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 Patricia Murphy with IBM. Ma’am, you may begin.

Thank you. This is Patricia Murphy, Vice President of Investor Relations for IBM, and I’d like to welcome you to our third quarter earnings presentation. I’m here today with Jim Kavanaugh, IBM’s Senior Vice President and Chief Financial Officer. Our 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 also 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 website 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’ll 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 Jim.

Thanks, Patricia, and thanks to all of you for joining us. In the third quarter, we delivered $18.8 billion of revenue, $3.6 billion of operating pretax income and $3.42 of operating earnings per share. And over the last 12 months, we generated $12.2 billion of free cash flow with realization over 100%. As compared to last year, our revenue was flat at constant currency though down 2% with the impact of the stronger dollar. Gross profit margin was flat, which is the best year-to-year performance in years. The improvement was led by services margin expansion. We expanded our overall operating pretax margin and we grew operating profit and earnings per share. We continue to see strong client demand in the emerging, high-value segments of the IT industry. And our performance this quarter was driven by the offerings in hybrid cloud, in security, in digital, and in analytics and AI, a testament to our ability to deliver differentiated value to our clients through innovative technologies with the skills and expertise to implement these technologies. We see the results in our strategic imperatives revenue growth of 13% over the last 12 months. We also see this playing out in higher operating margin over the last few quarters, which supports both, our long-term investment and return to shareholders. With our success in these higher value areas and our focus on delivering consistent operational performance, we remain on track to our full-year expectations of earnings per share and free cash flow. Coming into the second half, we said we expected to improve our services revenue trajectory and to expand total services margins for the half. We also said we face some headwinds as we wrap on the new mainframe launch and our strongest software performance in the third quarter of last year. And so…

Thank you, Jim. 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 for multiple questions and multi-part questions, so that we can make the best use of the time we have today. So, operator, let’s please open it up for questions.

Thank you. At this time, we will begin the question-and-answer session of the conference. [Operator Instructions] Our first question comes from Amit Daryanani from RBC Capital Markets.

Thank you. Jim, I guess, when I think about this quarter, there were multiple cross currents that IBM dealt with across the portfolio. So, I guess, it would be helpful just to hear how you would characterize IBM’s performance in September quarter versus what you guys were expecting 90 days ago, and importantly the sustainability of some of the trends that you’re seeing, especially on gross margins, which were flat on a very difficult compare I think versus last year. And then, on the other hand, you had Cognitive was down somewhat more than I thought. So, if you could maybe just characterize the performance and sustainability of some of these trends versus what you thought 90 days ago, that would be really helpful for us.

Okay. Thanks, Amit. And it’s a good place to start here talking about the characterization of our quarter, now that we’re through three quarters of 2018. But, I guess from my perspective, I would say, first, we had a solid quarter. We delivered $18.8 billion of revenue, which was consistent with our guidance of a typical quarter-to-quarter seasonality, even in light of a strengthening U.S. dollar, which continues to go against us. But, the headline overall would be, we fundamentally have taken the actions to reposition our business entering 2018. And you see that play out as we enter the second half where we grew operating profit, we expanded operating pretax margins by 50 basis points, we grow EPS 5% consistent with the first half, and we continue to drive strong free cash flow realization to deliver value back to our shareholders. Now, some of the underpinnings behind that. One, we still see strong demand in key high value segments and you see that play out in our third quarter performance, and we think that will continue moving forward. Areas like hybrid cloud where we’re winning with our hybrid cloud value proposition to the marketplace, data and AI, security, digital, all of these are instantiated in our strategic imperatives, which now from a trailing 12-month perspective were at $39.5 billion, pretty close to that $40 billion target that we put in place well over three years ago, when the IBM company had less than 25% of its portfolio in strategic imperatives; today, we’re roughly at 50%. That’s a massive transformation over a period of time. And that’s led to significant improvement in trajectory of our revenue growth overall, whereas quarter -- year-to-date, we’re up 2%. But underneath that you see some of the areas of growth around cloud, $19 billion,…

Thanks Amit. Can we please go to the next question?

Our next question is from Katy Huberty from Morgan Stanley.

Good afternoon. Jim, I want to get your early thoughts as you think about planning for next year, in particular because you face a number of headwinds, services backlog is down, the mainframe comps get more difficult, the dollars is strong, question of what tariffs do to demand. And so, in the context of all those headwinds, can you talk about what some of the offsets are as you start to plan for 2019? Whether there is a potential to continue to grow PTI as you go into next year, even as some of these headwinds don’t? Thank you.

Sure, Katy. Thank you very much for the question. Obviously, we’ve still got a lot of work to do. We’re 16 days into a very important fourth quarter. We are focused on delivering consistent operational performance to deliver value for our clients in the marketplace and also for our shareholders. So, with that said, we’ll give updates on guidance in January. But, let me give you -- and to your point, let me give you kind of what we see as the trajectory of our business in the connotation of a headwind, tailwind as we move forward. So, let me first start with services. You see, as we entered 2018, we talked about we had a much better position on our backlog near-term runout, and you’ve seen that play out throughout 2018. And I think that’s a combination of us taking some very bold actions about repositioning our services business and capitalizing on a differentiated services model, services practices and services value propositions to capture the growth in digital, cognitive and cloud. And we see great momentum in our GBS base of business, both on top-line and on bottom-line as we move forward. In our GTS business, again, we continue to make progress, see acceleration in revenue through the third quarter. We are leveraging our differentiated hybrid cloud value proposition. Our clients value our incumbency. They value it because we understand their infrastructure, their workloads, and they trust us to move them to the future. And we talked about in the beginning of the year, when you look at our outsourcing backlog, we were hovering around 25% of a $90 billion outsourcing backlog. But right now, exiting third quarter, that $90 billion backlog give or take, we are now in about 32%, 35% cloud content. So, we are winning in…

Okay. Thanks, Katy. Can we please go to the next question?

Next question is from Toni Sacconaghi from Bernstein.

Yes. Thank you. I was wondering if you could talk, Jim, a little bit about free cash flow for this year. You mentioned that it will be greater than 100% of GAAP net income this year, despite the fact that you have some headwinds in cash taxes and higher CapEx, and that number is higher than your longer term guidance of 90% to 100% realization. So, I’m wondering if you can help us understand what are the positive tailwinds that you’re seeing that are enabling free cash flow to be higher than 100% of GAAP net income? And can you explicitly comment on what your expected cash pension and retirement contributions are this year, and whether receivables factoring will benefit your free cash flow and to what extent?

Okay. Toni, thank you very much. And as always, many very good questions that you bring up. But, I hope I can capture many of them. If not, Patricia can get to all of you after the call. But, first of all, let me start at the big picture. Free cash flow, as we entered 2018, we entered 2018 coming off of a very strong fourth quarter in 2017 where we drew -- we actually contributed significant working capital efficiency through the launch of our mainframe product cycle. And we said in our January call that we expected about $12 billion of free cash flow in 2018 and the drivers of that from 2017 were really going to be centered around, one, incremental cash taxes that would be a headwind to us in ‘18, and by the way, that is playing out, and all of that is behind us now as we exit the third quarter; number two, that we work on a plan on driving that strong working capital efficiency with the introduction of our mainframe as we exit the fourth quarter of 2018, and that would be a headwind; and then third, we said we were going to continue to invest in our business to capitalize on our innovation and differentiate value around our hybrid cloud. And we’ve continued to invest, actually invested more this year, because we’re seeing an accelerated growth in our proud overall. Our CapEx is up, I think year-to-date 21%. So when you put those three headwinds in play, that’s what you’re seeing play out in our free cash flows through nine months. And by the way, we still feel comfortable and expect about $12 billion for the full-year based on any metric I look at in payment wise and our trailing 12 months…

Great. Could we please go to the next question?

Next question is from Tien-tsin Huang from JPMorgan. I’m sorry. Our next question is from Wamsi Mohan from Merrill Lynch.

Thank you. Jim, I was wondering if you can talk a little bit about the strategic imperative performance within Cognitive including the cloud revenues and as-a-service, both of which declined versus overall strategic imperative growth. Can you maybe talk about some of the puts and takes there and some color on what do you think drove that client buying seasonality that you mentioned to a prior question? And if I could, how do you think that some of these new announcements around AI OpenScale and multi-cloud could change the trajectory for Cognitive and when? Thank you.

Okay, Wamsi. Thank you very much for your questions. There is a lot there to compact into a one answer. But, let me talk about strategic imperatives first and then I’ll get into Cognitive next. But let’s put the strategic imperatives into perspective. So, as I stated on the call, trailing 12 months, $39.5 billion. We talked about three years ago, we put the signpost out there. They had $40 billion at that point in time, the IBM contribution was less than a quarter of IBM’s revenue. Now, we’re approaching 50%. We’re growing in the mid-teens, 13% I think, if I remember correctly, over the trailing 12 months. And that has lifted IBM’s overall revenue growth. As you’ve seen, year-to-date, we’re growing 2% at the IBM level. But within that strategic imperatives, our cloud business, to your point, is at $19 billion right now, up 20%. And the high-value as-a-service component underneath that is up 24%, consistent with where we’ve been in the first half of the year. And I think that’s an attestation to we are capturing the new and emerging workloads as the secular shift to as-a-service world is happening overall. Now, when you take a look at our strategic imperatives, let’s put this in perspective, where we were 90 days ago. We knew to hit that $40 billion that we needed to be at basically mid to high-single-digit growth in the second half. And we knew similar to how we laid out our expectation for guidance that we were going to wrap around the most successful mainframe product program that we’ve had in history. So, as we entered the second half, we knew we had a focus on driving that underlying high-value as-a-service content and continue to accelerate that to offset the impacts on that mainframe wrap…

Thanks, Wamsi. Let’s go to next question, please.

Next question is from Tien-tsin Huang from JP Morgan.

Thanks. Can you guys hear me now?

We can hear you now.

Sorry about that. I don’t know what happened. Good to hear from you guys. Just want to clarify, I guess on the on the 13.80, at least 13.80, trying of better assess the at least in that comment. And what’s required or how much cushion there is on the transactional side to achieve the outlook? Because if we use 13.80, that suggests 4Q earnings looks like a little below consensus and below each of the last two fourth quarters. So, just trying to understand the at least piece at this stage. Thanks.

Sure, Tien-tsin, and thank you very much for the question. I think a little bit below, when you’re doing the math. I mean, we just beat third quarter by $0.02. But, let’s put that aside right now. As always, when we take a look at our following quarter and most importantly for the year, and it’s one of the same right now, we always have multiple scenarios taking into account, one, the trajectory of our business and also the fundamentals and the operational indices that we see. And all support our expectation of the at least -- excuse me, at least $13.80 of earnings per share. So, if you put that in perspective, how are we entering fourth quarter? Well, if you look at the fundamentals of our business profile through third quarter we’re growing revenue, we’re growing operating profit, we’re growing earnings per share consistently, and we’re still driving that strong free cash flow realization. So, kind of -- let me walk down the I&E and give you a perspective. And again, there are multiple variables here. But the way we kind of see it triangulating each of these pieces. First on revenue. On revenue, as you’ve seen in our supplemental charts, the dollar continues to go against us and strengthen against foreign currencies. And right now on revenue, we see about a 2-point currency headwind here in the fourth quarter, pretty consistent by the way with the third quarter. But, we would expect a normal historical quarter-to-quarter seasonality probably in the range of somewhere around 3 to 5 years, I mean average seasonality of 3Q to 4Q. But putting that in perspective, year-to-date grown at 2%; and where we think fourth quarter can be, we continue to feel that we expect full year revenue at current spot rates…

Excellent. Tien-tsin, thanks. Mark, can we go to the next question, please?

Next question is from John Roy from UBS.

Thanks so much. Jim, I know obviously the mainframe has done very well. Is there any chance you continue to see slower moderation as you go through or is, are we back to the regular mainframe cycles? Thank you.

Thank you, John. I appreciate it, a very good question. And to be honest with you, I haven’t talked enough about mainframe because we couldn’t be more pleased with how we’ve been able to leverage our high-value innovation technology, which really is instantiated, and I would argue one of the most enduring platforms that delivers tremendous value to our clients overall. But with that said, mainframe, we had a good quarter in mainframe. It is the 5th quarter we’ve wrapped, we grew 6% on a successful z14 launch. And again, I’ll remind you, that’s of a 62% growth last year. We had double-digit growth in MIPs, 20%. And by the way, as you get to the back half of the mainframe cycle, we drive margin expansion, and that happened here in the quarter. So, again, best program ever. Against the prior cycle, we are still well in excess of that prior cycle. And I would expect us to continue to be well in excess of that prior cycle here in the fourth quarter. Although, I’ll caution you in a GA [ph] plus 5 or 6 quarter in, we typically do not grow. And again, we’re coming off of 71% growth last year on a strong launch. But, we are very pleased with the platform, the pervasive encryption, value proposition is really resonating. Now, as we get into the back half of the cycle, we drive margin expansion and now we start seeing the rest of the platform stack play out with regards to our maintenance base, our IGF base, our software base that’s on top of it.

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

Next question is from David Grossman from Stifel Financials.

Thank you. Jim, you touched on this briefly in one or two of the questions. But, is there anything you can share beyond the quarterly data points that will help us better understand the growth trajectory of the Cognitive segment going forward? I think, I understand the issues, but they seem somewhat open ended, and really having a hard time changing how to model growth of that segment going forward?

Okay. David, thank you for the question. Cognitive, so, from a net perspective, then, I’ll expand. We were impacted by enterprise client buying cycles, as I said in prepared remarks. And also challenges that we’ve talked about last quarter around our horizontal apps, in particular, talent collaboration and marketing and commerce where we’re seeing in some green shoots but again, time to value in that as you shift to SaaS, all you know quite well will play out as we get into 2019. But, let’s take a moment and really unpack this segment. To your point and part of this, I think is on us. But, there are many different pieces of this segment. So, we have a strong portfolio of high-value areas around domains like security, analytics, blockchain. We’ve got industry verticals like healthcare, our FSS portfolio, and IoT. We’ve got horizontal apps, as I talked about, like talent, collaboration and marketing in commerce. And then we have transaction processing software. So, let me unpack this. But, I’ll remind you, this segment’s high-value, high-margin. And we continue to expand even in third quarter and third quarter year-to-date, we’re expanding our pre-tax margins overall. But let me give you the different dynamics and how they’re playing out, I’ll do it kind of headwind, tailwind. First in terms of headwind, as you could see through the prepared remarks, we were impacted by TPS and by our horizontal apps. So, let’s talk TPS. TPS, high value business. Strategically important to our clients. By the way, it encompasses mission-critical systems that run many industries like banking, like airlines, like retail, and there is seasonality to this business. And what you saw play out in third quarter was tied to enterprise client buying cycles that really reflect the time of when they commit to…

Thanks, David. Let’s go to the next question, please.

Next question is from Keith Bachman from BMO.

Hi. Thank you so much for taking my question. I wanted to ask about Technology Services and Cloud Platforms. A little less focused on Q4 but more focused on the outlook say for CY ‘19. And the simple question is, can it grow? The backdrop to the question is, your backlog is down a little bit, but I think your duration is also down. But, against that context, is Technology Services support declined meaningfully this quarter down 3%? With presumably being a harder mainframe cycle next year, can that grow and enable the whole business unit to grow? So, if you could just talk more broadly about the outlook for Technology Services and Cloud Platforms, with particular bias to CY ‘19? Thank you.

Sure. Thank you very much for the question. I appreciate it. Remember, within this segment, we got multiple components. And I think you want to get to the services aspect of Technology Services and Cloud Platform. But, let me start first with the integration software, which is essential part of our integrated value proposition around our hybrid cloud strategy, which differentiates us in the marketplace. You’ve seen consistent growth over the last couple quarters. And we think given that differentiated value proposition that we’ve got momentum in that space, and we’ve always focused on being open, a secure platform in driving differentiation around multi cloud as we move forward. That integration software is going to be a critical component of that moving forward. So that’s that. Now, let’s go to our Technology Services or GTS part of the business. Remember, that’s made up of two primary offering segments, one TSS, which has been a drag on us throughout 2018, and that is entirely aligned to what our expectations would have been with a mainframe product launch cycle. Typically, we’ll see that cycle hurt us in the first 5 to 6 quarters and then it comes back and accelerate, especially coupled with our extension into multi-vendor service where we’ve been quite well as we move forward. And the margin dynamics by the way are very strong in that portfolio. So, as we start accelerating growth, we’ll see better operating leverage in that segment as we go forward. And then finally, you have your core infrastructure service offering, and that ties right back to our overall outsourcing backlog that you quoted and it ties back to our success in moving our enterprise clients to the cloud. And I talked earlier about over 30% of our backlog now sits in cloud in new SI content is approaching 45% overall. Durations, you’re right, have been reduced as we continue to execute. And again, fourth quarter is huge. We expect a good quarter, and that will position 2019 as we execute to deliver the value for our clients.

Okay. Thank you, Keith. Mark, let’s take just one more question.

Our last question is coming from Joseph Foresi from Cantor Fitzgerald.

Hi. I think you’ve given a mid-single-digit long-term growth target in Cognitive Solutions. Is that still a target and can you hit it in ‘19? And then, how do you feel about the portfolio at this point? Could you be divesting other pieces? Thanks.

Yes. Thanks, Joe. I appreciate the question overall. Obviously, we’ll get into 2019 in January. We got a lot of work to do ahead of us. Again, as I said, we’re 16 days into arguably the most important quarter, given the amount of large transactional business that we’ve got to get done. I talked about my answer on Cognitive. We see a good opportunity pipeline ahead of us right now. We believe in the portfolio, the strength of it, the offerings we have to deliver differentiated value to our enterprise clients overall. And we expect, as I stated, IBM software to return to modest growth here in the fourth quarter. And as we play fourth quarter out, we’ll see, as we get into January where we move forward. You’re right, our model is mid-single-digit growth. We believe we’ve got the right portfolio for that. But, as always, portfolio optimization has been a critical strategy to our overall business model and our financial model. And you’ve seen that play out over time not only on where we invest our capital organically, but where we leverage M&A and how we create value for our clients and for IBM shareholders and also where we divest in areas that either didn’t meet our strategic fit or our financial requirements on where we see growth and more importantly profit pools move forward. So we’ll continue to evaluate that, and we’ll update you in 2019 on where we’re at. So, with that, let me close up the call. And I like to thank all of you for joining us here today. So, our results through the third quarter reflect the work we’ve been doing collectively across 366,000 IBMers around the world, around how we reallocated capital, how we’ve taken bold actions around where we placed our investments, and how we’ve repositioned our business. And then we’ve done all the work on how we transform the way we operate in our operating model overall. And you see that play out in our margins, in our level of operating leverage and productivity here in the third quarter, which we expect going into fourth quarter and beyond. You see those results, profit margins are strong. You see it in the innovation and differentiation that we’ll bring into the market, especially in areas like hybrid cloud, how we’re winning in digital with our GBS business and around data and AI and security. So with that said, we’ll talk more about hybrid cloud in particular at the end of this month, when Arvind and Martin Jetter will host the next webcast in our investor webcast series. So, I’d like to thank you all for joining us today. And as always, it’s back to work for all of us. Take care.

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