Patricia Murphy - VP, Investor Relations Martin Schroeter - SVP and Chief Financial Officer

Katy Huberty - Morgan Stanley Toni Sacconaghi - Sanford C. Bernstein Tien-tsin Huang - JPMorgan Joseph Foresi - Cantor Fitzgerald Steven Milunovich - UBS Brian White - Drexel Hamilton Wamsi Mohan - Bank of America Merrill Lynch James Schneider - Goldman Sachs David Grossman - Stifel Nicolaus

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

Thank you. This is Patricia Murphy, Vice President 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 second quarter earnings presentation. The prepared remarks will be available within a couple of hours and a replay of the webcast will be posted by this time tomorrow. I’ll remind you that certain comments made in this presentation may be characterized as forward-looking under the Private Securities Litigation Reform Act of 1995. Those statements involve a number of factors that could cause actual results to differ materially. Additional information concerning these factors is contained in the company’s filings with the SEC. Copies are available from the SEC, from the IBM website, or from us in Investor Relations. Our presentation also includes certain non-GAAP financial measures in an effort to provide additional information to investors. All non-GAAP measures have been reconciled to their related GAAP measures in accordance with SEC rules. You’ll find reconciliation charts at the end of the presentation and in the Form 8-K submitted to the SEC. So with that, I’ll turn the call to Martin Schroeter.

Thanks, Patricia. In the second quarter, we generated $20.2 billion in revenue, $3.5 billion in pre-tax income and $2.95 of operating earnings per share. Ninety days ago, we told you what we expected for the second quarter. We said we’d continue to see strength in the strategic imperatives and we delivered 12% revenue growth led by cloud. We said we’d continue to build as-a-service capabilities. Our cloud-as-a-service revenue was up 50% and we exited the quarter with an annual run rate of $6.7 billion in our cloud-as-a-service businesses. That’s up from $5.4 billion last quarter. Certainly we have a benefit from the acquisitions recently closed but we has solid organic growth as well. We said we’d continue a high level of investment as we move into new areas and build new markets, and we did that both organically and through acquisitions. And we said that, given seasonality and actions we took in the first quarter, we’d grow our pre-tax income by about $2 billion quarter to quarter, and we grew a bit more than that. In total, we got done what we set out to do and we saw some improvements in trajectory relative to long-term trends, though, as always, the rate and pace varied by business unit and geography. Let me touch quickly on some of the drivers for the quarter. As I said, we continued to deliver double-digit revenue growth in our strategic imperatives. Over the last 12 months, strategic imperatives delivered $31 billion in revenue, and now represent 38% of IBM. Growth was led by cloud, where our revenue was up 30% to $3.4 billion in the quarter, and over $11.5 billion over the last year so good progress in cloud. Looking at revenue from a segment perspective, the strongest growth came from cognitive solutions led by our analytics and cognitive capabilities and security. In technology services and cloud platforms, our infrastructure services revenue continues to grow while integration software declined as we shift those offerings to cloud. And our GTS backlog grew on the back of strong signings. Our systems business again reflects the product cycle dynamics in terms of revenue and margin. And Global Business Services continues to reflect a shift in our business. We’re continuing to deliver double-digit growth in the strategic areas led by mobile and cloud and our application management business is stable though pressure in the more traditional areas of consulting and some inconsistency in our execution continue to impact the GBS results. As we shift IBM’s business overall, it’s important to understand that we’re not only moving them to new spaces but in fact creating entirely new markets. So as I said, we’re investing at a high level both by growing organic investment in areas like our Watson platform capabilities and our cloud data center capacity and getting acquisitions into our run rate. Our investments together with currency, product cycle dynamics, and the actions we took in the first quarter are reflected in our profit performance in the first half of this year. I’ll talk about how the second half plays out relative to the first later in the call as we continue to expect to deliver at least 13.50 of operating earnings per share for the year. Let me spend a minute on what we’ve got done as we move into new areas and become a cognitive solutions and cloud platform company. Clients are looking to become digital businesses and our cognitive solutions bring together digital business with digital intelligence to improve decision-making and add intelligence into all products and processes. For example, companies such as Kimberly-Clark, the ISS group, and sesame workshop announced in the second quarter they are working with IBM on innovative Internet of Things solutions for everything from facilities management to early childhood education. Healthcare organizations such as the U.K.’s National Health Service, the U.S. Department of Veterans Affairs, and the American Diabetes Association were among many in the quarter that announced they are leveraging Watson to create new approaches to treatment and patient care. And in the second quarter, we announced Watson for cyber security, a new cloud based version of our cognitive technology trained on the language of security. What these innovative client initiatives have in common is that they are industry-based cognitive solutions enabled by the IBM cloud and all of this is supporting the movement of our clients to hybrid environments. This quarter, we extended our cloud innovations available on Bluemix including the first Apache Spark development environment for data scientists to more quickly and easily analyze big data. We delivered new IoT services using Bluemix OpenWhisk, our event driven programming model to speed development of IoT applications on the IBM cloud. We announced block chain agreements with banks such as Mizuho and Crédit Mutuel Arkéa and we opened a Bluemix garage in New York City to help financial services clients rapidly design, build, and pilot their own block chain solutions as well as other emerging fintech applications and services. We leveraged recent acquisitions in Clearleap, Cleversafe and Ustream to announce new Video-on-Demand services deals with major brands such as Mazda, the Canadian Broadcasting Corporation and Comic-Con. We also continue to partner with major IT industry players, leveraging IBM’s unique hybrid platform to grow and extend their own offerings and client migrations. For example, we announced that IBM cloud would be a strategic partner of Box Zones in Europe and Asia. Box Zones and the IBM cloud will uniquely enable clients to store and manage data across hybrid environments in the country of their choice and we expanded our global partnership with VMware to deliver desktop services in a security-rich environment on the IBM cloud. We also announced a breakthrough in making quantum computing available on the IBM cloud. The IBM Quantum Experience is a great example of how cloud is making emerging technologies available that wouldn’t have been accessible in the past. This kind of open innovation will allow for the next stage of development in quantum information technology and help push a universal quantum computer to reality even faster. Now Quantum isn’t a new idea. Researchers have been working on it for a long time. But it’s a not niche either. On the day we announced it, it generated 138 million Twitter impressions and to give you a sense of that level of interest, it’s fewer than Andy Murray when he won Wimbledon. But it’s more than the impressions generated by Phil Mickelson’s record tying score in the first round of the Open last Thursday. Since the launch in May, we already have active users in nearly 150 countries that have run more than 175,000 experiments through the IBM Quantum Experience. As we move into new areas, we’re also continuing to deliver innovation in the core. For example, in Infrastructure Services, we’re shifting from being a systems integrator to a services integrator, connecting and streamlining multiple environments and delivering as-a-service solutions to our clients. You see this in our recent engagements with Pratt & Whitney and Emirates. To help systems innovation, this quarter we acquired EZSource to help developers quickly and easily update mainframe applications. And in software we entered into an agreement with a strategic partner to license the intellectual property of some of our assets within our core software portfolio to accelerate product innovation and extend the capabilities to hybrid cloud. I’ll expand on some of these solutions and go into more detail on our strategic imperatives performance in the segment discussions. But first let me walk through our financial metrics for the quarter. Our revenue for the quarter was $20.2 billion. While there was a lot of movement in individual currencies in total, currency translation had a 20 basis point impact to revenue growth. I’ll talk to our performance at constant currency. Our revenue is down 2.5%, and on a geographic basis Americas was down 2%. This was an improvement from last quarter’s rate across the U.S., Canada and Latin America. Europe was weaker, due primarily to Germany and Switzerland. And Asia Pacific was down about 2%. And with strong growth in India once again, and sequential improvement in all of the BRIC countries, the BRIC’s returned to growth. Our gross margin performance reflects higher levels of investment, especially in cognitive solutions and the fact that we’re building scale in our as-a-service businesses. Looking at expense on a year-to-year basis, there are a few items to note. First is an increase in investment levels. We also have a higher level of IP income this quarter due primarily to the licensing partnership I just mentioned. And while not an impact to this year, we did have work force rebalancing charges last year as well as some gains that mitigated those charges. And finally, we have a year-to-year impact from currency as last year’s hedging gains roll off. In fact, at a PTI level, when you consider both the hedge and the translation impact, currency impacted profit growth by about $250 million. Our tax rate for the quarter was 19% all in, at the higher end of the range we provided at the beginning of the year, which you will remember was 18% plus or minus a couple of points without discrete items. From a cash perspective we generated over $2 billion of free cash flow in the quarter and more than $13 billion over the last 12 months. This is over 100% of our GAAP net income, and over the same period we returned about 70% of our free cash flow to shareholders through dividends and gross share purchases. As we get into the segments, remember our strategy and point of view is that to be successful you need to bring together cognitive solutions to improve decision-making and outcomes, to approach that with an industry context and skills, and to enable that in a hybrid environment to get the agility of the cloud while leveraging the breadth of an enterprise data and processes. Now I’ll talk about how each of our segments plays a critical role in how we capture these opportunities. Starting with our Cognitive Solutions segment where revenue growth accelerated to 4% in the second quarter. We had sequential improvement in both solutions software and transaction processing software. Our solutions software revenue was up 6% for the quarter. Our strong performance in SAS continued with double-digit growth in revenue. Growth was led by analytics and security, and acquisitions clearly provided lift. Our Analytics business is the largest portion of the solutions software portfolio. Analytics grew in key areas including Cognos, information integration and big data, and of course Watson as we add to our capabilities. The Weather Company acquisition is off to a good start as we integrate it with Watson Technology. In June, we introduced Watson Adds [ph], leveraging the weather platform, which delivers as many as 26 billion forecasts daily. Consumers will be able to interact with IBM Watson through advertising, by asking questions and receiving relevant product information. Campbell, Unilever and GSK Consumer Healthcare will be the first marketers to collaborate with The Weather Company on Watson Adds [ph]. Security had strong revenue growth and together with our Security Services we outpaced the market by 3X. Our momentum is driven by our unique market position. We have built an extensive security portfolio tailored to the needs of our clients for integrated security across their entire operations. As a result, we’re the number one enterprise security software and services provider and hold a leadership position in 12 of the 14 segments according to Forrester, IDC and Gartner. This quarter we closed our Resilient acquisition, adding leading incident response technology and expertise to our portfolio. We had strong demand for our Guardian offerings as we saw clients moving to our database security offerings across a range of industries including Information Services and banking. And in May we announced Watson for cyber security, a new cognitive system we have been training and will make available in a beta program later this year for use by our customers. As part of this announcement, eight leading universities will also train Watson in the language of security. We’re growing and broadening the reach of Watson with new capabilities, partnerships, and engagements to accelerate adoption. Clients across industries are expanding their Watson engagements, moving from pilot use cases in consulting engagements into long-term production. As an example, in the second quarter, design software leader Autodesk signed a multi-year production SAS agreement with Watson to leverage Watson Engagement Advisor. This engagement builds on the value and strong usage proven during the pilot to resolve customer inquiries. This is one demonstration of our focus on the core conversational service for client applications and the developer community. We also introduced new offerings such as Watson Company Analyzer, which helps companies reduce the time and effort required to collect, digest, and synthesize information for building strategic business relationships and understanding competitive market spaces. And in Watson Health, we continue to capitalize on our differentiated ability to understand, reason, and learn with industry specialization. We launched Watson Care Manager, which provides structured programs and tools to support care coordinators in delivering care to patients. This offering enables patients to avoid rehospitalization. In the second quarter, we extended partnerships with the American Cancer Society and the American Diabetes Association, which are examples of the strong support and momentum Watson Health has with leading clinical and research communities. And at the White House Cancer Moon Shot Summit, we made a commitment to utilize our cognitive solutions to help doctors offer personalized care to 10,000 veterans fighting cancer. We’re working with Teva, a large pharmaceuticals client to improve drug efficacy for millions of patients with complex and chronic diseases by leveraging the IBM Watson Health cloud solution. We formed a medical imaging collaborative with 15 industry leaders to put Watson to work extracting insights from invisible unstructured imaging data. And in April, we closed the Truven acquisition. The data and insights from Truven will be integrated into our Watson Health cloud. So now looking at the profit results for the segment. Gross margin was down largely driven by mix shift to SAS and higher investments including acquisition content. Pre-tax income performance continues to reflect our higher level of investment and strategic growth areas like Watson platform, Health, and IoT again this quarter. Global Business Services delivered $4.3 billion of revenue. Our performance was similar to recent quarters with continued growth in our strategic imperatives, offset by declines in the more traditional consulting areas. We saw double digit growth in our digital practices around cloud, analytics, mobility, security, and cognitive. And we continue to aggressively shift resources and investments to drive these businesses. Our GBS team leads the industry mission for IBM as we have amassed over 100,000 industry resources. Our consultants build strategies that help our clients gain new insights on data and launch new business models for competitive advantage. We’re scaling the industry’s first cognitive consulting practice which draws on the expertise of more than 2,000 consulting professionals spanning machine learning, advanced analytics, data science, and development. We continue to ramp the IBM interactive experience. We have opened over 30 digital studios around the globe including new studios in Singapore and Seoul. We also completed the acquisition of Aperto, a digital agency in Berlin with over 300 employees and a roster of enterprise clients such as Airbus and Siemens. We’re shifting away from traditional on premise ERP to cloud-based application management and consulting. We closed on the acquisition of Bluewolf this quarter, a top sales force partner and recognized leader in cloud consulting and implementation services. We’re also growing our services on workday applications, leveraging the skills we brought on through our Meteorix acquisition last year. Overall, we delivered 60% growth in our cloud practice this quarter. Application Management remains stable as clients look to us to manage the lifecycle of their applications, and bring new applications to market faster through digital cloud platforms. Turning to profit. GBS gross profit and PTI margins were down year-to-year. These margin declines reflect the investments we’re making in our digital practices as well as some issues in our execution. And in some of the traditional service areas that are not as differentiated, we’re seeing price and profit pressure. We continue to invest and shift resources to our higher value services around digital and cognitive. We’re also taking actions to improve our delivery efficiency and execution while remaining focused on our commitment to our clients’ success. Technology services and cloud platforms delivered nearly $9 billion of revenue with growth in infrastructure services offset by declines in technical support services and integration software. Across the segment, our strategic imperatives were also up strong double digits. We had strong signings performance in GTS and the backlog for the segment continued to grow. We saw continued momentum in infrastructure services as clients turned to us to optimize their IT environments and move them to cloud. We again had strong growth in the IBM cloud. Our point of view is that clients can unlock the most value for their businesses by moving to hybrid cloud infrastructures which provide agility and enable new business models while at the same time tie back to their core systems of record. We always said that hybrid capabilities are critical for an enterprise grade cloud and we continue to lead in a rapidly growing hybrid cloud market. We’re shifting from systems integration to services integration as we connect multiple environments and build out hybrid infrastructures, delivered as a service to the client. Our as-a-service revenue for the segment was up over 50% for the quarter. We continue to sign transformative agreements with clients to optimize their infrastructure and help digitize their operations. At Pratt & Whitney, we’ll move their business, manufacturing, and engineering enterprise systems to a fully managed environment on the IBM cloud. They’re expecting to double their engine production by 2020 and we’ll provide them with the means to manage, analyze, and grow their infrastructure dramatically to accommodate the company’s growth. And this quarter, we signed a seven-year $1.3 billion agreement with CSC to expand our cloud partnership and build a secure scaleable and flexible mainframe infrastructure that will enable CSC to economically scale up and down demand to address current and future client needs and reduce its capital outlays. This builds on announcement earlier this year that integrated Bluemix into their cloud management platform. Bluemix provides our clients with speed and agility in launching new business models and applications in the cloud. And along with the rest of the integration software portfolio, it’s at the heart of our hybrid cloud strategy. Overall, integration software revenue declined. From a product perspective we had continued strength in our connect products as clients integrate applications, data, and processes for both on-prem and cloud-based acquisitions. Across integration software, our annuity content is growing and we accelerate the shift to an as-of-service consumption model through new cloud capabilities delivered on our Bluemix cloud platform. For example, this year Kaiser Permanente began its move to the IBM cloud and Bluemix as the strategic platform for their transformation to a more agile data driven organization engaging with millions of individual members and patients. This will allow them to take advantage of new technologies, existing data and back end systems in a hybrid model. Turning to profit, our gross profit was down year-to-year driven by the mix of businesses within the segment. Our PTI margin also reflects this business mix impact as well as the investments we’re making to build out our cloud platforms. Additionally, this quarter we entered into an agreement with one of our strategic business partners where we will license the intellectual property of select assets within the integration software portfolio while jointly going to market to ensure our clients’ success. This will shift our spending profile for these assets to a more variable cost structure anything forward. Systems revenue was down consistent with the cycle. Our systems hardware revenue was down 28%. Operating system software revenue was down 4% this quarter, which is a modest sequential improvement in year-to-year performance but as we said, we expect operating systems to continue to be a drag on growth. Revenues for our z Systems declined 40% in the second quarter while margins improved, consistent with where we are in the product cycle. We’re continuing to expand the z client base adding 13 new clients in the quarter and nearly 70 since the beginning of the cycle. We had had our first major z13 win in China this quarter with a large Chinese bank migrating its mainframe install base to our latest technology. We’re continuing to drive innovation in the z Systems platform. As I mentioned earlier, we acquired EZSource, which will help our clients modify applications for their digital transformation while also supporting agility and hybrid cloud. Our revenue was down in the second quarter with growth in the mid-range offset by declines in the high and the low end. The UNIX market is a high value space that’s been declining and we represent the majority of the market. Our performance here reflects the replacement dynamic, following strong performance in the high end of POWER8 in the second quarter of last year. While the midrange has been growing year-to-year, we will see a similar replacement dynamic in the third quarter as we ramp on the midrange POWER8 introduction. We’re also addressing the growing Linux market, and this quarter we grew year to year and quarter to quarter with our Linux on Power strategy. It is becoming a more meaningful part of our business with over 10% of our POWER revenue in the second quarter. We have seen particular success with Hanna [ph], a play that we started a year ago. We will expand the Linux-only portfolio by leveraging OpenPOWER, we plan to bring two new servers supporting cloud-enabled big data and cognitive applications to our portfolio and release our second generation HPC [ph] server with POWER8 processors connected to an Nvidia GPU acceleration. Turning to Storage, as we said in the past, storage value is shifting to software, which is reported in our Cognitive Solutions segment. In Storage Software, we’re continuing to grow software-defined storage, which includes object storage and our newly introduced Spectrum suite offerings. Storage hardware revenue decreased 13%, which continues to reflect weakness in the traditional disc storage market. We released the new all flash DSAK [ph] storage offering during the second quarter, giving us competitive differentiation with plans to deliver all flash offerings across the entire portfolio. Our Systems gross profit and pre-tax income declined, reflecting the revenue performance. Our Systems gross profit margin was flat with margin improvements in both z Systems and POWER, offset by lower storage margins and the impact of mix. So now after going through the segments, I want to address the performance of software across our segments. Our total software revenue was up 1%, driven by an acceleration in the annuity content. Subscription and support revenue was up reflecting increased deployment by our clients and steady renewal rates. And the investments in new areas are paying off with growth in SAS. Acquisitions contributed to that growth, and we also grew our annuity base on an organic basis. I will remind you that while the SAS acquisitions add to the top line, they’re a drag to profit in the first year. Looking at the annuity growth by business area, we had strong growth in cognitive solutions as well as integration software, while the annuity content in operating systems declined. Turning to cash flow in the balance sheet, we generated $3.1 billion of cash from operations excluding our financing receivables. After a billion investment in CapEx, we generated $2.1 billion of free cash flow in the quarter. For the first half, free cash flow of nearly $4.5 billion is essentially flat year to year, with lower cash taxes offsetting the year-to-year operational performance. These first half results support our expectation that we will deliver the high end of the full-year free cash flow guidance range we provided earlier this year. This takes into account the cash payments related to the work force rebalancing charge taken earlier in the year as well as the timing of tax payments in the second half. Looking at the uses of cash in the first half, we have invested $5.4 billion in acquisitions. So far this year, we have acquired 11 businesses, including Truven Health Analytics and the digital assets of The Weather Company. In the last six months we have returned $4.4 billion to shareholders, including $2.6 billion in dividends. In April, we again raised our dividend, and with that we’ve now doubled our dividend per share since 2010. In the first half, we bought back over 12 million shares and we ended June with 956 million shares outstanding and 3.9 billion remaining in our buyback authorization. Moving to the balance sheet, we ended June with $10.6 billion in cash. Our total debt was about $44.5 billion of which $26.5 billion was in support of our Financing business. The leverage in our Financing business remains at seven-to-one, and the portfolio remains strong at 52% investment grade. You can see more on this topic in our supplemental material in the backup. Our non-financing debt was 18 billion, and our non-financing debt-to-cap was 59%. The increase in both reflect the timing of our debt issuances relative to maturities this year. Our balance sheet continues to have the financial flexibility to support our business over the long-term. So now let me wrap up and talk about our view of the second half and put it in context of the first half performance. We thought we’d lay it out on a slide for you. You’ll recall in the first quarter we took significant actions to transform our workforce and change the way we work, resulting in significant workforce rebalancing and real estate charges. As we said, this is about rebalancing skills more than capacity reduction, and so these actions free up spend that can be reinvested to build capabilities as well as contributing to the bottom line. We’ve started to see some savings already, but the majority of the growth savings we’ll see in 2016 will come in the fourth quarter. We mapped all of that out in our last call, and we’re right on track. As expected, our mainframe product cycle also had an impact to our EPS growth in the first half. As we enter the second half, our mainframe compares will get easier. In fact, we expect mainframe to be fairly neutral to EPS growth. Over the last 12 months, we have been investing at a high level both organically and through acquisitions, as we build cognitive and cloud capabilities. The organic investments had a mid-single digit impact on our EPS growth. As we wrap on the higher level of spend in the back half of last year, this will have less of an impact on EPS growth over the next two quarters. We’ve completed 20 acquisitions over the last year. The acquired content is contributing to our top line and will continue to do so in the second half because these are primarily as-a-service capabilities and require additional investment as we create new spaces, they have a return profile with a longer payback. The acquisitions we’ve completed to date had a low-single digit impact to our EPS growth rate in the first half. They’ll continue to be dilutive in the second half, though at a lower level. Many of these new capabilities are delivered as a service. As these ramp, it’ll benefit our second half relative to the first, not only from a software mix perspective, but adding scale will also help our margins. And of course, we’ve talked about the impact of currency on our profit growth in 2016, due primarily to the roll-off of last year’s hedging gains. We can’t predict where currently will go from here, but at current spot rates the impact from currency will moderate in the second half due to year-to-year hedging dynamics and a slightly better translational environment. And finally, you’ll recall we had a significant discrete tax benefit in the first quarter. Relative to the ongoing effective tax rate, we continue to expect to be in the range we provided at the beginning of the year. Put it all together, and we expect our second half EPS dynamics to be significantly improved over the first and continue to expect to deliver at least $13.50 of operating EPS for the year. So with that financial context to our second half from a business perspective, we’ll continue to focus on using cognitive to help clients get value from their data, to improve decision-making and outcomes, moving our clients to hybrid cloud environments and with a strong industry dimension. As we do that, we’re moving into new spaces and, in some cases, creating entirely new markets. We’ll continue to shift our business toward our strategic imperatives, with strong growth in our as-a-service offerings and continued growth in software. And we’ll continue to invest to add capabilities and to deliver innovation across the business, all while returning value to shareholders. And so with that, we’ll take your questions.

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

Thank you. At this time, we will begin the question-and-answer session of the conference. [Operator Instructions] Our first question comes from Katy Huberty with Morgan Stanley. You may ask your question.

Thanks. Good afternoon. You didn’t mention the UK in your commentary around EMEA. How did the headlines around Brexit impact the month of June? And did it have any impact on not raising the full-year outlook despite beats in the first and second quarter? Thank you.

Sure, Katie. Thank you. So we certainly – I don’t think that Brexit coming at the end of the quarter helped us at all, but we obviously finished kind of right where we expected to finish. And when we look at our full view of the year, we don’t see an impact, if you will, that has any real materiality on us. And that’s why we continue to hold our operating EPS. So it certainly didn’t help but, again, no – nothing that said we should change our operating EPS for the year. What I typically observe in these kinds of instances is that our discussions with our clients have to go through a process of reprioritization, if you will. And remember, the extent of the discussions we have with our clients is about their most important processes. So as they reprioritize, the length of time that takes depends a lot on how much uncertainty they’re faced with. And obviously, the political leadership in Europe and the UK can help reduce that uncertainty, but we didn’t see – again, we don’t think it helped but it didn’t cause us to change our guidance.

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

Thank you. Our next question comes from Toni Sacconaghi with Bernstein.

Yes. Thank you. Martin, I estimate that software acquisitions helped about $350 million to $400 million in terms of the revenue impact year-over-year. And if that’s the case, then company revenues declined about 4% or a bit more and software revenues declined about 5% or a bit more. I was hoping you could clarify if those numbers are correct, because if they are, it actually suggests that both company revenue and software revenue decelerated from Q1 even though the compare was actually a bit easier. So I was wondering if you could address this notion of what appeared to be some deceleration in the business on an organic basis.

Sure, Tony. A couple of things. First, the acquisitions are part of IBM, so when you say company revenue, I think of the total as kind of company revenue. Within the total, as we’ve talked about, we did at Investor Day and I think this is generally true, given the volume of acquisitions we do, we generally over the long term see about a point help. And as I said in my prepared remarks, we got about twice that. We got about two points of help in total. Now, that’s not all software obviously. Also as you know, we’ve been acquiring some businesses for our GBS business. So on an acquisitive impact across IBM, it was about two points. What we saw in software in the second quarter, I would describe the dynamic as very similar to what we’ve seen over the past few quarters, which is we – in our largest clients, we see continued deployment, and therefore we continue to grow the annuity base in those large clients. And outside those large clients we continue to see growth in total. And then, again, the transactional business, which tends to have an out-sized impact in the second and the fourth quarter because of our mix of revenue – of transactional versus annuity also plays into this when you start looking at it sequentially because they’re not fully comparable, if you will. The mix is a bit different. So acquisitions clearly a benefit to us. About two points, as I said, in total, a mix of software and services. And a set of software dynamics underneath that that suggest to us continued deployment, continued growth in the annuity base, and still some transactional growth pressure, if you will, in some of our largest clients. A – Patricia Murphy: Thanks, Tony. Rowena [ph], can we please take the next question?

Thank you. Our next question comes from Tien-tsin Huang with JPMC. You may ask your question. Tien-tsin Huang: Great. Thank you. Good afternoon. Just on the services side, I saw that signings were up nicely. Anything unusual there? And can we see an eventual pull-through there with consulting maybe following behind it? And, Martin, you did mention some inconsistency on execution I think a couple times. Can you elaborate on that? Thanks.

Sure, Tien-tsin. Thanks. So we did have pretty good signings, and that signings kept the backlog in total flat year to year. What we’re seeing in the marketplace, if I start to disaggregate between GTS and GBS for a moment, we continue to see very strong growth in GTS. You saw that in the signings numbers and you see that in the growing backlog. And that profile, if you will, of what we’re working on for our clients is very consistent with what we’ve talked about in the past, which is our clients are looking to move to hybrid clouds. Our clients are looking for us to help them develop and deploy and run some of the latest technologies such as mobile. So that trend continues. The size of those deals continues to be quite substantial. Not every deal is a big deal, but we haven’t seen any reduction certainly in deal sizes. In fact, we’ve had some of the biggest deals – some of the volume of biggest deals that we’ve seen over the past few years continue in the GTS business. And when we look forward at that GTS relationship, if you will, in over the last, call it, 10 quarters, over two and a half years or so, we’ve had pretty good consistent book-to-bill greater than one. So the booking rates, as you know, are the signings we report. And then on the billing side, in GPS you have our maintenance business as well. And so obviously that doesn’t go into the bookings side of the equation. So you’ve got to do the math right but book-to-bill in GTS has been over the last 10 quarters very consistent. Again, reflects, I think, the strong value we bring to clients. On the consulting side in GBS, we did have a good signings quarter. There is plenty of business out there and we see good uptake of our most advanced offerings, if you will, those that help digitize our clients. We continue to pull back on that enterprise kind of wide application installation. When we say pull back, by the way, that means we’re moving resource and we moved again more than a third of our resource out of that part of the business. So it’s not a surprise that that part of the business is declining. So the consulting opportunity is certainly there. When we talk about execution, when I talk about execution issues, I guess the way I’d say it is, look, we – we take on our industry skills, take on some pretty complex projects for our clients, and sometimes we have to spend a bit more money than we would have thought in order to make it all working properly and making sure our clients are satisfied. So that’s on us. That’s on execution. The teams, you know, they’ll work through these things but I wouldn’t call it – I wouldn’t call it widespread. A – Patricia Murphy: Thanks, Tien-tsin. Can we go to the next question, please?

Thank you. Our next question comes from Brad Apelo [ph] with JMP Securities. You may ask your question. Q – Unidentified Analyst: Great. Thank you very much. Martin, one quick question I wanted to ask about the EPS trajectory in the second half. And I know you reiterated at least 13.50 in EPS. But in light of the macro headlines, I was wondering if you’re thinking about weighing Q3 and Q4 any differently in the second half of the year. Thanks. A – Martin Schroeter: Thanks, Greg. Sure. So we included a pretty detailed chart, I think, on some of the first half to second half trajectory changes. And I think the one point to make kind of across the board on that chart is that everything there, it gets either the same or better in the fourth. And so when we look at all of the impacts as an example, you know, we’ve got the chart that shows as-a-service scale helping and a chart that shows the actions we took in the first quarter helping in the second quarter. All of those have a bigger impact in the fourth than they do in the third. And the rest do as well, but those are just, again, two examples. So I guess the way I think about third versus fourth in a total perspective, you know, in total third quarter for us tends to be in a fairly tight range. You know, our annuity business plays a bigger role in our overall revenue streams than our transactional business does in the third. So in that EPS range in the third, we have typically been kind of 22% to 24% of the full year. And, you know, when we look at that with the momentum we have on the things that are on that chart, I’d say that we’re more in the middle to the high end of that range in the third and then, you know, the rest obviously in the fourth. So while, you know, those statistics are good indicators in total when we’re going through a transformation like this, you know, at the margin again in the third, we’d say kind of mid to high end of the historical range for third quarter EPS.

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

Thank you. Our next question comes from Joseph Foresi with Cantor Fitzgerald. You may ask your question.

Hi. I wanted to build on the margin question. I was wondering how should we think about the impact of the margin profile, the strategic imperatives through the transformation over the long term? Do you think we’re through the heavy CapEx there and, you know, will the exit of this year and the margin profile there be a good proxy for 2017? Thanks.

Sure, Joe. A couple of things on margins. First, we have talked a bit about what drives margin in the IBM financial model at length, and as you’ll remember, we talked about mix of our business. We’ve talked about productivity in our services business. We’ve talked about portfolio actions. And then this year we started talking about kind of as-a-service based on scale and you can see three of those four elements in our more detailed list of what changes first half to second half. The ones that’s not there obviously is portfolio actions because we don’t have any, you know, we don’t have any big divestitures planned here that are going to drive portfolio. In fact, the way I’d say it is when we look at the portfolio, we think each of the elements can drive value for our clients, and we still see high value in the elements. Part of the way we get comfortable with each of those elements driving value is when we look at the margins on the strategic imperative content relative to the rest, the margins on the strategic imperatives content has been and second quarter again higher than what we see on the core business. So I interpret that as, you know, the places we’re moving to, the places we’re building value for our clients looks like a pretty high value marketplace, and we’ll continue – it’s one that’s worth us continuing to serve. So we think, you know, we build on margin with three of those four components that we typically have from an as-of-service perspective I don’t think we’re through the capital requirements by any stretch. We’ll continue to shift our capital to the cloud business to make sure that we have got the right scale that we need for our model. So we’re not through it, but again I don’t think IBM is becoming more capital intensive overall. A lot of times it’s just a shift from one to another. And then obviously we’ll keep investing in the capital we need to drive our acquisitions as we integrate those as well. A – Patricia Murphy: Thank you, Joe. Rowena, can we please take the next question?

Yes, ma’am. Thank you. Our next question comes from Steve Milunovich with UBS. You may ask your question.

Great. Thank you. The strategic imperative revenue growth, I think it’s slowing. I think it was 17% year-over-year last quarter, 12% this quarter. Analytics is a big piece of that. I think that went from 9% to 5%. Could you talk about what kind of growth you see going forward as these numbers get bigger? And conversely what was the decline in the core franchise revenue? And what’s been the trend there the last few quarters? Thanks.

Sure. Thanks, Steve. On the core, if you will, everything outside the strategic revenue – everything outside the strategic imperatives, that’s kind of been flattish. Right. It’s been flat quarter-to-quarter I should say. It’s down but it’s kind of flat quarter-to-quarter. So in change in trajectory on that part of the business. In the strategic imperatives, you know, when we started talking about this a year and a half ago at our Investor Day, and we put on the table at the time that that business would grow to $40 billion or 40% of our revenue by, you know, at the end of 2018. We think, and we draw that plum line, we think we’re, you know, I’d say probably a little bit ahead of the track that we need to get there. We’re certainly ahead on the percentage mix because 38% of our business is already there, and we only got – we got 2.5 years to go from a timing perspective. So we’re on track to the $40 billion because with $31 billion now trailing 12 months, we actually don’t even have to grow at this rate to get over the line. Now, you know, the acquisitions will play a role in this, and we see continued momentum here. But we don’t even have to grow at this rate in order to get where we set out to get a year and a half ago.

Thank you, Steve. Can we please take the next question?

Yes. Thank you. Our next question comes from Brian White with Drexel. You may ask your question. Q – Brian White: Yeah. Martin, on the cloud business, so cloud it looks like grew 30% year-over-year. Has the cloud business reached the bottom in the margin profile and is on an upward trajectory? Or do we still have a little bit more of a decline? And if you can just put us – give us some type of an idea where are you in cloud margins versus where you hope to be optimally in, say, four or five years? Thank you. A – Martin Schroeter: Sure, Brian. So two things. Remember, you know, our cloud business, we’re really – if I had to oversimplify it, we have – we have part of our business helping our clients build their own clouds. And that includes hardware, it includes software, it has some services as well. And when we do that with our clients, the margins we see in those businesses are exactly what we kind of see in the rest. That’s kind of the demand profile of where some of that business is going. The margins don’t look any different from that perspective. To the extent the mix is different between how much hardware and how much software and how much services go in, there may be a different margin on the solution. But as I mentioned in total, our strategic imperatives are mixing a bit richer and so we’re seeing better margins in total across the imperatives. So that’s the – that’s the kind of help our clients build their own cloud. On the ads of service side of this, I think that as we put on the chart, you know, the ads of service component even though we’re going to continue to drive a fair bit of investment here, the as of service component will start to add – be accretive to our margins on a year-over-year basis starting in the second half already. Now, we’ll see where the marketplace goes and we’ll see where how much we rely on getting or keeping, if you will, that margin growth as opposed to reinvesting. But we see, again, on a big part of some of that cloud business, we see margins that are consistent with what we see in other parts, and the as of service business we start to see year-over-year accretion in the margins from that, even though again, we’ll continue to invest quite heavily.

Thank you, Brian. Rowena, can we please take the next question.

Yes, ma’am. Thank you. Our next question comes from Wamsi Mohan with Bank of America. You may ask our question.

Yes, thank you. Martin, for overall IBM strategic imperatives grew 38% of revenues, but in GBS strategic imperatives is already over 50% of segment revenue. But yet overall GBS revenue was down 3%. So I think there’s a notion of people expecting aggregate IBM to eventually get to growth as you see strategic imperative mix increase over time, but I was wondering if you can comment more specifically with respect to GBS. What some of the offsets were on that revenue line? I think execution you were alluding to margins, but more specifically on the revenue line, which caused deceleration? What would imply strong deceleration in the core on GBS?

Yeah. Thanks, Wamsi. And that’s right. We did see some pretty strong deceleration or declines in the core of that. And as I said, we’re continuing to shift our skills and our resources out of that part of the marketplace. So in a business which if you oversimplified it is really about how do – how do industry experts charge or bill for their time, your billing is going to be limited or constrained by how much resource you have applied to it. That won’t surprise you. And then as I mentioned, we moved about 35% of our resource applied to those core parts of the business over into the strategic imperatives. So that has two effects: One, it obviously reduces the ability of us to grow revenue in those places when you constrain the resource; and, two, because the productivity is not a one-for-one, you know, someone who – someone who is billing on an implementation in an enterprise resource kind of an application doesn’t immediately become a cognitive expert or doesn’t immediately become a mobile expert. So there is a productivity impact, and what we give up, while we give up 100% let’s say of that billing capability, we don’t get 100% back right away. And that’s really what you’re seeing in our Consulting business. In GBS outside of the Consulting, the Application Management, the Global Process Services businesses, they’re fairly stable within the overall GBS equation. But the Consulting business continues to go through this transition as we pull resources off and we put them into and devote the resource or the investments if you will to the strategic imperative areas.

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

Yes. Thank you. Our next question comes from Jim Schneider with Goldman Sachs. You may ask your question.

Good afternoon. Thanks for taking my question. Just a follow-up on the GBS segment, it sounds given what you just said about the continued pricing headwinds that you’re seeing in the traditional ERP implementations, and maybe the execution issues, that that’s going to be persistent headwind even in the back half of the year. So can you maybe give us some kind of commentary around when you would expect at least the impact of the runoff of some of that more commodity-like business to start to let – not be a headwind anymore? And can you see kind of the end of the execution issues in terms of the cost of some of those implementations that might have been overrun?

Sure, Jim. So a couple of things. One, on when do we kind of work our way through this, one thing to look at here is the signings performance in the quarter, and GBS did grow signings in the quarter. Now, there is obviously a lag. It sits in the backlog. And as you saw in our total backlog is flat. I mentioned earlier that GPS [ph] was up in backlog, and obviously therefore the GBS component of that is down a little. So while we are growing signings, which are a pretty good leading indicator of the kind of business, and that’s a function of all the people we have moved into those new areas while we’ve pull back from the others, that total signings equation is now starting to work. We grew signings in total, right? So the new stuff is offsetting if you will the old stuff. But not enough yet to get the backlog back to growth. And we’ve got to get that backlog back to growth in order to have kind of turn the corner for that signings equation, which we got back to growth to get the revenue equation, if you will, back to growth. A – Patricia Murphy: Thanks, Jim. Let’s take one last question.

Thank you. Our last question comes from David Grossman with Stifel. You may ask your question.

Thank you. So, Martin, there are several factors that are impacting the free cash flow conversion this year. Can you help us understand what known factors are out today? Headwinds or tailwinds that we should consider for conversion next year? A – Martin Schroeter: Sure, David. Thanks. So as we said, we reiterated our view of free cash flow at the end of the first. We were comfortable at the time and remain comfortable to be at the high end of what we had originally provided. So within that, realization for us is a pretty good measure of how we’re converting our cash. Our model is to be in the 90s, and I think with kind of the headwinds, tailwinds we see within free cash flow for the year, I’d say we’re probably more likely to wind up in the high 90s in 2016. Now as we get into next year, you know, there’s a lot that we have to get through in order to understand what next year is going to look like. But I am comfortable that while, you know, we’ll finish again probably high 90s this year. I’m comfortable that our model is right even for next year that we’ll be in the 90s again next year when we look at all of the pieces.

So let me conclude the call by reminding everyone that, you know, we’re running our clients’ most critical process, and that puts us into a pretty unique and terrific, quite frankly, position to move them to the future. And it’s not just about the infrastructure, which is obviously important. We’ve always felt that it’s important and we think it’s important today. But it’s also about helping them become digital businesses and helping them inject cognitive into everything they do. It’s what they’re asking for and it’s quite frankly been our perspective on where the world is going. So we’re not only doing that with our existing clients and not only doing that in kind of a traditional IT, but in some cases we’re building entirely new businesses, and entirely new markets. And so that, you know, for many is beyond what some of you would focus on in terms of infrastructure, but it’s becoming a bigger and bigger part of what IBM is becoming, and again it’s our view of where value will be created for clients and for our investors. And so as we make those shifts and as we build these new markets, you know, we take – we take our temperature, if you will, at the end of June and we’d say we’re right on track with what we wanted to get done for the year. So with that, thanks for joining the call

Rowena [ph], let me turn it back to you to close out the call.

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