Patricia Murphy - Vice President, Investor Relations Martin Schroeter - Senior Vice President and Chief Financial Officer, Finance and Enterprise Transformation

Bill Shope - Goldman Sachs Toni Sacconaghi - Sanford Bernstein Katy Huberty - Morgan Stanley David Grossman - Stifel Nicolaus Ben Reitzes - Barclays Lou Miscioscia - CLSA Steve Milunovich - UBS Tien-Tsin Huang - JPMorgan Sherri Scribner - Deutsche Bank Brian White - Cantor Fitzgerald

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 with Martin Schroeter, IBM's Senior Vice President and CFO, Finance and Enterprise Transformation. I want to welcome you to our second quarter earnings presentation. The prepared remarks will be available in roughly an hour, and replay of this 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. Now, I'll turn the call over to Martin Schroeter.

Thank you for joining us today. Our second quarter and first half results reflect the stability of our overall business model, as we transform the company. Looking at the dynamics of our portfolio, we're continuing to drive double-digit growth in the parts of our business that address the emerging trends in enterprise IT. We had stability in our core franchises, where we continue to drive innovation. We're dealing with secular shifts in parts of our hardware business and as we shift to higher value, we have the impact of a divested business. Overall, our year-to-year revenue performance improved from last quarter at actual rates and was fairly consistent at constant currency. We expanded margins and we grew earnings per share. The profit dynamics also reflect the actions we've taken to transform our business. I'll get into that shortly. In the first quarter, you'll remember that we announced a number of initiatives that support the shift to our strategic areas of data, cloud and systems of engagement. These included the launch of Bluemix, which is our cloud platform-as-a service for the enterprise. It included a $1.2 billion investment to globally expand SoftLayer cloud hubs, and it included a $1 billion investment to bring Watson's cognitive capabilities to the enterprise. In the second quarter, we made progress to implement these initiatives, including in June, Bluemix became generally available. We opened new SoftLayer data centers. We started to ship POWER8, and expanded the OpenPOWER consortium. And we completed substantially all of the divestiture of our customer care business. More recently, we announced additional actions to continue our shift to higher value. You saw last week that we're investing $3 billion over the next five years in research and in early-stage development to create the next generation of chip technologies. Those will fuel the systems required for cloud, big data and cognitive systems. And just a couple of days ago, IBM and Apple announced a strategic global partnership to provide a new level of business value from mobility for enterprise clients. The underlying theme of all of this, from the expansion of our cloud platforms and capacity to the OpenPOWER consortium, to the partnership with Apple for enterprise mobility to next generation chip technologies, is that we're leveraging our unique strengths and innovation, and enterprise capabilities to maintain our differentiation in the emerging areas of enterprise IT. While some of these actions impact our results in the short-term, they better position our business for the long-term. For the quarter, we delivered revenue of $24.4 billion and operating earnings per share of $4.32. Our revenue was down 2% or down 1% at constant currency, adjusting for the customer care divestiture. We improved gross margin by 10 basis points, the 22nd consecutive quarter of operating gross margin expansion. Our pre-tax and net margins are up significantly. Last year's profit base was lower, due to a workforce rebalancing charge of about $1 billion. We took a charge of a similar size in the first quarter of 2014, and so on a six-month basis the charges are fairly neutral to profit growth. On the bottomline, we reported operating earnings per share of $4.32 in the second quarter, which is up 34% and we generated $3 billion of free cash flow, which is up $300 million over last year. Let me spend a minute on the first half performance. The revenue performance for the half is very similar to the second quarter. Through six months, we had double-digit revenue growth in strategic initiatives, stable performance in our core franchises and the impact of some secular trends in parts of hardware and from the divested business. Looking at profit. We expanded gross margin 50 basis points, pre-tax margin by 70 basis points and net margin by 50 basis points. All while shifting investment to key areas. Operating earnings per share for the first half were up 9.5%. We generated free cash flow of $3.6 billion, which is down $800 million, though up $400 million without the higher level of cash taxes we paid in the first half. So now I'll get into the details of the quarter, starting with revenue by geography on a constant currency basis. Americas' revenue was up 1% year-to-year, a 3 point sequential improvement from the first quarter rate. From a regional perspective, the U.S. rate also improved 3 points, and we had another great quarter in our Latin America region. The improvement in the Americas was driven by the strong System z mainframe performance. EMEA declined this quarter. Within Western Europe, we had continued growth in Germany and Italy, though the U.K. and France were down. Eastern Europe also declined. Our performance in Asia-Pacific was pretty consistent with last quarter. We had another good quarter in Japan, our seventh consecutive quarter of revenue growth in the country. Asia-Pacific, outside of Japan, declined at a double-digit rate. In total, major markets were down 1%, while growth markets were down 4%. Within the growth markets, the BRICs were up 1%, which is a 7 point sequential improvement from the first quarter rate. The improvement was driven by Brazil, India and China, each up between 9 points and 10 points sequentially. Brazil grew over 20% year-to-year, driven by large deals in the financial sector and India returned to growth. Our revenue in China was down 11%, effectively halving the rate of decline from the last couple of quarters. So this is a change in trajectory in China, but we haven't yet seen improvement in the other Asia-Pacific countries. Put it all together, and we had modest sequential improvement in our growth markets performance. Turning to the segment perspective. Our Services revenue was up 1%, adjusting for the sale of the customer care business. Global Technology Services performance at constant currency was similar to last quarter, with growth in cloud and a ramp in the large outsourcing contracts we signed last year. Global Business Services once again had very strong growth in the practices that address the digital front office, however performance in the globally integrated enterprise offerings lagged. In Software, middleware is up 3%, while operating systems were down, resulting in modest reported growth for total software. We're continuing to drive strong results in strategic areas like mobile and security, as well as in some of our core franchises like our app servers and distributed databases. While still down, our hardware year-to-year revenue performance improved significantly from the first quarter rate, driven by our System z mainframe, System x and Storage. Looking at the gross profit, in total, our operating gross margin improved modestly. The increase was driven by margin improvement in Global Technology Services and an improving mix. This was mitigated by margin declines in Global Business Services and in Systems and Technology. When you look at gross profit dollars, the year-to-year decline was driven entirely by our Systems and Technology business. Aside from STG, our gross profit is flat, even after a $70 million impact from the divested customer care business, and while we transition to some of the emerging areas, where the profit and margins will benefit from scale. Our total operating expense and other income was better by 14% year-to-year. Acquisitions over the last 12 months drove 2 points of expense growth. For the last three years, acquisitions have contributed between 1 point and 3 points of expense growth each quarter. Currency drove 1 point of expense growth; so base expense, which is total expense less the impact of acquisitions and currency, was down 17 points. There is one large item that is impacting the year-to-year expense dynamics. As I mentioned earlier in the call, we had $1 billion workforce rebalancing charge in the second quarter of last year. This impacted the base performance by 12 points. So without the impact of that item, our base expense would have been better 5 points year-to-year. This is a better indication of the productivity in the base. The other item I'll mention is the gain of over $100 million from the sale of our customer care business, associated with the country closings we completed in the second quarter. This is in other income and expense. Keep in mind, the divested business removed about $70 million of gross profit. Within our base expense, we're also continuing to shift our spending to drive our strategic imperatives and differentiated offerings. The substantial investments we're making in cloud, which includes Bluemix, in Watson and in chip innovation are examples of this. Now let's turn to the segments, and we'll start with Services. This quarter, the Services businesses generated $14 billion in revenue, which was down 1% at constant currency. This is where we see the impact of the customer care divestiture in the year-to-year results. So adjusting for that divestiture, total services revenue was up 1% year-to-year. Services pre-tax profit was up 26% and margin improved over 4 points. I'll discuss the profit drivers within the brand details. Total backlog was $136 billion. We reduced backlog by nearly $4 billion, when we divested the customer care business in January. Adjusted for the divested business, total backlog was down 1% at spot rates. Global Technology Services revenue was $9.4 billion, down 1% as reported, but up 2% at constant currency, adjusted for the divestiture. SoftLayer contributed about 1 point to GTS revenue growth in the quarter. We're expanding our footprint, and in the second quarter, we opened a cloud data center in Hong Kong, and followed that with London, earlier this week. We'll continue to roll out additional capacity in the third and fourth quarters. GTS outsourcing, one of our core franchises, continue to improve, with revenue growth of 2% at constant currency, adjusted for the divestiture. Revenue growth was driven by the substantial new contracts we brought on in 2013 and we expanded gross margin. GTS pre-tax profit was up significantly in the quarter. The profit performance was driven by several key factors: first, we're continuing to make investments in key growth areas such as mobility, security, and cloud. These investments result in a differentiated set of capabilities that complement our clients' systems of record, and are a good example of how we continue to evolve our core franchises. Second, profit reflects the gain from the completion of several country closings in the customer care divestiture, partially offset by the profit lost from the divested business. Finally, we have the benefit from the past rebalancing actions. The year-to-year growth also reflects the absence of workforce rebalancing charges compared to last year. Turning to Global Business services, revenue of $4.5 billion was down 2%. Consulting and Systems Integration grew 1% and flat at constant currency. We had strong double-digit growth in our practices that address the digital front office, particularly in cloud, analytics and mobile. This was offset by declines in our traditional packaged application implementations. As our Digital Front Office offerings become a larger part of the portfolio, they will contribute more meaningfully to topline performance. Two days ago, we announced a strategic partnership with Apple to deliver a new class of enterprise ready, MobileFirst business applications for iOS. With this partnership, IBM's consultants and other client-facing specialists will help expand mobile device productivity, enabling big data and analytics at the point of contact. Application outsourcing was down 9%, in line with last quarter's results. Our performance continues to reflect pricing pressure and client contract renegotiations as well as a reduction in elective projects. GBS pre-tax profit grew 34% year-to-year, and reflects both year-to-year benefit in workforce rebalancing charges and the impact of lower revenue on a relatively fixed cost base. Software revenue of $6.5 billion was up 1% and flat at constant currency. Middleware grew 3%, and within that the branded middleware was flat at constant currency on a tough compare from last year. We had good growth in several of our strategic areas, cloud, big data and analytics, mobile and security. Across our software brands, Software-as-a-Service offerings are growing very quickly. This quarter our SaaS offerings grew by nearly 40%. Looking at our results by brand. WebSphere had another good quarter, up 5% at constant currency, led by app server, commerce and mobile solutions. Both on-premise and SaaS offerings contributed to WebSphere growth, with the majority of WebSphere growth coming from on-premise solutions. Our Application Server business delivered strong growth, with an increase in demand for on-premise software that was driven by mobile and analytics workloads. We continue to have strong growth in MobileFirst, leveraging over 5,000 mobile experts and our expanding capabilities. Supporting our partnership with Apple, our software group will develop unique enterprise cloud services, native for iOS, to deliver the full enterprise-class mobile experience from analytics to cloud storage and data security. Information Management software was down 2% at constant currency. Once again, relational database grew, though some product areas in the brand faced tough compares. Tivoli revenue was up 3% at constant currency, driven by security software. This is the 11th consecutive quarter of growth in security software, with most of those quarters up double-digits. That's also every quarter since we acquired Q1Labs and built our security division around that acquisition, supplemented by additional analytics capabilities. Workforce Solutions declined 8% at constant currency, as we transition from on-premise Notes, to our SaaS offerings. Across software, we are transitioning our portfolio to capture growth areas, and we continue to drive innovation in our core franchises. We're growing and building capabilities in emerging areas like Software-as-a-Service, mobile and security and also in more traditional areas such as application server and relational database, as new growth areas drive the need for on-premise capabilities. This quarter we faced a difficult compare, we expect our revenue growth to accelerate in the second half. Systems and Technology revenue of $3.3 billion was down 11%. This is a significant improvement in the year-to-year performance compared to last quarter. The improvement was driven by System z as well as sequential improvements in System x and Storage. This, together with actions to align our structure to the demand profile, resulted in progress in stabilizing our profit. Looking at our results by brand, System z revenue was down 1% on flat MIPS, which is significant performance in the seventh quarter following the product announcement. In the quarter, we had large deals in the financial sector in China, the United States and Brazil. When you compare this cycle to date versus the prior cycle, we have shipped 25% more MIPS, and the STG revenue and gross profit are each about 98% of the previous cycle, net of currency. The System z platform is one of our core franchises benefitting from IT trends. The value proposition for z becomes stronger as the scale of data and transactions grow as well as the need for security of that data and those transactions. Power revenue declined 28%. The year-to-year performance reflects fundamental changes in the business, and as we have talked about in past calls, we have taken actions to align our structure to the demand profile, while investing to address where we see opportunity in the future. First, we launched entry-level or scale-out POWER8 in June, and had a good start compared to previous cycles. Keep in mind that entry-level is a small portion of the Power business. POWER8 will be introduced into the mid-range and high-end segments over the remainder of the year. And second, we expanded our OpenPOWER consortium, doubling the number of alliance members in the second quarter. At the end of June, we had 36 members across 10 countries, including nine in China, so globally diverse. The membership is across the stack, from chip designers to hardware component OEMs, to system vendors to middleware and software providers. With this alliance, members have access to high-end technology, as the Power architecture is available for open development and to integrate new designs into their hardware platforms. For example, alliance members can design and control their own encryption. Our System x revenue was down 3%, which is an improvement from last quarter, when revenue was down 18%. As you know, we're in the process of divesting this business to Lenovo, and are awaiting regulatory approvals. Storage hardware revenue was down 12%, a sequential improvement from the rate in the prior quarter. We saw strong growth in our Flash Systems, as we doubled our revenue over last year and in our Storwize portfolio, which was up double digits. However, this was more than offset by weakness in high-end disk and the continued wind-down of our OEM business. We had a number of launches this quarter, including the V7000 update to our Storwize portfolio and Flash-enabled DS8K. As we've discussed over the last couple of earnings calls, our focus for STG in 2014 is to stabilize the profit base, and after the first half we are on track. Within that envelope, we will continue to make investments in this business to remain a leader in high-performance, high-end systems. Our announcement last week to invest $3 billion over the next five years to tackle the challenges of the post-silicon era, demonstrates our commitment to innovation, and to leading in the new era of enterprise IT. Moving on to cash flow in the quarter. We generated $3 billion of free cash flow, which was up $300 million year-to-year. Through the first half, our free cash flow of $3.6 billion was down $800 million year-to-year. This performance was impacted by the significant increase in cash taxes in 2014, which I talked about earlier this year. Without the impact of cash tax payments, our free cash flow was up $400 million year-to-year. Looking at the uses of our cash in the first half, we spent $600 million on acquisitions, including Silverpop and Cognea in the second quarter. We returned $13.9 billion to shareholders. Of that, $11.8 billion was in gross share repurchases and at the end of June we had $3.1 billion remaining in our buyback authorization. In June we reached a milestone, we finished the month with fewer than 1 billion shares outstanding. Let me put this in perspective. We started our share repurchase program in 1995, when we had more than 2 billion shares outstanding. So we've reduced our share count by more than 50% and the average price we've paid from the start in 1995 through June 30 of this year is less than $100 per share. We took our dividend up 16% in April, and through June we paid out $2.1 billion this year. This is the 19th consecutive year that we raised our dividend and the 11th year in a row of double-digit increases. With our cash flow performance in the first half, we are on track to generate $16 billion of free cash flow for the year. Turning to the balance sheet. We ended the quarter with a cash balance of $9.7 billion. Total debt was $46.5 billion, which includes over $29 billion to support our financing business. The leverage in our financing business remains at 7 to 1. Our non-financing debt was $17.1 billion and our non-financing debt-to-cap was 56%. As I mentioned last quarter, given the skew of free cash flow, we expect our debt-to-cap to be in the 50s through the third quarter, and roughly flat year-to-year at the end of the year. We continue to have the financial flexibility to support our business over the long term, as we transition to the new areas of enterprise IT. So now let me wrap up the discussion of the first half results, and put it in the context of what we discussed at our Investor Day in May. We have set of offerings that address the strategic areas of data, cloud and the way our clients are engaging. We said that the model was to deliver double-digit revenue growth for these areas, with high software content. Our first half results were consistent with that part of the model. Our business analytics revenue was up 7% on a large base and cloud revenue was up over 50%, with our as-a-service business doubling once again. Our security revenue was up over 20% and we more than doubled our revenue in mobile. Together, the revenue in our strategic imperatives was up double-digits and about half of the content was in software. At the same time in May, we discussed our core franchises, where we continue to innovate. These include our longer-term services business, our recurring software business and mainframe business with our large capacity clients. The model is a stable revenue base and we are on track here too. Finally, we have transactional businesses that are shifting to higher value. We're continuing to evolve the portfolio, investing in capabilities in some areas, while divesting businesses that don't support our shift to high value. In the first half, we completed the sale of our customer care business and announced the sale of our industry-standard server business to Lenovo. These impact our topline performance, but are clearly the right moves for us for the long term. We continue to drive these shifts. Let me summarize what we've gotten done in the first half of this year. We took Bluemix live, we're adding new SoftLayer cloud hubs and we're ramping our investment to commercialize Watson. We've introduced POWER8 for big data and cloud at the entry-level and are expanding our OpenPOWER consortium. And we've committed $3 billion to drive chip innovation, while launching an important new partnership with Apple to extend IBM's position in the enterprise mobile space. When you pull all of this together, for the half, revenue was relatively flat at constant currency, adjusting for the divestiture, pre-tax margin expanded by 70 basis points and net margin by 50 basis points and operating earnings per share were up 9.5%. As we look to the full year of 2014, we expect to deliver at least $18 of operating earnings per share. And we still expect to deliver at least $20 of operating earnings per share in 2015. These are points along the way to delivering performance and shareholder value over the long term. Now, Patricia and I will take your questions.

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. And second, as always I'd ask you to refrain from multi-part questions. Christine, please open it up for questions.

(Operator Instructions) The first question comes from Bill Shope with Goldman Sachs. Bill Shope - Goldman Sachs: Can you comment on how you're currently thinking about the potential for stabilization and perhaps even growth in the Asia-Pac, x Japan region, obviously, you saw some improvement in China? But in terms of the overall region, how should we think about the revenue and profit trajectory from here? And then I guess related to that, on the profit side, can you walk us through some of the permanent changes you're making to your cost structure in that region specifically?

I guess, I'd say a couple of things. As you noted, we did see a pretty good sequential improvement in China and in India as well in the second quarter, but as we noted in the prepared remarks, we did not see that sequential improvement in AP. And notably within that, I would say, we saw degradation in both Australia and Korea within that AP geography. Now, when we look forward, in China, we still see a continued improvement in the sequential performance out of China now. It's important to note in China, even though we were still down year-to-year sequentially, not only do we see a year-over-year improvement, but our business in China was about an $800 million business in the first quarter and in the second quarter it was over $1 billion. So we see a very typical sequential skew in China, which is growth in the second. So again, as we see that year-to-year sequential improvement in China that we expect, this is still a substantial business for us. Now, we did not see and we do not see yet a material change in the trajectory in the rest of Asia-Pacific. As I noted, Australia and Korea were slow in the second, and we don't see that. Outside that area -- I'll comment also on some of the other growth markets. Latin America as an example, as you heard in our prepared remarks, had another strong quarter, again led by Brazil, which was up double-digit. And although they are going to ramp on a strong second half from last year, we still see good performance coming out of Latin America. From an investment perspective, we have made substantial commitments to those growth markets and we see good opportunity to deploy the IBM platform. And we continue to invest in those growth markets to get that IBM platform deployed across the growth markets.

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

The next question comes from Toni Sacconaghi with Sanford Bernstein. Toni Sacconaghi - Sanford Bernstein: I appreciate all the investments in the pace of change that IBM is undertaking and accomplished so far in the first half. I guess, the question that I hear a lot from investors is, is that change big enough to offset what appears to be deterioration or secular pressures in the core franchise? So very specifically, coming out of last quarter, you did not have a good Software quarter, you were optimistic that Software would be notably better this quarter, it was worse. It was flat at constant currency. Similarly, when I look at Services, which is really the other big core part of your franchise, Services signings are now down 33% for the first half. The signings this quarter were the lowest in more than six years in absolute term. And you've got nine straight quarters with negative revenue growth in Services. So very specifically, can you address what was the shortfall in Software this quarter relative to much more positive expectations you had coming in? And secondly, when you look at Services, given the preponderance of data, I just offered to you, and given the leading indicator of signings being so weak, what secularly is going on there and how does the business get better from here?

Thanks, Toni. There is a lot there. So let me try to talk a bit about Software first and talk a bit about Services next. So first on Software, my view 90 days ago was that Software would accelerate through the remainder of the year. And I still feel like in second half, we will see Software acceleration back to mid-single digit growth. Now, in the second quarter, we saw a couple of things: one, the headwind that we have in that total Software segment from the operating system, content was 3 points and that's kind of the high point, if you will, of the headwind that we expect from that operating system content. So that headwind diminishes a bit; and then secondly, we continue to see a very good Software performance coming from our kind of typical Enterprise License Agreements, as we go through the second half, again to drive that mid-single digit revenue. On Services. Services, we said 90 days ago that we would see revenue performance kind of consistent with what we saw in the first quarter, and we still feel that way. Services was, when you adjust for the divestiture, Services was up 1 point and we continue to see that. Now, as you noted, we had a weak signings quarter in the second. Now, that was on the back of first quarter last year of signings growth, first and second quarter of last year north of 30%. So we had a difficult compare. We knew that in the first half. But we do see getting the signings content growing again in the third. And so when we look at the revenue streams for Services. Again, we expect them to be consistent with what we have seen to date. I think we feel, as though that the yield were getting out of the in-period revenue is a bit better than what you would normally do if you just ran it mathematically, we're getting the better yield. Two, we have outside of the backlog, you see, we have content, the transactional content like our cloud business, which continues to grow. And then third, we will, as I mentioned, get additional third quarter signings growth that will deliver the rest of that pretty modest 1% growth on an adjusted basis, without the divestitures going forward.

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

The next question comes from Katy Huberty with Morgan Stanley. Katy Huberty - Morgan Stanley: As a follow-up to last question on the weak Software and signings numbers, did you in fact see deal push-outs in the quarter? And if so what do you think caused that and have you been able to close the business in the third quarter?

There are deals that come in -- I don't know, I would not characterize it as a deal push-out. There are a few phenomena though, that I think are worth noting. In our key branded middleware business, it's a mix of both, transactional content as well as subscription and support, which comes in over time. So it's a mix of transactional content and subscription support, but very heavily transaction content. In our total middleware business, so in the other middleware that comprises that total middleware business, we have a mix, as well, some transactional content and some subscription content, but the mix is kind of flipped in that case. So there is a lot more subscription content. What we see in any given quarter, you can see this kind of a mix shift, we saw a much higher transactional content in that total middleware line. And then the key branded middleware quarter-to-quarter behave very similarly as what we saw in the first quarter. So last year in key branded middleware, first to second quarter, we grew that content just under $800 million quarter-to-quarter. And that delivered 10% growth by the way. This year we grew that same key branded middleware a bit over $800 million. So a bit more than last year, but because of the strong compare that drove kind of a flat year-to-year performance. So we have a phenomena of different mixes between transactional and subscription support, and we have quite frankly a tough compare in key branded middleware.

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

The next question comes from David Grossman with Stifel Nicolaus. David Grossman - Stifel Nicolaus: Martin, I think you had mentioned that free cash flow is down $800 million year-over-year for the first six months, and I think the math suggest that $1.2 billion of that $2 billion cash tax headwind is reflected in that figure. So assuming the $18 in earnings is a good number, how much visibility do you have on the change in working capital at this point in the year? And your ability to hit that $16 billion free cash flow target for the year?

I would say, there are couple of phenomena that are going to drive that free cash flow. So first is, as you pointed out, when we make earnings -- I guess I'd say it this way, when we make earnings, we'll make the free cash flow number. And I think that that phenomena that drives that obviously there is profitability skew in the second half here that drives on an absolute basis that drives that. And secondly, within the sales cycle working capital component, the other phenomena is our Enterprise License Agreement cycle we're in, that software content drives a substantial amount of free cash flow as well. So between, again, the profit and the mix towards the second half as well as the phenomena of the cash structure, if you will, of our ELA cycle, I think we have a very strong statement to say, when we make profit, we'll make cash flow.

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

The next question comes from Ben Reitzes with Barclays. Ben Reitzes - Barclays: I want to ask about hardware, and just sorry a two-parter, but mainframe down only 1% was much big improvement, very big improvement from last quarter. So what happened there and is that sustainable? And then, there are some reports out there, and I know you're aware of them about your -- what you might do with your chip making capabilities? And you announced a very large investment commitment to your chip making R&D during the quarter or during this month. So can you just reconcile that, I think you understand what we're hearing out there and what is the commitment to the chip making business as well?

Sure, Ben. So couple of things, first, on mainframe, we did have a very strong mainframe quarter, as you noted just down 1% and in the seventh quarter of the cycle down 1% is quite good. Now in the first half, we were kind of down in the mid-teens, right, in the first quarter we were down pretty healthy double-digit, down 1% in this quarter gets us to a down mid-teens, and that's very typical, that performance, that mid-teens is very typical of where we would expect the next couple of quarters to be again given the cycle. Now, I think the reason that the mainframe continues to do so well and we had in the prepared remarks that in this cycle the revenue and GP is roughly 98% of where it was in the prior cycle. This continues to be now a core franchise for us. But it is the critical infrastructure that drives still 70% of the world's enterprise data. And as our clients are moving towards new systems of engagement and mobility and they want the most secure platform, the mainframe remains the premier platform on which to drive a world-class enterprise structure. So I don't expect that we're going to see a minus 1% going forward. But I think that first half performance is consistent with what we would expect. And then, on the semiconductors, as you said, we did announce a $3 billion investment in semiconductor research and development. And as we've said a number of times it was in our Chairman's letter to shareholders, we've been very, very vocal about our goal to remain the leader, the absolutely leader in high performance and high-end systems. We're the leader today and we would expect with this kind of investment we can continue to maintain that leadership. Now, this R&D investment is clearly focused on the distant future where we have, we have to figure out how to scale semiconductors to seven nanometers, that's a big challenge. And then, obviously, we're also thinking about, as we indicated what the post-silicon world looks like. So we remain committed to being the leader of high performance and high-end systems. And we have not changed our view on that at all. We've been very vocal about it and we'll stay on that path.

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

The next question comes from Lou Miscioscia with CLSA. Lou Miscioscia - CLSA: Maybe if I could link something about China, and also your x86 business. I guess the question is that, we continuously hear that the Chinese government is pushing away from big U.S. tech companies, but obviously the x86 business bounce back, and it sounds like China bounced back, is the sale of that helping the situation there? And I guess I'll leave at that.

Again, we saw a sequential improvement, as I noted earlier in China quarter-to-quarter. And as I also noted, we would expect that sequential improvement to continue. Now, interestingly I would not characterize that sequential improvement as driven solely by x86 or any other of the single brands, in fact, it was across all of our segments, Global Technology Services, GBS, Software group, STG, all showed sequential improvement in China. And in fact, when we look at our strategic imperatives content that sits in China that was up very solid double-digit as well, which is consistent with the overall performance and our strategic imperatives. So really no difference from what we're seeing in our success in China from what we're seeing anywhere else in the world.

Thank you, Lou. Chris, can we go to the next question please?

The next question comes from Steve Milunovich with UBS. Steve Milunovich - UBS: Couple of odds and ends, Martin. First of all on these share repurchase, you did I think $11.8 billion through the first half. Does that mean you have roughly $3 billion to do in the second half? And then second, on emerging markets, I think in the annual report that you guys suggested you would see emerging market revenue growth in the second half? Is that correct? And does that still stand?

So on share repurchase, we have about $3 billion left on our authorization. And as we've said in the past, we would expect to spend about what we did last year, maybe a little bit less or something. I haven't changed my view on that capital allocation. But we do have about $3 billion left in our authorization. On growth markets, as I mentioned earlier, I would say that we would say a continued sequential improvement in growth markets. And as I noted earlier, L.A is going to ramp on a strong second half, but continues to do quite well. AP we do not see that sequential improvement yet. And I guess the other thing I'd point that's worth noting, particularly in the growth markets, we are in the process, as you know of divesting our industry standard server business, and that's going to have an impact on our revenue growth and that's a profound impact in the emerging markets as well. So when we sell that content, its going to be a pretty big headwind to growth for the emerging markets, notwithstanding the sequential improvements that we see in the business.

Thanks Steve. Let's go to the next question please.

The next question comes from Tien-Tsin Huang with JPMorgan. Tien-Tsin Huang - JPMorgan: Just wanted to ask about the GBS portion of services. I saw revenue accelerated, and margins contracted a bit. Curious, how much of this is cyclical versus secular? I heard pricing pressure and package limitation weakness. Did you adjust your workforce last quarter to address these things? Just trying to sketch out what the second half might look like given this trend?

So a couple of things on GBS. So there are secular shifts going on this space. And we've been talking about our, how we're shifting towards, we refer to it as the Digital Front Office. So to talk about it as our cloud and analytics and our mobile, that was that while we see that flow in our clients and we're obviously shifting both their resources, our skills, our training after that and we see very solid double-digit growth, we saw that in the second quarter. And in fact, we look at our pipeline going forward and over half of it is that kind of content. So there is absolutely a secular shift going on in that GBS space. And we are in the middle of it. And we are very competitive in that space. On the ERP implementations, and some of the custom development work, I guess what we are seeing is kind of a fewer of those large rollouts and that combined with the large rollouts that do occur, we're seeing them being broken up into small pieces. So they're not as large as they used to be. So I don't know, if I would consider that secular or cyclical, within that our clients where those back office workloads are stable, our clients are still looking for additional productivity. And so obviously, we are in a bit of a battle to win there, but they are looking for productivity. And so we are still competitive. But other than the absolute secular shift towards cloud and analytics and mobile, which we're playing in and which we have very solid double-digit growth in, we'll have to wait and see if the rest is secular or cyclical.

Thanks Tien-Tsin. Can we go to the next question please?

The next question comes from Sherri Scribner with Deutsche Bank. Sherri Scribner - Deutsche Bank: I wanted to dig a little bit into what you're hearing in terms of global demand and thinking about the second half of the year. Are you hearing that businesses are starting to get a little more confident? I think you made some comments about the developed markets being a bit better. And then thinking about that in terms of how it translates, since the second half of the year, do you think you could start to see some flat or potentially some growth in revenue?

Sure. So if we look at our major, we'll start with our major markets performance. And so I've talked a bit about the growth markets. Already, in major markets, we were flat year-to-year when we exclude our customer care business, which was an improvement sequentially in North America. And we also did quite well in North America in our mainframe business and we saw sequential improvements in some of our other platforms as well including power and storage and X. So there is a sequential improvement story, if you will, in North America business that we certainly benefited from in the second. In Europe, we saw a decline at constant currency, but we did see within that growth in our Services business. And so I would expect Europe to see sequential improvement going forward, but it is a challenged environment from our experience. And then in Japan, we had a very solid performance again in Japan. This is our seventh consecutive quarter of growth in Japan, as we noted in the remarks that our Japan team does quite well. And I think it's more than just macro. I think our Japan team is doing quite well. And then as I mentioned in the growth markets, we do expect to see sequential improvement going forward. And then again, all of this is in context from our own headwinds here in IBM. We have closed on our customer care divestiture, which is a headwind for the rest of us, for the year, for a bit over 1 point. And then, as I noted earlier in my growth markets commentary, if we're able to close our industry standard server, our X series divestiture that will also have a pretty substantial headwind for us as well.

Thank you, Sherri. Can we please take one last question?

The last question comes from Brian White with Cantor Fitzgerald. Brian White - Cantor Fitzgerald: Martin, when we think about the Systems & Technology business, the profitability has swung from, looks like $1.6 billion in 2011 to negative $300 million in 2013. Could you just delve into what was the biggest driver of that decline? And I also just want some clarity, do you think this business will be profitable in 2014?

We are still focused, as we talked about in the beginning of the year, we are still focused on stabilizing the STG profit base for the year, right, the Systems & Technology Group profit base for the year. And I believe, we are absolutely on track to do that to stabilize that profit base. The impacts against that profit base, when we look last year and what we're trying to stabilize, there are, one, some cyclical issues. We have certainly seen this downturn in the emerging markets, which has an impact on hardware. And we've talked about that on prior calls that the mix of our STG business in the growth markets is higher than other places. And therefore, that emerging market slowdown had a more pronounced effect on STG. And so there is some cyclical issues there. And then we have talked about the mainframe cycle, already a number of times. But in addition to that, we've had this secular issue around Power and trying to reposition that. And we've taken action pretty aggressively to make that platform the most viable for the future, including we just released POWER8, as an example, which is a Power platform built for the world of big data and analytics, and quite frankly, built for the world of cloud. And then we've also had a lot of success with our OpenPOWER initiative, which we've been able to expand again the alliance, being able to expand the alliance of those who will use and build on top of that. So a mix of cyclical and secular within that STG performance, but as I said, as we said at the beginning of the year, and we are confident with the actions we've taken, both address the secular, and also we've taken a fair bit of cost out of that business to better suit the demand profile, we still see that business stabilizing in profit on a full year basis. So I'm going to wrap up the call. And I guess, first I'll start with what we saw in the first half. We had very strong performance in the strategic imperatives, a lot of software content within that. And as we talked about it at Investor Day, that's very important for our business model. The core franchises were relatively stable, that's also as we said at Investor Day, important for our business model. And we made some progress in addressing some of those secular issues in POWER8. I talked a little bit about that in answer to a question. In the second half, we see, as I noted on an earlier question, we see our Software revenue growth accelerating to mid-single digit. And we see our Services profit growth of mid-single digit, driven by productivity in the base. And then on STG, as I just noted, we see that profit stabilization still. So when I think about the second half and how that plays out, as we did 90 days ago, I said that I think EPS in the second half will be a little bit faster in the fourth than in the third. So kind of a double-digit fourth quarter EPS and a single-digit third quarter EPS. And bear in mind, that that single-digit EPS growth even in the third because of seasonality kind of translates to no more absolute EPS than what we get in the second. So we still see that same mix skewed toward the fourth quarter, when we have the benefit of very strong Software performance, when the productivity hits and helps our margins and services and we get that transactional benefit from STG. Well, thanks very much, everyone. Thanks for joining us. And have a good evening.

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