Patricia Murphy - Vice President-Investor Relations Martin Schroeter - Senior Vice President and Chief Financial Officer

Toni Sacconaghi - Bernstein Katy Huberty - Morgan Stanley Tien-tsin Huang - JPMorgan Steve Milunovich - UBS Lou Miscioscia - CLSA Wamsi Mohan - Bank of America Merrill Lynch David Grossman - Stifel Keith Bachman - BMO Amit Daryanani - RBC Capital Markets

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

Thanks, Patricia. In the third quarter, we generated $19.2 billion in revenues, $3.7 billion in pre-tax income and $3.29 of operating earnings per share. As we think back to the discussion 90 days ago, it was around Brexit and its impact on Europe, global spending and sectors like banking and the attractiveness of investment in the emerging markets, all of these topics have the capacity to drive some volatility and results, but what you see in our third quarter results is stability in our revenue with continued strong growth and strategic imperatives and a top and bottom line consistent with what we expected. Our revenue was essentially flat relative to last year. Looking at the revenue dynamics, I want to point out a few things. Our clients are focussed on becoming digital businesses and have strong growth in cloud, security, mobile, and across our analytics portfolio reflects this. In total, we continue to deliver double-digit revenue growth in our strategic imperatives led by our cloud business. Cloud delivered as-a-service is part of a solid recurring revenue base across software and services, and our annuity revenue continued to grow. Of course, the acquisitions we made in the last 12 months contributed to growth about the same amount as last quarter and for the first time in quite a while currency was a modest tailwind to revenue growth. I’ll talk to our revenue at constant currency going forward. Looking at revenue from a segment perspective, we had very good performance in both cognitive solutions and technology services and cloud platforms. Cognitive solutions were up 5% and within that solution software was up 8%. Technology services and cloud platforms revenue also grew with continued strength in our infrastructure services and growth in integration software as we help our clients build hybrid cloud capabilities. And with another quarter of signings growth our GTS backlog is up year-to-year. Global business services made some progress this quarter in revenue trajectory as we continue to shift and mix to a digital offerings. Our systems revenue was down this quarter. The z Systems performance reflects the fact that we are seven quarters into the product cycle where POWER reflects the secular decline in UNIX mitigated by growth in Linux. There is a tremendous amount of change in our industry and we are continuing to invest where we see the best opportunities. With this, we are addressing new opportunity areas and building new markets as well as delivering innovation in our existing businesses. We are investing organically and we are acquiring key capabilities. We are remixing their skills, and we’ve had success in rebuilding our IP income base, utilizing partnerships that enable us to continue to innovate in some of the more traditional high value areas of the business. With all of that, we continue to have a very high margin business and we generate a lot of profit in cash. Our results reflect the success we are having and helping our clients to leverage cloud for speed and innovation and become cognitive businesses. You see this in the growth in our strategic imperatives which were up 15%. Over the last 12 months, strategic imperatives delivered nearly $32 billion in revenue and now represent 40% of IBM. We had strong performance in our cloud offerings which were up over 40% led by our as-a-service offerings. We exited the third quarter with an as-a-service run rate of $7.5 billion. That’s up from $6.7 billion last quarter and the bulk of the increases organic. So we are building scale in these businesses. We also had strong revenue performance in security and in mobile and we had strong growth in our analytic offerings which were up 14% this quarter with contribution from the core analytics platform to cognitive offerings including Watson platform, Watson Health and Watson IoT. We are building the industry’s broadest and deepest cognitive solutions and cloud platform portfolio and we are extending our capabilities. For example, this quarter we continued the global expansion of our cloud footprint and we now have 49 cloud centers. We formed a partnership with Workday, where IBM cloud will become the foundation for Workday’s development and testing environment. And we extended our partnership with VMware to enable easy hybrid cloud adoption. As we’ve talked about in the past, cognitive is about using data and adding intelligence into products and services to help clients make better decisions. It’s about augmenting human intelligence. This quarter, we introduced and expanded Watson platform offerings including Watson conversation service and Watson virtual agent for customer service. We are training Watson for cyber security, expanding the amount of security data Watson is injecting. In Watson Health, we launched Watson for drug discovery and Watson Health core and in Watson IoT we added new capabilities around block chain and security to draw insights from billions of sensors embedded in everything from machines to cars, to drones to ball bearings to buildings and even to hospitals. Where we are seeing real value is in providing cognitive capabilities in the IBM cloud, the third critical element of our strategy is our industry focus, and in the third quarter we introduced an industry platforms business that integrates cloud, cognitive industry and ecosystems capabilities to provide targeted solutions in specific industries. Initially industry platforms will address two substantial opportunity areas, once in financial services and block chain solutions. We believe block chain has the potential to do for trusted transactions what the internet did for information. We are building a complete block chain platform and are now working with over 300 clients to pioneer block chain for business, including CLS, who settles $5 trillion per day in the currency markets to implement a distributed ledger in support of its payment netting service and Bank of Tokyo Mitsubishi for smart contracts to manage service level agreements and automate multi party transactions. And in the third quarter, we opened the block chain innovation center in Singapore to accelerate block chain adoption for finance and trade and we now have block chain garages opened in New York, London, Tokyo, Singapore and San Francisco. In Watson Financial Services just a couple of weeks ago, we announced the acquisition of Promontory Financial Group, a leader in regulatory compliance and a risk management consulting. So just as we trained Watson on clinical research and medical guidelines to work with doctors treating cancer, we will apply the expertise of Promontory to train Watson to directly address escalating regulations, their risk management requirements in financial services. I’ll expand on some of these solutions and go into more detail on our strategic imperatives performance in the segment discussions, but first let me walk through our financial metrics for the quarter. Our revenue for the quarter was $19.2 billion. As I just mentioned currency was a modest tail wind to growth, about 80 basis points this quarter. On a geographic basis, we had sequential improvements in both the Americas and Europe. The Americas revenue was flat as compared to last year and the U.S. was also flat. Latin America was up 5% led by Brazil. While the environment remains uncertain, double-digit growth of Brazil this quarter reflects the importance of our z Systems platform to the banking sector. Europe performance improved four points sequentially, driven by the U.K. Germany, France and the Nordics. Asia Pacific decelerated including a decline in Japan and weaker performance in China. India continued to post strong results. Our gross margin was down this quarter, across the business the decline is driven by higher level of investments including the acquisitions we have made and the mix to as-a-service businesses that aren’t yet at scale. I’ll address the margin dynamics that are segment specific within the segment discussions. Our expense overall is down versus last year. I want to spend a minute on a few of the expense drivers. We’ve been investing at a higher level, both in organic capabilities like cognitive, security, cloud and block chain but also through acquisitions. When we look at the acquisitions we have done over the last 12 months, this drove about five points of expense growth. As we look at our investment levels, we want to allocate our skills to where we see the most opportunity in growth. Some of our assets are high value, but not necessarily in growing markets, so we are licensing not selling our intellectual property to partners who are allocating their skills to extend the value of these assets. This quarter, we signed three such agreements resulting in a higher level of IP income. Licensing as a part of a broader partnership to drive future innovation is a relatively new model for us. It allows us to retain and potentially grow the revenue stream while shifting our spending profile to a more variable cost structure. IP income is just one way that we monetize our technology, sometimes selling our intellectual property, other times licensing IP. The last thing I want to mention relative to expense is that we continue to have a year-to-year impact from currency, not only from the translation, but also as we wrap on last years’ hedging gains. This drove a three point impact to expense, so while currency is a modest help to the top line, we continue to have a meaningful impact to our year-to-year profit. Put it all together, and our reported expense is better 2% versus last year. Our tax rate for the quarter reflects an ongoing effective tax rate of 18% for the year which is in line with the expectation we discussed at the beginning of the year of 18% plus or minus a couple of points. It also includes a discreet benefit for closure of our foreign tax audit which lowered the tax rate in the quarter by two points. From a cash perspective, we generated $2.4 billion of free cash flow in the quarter and nearly $13 billion over the last 12 months. This was over 100% of our GAAP net income and over the same period we returned about two thirds of our free cash flow to shareholders through dividends and share repurchases. Now turning to our segments, our cognitive solutions revenue was up 5% which is a sequential improvement from the second quarter’s rate. Our solutions software revenue was up 8% while transaction processing software was down 2%. Analytics was a growth driver and we grew revenue in all spectrums of Watson. We saw strong SAS performance with double digit growth in revenue. Overall, gross margin was down due to the mix shift to SAS and the acquisition content. Our pre tax income performance also reflects ongoing higher levels of investment in strategic growth areas like our Watson businesses. Our Analytics business which is the largest portion of the solution software portfolio grew again in key areas such as information integration, big data and Watson. Watson underpins our cognitive strategy and continues to gain momentum. Watson’s conversation service launched in July provides developers a simple and easy entry into the next generation of engagement, through quick set up and tooling developers without deep machine expertise can leverage the science of Watson to develop engagement experiences across multiple channels. We introduced our Watson virtual agent for customer service building on our conversational capability to provide a cognitive repeatable application trained for customer service. For example, we recently announced that the Royal Bank of Scotland will begin using a Watson Powered Chatbot for customer service. The Chatbot will help seamlessly route customer service request through the correct channels and answer specific banking queries. Turning to our vertical plays, we are focussed on scaling our Watson Health business. We have over 7000 employees and target four major areas, life sciences, oncology, imaging and value based care. We launched new offerings, such as Watson for drug discovery which is a cloud based scalable platform that helps life science researchers discover new disease pathways, new drug targets and additional drug indications. We had several major client wins, including UPMC and Best Doctors. And earlier this month, we announced a strategic alliance with Siemens, to help health care providers deliver value based care-to-patients with chronic conditions such as heart disease and cancer. With Siemens, we’ll focus on accelerating U.S. adoption of Watson’s population health management offerings. Siemens will use the Watson Health Cloud as its preferred global technology platform. We’ve also been growing our geographic footprint, expanding it to China, South Korea, Finland and the United Kingdom this quarter alone. Hospitals in both China and South Korea announced plans to adopt Watson for our oncology. And in Finland, we announced a partnership with the Finnish government that will utilize Watson cognitive computing to help doctors improve the health of its citizens. Their vision is to build an open health care ecosystem based on compliant and efficient utilization of healthcare data, so Finland will put their healthcare data on our Watson Health Cloud. When you think about an entire country and trusting us with its healthcare data, this should give you some perspective as to how clients believe we have the right technology and consider us a trusted partner to drive healthcare innovation. This builds on a similar announcement we made with the government of Italy earlier this year. We also made great progress in Watson IoT. We opened our German location where we will co-create with our clients. We added new capabilities to our offerings. So now you can share IoT data from connected devices on a block chain, proactively identify potential security risks and protect devices, and tap the Watson IoT platform to develop new voice interfaces for customers all by leveraging these capabilities. IBMs leadership in IoT was recently highlighted by IDC. We more than doubled the number of new clients on our IoT platform in the quarter including Schaeffler and Thomas Jefferson University hospital. Schaeffler, one of the world’s leading automotive suppliers based in Germany is using Watson IoT to transform its business from its supply chain through to manufacturing and sales. This is a good example of how deeply embedded into our clients businesses we are becoming down to the ball bearing themselves. We are seeing exponential growth in both devices and developers and now we are expanding our industry differentiation and our reach with Watson Financial services. As I mentioned last month, we announced plans to acquire Promontory. Together, we will create cognitive solutions for risk and compliance. Global business services delivered $4.2 billion of revenue with a one point improvement in growth trajectory from last quarter. Our digital practises which now make up more than half of GBS were up double digits with strong growth in cloud analytics and mobile. Our cloud practise was up nearly 70% this quarter as we build and implement digital strategies to move our clients to the cloud. By line of business, we grew 2% in application management driven by growth in our digital foundation and mobile platforms. This was offset by a decline in consulting revenue as some larger contracts went down and clients continue to move away from on-premise enterprise application work to new business models focused on digital and cloud. Enterprises are looking for new ways to reach their customers and empower their employees to make faster decisions. We continue to see strong double digit growth in our enterprise mobility that are helping clients redesign work flows with specific industry context. Our growing collection of mobile first for our IoS applications are delivered on the cloud and can connect back to their core systems and infrastructure. This is reinventing the way employees make real time decisions by putting the POWER of the enterprise in their hands. We continue to bring new customers onto the platform, including VU University Medical Center in Amsterdam, RIMAC Insurance in Peru, and Amica Insurance here in the U.S. We also opened a new IBM mobile first garage in Bangalore, part of the network of centers that helps clients around the world achieve mobile-led digital transformations, at speed and at scale. Turning to profit, GBS gross profit margin was down 90 basis points. We expanded margins and application management as we mixed a new cloud in digital platforms. And with the benefit from our work force rebalancing actions, we are driving productivity in our delivery model. Consulting gross profit margin was down reflecting the investments we are making to grow our digital practises. Also, there were some accounts that required additional spending to deliver on important commitments; these dynamics are also reflected in our PTI margin. We are continuing to shift the business as we’ve added nearly 10,000 resources over the past year to our strategic imperatives. The acquisitions we have done over the last year impact our near term profit but add important capabilities, like cloud consulting skills around workday in salesforce.com. We’ve also expanded the IBM Interactive experience in our digital design capabilities. We are focussed on integrating and scaling these new skills as we continue to expand our digital practises. Technology services and cloud platforms delivered $8.7 billion of revenue and grew 1% year-to-year. Global technology services again grew signings and backlog and has now grown revenue for six consecutive quarters. As we shift from systems integration to services integration we continue to see momentum in our new offerings. Across the segment our strategic imperatives were up over 40% with cloud up over 50% and the as-of-service runrate up over 60%. Looking at the lines of business, infrastructure services was up 2% as our hybrid cloud strategy continues to resonate with our clients. We provide enterprise grade cloud solutions that are secure, agile and leverage the data and investment in their core systems. We continue to expand our cloud infrastructure announcing the opening of new cloud centers in South Korea and Norway this quarter. We now have 49 centers around the world enabling low latency connectivity to cloud infrastructure. And moving to the cloud, our clients need to be sure that data is secure. Those in regulated industries need to know where their data is and many need to keep it in country. Our cloud infrastructure allows clients automatically to provision virtual with bare metal service while meeting their data sovereignty and regulatory requirements. At JFE Steel, one of the largest steel manufacturers in the world, we announced the five year outsourcing agreement that will migrate core systems to the IBM cloud through a hybrid solution that will consolidate their infrastructure and streamline business operations. This will allow the company to speed up system development and services deployment, strengthen IT governance and reduce cost. And last week, we announced a new cloud object storage service that will enable clients to scale large unstructured data volumes across hybrid cloud environments. Italy has adopted this new object storage service to more quickly and easily analyse data that’s being produced by the more than the 10 million clicks it processes each month. Looking at the software component of our hybrid cloud solutions, integration software grew 4%. We saw a continued strength in our connect products that integrate applications, data and processes for on-premise and cloud environments. We also grew in some of our mission critical offerings such as Webster application server. We continued to shift more of our portfolio to another service model to our bluemix cloud platform which continues to scale across a broad catalog of high value services including cognitive, weather, internet of things and block chain APIs. We continue to build our partnerships and eco systems to help clients move to the IBM cloud, through our partnership with VMware nearly a 1000 clients have begun moving their VMware environments to the IBM cloud including Marriott International, Clarient Global and Monitise. We are helping organisations extend existing workloads to the cloud in hours versus weeks or months. Turning to profit, our gross margin for technology services and cloud platforms was about flat year-to-year. We expanded margins and infrastructure services as we see the benefit from productivity actions we’ve taken and continue to streamline our processes. We are investing in our technology and using our cognitive capabilities to shift to a more automated delivery model to improve performance and drive efficiencies. Our technical support services margin declined, driven by the mix to our multi vendor support offerings. Our PTI margin also reflects these dynamics as well as the continued investments we are making to build out our cloud platforms. Turning to our systems segment, there are some important market shifts in this business like spinning disc to flash, the rising importance of the hyperscale data market and new opportunities in block chain. We are shifting our business, delivering innovation in our offerings and introducing significant new capabilities. As always, our performance in the period is based on product cycle dynamics and portfolio transitions, and given where we are in the transitions and POWER and storage and in product cycles more broadly our revenue and profit is down after a strong 2015. Our z Systems results reflect a product cycle dynamics, seven quarters into the z13 cycle; revenue was down while margins continue to expand. We continue to add new clients to the platform and we are introducing new technologies like block chain. We announced new services to make it easier to build and test block chain networks in a secure environment as we build our block chain platform it’s been engineered to run on multiple platforms but is optimized for scale, security and resilience on both the IBM mainframe and the IBM cloud. As z Systems are well suited for these new workloads, due to its advanced security features that help protect data and ensure the integrity of the overall block chain networks. We are currently working with over 40 clients on pilot block chain used cases running on z. Our POWER performance reflects both our performance in a declining UNIX market as well as our growth in a growing Linux market. While our margins were relatively stable at the high end of POWER, mid and low end margins were down, driving a decline in overall POWER margins. We’ve been shifting our platform to address Linux and in the third quarter Linux grew at a double digit rate and faster than the market. It now comprises over 15% of our POWER revenue. Supporting that is their success with HANA where we are bringing in new clients and were replicating this strategy with others. This quarter, we expanded our Linux only server portfolio leveraging OpenPOWER partnerships to deliver a new high performance computing chip and system with NVIDIA GPU acceleration and new data optimized servers. And our POWER architecture had another win, this time for a major hyperscale data center with one of the world’s largest internet providers based in China. And finally at the end of September, we introduced new POWER midrange in high end systems designed for hybrid cloud computing and flexible consumption models to transform on-premise IT to the cloud. So in POWER, we are shifting to Linux while continuing to serve the high value UNIX base, but this is a long transition. In the near term we are focussed on stabilizing the margin base. Storage hardware was down 9% this quarter reflecting the ongoing shift in value towards software. Gross margin is down reflecting both volume and price pressure. The hardware decline was mainly driven by low end and mid range traditional disc storage. Our high end disc storage grew this quarter. All flash array revenue grew as we have expanded our flash technology across our product portfolio. We recently rolled out new products and transition to a full suite of flash offerings making us competitively positioned, and while now in our system segment we also continue to see double digit revenue growth in software-defined storage, so across system, we're facing product cycle headwinds and some transitions in POWER and storage, while continuing to deliver important technologies and capabilities to address cognitive and cloud. So now let me wrap up the segment discussion with the performance of software across our segments. Our total software revenue was $5.7 billion, up 3%. This is the third consecutive quarter of improvement in our software revenue growth trajectory. We've got a broad software portfolio from solutions that provide cognitive, analytics and security solutions to core transaction processing, to connecting on-prem data and processes to private and public cloud environment, our software is open, running on IBM and non-IBM environments. From a business area perspective this quarter, we had solid growth in cognitive solutions and integration software, while operating systems continue to be a drag in line with a longer term secular trend, across software, software annuity revenue was up mid single digits led by our SAS offerings. Acquisitions contributed to our SAS growth, but SAS was up organically as well. Our transaction revenue decline mid-single digits which is a significant improvement in the trajectory as compared to the last several quarters, as its typically in the third quarter our transactional software content was less than 20% of our software revenue, but remember in the fourth quarter due to seasonality transactions represent a larger portion of the software revenue. Moving on cash flow and the balance sheet, we generated $3.3 billion in cash from operations excluding our financing receivables. After $850 million of CapEx spend, we generated $2.4 billion of free cash flow in the quarter. Through the first three quarters of the year, our free cash of $6.9 billion was a little lower than last year with lower tax payments largely offsetting the year to year operational performance. Through September our CapEx spending is consistent with last year. As I mentioned earlier on a trailing 12 months basis our free cash flow was over 100% of our GAAP net income. This performance continues to support our expectation that we will deliver the high end of the full year free cash flow guidance range we provided earlier this years. This includes the expected cash payments related to workforce rebalancing charge taken earlier in the year, as well as the expected tax payments in the fourth quarter. Looking at the uses of cash, so far this year we've invested nearly $5.5 billion in acquisitions. We've acquired 12 companies, the largest being the digital assets of the Weather Company and Truven Health Analytics. In the last nine months we've return $6.6 billion shareholders including nearly $4 billion in dividends and we bought back almost 18 million shares. We ended September with just over 950 million shares outstand and $3 billion remaining in our buyback authorization. Moving on to the balance sheet, we ended September with $10 billion in cash and $42.5 billion in total debt, about $26 billion of our debt was in support of our financing business. The leverage in our financing business remains at about 7:1 and the portfolio remains strong at 51% investment grade. Our non-financing debt to cap was about 54.5% which is essentially unchanged from December and down about four points from year ago. Our balance sheet continues to be well-positioned to support our business over the long term. As I said upfront in an environment where there are lot of open questions our business is showing a lot of stability, that stability is driven by the kind of work we do for our clients. We're applying deep industry skills and innovative technologies to change real business processes and outcomes. This supports our ability to invest, to create new offerings in markets and our ability to find new ways to monetize our intellectual property. In the third quarter, we made progress across our business with continued strong growth in our strategic imperatives, some moderation and declines in our core businesses, remixing our skills and adding new capabilities through organic investments, acquisitions and partnerships. You'll recall in July we said that we expected our second half EPS dynamics to be improved over the first and we laid out a half a dozen or so areas where we expected to drive that. Now based on our third quarter performance and view with the fourth we'd say the second half improvement is pretty much in line with our view 90 days ago. While we may see a little less improvement from software revenue mix, we're more successful in monetizing our software through IP income. So bringing it all together and as we look at the full year we continue to expect to deliver at least $13.50 of operating EPS and free cash flow at the high end of the range we provided at the beginning of the year. And so with that, we'll take your questions.

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

Thank you. We will begin the question-and-answer session. [Operator Instructions]. And our first question is from Toni Sacconaghi with Bernstein. You may proceed with your question.

Yes. Thank you. Martin, I have hopefully straightforward clarification and then a question please. Just on the clarification the year-over-year IP gains were about $340 million or $0.30. And I appreciate that your licensing real software IP to get that, but how do we think about this has been sort of more one off rather than ongoing IP and should we be thinking of IP income increasing on an ongoing basis? And similar, if you could just clarify the tax rate, I had 14:2 [ph] as your tax rate. You talked about two points being helped from a discrete tax item. Was there something else that was impacting the tax rate that appear to get it down to at least by my model something that's closer to 14%. So if you could clarify those two that would help. And then the question is around free cash flow and how to think about it. This year you're going to be at the very high end into your range, probably free cash being a 100% or more than a 100% of GAAP net income. As we look forward next year given your guidance, is typically lower than that. Should we not be thinking about free cash flow declining in an absolute -- on an absolute basis in 2017?

Okay. Well, I think I got them all, Toni. So, we'll do the clarifications first and we won't count that as a multi-part question, we'll count that as a multi-part clarification, and then we'll talk about free cash flow. So couple of things on IP and this is actually a really important point I think Toni, our IP income, our IP income has been flat to down over the last say three, four, five years and we've been thinking about how do we continue to drive IP income? If you look back, and I'm sure you have all the data as well. If you back 15 years ago, we had as much as a $1.07 billion of IP income, now a lot of that was driven from the fact that we developed really good semiconductor manufacturers and really good semiconductor manufacturer processing technology and our ability to license that technology drove a lot of income. We have been thinking about how do we reinvigorate if you will the IP income business and part of it is what you'll see now as we're realizing some of these. So, the clarification that you asked about, is it about 340 million year to year? Yes, that's right. That's about 340 million year to year. But more importantly, we are going to continue to drive IP income. Now, we got a good third quarter on a year to-date basis where about 1.01 billion, so we're kind of flat. I don't think that we have enough to set a new annual record when we look back at the $1.7 billion that we printed 15 years ago or so, but it is certainly a focus, and keep in mind I think that these are relationships, they are long term relationships, right. So, they are not all public as some of our partners don't want to talk about what they are doing. Those that our public, though their multi, multi year relationship where they can drive now some of the value that they see, they can capture within the marketplace. We again, we license it to them, we don't sell it to them, so we have an interest going forward as well and can get some of the upside here. So this is a really -- it’s a terrific model, it's got a lot of legs. We see an opportunity for this over the next few years to continue doing this. So, I think that handles your clarification on tax. There are two points, your notes were right, two points were from the discrete piece of its. And then we are -- our view of the year now, because of the mix of our business has an operating ongoing effective rate of 18 plus or minus, which is where we were at the beginning of the year. So, it's really a kind of a view of where the mix of our businesses looks for the rest of this year. On free cash flow your question, we have been running at a realization which is above our model. Now keep in mind we got – we won a tax case earlier in the year and that means we got our money back, right. So that was a pretty substantial inflow. But we also had some pretty substantial outflows in terms of our workforce rebalancing payments and things through the year. So, as we said in our guidance, we would expect to finish at the high of the guidance. We said that already 180 days ago. We still feel confident about our ability to generate cash. As we start to look at next year, we don't see anything that fundamentally changes our realization from where we are in our model, so our model as you know is in the 90, so somewhere between 90% and 100% realization, and we don't see anything, knowing again everything we have now, everything we have now year to-date plus what's coming in the fourth, we don't see anything that would say our free cash flow realization is going to change. And so, when we get through now the fourth and we see where we are for 2017 and 90 days then we'll talk more about the absolutes, but we don't see anything in the realization that's going to drive our realization to be anything other than again 90% to 100% for next year.

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

And our next question is from Katy Huberty with Morgan Stanley. Your line is now open.

Thanks. Good afternoon. You didn't close any major acquisitions this quarter and yet cognitive growth margin sell 400 basis points year on year, 200 basis points sequentially. Should we not expect to see improving margins as-a-service revenue scale on the fixed cost base of data centers? And then Martin just connected to that you mentioned that the one variance to your plan for the year is that the software business, margins are tracking the plan, can you maybe touch on why that it is? Thank you.

Sure. So, I'll address actually the second one first, Katy, so when we talked about first half to second half and we laid out where saw the business in the second half, one of those elements we had on that chart last quarter was the idea of software mix and as-a-service -- software mix and as-a-service margins and it would go – it would turn into a modest positive. And I would say that's more neutral now. So not a dramatic change and it really has to do with the mix of business, you know, we're getting the kind of growth rates we would expect. You saw third quarter we had software up 3, which is an acceleration from the prior quarter, but it really is that we're also seeing good momentum in our cloud platforms business, so it’s really a mix statement that is driving that as oppose to something happening within our software margins. On the cognitive margin component the phenomena you described is absolutely accurate. As we slowdown those investments we'll see the as-a-service margin scale, we're starting to see the as-a-service business scale, but we still see so much opportunity we're going to keep driving the investments. And so we haven't gone to that point yet where the scale overtakes the investment levels in that as-a-service business.

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

Thank you. Our next question is from Tien-tsin Huang with JPMorgan. Your line is now open. Tien-tsin Huang: Great, thanks. Good afternoon. Just on the transactional sales down 5% in the third quarter, curious if there's any the line of sight here into this fourth quarter and what you might expect there in relationship to – in relation to which is on the third quarter maybe this is a question. Do we start to think about transactional sales and for the IP income, maybe together, I don't know if there is any correlation between the two in any way? Thanks.

Thanks, Tien-tsin, so a couple of things. The transactional business as we noted in the third, down five was an improvement from where we were in the second. So, we had reasonable transaction closing rates. Now, the thing to keep in mind as we go into the fourth, it is a much bigger transactional quarter for us and so while we have, what I would call a good opportunity pipeline, we have got now 85 days or a 75 days to see how the environment holds up and that will obviously drive the fourth quarter and drive the full year. When we look at – when I look at the revenue streams in the fourth, our annuity business which again smaller pieces in the fourth. Our annuity business has been growing pretty consistently quarter, to quarter, to quarter and I would expect that growth to continue into the fourth that transactional business which is again much larger tends to get a pretty good quarter to quarter sequential bump if you will about $1.5 billion. And based on our opportunity pull, we'd say that looks about like what we'll get done in the fourth as well, but there is some uncertainty in environment and here in the U.S. we've got an election to get through, but right now I'd say that my line of sight into 4Q says, that quarter to quarter impact in third to fourth is about $2.5 billion as we had – just for that transactional business.

Thanks Tien-tsin. Sam, can we can take the next question, please.

Thank you. Our next question is from Steve Milunovich with UBS. Your line is open.

Thank you. You talked quite bit about Watson. You've been running many Watson ads. I just wonder if you can give any updates from the Analyst Day on Watson. How much revenue are you generating? The revenue you do generate is it in the software or consulting buckets kind of relatively speaking that you expect going forward? You mentioned I think four, five ways, you're looking to monetize Watson at that meeting, I guess which ones are working. And you talked about it as a platform as well and I'm wondered if you consider running Watson on someone else's platform like on AWS?

Okay. Steve, I'll start with the last question first and last answer to that question is no, Watson runs on our cloud and our technology and Watson will run on the IBM cloud. With regard to the progress we're seeing, we've talked a bit about and you've seen many of our announcement around where Watson is showing up and the kind of work it’s doing, all of that as you know gets reported within our strategic imperatives and all of it goes into the cognitive solutions space that's where our Watson Health business is, that's where our IoT business is, and that’s where the Watson platform is. So, I'd say that with the cognitive solutions business we talked about it in total at plus five, the sub-segment of that where the Watson content shows up which we also provide is up eight, so good growth in that software solutions space. But keep in mind that we're also building new markets here and it's going to take some time for us to take the technologies and the processes that we bought for instant in our Watson Health business and now layer on the Watson technologies to get the ramp in growth that we expect to get out of some of them. So, yes, good progress, yes, it’s a long term investment, and all within that cognitive solutions segment and no, it's not going to run on anything but the IBM cloud.

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

Our next question is from Lou Miscioscia with CLSA. Your line is open.

Lou, we can't hear you. You are on mute.

Hello.

Well, there you are. Now we can hear you.

Okay. I hope it’s coming through okay. So on the software area which was up 3%, maybe can you go in there and just share with us what is organic, and would you say that we've actually gotten passed with flexible pricing situation that you've been obviously dealing with from negative growth standpoint for a couple of quarters or actually maybe about two years now?

So, a couple of things, Lou on organic, as you said software up 3 and acceleration for where this -- there is across IBM, the acquisition impact was about the same as it was last quarter, about 2 points across all of the businesses. Now lot of those businesses are software, so obviously an impact in software in the quarter, but not dramatically different again from what we saw in the second. We have – we continue to have good annuity content performance, so our annuity business continues to grow. The phenomena that we've talked about with regard to our largest customers is still part of the discussion with every large customer, it’s a question of how do they best view the deployment of their licenses. How do they best view the use of our technologies in order to make sure they are optimizing their own workloads, they make sure they are optimizing the projects they have going on. One of the things and important thing to us is are they, to make sure that they're still using our software and are they still – are they still, for instance, paying us in [Indiscernible] and are they renewing that, and our renewal rates have stayed very high and very consistent through the third quarter as well, and so we're confident that our software business has the right appeal if you will to our clients, because they continue to use it, they continue to deploy it on any large customer basis, any large customer, the discussion could be a little bit different, but again good software performance in the quarter, some benefit from acquisitions, but I would expect that our annuity base will continue to keep growing as well.

Thanks, Lou. Sam, can we go to next question please?

Thank you. Our next question is from Wamsi Mohan with Bank of America Merrill Lynch. Your line is open.

Yes, thank you. I have a quick clarification and a question as well. So, Martin when you alluded to sort of moving into this high transactional quarter in the fourth quarter, I think you alluded to about 2.5 billion sequential improvement quarter on quarter in that business, is that the baseline that is needed to achieve the 2013 and 2015 in guidance, that's my clarification. And for my question, if you think about sort of the unique one-time benefits in 2016 you had tax which was the big driver for first quarter. I know you had associated investments and then now you look at the third quarter there are some significant IP other income and I appreciate your comments around the increasing nature and sustainability of this. And I know you're not guiding it to 2017, but conceptually these elements make it seemingly tougher to grow earnings in 2017 especially at a time when base of buybacks are moderating at sub 1 billion for the last four quarters and gross margins continue to compress, so maybe you can help us taking through at a high level maybe some puts and takes and what potentially will be positive drivers are offsetting some of these headwinds in 2017?

Sure, Wamsi, and again the multi-part clarification with the question is an interesting approach, but – so first on the revenue quarter to quarter, yes, so when we look at our third to fourth as I said, we typically get about $2.5 billion in transactional revenue in the quarter and that's sort of build in one-off, I mean, we got a different – we have a lot of different scenarios on what the year might look like, but that is certainly the predominant if you will scenario on how the fourth comes in. On the view of 2017 which I'll come back to you in moment, again, I know you – and you said it I think, you did listen to my answer on IP, but this is not a onetime thing, right again, IBM has had as much as $1.07 billion of IP in our income statement, it is one of ways we monetize all of our intellectual property, it’s only one, right, we also obviously sell a lot too, but we license their IP is part of our business model. I don't think about it is one-time. We're going to continue to drive this and hopefully grow it. We've got a reasonable pull in the fourth of clients and partners who want to license our technology, so you shouldn't think of it is one-time at all. Now, as we go into 2017, with our big transactional quarter coming up obviously and 90 days we'll talk about what we saw in the environment and what that position us for 2017, but I do think we know, we know a few things as we head into next year already today, so we know for instance we've got good momentum in our strategic imperatives and we continue to see with our investments and our view of the market, how that resonates with clients and I think we would expect to continue to see good strategic imperatives performance which also by the way will drive some investments but keep in mind that with everything we got done this year, the bulk of the spending, the bulk of the investment dollars we freed up next year, that's a much bigger number next year, so we have a freedom and an ability to invest more heavily given what we've got and done so far this year. So that's one thing we know. Secondly, we're seeing good sign ins and backlog performance in our GTS business, that was sign-ins and backlog up again and within that GTS business, the biggest part of that our infrastructure services business which drives by the way that backlog also expanded margins in the quarter, so that's a big deal for us obviously. We also saw expanding margins in our – in parts of our GBS business and our application management business, again as we drive productivity. So, we know again good performance and momentum in strategic imperatives. We have good sign-ins and backlog growth in our GTS business with margin expansion in some of services businesses. And then at this point we'll see where currency winds up in the next 75 days. At this point, it’s kind of neutral shift you will, it certainly not the billion plus impact we took this year as we wrapped on all the hedging from last year, so its far more neutral next year. Now, at the same time as you said we don't another tax case that we're going to close next year, but at the same time most of that was reinvested if you will or consumes elsewhere, it didn't show up on the bottom line. So, yet too soon to tell, we'll get through the fourth, we'll talk about the 90 days when we see, but there is some -- there's momentum here in parts of this business that we'll be spending more time on.

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

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

Thank you. So, Martin, if we look at organic growth rate of the imperatives, it looks like that began decelerating in the fourth quarter of last year and through the second quarter of this year. And then they looks at least, if my math right, they bounce back this quarter, and you did a good job of telegraphing that last year's growth was not sustainable. That said, the number are seems to be a little bit more volatile than expected. Is there any way you can help us parse this disclosure and just help us better understand what drove the deceleration and then what drove the subsequent rebound this quarter?

Sure. I think the best thing to do, David, is to look at all of this on a trailing 12 months basis. You know, we recently started giving this on a quarterly basis. It’s a good disclosure and the sense that everyone ask for it and we try to provide the components of our strategic imperatives within each of our new segments. And I think in general people appreciated having that level of detail, but to your point, if you're looking for my advice and how best to interpret this I had interpreted on a 12 months trailing basis. Our clients aren't making big, big investment decisions like who do I trust with my data and what cloud am I going to move on to? That's a decision that is going to last much longer than say, a 90 day reporting cycle. So, in any given reporting cycle there will be volatility. My advice look at it on a trailing 12 months basis and you can see the trend.

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

Thank you. Our next question is from Keith Bachman with BMO. Your line is open.

Hi. Thank you very much. I also want to ask about cognitive solutions, you mentioned that the rollout of SAS if you will or software service is impacting the margins, yet you had still a very small part of the total, it's perhaps 100% of the current revenue base. As that ramp what that continue to place pressure on your margin structure? Or to say it different way, could you characterize that we look at 2017 would margins and cognitive solutions be at a minimum flattish. How are you thinking about that? And one clarification also just, did you mentioned what the total revenues in organic sources were or was M&A about two points I hope this quarter as well?

Yes. So in total Keith, our acquisitions contributed about two points a growth, same as second quarter.

Okay. Yes.

So, on our cognitive solutions and our margins, so first keep in mind, this is our highest margin business, it is primarily software and within that it's got very heavy high value content in the on-premise category if you will, right. And so these margins which are very high, we want to and we're moving some of this business and investing in the as-a-service, so as that moves into the margin profile, the cognitive solutions could it see a little bit of margin pressure over the long term. Yes, but it’s coming from a very, very high base. And as-a-service component that's going in, it still better margin than all of the other segments in general. So, yes, the as-a-service component of cognitive solutions may have a bit of an impact just on that segment but overall it will still help IBM and again this is a very, very high margin segment at north of 80% here so.

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

Thank you. Our next question is from James [Indiscernible] with SPE [ph]. Your line is open.

Thank you very much. And Martin thanks for the explanation about the additional investments you're doing that impacts gross margin. Can you help us understand incrementally going forward, so not say, year-over-year but kind of incrementally going forward, the efforts you been doing kind of this year. Should we expect the same type or incrementally do you feel like you're going to have to incrementally do more investments forward or just kind of at this level? Thank you very much.

Sure, Jim. I'd say that given, yes, we'll continue to invest. Do I think the rate of growth of investment has to continue? Well, the short answer is it may, but again remember how much we got done this year in terms of making room in the overall IBM equation and the productivity we are driving in parts of our services businesses, I know that we are seeing margin expansion in some of those. So yes, we will continue to invest and infact I think that some of these markets require this level or the markets require this level of investment in order to be at the leading edge with our clients, but we do make a lot more room if you will in the overall IBM equation given everything we got done this year. And we’ll spend more time in 90 days on how all of that plays out for 2017, but again we made a lot of room for investments for ourselves for next year.

Thank you. Can we please take one last question?

Thank you. And our last question is from Amit Daryanani with RBC Capital Markets. Your line is open.

Thanks. [Indiscernible] I’ll keep to one clarification and one question up. I guess you know the question really is when I look at your free cash flow usage over the last four quarters; it’s been you know more skewed towards acquisition versus what one would have thought in the past. As you look at 2017, do you think it optimizes more i.e. buybacks to be much more than you know the $1billion run rate you guys are running at and acquisitions could be small, just help us on this on the mix as you go forward. And then just to clarify when you talk about 90% to 100% conversion of net income to free cash flow in 2017 is that of a GAAP or non-GAAP number?

Sure, sure I’ll do the clarification first Amit. So that’s our GAAP net income realization. We’ve just kept it consistent in terms of GAAP net income. It was the most straightforward for we think for everyone to understand. So the free cash flow realization data is GAAP net income. On how free cash flow, skews next year and the application of our capital, I’d say first you know you can be assured that we are going to put all of our money to work as we have. We don’t tend to -- we don’t keep capital here to the extent its excess, after we’ve invested in organically and after we’ve purchased what we think we need through acquisitions and after we’ve paid the dividend we do return capital to shareholders. Over the long term in the form of share repurchase, we over the long term as we said now pretty consistently, we think over the long term we can reduce our share count by 2% to 3% and that obviously recognizes that we will continue to be acquisitive. So, I would say that Amit what -- again we’ll talk more about what we have assumed when we get to 2017 but we will absolutely continue to invest organically, we’ll absolutely continue to be acquisitive. We’ll absolutely continue to grow the dividend and then to the extent that we have access capital to return we will return it on over the long term that number from a share repurchase would be a 2% to 3% reduction. So, let me conclude, let me conclude by reminding you that we are running a highly differentiated play here. We are building obviously cognitive capabilities well beyond what others are doing with individual AI services if you will and we are building the platforms to help deliver that and we are making all of that available on another platform, the IBM cloud. And it came up as you heard on the call, will Watson run on someone else’s cloud? No, it won’t, it will run on the IBM cloud. And we are doing all of that with deep industry expertise and that’s what our clients are looking for, that cognitive capability on the IBM cloud with deep industry expertise and you can see that in our health, you can see that in our IoT and you can see now in financial services which we just announced a couple of weeks ago. So we are very excited about what we are doing and we are very excited about the businesses we are building and of course we are very excited with the help and what are allowing and enabling our clients to become which is cognitive businesses. So as we do that, we’ll continue to be deeply embedded in the fabric of how they run their businesses and the most important work they do. They trust us with their data, they trust us to be their partner and becoming cognitive businesses and quite frankly that’s how we make sure that we are successful over the long term. So thank you for joining our call today.

Thanks Sam. Can I 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.