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

Katy Huberty - Morgan Stanley Toni Sacconaghi - Bernstein Tien-tsin Huang - JPMorgan Brian White - Drexel Hamilton Steve Milunovich - UBS Keith Bachman - Bank of Montreal David Grossman - Stifel James Schneider - Goldman Sachs Maynard Um - Wells Fargo Amit Daryanani - RBC Capital Markets

Welcome and thank you for standing by. At this time, all participants are in a listen-only mode. After the presentation, there will be a question-and-answer session. [Operator Instructions] Today's conference is being recorded. If you have any objection, 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 want to welcome you to our Third Quarter Earnings Presentation. 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 become reconciled to the related GAAP measures in accordance with SEC rules. You'll find reconciliation charts at the end of the presentation and in the Form 8-K submitted to the SEC. Now, I'll turn the call over to Martin Schroeter.

Thanks, Patricia. For some time, we've been talking about the tremendous changes in our industry as our clients move to new areas, get great in value from their data and IT environments and implement new business models. So as we transform our business, we invest where we see higher value over the longer term. We drive growth in the areas where we're investing, while other areas decline as we shift the business and we expect to expand margins in our move to higher value. This is how we transform from one era to the next. Our third quarter results reflect the progress we're making in that transformation. We continued strong growth in our strategic imperatives. We expanded gross and net margins. We generated substantial free cash flow and we continue to high level of investment while returning value to shareholders. We always said this would play out over time, though this quarter we fell a little short of the revenue expectations we set for ourselves. The GBS transformation is taking longer as the market shifts away from some of the more traditional application areas and our storage disc business was weaker as more of the demand moves to our flash. And while our software performance for the quarter was consistent with what we seen all year we did have some weakness in transactions at the end of the quarter. In addition, our revenue trajectory continues to reflect significant impacts from currency movements in our divested businesses, in fact over 12 points of growth in total. Put it altogether and the progress we're making demonstrates that we're on the right strategy as we help our clients move their businesses to the future. We see a lot of opportunity and with this momentum and strategic imperatives; we're going to continue to invest at a very high level to accelerate the shift in our business. At the same time, we considered the pace of the GBS progress and applied the trajectory and transactions we saw at the end of the quarter to the larger fourth quarter transaction base which reduces our view of the year. Taking all of this into consideration, we believe it is prudent to update our expectations for full year operating earnings per share to $14.75 to $15.75 while our view of free cash flow remains relatively flat year-to-year. I'll come back to this after going through the results of the quarter. Let me start by providing a little more color on the strategic imperatives performance. Our revenue and cloud, analytics, social, mobile and security was up 27% in the third quarter which puts us up over 30% year-to-date. This is without the impact of currency and divestitures and throughout this presentation I'll focus on that view. Our cloud revenue was up over 65% through three quarters with strong year-to-year performance across both our private foundations revenue and our as a service offerings. Over the last 12 months, our cloud revenue was $9.4 billion and we exited the third quarter with an annualize of service run rate of $4.5 billion. Analytics revenue is up nearly 20% year-to-date and in the area of engagement, the revenue from these businesses nearly doubled over last year. Our security business was up 12%, social up about 40%, and our mobile business quadrupled. Looking at the transformation or shift to strategic imperatives from a segment perspective, in Global Technology Services, we're bringing in more cloud, mobility and security to infrastructure services both to new clients and to help existing clients move to the future. Our GTS results reflect growth in revenue and in the backlog. And when you look at high end servers, we've repositioned the portfolio and delivered innovation as these systems run the most contemporary workloads. Throughout this year, we've had strong growth in our Z Systems and continued success in POWER. These are just two examples of what that shift looks like. We're continuing to invest and add capabilities to accelerate this shift. And in the last 90 days, we've committed more capital including the acquisitions of Merge Healthcare to give Watson the ability to see millions of medical images, along with Cleversafe, Compose, Strongloop and Meteorix, each bolstering our cloud capabilities. We also just launched the industry's first consulting practice dedicated to cognitive business. These actions all advance our transformation of the IBM Company. Our approach is to integrate acquired content with our own organic capabilities and leverage partnerships and a broader ecosystem to build new high value platforms like Watson, SoftLayer, Bluemix and OpenPOWER. Last quarter, I talked about the creation of Watson Health which incorporated our Watson capabilities, the acquisitions of Phytel and Explorys, partnerships with leading healthcare companies and creation of a compliant cloud. We've continued to announce new partnerships and new cloud services. The acquisition of Merge Healthcare brings together Watson's advanced analytics and cognitive capabilities with data and images from Merge's medical imaging platform to help doctors make sense of one patient's medical images in the context of the massive related images. We're creating similar platforms for other industries and areas such as internet-of-things. For example, we're working with a major global airline on how to apply cognitive thinking to understand all of the variables impacting fuel demands of any given flight. They're looking a structured and unstructured data, included predicted taxi time, weather conditions, air traffic control delays, and in flight mechanical issues so as to optimize fuel load and we're working with the European Hospitality Company on how to apply cognitive thinking to understand how to maximize revenue from new high-end kiosk-based coffee shops. They are looking at structured data such as frequency and timing of credit card purchases, combined with unstructured data including social chatter on Twitter and real-time weather. They use Watson cognitive APIs to make sense of the data. This requires a platform approach that integrates industry expertise, analytic software, cognitive APIs, cloud, Bluemix, and multiple data streams, very powerful. As I said earlier this is a longer term play. We're creating new platforms and building ecosystems and much of this is an as a service model. We're continuing to invest at a high level as we shift our spending to our strategic imperatives. Let me now turn to the financial metrics for the quarter. Our revenue of $19.3 billion was down 1%, reflecting transition we've been describing. We expanded gross margin, driven by our portfolio actions and the relative strength of Z Systems' revenue, in other words driven by our shift to higher value. As we said last quarter, our PTI trajectory in the third quarter would be similar to the second, reflecting continued high level of investments across the business and currency impacts and our PTI margin was flat year-to-year. Our ongoing effective tax rate remains at 20% while the third quarter rate reflects discrete period items. And so bottom-line, we delivered $3.34 of operating earnings per share. We generated over $2.5 billion of free cash flow in the quarter and over the last 12 months, we've generated $13.6 billion of free cash flow with a realization of GAAP net income over 90%. Over that same period, we reduced our share count by 2% and increased our dividend returning about two-thirds of our free cash flow to shareholders. Now turning to the revenue by geography. Our performance varied across the major markets. Our U.S. revenue was down 4%, a decline in traditional enterprise app implementations is impacting our consulting business and in the month of September, we had a slowdown in our software transactions. That said, we did have another quarter of strong Z Systems performance in the you U.S. By contrast, two of our other largest countries, Japan and Germany posted the strongest growth. In fact this is the 12th consecutive quarter of revenue growth in Japan and this quarter, we had growth across services, software and hardware. We also had improved performance in the U.K., France, and Canada. The growth markets in total were down 3%, a two point sequential improvement from last quarter. From a regional perspective, growth in Latin America and the Middle East and Africa was offset by declines in Asia-Pacific. You'll recall last quarter I talked about the weakness in the BRICs which were down 18%. This quarter the BRICs were down 7% with sequential improvement in the year-to-year performance of all four countries. Brazil was down 4% off a strong double-digit growth last year. Russia was also down at a single-digit rate. China was down 17% with fewer large transactions in the quarter and the bright spot, again, was India which grew for the third consecutive quarter. In fact this quarter, India was up double-digits leveraging growth in the services backlog and an improvement in the hardware business. Turning to the segment perspective, our total revenue was down 1% and gross margin improved 80 basis points. Our Global Technology Services revenue grew and is now up in six of the last seven quarters as we deliver value to new clients and help existing clients move to the future. In Global Business Services, we've been shifting resources and investing to drive growth in the strategic imperatives, the weakness in consulting specifically around enterprise apps is impacting our overall performance. In our Systems business, as I mentioned we had strong performance in our Z Systems and POWER once again grew as we capture both the Unix and Linux opportunity. The hardware decline was driven by storage which continues to be a tough market. Software revenue performance was consistent with what we've seen over the past year, with growth across our solution areas of security, analytics and social, offset by a headwind from operating systems and a decline in transactional revenue. Our total margin improvement continues to be driven by a shift to higher value, primarily through portfolio actions and the relative strength of Z Systems, mitigated by investments and contract mix in our services business. The reported operating expense and other income is down 12%. At this level of spend, our expense to revenue ratio was up 80 basis points. The expense dynamics have been very consistent all year. We're driving significant shifts within our large operational expense base driving productivity and efficiency in some areas while increasing investment in support of our strategic imperatives. You'll recall that at the beginning of the year, we said we would shift an incremental $4 billion of spend across cost, expense, and capital expenditures to our strategic imperatives and we're on track to do that. The reported decline in expense this quarter is again driven by currency and the divestiture of system x. We also had a higher level of workforce rebalancing and lower amount of performance based compensation. Nine points of the decline was driven by currency between the translation of non-dollar spending and hedging gains that are reported in other income and SG&A. Two points of the decline are due to the fact that we no longer have the expense of the system x business in our run rate. We'll wrap on this in the fourth quarter, but recall we did have a gain associated with that transaction in the fourth quarter of last year and in the third quarter, we took a charge for workforce rebalancing with essentially no activity last year this was up nearly $100 million year-to-year contributing two points to expense growth. Now, let's turn to the segments and we'll start with services. Global Technology Services delivered $7.9 billion of revenue which is up 1%. Our outsourcing business is based on long-term partnerships, where our clients entrust us with the most important elements of their business and look to us to deliver innovation to help them transform their enterprises. We've been reinventing our portfolio, providing the most modern IT services that connect our clients to the cloud-based mobile world and it's showing up in the business we're signing. For example, we recently signed a 10-year, $700 million agreement with Abu Dhabi based Etihad Airways to deliver a range of efficient technology allowing the airline and its equity partners to transition their IT infrastructure into a globally integrated hybrid cloud-based platform. Etihad Airways will use IBM's mobile solutions developed under the Apple-IBM alliance to provide enhanced mobile capabilities to its employees and guests. The agreement also includes plans for a new cloud data center in Abu Dhabi as well as a joint technology innovation council to develop more personalized travel solutions. And earlier this month we signed a $1 billion long-term partnership with EVRY, one of the leading IT services companies in the Nordics, using our innovative cloud technology and global scale, we'll provide a foundation for EVRY to build solutions that create business value and business outcomes for their customers. This allows EVRY to accelerate the ongoing transformation of their infrastructure business through access to hybrid cloud solutions, based on our SoftLayer platform. These are examples of clients that chose to partner with IBM because we can move their operations into the future. We take over their IT systems and move them to cloud while insuring integration with their existing infrastructure. We make them more efficient and ultimately drive competitive advantages. Our capabilities and industry expertise give us the ability to address changes in their industry demand and help them compete in markets where data is the new natural resource. Looking at Integrated Technology Service, revenue was up 4% driven by our cloud solutions. SoftLayer grew strong double-digits this quarter as we continue to increase our capacity. In September, we opened our second cloud data center in Brazil which offers a full range of SoftLayer infrastructure services including bare metal and virtual servers, storage, security services, and networking. This past week we just opened a cloud data center in India as we continue to enable local companies to build in-country cloud solutions and we're partnering with NASSCOM to create a platform for thousands of start-ups. Maintenance revenue grew 1% with continued strength in our third-party hardware maintenance offerings which allows clients to leverage our global reach and inventory capabilities. Our GTS margin improved quarter-to-quarter, but is down year-to-year, largely reflecting investments we've been making. We continue to invest to bring the most contemporary offerings that are built with cloud, analytics, mobile, security and cognitive technologies enabling us to transform our clients' enterprises and we're investing to expand our global delivery and increase delivery efficiency through automation. This also requires we continue to rebalance our workforce and we took a charge in the quarter essentially all of which is a year-to-year impact on profit. Finally, currency remains the largest year-to-year impact on profit growth given the strong dollar currency environment. Turning to Global Business Services, revenue of $4.2 billion is down 5%. Outsourcing was up with growth in both process outsourcing and application outsourcing offset by a decline in consulting and systems integration. As we talked about in the past, in the enterprise application space, we are seeing a shift away from traditional large ERP implementation projects to smaller initiatives that are built around cloud, mobility, security and analytics. We're continuing to grow in these high value services, but we're still being impacted by larger contracts that are reaching their maturity. Our decline in consulting and systems integration reflects this shift in market demand. In GBS, we had strong double-digit growth in our strategic imperatives. Cloud and analytic services were both up double-digits this quarter and our mobile practice grew nearly five times. Earlier this month, we launched the industry's first consulting practice dedicated to helping clients realize the transformative value of cognitive business. The new practice draws on the expertise of more than 2,000 consulting professionals who will help our clients leverage cognitive computing to unlock new possibilities for their business. Let me give you an example of where we already have work under way with one retailer. When you look back at history, they've been using data for a long time, but even the best retailers would forecast demand based on what happened in the prior year. They would look at what was sold, what season and at what price. Over time these forecast models became more sophisticated and will include other variables such as location and climate, various market differences. Accuracy improved as more historical data was built up but insight was limited to what was able to be tracked and programmed into their IT systems. This worked in the past, but let's fast forward to today where much of the new data is unstructured and not able to be understood by traditional systems or traditional programming approaches. Companies that can somehow gain insights from this data will have a competitive advantage. Today, we're working with this client to build the cognitive solution that harnesses all this unstructured data. The solution will combine the client’s internal data with all kinds of external real-time data sources such as current weather patterns, local events and social commentary. We are laying the ground work for a Supply Chain that can evaluate the immediate situation, sense anomalies and learn as it goes. This is the potential we’re unlocking with our cognitive capabilities integrating Watson along with the data scientists and industry experts of the GBS cognitive practice. To further add to our GBS capabilities, at the end of September, we announced plans to acquire Meteorix, a premier Workday services partner. This will expand our reach as Meteorix is cultivated deep expertise and best practices for maximizing returns from these cloud-based HR applications. Our profit in GBS was down and reflects the market shift that I talk about earlier. In parts of our portfolio, where the market is declining we're seeing price and profit pressure. We continue to shift away from these areas into our high value services around cloud and engagement, but we need to move faster. Workforce rebalancing charges are up modestly year-to-year as we continue to remix our skills to these strategic imperatives. We also remain focused on our cost competitiveness through alternate labor models and enhancing our global delivery capabilities. To wrap-up on services, we've built capabilities to deliver the most contemporary offerings to our clients that transform their operations and help them become data driven enterprises. You can see that in our consistent revenue growth in GTS and you can see that in our total services backlog which again grew this quarter. Our software revenue of 5.1 billion was down 3% which is in line with the trajectory we've seen all year. When you look under the total, we continue to have a headwind from Operating Systems which were down 7% in the quarter and our other middleware which is also down. Revenue in our key branded middleware which represents about two-thirds of the total was down 1%. We've said in the past that many of our large clients are utilizing the flexibility we've provided in deployment of their software as they build out their environments. This is reflected in our results with growth in our annuity revenue offset by a decline in transactional revenue. As I just mentioned our software revenue trajectory didn't change from the second to the third quarter, but we did have a slowdown in the transactional revenue at the end of the quarter, predominantly in the U.S. This quarter we again had growth across the solution areas including security, analytics and social and within that, we saw strong growth in our software as a service offerings. Security software grew to double digit rate. Our security solutions are built on the platform of intelligence, integration, and expertise which in the world of connected devises and an era of hybrid cloud is a key differentiation we bring to the marketplace. Our solutions are based on platforms, leveraging hybrid environments with an industry dimension. I'll give you an update on two of our platforms, Watson and Bluemix. Last quarter, I talked about how we're building an ecosystem around Watson. Today, I want to focus on how far along we've come on another dimension when Watson played jeopardy in 2011, Watson just did one service, question-and-answer, underpinned by five technologies like machine learning and natural language processing. Today we have more than 25 different services or APIs, underpinned by more than 50 different technologies like dialogue framing, knowledge validation, voice synthesis, language modeling and visual analysis. As I discussed earlier, we're also bringing an industry dimension to the Watson platform starting with Watson Health. I'll comment also on progress in our Bluemix platform as a service. The addition of strong loop helps developers connect enterprise apps to mobile IOT and web applications in the Cloud and compose expands Cloud Data Service. Our Bluemix platform now offers over 130 IBM and third-party services. Security, reliability, and scalability are important in this hybrid environment and to address this, starting this month, Bluemix is now also available on premise behind our customer's firewall. Clients are taking advantage of our hybrid capabilities, connecting new Cloud and mobile apps to their existing IT infrastructures. This year we've added more than a thousand new customers on our systems middleware like WebSphere which is a reflection of the continued need for clients to support hybrid IT environments. When you look at our profit performance and software it's driven by the overall revenue trajectory and higher level of investments in areas like Watson and Bluemix and an impact from currency translation. Turning to our systems hardware segment, revenue of 1.5 billion was down 2% driven by decline in storage. This quarter, z Systems revenue was up 20% since the launch of z13 in the first quarter we've delivered growth of over 40%. Building on the success of Linux on z Systems in the third quarter we introduced the Linux 1 family of products which embraces open source based technologies that are the industry’s most powerful and secure enterprise servers designed for the Hybrid Cloud environment. These innovations continue to resonate with our customers and we continue to add new customers to the platform across several different industries and countries including Japan, Australia, Singapore, Germany and the U.S. As we contemporize the platform many of our customers select Linux based z Systems not only to consolidate existing systems to Linux on z to drive operational efficiency, but also to leverage scalability and security that these systems offer. Power revenue grew 2% which is the third consecutive quarter of growth for the platform. This reflects the kind of revenue performance we would expect from power in a product cycle year. We saw growth in both entry level and the high end systems including strong growth and continued customer adoption in Linux based systems. Our open power initiative continues to progress as we both integrate innovation from the broader ecosystem into our own products and license IP to support third-party power based offerings. The announcement of our LC line of power based Linux servers and recent collaboration agreement with GENCI, the high performance computing agency in France and our third such large high performance computing national partnership are two examples of how we're bringing innovation from open power partnerships to IBM zone offerings. These power results continue to reflect the progress we're making to transform the platform to align around data and cloud while embracing an open ecosystem. The growth in our high end servers was more than offset by a double-digit decline in storage hardware driven by weakness in the high end disc and tape. This market is shifting rapidly to flash where we again had very strong growth. When we set out this year, we saw leverage in the business through the z Systems and power platforms. Our results confirm the progress we've made in the first three quarters and our profit is up 600 million compared to the first three quarters of last year. Moving on to cash flow. We generated 3.5 billion of cash from operations excluding our global financing receivables. We invested another 900 million in CapEx with a good portion of our spend to build our cloud capacity. And so we generated 2.6 billion of free cash flow which is up 400 million year-to-year. Through the first three quarters of the year, our free cash flow of 7 billion is up over a billion dollars year-to-year. The primary drivers are lower tax payments and continued improvements in our sales cycle working capital. This was mitigated by the remaining working capital impact to cash flow from our System x divestiture payments for performance based comp which were accrued last year and year-to-year profit performance. Looking at uses of cash, we spent over 800 million on acquisitions. We've acquired seven companies this year including two in the third quarter which further extend our cloud capabilities and industry expertise. In addition, merge closed last week and we expect Cleversafe to close by the end of the year, so the spend will be included in our fourth quarter results. In the last nine months, we've returned $7.5 billion to shareholders with dividends of 3.6 billion and 3.8 billion in gross share repurchases to buyback over 24 million shares. Our share count at the end of September was 970 million shares and we had $2.4 billion remaining in our buyback authorization. Turning to the balance sheet, we ended the quarter with a cash balance of $9.6 billion up over a $1 billion from December and flat year-to-year. Total debt was 39.7 billion of which 26 billion was in support of our financing business. The leverage in our financing business remains at 7 to 1. Our non-financing debt of 13.7 billion is 3.4 billion lower than a year ago. Our non-financing debt-to-cap was 58%, a point lower than December and the 3.5 points lower than last year. At these levels, we continue to have the financial flexibility to support our business over the long term. So now let me wrap up. When you look at our results through the first three quarters of this year, we've expanded margins on a fairly stable revenue base, while we're reinventing our business. We've maintained high levels of investment as we shift our spending to our strategic imperatives. We're creating new platforms and are building ecosystems including Watson, Watson Health, SoftLayer and Bluemix. And we've been getting returns on our investments, with growth in the strategic imperatives over 30%. At the same time, the core is declining in a declining market as we deliver productivity to our clients so they can reinvest in the new areas. We've always said this takes time. Especially because much of the new content is delivered as a service and our progression wouldn't be a straight line, but our execution over the sustained period is a proof point that we're on the right path. So let me come back to our view of the full year. When we look at the transformation we're driving we've made a lot of progress but the GBS transformation is taking longer which is putting some pressure on revenue and profit. And we had a weaker transaction performance at the end of the quarter, which one applied to the larger transaction base in the fourth quarter as a more significant impact. At the same time, we're going to continue to put a lot of investment into these strategic imperatives where we see tremendous opportunity to accelerate the transformation. Taking all of this into consideration, we've updated our view of the year to $14.75 to $15.75. Let me put the low end in perspective. 14.75 not only reflect our transaction trajectory at end of the quarter, but is also in line with the typical third quarter to fourth quarter skew. So we're comfortable at that 14.75 level. The change in our view of profit has less impact on free cash flow for the year as most of the transactions would occur late in the quarter anyway and so we still expect free cash flow to be roughly flat for the year. Let me close with what remains constant. We certainly expect to continue strong growth in our strategic imperatives. We will continue to invest at a high level to drive our transformation while returning value to shareholders and importantly we're continuing to manage the business for the long term. Now Patricia and I will take your questions.

Thank you, Martin. Before we begin the Q&A, I’d like to mention the 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 question. Chris, can you please open it up for questions?

[Operator Instructions] The first question comes from Katy Huberty with Morgan Stanley. You may ask your question.

Yes, thanks good afternoon. You mentioned that the weaker transaction trajectory going into the fourth quarter would not have a meaningful impact on free cash flow this year due to the late timing of those deals, but does that have a negative influence on 2016 and I appreciate it's too early to give guidance, but what are some of the high level gives and takes on free cash flows as you go into next year? Thanks.

Sure, thanks, Katy. A few things. As we noted, in the call because of the late nature we don't expect it to have a profound impact in 2015. Now we'll see obviously we have a range in our guidance as you know so we'll see where we finish and if we were to start at a lower point in terms of transactional content coming out of 2015 then there would be an early year impact I would call it but at this point, as you said it's a bit early to call guidance and then we've got 12 months next year to figure out what the macro environment and what the sales cycle looks like, so it is too early to decide if that has a meaningful impact on next year. And as we go into next year, then we also have a tax impact potentially next year, we're working through cash taxes now so there may be a small cash tax impacted if not the same magnitude as it was in 2014, but there may be a small cash tax impact. And then we have some things that are going our way. We've been quite efficient at improving our sales cycle working capital this year again and we think there's some momentum there. We also will wrap on the divestiture of our System x business in the first half of next year which was a headwind in this year’s cash flow. So there are a few headwinds and tailwinds which we'll be able to better describe as we get into next year but it's too early to declare that this particular element is going to be an impact next year.

Thanks, Katie. Chris, can we take the next question please?

The next question comes from Toni Sacconaghi with Bernstein. You may ask your question.

Yes, thank you. It sounds like the message that you're providing to investors is the strategy of moving to higher value is correct and that it will take time going forward. That said, it feels like you have been surprised or the results would suggest that you've been surprised at the pace at which this stabilization and migration in the business is taking. You've guided down four out of the last five quarters and against an easier comp the last two quarters, your revenue has gotten fractionally weaker. So I wanted to get your perspective on what has really been different from your forecast and as we look forward, if I just think about 2016, you have currency hedges rolling off, you have very tough mainframe and you power comps because of the product cycles this year, your backlog is down $10 billion in nominal terms which is what you have to deal with for next year. And you've stated that you're going to continue to aggressively invest and so to the timing point I guess, should we be thinking that things actually continue to get worse in the near-term before they get better and I guess the question would be why not and what if any changes are you making?

Okay, well we've -- I think I've gotten all of the questions in so let me try to address them, Toni because there's a lot in there and let me try to address them kind of piece-by-piece. So, we put our guidance in place for 2015 back in January and we said that the trajectory -- the difference between the high and the low was primarily the software trajectory and as we talked about in our prepared remarks and we came out of third we've given the trajectory we would have said we're pointed right at that 15.75 level, but we did observe some longer sales cycle-times particularly in software which we think it's prudent to reflect that experience in our updated guidance, along with what we put in our prepared remarks around transitioning our GBS business into these new areas. By the way, that transformation which I would characterize is well under way is going well. It's just not going at the speed we'd like it to go. So, we know we have to drive that a bit harder. When we get to next year, a few comments I think that's important and you brought up currency and I think currency is an important discussion, so we have -- in the third quarter results, we have a pretty substantial headwind from -- in the revenue line and quite a substantial EPS impact in currency in the third quarter. And in fact, when we look at the fourth, there is still a significant impact in the fourth quarter in currency. So, if we look at the high end and the low end of our guidance and just in the context of currency, at the low end of guidance, EPS at this level would be down 11% and at the high end it's down about 3%. The currency impact within that in the low end is about half of the year and I'm going to put that now in context of next year because I think it's important. At the low end of guidance, we would actually be growing EPS and that is as we transform the business and we've ramped up our investment. So, yes, currency is clearly an impact. We don't know when the currency environment will be different. But as we head into next year, what's really important from a currency impact, yes, there will at least at this point based on where the spots are today, there will be an additional impact because we will wrap on hedges, but importantly, we are not losing competitiveness in the marketplace because of currency. We have a global delivery platform that allows us to make sure we can be competitive in our services business and we have a high margin strategy which allows us to make sure we can be competitive in local marketplaces for our hardware and software. Now that translation impact or the effect of having that high value and being able to maintain your competitiveness is this issue around how it translates back to profit. And as I mentioned earlier, the impact this year is pretty profound and I would expect that we'll have a currency impact next year that we'll start to talk about when we see where the spots are in January when we provide guidance. So, in the context of -- again ex-currency or ex-currency, ex-divestitures, revenues down about one for the year so far we'll see where we finish fourth quarter, margins have been expanding and again we'll see where we are for the -- in the fourth, but I would expect margins will expand for the full year and with a currency kind of defining anywhere from half to more than the year-to-year EPS decline, then I think this transformation is making very solid progress and as you said yes, the investments we're making are driving that strategic imperative growth and we're pleased with those results and it's the right thing for us to do to keep these investment levels high.

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

The next question comes from Tien-tsin Huang with JPMorgan. You may ask your question. Tien-tsin Huang: Hi, thanks. Just want to build on Toni's question within GBS and consulting and systems integration. I know that took a step back, I heard the transitioning is slower than you expected, but should we expect this to get worse before it gets better? What are you making in the fourth quarter? I know you've been doing a lot of hiring and workforce rebalancing and it's a people business, just trying to get a sense of where we are in that transition.

Sure, Tien-tsin. So, it is -- as you said, it is a labor-based business and it's important that everyone I think recognize that in the labor-based business particularly when you have the kind of deep client relationships and you're doing the important kind of work that our clients rely on us it's a business that takes time to shift. So, when we look at that GBS business today, there is absolutely a high value strategy for this business and when we look at the strategic in imperatives and we look at the margins we're getting on that part of the business in GBS, they are actually higher than the average GBS business and as you know, we announced the creation of the first Cognitive Consulting Group for the enterprise and that's another example of us moving where we see tremendous amount of value, so we will transition this business. I don't know that I'd characterize where in the process we are. I can say that within our guidance, at the low end, we've not assumed a dramatic improvement and at the high end, we would assume that we make a bit more progress, but we aren't counting or relying on dramatic improvement in the GBS business at this level of guidance. But again, it is a business that where we get to the other side and we do see high value. It is has a lot of appeal and quite frankly it's what part of what differentiates us in the marketplace. We bring a lot of industry skill into our clients' environments and that's done through GBS, so we're going to keep driving that transformation, we're going to keep remixing those skills, we’re going to keep that team focused on moving where the high value is and again, Cognitive like I said is a good example of that.

Thanks, Tien-tsin. Can we take the next question, please?

The next question comes from Brian White with Drexel. You may ask your question.

Yeah, Martin, I'm wondering if you could talk a little bit about the trends you're seeing with your top 250 clients in this software business and where that's headed? And also I'm just curious the week is in the transactional business at the end of September; do you think that's more macro or that the industry will see or more IBM-specific? Thanks.

Sure, Brian. Thanks, so a couple things and we've talked for the last year or so about the large client impact if you will within our transactional software business and remember the transactional part of our software business is only about 30% of the total, but it does have a profound impact on the trajectory of that business. And in the third quarter as you saw, we printed down three for the segment, we were down three in the second, so no real change to the trajectory and that's the way I'd characterize also that large client activity. No dramatic change in trajectory between second and third quarter and the phenomenon continues. We continue to provide our clients with flexibility for them to deploy the broadest possible part of the IBM portfolio and I think that's the right thing to do. We think that's the right thing to do and we think it's a way to keep our clients moving toward the future of hybrid. Within the month if you will, I think we'll have to see how the quarter plays out, but there are I think two important elements to keep in mind. One, enterprise technology as you know is a very complex area, so our clients are dealing in very complex environments and they're asking us to help them get to hybrid which means we have to embed our as a service content into the structures they already have and that includes not only the technical aspects of that, but there are business aspects to doing that as well and how they can align their consumption patterns to the way we are able to contract with them. So, there's complexity in the environment, that's a technology statement as well as a business statement and unfortunately, I guess the reality is that not every one of those discussions aligns really, really well with a 90-day reporting period. And at the same time, the other thing to keep in mind is that every CIO, every enterprise is dealing with its own environment and it would be too soon to tell how that plays out for the quarter, but I do think there is always a reality that our CIOs and others are dealing with around how they navigate their own circumstances. So, we'll see how the quarter plays out.

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

Next question comes from Steve Milunovich with UBS. You may ask your question.

Thank you. Martin could you break down the 9 billion of cloud revenue a more granular way, how much comes from maybe hardware, software of services what the growth rates of those pieces might be?

Steve, sure. A couple things. So we had very good cloud performance again in our business and now this is up 50% in the third quarter on trajectory to be up more than 60 on a year-to-date basis and when we look at the content that we're signing in the new deals for instance we just announced Etihad Airways, we just -- we saw that the elements of those, the things that Etihad is looking for us to do is to bring them into the cloud, so a big component of that is that services element moving into the cloud. They are also asking, by the way, to help us build a mobile platform that will scale with them and have the global presence they need and that's not dissimilar to what we're seeing in the Lufthansa contracts and the EVRY contract that we just signed. So, within services we're seeing very good performance, but as you know, not only do we have an as a service business that performed pretty well. We also do a lot of on-prem work where our clients want the agility if you will of the cloud, but their economics suggest that they are better off if they build it themselves. And so we have a pretty big private cloud business and they build those on our hardware and software content. So, clearly there's some element of the premier Z-platform and the power platform that's sitting within that cloud business. But the hardware performance within the overall trajectory is not having a profound impact on the growth rates. It really is the software business and the services business that's driving the bulk of that growth.

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

The next question comes from Keith Bachman with Bank of Montreal. You may ask your question.

Hi. I also wanted to drill down on the software business. It seems like mix is going against you in two ways. First, you have about 34% of your revenue wrapped up in operating systems and other which is in sector of the client and also key brand in middlewear which you said is a little over two-thirds decline this quarter, 1% in constant currency, so I was hoping you could answer two questions. First is as investors think about a decline of 3% in constant currency, is that the right frame of reference that investors should be thinking about as they look at calendar year 2016? And as part of that, the second question would be could you give us an update on where you are in terms of business model? In other words IBM has traditionally been license and maintenance and you talk about moving more to consumption or subscription-based model but I would imagine it's a very small part of your business and probably a headwind as we look out at future revenue growth and a source of deceleration. Could you give us any percentages on where you are in terms of that business mix as it relates to your customers? Thank you.

Sure, so Keith a few things. So, first, we will I think address -- we should address operating systems. Operating systems are about a point headwind to us now and quite frankly, I don't think that point headwind is going to go away in the near-term. In fact we have some of our models suggest it's sort of ever present if you will, so on a segment basis, I think we'll be dealing with a one point headwind from our operating system business. Now, it will round up to a point. Right now it rounds down to a point, so it's a bigger impact now than it will be, but I think that it's safe to model that business as sort of an ongoing headwind. That's a pretty small part of the business by the way. So, if we take that part of the system, of the software out and we just talk about the recurring nature of the software business and as I mentioned earlier on a question about 70%, now that includes the operating system, but 70% of our software business is that annuity kind of structure, so think of it as our SAS portfolio which is showing terrific growth rates, but we've got to drive more content into that SAS platform. Now, that's also by the way newer kind of content for us and so it's a new space and so even though the GP in that area is a little bit lower than what we see in our on-prem business because it's net new content, it's accretive to our margins overall at the IBM level. So we've got a SAS business that sits within that 70%. We have our monthly license charge business which is the bulk of both our mainframe software as well as our distributed platform software. Remember our software runs across all platforms and so we've got a pretty powerful monthly license charge business across our hardware platforms and others hardware platforms that's really driving the bulk of the software revenue. There is a subscription support part of this in the software business as well but you put those all those together again ex Operating Systems because it is a long term headwind we see the rest of those are all growing. That part of the business grows and then in the transactional side as we talked about with Brian a few moments ago, the large client transactional business is being impacted by the consumption if you will and the flexibility we're providing our clients. Outside the large clients on a year-to-date basis the transactional business is also growing. It's just that it's kind of overshadowed at this point by the larger transactional business, so as we move into 16’, similar to the prior discussions on 16’, we're a bit early to talk about where we are going to be here but our software business I guess what we do know about the software business is one, small headwind from the Operating Systems. We know that our SAS portfolio will both continue to grow and continue to expand so that will be a positive and we know that we've got some momentum in other parts of the business across our MLC space and across on a year-to-date base -- again getting our software into smaller clients. Clients who haven't absorbed it all I should say, and so I think again we'll see where we go into 2016 but this is not a business that has the characteristics of some long secular decline in it. It is actually made up of a few piece only one of which I think has a long term secular decline and that's a small part it's that Operating System piece.

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

The next question comes from David Grossman with Stifel. You may ask your question.

Excuse me. Thank you. I'm just wondering, Martin, I haven't gone through this technology transition and the corresponding impact on your growth rate. Are you or is the Company thinking any differently about the scale of the overall business and the need to have as far reaching of a business as you historically have?

You know, it's a good question, David, and it is one that we think about not from the perspective of size or scale because as you know, we're not trying to be the largest of something. What we are though is trying to be the highest value, so as we move to value, that has, that plays a large influence in how we think about deploying capital and where we think about putting our dollars to work and so at this point, when we look at our businesses and the way they work together and I would argue that the world is moving more toward bringing solutions together in front of a client. The world is working moving more toward having industry expertise that can apply across a pretty broad platform. We see each of the elements that we have today bringing or adding to that context and so even in businesses where we know we're in transition like our storage business, you know, we said as we said in the prepared remarks our demand is moving to our flash products which is terrific, the right thing to do for our clients and our business is moving to the software side of storage. That's high value and at the same time, while our acquisition of Cleversafe is really about the cloud, it will also help dramatically our storage business as we put objects storage technologies into our storage business, so that makes that part of the business relevant to the way the world's going in cloud. The future in storage is flash. It's software and it's cloud capable if you will which means object store so what I didn't say in there was we want to be the biggest in storage for instance because we're again on a high value model and you can look across our business and across our segments and we do have that perspective of where we do we think the value is going to be, not is so much of what's going to be the biggest element of that.

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

The next question comes from James Schneider with Goldman Sachs. You may ask your question.

Good afternoon. Thanks for taking my question. Martin I was wondering if you could address the trends within the consulting and systems integration part of GBS this quarter down 7% versus prior quarter down four. How much of that worsening in the rate of growth is down for pricing versus just macro weakness and what are the prospects of that improving at any point in the future, can you see a point at which that could possibly get out of this negative mid-single digits rate that we're at now and what will be the factors that would drive that or is it simply just a function of the secular decline of that ERP slice of business?

So sure, James and welcome to the call. I think you just picked up coverage on us so welcome to the call. On our GBS business as I noted earlier, we do see where we're making the shift to the most contemporary areas, and digitizing for instance our client’s front offices. We're seeing terrific results. Now they are overshadowed at this point by some of the price pressure we're seeing in other areas of the market but it really is on us here to shift those resources as we can free them up from doing the work they are doing for our clients. This is not a business that is in long term secular decline. This is a business that relies on us to drive the shift as quickly as possible and I think when you have a business that is so powerful in our clients with such industry expertise that it gives you two things it gives you the visibility to how powerful that model can be but it also says that it's going to take a little while, so some of this is clearly the pricing environment we're in. I don't think that no there is any reason we shouldn't be able to shift this business and again, the results we see when we do shift are better margins and we see a real ability to influence and to lead our clients into new areas so those are pretty powerful part of our overall model and it is really up to us to keep driving that transformation but it's a big labor based business so it's going to take some time.

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

The next question comes from Maynard Um with Wells Fargo. You may ask your question.

Hi, thank you. Can you just talk a little bit about the pressures driving the declines in the storage? You talked about that little bit but maybe be a little bit more specific in terms of what you're seeing in terms of the competitive landscape and what I guess if you can sort of clearly layout your strategy to stabilize or turn that around? Thanks.

Sure thanks, Maynard. So on storage I think this is the most we've talked about storage by the way on this call in over a year but I'm glad because this is an important part of the business and we see a lot of opportunity in storage. The storage environment and the pricing environment that we were noting in terms of pressure is really in that high end spinning disc environment, so I don't see that changing dramatically given the industry landscape. In fact our view has been continues to be that the faster we can move to flash and the faster we can continue to build out our high value software defined storage platforms, and we've had some pretty exciting announcements this year as you know, the sooner we'll see a return to growth in storage. Now as I noted the storage market is being, is part of the cloud and part of the future of cloud but it’s got to be around objects store because that plays such a critical role in the kinds of use cases that clouds are using, so we'll take as I mentioned the Cleversafe technologies and embed it within our storage, so when we look at the future of the storage business we see terrific growth in flash up again more than 50% in each of the last three quarters, so all this year. We introduced as I mentioned spectrum software which is around our software storage product and we’ve also announced intentions to continue to invest and to drive our investment where we're seeing those returns and those look quite positive and then as I mentioned the other part of our strategy here is to be I have a more cloud-based offering and that means hybrid and that for us means Cleversafe and embedding our objects store so a lot of price pressure and the spinning disc business but there is a future in storage and it's all about flash. It's all about software defined and it's all about object store.

Thanks, Maynard. Chris, why don't we take one last question?

The last question comes from Amit Daryanani with RBC Capital Markets. You may ask your question.

Thanks, for squeezing me in guys: Martin, I just want to understand are you talking about a weaker transactional business especially at the September quarter and as you go into the next few quarters your mainframe cycle starts to get fairly difficult, I mean do you envision a scenario where assuming FX and macro static you could see some of the revenue stability it of growth in the next quarter?

Well I think I heard the question. You cut out at the end but I'll answer what I think you asked so first of all, boy, I'd love to assume a static currency environment. I'd be thrilled and we know that's not true so we'll be facing a currency headwind over at least the next nine or 10 months but that wasn't your question. Your question was around how do we wrap and what do we look like, how do we wrap on the mainframe and what do we look like when we come out of the next few quarters and I think a few things we'll have to see how the year plays out in terms of what eventuates from this weaker transactional performance we saw right at the end of the quarter. It's too soon at this point to determine if this is something that's going to persist all the way through the fourth or it's going to persist into the first we don't know. That's why we gave a range by the way because as we head into the fourth quarter which is as you know our largest transactional quarter, that phenomenon against the much larger transactional quarter says that it's prudent to guide the way we did. Now we will wrap on a mainframe cycle at some point, but the mainframe cycle is not going to have a profound impact on the overall IBM. It does have obviously it does provide a good bit of revenue tailwind when we're in that cycle but remember that the margins start to expand in the mainframe business as we get toward the later parts of the cycle, so we'll see how we put together 2016 based on how we come out of this year but our guidance right now reflects at the low end a slowdown if you will in the revenue trajectory on a year-to-year basis and the high end reflects a slight improvement so in the trajectory so again, too soon to tell how this plays out for next year.

Let me make a few final comments to wrap up the call. So as we've been talking about on these calls frequently, we are going through a significant transformation and where we've been investing we've been driving tremendous growth and that obviously gives us tremendous confidence that the strategy is right. The offerings we're delivering into that marketplace are right on and resonating with customers and we're seeing returns. Now as everyone knows, some of the investments we're making have much longer tails, so we're investing heavily in Watson. We're investing heavily in Watson Health. Those returns aren't even in our revenue streams yet but they are the right things to do because those have tremendous futures to them. Within the current transformation though we're also improving margins as we continue to manage the portfolio and we're expanding margins on what year-to-date has been a fairly stable revenue base and that also includes some pretty aggressive investments that we think is important to drive and as I mentioned we're seeing results so we want to keep driving those investments but we also did say from the beginning of this that it would take time and we also said that we're going to manage for the long term and we're confident in our strategy and confident we're on track to get to the long term trajectory. So thanks again for joining us today.

Okay, Chris I'll turn it back to you to close out the call.

Thank you. This concludes today’s conference. Thank you for your participation. You may disconnect at this time.