International Business Machines Corp (IBM) — Q1 2015 Earnings Call Transcript

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 First 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 the 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 will turn the call over to Martin Schroeter.

Thanks, Patricia. In the first quarter, we delivered $19.6 billion of revenue, $2.9 billion of operating net income, and operating EPS of $2.91; that's up 9% from last year. It's quite a good start to the year, and obviously better than the mid-single-digit growth we discussed 90 days ago. Our revenue was flat year-to-year, excluding the impact of currency and the divested businesses. There's been a lot of focus on the implications of a stronger dollar, especially to companies like IBM, where, as you know, two-thirds of our revenue are outside the U.S. So let me address this right up front. In the first quarter, we had an eight point impact from currency translation. This impact is even greater than 90 days ago, and also from the update we provided at the end of February. As always, we put a chart in the back-up that shows the impact of currency translation to revenue for the first quarter and the full year. And as we shift our portfolio to higher value and divest businesses that no longer fit our strategic profile, this also results in an impact to our reported revenue growth. In the first quarter, it was over four points. So, together, the impact of currency and the divested businesses reduced the reported revenue growth by 12 points. Now, for the balance of the presentation, I'll focus on our revenue performance at constant currency and excluding the impact of the divested businesses. This is the way we look at our business, and again, on that view of our business, our revenue was flat year-to-year. At our investor briefing at the end of February, we spent a lot of time on how we are transforming our business to where we see long-term value in enterprise IT. We have a core portfolio that's high value to our clients and high value to us. Quite frankly, it's essential. While the market for these capabilities isn't necessarily growing, we continue to reinvent and innovate to deliver that value. We've also been investing in our strategic imperatives, our solutions that address the opportunities in data, cloud, social, mobile, and security. These are high-value solutions and we're able to grow at a rate significantly faster than the market because our offerings are highly differentiated and because our core businesses provide the industry perspective and deep insight into how our clients operate. In February, we showed you the revenue across our strategic imperatives has been up 19% to 20% in each of the last five years. And now in the first quarter, revenue in our strategic imperatives grew more than 30%, so a good start toward another strong double-digit year. Analytics was up more than 20%; Social, more than 40%; and Mobile, more than 4x. Our cloud revenue was up over 75% year-to-year. On a trailing 12-month basis, our cloud revenue was $7.7 billion. This is a demonstration of high growth in the higher value cloud opportunities across public, private, and hybrid. We had a terrific performance in our cloud foundational and as-a-service offerings and we exited the quarter with an annual as-a-Service run rate of $3.8 billion; that's up $1.5 billion in the last year. The bulk of that growth was organic, the result of our deep insights into how our clients run their business. We've applied that insight to develop a strong point of view on cloud, that the value in cloud is hybrid. In February, we announced a program to make hybrid cloud a reality for the enterprise, extending our clients' control, visibility, security, and governance in a hybrid cloud environment, similar to what they have in their private cloud and existing IT systems. And to deal with the data sprawl, we're providing increased data portability across environments. Now while we're investing and driving growth in our strategic imperatives, we're continuing to reinvent and bring innovation to our core portfolio. For example, in our hardware business, we've continue to invest and innovate. That's how we've been able to introduce the z13 mainframe that is built for the mobile economy and roll out Power 8, optimized for data and cloud. We've also made some visible divestitures and we're now starting to see the results of those actions. In March, we shipped the first z13 system and our mainframe revenue more than doubled on MIPS shipments that were up 95%. Power returned to growth, leveraging strong performance in our scale-out systems. All of this is driving our shift to higher value, resulting in a higher margin and supporting targeted investments. In fact, in 2015, we're shifting billions of dollars of spending to data, cloud, and engagement to extend our differentiation in the market. And in the last few weeks, we've announced two initiatives, Internet of Things and Watson Health, that will further strengthen our position as a high-value innovation company providing solutions at the intersection of business and IT. So, to sum it up, our results this quarter at the IBM level and the segment level reflect the transformation in our business. We had continued momentum in our strategic imperatives and strong growth in hardware, resulting from the innovation we continue to deliver. The declines in the core portfolio were consistent with the second half of last year, and our shift to higher value drove margin expansion and we're continuing to shift investments and rebalance resources to address the best long-term opportunities in the market. So, now I'll get into the details of the quarter. Our revenue was flat year-to-year, a two point improvement from our year-to-year performance in the third and the fourth quarters. At the risk of oversimplifying this quarter's revenue dynamics, our strategic imperatives were up over 30%, which is 10 points faster than last year. And bear in mind, we have a pretty substantial business in cloud and analytics alone, so it's on a big base. And our core businesses had a similar trajectory to what we delivered in the second half of last year, so our substantial strategic imperatives growing 10 points faster drove two points of sequential improvement. Looking at our margins, we had an 80 basis point improvement in gross margin, driven by both portfolio actions and strong growth in System z. To put that 80 basis points into historical context, gross margin of 49.3% is up about 1,400 basis points in the last 15 years. And you'll get that same trend from a margin perspective whether you back three, five, or 10 years. In terms of gross profit dollars, we generated $9.5 billion in the quarter, and that's up $2.7 billion from 15 years ago. So, this is clearly the result of our long-term relentless shift to higher value. Our pretax and net margins benefited from the shift, as well, but they also reflect a smaller charge for workforce rebalancing this year. On the bottom line, we reported operating EPS of $2.91, up 9%. We generated $1.1 billion of free cash flow in the quarter, which is up from last year, and as you know, there's a lot of seasonality in the timing of our cash flows, much more so than in our net income. We return $1.2 billion through share repurchase and nearly the same amount in dividends, and we ended the quarter with $8.8 billion of cash on hand, up from year-end. Now turning to the revenue by geography, we had sequential improvement in our year-to-year performance in both the major markets and the growth markets, led by the U.S., Japan, and Latin America. Revenue in the major markets was flat year-to-year. We grew in the U.S., with strong growth across our hardware portfolio and some large software deals, so we had a good transactional performance in the U.S. Japan growth accelerated on the strength of services and hardware. We continued to the mixed performance in Europe, with growth in the U.K. and declines in Germany and France. From a brand perspective, we had good growth in mainframe and power, and continued momentum in outsourcing signings, as clients look to integrate cloud and mobile capabilities into larger scale IT environments. Overall, while our performance in Europe decelerated, it was in line with the market. In the growth markets, Latin America returned to double-digit growth, with broad-based growth in the region, and we had growth in the Middle East and Africa. The Asia-Pacific growth markets again declined, though we had sequential improvement in some key countries. Our year-to-year performance in the BRIC countries improved sequentially, though the total BRIC number is not reflective of the individual country's performance; we had growth in Brazil and India, and declines in Russia and China. In China, we again had very strong growth in mainframe, but our services revenue declined as we shift our focus away from some of the lower margin offerings. Bear in mind, we do have a profitable business in China. Turning to the segment perspective, our total revenue was flat and gross margin improved 80 basis points. As always, I'll go into the revenue drivers in the segment discussions, but I want to spend a minute on margin dynamics. When you look at the drivers of margin improvement we've talked about in the past, a shift to higher value has been a big contributor. This quarter, we saw the shift coming from portfolio actions and strong System z performance. Over long periods of time, investment levels can improve margins, but given the market shifts and transformation we're driving, investments are currently reducing margins. Similarly, currency is typically neutral over an extended period, though our margin this quarter had a translational impact of the stronger dollar. With all of that, we drove margin improvement of 80 basis points. The reported operating expense and other income is down 17%. The reported decline is driven by currency, a lower level of workforce rebalancing, and the fact that we no longer have the expense of the System x business in our run rate. I'll comment on each. Eight points of decline was driven by currency, between the translation of non-dollar spending and the hedging gains that are reported in expense. Two points of the decline are due to the divestiture of System x. And we're continuing to rebalance our workforce, and this quarter, we took a charge of $280 million, but that's down $580 million year-to-year, so with a lower level of workforce rebalancing charges, drove another seven points of decline. As we continue the transformation of our business, I'd expect a similar level of workforce rebalancing next quarter, which will impact our year-to-year profit performance. I should also mention that last year, we had nearly a $100 million gain from the sale of our customer care business and other income, which obviously wasn't replicated this year. Within our base expense, we're continuing to shift resources and spending to areas where we see the most opportunity. In February, we talked about shifting $4 billion in spending in 2015, that's across expense, cost, and capital, and in the first quarter, we've been executing to that plan. We've increased expense in areas like SoftLayer, Watson, and Bluemix, just to name a few and we'll see the benefits over the longer term. Now, let's turn to segments, and we'll start with Services. Combined Services revenue was $12.2 billion, which is down 2% year-to-year. This quarter, we closed 15 deals greater than $100 million, with about half of that for new clients or new scope with existing clients. This reflects the strength of our offerings and our clients' confidence in our ability to manage the most critical assets in their business. We ended the quarter with total Services backlog of $121 billion, which was flat at constant currency and adjusting for the divestiture. Global Technology Services delivered $7.9 billion of revenue. GTS Outsourcing reflects the mix and timing of contracts from the backlog. As expected, many of the larger contracts signed last year did not contribute to revenue in the first quarter. We're continuing to see clients sign large infrastructure outsourcing deals with embedded cloud and mobile initiatives, creating large-scale hybrid IT environments. IBM is the trusted partner for these core business transformations because of our global capabilities and portfolio breadth. And in fact, the Forrester Research Wave evaluation cited IBM as far and away the leading supplier in the global infrastructure outsourcing segment. Within ITS, we had good growth in cloud, security, and business resiliency, but overall performance was impacted by a shift away from lower-value services, such as data center build-outs and OEM hardware deployments. Software grew solid double-digits this quarter, improving sequentially and building on the expanded data center capacity. We continued our steady progress with the opening of a few new footprints in Montreal, Sydney, and Amsterdam. Clients like ShopDirect are choosing SoftLayer as the platform to integrate cloud initiatives with their core systems into a unified hybrid IT model. This architecture provides them with on-demand burst capability, as well as the ability to plan for and deliver consumer apparel and home goods, based on real-time demand. This kind of value is only unlocked when the emerging technologies like cloud and analytics are integrated with the large sets of customer data enterprises already have. Maintenance was up 2%, with the growth driven by our multi-vendor support services, which is our third-party hardware maintenance offering. The continued growth of maintenance is another demonstration of the strength of our global reach and capabilities. GTS pretax margin was driven by a few elements. Currency was the biggest impact to profit year-to-year and our maintenance profit was down due to the System x divestiture. Profit margin performance also reflects the continued investments in the business to expand our operational capabilities; the SoftLayer data center expansion I just mentioned is one example. This gives us a highly differentiated offering in hybrid cloud, especially as it relates to data residency requirements. We're also increasing our sales hiring in our mobile and security practices, and making investments in our resiliency business. And we're accelerating our transition to a more significant global delivery model, which requires hiring and training costs ahead of the expected savings. Finally, we had a year-to-year benefit from a smaller workforce rebalancing charge in the quarter, but we haven’t yet realized the bulk of savings from our recent actions. Global Business Services revenue was $4.3 billion. We’ve had solid performance in many markets and solution areas. In Japan we’ve been consistently growing revenue and expanding margins, with solid growth in consulting and application outsourcing. And in Europe this quarter we returned to revenue growth. Across all our geographies, we continue to drive strong growth in the offerings that address our strategic imperatives. Our cloud solutions more than tripled year to year, analytics grew double digits, and we had very good growth in mobile and social. We’re helping clients create new business models and opportunities for client engagement. The challenge for Global Business Services is North America. While we have solid growth in our strategic imperatives, we’re dealing with a slowdown in some of the more traditional areas. Because the U.S. is our largest geography, its performance has a significant impact on the overall segment. But again, the U.S. has some very positive elements in GBS. Let me give you one example of the kind of work we’re doing to help clients create opportunities for client engagement. In February, we announced our strategic partnership with AMB Sports & Entertainment to transform the fan experience at the new Atlanta stadium. When complete, when you go to the stadium, you’ll be able to see in real-time which parking lots are available and which are filled, where the shortest concession lines are during the game, and have access to statistics and information from the bleachers. All because we can combine GTS outsourcing and technology capabilities with our GBS process and application expertise to provide a complete solution, creating new markets that didn’t exist even a few years ago. Before wrapping up revenue, let me just remind you that we’ve integrated Global Process Services, our BPO business into GBS to create a seamless end-to-end business transformation capability for our clients and to better leverage our industry knowledge. Looking at GBS profit, the pre-tax margin had a mix of drivers. We got some year-to-year benefit from the lower workforce rebalancing charge, and some savings yield from last year’s action. We were impacted by the Customer Care divestiture, both by the loss of operational profit and by not having a gain in this year’s results. The balance of the margin decline was driven by our cost structure in those geographies where we’re not growing revenue. We’re making investments and taking actions to make our cost structure more competitive, including rebalancing to more global delivery, use of alternate labor models, and shifting resources toward higher-value Strategic Imperative offerings. Our Software revenue of $5.2 billion was down 2%, a modest sequential improvement from the rate in the prior quarter. Key branded middleware grew one percent driven by growth in our Software-as-a-Service offerings, which were up nearly 50%. Total software growth reflects a one-point headwind from operating systems. We had growth across many solution areas. Our analytics software was up, and our mobile software grew at a strong double-digit rate, led by our MobileFirst offerings. We had solid growth in our commerce solutions, where a large proportion of the business is Software-as-a-Service. And our Social solutions grew double digits driven by strong performance in both Kenexa and advanced collaboration offerings. Across software, we’re continuing to drive innovation and capture growth areas importantly building our software into broader solution capabilities. Just this month, we have made two major announcements, IoT and Watson Health. These are a continuation of what we started last year with Watson, then earlier this year with analytics, commerce and security. There are some common threads throughout. They are all based on a unique point of view around cloud and the value of hybrid. They all use analytics to leverage data. And they all have an industry dimension. Let me comment briefly on the two announcements. At the end of March we announced the creation of an Internet of Things unit, committing $3 billion of spend over the next four years. As part of this, we are establishing a cloud-based open platform to help clients and partners build and deliver vertical industry IoT solutions. We have also created an IoT zone within Bluemix, our platform-as-a-service and we are expanding an IoT ecosystem to leverage a growing developer and entrepreneur community. This is similar to what we’ve done successfully around Watson, where we not only have large partners like Softbank in Japan, but we have hundreds of ecosystem partners you may not have heard of yet like Wayblazer, Fluid, Redant, MD Buyline, Elance, Sellpoint, SparkCognition, and LifeLearn, all of whom are building commercial applications on Watson. And then last week we announced Watson Health, which we believe will transform healthcare, by bringing together the advanced cognitive capabilities of Watson with a vast ecosystem of partners, practitioners and researchers. There are several aspects to the Watson Health announcement, from the creation of a Watson Health Cloud, to partnerships with leading companies, to the acquisition of two companies that extend our healthcare analytics capabilities. These are the two most recent examples where we are partnering in new ways to drive innovation and build an ecosystem to transform industries. Turning to our Systems Hardware segment, revenue of $1.7 billion was up 30%, as we continue to deliver innovation across our high end systems. This quarter System z MIPS were up 95% year to year, resulting in revenue more than doubling. We started to ship our new z13 in the second week of March and this was the fastest start in terms of number of systems we shipped in over a decade. We also booked the highest revenue growth in any quarter in more than a decade. The capabilities of the z13 mainframe around mobile, cloud and real-time insights and fraud detection are resonating well with our customers. Let me give you a real example of what we’re talking about. If you are UPS, one of the largest logistics companies in the world, you have to manage nearly 5 billion deliveries a year with highly seasonal changes in demand. Your customers expect their packages to arrive on time, and they expect to schedule, manage and track shipments anywhere, anytime, and increasingly through their mobile devices. These mobile transactions can lead to dramatic increases in overall traffic as customers complete transactions at will. This requires a system that can handle the growth and scale seamlessly when activity spikes, maintaining a secure system that’s always available. That’s why UPS chose to upgrade to the IBM z13 mainframe because it could meet the expanding demands of the mobile economy. Now moving on to Power, revenue returned to growth. We not only took share in the declining Unix market, but we are also expanding beyond Unix, with Linux on Power and our OpenPOWER IP opportunity. We are expanding our customer base in the entry-level Linux systems as well as with large cloud-based players. The likes of OVH, the largest internet hosting company in Europe, Rackspace, and very recently Zuchetti, a leading IT provider in Italy, have all selected Power-based Linux systems to deliver their cloud offerings. In addition, just over a year ago we launched the OpenPOWER Foundation, to open up the Power technology and build an ecosystem to share intellectual property. The ecosystem of partners includes large established players such as Google, Nvidia, Mellanox, Samsung, Tyan and Inspur. But the consortium includes other smaller and emerging players, such as SK Hynix from Korea, Teamsun from China and Nallatech from Scotland, adding tremendous breadth and reach. Last month, the foundation unveiled more than ten new hardware innovations that continue to make Power technology relevant beyond the Unix market. And in the first quarter, we closed our first substantial intellectual property deal, a confirmation of our strategy on Power as an open chip processor. This is an important step for the first OpenPOWER-based system for China. As an example, Zoom Netcom, a data communication and equipment supplier, will launch a system in the market later this year, which is based on the first derivative of a POWER chip unveiled by Suzhou PowerCore. This clearly shows that our Power strategy is working and we see momentum in the business. Our Storage hardware revenue was down 2%, a modest sequential improvement. We again saw strong growth in our Flash Systems. This growth was offset by the wind down of our OEM business and continued price weakness in high-end disk. We see value in the storage market shifting to software and in the first quarter we unveiled IBM Spectrum Storage, new storage software in support of hybrid cloud environments. The portfolio provides greater access to data, accelerates speed to insights and improves data economics. Our Systems Hardware segment growth is a clear result of the actions we have taken to position our Systems business for the future. With good adoption in z13 and Power systems, and launch of the remaining P8 based systems later this quarter, we continue to see good growth in this business. Moving on to cash flow in the quarter, we generated $2 billion of cash from operations, excluding our Global Financing receivables. We spent just under $1 billion in CapEx which is flat year to year, but includes a shift in spend as we build out our SoftLayer cloud centers. And so we generated $1.1 billion of free cash flow, which is up $400 million year-to-year. The primary driver was lower tax payments. This was partially offset by the working capital impact associated with the sale of our System x business, and higher payments for performance-based compensation which was accrued last year. I mentioned earlier that our free cash flow generation is skewed to the back end of the year, and we continue to expect to deliver on our full year objectives. Looking at the uses of cash in the quarter, we returned over $2 billion to shareholders, including $1.1 billion in dividends and $1.2 billion to buy back almost 8 million shares. At the end of March, we had 985 million shares outstanding and $5 billion remaining in our buyback authorization. With the flow through from last year’s share reduction, our first quarter spend, and the remaining authorization, we can achieve the level of share reduction we’ve assumed in our model for the year. Turning to the balance sheet, we ended the quarter with a cash balance of $8.8 billion, which is up from December, but down from a year ago. Total debt was $38.8 billion, with over $26 billion in support of our financing business. The leverage in our financing business remains at 7 to 1. Our non-financing debt was $12.6 billion, which is down $3 billion from a year ago. Our non-financing debt-to-cap was essentially flat vs. December and four points higher than last year. Remember our equity was impacted in the latter half of last year by pension, currency, and the semiconductor manufacturing divestiture. The changes in book equity and the resulting impact on our debt-to-cap ratio do not adequately reflect the financial flexibility we have to support our business over the long term. In fact, on the basis of a core debt to EBITDA metric, we are well positioned to support our long-term growth objectives. Finally, I want to mention that as a result of several court rulings in Spain, including one in March, we booked a $230 million pre-tax charge related to litigation involving IBM Spain retirement plans. The court ruling reverses a voluntary employee program to join a defined contribution plan that was offered more than 20 years ago. This non-operating charge impacted GAAP earnings and pension liability in the first quarter. So now let me summarize the quarter and talk about our full year expectations. We’ve been very clear that we’re transforming our business, and we continue to see signs that the transformation is working. In the first quarter, you see it at the IBM level, and in our segments. Our revenue trajectory improved, driven by an acceleration in our strategic imperatives. We had strength in high-end systems, as our new products address the most contemporary workloads of data, cloud, and mobile. This strength, together with our overall shift to higher value drove margin expansion for IBM. All together, our revenue was flat year-to-year, excluding currency and the impact of divested businesses. And we had mid-single-digit operating net income growth, and high single-digit EPS growth as reported. At the same time, we’ve made a number of bold moves that build on the momentum we started in 2014. These include our hybrid cloud announcement in February, a set of initiatives around Internet of Things in March, and just two weeks ago the launch of Watson Health. It was a good start to the year. Looking forward, we’ll continue to deliver strong growth in our strategic imperatives, while the transitions in some of our businesses continue. We’ll continue to expand our margin as we shift to higher value, and we’ll continue a high level of investment, shifting to areas where we see the best opportunity. We’re deploying capital through different models, organic R&D, capital expenditures, and acquisitions. And we’re building partnerships and ecosystems, not only with the big household names, but with hundreds of smaller firms. This leverages our mutual strengths and expands our reach, all at a high level of return. And of course we’ll continue to return value to shareholders through both share repurchase and dividends. For the full year, we continue to expect to deliver Operating EPS of $15.75 to $16.50. And at that level of profit, we continue to expect free cash flow to be flat for the year. With these dynamics and level of performance, we’ll exit 2015 as a higher-value business. Now Patricia and I will take your questions.

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

Thank you. Martin, could you provide more insight into the overall progress of the transformation? When I look closely, hardware has seen significant growth. However, if we exclude hardware, the rest of the company has experienced a decline of 2%, which aligns with what we've seen in recent quarters. You mentioned that the strategic imperatives are growing at an accelerated rate. If we remove hardware from the equation and acknowledge that the strategic imperatives are improving, does that imply that the core businesses, excluding hardware and these strategic initiatives, are actually performing worse? Additionally, the gross margin for services and software, which make up over 90% of your business, has deteriorated year-over-year even after accounting for the restructuring. I would like to understand better the progress of the transformation beyond what we've observed in hardware, which I assume is cyclical. Should we anticipate a sustainable growth rate of around 30% for the strategic initiatives, and could you help us understand what drives that growth?

Thank you for the question, Toni. There is a lot to unpack in your inquiry, so I will address it at a high level. First, regarding the strategic imperatives continuing at 30%, we do not anticipate this level of growth every quarter for the remainder of the year. As we've noted during Investor Day, these imperatives have been consistently growing at a rate of about 19% to 20% year-over-year. They now represent a significant portion of our business, and we attribute the 30% growth to the mainframe and power cycle. Looking ahead to the rest of the year, we expect to maintain growth in the range of 19% to 20%, and our guidance does not depend on achieving 30% growth. Instead, we anticipate a return to the robust growth we've experienced, which remains strong compared to the market and continues to contribute meaningfully to IBM's overall growth. It's more appropriate to consider it as around 20% growth. In the quarter, as mentioned in my prepared remarks, the performance outside of the strategic imperatives has seen a decline in high single digits, reflecting market conditions, which we noted in the first quarter. Thus, the revenue dynamics in the first quarter were indicative of that trend rather than any fundamental shift in the core business. Additionally, we are making progress in our transformation across the marketplace, at our investment levels, and our focus, all of which are crucial for us to maintain our leadership in enterprise IT. For example, by this time last year, we established the Watson unit and identified a significant SoftLayer expansion plan that we implemented throughout the year. This year, we have restructured some of our business units to better align with how clients engage with us, such as IBM Analytics, IBM Commerce, and IBM Security. Furthermore, we have recently created an Internet of Things group to build upon our Smarter Planet and Smarter Cities initiatives, along with the formation of the IBM Healthcare unit, which leverages several acquisitions and partnerships in that area. Our transformation is continuing at a rapid pace, essential for sustaining our leadership in enterprise IT. However, our guidance is still based on a growth rate of about 20%, as we have successfully delivered over the past five years.

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

Hey, thanks. Just want to ask on the services side, how that came in both in revenue and margin versus plan. Seemed like with mostly done with the heavy workforce rebalancing, heard a little bit about China making shifting away from the lower margins from GTS being a little bit weak. But seems like we could assume certainly better performance starting in Q2, can you maybe expand on that Martin?

Sure, Tien-Tsin. Thanks. So a couple of things. One, we did see a deceleration in GTS in the first quarter in Global Technology Services. But keep in mind that when we had these pretty substantial transactions and new relationships that we signed last year. Those will only move into the run phase over the next few quarters, primarily in the second half. So we would expect those to contribute a bit more or something in fact, they didn’t contribute anything in the first quarter. But they will start to contribute in the Global Technology Services. Margins within Global Technology Services will continue to reflect the currency environment we’re in as well as the investments we are making in order to grow out our SoftLayer platform and to shift the business to these new higher areas. As you noted on our prepared remarks we talked about shifting away from lower margin offerings in some of our site facilities business and redeploying that and that will continue. So from a Global Technology Services perspective between the currency environment that we are in and the shift we are making, and the investments we are making, we are not relying on dramatic growth or margin improvement in GTS in our guidance. On GBS, we've got some very strong results, continued strong results in Japan and in Europe. And we continue to shift that business as well into these new areas where we are comfortable that the margin profile there will be consistent with our guidance also, so two different stories between GTS and GBS within our guidance. We are not relying on dramatic growth here. But we will see some improved performance coming out of the backlog because of the big deals we signed last year.

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

Thank you. Martin, I wondered if we could just look in a little more detail for the software business. The compares get much easier in the back half of the year. And based somewhat on what you're seeing in the business today and if there are no material shifts in the economic backdrop. Would these comps be enough to stabilize the software segment on its own, or is it possible that growth could remain negative given all those different things you talked about in the back half of the year even against the negative comps that we see versus last year in the back half of the year?

Sure, David. Thanks. So software, as we talked about when we provided guidance initially back in January, we said we still feel this way. The difference in our low end of our guidance and our high end of our guidance really depends on the trajectory of software. What we saw in the first quarter was a one point improvement in the trajectory, not back yet to growth, but a one point improvement in our trajectory. Now that's not all year. We haven’t seen it yet all years. But again, the difference high and low guidance is that trajectory improvement. Assuming we were at the same level, same trajectory we had last year, we said that's kind of the low end of our guidance. We do see an environment where that's kind of the trajectory performance that we can rely on, if you will. We continue to sign ELAs with clients. We signed 200 ELAs again in the first quarter. We continue to have an impact in our growth from the operating system component of software. But we saw pretty good uptake in our as-a-service offerings which are driving growth of more than 50%. And at the same time, our clients with their reduced visibility continue to look for flexibility in our offerings for those who have deployed the most. So software again represents for us the difference between the low end and the high end of our guidance. We saw that one quarter sequential improvement in the first and we see how we go for the rest of the year.

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

Thank you. Martin, would you be able to share with us the EPS impact on currency? You gave us revenue, but could you tell us cents per share? And then I was curious on the free cash flow you gave us flat for the year, could you talk a bit about the plus and minus factors that you've got there, CapEx, cash taxes and so forth and how those are going to play out?

Of course. And since currency and free cash flow are so related we will count that as a one part question, Steve. First, regarding currency, we mentioned that the impact on revenue was approximately eight points, translating to over $1.7 billion in the first quarter revenue when converted to dollars. We observed significant fluctuations not just since January but also since our Investor Day, leading to a notable effect on our revenue. In terms of profit, estimating the impact is somewhat imprecise, but we believe the year-over-year profit growth was influenced by about $0.15 to $0.20 in the quarter, which is substantial and affects our margin. Now, with the current state of the dollar, this impact could lead to an estimated $0.80 year-over-year effect on earnings for the full year if rates remain stable, something we are actively considering and managing. As for free cash flow, we anticipate it will remain relatively flat year-over-year. The contributing factors are mainly cash taxes, which we expect to improve by about $2 billion compared to last year. However, this will be offset by increased capital expenditures we've previously discussed. While we anticipate a decrease in workforce rebalancing charges, the timing of these charges may increase cash flow impacts this year by around $0.5 billion compared to last year. Additionally, performance-related cash payments for prior year accruals are expected to rise by $700 million to $800 million. Overall, our cash performance will align closely with our income performance, which is expected.

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

Okay. Thanks. I have a question on the mainframe side. If you are only shipping the new mainframes in the last few weeks of the quarter and you were able to double revenue. Should we assume that we still have some potential for growth to accelerate from here? And then I guess just looking at the cycle overall, can you talk about whether there are any unique financial dynamics for this cycle that we should consider relative to last few cycles. I guess, I'm particularly focused on the dynamics around pricing where it looks like you actually had an ASP tailwind relative to MIPS growth this quarter and also the pull through for as-a-service on this platform. Thanks.

Sure, Bill. Regarding the mainframe, we had an excellent first quarter, which aligned with our expectations. This performance was anticipated and not a surprise to us. It’s important to note that many misunderstand two key aspects of the mainframe. Firstly, there’s often an underappreciation of its essential role and the impact that an upgraded mainframe has for our clients, such as UPS, which relies on timely delivery of 5 billion packages, requiring reliability. Secondly, it's crucial to recognize the difference between consumer technology and enterprise technology. While we started shipping the mainframe in March, discussions with around 60 clients have been ongoing for months to tailor these systems to their needs. The January announcement marked the beginning of building value propositions for our clients, and our sales efforts commenced then. The timing in March indicates how effectively our supply chain fulfilled demand in that quarter. Understanding this process from an enterprise perspective is different than viewing it through a consumer lens. We were very satisfied with the first quarter's performance as it met our expectations. Historically, the second quarter tends to be our largest for the mainframe, and we anticipate it will be larger this year than the first. Although we will face comparison challenges due to last year’s strong second quarter, we expect solid growth, potentially around 50% between the first two quarters. With a notable increase in revenue against a slight rise in MIPS, it’s clear our clients find tremendous value in the mainframe, which benefits IBM significantly. We're pleased with the mainframe’s results; it’s a robust platform powering global business.

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

Yeah Martin, I'm wondering if you could talk a little bit about how customers are feeling in the broad IT spending environment. It seems like financials in the first quarter were actually very strong and a huge FX impact. So, I'm just curious how customers are feeling and how we should think about general seasonality throughout the year?

For us, Brian, I think couple of things. One, we have not seen a dramatic shift in trajectory across a lot of our sectors. The financial services sector is obviously one where the mainframe plays a pretty vital role in how the world banks run and when you get a new mainframe, particularly when so relevant to them shifting their business into mobile, particularly one where counter fraud is such an important part of what they have to think about every day. And again, you need scalability, you need reliability. You have to run all the time. That, as a particular, that new mainframe as an emphasis within the financial services sector, and therefore we did see an improvement in the trajectory in financial services. But across the rest, I would say not a dramatic shift in what we saw in the first quarter. Again, the common thread that we're seeing is not a sector-by-sector other than what I pointed out in the financial services. The common thread here is the relevance of our offering in the strategic imperatives where the need for mobility, the need for social ways of engaging either your employee base, your client base and the need for really powerful scalable systems kind of drove the day in the first quarter with 30% growth year-to-year relative to what had been a 20% kind of growing business.

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

Hi, Martin, thanks for taking the question. I want to go back to cash flow, if I could. In your past comments, you talked about this year being flat, but previously called out a number of one-time items including pensions. And I was just wondering if you could comment directionally how we should be envisioning cash flow in 2016 relative to 2015. It seems like some of the items should be one-time in nature, but the tax payments, restructuring, et cetera, been both directionally and relative to the percent that you normally provide versus net income.

Sure. A few things, Keith. First, as we've mentioned multiple times, we expect cash flow to remain flat in 2015 compared to 2014. The drivers of our realization in 2014 were mainly two-fold. We had a significantly high cash tax rate last year in relation to net income, and as I noted earlier, we don't anticipate facing the same level of challenges this year. Therefore, taxes will not negatively affect cash flow in 2015. I’ll discuss 2016 shortly. Additionally, last year, we experienced a substantial gain that appeared as cash in IBM Corporation but affected the investing line rather than the free cash flow line, which diminished our realization by about 20 points. This year, as mentioned, we won't have cash taxes as a major hurdle, and we expect a significant improvement in our realization this year. I also touched on the differences in cash flows this year, including performance-related payments, workforce rebalancing payments, and increased capital expenditures in 2015, but we still anticipate an improved realization rate this year. Looking ahead to 2016, I expect a few things to occur. We will likely face cash tax challenges again. However, this is at a planning level, and since we’re nine months from the start of the year, there’s still a long way to go before closing out audits and other considerations. At this point, we foresee another cash tax headwind in 2016. Regarding pensions, we’ve been managing our closed pension plan and adjusting our asset portfolio to more closely align with our liabilities by shifting to more debt instruments and interest rate securities. This has reduced our risk in the portfolio. Our U.S. pension remains very well-funded, and our global pensions are in a stable funding position, so we don't expect significant impact from pensions at this time.

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

Hi. Thanks. Martin, I was hoping you could walk through your expectations for profitability as we move through the year? It looks like from a profitability perspective on a year-over-year basis, services and software declined a bit but hardware was more profitable. Hoping you could walk us through the rest of the year. Thanks.

Sure. I'll discuss our expectations for the remainder of the year, starting with a full-year outlook before focusing on the near-term, particularly the second quarter. First, as mentioned earlier, our low end of guidance assumes that software performance remains stagnant for the rest of the year. The first quarter slightly exceeded that expectation, while the high end of guidance anticipates a modest improvement in our software business, returning to nearly flat. In the near-term, we typically experience a change in our pretax profit from the first to the second quarter. As we continue to transform our business and make investments, we expect to see growth in our strategic initiatives, and another solid quarter from the mainframe. However, the transformation process may still result in a typical change in pretax profit between the two quarters. Additionally, on a year-over-year basis, our workforce rebalancing charges from previous years can make growth rates appear unusual. With a similar level of workforce rebalancing expected from the first to the second quarter this year, we can eliminate that variable. Consequently, while considering the transformation and our mainframe cycle, we anticipate a more standard sequential improvement of around $1 billion in pretax profit quarter over quarter. Overall, the difference between the high and low ends of our guidance is primarily influenced by the expected trajectory in software performance.

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

Yes, thank you. Thanks for taking my question. Martin, could you talk about any changes in IT spending demand trends, especially in regions where there were significant effects, double the factor at all in terms of any deferrals? And can you help us think through how the expense levels will change with FX relative to the revenue levels as we go through the year. This quarter they were in pretty good alignment, but you also saw a pretty strong America's revenue. So, just wondering what the puts and takes there could be.

Yes, I have a few points to share. We didn't observe any significant improvement in the Asia-Pacific region, where we continue to experience a slow spending environment that reflects the broader market conditions. In Japan, spending is doing well and our performance remains strong there. This success is attributed not only to the environment but also to our team's exceptional efforts in sustaining growth for three consecutive years, supported by a reasonable spending backdrop. Meanwhile, in North America, particularly the U.S., we have seen positive performance and a spending environment that is conducive to our investment strategies and business transformation. Overall, aside from a few areas with weak spending in Asia-Pacific, the general environment appears reasonable. Regarding expenses, we are focused on maintaining our investment levels, and as noted earlier, excluding currency translation effects and divested content, our spending has been relatively stable year-over-year. Consequently, on an EDR basis, it remained about the same, and we will continue to allocate spending towards strategic initiatives. While we achieved 30% growth, which we don't expect to maintain, it's important to note that this growth is supported by a significant shift in spending within IBM, with funding coming from our core businesses. Thus, some of the decline in the core business is a result of this engineered shift towards our strategic imperatives.

Thank you, Wamsi. Dory, let's take one last question, please.

Thank you very much. And if you can focus a little bit on the Services segment. Help us understand kind of what's going on there. It looks like both GBS and GTS profitability is down year-over-year and the signings have a lot of volatility around them. But kind of the rate of $10 billion seems to be a multi-year low. How should we kind of think about what's going on in services, mostly the shift to the strategic imperatives and how should we kind of think about that. Could it be the shift we would expect profitability to actually be up year-over-year, or maybe it's FX? Thank you.

Certainly, there are several factors to consider. It's true that foreign exchange is impacting how some of our service profits are converted back to U.S. dollars. However, in a broader sense, there is significant potential for growth in signings during the first quarter. We definitely see ample opportunities for continued expansion in our outsourcing segment, which is experiencing double-digit growth across all areas. While the total backlog remained essentially unchanged year-over-year—despite some fluctuations due to currency and divestitures—it's worth noting that in services, particularly within Global Technology Services, we are making substantial investments. For example, we are enhancing our SoftLayer platform and developing our infrastructure-as-a-service offerings, both of which are showing strong growth. Additionally, in the GBS sector, we are seeing solid performance in Japan and a return to growth in Europe, which is promising. There are also strengths in several emerging markets, including Latin America and the Middle East and Africa. However, we are experiencing a slowdown in revenue from our U.S. operations, primarily driven by consulting services. Despite that, we have managed to grow our signings in the U.S., which indicates that we are building a backlog that should generate future revenue. We acknowledge that our U.S. consulting business is facing challenges, yet the mix within GBS remains consistent globally and is heavily weighted towards strategic imperatives, which are driving high growth. Overall, while we recognize that we have work to do in the U.S. market, there is encouraging growth and performance in other regions for GBS. So, I wanted to wrap up the call just with a few points. And again, to thank you for joining this afternoon. Our first quarter performance, we view as another proof point that the strategy is right, the actions we're taking to reinvent our businesses, the innovation we're delivering in our hardware business and our software business and in our services businesses, is starting to pay off and the investments and the focus on those solution areas are all contributing to the very strong growth we saw in the strategic imperatives. So, as we move through the year, we'll continue the transformation. We'll continue to make these investments and to build those ecosystems that we talked about. It certainly takes some time. But, certainly this was a very good start to the year. So, thanks for joining.

Dory, can I turn it back to you to close out the call for us?