International Business Machines Corp (IBM) 2013 Q1 法說會逐字稿

Welcome, and thank you for standing by.

At this time, all participants are in a listen-only mode.

Today's conference is being recorded.

If you have any objections, you may disconnect at this time.

Now I will turn the meeting over to Ms. Patricia Murphy, Vice President of Investor Relations.

Ma'am, you may begin.

Thank you.

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

I'm here with Mark Loughridge, IBM's Senior Vice President and CFO, Finance and Enterprise Transformation.

Thank you for joining our first-quarter earnings presentation.

The prepared remarks will be available in roughly an hour and a replay of this webcast will be posted to our Investor Relations website by this time tomorrow.

Our presentation 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 and in the Form 8-K submitted to the SEC.

Let me 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.

Now, I'll turn the call over to Mark Loughridge.

Thank you for joining us today.

In the first quarter, we reported $23.4 billion in revenue, expanded gross pretax and net operating margins, and delivered operating earnings per share of $3, which is up 8% year-to-year.

But this quarter certainly didn't close the way it started.

We had solid profit performance in January, but as the quarter ended, hundreds of millions of dollars of very profitable Software and System z mainframe deals fell short of the goal line.

This impacted the first quarter close, but the rollover of these deals positions us for a strong start in our Software and Mainframe business in the second quarter.

Taking full consideration of our first quarter performance and a number of actions to improve this performance, we continue to expect operating EPS of at least $16.70 for the year.

Now, let me make four points about what we saw in our business this quarter.

First, our total Services business performed as expected, with year-to-year constant currency revenue growth in line with last quarter and pretax profit up 10%.

Our backlog was up 1% year-to-year, or 5% at constant currency, driven by a lot of new business in the quarter.

Second, we had a shortfall in sales execution in our Software and Mainframe businesses, but with a good list of rollover transactions coupled with improved execution, we've got a strong hand going into the second quarter in these businesses.

Third, in our growth initiatives, Smarter Planet was up over 25% and Cloud over 70%.

Business analytics was up 7%, led by double-digit growth in GBS.

But our growth markets revenue was up 1% at constant currency, clearly not what we expected or what we needed.

Across IBM, we delivered strong growth in several of our offerings to address market trends, like SaaS and mobile, where we grew over 50%, leveraging our organic and acquisitive investments.

As these become a larger part of our business, they will contribute more to our growth.

Finally, there are parts of our business that are in transition or have been underperforming, like elements of our Power Acts and Storage product lines that show disappointing performance in the first quarter.

Here, we're going to take substantial actions.

Now, let me describe how this impacts the year.

With the improved execution in our Software and Mainframe businesses, we would expect the operating EPS growth in the second quarter to be similar to that of the first.

However, given our first quarter performance, we now expect to take the bulk of our workforce balancing actions for the year in the second quarter.

As opposed to last year when it was distributed across the quarters.

Though we certainly don't have a specific approved action, this will result in a charge that will additionally impact the operating EPS we report.

Like all years, we have a number of actions planned to improve the business for the long-term, acquiring and divesting businesses and rebalancing our resources.

This will result in charges in the second quarter and gains in the second half, which we expect will roughly offset for the year.

By the end of 2013, taking into account our operational performance, benefits from the workforce rebalancing activity, and gains in charges, we're confident we can achieve at least $16.70 of operating EPS for the year.

Let me now walk you through the financial metrics for the first quarter.

In total, IBM's revenue growth at constant currency was down 3%.

We entered the quarter with a modest currency headwind, but became more pronounced due to currency movements over the last 90 days, especially in the yen.

When you look at the reported revenue for the quarter, currency impacted our revenue growth by 2 points.

Turning to the profit metrics, our ongoing focus on productivity and our shift to higher value contributed to our margin performance, with expanded operating gross margin by 1 point, led by Services and an improving mix.

And we expanded operating pretax margin by 0.8.

Our tax rate for the quarter was 17.3%, down approximately 3 points year-to-year.

The lower tax rate is primarily due to benefits recorded to reflect changes in tax law enacted during the quarter, including the reinstatement of the R&D tax credit for 2012.

We expect our ongoing operating tax rate for the next three quarters to be in the range of 25%.

Our operating net income grew 3% and our margin was up over 1 point.

With nearly 12 billion in gross share repurchase over the last 12 months, we reduced our share count by 4%.

When you bring all of this together, we delivered operating EPS of $3, which is up 8%.

Turning to cash, we generated $1.7 billion of free cash flow in the quarter and ended the quarter with a cash balance of $12 billion.

Now, I'll get into the results, starting with revenue and gross margin by segment.

Year-to-year constant currency revenue performance in our combined Services businesses was consistent with the fourth quarter.

At constant currency, GBS performance improved 2 points, while GTS revenue growth slowed due to continued pressure on sales into existing accounts, and actions taken to restructure the low margin outsourcing contracts.

In Software, we had good performance in several key areas such as Smarter Commerce, Social Business, Security, and Storage Management, but our growth rate was impacted by the inability to close some large transactions at the end of the quarter.

In Systems and Technology, while we're delivering good performance in System z mainframe, despite the slipped deals, and in our PureSystems offerings, weakness in Power, System x, and Storage resulted in overall declines.

Looking at our gross profit, our operating gross margin improved 1 point, driven by a combination of good margin expansion in both Services segments, and an improving segment mix.

Looking at revenue by geography on a constant currency basis, Americas' revenue was down 3%, with declines in both the US and Canada mitigated by double-digit growth in Latin America, led by Brazil and Mexico.

Our EMEA revenue was down 4% year-to-year, about 0.5 point lower than last quarter.

Most of the major countries declined, though Spain returned to modest growth.

In Asia-Pacific, revenue was down 1%.

Within that, Japan revenue was up 3%.

This was the second consecutive quarter of revenue growth in Japan, reflecting the stabilization of our business in that country.

The balance of AP, which is part of our growth markets, declined.

Across all geographies, our growth markets revenue was up a disappointing 1%, though 5 points faster than the major markets.

BRICs were up 3% led by Brazil.

But China and Russia posted modest declines.

China's performance was impacted by weakness in large deals and a slowdown in our low end and midrange products.

Now, let's take a look at our expense profile.

Our total operating expense and other income was down 4%.

Acquisitions over the last 12 months drove 2 points of expense growth.

Currency contributed 1 point of expense decline, driven almost entirely by translation.

Consequently, our base expense, excluding currency and acquisitions, was better by 5 points.

I'll comment on a couple of expense items that had larger year-to-year impacts to our profit.

First, workforce rebalancing was better by about $200 million year-to-year, driven by a charge in last year's results.

Second, our IP income was down over $70 million year-to-year.

Typically, we talk about the impact of our hedging programs as a driver of expense.

In first quarter, the hedge activity was neutral year-to-year, with very modest gains in both periods.

In the quarter, we were impacted by significant depreciation of the yen, as our business in Japan is more heavily skewed to local services, the ability to hedge cross-border cash flows is low compared to most other countries.

This had a profit impact in the quarter, which would continue at current spot rates.

So now let me go into the segments.

This quarter, the two Services segments generated $14 billion in revenue, grew pretax profit 10%, and expanded pretax margin by 2 points.

Total backlog was $141 billion, up 1% at spot rate, but up 5% at constant currency.

Backlog grew in both the transactional and outsourcing businesses.

In fact, we had 22 deals greater than $100 million.

We closed large transformational deals in every geography, but we had particularly good performance in our major markets, where the vast majority of these 22 deals were done and nearly 50% of those were new Services contracts.

These deals contributed to our major markets backlog, which was up 3% in constant currency and grew for the first time since the end of 2010.

Turning to the two segments, Global Technology Services revenue was $9.6 billion, down 4% as reported, and down 2% at constant currency.

There were two major categories affecting revenue growth.

The first was a continuation of the decline in revenue from sales into existing base accounts.

This activity tends to be more transactional in nature and economically sensitive.

And as expected, GTS revenue continued to be impacted by the work we've done to improve profitability of the restructured low margin outsourcing contracts.

That initiative has helped improve our margin performance again this quarter, but does reduce the top line.

We estimate that impact to be about 1 point of revenue growth to GTS and to Services in total.

These two items were reflected primarily in GTS outsourcing revenue, which was down 3% at constant currency.

In Integrated Technology Services, revenue was up 2% at constant currency, led by continued strength in the growth markets and a third consecutive quarter of growth in Japan.

GTS delivered 7% pretax profit growth in the quarter and expanded pretax margins by about 2 points.

This quarter, margin expansion was driven by continued efficiency improvements, primarily through our enterprise productivity initiatives, and lower workforce rebalancing charges.

Turning to Global Business Services, revenue was $4.5 billion, down 3% as reported, and flat at constant currency.

This represents an improvement of 2 points quarter-to-quarter at constant currency.

From a geographic perspective, the growth markets in Japan drove the strongest performance, while North America slowed its rate of decline versus last quarter.

Looking at the GBS business by offering, we had good results in our solutions that address the digital front office.

We delivered double-digit growth across the Initiatives, Business Analytics, Smarter Planet, and Cloud.

As these become a larger part of GBS, they will contribute more to the top line performance.

And as we address the Globally Integrated Enterprise, our traditional back office solutions, we're continuing to focus on improving our performance in implementation services that support the traditional packaged applications.

Turning to profit, GBS pretax income improved 17% year-to-year and pretax margin expanded 3 points.

The main year-to-year profit drivers were continued benefit from our Enterprise Productivity Initiatives, lower workforce rebalancing charges, and improved contract performance.

So to wrap up Services, we grew backlog 5% at constant currency, with the major markets up for the first time since the end of 2010.

Growth initiatives continued to perform well.

We're continuing to improve in transition areas like traditional packaged application implementations, and we expanded profit margins and delivered 10% growth in our pretax income.

Software revenue of $5.6 billion was flat year-to-year, or up 1% at constant currency.

Pretax income was up 4% year-to-year and pretax margin is up 1.2 points to 31.5%.

As I stated up front, Software growth was impacted by a number of large transactions that rolled into the second quarter.

E branded middleware grew 1% or 2% at constant currency.

Now, let me give you some insight into our branded middleware performance.

WebSphere grew 7% at constant currency.

For the 12th consecutive year, Gartner designated IBM the worldwide market share leader in the application infrastructure in middleware segment.

In the quarter, we had strong double-digit growth in Smarter Commerce in Smarter Cities, leveraging our organic and acquisitive investments.

Our SaaS offerings contributed to this strong performance.

To address the emerging opportunity around Enterprise Mobile computing, in the first quarter, we introduced MobileFirst, which combined deep mobile expertise with Cloud-based services.

Information Management was down 1% at constant currency.

The brand most impacted by the large rollover transactions.

However, we did hold share.

Tivoli was up 3% at constant currency, driven by Security and Storage.

Security was up 15% at constant currency, driven by a Security Intelligence and Identity and Access Management product segments.

Security Intelligence, which more than doubled this quarter, provides solutions to help clients identify threats more quickly, prioritize risks more effectively, and automate compliance activities.

Identity and Access Management was up double-digits, allowing organizations to mitigate risk by controlling and monitoring users' access, which is even more critical as IT infrastructures become more interconnected.

Tivoli Storage, which enables customers to manage their rapidly growing data, grew 11% at constant currency.

Social Workforce Solutions, which includes our recently acquired Kenexa business grew 9% at constant currency.

We began building a Social Business platform several years ago and we've been ranked as the number one Enterprise Social Software vendor for three consecutive years by IDC.

Across the Software brands, as we close the transactions that rolled over, we should deliver double-digit growth in key branded middleware in the second quarter.

Systems and Technology revenue of $3.1 billion was down 17% year-to-year, or 13% at constant currency, adjusting for the divestiture of Retail Store Solutions.

System z grew 8% at constant currency.

MIPS were up 27% and more than 50% of the MIPS were from Specialty Engines, which were up more than 65%.

Within that, Java was up 70%.

Database, 24%.

And Linux nearly doubled.

Like Software, as we close the large transactions that rolled over from the first quarter, we should be able to deliver double-digit revenue growth in our System z Business in the second quarter.

We're also continuing to see traction in PureSystems, our expert integrated systems.

We completed our first 12 months of operations for PureSystems and have sold over 4,000 systems in over 90 countries.

Power revenue was down 31% at constant currency.

Our declines were driven by both the high performance computing segment, where we had a strong performance last year, and the impact of the transition to Power7 Plus.

Let me step back and provide a broader perspective.

We are by far the market leader in UNIX.

We are expanding our Power platform to go after the Linux opportunity.

This opportunity is of similar size to UNIX, but growing faster.

We have already had some key successes with wins this quarter in China and in Europe, and in fact, Watson is based on PowerLinux.

Though this will take time to mature, it provides a real opportunity for future growth.

System x was down 8% at constant currency and our Storage revenue was down 10% at constant currency.

We had strong growth in our new midrange products.

Storage gross profit was up, as our organic Storwize products grew over 50% and replace older OEM products.

The value in Storage continues to shift to Software.

Our Storage software, which is reported in Tivoli, grew 11% at constant currency.

For Systems and Technology, this is not the quarter we expected.

Our performance was impacted by product transitions and our own execution.

We expect to improve our revenue performance in the second quarter and return to profitability, excluding the second quarter workforce rebalancing activity.

Moving on to cash flow in the quarter, we generated $1.7 billion of free cash flow, down almost $200 million year-to-year.

The year-to-year performance was driven by a decline in our accounts receivable clearance rate and an increase in cash tax payments.

These were mitigated by a year-to-year benefit associated with the timing change of funding our 401(k) and a lower level of CapEx.

Looking at the uses of cash, we have closed two smaller acquisitions this quarter, StoredIQ and Star Analytics.

We returned $3.5 billion to shareholders, including almost $950 million in dividends and $2.6 billion in gross share repurchases.

We bought back 12.3 million shares in the quarter and at the end of March, we had $6.2 billion remaining in our buyback authorization.

Turning to the balance sheet, we ended the quarter with a cash balance of $12 billion, up $900 million from year-end.

Total debt was $33.4 billion, of which over $25 billion was in support of our financing business, which is leveraged at 7.2 to 1. Our non-financing debt was $8.2 billion, down $600 million from year-end.

At these debt levels, non-financing debt to cap was 34%, down 2 points from year-end.

We continued to have a high degree of financial flexibility and our balance sheet remains strong to support the business over the long-term.

So now let me start to wrap up with a summary of the drivers of our operating earnings per share performance this quarter.

Our revenue decline impacted our earnings growth by $0.14.

The contribution from margin was $0.23, with gross pretax, the net margins all up year-to-year, driven by our mix to higher value, margin expansion in Services, and a lower tax rate resulting from changes in tax law during the quarter.

A lower share count resulting from our ongoing share repurchase program contributed an additional $0.13.

For the quarter, we delivered 8% operating earnings per share growth.

As I said at the beginning of the call, the quarter didn't end the way it started, so we're going to roll up our sleeves and get this back on track.

First, by improving our sales execution to close the rollover deals in Software and Mainframe, and recover our position in the growth markets.

Next, by taking the bulk of our workforce rebalancing actions in the second quarter, we'll start to get the benefits from those actions earlier in the second half.

Finally, by taking actions to improve our underperforming businesses, including expanding our Power platform to address the Linux opportunity, and leveraging our investments in Flash and Midrange Storage solutions.

Some of these actions will yield benefits quickly, while others will play out over time.

And of course, we're going to continue to deliver on the core elements of our business model, as we continue to shift to higher value, leverage our key growth initiatives, drive productivity across the enterprise, invest in innovation, and return value to shareholders.

Now, we've got a lot of work to do, but we know how to get it done.

By the end of 2013, taking into account our operational performance, benefits from workforce rebalancing activity, and gains in charges, we expect to deliver at least $16.70 of operating EPS for the year.

All of this is consistent with our objective to achieve at least $20 of operating EPS in 2015.

Now, Patricia and I will take your questions.

Thank you, Mark.

Before we begin the Q&A, I would like to remind you of a couple of items.

First, we have supplemental charts at the end of the deck that complement our prepared remarks.

Second, I would ask you to refrain from multi-part questions.

When we conclude the Q&A, I'll turn the call back to Mark for final comments.

Operator, please open it up for questions.

(Operator Instructions)

Toni Sacconaghi, Sanford Bernstein.

Yes, thank you.

Mark, I just wanted to make sure I understood what you're commenting for Q2 and how that relates to the rollover impact that you also mentioned.

So I think you said that operating EPS growth would be similar in Q2 to Q1, which I think was about 3.5%.

I'm surprised that that's not dramatically higher than it was in Q1, because you have a much easier comparison and also because you're suggesting that you had several million dollars in pushed out revenues, that's high margin.

In fact I think if you work backwards from consensus, you missed revenues by $1.4 billion.

If you take out currency, you missed by almost $1 billion.

If you really were on plan other than slipped deals, that would suggest that you should have $1 billion of high margin incremental deals next quarter.

And I'm not sure why your pretax -- why your EPS growth wouldn't be a lot higher.

Related to that, are you expecting any EPS growth after your restructuring charges in fiscal Q2?

Okay, let me talk through that.

First of all, when you look at the second quarter, in your comments on the second quarter, we have a very good set of rollover transactions going into second.

As you correctly pointed out.

And if you look at that composite that rolled over the dateline for us, we're talking about, you know, more than $400 million of mainframe software and intellectual property.

Now, so that does give us confidence in the second quarter.

Toni, I did not mean to indicate that all else would also be on the original performance track.

So in fact, I still believe there are parts of our business that are in transition or have been underperforming that also were disappointing that are going to take some time to recover.

So let me do a couple of things to help clarify that.

If we look at the first quarter, I think our total Services business did perform as expected on an I&E basis and the revenue was about what we saw in the fourth quarter, pretax profit was up 10%.

The real positive news out of the Services business in the first was in fact backlog performance.

So backlog was up 5% at constant currency, and I'm sure you've looked at all the supplementals.

We've really had a great quarter for bookings, up almost 50%.

So that drove a lot of new business in the quarter.

That backlog performance is well distributed.

Major markets backlog is up 3%, growth markets backlog is up 10%.

If you looked at the other elements through the different axes, outsourcing backlog up 4%.

Transactional, up 9%.

So I think the teams and services delivered on their objectives on profit and they did sign a lot of new business.

And I will tell you when you look at the content of the deals that they, too, have rolling into the second quarter, they have got a very strong lineup.

So with that, I think for both of the Services businesses, by the time we get into the second half, they should be growing at low single digit and I would peg that at about 2% constant currency for both of them.

We'll start to see this backlog really improve their performance.

Second, as you did point out, and I quite agree with your comments, we had a shortfall on the sales execution of our Software Mainframe businesses.

Those should roll over.

And they should present those with very good performance in the second quarter.

Now, by that, in that over $400 million of Mainframe software and intellectual property that rolled over, we should see our strategic middleware, I think, in kind of the double-digit framework, which would give us total Software in mid single digits.

We should see our Mainframe business at double digit as well.

So with that performance, really our STG business should return to profit in the second quarter.

Third, when you look at our growth initiatives, I think to be quite clear about it was mixed, Smarter Planet I think did well up 25%, our Cloud business up 70%.

I thought they did well, and it came across content that we sell to our customers so they can set up a private could, that was up more than 75%.

Managing that content for our customers in private cloud doubled.

Our Software as a Service business was up 65%.

So all of those elements I thought performed well.

But on the other side, our growth markets revenue was up only 1%.

So they need to get that back to that mid single-digit characteristic that we're looking for in the second quarter.

If you looked at their metrics today and put them on the table, they would be pointing at mid single-digit performance.

But I think to your, to the point I was making earlier, there certainly are parts of our business that I've put in the category of underperforming and they did disappoint us in the quarter.

Power Storage products within that, and I do think in Power, if you look at their performance in that opportunity of unit space, once again they picked up share.

But it doesn't mean much if you're declining at double digits.

Now, part of that was compared based on high performance computing, but it is easy to subtract out their double-digit decline.

New products are going to take some time to improve their performance by six to nine months.

But they also need to move into new opportunity spaces like Linux in a bigger way.

We do have some real successes there.

And the Linux market right now is as big really as the UNIX market and growing more rapidly.

Then the Storage products, we need to take advantage of the flash memory content that we built up and that we reviewed in Almaden.

If you look at the second quarter, flash memory could improve that storage growth rate by about a point and a half.

By the time we get to the fourth quarter, by 3 to 4 points.

But those elements are going to take more time than I think we would originally have thought.

The other point that I would tell you about, the second quarter, I want to be clear about is the yen.

So the yen had an impact -- total currency had an impact of point and a half in the first quarter.

Then we would see about 2 points in the second quarter and current spot rates that would lead to a year of about 2 points impact.

A lot of that impact is frankly the yen.

And you've seen how much the yen has moved in the short period of time.

Now, when we hedge free cash flow, we hedge the underlying cross-border cash flows.

So you tend to have royalties for Software.

You have costs for our hardware content, really related to the big export business that we do.

But on Services, you don't have that underlying cross-border cash flow to hedge, and most of that is done on a local basis, with local resources, local competition.

Not many cross-border cash flows in a lot of that content, especially in Japan.

And in Japan, the lion's share of the business, and I mean we're talking 75%, 80%, is Services content.

So when we get hit by the yen in our largest country without the ability to hedge that free cash flow on a cross-border basis, that does fall to the bottom line.

And we would look at the impact in the second quarter at about $0.10.

Thanks, Toni.

Could we go to the next question, please?

Steve Milunovich, UBS.

Thanks, Mark.

First, I wanted to clarify the employee work force charges in the second quarter.

Are you excluding that from your operating earnings guidance, or is that somehow in there?

In the past, you've often been able to find gains to offset that, but it sounds like you're kind of excluding that.

Then I just wonder if you would comment on the environment.

Had you some execution problems in the third quarter last year.

You've apparently got some in the first quarter.

It sounds like either you need to maybe swap out some managers or more likely, everybody's missing enterprise numbers this quarter.

What do you think is going on?

Is it macro?

Is it people looking at their Cloud architectures and just delaying things?

And why particularly at the end of the quarter?

Okay.

Let me take both of those questions.

I'm going to start with your first.

First of all, let me put this in context.

So when we gave our original guidance in January this year, we said that this year would be like other years in that we're going to buy and sell businesses, we're going to record gains and charges, we're going to invest in innovation, and continue to rebalance our work force to future opportunities.

We said that in an all-in basis, we feel confident with an at least $16.70 of operating EPS for the full year.

And that is still the case.

Now, in the first quarter, we recorded 8% EPS growth.

And as we look at our book of business, especially the strength of the rollover deals for Software Mainframe, we should see similar EPS growth in the second quarter just as we had a conversation around Toni's question.

However, this will be further impacted by work force rebalancing charges, which I will come back to.

In the second half of the year, we would expect our EPS growth to improve in the third quarter and further improve in the fourth quarter to double digits.

So even excluding the second quarter work force rebalancing charge and second half gains, we feel that very confident we can achieve the 9.5% EPS growth for the year to drive at least $16.70 of EPS.

Now, remember, last year we had about $800 million in work force rebalancing charges spread across the year.

This year we expect the work force rebalancing charges to be closer to $1 billion and concentrated in the second quarter, though we really haven't finished the work for a specific action yet.

But like last year, we expect the bulk of that charge to be outside the US.

And with that, on an all-in basis, including all gains and charges, we're confident we can achieve at least $16.70 of operating EPS for the year, just as we said in January.

Now, on your second question, regarding the first quarter, let me give you a view on a kind of our side of the table, the IBM Corporation, and then I'll give you a feeling for some of those macro issues that we also faced.

So I think as we explained in the prepared remarks that by and large this is an execution problem.

I mean, we should have closed on those rollover deals.

And we thought we had them right up to the end, and we put a lot of work into how to build that pipeline and our execution against it to compensate in a way for Easter at the end of the quarter.

And the last time we had an Easter in March, you know, was 1Q '05 and that was also a very disappointing quarter for us.

But were those deals affected by Easter?

Well, the bulk of that 400-plus deals that closed across the dateline, the bulk of them, and I mean really by far the majority, were in Europe and they were in the US.

So it's hard to imagine that we weren't affected by Easter.

Secondly, if you look at the US, was there an effect of, some effect of the sequester?

It's hard to measure.

I can tell you that our US federal business was down 13%, which was certainly a drag on the US performance.

But I think the other element that in a way we kind of misjudged, the change in the Chinese government really ripples down all the way to the provinces and state-owned businesses.

And as we went through that, I mean, we're talking about once every 10-year event.

As we went through that with the team, I don't think we fully accounted for the impact that would have.

And then the last point I would make is the yen.

But once again, I want to return to the point that had we simply closed on those deals at the end of the quarter, we would have certainly had sufficient business to close the first and enter the second with strength.

Thank you, Steve.

Operator, can we take the next question, please?

Ben Reitzes, Barclays.

Yes, hi, Mark.

Wanted to ask about your cash usage in the second quarter.

If you had such good bookings and the second half is going to be so much better, it would seem that it would be prudent to accelerate your buyback and you have $6 billion left.

And then I also wanted to sneak in another and ask, there's some speculation that you might sell the X86 server business on the tape and maybe, you mentioned divestitures in your prepared remarks.

I was wondering if you could elaborate on that and clarify what we're hearing.

Sure.

First of all, let's talk about cash and the implications for cash.

So, if you looked at the first quarter, our free cash flow was $1.7 billion, and as we pointed out, that's down $200 million.

Now, there were two very distinct implications to that that I will cover now.

The first is the impact of cash taxes, and the second sales cycle working capital.

So let's take cash taxes first.

If you look at cash taxes, in fact, on a year-to-year basis in the first quarter, cash taxes were an impact of about $200 million, and as we faced the second quarter, there will be an impact of about $900 million, and for the year, as much as $2.4 billion.

So if you look at our free cash flow performance in the year, excluding that cash tax implication, I feel confident that we'll be growing our free cash flow outside of that, but we're not going to overcome $2.4 billion of additional taxes in a year.

If you look at that as a percentage against the book tax rate in the first quarter of about 17% on an operating basis, actually our cash tax rate was about 30%, and if you roll that out through the quarter, for the year, this year the cash tax rate and the book tax rate, we expect to relatively converge on a full-year basis.

Now, let's talk about sales cycle working capital.

That, too, was an impact of about $200 million in the quarter.

Against that, what we did see is a growing propensity for late payments on customers' parts.

And frankly, our receivables clearance rate, the rate at which we clear them, was not as good as we had expected either.

And then lastly, in the negotiations on deals, a lot of attention on our customer side on Ts and Cs affecting the cash flow elements receivable payables, in some respects even more than price.

So what we saw, what we took from that is lot of attention to the cash balance and holding on to that cash balance.

Now, all of this content, however, I want to reassure you was considered as we went through the view of free cash flow across the road map in that range of $90 billion to $100 billion.

And so, very confident that we're going to complete the $50 billion of share buyback.

If you look at it, we've done almost $30 billion to date.

$20 billion of acquisitions is a very realistic number, both from cash availability and opportunities and $20 billion in dividend for a total of $90 billion.

And with that, we should still have good flexibility, financial flexibility at the end of 2015.

Secondly, on speculation and rumors, I'm obviously not going to comment on rumors, Ben.

Thanks, Ben.

Can we go to the next question, please?

Katie Huberty, Morgan Stanley.

Thanks.

Hi, Mark.

First, how much of the $400 million in delayed deals have you closed so far in April?

And then just curious if you think there's a reasonable explanation for why IBM was able to close so many large Services deals in the quarter, but customers at the same time are delaying the big systems and software purchases.

Could we be seeing customers taking a step back and reconsidering their IT infrastructure and maybe looking more at the Cloud and needing services for that, but delaying their infrastructure purchases?

Thanks.

So if you look at the $400 million in deals, my experience in this area is when you close that dateline, you kind of reset to a skew across the quarter.

It doesn't all close as you go into the next month period.

Now, that said, we have closed some of the substantial deals in that category.

But we'll see those, I think, kind of generally feather in across the quarter, based on our customer buying patterns, not just ours.

Secondly, when you look at the Services content, boy, they just had a great pipeline of deals teed up, right from the beginning.

And so if you looked at their performance on a week by week by week basis, they just had a head of steam the entire quarter.

You look at the, the Software Mainframe content, I still think Mainframe did a reasonable job, up 8%, but compared to a more typical Z series cycle, I think they could have done, by our math, another 100, 150.

That kind of is the quantification of the deals crossing the dateline into the second quarter.

On the Software side of the house, they had a very good list of deals and I think this was pure execution.

We should have closed those on the sales side.

We got to get off to a good start as we go into the second quarter.

We had tremendous number of views with the, the management team in Software and the financial team in Software, and they felt very confident in their position going into the second quarter.

Thanks, Katie.

Could we go to the next question, please?

Bill Shope, Goldman Sachs.

Okay, great.

Thanks.

I have a question on the guidance as well.

Mark, can you clarify the effective tax rate you're assuming for the full year?

I know you talked about the next three quarters, but your previous guidance coming into this year was for a 25% rate for the full year.

And obviously, this quarter, the tax rate was a fairly healthy benefit for EPS.

So including that, does your full-year guidance imply pretax performance that was quite a bit below what you previously expected?

And given the incremental restructuring you're talking about, as well as the closing of some of these slipped deals, can you talk about that shortfall relative to your previous pretax expectations.

Yes, we would see the balance of the three quarters per year at a book rate of relatively 25%.

And putting everything into the, those categories and any unique events that we might have, we think the full year is probably going to be in the range of about 24%.

So going through a first quarter to have that full-year view of the business being within about 1%, is I think pretty reasonable.

Now, when you look at the tax rate, there really two things that really drove that.

You got to recognize when we get an event within the quarter, we have to recognize that in our tax rate, our book tax rate within the quarter, like many that are reporting, we took advantage as we were required to of the tax extenders, that was including the investment tax credit was in a sense the retrospective reinstatement and that affected our tax rate.

But there was also within the quarter change in tax law within New York state that also had an effect.

Really that change in the tax rate was due to change in tax law within the quarter and the change in New York state was like March 29th.

Thanks, Bill.

Let's go to the next question.

David Grossman, Stifel Nicolaus.

Thank you.

Mark, you made some comments about the growth markets.

It sounds like, if I heard you correctly, that the rollover was primarily in the US and Europe.

And I know you mentioned China as being a surprise or an issue in the quarter, but were there any other things that you can talk about that impacted growth in the growth markets and help us understand what kind of visibility, if any, you have on improvement as we go into the second half of the year?

Yes.

So if you look at the content within the growth markets and you look at it by the business categories, about 20% of the business in the growth markets is the hardware, STG, content, slightly over 20%.

So if you look at about a fifth of it and look at the balance of the business, the balance of the business in the Software Services content really performed in that kind of mid single-digit framework that we discussed.

Now, underneath that, we certainly weren't satisfied with that hardware content, but I think outside of the hardware content, they did come through in that mid single-digit category that was consistent with their objectives.

And if you look at GMU from kind of a category, really Latin America did a great job, up 14%.

When we look at Central Europe and Russia, they tend to be transactional deals, more volatile.

We've had in the CE or Russia pretty broad swings in a quarter.

So the issue that we saw really was the growth market content in Asia.

And with Asia, it was pretty much specifically China.

So China needs to do a good job responding from that, going into the second quarter.

They do have tough compares in the rear view mirror for the second and third quarter.

They were up mid-20%s and 19% in the third.

But I think they, too, have had a good record on hardware content.

We're not solely dependent on that hardware content.

And if you look at even from a Services standpoint, the backlog growth in growth markets was up 10%, which should give them some opportunity there as well.

Thanks, David.

Operator, can we take the next question?

Peter Misek, Jefferies.

Thank you.

Just a question on Smarter Planet, Watson-type initiatives.

Can you walk through how much of hardware revenue was tied into that and how we should be modeling that going forward?

You reported that some of the smarter growth initiatives were outstanding, but correspondingly, we had weakness on the hardware side.

Seems to be a bit of a disconnect there.

Maybe you can help reconcile that.

Well, when you look at the business analytics content and you look at the Smarter Planet content, really, the key in them is the relationship between the GBS content that leads those engagements, and frankly, the more important linkage there is the Software content.

That's why when we look at the margin along those key initiatives axis, they tend to be really high, because that mix of Software tends to be about 50%.

So when you look at Smarter Planet and business analytics, the missing ingredient there was the Software content.

Again, that kind of got hung up at the end of the quarter.

Actually, the GBS team did a very, very good job on both.

And frankly, if you look underneath the GBS profile and break it down to the component parts, they did a great job in the parts of their business aligned with those growth initiatives.

There was still some impact in some categories on those traditional packaged apps.

Those traditional packaged apps tend to have been more rapid turnover, but the content in their backlog that they are building along these growth initiatives should be sustaining and long-term with I think good margin performance, but when I look at the growth initiatives in the first quarter, the impact that was more material I think was the Software performance.

The Service performance did very, very well, and Software performance drives the margin content within them.

Thanks, Peter.

Can we take the next question, please?

Keith Bachman, Bank of Montreal.

Hi, Mark.

Could you talk a little bit about your confidence for the Services more broadly?

In the past, you've been reluctant to provide top line expectations, and you indicated that you thought both GTS and GBS would have positive growth in the second half of the year.

And I think you even called out kind of 2% constant currency.

Could you distill that a little bit because the signings were very strong, but particularly in outsourcing, so I would be surprised if that really helped as early as the September quarter.

Was there other things like the cessation, you're not losing share in the market as you think have been over the last couple quarters as you get more selective?

There's something going on there.

In addition, if you could just talk about what the pipeline looks like after the $17 billion in signings this quarter?

Thank you.

Yes, when you look at the content in the Services performance, again, I would kind of steer the conversation to backlog.

And on a constant currency basis, our outsourcing backlog was up 4% but our transactional backlog was up 9%.

So we're now seeing the GBS business as an example that they have been piling up backlog growth now for four years and that is going to materialize.

They just tended to be as we did further analysis, those are longer-term contracts.

But mathematically, as we went through it with the teams, if they can continue this rate that we've seen, and they do have a very good deal structure going into the second quarter, simply the math would suggest that they should be able to get back to this low single-digit, kind of 2% constant currency revenue growth.

And with that, with all of the work that they have done on their cost base, which they do so well, they should get a lot of leverage off that capability in the second half.

Thanks, Keith.

Let's go to the next question, please.

Joseph Foresi, Janney Montgomery Scott.

Hi.

I just wanted to kind of follow up on that, the last question that was asked.

In the Services business, do you feel like you've fully turned the corner there?

And do you expect the backlog to grow?

I know you've given some commentary on the business growing.

And then finally, can you quantify or help us understand the margin impact as you become more profitable in the GTS side?

Well I think when you look across those Services business, they have done a very good job at kind of delivering on the margin capability, even through more challenging revenue quarters.

So the key ingredient, I think, to continue with that margin performance, is getting back to revenue performance in the second half, second half of the year.

I don't know if I would say we've turned the corner on growth.

I think we've got to get to the second half to see the growth.

But it's pretty encouraging if you can see 5% growth in the constant currency backlog when you're talking about $141 billion of back -- I mean, that's a lot of backlog to move in a quarter.

So that's the number one point I would make on that.

But number two, we had a lot of deals in the Services side of the business cross that dateline as well in the second quarter, so they certainly did not bleed the pipe just establishing this level of performance in the first quarter.

They should have, based on the deals that they had in that trajectory, a lot of opportunities to have another very good quarter.

Now, obviously, within this, whether it's Mainframe or it's Software or it's Services, you have to close the deals.

You've got to win and you got to win in the customer's office.

So there's that dimension, of course.

But within that, the opportunity to do well in the second quarter I think is certainly there.

And that should drive second quarter revenue performance.

Thanks, Joe.

Operator, let's take one more question, please.

Jim Suva, Citi.

Thank you very much.

And Mark, just a quick follow-up.

On the Service side, whether we take a look at the backlog and/or the signings, can you help us understand about, were those improvements that you saw, were they concentrated on a couple customers that were larger in size, were they just scattered amongst a lot of smaller ones, and maybe what geographic locations that you saw on that backlog and signings?

Well I think the best answer, when you look at the content underneath that, we had -- it wasn't like one contractor.

We had 22 deals over $100 million.

So, boy, there was a lot of flow in those deals and there was a lot of flow on the GTS side.

There was a lot of flow on the GBS side.

No, this was not just one deal.

It was well distributed.

We had 22 deals over $100 million.

That's a lot of deals over $100 million.

And it was across the geography.

I think that was good performance.

Let me make a few comments to wrap up the call.

Now, we're clearly not immune from changes in the global economy.

We have a good set of plans and actions to achieve our objective of at least $16.70 of operating EPS for the year.

First, our sales team need to close those rollover transactions that we discussed.

Second, we are going to regain our position in the growth markets and the growth markets team need to lead that.

If you look at the metrics right now, it clearly points in GMU to that mid single-digit constant currency performance and they need to get that back on track.

Third, we're going to rebalance our work force to better align our resources to opportunity.

Fourth, reposition Power to address the Linux space, and five, capitalize on our flash technologies and Storage, so clearly those last two will take some time.

It's not going to all pop back in the second quarter, but it should give us a better trajectory as we go through the year.

We're managing our business to be successful over the long term, so not only do these actions support our view of the year, but they are part of our model of continuous transformation.

As we move towards our 2015 road map objective of at least $20 of operating EPS.

So thanks again for joining us.

And now, as always, it's back to work.

Operator, can I turn it back to you to close out the call please?

Thank you for participating on today's call.

The conference has now ended.

You may disconnect at this time.