Patricia Murphy - VP, IR Martin Schroeter - SVP and CFO

Toni Sacconaghi - Bernstein Tien-Tsin Huang - J.P. Morgan David Grossman - Stifel Nicolaus Steve Milunovich - UBS Bill Shope - Goldman Sachs Brian White - Cantor Fitzgerald Keith Bachman - Bank of Montreal Sherri Scribner - Deutsche Bank Wamsi Mohan - Bank of America Merrill Lynch Jim Suva - Citi

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

Thank you. This is Patricia Murphy, Vice President of Investor Relations for IBM. I'm here today with Martin Schroeter, IBM's Senior Vice President and Chief Financial Officer. I'd like to welcome you to our First 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 the related GAAP measures in accordance with SEC rules. You will find reconciliation charts at the end of the presentation and in the Form 8-K submitted to the SEC. Now I will turn the call over to Martin Schroeter.

Thanks, Patricia. In the first quarter, we delivered $19.6 billion of revenue, $2.9 billion of operating net income, and operating EPS of $2.91; that's up 9% from last year. It's quite a good start to the year, and obviously better than the mid-single-digit growth we discussed 90 days ago. Our revenue was flat year-to-year, excluding the impact of currency and the divested businesses. There's been a lot of focus on the implications of a stronger dollar, especially to companies like IBM, where, as you know, two-thirds of our revenue are outside the U.S. So let me address this right up front. In the first quarter, we had an eight point impact from currency translation. This impact is even greater than 90 days ago, and also from the update we provided at the end of February. As always, we put a chart in the back-up that shows the impact of currency translation to revenue for the first quarter and the full year. And as we shift our portfolio to higher value and divest businesses that no longer fit our strategic profile, this also results in an impact to our reported revenue growth. In the first quarter, it was over four points. So together, the impact of currency and the divested businesses reduced the reported revenue growth by 12 points. Now, for the balance of the presentation, I'll focus on our revenue performance at constant currency, and excluding the impact of the divested businesses. This is the way we look at our business, and again, on that view of our business, our revenue was flat year-to-year. At our investor briefing at the end of February, we spent a lot of time on how we are transforming our business to where we see long-term value in enterprise IT. We have a core portfolio that's high value to our clients and high value to us. Quite frankly, it's essential. While the market for these capabilities isn't necessarily growing, we continue to reinvent and innovate to deliver that value. We've also been investing in our strategic imperatives, our solutions that address the opportunities in data, cloud, social, mobile, and security. These are high-value solutions and we're able to grow at a rate significantly faster than the market because our offerings are highly differentiated and because our core businesses provide the industry perspective and deep insight into how our clients operate. In February, we showed you the revenue across our strategic imperatives has been up 19% to 20% in each of the last five years. And now in the first quarter, revenue in our strategic imperatives grew more than 30%, so a good start toward another strong double-digit year. Analytics was up more than 20%; Social, more than 40%; and Mobile, more than 4x. Our cloud revenue was up over 75% year-to-year. On a trailing 12-month basis, our cloud revenue was $7.7 billion. This is a demonstration of high growth in the higher value cloud opportunities across public, private, and hybrid. We had a terrific performance in our cloud foundational and as a service offerings and we exited the quarter with an annual as-a-Service run rate of $3.8 billion; that's up $1.5 billion in the last year. The bulk of that growth was organic, the result of our deep insights into how our clients run their business. We've applied that insight to develop a strong point of view on cloud, that the value in cloud is hybrid. In February, we announced a program to make hybrid cloud a reality for the enterprise, extending our clients' control, visibility, security, and governance in a hybrid cloud environment, similar to what they have in their private cloud and existing IT systems. And to deal with the data sprawl, we're providing increased data portability across environments. Now while we're investing and driving growth in our strategic imperatives, we're continuing to reinvent and bring innovation to our core portfolio. For example, in our hardware business, we've continue to invest and innovate. That's how we've been able to introduce the z13 mainframe that is built for the mobile economy and roll out Power 8, optimized for data and cloud. We've also made some visible divestitures and we're now starting to see the results of those actions. In March, we shipped the first z13 system and our mainframe revenue more than doubled on MIPS shipments that were up 95%. Power returned to growth, leveraging strong performance in our scale out systems. All of this is driving our shift to higher value, resulting in a higher margin and supporting targeted investments. In fact, in 2015, we're shifting billions of dollars of spending to data, cloud, and engagement to extend our differentiation in the market. And in the last few weeks, we've announced two initiatives, Internet of Things and Watson Health, that will further strengthen our position as a high-value innovation company providing solutions at the intersection of business and IT. So, to sum it up, our results this quarter at the IBM level and the segment level reflect the transformation in our business. We had continued momentum in our strategic imperatives and strong growth in hardware, resulting from the innovation we continue to deliver. The declines in the core portfolio were consistent with the second half of last year, and our shift to higher value drove margin expansion and we're continuing to shift investments and rebalance resources to address the best long-term opportunities in the market. So, now I'll get into the details of the quarter. Our revenue was flat year-to-year, a two point improvement from our year-to-year performance in the third and the fourth quarters. At the risk of oversimplifying this quarter's revenue dynamics, our strategic imperatives were up over 30%, which is 10 points faster than last year. And bear in mind, we have a pretty substantial business in cloud and analytics alone, so it's on a big base. And our core businesses had a similar trajectory to what we delivered in the second half of last year, so our substantial strategic imperatives growing 10 points faster drove two points of sequential improvement. Looking at our margins, we had an 80 basis point improvement in gross margin, driven by both portfolio actions and strong growth in System z. To put that 80 basis points into historical context, gross margin of 49.3% is up about 1,400 basis points in the last 15 years. And you'll get that same trend from a margin perspective whether you back three, five, or 10 years. In terms of gross profit dollars, we generated $9.5 billion in the quarter, and that's up $2.7 billion from 15 years ago. So, this is clearly the result of our long-term relentless shift to higher value. Our pretax and net margins benefited from the shift, as well, but they also reflect a smaller charge for workforce rebalancing this year. On the bottom-line, we reported operating EPS of $2.91, up 9%. We generated $1.1 billion of free cash flow in the quarter, which is up from last year, and as you know, there's a lot of seasonality in the timing of our cash flows, much more so than in our net income. We return $1.2 billion through share repurchase and nearly the same amount in dividends, and we ended the quarter with $8.8 billion of cash on hand, up from year-end. Now turning to the revenue by geography, we had sequential improvement in our year-to-year performance in both the major markets and the growth markets, led by the U.S., Japan, and Latin America. Revenue in the major markets was flat year-to-year. We grew in the U.S., with strong growth across our hardware portfolio and some large software deals, so we had a good transactional performance in the U.S. Japan growth accelerated on the strength of services and hardware. We continued to the mixed performance in Europe, with growth in the U.K. and declines in Germany and France. From a brand perspective, we had good growth in mainframe and power, and continued momentum in outsourcing signings, as clients look to integrate cloud and mobile capabilities into larger scale IT environments. Overall, while our performance in Europe decelerated, it was in line with the market. In the growth markets, Latin America returned to double-digit growth, with broad-based growth in the region, and we had growth in the Middle East and Africa. The Asia-Pacific growth markets again declined, though we had sequential improvement in some key countries. Our year-to-year performance in the BRIC countries improved sequentially, though the total BRIC number is not reflective of the individual country's performance; we had growth in Brazil and India, and declines in Russia and China. In China, we again had very strong growth in mainframe, but our services revenue declined as we shift our focus away from some of the lower margin offerings. Bear in mind, we do have a profitable business in China. Turning to the segment perspective, our total revenue was flat and gross margin improved 80 basis points. As always, I'll go into the revenue drivers in the segment discussions, but I want to spend a minute on margin dynamics. When you look at the drivers of margin improvement we've talked about in the past, a shift to higher value has been a big contributor. This quarter, we saw the shift coming from portfolio actions and strong System z performance. Over long periods of time, investment levels can improve margins, but given the market shifts and transformation we're driving, investments are currently reducing margins. Similarly, currency is typically neutral over an extended period, though our margin this quarter had a translational impact of the stronger dollar. With all of that, we drove margin improvement of 80 basis points. The reported operating expense and other income is down 17%. The reported decline is driven by currency, a lower level of workforce rebalancing, and the fact that we no longer have the expense of the System x business in our run rate. I'll comment on each. Eight points of decline was driven by currency, between the translation of non-dollar spending and the hedging gains that are reported in expense. Two points of the decline are due to the divestiture of System x. And we're continuing to rebalance our workforce, and this quarter, we took a charge of $280 million, but that's down $580 million year-to-year, so with a lower level of workforce rebalancing charges, drove another seven points of decline. As we continue the transformation of our business, I'd expect a similar level of workforce rebalancing next quarter, which will impact our year-to-year profit performance. I should also mention that last year, we had nearly a $100 million gain from the sale of our customer care business and other income, which obviously wasn't replicated this year. Within our base expense, we're continuing to shift resources and spending to areas where we see the most opportunity. In February, we talked about shifting $4 billion in spending in 2015, that's across expense, cost, and capital, and in the first quarter, we've been executing to that plan. We've increased expense in areas like SoftLayer, Watson, and Bluemix, just to name a few and we'll see the benefits over the longer term. Now, let's turn to segments, and we'll start with Services. Combined Services revenue was $12.2 billion, which is down 2% year-to-year. This quarter, we closed 15 deals greater than $100 million, with about half of that for new clients or new scope with existing clients. This reflects the strength of our offerings and our clients' confidence in our ability to manage the most critical assets in their business. We ended the quarter with total Services backlog of $121 billion, which was flat at constant currency and adjusting for the divestiture. Global Technology Services delivered $7.9 billion of revenue. GTS Outsourcing reflects the mix and timing of contracts from the backlog. As expected, many of the larger contracts signed last year did not contribute to revenue in the first quarter. We're continuing to see clients sign large infrastructure outsourcing deals with embedded cloud and mobile initiatives, creating large-scale hybrid IT environments. IBM is the trusted partner for these core business transformations because of our global capabilities and portfolio breadth. And in fact, the Forrester Research Wave evaluation cited IBM as far and away the leading supplier in the global infrastructure outsourcing segment. Within ITS, we had good growth in cloud, security, and business resiliency, but overall performance was impacted by a shift away from lower-value services, such as data center build-outs and OEM hardware deployments. Software grew solid double-digits this quarter, improving sequentially and building on the expanded data center capacity. We continued our steady progress with the opening of a few new footprints in Montreal, Sydney, and Amsterdam. Clients like ShopDirect are choosing SoftLayer as the platform to integrate cloud initiatives with their core systems into a unified hybrid IT model. This architecture provides them with on-demand burst capability, as well as the ability to plan for and deliver consumer apparel and home goods, based on real-time demand. This kind of value is only unlocked when the emerging technologies like cloud and analytics are integrated with the large sets of customer data enterprises already have. Maintenance was up 2%, with the growth driven by our multi-vendor support services, which is our third-party hardware maintenance offering. The continued growth of maintenance is another demonstration of the strength of our global reach and capabilities. As organizations expand, they want a partner who has scale and can provide global parts and support capabilities. GTS pretax margin was driven by a few elements. Currency was the biggest impact to profit year-to-year and our maintenance profit was down due to the System x divestiture. Profit margin performance also reflects the continued investments in the business to expand our operational capabilities; the SoftLayer data center expansion I just mentioned is one example. This gives us a highly differentiated offering in hybrid cloud, especially as it relates to data residency requirements. We're also increasing our sales hiring in our mobile and security practices, and making investments in our resiliency business. And we're accelerating our transition to a more significant global delivery model, which requires hiring and training costs ahead of the expected savings. Finally, we had a year-to-year benefit from a smaller workforce rebalancing charge in the quarter, but we haven’t yet realized the bulk of savings from our recent actions. Global Business Services revenue was $4.3 billion. We’ve had solid performance in many markets and solution areas. In Japan we’ve been consistently growing revenue and expanding margins, with solid growth in consulting and application outsourcing. And in Europe this quarter we returned to revenue growth. Across all our geographies, we continue to drive strong growth in the offerings that address our strategic imperatives. Our cloud solutions more than tripled year to year, analytics grew double digits, and we had very good growth in mobile and social. We’re helping clients create new business models and opportunities for client engagement. The challenge for Global Business Services is North America. While we have solid growth in our strategic imperatives, we’re dealing with a slowdown in some of the more traditional areas. Because the U.S. is our largest geography, its performance has a significant impact on the overall segment. But again, the U.S. has some very positive elements in GBS. Let me give you one example of the kind of work we’re doing to help clients create opportunities for client engagement. In February, we announced our strategic partnership with AMB Sports & Entertainment to transform the fan experience at the new Atlanta stadium. When complete, when you go to the stadium, you’ll be able to see in real-time which parking lots are available and which are filled, where the shortest concession lines are during the game, and have access to statistics and information from the bleachers. All because we can combine GTS outsourcing and technology capabilities with our GBS process and application expertise to provide a complete solution, creating new markets that didn’t exist even a few years ago. Before wrapping up revenue, let me just remind you that we’ve integrated Global Process Services, our BPO business into GBS to create a seamless end-to-end business transformation capability for our clients and to better leverage our industry knowledge. Looking at GBS profit, the pre-tax margin had a mix of drivers. We got some year-to-year benefit from the lower workforce rebalancing charge, and some savings yield from last year’s action. We were impacted by the Customer Care divestiture, both by the loss of operational profit and by not having a gain in this year’s results. The balance of the margin decline was driven by our cost structure in those geographies where we’re not growing revenue. We’re making investments and taking actions to make our cost structure more competitive, including rebalancing to more global delivery, use of alternate labor models, and shifting resources toward higher-value Strategic Imperative offerings. Our Software revenue of $5.2 billion was down 2%, a modest sequential improvement from the rate in the prior quarter. Key branded middleware grew one percent driven by growth in our Software-as-a-Service offerings, which were up nearly 50%. Total software growth reflects a one-point headwind from operating systems. We had growth across many solution areas. Our analytics software was up, and our mobile software grew at a strong double-digit rate, led by our MobileFirst offerings. We had solid growth in our commerce solutions, where a large proportion of the business is Software-as-a-Service. And our Social solutions grew double-digits driven by strong performance in both Kenexa and advanced collaboration offerings. Across software, we’re continuing to drive innovation and capture growth areas importantly building our software into broader solution capabilities. Just this month, we have made two major announcements, IoT and Watson Health. These are a continuation of what we started last year with Watson, then earlier this year with analytics, commerce and security. There are some common threads throughout. They are all based on a unique point of view around cloud and the value of hybrid. They all use analytics to leverage data. And they all have an industry dimension. Let me comment briefly on the two announcements. At the end of March we announced the creation of an Internet of Things unit, committing $3 billion of spend over the next four years. As part of this, we are establishing a cloud-based open platform to help clients and partners build and deliver vertical industry IoT solutions. We have also created an IoT zone within Bluemix, our platform-as-a-service and we are expanding an IoT ecosystem to leverage a growing developer and entrepreneur community. This is similar to what we’ve done successfully around Watson, where we not only have large partners like Softbank in Japan, but we have hundreds of ecosystem partners you may not have heard of yet like Wayblazer, Fluid, Redant, MD Buyline, Elance, Sellpoint, SparkCognition, and LifeLearn, all of whom are building commercial applications on Watson. And then last week we announced Watson Health, which we believe will transform healthcare, by bringing together the advanced cognitive capabilities of Watson with a vast ecosystem of partners, practitioners and researchers. There are several aspects to the Watson Health announcement, from the creation of a Watson Health Cloud, to partnerships with leading companies, to the acquisition of two companies that extend our healthcare analytics capabilities. These are the two most recent examples where we are partnering in new ways to drive innovation and build an ecosystem to transform industries. Turning to our Systems Hardware segment, revenue of $1.7 billion was up 30%, as we continue to deliver innovation across our high end systems. This quarter System z MIPS were up 95% year to year, resulting in revenue more than doubling. We started to ship our new z13 in the second week of March and this was the fastest start in terms of number of systems we shipped in over a decade. We also booked the highest revenue growth in any quarter in more than a decade. The capabilities of the z13 mainframe around mobile, cloud and real-time insights and fraud detection are resonating well with our customers. Let me give you a real example of what we’re talking about. If you are UPS, one of the largest logistics companies in the world, you have to manage nearly 5 billion deliveries a year with highly seasonal changes in demand. Your customers expect their packages to arrive on time, and they expect to schedule, manage and track shipments anywhere, anytime, and increasingly through their mobile devices. These mobile transactions can lead to dramatic increases in overall traffic as customers complete transactions at will. This requires a system that can handle the growth and scale seamlessly when activity spikes, maintaining a secure system that’s always available. That’s why UPS chose to upgrade to the IBM z13 mainframe because it could meet the expanding demands of the mobile economy. Now moving on to Power, revenue returned to growth. We not only took share in the declining Unix market, but we are also expanding beyond Unix, with Linux on Power and our OpenPOWER IP opportunity. We are expanding our customer base in the entry-level Linux systems as well as with large cloud-based players. The likes of OVH, the largest internet hosting company in Europe, Rackspace, and very recently Zuchetti, a leading IT provider in Italy, have all selected Power-based Linux systems to deliver their cloud offerings. In addition, just over a year ago we launched the OpenPOWER Foundation, to open up the Power technology and build an ecosystem to share intellectual property. The ecosystem of partners includes large established players such as Google, Nvidia, Mellanox, Samsung, Tyan and Inspur. But the consortium includes other smaller and emerging players, such as SK Hynix from Korea, Teamsun from China and Nallatech from Scotland, adding tremendous breadth and reach. Last month, the foundation unveiled more than ten new hardware innovations that continue to make Power technology relevant beyond the Unix market. And in the first quarter, we closed our first substantial intellectual property deal, a confirmation of our strategy on Power as an open chip processor. This is an important step for the first OpenPOWER-based system for China. As an example, Zoom Netcom, a data communication and equipment supplier, will launch a system in the market later this year, which is based on the first derivative of a POWER chip unveiled by Suzhou PowerCore. This clearly shows that our Power strategy is working and we see momentum in the business. Our Storage hardware revenue was down 2%, a modest sequential improvement. We again saw strong growth in our Flash Systems. This growth was offset by the wind down of our OEM business and continued price weakness in high-end disk. We see value in the storage market shifting to software and in the first quarter we unveiled IBM Spectrum Storage, new storage software in support of hybrid cloud environments. The portfolio provides greater access to data, accelerates speed to insights and improves data economics. Our Systems Hardware segment growth is a clear result of the actions we have taken to position our Systems business for the future. With good adoption in z13 and Power systems, and launch of the remaining P8 based systems later this quarter, we continue to see good growth in this business. Moving on to cash flow in the quarter, we generated $2 billion of cash from operations, excluding our Global Financing receivables. We spent just under a $1 billion in CapEx which is flat year to year, but includes a shift in spend as we build out our SoftLayer cloud centers. And so we generated $1.1 billion of free cash flow, which is up $400 million year-to-year. The primary driver was lower tax payments. This was partially offset by the working capital impact associated with the sale of our System x business, and higher payments for performance based comp which was accrued last year. I mentioned earlier that our free cash flow generation is skewed to the back end of the year, and we continue to expect to deliver on our full year objectives. Looking at the uses of cash in the quarter, we returned over $2 billion to shareholders, including $1.1 billion in dividends and a $1.2 billion to buy back almost 8 million shares. At the end of March, we had 985 million shares outstanding and $5 billion remaining in our buyback authorization. With the flow through from last year’s share reduction, our first quarter spend, and the remaining authorization, we can achieve the level of share reduction we’ve assumed in our model for the year. Turning to the balance sheet, we ended the quarter with a cash balance of $8.8 billion, which is up from December, but down from a year ago. Total debt was $38.8 billion, with over $26 billion in support of our financing business. The leverage in our financing business remains at 7 to 1. Our non-financing debt was $12.6 billion, which is down $3 billion from a year ago. Our non-financing debt-to-cap was essentially flat vs. December and four points higher than last year. Remember our equity was impacted in the latter half of last year by pension, currency and the semiconductor manufacturing divestiture. The changes in book equity and the resulting impact on our debt-to-cap ratio do not adequately reflect the financial flexibility we have to support our business over the long term. In fact on the basis of a core debt to EBITDA metric, we are well positioned to support our long term growth objectives. Finally, I want to mention that as a result of several court rulings in Spain, including one in March, we booked a $230 million pre-tax charge related to litigation involving IBM Spain retirement plans. The court ruling reverses a voluntary employee program to join a defined contribution plan that was offered more than 20 years ago. This non-operating charge impacted GAAP earnings and pension liability in the first quarter. So now let me summarize the quarter, and talk about our full year expectations. We’ve been very clear that we’re transforming our business, and we continue to see signs that the transformation is working. In the first quarter you see it at the IBM level, and in our segments. Our revenue trajectory improved, driven by an acceleration in our strategic imperatives. We had strength in high-end systems, as our new products address the most contemporary workloads of data, cloud and mobile. This strength, together with our overall shift to higher value drove margin expansion for IBM. All together our revenue was flat year to year, excluding currency and the impact of divested businesses. And we had mid-single digit operating net income growth, and high single digit EPS growth as reported. At the same time, we’ve made a number of bold moves that build on the momentum we started in 2014. These include our hybrid cloud announcement in February, a set of initiatives around Internet of Things in March, and just two weeks ago the launch of Watson Health. It was a good start to the year. Looking forward, we’ll continue to deliver strong growth in our strategic imperatives, while the transitions in some of our businesses continue. We’ll continue to expand our margin as we shift to higher value, and we’ll continue a high level of investment, shifting to areas where we see the best opportunity. We’re deploying capital through different models, organic R&D, capital expenditures, and acquisitions. And we’re building partnerships and ecosystems, not only with the big household names, but with hundreds of smaller firms. This leverages our mutual strengths and expands our reach, all at a high level of return. And of course we’ll continue to return value to shareholders through both share repurchase and dividends. For the full year, we continue to expect to deliver Operating EPS of $15.75 to $16.50. And at that level of profit, we continue to expect free cash flow to be flat for the year. With these dynamics and level of performance, we’ll exit 2015 a higher-value business. Now Patricia and I will 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 refrain from multi-part questions. Operator, can you please open it up for questions.

Thank you. [Operator Instructions] Our first question comes from Toni Sacconaghi with Bernstein.

Yes. Thank you. Martin, I was wondering if could comment more broadly about progress in the transformation. Because if I kind of look at this very narrow-mindedly, hardware grew enormously. And if I take out hardware, the rest of the company grew at minus 2 which is what you've been doing the last couple of quarters. And you commented that your strategic imperatives had actually accelerated in growth. So if we takeout hardware and the strategic imperatives are actually growing faster than before, doesn’t that suggest the core businesses outside of hardware and the strategic initiatives are actually getting worse. And when we look at the gross margin profile of services and software which are 90% plus of your business, they actually got notably worse year-over-year even adjusting for the restructuring. So I would like to just maybe push back a little bit on -- beyond what we saw in hardware which I think is probably cyclical, what is the progress in the transformation. And should we be thinking more like 30% growth rate in the strategic initiatives and that's sustainable on what drives it or perhaps you can just help us think through that.

Sure. Sure, Toni. Thanks for the question. Well, there is lot in that question. So, I will -- I will try to address it at a high level. First, in terms of the strategic imperatives continuing 30%, we are not thinking that this is a 30% strategic imperative growth every quarter now for the rest of the year as you know. And as we've talked about in Investor Day, they’ve been on a very steady 19%-20% growth rate year-to-year. Now they are a pretty substantial part of our business now and we view that 30% growth -- part of its driven obviously by the mainframe and power cycle. And we are thinking now when we look at the rest of the year that we are kind of accounting on a continued 19% to 20% growth. So our guidance is not requiring 30% growth. In fact, we expect it to kind of return to what we've seen, still very strong growth, still ahead of the marketplace and still contributing a fair bit of growth to IBM. But think of it as more of a 20% growth. With the quarter, as we talked about on the call -- on the prepared remarks, outside the strategic imperatives we've been talking about that business in kind of a high single digit decline similar to the market that it sits in and we kind of saw that again in the first quarter. So the revenue dynamics in the first quarter were really a reflective of that acceleration, not a change in the core underneath that. Couple of other points, I think that you are ready to. One, progress in the transformation, I think the transformation that is underway in the marketplace and is underway in our investment levels, is underway in our focus, continues at not only a very rapid pace, but a pace necessary for us to continue to lead in enterprise IT. So by this time last year we had created the Watson unit. We had identified a pretty substantial SoftLayer expansion plan that we rolled out throughout the year. As a couple of examples, by this time this year, as you saw early in January we reformulated some of our business units to more directly engaged with clients the way they consume. So we have IBM Analytics, we have IBM Commerce. We have IBM security as examples. And so we got that done. You saw earlier and I noted this in my prepared remarks we created an Internet of Things group which will build off of what we've done in Smarter Planet and Smarter Cities. Just recently we've created now the IBM Healthcare unit which will build off a couple of acquisitions as well as partnerships with some leading names in that space. So the transformation continues at a very rapid pace. It continues a pace, again, necessary for us to maintaining our leadership in enterprise IT. But we are not building guidance around, again, that strategic imperative revenue continuing to growth at 30%. We are still thinking and kind of relying on that 20% growth rate that we've been able to deliver the last five years.

Thanks Toni. Let’s go to the next question please Dory.

Thank you. Our next question comes from Tien-Tsin Huang with J.P. Morgan. Tien-Tsin Huang: Hey, thanks. Just want to ask on the services side, how that came in both in revenue and margin versus plan. Seem like with mostly done with the heavy workforce rebalancing, heard little bit about China make shifting way from the lower margins from GTS being little bit weak. But seems like we could assume certainly better performance starting in 2Q, can you maybe expand on that Martin?

Sure, Tien-Tsin. Thanks. So a couple of things. One, we did see a deceleration in GTS in the first quarter in Global Technology Services. But keep in mind that when we had these pretty substantial transactions and new relationships that we signed last year. Those will only move into the run phase over the next few quarters, primarily in the second half. So we would expect those to contribute bit more or something in fact, they didn’t contribute anything in the first quarter. But they will start to contribute in the Global Technology Services. Margins within Global Technology Services will continue to reflect the currency environment we’re in as well as the investments we are making in order to grow out our SoftLayer platform and to shift the business to these new higher areas. As you noted on our prepared remarks we talked about shifting away from lower margin offering in some of our site facilities business and redeploying that and that will continue. So from a Global Technology Services perspective between the currency environment that we are in and the shift we are making, and the investments we are making, we are not relying on dramatic growth or margin improvement in GTS in our guidance. On GBS, we've got some very strong results, continued strong results in Japan and in Europe. And we continue to shift that business as well into these new areas where we are comfortable that the margin profile there will be consistent with our guidance also, so two different stories between GTS and GBS within our guidance. We are not relying on dramatic growth here. But we will see some improved performance coming out of the backlog because of the big deals we signed last year.

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

Thank you. Our next question comes from David Grossman with Stifel Financial.

Thank you. Martin, I wondered if we could just look in little more detail for software business. The compares get much easier in the back half of the year. And based somewhat you are seeing in the business today and if there is no material shifts in the economic backdrop. Would these comps be enough to stabilize the software segment on its own or is it possible that growth could remain negative given all those different things you talked about in the back half of the year even against the negative comps that we see versus last year in the back half of the year?

Sure David. Thanks. So software, as we talked about when we provided guidance initially back in January, we said we still feel this way. The difference in our low end of our guidance and our high end of our guidance really depends on the trajectory of software. What we saw in the first quarter was a one point improvement in the trajectory, not back yet to growth, but a one point improvement in our trajectory. Now that's not all year. We haven’t seen it yet all years. But again, the difference high and low guidance is that trajectory improvement. Assuming we were at the same level, same trajectory we had last year, we said that's kind of the low end of our guidance. We do see an environment where that's kind of the trajectory performance that we can rely on, if you will. We continue to sign ELAs with clients. We signed 200 ELAs again in the first quarter. We continue to have an impact in our growth from the operating system component of software. But we saw pretty good uptake in our as a service offerings which are driving growth of more than 50%. And at the same time our clients with their reduced visibility continue to look for flexibility in our offerings for those who have deployed the most. So software again represents for us the difference between the low end and the high end of our guidance. We saw that one quarter sequential improvement in the first and we see how we go for the rest of the year.

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

Thank you. Our next question comes from Steve Milunovich with UBS.

Thank you. Martin, would you be able to share with us the EPS impact on currency. You gave us revenue, but could you tell us cents per share? And then I was curious on the free cash flow you gave us flat for the year, could you talk a bit about the plus and minus factors that you've got there, CapEx, cash taxes and so forth and how those are going to play out?

Of course. And since currency and free cash flow are so related we will count that as a one part question, Steve.

Thank you.

So, first on currency. We did talk -- as we mentioned in the call, currency was an impact of about eight points on the revenue line. So a bit over a $1.7 billion in terms of translating the first quarter revenue back to dollars and we saw some significant movements not only since January, but also even since we provided an impact on the day of our Investor Day, so a pretty big impact on the revenue line. From a profit perspective, now, this is somewhat of an imprecise calculation, right? It is not knowable. It is unknowable number. We can estimate it. But we think their profit growth was impacted year-to-year by somewhere between $0.15 and $0.20 in the quarter. That's a pretty big impact. So, obviously, that shows up in margin. And that first quarter impact then given where the dollar is now, you could adjust. We are working to try to -- we will obviously have to manage our way through this. But if you just took that $0.15 to $0.20 impact at the high end assuming the rates stay here, you could see an $0.80 year-to-year impact full year on earnings from this, again, without us having done anything. So, obviously, it’s something we are thinking about and working on pretty hard. In terms of free cash flow, we said relatively flat year-to-year in full year. The bridge items are not dissimilar or not going to surprise you. First, we do see cash taxes this year being better year-to-year than they were last year. So that's probably about $2 billion better year-to-year, so that will certainly help. Reducing that on a full year basis though, will be increased CapEx investments which we'll be making. We've talked about that already in January and we mentioned again in Investor Day. We also have while we expect a lower level of workforce rebalancing charges, the timing of those, the cash impact of those is likely to lead to an increase this year relative to last year of about $0.5 billion. And then our performance related cash payments this year for prior year accruals will probably be up $700 million to $800 million as well. So outside of that, our cash performance will look a lot like our income performance which is kind of what you would expect I think.

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

Yes. Thank you. Our next question comes from Bill Shope with Goldman Sachs.

Okay. Thanks. I have a question on the mainframe site. If you are only shipping the new mainframes in the last few weeks of the quarter and you were able to double revenue. Should we assume that we still have some potential for growth to accelerate from here? And then I guess just looking at the cycle overall, can you talk about whether there are any unique financial dynamics for this cycle that we should consider relative to last few cycles. I guess, I'm particularly focused on the dynamics around pricing where it looks like you actually had an ASP tailwind relative to MIPS growth this quarter and also the pull through for as-a-service on this platform. Thanks.

Sure, Bill. Few things on the mainframe. So first, we had a terrific first quarter in the mainframe. But I think it’s important to understand two elements of this, first, this is what we expected our mainframe performance to be. This was not a surprise to us. And so I don’t think that you should take away from either our prepared remarks or even the questions that we think we did better than we would have. We think this was the mainframe performance we expected very clearly. I think that the element for the mainframe, though, that are most widely misunderstood by many who follow us are twofold. One -- and this has to do with the timing of what you’re seeing in the quarter. One, I don’t that mainframe is fully appreciated for the essential nature of the work it does for the impact that our clients feel from an upgraded mainframe and for the kinds of enterprise class saleable workloads that it drives. So we used the example of UPS in the call, 5 billion packages they have to deliver on time and again they can't be down. So, one, I think there is an under appreciation for the mainframe and its value to our clients. Two, I think there is a huge difference, obviously between how consumer technology works and how enterprise technology works. And so when you read that we were shipping the mainframe since March, remember, we've been having the discussions with about 60 of our clients for months and months and months, because they help us build and design this for their needs in those enterprise spaces. But the January announcement is when we start building the value propositions for our clients, and so the work for the sales teams begin in January. The fact that it was only shipped in March really only means that our supply chain, our fulfillment teams did a phenomenal job in a relatively short period of time to get fulfill the demand that we saw within the quarter. But from an enterprise buying cycle, I think, you really do have to understand that these are built our clients. These are -- we discuss the value prop with our clients before that March date, that’s not as critical a date as you might think if -- again, if you are thinking about it from a consumer side. From a first quarter perspective, as I mentioned, we are very pleased with how it did. But it didn’t surprise us. And as we've talked about in the past, the second quarter tends to be the largest quarter for mainframe and we still see that in this quarter as well. So we had very good quarter in the first. We would expect that the mainframe will be the larger in the second than it was in the first. But keep in mind now you will get into compare issues. Right? So from a dollar perspective it will be larger. But we also had a great mainframe quarter second quarter last year. So the growth year-to-year will look a lot different than the first quarter, but the absolute number in the second will be higher. We would expect that in the first half, we'll probably finish at solid 50% growth in the mainframe between the first two quarters, which is very typical, very traditional, in terms of the mainframe. From a margin perspective, as you noted, with MIPS only going up 95%, I say only with a smirk -- with MIPS going of 95% and revenue up 130% on a constant currency basis, yeah, there's obviously a lot of value that our clients see here and a lot of value for the IBM Corporation. So, we are delighted with how well the mainframe did, but it wasn't as apprised was. It's a powerful, powerful platform for the world's business.

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

Yes, thank you. Brian White with Cantor Fitzgerald.

Yeah Martin, I'm wondering if you could talk a little bit about how customers are feeling in the broad IT spending environment. It seems like financials and first quarter were actually very strong and a huge FX impact. So, I'm just curious how customers are feeling and how we should think about general seasonality throughout the year?

For us, Brian, I think couple of things. One, we have not seen a dramatic shift in trajectory across lot of our sectors. Financial services sector is obviously one where the mainframe plays a pretty vital role in how the world banks run and when you get a new mainframe, particularly when so relevant to them shifting their business into mobile, particularly one where counter fraud is such an important part of what they have to think about every day. And again you need scalability, you need reliability. You have to run all the time. That, as a particular, that new mainframe as an emphasis within financial services sec are, and therefore we did see an improvement in the trajectory in financial services. But across the rest, I would say not a dramatic shift in what we saw in the first quarter. Again, the common thread that we're seeing is not a sector-by-sector other than what I pointed out in the financial services. The common thread here is the relevance of our offering in the strategic imperatives where the need for mobility, the need for social ways of engaging either your employee base, your client base and the need for really powerful scalable systems kind of drove the day in the first quarter with 30% growth year-to-year relative to what had been a 20% kind of growing business.

Thanks, Brian. Dory can we take the next question, please?

Thank you. Our next question comes from Keith Bachman with Bank of Montreal.

Hi, Martin, thanks for taking the question. I want to go back to cash flow, if I could. In your past comments, you talked about this year being flat, but previously called out a number of one-time items including pensions. And I was just wondering if you could comment directionally how we should be envisioning cash flow in 2016 relative to 2015. It seems like some of the items should be one-time in nature, but the tax payments, restructuring, et cetera, been both directionally and relative to the percent that you normally provide versus net income.

Sure. A few things, Keith. One, as we said a number of times, cash flow, we expect to be flat in 2015, relative to 2014. And relative to 2014, what we showed in Investor Day were the drivers of our realization and 2014, were really two-fold. One, we had a very high cash tax rate last year relative to net income and as I mentioned in the prior answer, we don't see that same level of headwinds this year. So, on a realization basis, taxes -- cash taxes will not be an impact to 2015. I'll come back to 2016 in a moment. And then all so last year, we had a pretty substantial gain, which obviously showed up as cash in the IBM Corporation, but showed up in the investing line not in the free cash flow line so that drove realization down about 20 points from the -- say if we set ourselves high 90s. So, this year, as I mentioned, we don't the cash taxes as a primary headwind and we do expect to improve realization this year pretty dramatically. I did talk about, a little bit, on a full-year basis about some of the differences in cash flows this year including performance related payments and workforce rebalancing payments and increased CapEx within 2015, but still an improvement in our realization rate in 2015. Now, when we get to 2016, I think a few things happen. One, we again will have, I think, the cash tax headwind. Now this is at a planning level and we're nine months away from the start of the year, which means we're 21 months away from figuring out the settlement of audits and things. So, we've got a long way to go, but right now, we would envision a cash tax headwind again in 2016 that we can see. From a pension perspective, we're kind of -- we're in our pensions by the way. We've been -- we have a closed pension and we've been moving our asset side of our portfolio to more mimics the liability side, which is we've been moving to more debt instruments within that and allocating to more interest rate securities. So, we don't have as much risk in the portfolio and our U.S. pension remains very well-funded and our global pensions are in a pretty good funding position, so we don't see a lot of -- at this point, we don't see a lot of impact from pensions.

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

Thank you. Our next question comes from Sherri Scribner with Deutsche Bank.

Hi. Thanks. Martin, I was hoping you could walk through your expectations for profitability as we move through the year? It looks like from a profitability perspective on a year-over-year basis, services and software declined a bit but hardware was more profitable. Hoping you could walk us through the rest of the year. Thanks.

Sure. Let's -- I'll talk about how we see the rest of the year playing out, first in -- from a full-year perspective and then I'll bring it to the near-term and what we see coming in the second quarter. So, first, as I mentioned earlier, our low end of guidance assumes, essentially, that software doesn't improve for the rest of the year and as we already saw that first quarter was just a bit of head of that, so the high end of guidance assumes – as we see a slight trajectory improvement in our software business right back to essentially flat. In the near-term -- so that's the difference between high and low -- the near-term, from a profitability perspective, we have a fairly typical skew in our pretax profit from first to second quarter. It's fairly typical. Now, as we transform our business, as we continue to make investments, as we continue to see growth in our strategic imperatives business, we will get, as I mentioned another good quarter out of the mainframe. But as we transform that business, I would expect to see a fairly typical skew from first to second quarter on a pretax profit basis. Now, on a year-to-year basis we have dynamics within our workforce rebalancing charges from prior years that drive the growth rates to look at odd. So, with essentially roughly the same level of workforce rebalancing from first quarter to second quarter this year, we take that out of the equation, therefore, on a quarter-to-quarter basis, but the transformation of our business and the cycle we are in the mainframe, I think, probably gets us to a typical -- a more typical, if you will, sequential improvement of about $1 billion of pretax profit quarter-to-quarter. And again, on a full-year basis, we see the difference in the high end and the low end of being that software trajectory.

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

Thank you. Our next question comes from Wamsi Mohan with Bank of America Merrill Lynch.

Yes, thank you. Thanks for taking my question. Martin, could you talk about any changes in IT spending demand trends, especially in regions where there were significant effects, double the factor at all in terms of any deferrals? And can you help us think through how the expense levels will change with FX relative to the revenue levels as we go through the year. This quarter they were in pretty good alignment, but you also saw a pretty strong America's revenue. So, just wondering what the puts and takes there could be.

Yes, I mean I'd say a few things. So, we did not see dramatic -- we didn't see any improvement in, for instance, in Asia-Pacific. So, we continue to see a slow spending environment in AP and I think our performance there mimics what we're seeing in the marketplace in general. Japan, spending continues to go quite well and we continue to perform. But it's more than just the environment in Japan. The team has done a terrific job of maintaining growth now well into their third year and so it’s the strength of our offerings that are underpinned by a reasonable spending environment within Japan. In other places, as we noted on the call, North America, U.S. did quite well and we see a spending environment there that is supportive of the investments we're making in the way we are shifting the business. So, in total, with some exceptions where we see weak spending environment in AP, we see a reasonable environment. Now, from an expense perspective, our focus is obviously on continuing to drive that in those investment levels and as we talked about in the prepared remarks, outside of the translation impact of currency and outside of the divested content, our spending was essentially flat year-to-year. And so on an EDR basis, that was about the same and we will continue to shift within that our spending toward the strategic imperatives. And so, when you look at 30% growth and again, we don't expect it to stay at 30 -- but when you look at 30% growth that supported by a pretty dramatic shift of spending within IBM and at the same time, that funding, that spending is coming from those core businesses. So, some of what you're seeing in that core business decline is that engineered shift toward the strategic imperatives.

Thank you, Wamsi. Dory, let's take one last question, please.

Thank you. Our final question comes from Jim Suva with Citi.

Thank you very much. And if you can focus a little bit on the Services segment. Help us understand kind of what's going on there. It looks like both GBS and GTS profitability is down year-over-year and the signings have a lot of volatility around them. But kind of the rate of $10 billion seems to be a multi-year low. How should we kind of think about what's going on in services, mostly the shift to the strategic imperatives and how should we kind of think about that. Could it be the shift we would expect profitability to actually be up year-over-year, or maybe it's FX? Thank you.

Sure, so a few things. And you're right; FX is obviously playing a role here in how some of those services profits translate back to U.S. dollars. But on a broader context, signings growth in the first quarter, which is there plenty of opportunity out there? There certainly is. We see a lot of opportunity for continued growth in our outsourcing business, double-digit growth, in fact, across all our outsourcing businesses and signings. And the backlog, in total, was essentially flat year-to-year. Obviously, there is a currency impact here on the divestiture impact, but backlog in total was essentially flat. What we see and services is really a couple of things. One, within Global Technology Services, we continue to invest pretty heavily, as I noted earlier, in order to drive that SoftLayer platform, for instance. We continue to invest to build out that infrastructure as-a-Service capability where we're seeing very good growth in our SoftLayer platform and very good growth across cloud. In the GBS business, we're seeing very good performance in Japan. We got a return to growth in Europe, which was quite encouraging and there are some areas of strength in other parts of those emerging market. Latin America did quite well, doing well in the Middle East and Africa. What we are seeing is the slowdown that's driving the revenue line in the U.S. Now, some of that's driven by consulting. But quite frankly, now, we did grow our signings again in the U.S. So, we have -- we're building, if you will, a backlog that will turn into revenue in the future. But right now, we're dealing with the slowdown in our U.S. consulting business. The mix of our business in GBS is pretty consistent around the world. They have a very high mix of the strategic imperatives. And within that mix, the growth is very high. So, we're comfortable that we're making the shift in GBS. We obviously have, as I noted, some work to do in our U.S. business. But we do see good -- some pretty good growth and pretty good performance in other parts of the world in GBS.

So, I wanted to wrap up the call just with a few points. And again, to thank you for joining this afternoon. Our first quarter performance, we view as another proof point that the strategy is right, the actions we're taking to reinvent our businesses, the innovation we're delivering in our hardware business and our software business and in our services businesses, is starting to pay off and the investments and the focus on those solution areas are all contributing to the very strong growth we saw in the strategic imperatives. So, as we move through the year, we'll continue the transformation. We'll continue to make these investments and to build those ecosystems that we talked about. It certainly takes some time. But, certainly this was a very good start to the year. So, thanks for joining.

Dory, can I turn it back to you to close out the call for us?

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