Patricia Murphy - Vice President, Investor Relations Martin Schroeter - Senior Vice President and CFO.

Katy Huberty - Morgan Stanley Toni Sacconaghi - Bernstein Steve Milunovich - UBS Bill Shope - Goldman Sachs Benjamin Reitzes - Barclays Brian White - Cantor Fitzgerald Tien-Tsin Huang - J.P. Morgan Joseph Foresi - Janney Montgomery Scott David Grossman - Stifel Nicolaus Amit Daryanani - RBC Capital Markets.

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

Thank you. This is Patricia Murphy, Vice President of Investor Relations for IBM. I'm here today with Martin Schroeter, IBM's Senior Vice President and Chief Financial Officer. I want to welcome you to our Fourth 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 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..

Thanks Patricia. Today I will start with a brief overview of our fourth quarter and full year performance, review the details of the quarter and wrap up with a discussion of 2014 and expectations for 2015.

Our strategy is focused on leading in the areas where we see the most value in enterprise IT and in 2014 we made tremendous progress in repositioning the portfolio and making investment to shift into these areas. Our results reflect all of that.

In the fourth quarter, we delivered revenue of $24.1 billion, net income of $5.8 billion, free cash flow of $6.6 billion and operating earnings per share of $5.81.

Our total revenue performance reflects the divestitures of System x and Customer Care, which together had $1.6 billion of revenue in the fourth quarter of 2013 and we had about a $1.2 billion impact from currency movements. So combined, this represents about $2.8 billion of revenue or a 10 point impact to the reported revenue growth rate.

That currency impact was even greater than spot rates suggested 90 days ago, excluding the impact of currency and divestitures, our total revenue was in line with our expectations. We once again had strong performance in our strategic imperatives that address the market shifts in data, cloud and engagement.

Together, they posted double-digit growth as they did in every quarter of 2014. We had solid improvement in gross and pretax margin as we drive our overall business to higher value.

That will certainly continue into this year as we benefit from the recent portfolio actions and we are continuing to shift our investments and resources to our strategic imperatives and solutions that address our clients most critical issues.

Looking at the full year from a financial perspective, we delivered $21 billion of pretax income and operating earnings per share of $16.53. We generated about $12.5 billion of free cash flow, paid out over $4 billion in dividends and reduced our average share count by over 8%, while reducing our core debt by $0.5 billion.

Our strategic imperatives continue to drive strong growth, up 16% in 2014 and that includes an impact from currency. Together, cloud, analytics, mobile, social and security generated $25 billion in revenue, which is 27% of IBM. Analytics was up 7% on a large base and with 60% revenue growth, our cloud business is substantial.

It's now $7 billion in revenue and we exited the year with an annual as a service run rate of $3.5 billion. That's up from $2.2 billion a year ago.

During the year, we once again spent 6% of our revenue in research and development, and invested about $4 billion on capital, supporting actions in a number of areas that will yield financial benefits in future years. Let me mention a few.

We introduced our cloud platform-as-a-service Bluemix and are shifting capital to globally expand our SoftLayer Cloud Data Centers. We're bringing Watson’s capabilities to the enterprise and building a partner ecosystem, effectively creating a market for cognitive computing.

We introduced cloud application innovations around Watson Analytics and Verse. We launched POWER8 and are building the OpenPOWER consortium. We formed a partnership with Apple for enterprise mobility with twitter for big data and with SAP and Tencent for cloud. Clearly, we are the go-to platform for the enterprise.

In 2014, we divested large businesses that no longer fit our strategic profile, System x and customer care BPO and announced the divestiture of our semiconductor manufacturing business. These three businesses drove $7 billion of revenue in 2013 but lost about $0.5 billion of pretax profit.

While we certainly have a smaller business in terms of revenue and of course, the divestitures reduced the number of employees, it is a higher value, higher margin business. Within that, we are continuing to remix our skills and as an example, we had over 45,000 hires in 2014 adding to our capabilities in our strategic areas.

So we got a lot done in 2014 that positions us for the longer term, I will talk more about the full year and what it means for 2015 after going through the details of the quarter. But now let me get into the fourth quarter results. These are all operating results, which are based on continuing operations.

We delivered $5.8 billion of operating net income on revenue of $24.1 billion. Revenue was down 12%, but as I just said, that includes about 10 points of impact from currency and divestitures. So we were down 2% at constant currency excluding the divested businesses.

On net basis, services revenue was flat, our software segment declined 3% and systems and technology revenue was down 12%. We have seen significant strengthening of the dollars since September. Currency impacted our revenue performance by about 4.5 points or $1.2 billion.

This is a 1.5 of growth or $400 million more than anticipated based on spot rates 90 days ago. Our gross margin was up 60 basis points driven by improvements in GBS and a mix away from the low-margin System x business. Pretax margin was up 3 points this quarter.

PTI includes the gain from the sale of System x, which net of related transaction and performance-based costs was $1.1 billion, as well as nearly $600 million of workforce rebalancing charges. We had a substantial tax headwind in the fourth quarter. Last year, our rate included the benefit associated with the settlement of the U.S.

tax audit and as a result, our tax rate is up nearly 10 points over last year. On the bottomline, we reported operating EPS of $5.81. Looking at our free cash flow, we generated $6.6 billion in the quarter, which is more than half of the full year. We ended the year with $8.5 billion of cash on hand.

Now turning to the revenue by geography because of the geography mix of the System x business, the divestiture impacted major markets growth by 4 points and growth markets by 9 points. So I’ll focus on year-to-year performance at constant currency and adjusting for the divested businesses in all periods.

On this basis, both major markets and growth markets were down 2%. Within major markets, we had growth in Japan while North America and Europe declined. Europe’s performance improved from last quarter with improvements in the U.K. and Italy and continued growth in Spain.

Our North America revenue was down driven by declines in global business services, the signings grew for the second consecutive quarter. Our growth markets year-to-year performance improved nearly 2 points from last quarter. This was driven by China which was down 1% this quarter.

The improvement in the year-to-year trajectory was driven by strong software performance and several large mainframe transactions. In fact, four of our five largest banking clients in China added substantial new mainframe capacity.

Overall BRIC performance was consistent with last quarter with the improvement in China offset by weaker performance in Brazil. Turning to the segment perspective, our total services revenue was flat at constant currency, adjusting for the divested businesses.

On that base, GTS was up 2% and we had growth across all business lines, outsourcing, integrated technology services and maintenance. Global Business Services revenue was down with significant growth in the strategic imperatives offset by weakness in some of the more traditional application areas.

In software, we had good growth in key areas like security, cloud and mobile but our software customers continue to utilize the flexibility we’ve provided impacting transaction revenue growth and weakness in operating systems.

System’s performance reflects the end-of-the-product cycle in our System z mainframe, and declines in power and storage though both had modest sequential improvement in year-to-year performance. Our gross profit margin was nearly 54%, that’s up 60 basis points from last year.

We had solid improvement in GBS as we mixed toward the higher-margin strategic imperatives. The GTS margin is relatively flat even with an impact from the divestiture of System x maintenance. Software continued to have a very strong margin at 90%.

And we had significant margin improvement in systems, driven by the divestiture of the lower margin System x business so our focus on moving to higher value spaces is showing up in our gross margin.

The reported total operating expense and other income reflects not only the ongoing run rate of the business but also the impact of the System x divestiture and the charge for workforce rebalancing.

In total, the reported level of expense is down 20% though the entire decline is driven by the combination of the System x gain and the fact that we no longer have the expense for the System x business in our run rate.

Normalizing for the System x divestiture, our expense and other income would have been up about 2% or about 6% adjusted for currency and acquisitions. You'll recall last October I told you that we expected to take a charge for workforce rebalancing in the fourth quarter.

SG&A includes the workforce rebalancing charge of about $580 million, nearly all of which is a year-to-year increase. Within our base expense, we’re continuing to shift resources in spending to areas where we see the most opportunity, including Watson, SoftLayer, BlueMix and in support of our Apple partnership.

Finally, I want to spend a minute on the impact of currency. The dramatic dollar strengthening started in September and has continued at a rapid pace. In addition, the currencies have nearly all moved in an unfavorable direction for our business profile. The result is an impact to our revenue and our earnings.

We hedge a portion of our cross border cash flows, which defers the impact of the currency movement but it doesn't eliminate it. Our hedges are designed to provide the stability around the receipt of cash.

But there is no year-to-year benefit in the income statement when a currency's direction is sustained over a longer period and that’s what we've been dealing with. Looking at the fourth quarter, we estimate the impact to our profit growth was nearly $300 million.

At current spot rates, we would expect a significant impact to revenue and profit in 2015. The chart at the back of our presentation sizes the revenue impact at current spot rates. Now let’s turn to the segments and we'll start with services.

Our total services backlog was $128 billion when adjusted for currency and the customer care and System x divestitures, it was flat year-to-year. This is an improvement from the 2% decline we reported in the third quarter on that same basis.

The sequential backlog improvement was driven by several significant new outsourcing contracts closed in the period. As a result, outsourcing backlog returned to growth and was up 1% at constant currency, adjusted for the customer care divestiture.

The combined services revenue was $13.5 billion dollars, which is flat year-to-year at constant currency adjusting for the divestitures. Revenue for Global Technology Services was $9.2 billion, up 2% at constant currency adjusted for the divestitures.

GTS outsourcing was up 1% at constant currency for the quarter and for the year adjusted for the customer care divestiture. Clients are continuing to sign large outsourcing engagements that leverage our cloud, business analytics and mobile solutions.

Clients are using these outsourcing engagements as ways to optimize their IT infrastructure while at the same time, enabling new services to their customers. Lufthansa and ABN AMRO, both of which were over a $1 billion in contract value are great recent examples of this.

ITS revenue was up 4% at constant currency, driven largely by our high-value security, mobility and resiliency offerings. SoftLayer continues to attract new workloads to the platform. And in October, we announced IBM was selected by SAP to be their global cloud provider for their enterprise cloud solution.

IBM's ability to integrate public and private workloads within our hybrid cloud was a critical differentiator for SAP. We continue to expand our data center footprint. And in the fourth quarter, we opened cloud centers in Melbourne, Paris, Mexico City, Tokyo and Frankfurt.

Maintenance was up 1% when adjusted for currency and the impact from the System x divestiture. GTS pretax profit was down significantly in the quarter. Year-to-year performance was driven by several key factors. First, we have the loss of year-to-year profit resulting from the customer care and System x divestitures.

Second, we took a workforce rebalancing charge in the quarter, which impacts profit.

Finally we’re continuing to invest in both offerings and operational capabilities that includes targeted investments in mobility, security and cloud which complement our client systems of record as well as operational improvements such as the savings yield from the rebalancing action we took earlier this year and more broadly deployed automation in the delivery centers.

Overall the profit performance in GTS reflects the actions we've taken to transform the business this year. We've invested in our strategic imperatives to accelerate growth.

We’ve continued to optimize our delivery platform through the workforce rebalancing and broader use of automation and we’ve divested businesses, impacting our year-to-year results. While those actions all have near-term impacts to profit, they better position us going forward and enable us to deliver more value to clients.

Global Business Services revenue was $4.3 billion, down 3% at constant currency. Consulting and Systems Integration declined 3% at constant currency. Revenue was down in our traditional back-office implementations, particularly in North America. We again had strong double-digit growth in our practices that address cloud, analytics, mobile and social.

Through our Apple partnership, we released the first 10 MobileFirst for iOS solutions in the fourth quarter, with more to come by the end of this quarter focused in Healthcare, Energy and Utilities.

We’ve seen strong customer interest and this partnership is another example of how we're helping enterprise clients to transform their business models and sources of value. Application outsourcing was down 2% at constant currency, reflecting sequential year-to-year improvement but we still see a challenging pricing environment.

GBS gross margin expanded roughly 1.5 year-to-year which is a good indicator of the value our offerings deliver. Pretax profit declined, including a 15-point impact from the workforce rebalancing charge which will pay back in 2015. We continue to see a slowdown in back-office implementations in the traditional parts of the portfolio.

We are investing in strategic partnerships and those will pay off in 2015 as well. To wrap up GBS, we've integrated Global Process Services, our BPO business, with GBS to create a seamless end-to-end business transformation capability for our clients.

Starting in the first quarter, our reporting will reflect this shift of GPS from our Global Technology Services segment to GBS. Software revenue of $7.6 billion was down 3% at constant currency. After the third quarter, we said we didn't expect a change in trajectory in the fourth and our fourth quarter performance was fairly similar to the third.

Total software growth reflects a headwind from operating systems, driven by the divestiture of System x and our Power results.

It also reflects business model changes, which impacted our transaction revenue growth as our customers continue to use the flexibility we have provided in the deployment of software purchased through enterprise licensing agreements. The flexibility enables clients to optimize their capacity on our platform for the long-term.

We had solid growth in many of our solution areas, including security, mobile and cloud. Our security software once again grew at a double-digit rate. In fact, this was the ninth consecutive quarter of double-digit growth. Cybersecurity threats are one of the key issues that all our customers are facing.

We have brought our analytics, big data, research IP, mobile and cloud capabilities to create security offerings to address this market opportunity. Our software mobile offerings more than doubled in the quarter, as we leveraged our integrated MobileFirst portfolio, and our Software-As-A-Service offerings are up nearly 50%.

Across software, we continue to drive innovation and capture growth areas. We are integrating analytics and security capabilities that are needed to operate seamlessly in a hybrid environment. For example, we are introducing several new offerings that further enable our analytics portfolio in a cloud environment.

And we recently announced IBM Verse, a cloud-based email and collaboration offering that integrates Watson capabilities. This type of continued innovation in our offerings, together with expanding services on our Bluemix platform-as-a-service, will allow our customers to move to a hybrid environment.

Systems and Technology revenue of $2.4 billion was down 12% at constant currency, adjusting for the divestiture of our System x business. Last January, our Systems and Technology business had just reported a $1.7 billion year-to-year profit decline for 2013 and we said we’d stabilize the profit on a go-forward basis.

I'm pleased to say that after a lot of work to reposition the business, we have stabilized the profit. Looking at our fourth quarter results, Systems z revenue was down 23% at constant currency, reflecting the fact that we are in the tenth and final quarter of this product cycle. Our last 10-quarter cycle was z10.

Comparing the current cycle to that of z10, program-to-date System z revenue and gross profit is right on top of that cycle. We continue to innovate on the platform and last week, we announced z13, the new generation of the IBM Mainframe.

The z13 system culminates a billion dollar investment, five years of development, exploits the innovation of more than 500 new patents and represents a collaboration with more than 60 clients. The result of this innovation is a Mainframe that has the world's fastest processor that can execute two and a half billion transactions a day.

With this generation of Mainframe, we've dramatically enhanced the capabilities around analytics, mobile, security and cloud to address the needs our clients see in their businesses. These capabilities span from real-time insights to real-time fraud detection in a system that can consistently run at 100% utilization with 100% uptime.

IBM continues to innovate on the platform to address client needs and extend its leadership in high-end systems, a core franchise that has nearly doubled in installed capacity over the last five years. Power revenue declined 11% at constant currency, which is a modest sequential improvement in year-to-year performance.

We have repositioned Power, which is now a systems business, as well as an open chip processor and an IP opportunity through the OpenPOWER foundation. We saw double-digit growth in the low-end, driven by entry-level POWER8-based system. And in the fourth quarter, we introduced our high-end Power 8 enterprise systems.

OpenPOWER foundation membership continues to expand, which started in 2014 with five members and now stands at over 80, 14 of which are in Greater China. Since the establishment of the consortium a year ago, several products have been introduced.

For example, on the scale out systems, Tyan launched the first OpenPOWER customer references and on the high-end, the U.S. Department of Energy recently awarded IBM a $350 million contract to create future super-computers based on OpenPOWER technology.

In addition, we've initiated a strategic partnership with Suzhou PowerCore, which intends to use POWER architecture to develop and market processors for servers in China. Our Storage hardware revenue was down 5% at constant currency, a modest sequential improvement from the rate in the prior quarter.

We again saw strong growth in our FlashSystems and Storwize portfolio. This growth was offset by the wind down of our legacy OEM business and continued weakness in high-end disk.

Recently IDC reported that IBM was the leader in all-flash systems shipped capacity during the first half of 2014, outpacing the number two and number three competitors combined.

Over the course of the year, we took significant actions to reposition our Systems and Technology business for higher value and reinforced our commitment to driving innovation in our high-end systems and storage.

We repositioned Power through creation of our Power 8 systems which are built for cloud and big data and made available the POWER8 architecture through the OpenPOWER consortium to build an open ecosystem and an IP play. We are divesting our microelectronics manufacturing, with future chip supply coming from an at-scale provider.

And we committed $3 billion of investment in the next era of chip technology, as we strengthen our semiconductor R&D and systems innovation. We also divested System x, our low-end server business. And as I mentioned, just last week we announced z13, the new generation of the mainframe.

Our Systems and Technology segment grew profit in the fourth quarter and was profitable for the year. With our portfolio repositioned and introduction of the new mainframe, we should now see profit leverage. Moving on to cash flow in the quarter, we generated $7.6 billion of cash from operations, excluding our Global Financing receivables.

We invested a billion dollars in capital expenditures and we generated $6.6 billion in free cash flow, which was up $4.4 billion quarter-to quarter but down $1.8 billion year-to-year. As I said earlier, we generated more than half of our annual cash flow in the fourth quarter, in line with our average over the last five years.

For the full year, our cash from operations excluding GF receivables was $16.2 billion. We invested almost $4 billion in capital expenditures, with consistent spend throughout the year. And within that we shifted significant spend to strategic areas such as SoftLayer and Watson. So, our free cash flow was $12.4 billion, down $2.6 billion year-to-year.

The bulk of that was driven by an increase in cash tax payments and working capital impacts associated with the System x divestiture. While not in free cash flow, we received proceeds of $2.4 billion from divestitures, including the System x and Customer Care business. As for the uses of free cash flow for the year, we acquired six companies.

We paid $4.3 billion in dividends and bought back almost 72 million shares, reducing our average share count by 8%. Let me comment on our share repurchase activity over time.

Since the beginning of our share repurchase program in 1995, we've taken or share count from roughly 2.35 billion shares to fewer than 1 billion shares, that’s reduction of 58% program to date at an average purchase price of less than $100 per share. At the end of the year, we had $6.3 billion remaining in our buyback authorization.

Turning to the balance sheet, we ended the year with a cash balance of $8.5 billion. Our total assets reflect a year-to-year reduction associated with the semiconductor transaction, as well as a reduction in our pension assets. We had strong returns on our pension assets, above the long-term expected return assumption.

The asset decline was driven by a year-end re-measurement of liability. I will address that in a minute. Total debt was $40.8 billion, of which $29.1 billion was in support of our financing business. The global financing leverage at year end was 7.2 to 1, consistent with last December.

Our total debt was down almost $5 billion since September and up $1.1 billion in the last year. Our non-financing debt drove the quarter-to-quarter decline. At $11.7 billion, it was down $5.4 billion since September and down $0.5 billion year to year. Let me put our current non-financing, or our core debt level in perspective.

In May of 2007, we re-introduced debt to our core capital structure and in June of that year, we had $11.8 billion of core debt. So while our debt level has varied over time, it's at the same level as when we introduced debt to our structure. Looking at debt-to-cap, we improved our ratio since September, though not as much as expected.

We reduced debt levels and profit performance increased equity, both as we expected. However, our debt-to-cap ratio was impacted by a $7 billion reduction in equity since September due to currency and pension.

A $1 billion of the equity hit was due to currency translation, and over $6 billion for pension re-measurement driven by a reduction in the discount rates, and taking into account the recently released U.S. mortality tables. Our pension funding levels remain solid despite the impacts from rates and mortality. The U.S.

and worldwide tax-qualified plans were 102% and 97% respectively. Our balance sheet continues to have the financial flexibility to support our business over the longer term. So now let me wrap up 2014, and I want to put our revenue and profit performance in the context of the framework we provided at our Investor Day back in May.

The strategic imperatives are focused on the market shifts of data, cloud, and engagement. The model for these combined strategic imperatives is to deliver double-digit growth, with high contribution from Software, which obviously drives a more profitable business mix.

In 2014, revenue from our cloud, analytics, mobile, social, and security solutions together, was up 16%. And that includes the impact of currency as well as the divested System x business. In total, the strategic imperatives generated $25 billion in revenue, which is about 27% of IBM's total.

And our software content is well above the level for overall IBM. Business analytics revenue for the year was $17 billion, up 7% over last year. Growth was led by our consulting business, as we help our clients extract value from their data.

Our cloud revenue in 2014 was up 60% to $7 billion, as we see growing client demands for higher-value cloud solutions across public, private, and hybrid. Revenue from our as-a-Service offerings increased about 75% to $3 billion for the year, and we exited 2014 with an annual run rate for our as-a-Service business of $3.5 billion.

The $7 billion also includes revenue from our foundational offerings, where we provide software, hardware and services to clients to build private clouds. Turning to engagement, our mobile business more than tripled. We had strong growth in MobileFirst driven by an integrated portfolio of offerings, and a great start to our partnership with Apple.

Social was up 3% and Security was up 19%. So very good growth in these businesses in line with the double-digit objective. These are also the areas where we are launching initiatives and targeting investment. Earlier I mentioned investments to build out Bluemix, SoftLayer, Watson and the partnerships with Apple, Twitter, SAP and Tencent.

These investments and actions support growth into the future. Now, our Recurring Core Franchises includes our annuity businesses and highly recurring portions of our transactions business, such as mainframe revenue from our largest clients. Most have annuity characteristics, and in many cases, these support mission critical processes for our clients.

The model, or signpost, is for these combined businesses to have stable revenue, with improving margin. This year, revenue was down about 3%, with a modest decline in margin. The decline was driven by mainframe cycle and by currency.

We also have high value transactional businesses, which include project-based work in services, transactional software, and Power and Storage, in areas other than our strategic imperatives. The objective here is to optimize our business model, and maintain margins. We've been clear that some parts of our hardware business have had secular challenges.

I talked earlier about all of the actions we've taken to reposition our hardware business for high value. While revenue is down as we work through these transitions, our gross margin remains attractive at over 40%.

And of course, we've divested businesses that don't fit our strategic profile, Customer Care, System x, and microelectronics manufacturing. Together these businesses were about $7 billion of revenue in 2013, but lost $500 million of profit.

So the divestitures reduce our revenue, but improve our profit profile, clearly in line with our shift to higher value. Our strategic direction is clear and compelling, and we have made a lot of progress. We have been successful in shifting to the higher value areas of enterprise IT.

The strong revenue growth in our strategic imperatives confirms that, as does the overall profitability of our business. We expect the industry to continue to shift, and I want to spend a minute on what we see over the longer term, not in terms of an absolute end point or multi-year objective, but rather in terms of a long term growth trajectory.

We have $25 billion of revenue in our strategic imperatives, and we continue to expect to grow this revenue at a double-digit rate. Keep in mind these areas are as high value as other parts of our business, which continue to manage our clients' most critical business processes.

As we get our cloud business to scale, and drive ongoing productivity improvements across our business, we see opportunity to continue to expand margin. And we will continue to allocate capital to investments, and to return value to shareholders through a combination of dividends and share repurchases.

So over the longer term, when we look at the opportunities we will continue to develop, we see the ability to generate low-single digit revenue growth, and with a higher value mix, high-single digit operating earnings per share growth, with free cash flow realization in the 90's.

Of course we will spend more time on the rate and pace of achieving that trajectory at our investor meeting next month. Now in the near term, there are a few dynamics that are inconsistent with that trajectory. For 2015 specifically, we are dealing with some transitions in our business.

For example, while we are fully participating in the shift to cloud, margins are impacted by the level of investment we are making, and the fact that the business is not yet at scale. We will see some year-to-year benefit to margins in 2015 as the business ramps, but we won't yet be at scale.

And I talked about the impact to our software transaction revenue growth as customers utilize the flexibility we've provided, as they commit to our platform for the longer term. And then there are cyclical considerations. Given the geographic breadth of our business, we have seen challenges in some markets, most notably many of the growth markets.

We firmly believe these are important markets over time, and we've been investing to capture the opportunity, but we're not counting on a robust demand environment in many geographies in 2015. And then of course, there is the impact from currency. The impact to our revenue growth is obvious as we translate results back to U.S. dollars.

But as with all companies with a similar business profile, with the dollar strengthening, currency will have a significant translation impact on our profit growth. Now, we do have some cyclical benefits, like a tailwind from the new mainframe cycle, and we will have a full year of Power 8.

Now when you step back and look at the business, and take into account everything I have just told you about 2015, we will continue to grow in a lot of areas.

We will continue to deliver strong growth in our strategic imperatives, we will continue to expand margins, and we will continue a high level of investment and hiring, shifting to areas where we see the best opportunity. Now in this currency environment, and with the divestitures we've completed, our total revenue as reported will not grow in 2015.

I expect less spending in workforce rebalancing, and while we always have gains, we won’t replicate the $1.6 billion of gains we had in 2014, so that will be a net impact to our profit. When we put it all together for 2014, we expect operating EPS in the range of $15.75 to $16.50.

And at that level of profit, we expect free cash flow to be relatively flat. More importantly, we will exit 2015 with a higher value, higher margin business. Now, Patricia and I will take your questions..

Thank you, Martin. Before we begin the Q&A, I’d like to mention a few items. First, we have supplemental charts at the end of the slide deck that provide additional information on the quarter and the year. We also have provided historical data on continuing operations. And second, I’d ask you to refrain from multi-part questions.

Operator, can you please open it up for questions..

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

Yes. Thank you.

As it relates to the EPS guide, how are you expecting PTI in the hardware, software and services businesses to trend relative to the fourth quarter? And then also, should we expect the tax rate to continue to climb higher?.

Sure, Katy. A few things. So first, on tax, we’ll address that first, because that’s probably the easiest. We’re assuming a tax rate at 20% in the full year, so a slight decline from where we finished 2014.

Now on the guidance in terms of what we saw coming out of the fourth, I think there are a few things that I would mention relative to the trajectories in some of our businesses. We do expect that the launch of the mainframe, along with the success in Power 8 that we’re seeing, that will generate some momentum.

And so we would expect to see growth in our systems in kind of the mid-single digit range of growth coming out of '14 when we didn't have the cycle. In services, we’ve not built a revenue trajectory or assumed revenue trajectory that requires a lot of growth within our EPS. And then the most important I think from a guidance perspective is software.

So we have, as you know, a range in our EPS. And I think the way to characterize the bottom of the guidance and the top of the guidance is that at the bottom of the guidance, we're not assuming that we see an improvement in the trajectory of our software business.

And I would characterize the top of the guidance as sort of a stabilization of the software business relative to 2014..

Thanks, Katy.

Can we please go to the next question?.

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

Yes. Thank you. I’m wondering if you could elaborate a little bit further on cash flow for 2015. Looks like you're guiding for it to be flat, which is under 80% of net income if I sort of work back or it’s from the midpoint of your range.

Can you help us understand what the forces at work are that create the significant discrepancy between free cash flow and net income? And can you also help us understand how we should be thinking about relative free cash flow spending on acquisitions versus dividend and stock repurchases relative to history?.

Sure, Toni. A couple of things. So our free cash flow guidance is essentially flat year-to-year, given the range of profit we provided and a couple of things within that. And I’ll try to address this sort of in the reverse order that you asked about it.

Relative to share repurchase, we've only assumed about a 2 to 3 point impact from share repurchase, which is obviously less than what we were able to do in the last year, so a reduced level of share repurchase.

I guess, the way to think about it is we entered 2015 with a bit over 6 billion of authorization remaining and we've just assumed that we used the authorization now. There obviously, timing will impact that's impact on EPS, but think about our share repurchase in the year as consuming the bulk of that authorization.

In terms of dividends, we have assumed that we would obviously, continue to pay the dividend and we’d like to and will talk about the dividend with the Board. We’d like to talk about how we might grow the dividend as well. We typically do that, as you know, in April. So those discussions will start soon.

From a realization perspective, we printed a 79% realization in 2014 and we see that improving to the mid 80's. Now there are a few elements of our free cash flow relative to realization that I think are important to keep in mind. We’ll start it, call it a 100% just for simplicity.

We get a 5, 6 point impact just because we have a pension in terms of realization now. Sometimes that is not as steep as that and sometimes it can be more depending on what the markets due to the pension. But right now in 2014, we saw about a 5-point impact in realization.

We also saw in 2014 a substantial impact in realization from our cash taxes, that was about a 10-point impact last year. So pretty substantial impacts in realization. We do see that, as I mentioned, improving to the mid 80's in 2015 based on our guidance.

Now there are some unique items within our guidance as well for 2015 that I think it's important to realize. One, we assumed or we are assuming a further increase in our capital acquisitions, our capital expenditures of over $0.5 billion year-to-year, as we continue to build out our cloud platform as we continue to invest in software.

We grew -- excuse me, we grew SoftLayer investment pretty aggressively in 2014. And we’ll continue to do that into 2015. We also have a year-to-year impact in cash flow in our guidance to recognize the timing of the payments for the restructuring actions we've taken. And then finally, as we had in 2014, we also have in 2015.

There is a year-to-year impact from the x series business being out of our results but because of the structure of that there is a working capital impact.

So overall guidance that we provided has a profit decline embedded within it and again those -- that combined with the year-to-year impact we see in terms of CapEx restructuring and x series being out, delivers that essentially, flat year-to-year free cash flow..

Thanks, Toni. Kristine, can we go to the next question please..

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

David, you are on mute?.

It looks like he has disconnected.

Would you like to move on?.

Yes, please..

Thank you. The next question comes from Steve Milunovich with UBS. You may ask your question..

Thank you. Philosophically, Martin, how did you approach this guidance, even at the low end, you’re only down about 5% in EPS from what you did in ‘14.

And given how currencies moved against you and so forth, do you feel you're being conservative enough particularly, given that, it doesn’t sound like the share counts going to come down too aggressively.

And maybe you talk about what you're assuming for restructuring since restructuring is part of your reported EPS?.

Sure. Sure. Steve, so first thing I’d say, the guidance is only about an hour and 15 minutes old. So I’m not going to recharacterize what we’ve already provided.

Now having said that and we talked -- I talked a little bit about it in response to Katy’s question, at the low and the high end of the range, I think the primary difference is the software trajectory that you assume. One assumes no change in trajectory at the low-end and one assumes in software stabilization if you will.

And as you said, we’re not going to get the same year-to-year improvement from our share repurchase program that we got last year. But at the same time, we've taken a lot of action to position our business coming out of 2014 that we feel very, very good about.

So that $25 billion of strategic imperatives revenue growing at 16% a year is a very powerful part of the portfolio now. And in fact those deliver gross profit margins that are better than the IBM portal on average I should say because they have a higher software mix in them.

So we are not going to get the same level of EPS at a share repurchase I’ve shared. Again the dynamics on software and then the other part that you asked about was restructuring. We are not going to replicate the same level of restructuring that we had last year. It will be a lower mountain. Now we will continue to remix our skills.

It’s part of our business. As you said, we include it in the way we report. So its part of our business, but we will not spend at the same rate. And we will get obviously some of the rollover benefits from what we’ve done this year.

So parts of our business continue to do very well, and the elements of the business that don't have that same level of growth remain very high margin, very profitable, very high value for us. Now I should remind you that currency is a big impact for us. We've included in the backup charts the impact to revenue.

It’s about 5 to 6 points based on spot, that's just a revenue impact. As we saw in the fourth quarter, it was nearly a $300 million impact to us in the fourth. And a $300 million on our base that is really the difference between growing pretax income and not growing pretax income in the fourth quarter for us.

So it will be a big impact and despite that, we will grow margins next year or this year as well. So a few, I guess, I’d say puts and takes on this but again I'm not going to re-characterize the guidance, which is now an hour and eighteen minutes old..

Thanks Steve.

Can we go to our next question please?.

The next question comes from Bill Shope with Goldman Sachs. You may ask your question..

Okay, thank you. I wanted to see if you could get a bit more detail on the cash flow comments that you made earlier. At the other elements, you mentioned that sustained the gap between cash flow and earnings for this year, which specifically are likely to be less of a factor beyond 2015.

And I guess what specifically should allow you to get to that 90% conversion goal overtime?.

Sure, a couple of things. So again if I worked down from the 100, we do see an increased allocation of capital to the investments we are making. As I mentioned, we've included in our ‘15 guidance about a more than $0.5 billion of increase. Now we don't see that rate and pace continuing forever.

So yes we see increased capital expenditure requirements overtime as we continue to invest in things like our cloud, but not at the same rate and pace. So that will slow a bit.

At the same time, as we see markets perform or differently, we don't assume that the pension impact, it will not be a year-to-year impact I should say, continuing into the future. So slower CapEx spending growth, reduced impact from the pension on a year-to-year base.

And then, we do see as we go through this transition, as we’ve talked about in our longer-term trajectory, we see profit growth in the high single-digits. And that profit growth has been the primary driver of our free cash flow growth over the year, as we talked a bit about this in Investor Day.

The primary driver over the past 10 years of our free cash flow has been profit growth and as we get back to that profit growth, we see most of that converting back into free cash flow as well..

Thanks, Bill.

Christine, can we please take the next question?.

The next question comes from Benjamin Reitzes with Barclays. You may ask your question..

Yeah. Thank you. Hey, Martin. You mind talking about acquisitions.

Do you feel like you may need to acquire more to recapture a growth trajectory and/or will that be, or will you use the same tuck-in model that you guys have been using previously? I guess my question is do you see a need for bigger bets? And what is the acquisition budget within your guidance for this year? Thanks..

Sure. A couple of things, Ben. One, the way we approach acquisitions, which has worked very, very well for us is the way to complement the organically developed innovations we can create and then to build around what we view as the future of enterprise IT.

So over the last few years with that as sort of an approach, we've been pretty aggressive in acquiring analytics companies. We’ve been pretty aggressive in acquiring -- we bought SoftLayer. We've been building out our cloud platform. We've been aggressive in acquiring new ways for clients to engage with their customers.

So our acquisition model again has been built around our view of the future of enterprise IT and how we supplement the technologies and the innovations we are bringing to market. I think that model works really, really well. Now, I do think that we see two differences, as we move into the future on our acquisition policy or our acquisition approach.

One is more of our acquisitions will probably be on an as a service basis as opposed to say an on-premise model. And that’s kind of the nature of the market and that's also where we have a lot of opportunity because we don't really play in some of those areas today.

So, we have over 100 as-a-service offerings, our as-a-service business in total, finished at $3.5 billion on an exit run rate. But we still see a lot of opportunity to expand, if you will in that as a service base.

So one is more as-a-service acquisition content and then secondly, we've been more active and been very successful in partnering with leading companies in order to help transform industries and in order to help transform professions.

And I think there is a great example in Apple and what we're working on with them and there's a great example in Twitter. So those partnership models obviously require investment and we investment in them heavily. But we don't have to own all the technology in order to bring it to our clients.

And one of the things our clients also went over again is that they look to us to help bring some of these things together so they can they can use it in the most effective enterprise class way. So, you'll see also more partnerships, if you will as opposed to acquisitions.

But from an acquisitions standpoint, more as-a-service I would think as opposed to on-prem..

Thanks, Ben. Let’s go the next question, please..

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

Yeah. Hi, Martin. I am wondering if you could talk about how you are thinking of cloud growth in 2015. You talked about 60% growth in 2014.

How are you thinking about 2015 in the cloud and net-net, if you could just give us a view on the impact the cloud is having on IBM? Obviously this business is growing, but it’s impacting other parts of the IBM business. Thank you..

Sure. So, cloud for us, a $7 billion business. I think that kind of puts us at the forefront of cloud in the cloud industry, in the cloud space if you will, so $7 billion growing 60%. We are delighted with the investments we've made and we see a very powerful opportunity in the cloud.

That cloud business for us is made up not only of as-a-service business, which as I mentioned was a $3.5 billion dollar run rate at the end of the year. It also has our foundational offerings in it, where clients are building private clouds and deploying hybrid environments and we've been talking about hybrid for many years now.

We think that the hybrid environment is the way that we see most enterprises getting the benefit of the agility of the cloud linked in with their systems of record. So our foundational offerings are deploying private clouds and hybrid clouds and we see that trend continuing as well.

So, $7 billion, we see continued strong double-digit growth in that for us. Cloud for us remains a terrific opportunity for all aspects of our business.

When we sign as an example these large services deals that you’ve seen for instance coming out of Europe, big element of those outsourcing transactions is also to embed and include the cloud environment for those clients as well.

So cloud is sort of permeating a lot of the elements that that we are bringing to market and as part of why we brought all that together into a cloud organization just in January this year, something we mentioned we would do back in October and we announced the cloud unit in January, which will bring all that together for our client.

So very powerful opportunity, very substantial business opportunity for us now at $7 billion last year and we see continued strong growth..

Thanks, Brian.

Can we go to the next question?.

The next question comes from Tien-Tsin Huang. You may ask your question..

Geography and outlook there, it look like Asia plays nicely in the fourth quarter..

Tien-Tsin, can you start again..

Yeah. Can you start again? You cut off in the beginning..

Is this little better?.

Yeah. Great. Thank you..

Okay..

Yeah. Just want to ask on geography and the outlook there. I was just saying that Asia look like got a little bit better, Japan and China on the better place.

So, any calls out on growth guidance by geography overall for the year? Thanks?.

Sure, Tien-Tsin. A couple of things, Japan, again had a very good quarter, very consistent growth now and boy we are delighted with the progress that Japan team has made and the way they are bringing innovation to their clients. So I think it's a terrific story for us.

When we look at the other growth markets, the other highlight I’d point out is China, as I said on the prepared remarks, down 1% in the quarter at constant currency, now that’s without the divestiture of the System x business, but we had seen some pretty dramatic declines in that business prior to that.

So with our top banking customers deploying substantial new mainframe capacity in the quarter, we are pleased to see that that business is starting to stabilize.

Again X currency, X divestitures, we are pleased to see that business is stabilizing and quite frankly, China has been a substantial business for us and it was again in the fourth and continues to be. We will continue to be a very important part of our business.

And the other geographies in Latin America, I think it's probably worth talking a little bit about because in Latin America, what we had -- in the fourth quarter was an impact from our transactional business as it wrapped on some very strong prior year.

So more annuity like businesses in Brazil and LA, in Brazil in particular, in LA we are fairly stable with good growth and our transactional businesses, which had been growing in the first nine months of the year hit a tough compare and so we are down. So LA finishes the year with growth, very good growth at about 8%, but down in the fourth quarter.

And then in Asia-Pacific, you we did not see a dramatic change in trajectory here going into the fourth in the third and the fourth and even the full year kind of 6% to 7% declines in Asia-Pacific. And fairly consistent even when we look across some of the constituents in the geography, Australia did not get any better, Asian did not get any better.

So we are seeing some challenging growth environment in Asia-Pacific.

The one driver, I would say that's going to permute across all these organizations though is that the shift to the cloud, the shift to big data and analytics, and the shift to new systems of engagement is a key source of growth within all these geographies and we see that fairly consistently in our business, that phenomenon is consistent across the geographies..

Thanks, Tien-Tsin.

Can we go to the next question please?.

The next question comes from Joseph Foresi with Janney Montgomery Scott. You may ask your question..

Hi. I was wondering if we could get a little bit more color around the margin profile for cloud and the timeframe for improving those margins and any targets for the strategic initiatives as a percentage of revenue over the long-term? Thank you..

Sure. First, I will talk about the margin profile. So what we see across all of our strategic imperatives. We see on that $25 billion base is the gross profit margin that is greater than the IBM average. So we're actually seeing very good margin performance in gross margin on that strategic imperative content and again growing very rapidly.

Now we are investing heavily. So net margins are not -- they don't have that same dynamic. They are not yet greater.

But we will see in that as a service business now as we talked a bit about on the call, we will see an improvement in scale, we are not yet at scale, but we will see an improvement in scale as that business from $3.5 billion on a negative run rate continues to grow.

So we see good margin opportunity in our strategic imperatives as we deliver high value. And then in terms of revenue target for strategic imperatives over the long run.

I wouldn’t pick a number of percentage per se, what I would say is that, a $25 billion growing solid double-digit just on a trajectory basis, the math would say, you continue to make pretty good progress i.e. continues to represent a bigger and bigger percentage of your revenue.

But bear in mind that the recurring core franchise business to us, which is fairly stable and we expect it to continued to be fairly stable, remains very high margin as well as very high value. So those strategic imperatives will continue to grow, very good performance over the long run. They will represent a larger percentage of our business.

Obviously, a sheer math would suggest that. But those other Recurring Core Franchises are delivering very high value to clients as well..

Thanks, Joe.

Can we go to the next question, please?.

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

Thank you. Sorry I dropped. So if this has been answered, feel free to take it offline. But I wanted to ask a quick question about software, information management and WebSphere are probably the segments with the most noticeable and perhaps impactful deceleration. And you’ve outlined the issues related to the structuring of the ELAs.

Can you provide for us some framework that would help us better understand when you would expect growth to return to more normalized levels and why you would expect that?.

Sure, David. And no, it hasn’t been asked yet. So, I’m glad you got back in. Couple things on software. First, we have to remove from a growth trajectory perspective, I'll take the currency impact out and I will talk about it, excluding currency.

Full year growth in our software business was -- clearly our software segment was clearly impacted by the operating system content. So that was about a point and a half of impact over the years. So total software group, as you saw at constant currency was down about 1%. That includes just under 1%.

That includes the impact of the operating system content. So the difference between the total segment is really the total middleware. Our total middleware business did grow, grew about 1%, excluding the currency. Now as we’ve said, there is a software-as-a-service business in there that's doing very well, growing 50%.

We have elements of our middleware that are doing quite well. And in the prepared remarks, we talked about the flexibility we provided within that growth rate and we saw that in the fourth quarter as well.

The elements of that, the flexibility that we provided to our larger customers, as they deploy, as I mentioned earlier, things like hybrid cloud environments and private cloud environments. Their commitment to the platform over the long-term comes with our giving them some flexibility on how they deploy.

So it's an impact of the growth, as I mentioned, total middleware was up a bit in 2014 on a full year basis. And then within that content, if you look at the more transactional elements of our business, we still signed 350 or so ELAs in the fourth quarter. So the ELA structure still continues to be highly valued by clients.

They really are just looking for this flexibility and how they deploy. The other way to look at it or in other way that we think about it, those large clients use flexibility to deploy outside of those large clients. We actually saw growth in our middleware business, very good growth in our middleware business.

So part of way we set the guidance the way we did was really reflective of the question that you asked. And I guess, the way I’d answer it is for our guidance, we’re not relying on an improvement in trajectory in -- at the low end of guidance. And we are -- we would need a stabilization if you will in order to see the high-end of guidance.

But the phenomenon here is middleware is growing. Total middleware is growing. Different deployment rates in our larger customers than the growth we’re seeing in the rest of our customers..

Okay, Christine, let’s take one last question please..

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

Thanks a lot. Martin, I guess my question is regarding the transition IBM is undergoing. It looks like 2015 will be another year of EPS decline as we shift revenues towards the strategic imperatives.

I’m curious when do you think the business model gets an optimal level where you see the target you outlined of low single-digit sales, high single-digit EPS growth.

Is 2016 the year we get there or do you see that happening at a later point?.

Well, Amit, we’re going to talk more about the longer term at Investor Day in February. So I'm going to limit my guidance today to talk about 2015 in what we just provided. And I think we characterized it pretty well for what we’re expecting and what is implied if you will in that guidance.

But we look at 2014 and we look at how much we got done in positioning our business for the longer term. Again $25 billion business growing at 16%, including the impacts of currency.

We look at the investments we made in our cloud business, including building out our software platform across 15 countries now including things and by the way, we will see the impact of that and the uptake of that capacity going forward.

We look at the relationships we are building and now executing on with again partners like Apple and Twitter and that's not yet in the 2014 obviously because we just did them that has a lot of good growth coming up. We look at the analytics business, the substantial business, $17 billion last year with reasonable growth.

And importantly, we’re really pleased with the progress we’re making in commercializing Watson. I would not characterize the $17 billion as reflective of a substantial revenue impact, if you will, from Watson, certainly a big investment for us but it's absolutely a right investment. And we’ll see all that growth still coming to us.

And then we look at other elements of our portfolio like mobile tripling and security up solid double-digit. So from a growth and investment standpoint, we feel terrific about what we got done in 2014. And then we also undertook a lot of difficult decisions to position our business over the long term for other elements.

So we stabilized our STG business in terms of its profitability. We completed the divestiture of our lower value x series business as well as the divestiture of our semiconductor manufacturing, which is not going to be a payoff in 2015 or 2016.

There's a payoff down the road for that but it is the right thing to do for us to remain the leaders in high-performance computing. So I think 2014 we’ve got a lot done. We feel very good about the progress we made in building out those strategic imperatives to $25 billion business. We feel very good about the overall high-value strategy.

We did deliver $21 billion across the corporation of pretax income. And so we feel great about how we’re exiting 2014 and then when we exit 2015, we’ll have again a higher margin business than we did in 2014. So let me make a few final comments to wrap up the call. So as I just covered kind of it within that, we did get a lot done in 2014.

We've got a lot of proof points as I just went through. For 2015, as we indicated we see EPS, operating EPS in the range of $15.75 to $16.50. And within that -- excuse me, within that, we’d see mid single-digit EPS growth in the first quarter. Now keep in mind, we had large charge last year.

So that growth in 1Q is off a low base because it has the charge in it. But again as I finish with Amit, we will exit 2015 with a higher value and the higher margin business. So thank you for joining the call. We look forward to seeing you at Investor Day..

Thanks Christine.

Can you close out the call for us, please?.

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