3; are you suggesting that's not something that's appropriate? And then more specifically, my question -- for strategic imperatives, it sounds like you feel organic growth is 7%, are you still confident overall growth will be 10% plus which is something you articulated at your investment day? And if you are, is the proper implication to think about three points of strategic imperative growth coming from acquisitions which is about $1 billion a year in acquisition revenue; is that sort of the framework by which we should think? And are you still confident in that double-digit sustained growth for strategic imperatives? Thank you.

Sure, thanks Toni. So first on the non-question clarifying piece; look, we've got a base $3 plus on a base, we're roughly flat, I think we're at a level now where it's just too fine a number in order to say am I talking about $0.09 on a three -- almost mid-three, anyway, it's a big base, $0.09, too fine for me. On strategic imperatives, again, you know, I do expect us to accelerate in the second half for the year for the reasons we've talked about, right; we get new mainframe, a lot of the new contracts are coming on. And then the other elements within this and you can actually see it in the segment charts, we've got good growth in technology services and cloud platforms on the strategic imperative base, that is organic. We have good growth in GBS, that is by large organic. We have slower growth in the cognitive solutions but that's a massive base. And then obviously what -- where we'll accelerate the most in the second half is the systems business which was down dramatically in the quarter but again, we're at the part of the cycle here where we would expect it to be down, so we gave the segment view already when we changed the segment reporting, we gave the segment view so you could try to put together now where we see that shift of business coming from. And as we go into second half, I think the most profound shifts are going to be in the systems business, we'll see continued good growth in the technology services cloud platforms unit, we could see continued good growth in GBS. And then cognitive; you know, we have made investments, we're getting growth out of that part of the business, it is as a service primarily and therefore it's impact on the overall is more muted but if we were to acquire something it would go -- it would likely go back in there. But again, it's more muted because it's via the service business.

Thanks Toni. Can we go to the next question, please.

Our next question is from David Grossman with Stifel Financial. Your line is open.

Thank you. And perhaps Martin you addressed some of this in the last question but I was hoping you could help us better understand the growth dynamics in the cognitive and GBS segments. It looks like the strategic imperatives are well over 50% of the revenue mix in both of those units but they both are experiencing revenue declines; so if I've got that math right, can you help us better understand that dynamic and what that implies for the overall mix as strategic imperatives increase the greater percent of IBM's overall revenue mix?

Sure, David. So we'll do it kind of piece by piece and I'll give you two words trying to describe both of them. One is magnitude, and I'm going to put that against cognitive; we've got -- it's a big, big business and obviously the service that we're building, it has a smaller impact and so we see growth but it's going to take -- and we're getting growth and they as a service portfolio but it's going to take time to build that and part of that portfolio, TPS, our transaction processing business as we have on the slide is down four, so that's a very high value business but it's a big on-prem [ph] business that it's going to take a while to outbuild if you will from as a service perspective. And then on GBS, the word I'd give you is the transition. So I described a bit on our consulting business where we got the backlog back and back to flat and the consulting business has accelerated, the signings in consulting are good, the things that the growth is quite strong, the things that we're engaging with our clients on digital offering, those are resonating. So the consulting business comes back pretty well than the application management business; it's a fairly stable business and yes, we're helping our clients move those into clouds, we're helping them contemporize if you will, the way those applications work but that's not a big growth engine, it really is kind of a very stable base. And then in GPS, in our global processing systems business, that's not high content of strategic imperatives but it is important work for our client and it's quite valuable to us. So in GBS as we make this transition, you know, the overall will be lifted and as we said we planted the flag on revenue growth back in the fourth quarter, now we've seen a moderately improving trajectory now and we would expect -- as I said the prepared remarks that third and fourth would be better again in terms of trajectory and revenue.

Thanks, David. Let's take the next question.

Thank you. Our next question is from Amit Daryanani with RBC Capital Markets. Your line is open.

Perfect, thanks a lot, good afternoon guys. I guess just trying to understand the gross margin discussion Martin, I realize 180 basis points decline in June is much better than the 300 basis points decline you had in the March quarter; but at what point do you see gross margins from a year-over-year perspective starting to stabilize and does stability in gross margin have to come in-line with strategic revenues essentially decelerating a little bit?

Well, we do see as we said in the prepared remarks that we do see continued improvement in the trajectory, right. So down three in the first, down 18 in the second and then second half, driven by both mix and driven by the work we have underway in delivering productivity across our services platform, the work we have in improving our GBS margins which is now starting to come -- to show up in the ledger. So we see both, a mix of kind of structural benefits from productivity, we see a mix of execution benefits from realizing if you will the higher value of the solutions we're selling and we see a mix from just the fact that we're in high value systems business which is going to mix more strongly. So yes, we do see continued gross margin improvement on a sequential basis and improvement on a year-to-year basis sequentially, and that would position us pretty well I think then for 2018 but we've got work to do here in the second half to put that on the table but we do see it in the third and the fourth.

Thanks, Amit. Let's go to the next question please.

Our next question is from Brain White [ph] with [indiscernible]. You may ask your question.

Martin on the z14, it sounds like it will have an impact, a positive impact in the second half of the year; do you think it will have a more favorable impact in 2018? And if you could give us just some guide post around the attach rate of the z14 or any mainframe cycle to both sales and profits of IBM, obviously it's a small direct percent of IBM's total sales and profits but if you look at the overall portfolio and the software and services that it ranks through that would be great. Thanks.

So first, I think what you started by saying was z14 not much impact in second half and I think what we're saying is that it's going to have quite an impact in the second half, right. It was announced yesterday, it will become publicly available in September and so we'll get a month in the quarter but we'll get three months of it in the fourth quarter. So just to make sure we're clear, we do see a pretty good impact here in the second half from Z. Now the timing that impact will be most profound in the systems space because the hardware is what obviously goes out first. We also provide as you know, we provide maintenance for that but the warranty period is on, so that's not going to be sold for until after the warranty period expires, that's in 12 months plus. There is a software that goes with it but that tends to be driven by usage, not by a placement of hardware and so that also isn't going to be in the second half. We financed these, right, that happens overtime and so we get that money back overtime. So the -- and then we sell storage, there is a little bit of tailwind in the hardware side but again a lot of it is software defined storage, so the benefit in the second half is systems driven, the rest of the platform if you will, will continue to drive profit overtime and a lot of that will been dependant on the workloads that it can attract and the workload is running [ph] now and how people scale which we feel quite good about. You know, one of the things we haven't spend a lot of time on, on the mainframe because the interest has been around security, the interest has been around in-line machine learning but one of the elements of the new mainframe is new software model which will allow our clients to partition off parts of the mainframe and run new workloads and test new workloads in a much more economic way so they will attract new workloads onto the platform again. So in overtime, again, we're not relying on the mainframe as a platform to be anymore valuable it has in the past but I'll tell you what this mainframe solves a lot of problems at clients who don't use it today, have; and it provides a lot of new on-ramps for other workloads.

Thanks, Brian. Can we please take the next question.

Our next question is from Jim Suva with Citi. You may ask your question.

Thanks very much, it's Jim Suva from Citi. Martin, you had mentioned [indiscernible] several times in different parts of the businesses which is greatly appreciated. The question I have for you is, is there any correlation to cash flow and cash flow generation regarding those black [ph]. Like for example, if signings result from positive services growth, is there any impact of future cash flow as they start [ph] and how should we think about the cash flow with your sign-post or flag-post comment? Thank you.

Sure, Jim. I think I heard it but you are -- you must be on mobile, so it was little bit hard to hear it. But I think the question was is there a correlation between planting the flag on some of the revenue trajectories and cash flow. So broadly speaking, the answer is obviously yes but it's kind of at the margin if you will. So as we turn our GPS business and we start to bring on all these new clients that we have and put them on the IBM cloud, of course, we expand the capacity of the cloud but that's already in our plans, right. So at the relationship level, everything that has to do with driving revenue is going to have an impact with cash but the way we have planned and talked about our cash flow all year has been flat year-to-year, we've recognized already that we're driving capacity into the cloud that we have to build the capacity in the scale we need and so it doesn't have an impact into the way we've guided it but obviously there is a correlation between what kind of growth we get and the cash demands if you will of the business but not different from what we've talked about all year.

Thanks, Jim. Let's take one more question please.

Our last question is from Meena [ph] with Wells Fargo. You may ask your question.

Hi, thanks. If you look historically at sort of the make up of the different quarters for the full, the last six years you generated roughly about 23.5% of your earnings for the full year in the third quarter. Is that based on your comments about the mainframe and the fourth quarter; is that still the right way to think about the third quarter and then you get the bulk of the benefit from the mainframe really driving the fourth quarter earnings profit?

Well, again, I think we talked a bit about the EPS Q [ph] and we talked where I think we're going to land. But as we said for the third -- but as I said, in the fourth is where we see most of the growth begin because the mainframe in the fourth is where the bulk of it is going to sit. So you do the SKU math in terms of percentage in the third but yes, the answer is yes, we're going to see the bulk of the growth from the mainframe in the full quarter mainframe in the fourth, as well as the services signings that will have a full quarter impact. And then obviously as we go through time and we talked a bit about this on the prepared remarks and you've seen some of our announcements about for instance the cognitive delivery platform that we're building; those build as you go through time as well, and so all of that will have more of an impact in the fourth quarter. So just to wrap up, again, quickly; we finished the first half kind of spot-on where we said we would, we've positioned ourselves now to have the second half, that we're confident we'll deliver. The path from here though as we said is pretty -- at a high level, it's an improved revenue trajectory, it's an improved GP margin trajectory, and it's an improved expense trajectory and we have now I think in the second quarter shown that the GP margin trajectory is there; we've obviously got the ability and we've showed good expense management and disciplined investments. And then on the revenue we've going to go through it piece by piece to talk about where we planted the flag and the most recent again, second quarter we'll plant the flag on GTS, so we'll drive an improved revenue trajectory. So thank you for joining the call. We look forward to talking to you in 90 days.

Operator, let me turn it back to you to close up the call.

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