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

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

Thank you for joining us today. Our second quarter and first half results reflect the stability of our overall business model, as we transform the company. Looking at the dynamics of our portfolio, we're continuing to drive double-digit growth in the parts of our business that address the emerging trends in enterprise IT. We had stability in our core franchises, where we continue to drive innovation. We're dealing with secular shifts in parts of our hardware business and as we shift to higher value, we have the impact of a divested business. Overall, our year-to-year revenue performance improved from last quarter at actual rates and was fairly consistent at constant currency. We expanded margins and we grew earnings per share. The profit dynamics also reflect the actions we've taken to transform our business. I'll get into that shortly. In the first quarter, you'll remember that we announced a number of initiatives that support the shift to our strategic areas of data, cloud and systems of engagement. These included the launch of Bluemix, which is our cloud platform-as-a service for the enterprise. It included a $1.2 billion investment to globally expand SoftLayer cloud hubs, and it included a $1 billion investment to bring Watson's cognitive capabilities to the enterprise. In the second quarter, we made progress to implement these initiatives, including in June, Bluemix became generally available. We opened new SoftLayer data centers. We started to ship POWER8, and expanded the OpenPOWER consortium. And we completed substantially all of the divestiture of our customer care business. More recently, we announced additional actions to continue our shift to higher value. You saw last week that we're investing $3 billion over the next five years in research and in early-stage development to create the next generation of chip technologies. Those will fuel the…

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

(Operator Instructions) The first question comes from Bill Shope with Goldman Sachs.

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

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

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

The next question comes from Toni Sacconaghi with Sanford Bernstein.

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

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

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

The next question comes from Katy Huberty with Morgan Stanley.

As a follow-up to last question on the weak Software and signings numbers, did you in fact see deal push-outs in the quarter? And if so what do you think caused that and have you been able to close the business in the third quarter?

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

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

The next question comes from David Grossman with Stifel Nicolaus.

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

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

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

The next question comes from Ben Reitzes with Barclays.

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

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

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

The next question comes from Lou Miscioscia with CLSA.

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

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

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

The next question comes from Steve Milunovich with UBS.

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

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

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

The next question comes from Tien-Tsin Huang with JPMorgan.

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

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

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

The next question comes from Sherri Scribner with Deutsche Bank.

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

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

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

The last question comes from Brian White with Cantor Fitzgerald.

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

We are still focused, as we talked about in the beginning of the year, we are still focused on stabilizing the STG profit base for the year, right, the Systems & Technology Group profit base for the year. And I believe, we are absolutely on track to do that to stabilize that profit base. The impacts against that profit base, when we look last year and what we're trying to stabilize, there are, one, some cyclical issues. We have certainly seen this downturn in the emerging markets, which has an impact on hardware. And we've talked about that on prior calls that the mix of our STG business in the growth markets is higher than other places. And therefore, that emerging market slowdown had a more pronounced effect on STG. And so there is some cyclical issues there. And then we have talked about the mainframe cycle, already a number of times. But in addition to that, we've had this secular issue around Power and trying to reposition that. And we've taken action pretty aggressively to make that platform the most viable for the future, including we just released POWER8, as an example, which is a Power platform built for the world of big data and analytics, and quite frankly, built for the world of cloud. And then we've also had a lot of success with our OpenPOWER initiative, which we've been able to expand again the alliance, being able to expand the alliance of those who will use and build on top of that. So a mix of cyclical and secular within that STG performance, but as I said, as we said at the beginning of the year, and we are confident with the actions we've taken, both address the secular, and also we've taken a fair bit of…

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