International Business Machines Corp (IBM) 2015 Q4 法說會逐字稿

Welcome and thank you for standing by.

(Operator Instructions)

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 our host, Ms. Patricia Murphy, Vice Precedent of Investor Relations.

Ma'am, you may begin.

Thank you.

This is Patricia Murphy, Vice President of Investor Relations for IBM.

I'm here today with Martin Schroeter, IBM's Senior Vice President and Chief Financial Officer.

I'd like to welcome you to our fourth-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 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.

Let me start by saying we are pleased with the progress we made again this quarter.

We delivered revenue of $22.1 billion, operating net income of $4.7 billion and operating earnings per share of $4.84.

As we get to our results, you will see that our fourth-quarter and full-year performance reflects the transitions in our business as we address the significant shifts in our industry as well as some of the cyclical challenges of the global business environment.

Though as always in January, I'll start out that with some comments on the year, show you the progress we've made in our transformation, discuss the details of the quarter and then wrap up with our view of 2016.

For the full year we delivered nearly $82 billion of revenue in $14.7 billion of operating net income, and our operating earnings per share were $14.92.

As we've said, this transformation will play out over time, and with revenue down 1%, for the second consecutive year we've had modest improvement in our year-to-year revenue performance excluding the impact of currency and divestitures.

I'll comment on year-to-year revenue performance on this basis throughout.

Our strategic imperatives continued strong performance, up 26% for the year.

This now represents 35% of IBM's revenue.

Our profit and margin reflect our portfolio actions as we shift the higher value as well as the level of investments we're making to drive our transformation.

We generated over $13 billion of free cash flow which is up year-to-year.

This is 98% of our GAAP net income in line with our expectations that free cash flow realization will be in the 90s.

A couple of years ago we laid out our strategic imperatives around big data and analytics, around cloud and around mobile and security, the areas where our clients are looking to us to help move them to the future.

I want to spend a minute on the progress we've made since then in shifting our business toward these strategic imperatives and the investments we've been making which aren't yet reflected in our revenue streams.

We've said we expect these strategic imperatives to deliver double-digit revenue growth, and in 2015 our performance in our strategic imperatives accelerated.

Together cloud, analytics, mobile, social and security grew 26% and delivered $29 billion in revenue.

As I mentioned, they now represent 35% of IBM which is up from 22% two years ago.

With 57% revenue growth over the last year, cloud is now a $10 billion business for us.

This made us the largest cloud provider in 2015 which is what you'd expect given our extensive relationships in enterprise IT and incumbency in the data center, positioning us to help our clients implement hybrid cloud environments.

Revenue from our as-a-service offerings increased about 60% to $4.5 billion for the year, and we exited 2015 with an annual run rate for our as-a-service business of $5.3 billion.

The $10 billion also includes $5.6 billion of revenue from our foundational offerings where we provide software, hardware and services so clients can build their own clouds.

In either case, what we've been saying for some time is that clients are utilizing the cloud not just to reduce costs but to gain agility and enable innovation.

And whether they are consuming as-a-service or through their own clouds, or as in the case of most enterprise clients who are implementing a hybrid environment, we are leading that move.

To address opportunities we see in this space, in 2015 we made seven cloud acquisitions including Cleversafe for Object Storage, Gravitant for cloud brokerage services and Clearleap for cloud video services.

We also invested nearly $1 billion in capital expanding our global cloud data center footprint to 46.

We already have an ecosystem of millions of developers globally, and our Bluemix platform as a service has already expended to over a million users adding 15,000 developers a week.

With nearly $18 billion of analytics revenue, we are also the largest analytics provider and will extend that lead by moving into new areas including Watson Health and Watson Internet of Things.

In Watson Health, we are integrating our own organic capabilities with content acquired through Merge, Phytel and Explorys.

Healthcare is a new revenue and profit opportunity for us as we change the face of health care through our cognitive platform to provide value to providers, payers and partners.

We are also addressing the IoT market, and our Weather Company acquisition not only gives us tremendously valuable data and digital content but a high-volume, cloud-based insight driven platform that will integrate with Watson to address significant new opportunity spaces.

We will talk but how we are addressing these opportunities at our investor briefing at the end of February.

And while we are investing in capabilities for the future, we are also returning significant value to shareholders.

We paid out nearly $5 billion in dividends, and we reduced our average share count by 2.7%.

We got a lot done in 2015.

To sum it up, our revenue for the year was down 1%, we expanded gross margin, we invested heavily for the future and we returned capital to shareholders all while transforming the business.

The progress we're making gives us confidence that we are on the right strategy, and the actions we've taken not only advance our transformation but also will contribute to our growth rate in the future.

I will come back to the full-year in 2016 after going through the details of the quarter starting with the financial metrics.

Our revenue for the quarter of $22.1 billion was down 2% reflecting the transition we've been describing.

I will spend just a minute on currency which continues to be a headwind.

Currency impacted our reported revenue by over 6 points, or $1.5 billion which is about $350 million more than the spot rates suggested 90 days ago.

For the year, currency translation reduced our revenue by over $7 billion.

That by itself is the revenue of a Fortune 500 Company.

And currency was also a headwind to our profit performance.

We estimate it impacted our profit growth by about $300 million in the fourth quarter and over $1 billion for the year.

At current spot rates, we would expect a significant impact to revenue and profit again in 2016 not just from the translation but from the year-to-year cash flow hedging dynamics.

I will come back to this.

Our margin performance reflects some ongoing dynamics in the business like higher-levels of investment and an impact from the mix of contracts and resource shifts in our Services business.

But it also reflects some unique items in the fourth quarter of last year, the largest of which was a $1.4 billion gain from the sale of our x86 server business.

This prior period gain represents effectively all of the year-to-year decline in PTI margin.

I'll talk more about the margin drivers in the segment discussions.

Our underlying effective tax rate was 20%, and this quarter the rate also reflects the recent US tax legislation and the settlement of our US tax audit which we've talked about throughout 2015.

So bottom line we delivered $4.84 of operating earnings per share.

We generated over $6 billion of free cash flow in the quarter and $13 billion for the year.

And as I mentioned this is 98% of GAAP net income.

We returned about three quarters of our free cash flow to shareholders in 2015 through dividends and gross share repurchases.

Now turning to the revenue by geography, we had good performance across many of the major markets.

Europe returned to growth led by continued growth in Germany, France and the UK.

In fact, Germany posted double-digit growth.

And in December we announced Munich as the headquarters for our new Watson IoT business as well as our first European Watson innovation center.

In Asia-Pacific Japan continued to post growth led by Services.

In the AP growth markets we had double-digit growth in India and Australia though China declined.

Our US revenue was down.

We had strong growth in the US in all hardware platforms, z Systems, Power and Storage, but it was offset by weak services and transactional software performance.

The growth markets in total were down 4%, roughly in line with the last two quarters.

And from a regional perspective, growth in Latin America and the Middle East and Africa was offset by declines in Asia-Pacific.

Turning to the segment perspective, our total revenue was down 2%, and gross margin declined about a point.

Our global technology services revenue grew as we help our clients transition to a hybrid cloud services platform bringing in more cloud, mobility and security to infrastructure services.

This contributed to our backlog growth for the year.

Our GTS gross margin decline is driven by investments in cloud data centers and the ramp up new contracts which generally have lower upfront margins.

In Global Business Services, we adding resources and growing quickly in strategic areas while transitioning away from some of the more traditional areas.

This shift of resources impacts productivity in the near term which puts pressure on margin.

In Software, our annuity content growth, but transactional performance has been impacted by the flexibility we've been providing in ELAs with our larger clients.

The transactional performance in the fourth quarter was consistent with what we saw in September, but a larger transactional mix in the fourth quarter drove a deceleration in the overall Software growth rate.

Our Systems hardware revenue was up driven by z Systems and Power.

This caps a very strong year in our Systems business reflecting that our leading edge servers run the most contemporary work loads.

The Systems margin is driven by the lower mainframe margin as is typical at this point in the cycle.

Turning to expense, our operating expense and other income was up 9%.

There are a few large items that impacted the growth rate this quarter.

As I mentioned earlier, we closed the sale of our System x business in the fourth quarter of last year resulting in a gain of $1.4 billion in that period.

In this quarter we took a charge of about $85 million for the write-down of the equity component received as consideration.

So together, these were a $1.5 billion year-to-year impact to our expense.

We also had a year-to-year reduction in workforce rebalancing.

We had $580 million of workforce rebalancing charges in the fourth quarter of last year with essentially none this year, so this reduced expense growth by 10 points.

And currency reduced expense growth by 8 points between the translation of non-dollar spending and the cash flow hedging gains that are reported in other income and SG&A.

This is pretty consistent with what we've seen all year.

Outside of these larger items our expense dynamics have been consistent throughout the year.

We are accelerating shifts within our operational expense base driving productivity and efficiency in some areas while increasing investment in support of our strategic imperatives.

This year we shifted $5 billion of spend to our strategic imperatives; that's across cost, expense and capital expenditures.

Now let's turn to the segments, and we will start with Services.

We ended the fourth quarter with a Services backlog of $121 billion which grew for the third consecutive quarter.

We continue to see momentum in our Services offerings that modernize our clients' IT Systems and move their operations into the cloud-based mobile world.

We've seen reports that suggest the adoption of cloud mean shrinking deal sizes, but this is not what we're seeing.

Clients are looking to transform their most critical systems into hybrid cloud environments and the complexity of these partnerships in many cases results in larger engagements.

In fact, this quarter we've signed 26 Services deals greater than $100 million, and for the full year we signed over 70 of these substantial transactions which is 40% more than last year.

So with a growing backlog and a 40% increase in large deals during the year we are not seeing shrinking deals.

Now about 70% of those transactions feature hybrid cloud content which reflects both the value our clients see in hybrid and the reality than not all of their work loads will be optimized for the cloud.

Just recently we signed a $1.4 billion expansion in the scope of our relationship with European Bank BNP Paribas.

This is a joint GBS and GTS engagement and as part of the agreement we will operate two of the bank's data centers in Belgium as hybrid cloud centers, providing cloud infrastructure and a full suite of business transformation services spanning applications testing, business intelligence, security and core banking solutions.

Global Technology Services delivered $8.1 billion of revenue and grew for the third consecutive quarter.

Our strategic imperatives including our hybrid cloud services and GTS grew strong double digits this quarter and for the full-year.

This includes strong demand for Software, which again grew double digits this quarter.

This Infrastructure as a Service cloud platform provides our clients with a full range of cloud services including virtual and bare metal servers along with the dedicated dark fiber network infrastructure.

As clients evaluate their technology roadmap they are looking for agility and innovation and to gain insight into data from all sources.

Our hybrid cloud stack is an open platform that enables this innovation.

Our clients can choose from public, private and dedicated environments based on their needs such as workload, performance, data sovereignty and regulatory requirements.

Entire industries and value chains are being disrupted, and our clients are looking to us for a competitive advantage.

To expand our cloud capabilities this past quarter we announced the acquisition of Gravitant.

Gravitant develops cloud-based software to enable organizations to easily broker software and computing services across multiple suppliers and cloud environments from a single screen.

We also announced the acquisition of Clearleap, a premier provider of cloud-based video services.

This will provide our enterprises with a fast and easy way to securely manage, monetize and grow user video experiences.

The Clearleap video platform is optimized for massive scalability of which enables clients to ramp up and support millions of concurrent users within seconds to support special events.

The innovations have attracted leading brands such as HBO, A&E Networks, the NFL and Sony Movie Channel.

Finally our maintenance business continues to contribute significant revenue and profit by delivering a wide range of support services to maintain and improve our clients' IT infrastructure.

We continue to see strong demand for our multivendor support services where clients leverage our global distribution and inventory capabilities.

Our GTS PTI margin is up about two points year-to-year.

This was driven by lower workforce rebalancing charges and savings from actions taken throughout the year to drive efficiency in our delivery model.

Mitigating these savings we continue to invest to contemporize our clients' IT systems, transforming them into digital enterprises.

We are scaling our Software footprint with 46 cloud data centers opened around the world.

Finally as we have talked about throughout the year, currency is impacting margin and remains largest impact on year-to-year profit growth given the strong dollar environment.

Turning to Global Business Services, revenue was $4.3 billion in the quarter.

We continue to transform our GBS business and our signings were up double-digits this quarter driven by our digital offerings.

Revenue from our strategic imperative practices was again up strong double digits.

Our analytics practice grew over 20%, our cloud services were up over 60%, and our mobile practice with than doubled.

Our revenue continues to be impacted by the wind down of traditional enterprise application implementations.

Clients are moving away from ERP engagements to initiatives that focus on digitizing their business with analytics, cloud and mobile technologies.

In December we announced that as part of our partnership with Apple, we've now delivered over 100 mobile firsts for iOS applications.

This unique partnership brings together the simplicity of design and ease of use of the Apple mobile device with our ability to build applications that scale securely and efficiently to the enterprise helping to transform the way work gets done across 14 industries and 65 professions.

These apps allow our clients to securely access their most critical data and processes so they can redesign workflows and drive productivity.

Since we announced the partnership with Apple, we've generated over $1 billion in signings from the program.

GBS profit margin was flat year-to-year.

Let me talk about some of dynamics within that.

We have a benefit from lower workforce balancing charges.

In parts of the portfolio where the market is declining we are seeing price and profit pressure, and we're taking actions to optimize our cost structure.

We continue to invest in our analytics, cloud and mobility practices.

We've hired and shifted significant resources to these areas which impacts productivity and margin in the near term.

We are also scaling a new cognitive consulting practice launched last quarter that is focused on helping our clients unlock the transformative value of cognitive business.

Our Software revenue was $6.8 billion in the fourth quarter.

Our annuity content grew year-to-year while transactional content declined.

Our Software profit performance continues to reflect the revenue trajectory, a higher level of investments in areas like Watson, Watson Health, IoT and Bluemix and an impact from currency translation.

Let me spend a minute on the revenue dynamics.

Looking at the transactional content, recall in our last earnings call we talked about weaker transactional performance at the end of September which impacted the third quarter.

Our fourth-quarter transactional performance was very similar to what we experienced in September.

Given the much higher transactional mix in the fourth quarter, this had a larger impact on our total Software performance resulting in a deceleration in Software growth in the fourth.

Looking ahead to first quarter, which has a lower transactional mix, we will see an improvement in our revenue trajectory.

We've said in the past that our performance reflects that many of our large clients with multi-year contracts are utilizing the flexibility on deployment of their Software as they build out their environments with our broad portfolio.

And this is continuing.

Outside of our top 250 clients, our Software revenue was up low single-digit in the fourth quarter and for the full-year.

On an annual basis, about 70% of our Software business is annuity-like including software-as-a-service and subscription and support.

Our renewal rates are steady, our SaaS business is growing and our overall annuity revenue grew in the fourth quarter and the full-year.

Middleware serves the purpose of integrating different environments on-prem and cloud.

To enable hybrid environments, our key capabilities have now been delivered on SoftLayer or as part of our IBM Bluemix platform.

IBM's Middleware remains the number one integration platform in the world and now integrates across cloud environments.

To put it simply, this allows clients' existing apps to access the cloud and new born on the cloud applications to access clients' existing assets.

To accelerate the integration of Middleware in a hybrid cloud environment we have made an organizational change at the beginning of this year moving a portion of our Middleware business into our cloud business reflecting the importance of our Middleware and the hybrid cloud marketplace.

We are also adding substantial new capabilities into our Software and solutions portfolio.

One example is the Weather Company acquisition which will provide the basis for our IoT platform.

This opposition brings with it a high-volume platform that can ingest sensor data at scale.

This platform can handle enormous complexity taking in 4 billion weather forecasting points and 26 billion queries in its cloud service each day.

This is the fourth most used mobile app handling seven times more transaction volume than the world's leading search engine.

Some of this has been running on our cloud already, and of course we will move all of this to the IBM cloud.

Then we will layer in Watson to give it the cognitive capability to apply machine learning at scale.

This then gives us the ability to expand this platform capability to industries beyond weather, like health.

The Power of the platform is its ability use Watson cognitive capabilities to gather new insights by connecting data at scale from multiple industry domains.

Our Systems hardware segment revenue was $2.4 billion.

This was the fourth consecutive quarter of growth in both the z Systems and Power.

We have continued to deliver innovation to our Systems to enable them to run the most contemporary work loads.

In fact, about half of our system segment revenue in 2015 was to address analytics workloads or hybrid and private clouds.

This quarter z Systems revenue was up more than 20%.

Since the launch of z 13 in the first quarter of 2015, we have delivered growth of 35%, with strong double digit growth in every quarter since the launch.

Z 13 was contemporized for the workloads around mobile, hybrid cloud and analytics which continues to resonate well with our existing customers and bringing new customers to the platform.

For the year, we added 50 new clients across 25 countries.

Power revenue grew 8% which is the strongest performance of the year.

In Power we are serving a high-value market while adding capabilities and finding new economic models to grow over time.

UNIX is a declining market, but we continue to address it because it is a very high value space.

At the same time we introduce low-end Linux based Power Systems to capture the growing Linux market and are building an IP stream through the OpenPOWER ecosystem.

Even though the UNIX market is declining, by delivering innovation and repositioning the platform, our Power Systems have grown four quarters in a row.

This is a good example of how we transform ourselves.

The growth in our servers was mitigated by a 7% decline in Storage hardware which continues to be impacted by weakness in traditional disk and tape.

As we've said, value in the Storage market continues to shift to Software and offering requirements that are driving demand for flash and object-based Storage.

We are well-positioned in these new areas with growth in flash and our recent acquisition of Cleversafe.

Looking back at 2015 our Systems results reflect a successful transformation and repositioning of the business.

Revenue was up 8% for the year and profit up about $600 million.

This performance reflects our solid mainframe product cycle and the successful Power transformation with Power revenue growing for the first time since 2011.

Moving onto cash flow, in the quarter we generated $7.1 billion of cash from operations excluding our Financing receivables.

We invested $1 billion in CapEx and generated $6.1 billion of free cash flow.

For the full year, we generated $17 billion of cash from operations.

We invested almost $4 billion in CapEx this year with a significant amount going to support our growing Services backlog and for cloud as we build out cloud data centers.

And so we generated free cash flow of $13.1 billion, an improvement of almost $700 million year-to-year.

The primary driver of this improvement was lower cash tax payments of about $3 billion.

Our cash and tax book rates for 2015 were fairly consistent, and so the year-to-year benefit to cash flow was driven by a much higher cash tax rate in 2014.

We also had over $1 billion of improvement in our sales cycle working capital.

This was partially offset by a decline in our profit performance and payments of performance-based compensation.

Looking at uses of cash we've invested over $3 billion on acquisitions this year.

We've acquired 14 companies including 7 in the fourth quarter.

The Weather Company acquisition I mentioned earlier will close in the first half of 2016.

Over the course of the year we've returned $9.5 billion to shareholders including dividends of nearly $5 billion and $4.6 billion in gross share repurchases.

We bought back 30 million shares, reducing our average share count by 2.7%.

At the end of the year we had $5.6 billion remaining in our buyback authorization.

Turning to the balance sheet, we ended the quarter with a cash balance of $8.2 billion.

Total debt was nearly $40 billion of which $27 billion was in support of our Financing business.

The leverage in our financing business remains just over 7 to 1. The credit quality of our financing receivables remains strong at 55% investment grade.

You can see this in our supplemental charts.

The year-to-year reduction in investment grade was driven by rating changes to our existing portfolio not by changing our approach to the market.

Our non financing debt of $12.7 billion was almost $1 billion lower than September and up just over $1 billion year-to-year.

Our non financing debt to cap was 54%, 4 points lower than September and 5 points lower than a year ago.

Our debt to cap ratio was impacted again this year by a reduction in equity due to currency translation and pension re-measurement.

Together these impacted our equity by about $3.5 billion.

The performance of our retirement related assets and return and discount rate assumptions at year-end are in our supplemental charts.

You can see our funding levels remain solid, but the US and worldwide tax qualified plans at 101% and 97%, respectively.

And importantly our balance sheet continues to have the financial flexibility to support our business over the long-term.

Let me wrap up where I started the call, by saying that we are pleased with the progress that we made again this year in the transformation of our business.

We are continuing to invest and add capabilities to drive the transformation.

In 2015 we spent over 6% of our revenue in R&D.

We invested about $4 billion in capital and over $3 billion to acquire 14 companies.

We are integrating acquired content with our organic capabilities and leveraging partnerships and a broader ecosystem to build new high-value platforms.

And we are applying our cognitive capabilities to more of what we do.

Within our spend we are shifting to key opportunity areas, and we're seeing the returns in our strategic imperatives results.

With $29 billion of revenue, these now make up 35% of IBM.

In 2015 we had a successful mainframe cycle, and Power grew as we've repositioned it to address a broader opportunity.

Our Services backlog was up, and we exited the year with $121 billion book of business.

Our Software annuity base, which is about 70% of our Software revenue, also continued to grow.

Our overall Software performance reflects reduced transactional levels as our largest customers utilized flexibility we've provided and commit to our platform for the longer-term.

The macro environment as always is mixed, and currency continues to be a significant headwind.

While we're focused on remaining competitive in local markets, the translation impact is significant.

It was an 8 point impact to revenue growth in 2015, and at current spot rates, currency would be another 2 to 3 point impact this year.

The profit impact is substantial as well, and, given the sustained period of dollar strengthening, the profit impact in 2016 will in fact be greater than 2015.

Both because of the translation impact and roll off effect of cash flow hedging gains.

At current spot rates we expect currency to impact pretax profit growth in 2016 by about $1.3 billion, with nearly three quarters of that coming from a year-to-year reduction in cash flow hedging gains.

But now as we look forward to 2016 we will continue to deliver strong growth in our strategic imperatives.

We expect some modest expansion in gross margin and will continue to invest at high levels.

And we will continue to return value to shareholders through share repurchases and dividends.

Taking all of this into consideration, we expect operating EPS of at least $13.50.

This reflects an impact from currency of over $1 of EPS which is about a 7.5 point impact to the growth rate.

Our free cash flow will follow our profit performance, and we continue to see our free cash flow realization in the 90s.

Looking at the quarterly skew, as you know, the first quarter represents the smallest quarter in terms of contribution to our full-year earnings.

At this point in prior years our first-quarter view has been from 14% of the full-year to a few points higher than that.

Given the magnitude of the currency headwind and the skew of our investments this year, we would expect the first quarter of 2016 to come in at about 15% of the $13.50.

Bottom line, we remain confident in our strategy and in our ability to execute, and we look forward to continued progress in our transformation in 2016.

Now Patricia and I will take your questions.

Thank you, Martin.

Before we begin the Q&A I would 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 the year.

And, second, I'd ask you to refrain from multipart questions.

Operator, let's please open it up for questions.

(Operator Instructions)

Toni Sacconaghi, Bernstein.

Yes, good afternoon, Martin.

When you began 2015, you talked about software as really being the pivot for whether you might hit the high-end of your guidance range or the low end of your guidance range, and you anticipated or hoped that software would improve in the second half.

What we saw was the opposite, is that software decelerated significantly in the second half of this year, and I'm wondering if you could reflect on, A, what happened, and B, while there should be some improvement next quarter because of less transaction, and I gather the Weather Channel will be added into that division, how do we think about software in 2016?

Should we be expecting a business that is down low single-digits at constant currency again?

And perhaps you can talk about the forces that play both, again, what happened in terms of deterioration in the second half and how we should think about the forces at play in 2016?

Thank you.

Sure, thank you -- thanks, Toni.

A few comments on software.

As we said in our prepared remarks, the deceleration third to fourth really was driven by this -- by the mix shift and the continuation of the transaction closing rates that we saw in September.

So we talked about -- coming out of September we talked about a slower rate of closing in some of our larger deals, and that's what we experienced as well in the fourth quarter.

And as I mentioned in my prepared remarks, because of the mix shift alone, we see an improvement.

And as you point out, the Weather Company, and other acquisitions, by the way, to the extent that they are -- as software in them, they will obviously bolster that growth rate.

A few things I think are important to note within software.

First, as we said in our prepared remarks -- and the phenomena is really no different in the fourth than what we've seen all year.

Our annuity business within the software business, so that's about 70% of our overall software stream, our annuity business continues to grow.

So that has as-a-service in it.

It has our subscription and support business in it as well, so that continues to go.

And then outside of our largest clients, and this is a phenomena that we've been talking about.

Outside of our largest clients where they don't have as broad access to our software portfolio, we continue to see growth as well.

Both transactionally, and they are obviously part of the as-a-service stream.

Within the large clients, as I mentioned earlier and as we talked to in our prepared remarks, we provide flexibility.

It gives them -- it gives our clients an ability now to manage their projects, and they deploy maybe differently than they had anticipated at the beginning of the year.

And from my discussions with our clients, a lot of that depends on the visibility they have both with their demand patterns and the visibility they have to the kinds of projects they might have to implement in the near term.

I don't think that's any different than what we've experienced in the past.

I would say that one of the things we look at closely, particularly with regard to the usage of our software and how it is getting deployed, is our ability to maintain these renewal rates on our subscription and support.

And our renewal rates around the world remain very high, in the mid-90s globally, and if we look in the US where we had a weaker software transactional performance, actually our renewal rates in the US are even higher than that.

They are higher than they are in Japan.

They are higher than they are in Europe.

They are higher than they are in Australia.

So our renewal rates continue in a very good track, and that suggests that our annuity business within software has some good growth prospects.

But as we said in our prepared remarks, again, just from the mix benefit of having more of that annuity mix in the first quarter, we will see an improvement.

And then as you noted, the acquisitions will sit on top of that.

Thanks, Toni.

Can we go to the next question please?

Katy Huberty, Morgan Stanley.

On a high note in servers, both mainframe and Power, how are you thinking about growth rates in 2016 as you move into the latter half of the cycle?

How might that influence gross margins?

It looks like it has an impact in the fourth quarter.

Thank you.

Sure, your question actually cut off a little bit.

I think you said finishing at the high note in the fourth quarter.

I'm going to assume that was the question, Katy, so I will answer for mainframe and for Power and how we are entering 2016.

So first on mainframe, another very good cycle in mainframe.

So as you know, we announced that in the first quarter, the growth rates have been pretty consistent throughout it.

We doubled in the first, growth in the second, good third quarter.

Again, the fourth quarter we finished at about 20% year-to-year at constant currency, and the adoption rates are consistent with what we would expect.

So for the full year, the mainframe is up 35%, and as is typical in the mainframe cycle, margins in the announcement year tend to be a little bit lower.

And we will see margin improvement as we get to the latter half of the -- or latter part of the mainframe cycle in 2016.

From a Power perspective, the Power team has done a wonderful job of transforming a businesses.

And I think it's a really good example of how IBM transforms its businesses.

So, since, as we put in the prepared remarks, we have not grown since 2011 and fourth -- in 2015 we grew each of the four quarters in the Power business, finishing the fourth at plus [8].

I think what underpins that and what's important to note is we continue to serve a declining market for part of that Power business.

The UNIX market is declining, it has been declining, but it is still high value and it still serves a very important role in our clients' environments and does some of their most important work, so it continues to be an important marketplace.

But at the same time, the team has been able to reinvent the platform, make it relevant in the Linux space, so we are seeing very good Linux placements in Power.

And the applicability of that POWER8 platform in cloud spaces, for instance, and running other ERP type missions has been a terrific boost to the overall growth rates.

Then keep in mind that we've also -- the team has also put in play from a business model perspective the OpenPOWER foundation, which is an intellectual property play.

So that will also boost margins.

So the Power -- again the Power team has done a terrific job of repositioning a product which had a very strong acceptance and is delivering high-value in a declining market space into now a business that has grown four quarters in a row with a lot of leverage from here as our OpenPOWER consortium members start to deliver their own systems into that Linux space.

Thanks, Katy, can we go to the next question?

Tien-tsin Huang, JPMorgan.

Great, thank you.

Good afternoon.

Just wanted to ask on services, if we can expect some improvement and growth in 2015, given the backlog trend you talked about there, Martin?

And also, your confidence in services margin expansion in 2016, because if I heard correctly, no workforce rebalancing in the fourth quarter.

Is that a signal that you are in a good place with your offshore delivery rightsizing?

Thanks.

Thanks, Tien-tsin.

A couple comments, and I'll disaggregate.

I guess I'll talk about GTS and GBS separately.

First, we did, as we said in our prepared remarks, we finished with a very good backlog growth of 1% ex-currency.

Now, that is $121 billion book of business, so even 1% growth is a lot of additional business.

We feel quite good about the backlog we are entering with.

And even when we look at the signings progress throughout the year, for the full-year, GTS Global Technology Services grew signings, and GBS grew signings.

And in fact, GBS exited fourth quarter with double-digit signings growth in the quarter.

So very strong return to growth, which put them into growth for the year.

From a backlog perspective and from a relevance of our offerings perspective, I think those signings numbers suggest that there are substantial deals out there.

There are deals that play well to our high-value view and our ability to move our clients into hybrid environments and our ability to continue to grow that backlog.

From a margin perspective in GTS, keep in mind that at a total GTS level, we have very good margins.

But we also have a maintenance business in there which has a lot of margin within it.

When you pull out the maintenance margin and just look at the SO business, we still see opportunities to expand margins in that area.

And keep in mind, with regard to workforce rebalancing, while we did not have a charge in the fourth, we are continuing to remix our skills and will continue to move our work to where the global delivery centers can best do it.

That will not be a necessarily year-to-year impact in the first quarter, but we will continue to remix skills And so as we bring on new contracts as an example, and we have seen a lot of contract growth in Europe, we've seen a lot of contract on growth in Asia.

We will have an opportunity -- we do have an opportunity to continue to expand our margins as we globalize some of that work.

Our movement of work into global delivery centers, it varies by geography, and quite frankly, it varies by country.

In the US, we are in a pretty good spot here, but where we sign new contracts, obviously we take on a lot of people, and we've got to figure out, how do we optimize those delivery platforms.

Then in GBS, as we've talked about, we continue to work our way through it transformation toward higher value.

And what we see from the margin perspective is that the work we are doing to digitize our clients' front office, the work we are doing to provide a cognitive solution to our clients, which is just starting out a roll into our consulting results, that is all high margin.

And we see a lot of opportunity continue to generate those kinds of margins.

In the work we are transitioning out of, that is pretty price competitive, and then -- and so we are seeing declining margins.

But more importantly, as we shift the resources and as we move those skills, there is a productivity hit the overall business.

So we are not relying on a dramatic snap back, if you will, of our GBS margins going into the year, but we do see a very good opportunity on the other side as we finish that transition.

Thanks, Tien-tsin.

Let's go to the next question please.

Brian White, Drexel.

Martin, if we look at the different business segments in 2016, what businesses do you think have an opportunity to actually grow in constant currency, and what businesses have an opportunity to expand margins in 2016?

Thanks.

Sure, Brian, thanks.

A few comments.

I think what we are going to see in 2016 is really the phenomena that we've been talking about now for a couple of years.

Which is our clients are investing heavily in these growing areas of cloud, of analytics, of mobile, social and security.

And as you saw in the full year of 2015, we grew that 26%.

Right now it is 35% of our business.

So our client discussions today are still built around those -- that shift into those parts of the business.

We will also see a continued discussion around parts of our business where they are focused on us delivering productivity to them.

Now, productivity to our clients means reduced revenues for us, but that's the phenomena we've been in.

And so when we look at 2016, I think we will see continuation of both of those.

As you know, in 2015 we ended the year with a revenue base that was about 1% smaller than it was the prior year, given those two dynamics, strong growth in the strategic imperatives and delivering productivity to our clients in the rest.

That trend is what we are going to see.

The mix will obviously be different, the strategic imperatives are representing a larger part of the business than they did - than where they started in 2015, but that trend will continue.

On a segment by segment basis, GTS has grown now three quarters of the year, and as I said, with pretty good backlog growth, and we think that trajectory continues to hold.

GBS improved in the fourth relative to the third, so a sequential improvement in its year-to-year growth rate, but we are not relying on that bouncing back rapidly.

As we know, we're going through a transition there, and we want to get through that transition as rapidly as possible.

But having said that, about half of their business now is in strategic imperatives, but half isn't, so we're going to continue that transition.

The systems business will continue to see momentum as I mentioned in the Power business where the team has done a terrific job of repositioning the platform.

But the mainframe's coming into the back half of the cycle, and so we won't see the same growth levels that we saw.

And then software, as I mentioned in response to the prior question, that transactional mix will not play as a big a role in the first quarter as it did in the fourth.

And so obviously we will see how we transition through the year, but bolstering that software growth will also be some of the acquisitions.

So I think the discussions with our clients, as I started, with discussions with our clients are going to reflect these two halves of our business, which is discussions around moving to the future and on the other discussion on helping them drive productivity.

Thanks, Brian.

Can we go to the next question please?

Steven Milunovich, UBS.

Great, thank you.

Could you talk a bit about free cash flow?

You said free cash flow will follow profit.

Does that literally mean you expect about $13.50 in free cash flow per share?

I would think maybe not, given that you had a $3 billion positive swing on the cash taxes.

So maybe you could go through cash taxes, pension, working capital, CapEx, some of the swing factors and where you think that will come out on free cash flow this year?

Sure, Steven, you are right.

What my recorded -- my remarks were not intended to say we are going to do a $13.50 in free cash flow per share.

That was not the intent, but what we do want to say is that our free cash flow performance in absolute terms will follow the profit performance, so a few comments.

First, we did have a year-to-year reduction in our cash taxes, but keep in mind that in 2015 our cash taxes -- our cash tax rate and our book rate were pretty similar, and so the relationship you see in 2015 is the right relationship.

Yes, year-to-year there was a benefit, but that's because we had a very high cash tax rate in 2014.

The 2015 relationship which we -- where we produced 98% of GAAP net income was the realization for free cash flow is the one we are talking about for 2016 as well.

We see that relationship.

Now, within that 20 -- the guidance at -- at least $13.50 would translate to free cash flow in the $11 billion to $12 billion range.

Within that, we have assumed some growth in CapEx for the year as we continue to drive our cloud platform and our investments in our system -- our services business.

The operational performance that's embedded within that obviously will have an impact.

Then the rest, and I will give you a few pluses and minuses here.

The rest translates to basically flat, so it really is the profit performance.

So we will have slightly higher income tax payments as an example.

We will have a little bit of a less benefit of working capital.

We have slightly lower pension payments.

We have slightly lower workforce rebalancing payments assumed.

So you put all that together, and what I meant by free cash flow will follow profit is that free cash flow at $11 billion to $12 billion of free cash flow roughly translates to what we see in profit performance at that at least number.

Bear in mind that as we talked about on profit, there is about $1.3 billion impact to profit year-to-year from currency, and while the dynamics are a little bit different in cash flow, that does translate roughly to the impact to free cash flow as well.

What you are seeing in here in our guidance, which was a big impact from currency, is also a big impact in free cash flow for next year.

Thanks, Steve.

Can we go to the next question please?

David Grossman, Stifel Financial.

Thank you.

Martin, if I read the press release right, it said the strategic imperatives decelerated to about 16% growth year-over-year in constant currency, and that's obviously down from what you were in the first three quarters.

What were the primary components driving that deceleration, and what would be a reasonable target for growth in those strategic imperatives in 2016?

Sure, thanks, David.

A couple of things.

As we said, for the year we were at -- we had very good growth at $29 billion.

What we saw in the quarter was about $1.7 billion sequential increase in strategic imperatives revenue.

That's better than it was first to second, better than second to third.

So we did see a typical seasonal sequential improvement in our strategic imperatives from third to fourth.

When we talked about our strategic imperatives at Investor Day, we said they have been going in this uncanny rate of 18%, 18%, 19%, 19%, 19%, very steady over last few years.

And we said that our model assumes that we will transition to those areas at a similar kind of rate.

I think we had 15% to 19%.

Think of it as high teens, if you will.

As we went through this year and as we said at the beginning, first quarter we printed over 30%, and as we said, we are not relying on that throughout the year.

So we finished the year on a full-year basis.

Now, relative to that 15% to 19% range where we finished at 26% growth year-to-year.

So we are ahead of what we expected.

We are transitioning into those areas faster than we had expected back at Investor Day.

And so we finished at 35% of the revenue streams and again, at Investor Day, we said by 2018 we would get to about 40%, or at least 40%.

We think we are in good shape to make it there, but the 26% we are pleased with, because we are transitioning faster than we have over the last four or five years, and again, it is on higher base.

So we are pleased with the progress we are making in continuing to grow the strategic imperative.

Thanks, David.

Can we go to the next question please?

Jim Schneider, Goldman Sachs.

Jim, we cannot hear you if you are on mute.

Thanks for taking my question, can you hear me now?

We can.

Okay.

Just in terms of the software performance during the quarter, can you maybe talk about the impact and quantify the impact you saw from the ELA transactional weakness in Q4?

And then can you maybe give us some kind of bracketing for 2016 about what impact do you expect from ELAs to the extent you can see it going forward over the next couple quarters?

Sure, Jim, a few things.

One, and I'm not saying you implied this, but ELAs are a very -- ELAs are enterprise license agreements for all of our listeners.

ELAs, enterprise license agreements are a very powerful way for our clients to consume our software.

It gives them broad access to the portfolio we offer.

Like our Middleware platform, which is quite valuable to them as they think about their hybrid cloud environment.

We do more ELAs, more enterprise license agreements, we did more in 2015 than we did in 2014.

We have not seen a dramatic change in the length of time our clients commit to the platform for those.

As I mentioned on an earlier question, our renewal rates for the subscription and support that underpins their deployment of those continues at very high rates.

The ELA structural is one that we think is -- and our clients think is a terrific way to consume our portfolio.

Now, parts of our portfolio will continue to be consumed on an EL basis -- ELA basis, and as you saw us -- maybe you saw us earlier this year, we moved parts of our Middleware portfolio into our cloud business.

That's really a reflection of the importance our Middleware plays in these hybrid cloud environments.

So some of that could get -- start to get consumed in different models from ELAs that maybe they get consumed on a more individual basis, maybe they get consumed on an as-a-service basis, but the ELA construct remains quite powerful.

As I noted earlier, the big difference we saw was in the breadth of the access that some of our clients have, and because they don't have the visibility they need to their demand environment or because they don't have visibility to the most immediate need they might have, they will move around the deployment of those licenses into different areas.

But again, with our renewal rates staying high, we know that they are still consuming those.

The ELA construct quite powerful.

It is the right way, I think, for our clients to consume our software and the right way to give them flexibility to deploy it.

Thanks, Jim, can we go to the next question please?

Lou Miscioscia, CLSA.

Martin, just sticking on the software, if you go back to the second half of 2014 when the flexible pricing started to hit softer growth in a meaningful way, then obviously you hit it all through 2015, when are we going to get the grandfathering position where we can get past the flexible pricing?

Which I know that you -- when we've talked about this before, you said that it was the right thing to do for the customer.

But customers want everything for free, and I assume you are not trying to move to an open source type of model.

So I'm just wondering when would you get past it, or what else you can do to try to get software growth in your most profitable area in the Company?

Sure, Lou, a couple of things that I would say.

First, this is the right thing to do, to offer our clients flexibility as they try to get insights into their demand environments and as they try to deploy their projects.

So it is absolutely the right thing to do.

We felt that way when we started talking about it, and I think it is still the right thing to do.

Again, what's important to us is that they commit to the platform, number one, and number two, they are actually deploying the software.

And we see that as, I mentioned in our renewal rates, where as long as our renewal rates are staying high, we know that they are using our software.

So all of that is good for the model.

And in the long term, we think that we will benefit from all this.

Now, bolstering our software growth this year and our software performance this year will be some acquisitions we made, so those will certainly help as we go through the year.

But again, it is the right thing to do for our clients.

And as we continue to move our software into a broader and broader ecosystem, we will continue to see growth in those clients that don't have access to so much, so that will continue.

But from an overall perspective, with the acquisitions, which will help a bit, and again, our renewal rates staying high, over the long term this is a terrific business for us.

Thanks, Lou, let's go to the next question please.

Keith Bachman, Bank of Montreal.

Hi, many thanks.

I also wanted to focus on the software area.

I think on the last call you mentioned that software-as-a-service was a small part of your existing portfolio, I think around 5% of revenues.

As you think about 2016, could you address how you see the growth of as-a-service impacting your software, both revenue growth and profitability?

And more specifically, I don't think we've gotten a specific answer on, can you grow software in 2016, and will your margins be up, down or flat?

Thank you.

Sure, Keith, so a few things.

Our SaaS revenue overall as a percentage of our total software business is still a fairly small business, but it is growing, and it is growing quite well.

And we are always releasing new SaaS and acquiring new SaaS opportunities, so we see continued very strong growth in our SaaS portfolio into 2016.

Now, it is small and so relative to the total, it is not going to drive a ton at the top line, but over the long term, this will be a good economic model for IBM.

Additionally, the new businesses we are building have this strong SaaS component or as-a-service component to them.

Watson, for instance, is an as-a-service offering.

Our new Watson Health business is built heavily on an as-of-service offering, and others as well are moving into much more heavily weighted for as-a-service.

So the as-a-service piece, which is part of our overall as-a-service exit run rate at 5.3, has pretty good growth in it.

In terms of profitability, we talked on -- in our prepared remarks about continued margin expansion in 2016, and part of that, quite frankly, is going to be driven by additional volumes on our as-a-service platform.

That's both software-as-a-service, infrastructure-as-a-service and our platform-as-a-service, our Bluemix property.

So we will see, as those revenues climb, we will see profitability and in fact margin expansion out of those as-a-service properties.

Within SaaS specifically, our margins in software are quite high.

While the move into a SaaS model is not accretive to margins in software, it is not a big impact, and it is accretive to margins in total IBM, because we don't have a lot of these SaaS properties.

In 2016, we see margin improvements across our as-a-service properties, margins within SaaS specifically are accretive to IBM, and we see that continuing in 2016.

Okay, thanks, can we please take one last question?

Amit Daryanani, RBC Capital Markets.

Thanks for taking my question, guys.

Martin, just on the strategic imperative revenue stream that you guys have, you obviously have a fair bit of scale I would imagine right now, especially in analytics and cloud.

Do you think you can talk about what do you think the margin and free cash flow profile of the strategic imperatives asset is versus overall IBM?

I think it would be helpful for people to understand.

And then is the mix of strategic imperatives, software service and hardware changed a whole lot from the last analyst day where you guys talked about it?

Sure, Amit, a few things.

I will answer the strategic imperative revenue part of your non-multipart question first.

So on strategic imperative revenue, I guess the margin profile of that for the bulk of that business which is focused on, again, cloud, on our analytics business.

For a lot of that, it just looks like our existing margin profile.

So where we are selling our hardware, where we are selling our software in for clients to build an analytics solutions or for them to build their own cloud, then that margin profile looks like IBM's.

And as you know, IBM is a high margin solution Company.

For the as-a-service component of that, the margins are a little bit lower than that.

Now, a lot of that is because we don't yet have the scale that we would like.

Or said differently, we are investing very heavily in order to drive that platform into our clients' environments.

So we will see margin improvement as we go into 2016 as we add more scale or take advantage, if you will, of the investments we've made.

So in total, the strategic imperative revenue over time will not have a dramatically different margin profile than what we see today.

Again, because most of it has what is our margin profile today, and the rest will continue to improve margins as our investment rates -- as our revenue growth rates meet up and the capacity meets up the investment rates.

Relative to the mix, our software mix within our strategic imperatives is still at about twice as high as the rest, if you will, the rest of the business.

As you know, across services, hardware and software, if you look at the mix of those, the software piece in the strategic imperative is twice as high as what we see in the rest of the business.

Now, it's down a little bit year-to-year as we in any given year or any given quarter we have a different mix, we have certain programs that roll in.

But it remains in total at about twice as high a mix as what we have in our core business.

Thanks, Amit.

Let me just wrap up the call with a couple of comments.

First, and I think we've been clear about this, we manage our business for the long-term, and in 2015 we made a lot of progress, a lot of very good progress in transforming the IBM Company.

You see this not only in the growth rate in the strategic imperatives, but importantly, you see in the big steps we've taken to address some of these new opportunities.

We had an opportunity last year to invest quite a bit of capital.

We bought 14 companies, we will continue to be acquisitive.

With the returns we are seeing on our investments, we are more and more encouraged that the strategy is right and that we are executing to transform IBM.

In 2016 we will have our Investor Day in February.

We're going we going to talk more about both the transformation of IBM.

We're going to talk about how we present their information to the financial community to help understand IBM, particularly as we emerge as a cognitive solutions and cloud platform Company.

I think it is very important to understand what IBM is emerging as, and again, we will talk about that in our Investor Day.

So thank you very much for joining the call today, and we will see you in February.

Thank you for participating on today's call.

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