International Business Machines Corp (IBM) 2013 Q2 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 second-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 second quarter, we reported revenue of $24.9 billion, and operating earnings per share of $3.22.

Our EPS includes a $1 billion charge for workforce rebalancing.

Excluding workforce rebalancing activity in both years, our operating EPS was $3.91, up 8% year to year.

We had good performance in our high-value, higher-margin businesses, contributing to sequential improvement in our year-to-year revenue performance and to margin expansion.

Software returned to mid-single-digit growth.

In fact, this was the best constant-currency software growth since the first quarter of 2012.

Performance was led by 10% growth at constant currency in our key branded middleware, and we gained share in all five brands.

In Services, GBS improved revenue performance, and returned to growth at constant currency, while GTS revenue growth was consistent with last quarter.

With a significant amount of new business in the quarter, our total Services backlog was up 7% at constant currency, or 3% at spot rates to $141 billion.

Our hardware performance was mixed.

We got strong performance in System z mainframe, which generated double-digit revenue growth at constant currency.

Power and Storage had some modest improvement in year-to-year performance, though it still declined.

Across our segments, Smarter Planet was up over 25%, and Cloud over 70% for the first half.

Business Analytics growth improved this quarter to 11%, with good performance across GBS and Software.

These initiatives address key market trends like mobile, social and big data.

From a geographic perspective, our growth markets performance was consistent with first quarter, at 1% constant-currency growth.

Major markets declined year to year, though improved from last quarter's rate.

Overall, we improved our performance in several areas of the Business this quarter, and our first-half operating EPS is nearly flat, and that's after fully absorbing the $1 billion workforce rebalancing charge.

This puts us on a good footing as we enter the second half.

Let me spend a minute on our view of the full year.

90 days ago, when we made our first-quarter earnings announcement, we said that on an all-in basis, we expected at least $16.70 of operating EPS for the full year.

We also said that excluding the second-quarter workforce rebalancing charge, and second-half gain, we felt confident that we could achieve at least $16.70 of EPS for the year.

As you'll see, we're taking this view of our Business up $0.20.

So let me update this statement for new information.

First of all, the substantial second-half gain that we were counting on in our all-in view of EPS will not likely close by the end of this year, but we're still in active discussions.

As you know, we have a very disciplined M&A process.

We're not going to under-price or rush a divestiture simply to close within 2013.

Consequently, we need to fully absorb the workforce rebalancing charge in the all-in view without offset from this gain.

The value of this charge is roughly $0.65.

Based on our performance in the second quarter, our solid prospects for growth initiatives, tough decisions on spend management and potential tax settlements, we're increasing our full-year view of operating EPS, excluding the second-quarter workforce rebalancing charge, by $0.20 to at least $16.90.

I think this is a pretty positive statement, given that currencies have moved significantly against us in the last couple of weeks, especially in those that are largely unhedged, such as the yen and emerging-market currencies.

With that, we've updated our all-in view of the year to at least $16.25, with a net impact of $0.45, driven by the elongated discussions for our larger divestiture project.

We're driving to our objective of at least $20 in 2015 on an all-in basis.

In our current view, we'll establish our 2014 trajectory off the 2013 base of $16.90.

In other words, we will position the all-in view as if we closed the divestiture transaction, to establish our future trajectory, since fundamentally whether we close a large divestiture this year or not will not have any effect on our ability to achieve our 2015 objective of at least $20 per share on an all-in basis.

Now turning back to the second quarter, I'll walk through the financial metrics.

Our revenue growth at constant currency was down 1%.

This is a 2-point improvement from the first-quarter rate, driven by Services, Software and Hardware.

We entered the quarter with a modest currency headwind, but it became more pronounced with the strengthening of the dollar.

When you look at the reported revenue for the quarter, currency impacted our revenue growth by 2 points, and at current spot rates, this increases to a 3-point impact in the second half.

Turning to profit metrics, we expanded operating gross margin nearly 1.5 points, led by Services and mix to more profitable segments.

The $1-billion workforce rebalancing charge impacts our PTI and net income dynamics.

Excluding the workforce rebalancing activity in both years for comparison purposes, our operating PTI was flat year to year, with margin up 0.8 points.

Now, within this profit performance, we absorbed a significant impact from currency movements.

This has a greater impact to us when the yen devalues sharply, because of the limited cross-border cash flow that we can hedge.

At current spot rates, the currency impact will continue.

IBM's tax rate in the quarter includes a discrete benefit associated with a tax ruling received this quarter, and so our operating net income, excluding the impact of the workforce rebalancing activity, was up 3%, with margin expansion of 1.1 points.

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

When you look at the major year-to-year drivers of our second-quarter operating EPS performance, the 3% decline in revenue at constant margin impacted our earnings growth by $0.12.

The contribution from margin, excluding this year's charge, was $0.24, but this was more than offset by a $0.59 year-to-year impact from higher workforce rebalancing charges.

The lower share count contributed an additional $0.18.

So operating EPS of $3.22 was down 8%.

You can see the operating EPS, excluding workforce rebalancing, is $3.91, which is up 8% year to year on a comparable basis.

Now let's get into the results, starting with revenue by geography on a constant-currency basis.

Americas revenue was down 3%, with declines in both the US and Canada, though both improved the growth rate slightly from last quarter.

But once again, we had really strong performance in Latin America, led by Brazil.

Our EMEA revenue was down 1% -- that's 3 points better than our growth rate in the first quarter.

We had improvement in the growth rate of several of the major countries.

UK and Spain not only improved, but grew in the quarter.

In Asia-Pacific, revenue was flat.

Within that, Japan's revenue was up 3%, with good performance across Hardware, Software and Services.

This was the third consecutive quarter of revenue growth, so clearly the team in Japan has done a great job to return the Business to growth.

Growth markets revenue was up 1%.

In the first half, we've had strength in Latin America, and the Middle East and Africa region, but declines in some of our larger markets like China and Australia have impacted the overall performance.

Turning to revenue by segment, year-to-year constant-currency revenue performance in our combined Services business improved from the first quarter.

At constant currency, GBS performance improved a couple of points, led by consulting and systems integration, while GTS revenue growth was unchanged.

In Software, we had broad-based strength across our strategic brands, led by our offerings in Smarter Commerce, Social Business, Security, and Storage Management.

In Systems and Technology, we had good performance in System z mainframe.

While we had some improvements in Power and Storage, they continue to decline.

Looking at our gross profit, our operating gross profit margin improved almost 1.5 points, driven by a combination of good margin expansion in Services and Software, and improving segment mix.

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

Our total operating expense and other income was up 11%, or down 1% excluding the year-to-year impact of workforce rebalancing charges -- so, well managed on an operating view.

Acquisitions over the last 12 months drove 1 point 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 2 points, excluding the charges.

The workforce rebalancing is the one item in expense that had significant year-to-year impact to our profit.

This year's charge was about $1 billion, in line with what we told you back in April.

This compares to last year's rebalancing charge of about $150 million, so about an $850-million impact to profit year to year.

We'll see some of the benefit from the rebalancing activity in the second half.

Now I want to comment on the impact of currency this quarter.

In the second quarter, the hedge activity was fairly neutral year to year, with modest gains in both areas.

The dollar strengthened against many currencies, but we were significantly impacted by the depreciation of the yen.

Because our business in Japan is more heavily skewed to local services, we have less ability to hedge cross-border cash flows as compared to most other countries.

I mentioned this last quarter, but the year-to-year profit impact was much larger in the second quarter.

This would continue at current spot rates through the rest of the year.

We saw a similar trend in other growth market currencies.

Now let me go into the segments.

This quarter, the two Services segments generated $14 billion in revenue.

Pre-tax profit was down 17%, reflecting the impact of the workforce rebalancing charge.

Excluding workforce rebalancing in both years, profit was up 2%, and pre-tax margin expanded just over 1 point.

Total backlog was $141 billion, up 3% at spot rates, but up 7% at constant currency.

Backlog again grew in both the transactional and outsourcing businesses, and in fact, we had the best growth of our book of business at constant currency in four years.

Within that, both major markets and growth markets grew backlog this quarter, and our major markets accelerated their growth at constant currency from last quarter.

We had 15 deals over $100 million, including a mega-deal in Europe.

Turning to the two segments, Global Technology Services revenue was $9.5 billion, down 5%, or down 2% at constant currency.

Our out-sourcing business was down 3% at constant currency, with the bulk of this decline driven by previous actions to restructure lower-margin contracts.

While this impacted revenue, it raised the profitability of the outsourcing portfolio.

We'll wrap on the year-to-year dynamics in the second half, though the Business will continue to operate at this higher profit base.

For the quarter, we estimate the impact to revenue to be about 1.5 points to GTS, and 1 point to Services in total.

In Integrated Technology Services, revenue was up 1% at constant currency, led by Japan, with its third consecutive quarter of double-digit growth.

Last week we closed the acquisition of SoftLayer Technologies, the world's largest privately held Cloud computing infrastructure provider.

As businesses add public Cloud capabilities to their on-premise IT systems, they need enterprise-grade reliability, security and management.

IBM has built a portfolio of high-value private, public and hybrid Cloud offerings.

With SoftLayer, IBM will accelerate the build-out of our public Cloud infrastructure to give clients the broadest choice of Cloud offerings to drive business innovation.

This quarter, GTS pre-tax profit declined, but adjusting for the workforce rebalancing activity, profit was up 3%, and pre-tax margin was higher year to year by 1.3 points.

On this basis, margin expansion reflects improved efficiency and productivity, as well as tough-minded spend actions.

Turning to Global Business Services, revenue was $4.6 billion, down 1% as reported, and up 2% at constant currency.

This represents an improvement of 2 points at constant currency from last quarter's year-to-year rate.

From a geographic perspective, North America led the improvement, and was up mid-single digits.

Growth markets in Japan continue to drive solid performance, and Europe slowed its rate of decline versus last quarter.

Looking at the GBS business by our two major categories, we had good results across the portfolio.

Within the digital front office, we again delivered double-digit growth across the initiatives, Business Analytics, Smarter Planet and Cloud.

And within our back-office solutions that we call the Globally Integrated Enterprise, we returned to growth in implementation Services that support the traditional package applications.

Turning to profit, adjusting for workforce rebalancing activity, GBS profit grew 2% year to year, and PTI margin expanded by 0.5 points.

So to wrap up Services, growth initiatives continue to perform well, and we're investing to accelerate our transformation.

We've made good progress in transition areas like traditional packaged application implementations, and have largely wrapped on the outsourcing contract restructuring.

And we're entering the second half with the strongest backlog growth at constant currency in years.

Software revenue of $6.4 billion was up 4% year to year, or 5% at constant currency.

Software PTI was down 2% year to year or, on an adjusted basis, was up 6% to $2.7 billion.

Key branded middleware, which was over two-thirds of total Software revenue, grew 9%, or 10% at constant currency.

Each of the five key brands gained share in the second quarter, and four of the five grew double digits at constant currency.

We have built a portfolio of solutions that target the faster-growing segments of the market, including mobile, social and security.

Differentiated by advanced analytics, these solutions provide value to a new set of IT buyers in the front office.

And many of these are delivered through our SaaS offerings, which were up over 50% this quarter.

Now let me take you through the key brands.

WebSphere grew 10% at constant currency.

Within WebSphere, the key contributors, Smarter Commerce and Mobile, grew double digits.

IBM Smarter Commerce initiative helps our clients transform their business processes to rapidly respond to shifting customer demands in today's digitally transformed marketplace.

Our mobile portfolio, led by MobileFirst, combines security, analytics and app development software to manage clients' mobile infrastructure, regardless of device.

Information management software grew 6% at constant currency.

Analytics run through our portfolio of solutions, enabling clients to develop and execute a big-data strategy that connects their existing business data to new data sources, delivering business insights in real time.

Tivoli Software was up 14% at constant currency, with growth in each of the three key business areas.

Our security business had a great quarter, with growth of 20% at constant currency.

In the age of mobile access, security intelligence is critical to safeguarding data, transactions, and every day business operations.

Within Tivoli, Storage was up 17% at constant currency.

Storage Software delivered its 10th consecutive quarter of double-digit growth.

Social Workforce Solutions grew 23% at constant currency, driven by the recent acquisition of Kenexa, and our existing smarter workforce offerings.

In the second quarter, IBM was ranked number one in enterprise social software for the fourth consecutive year by IDC.

Across the board, Software had a good quarter, with solid top line (inaudible - technical difficulty) 12% year to year, or 7% at constant currency, adjusting for the divestiture of Retail Store Solutions.

System z grew 11% at constant currency; MIPS were up 23% year to year; and we continue to have more than 50% of the MIPS from Specialty Engines, which were up double digits.

Last week we announced an agreement to acquire CSL International, which expands System z's cloud capabilities, including simplified management of virtualized Linux on z. In PureSystems, we've now sold over 6,000 systems in over 100 countries in the five quarters since announced.

While power revenue was down 24% at constant currency, this does represent a 7-point improvement from last quarter's rate.

Power continued to out-perform the UNIX competition, and gained share again this quarter.

And we continue to expand our power platform to go after the Linux opportunity.

We expect a sequential improvement in power will continue in the second half, as adoption of our new Power7 Plus products continues.

System x was down 10% at constant currency.

Storage hardware revenue was down 6% at constant currency, but flat including Storage Software, which is reported in Tivoli.

Strong double-digit growth in our mid-range Storwize products was offset by declines in our legacy OEM mid-range offerings, and softness in the high end.

Our Flash products offerings contributed 2 points of year-to-year growth to total Storage.

Systems and Technology returned to profitability in the second quarter, excluding workforce rebalancing charges, and we expect to remain profitable for the full year.

Moving on to cash flow in the quarter, we generated $2.7 billion of free cash flow, down about $1 billion year to year.

Through the first half, our free cash flow of $4.4 billion was down about the same.

The first-half year-to-year performance was impacted by a significant increase in cash taxes, and lower accounts receivable collections.

This was mitigated by year-to-year benefit from lower capital expenditures, and the benefit associated with the timing change of funding our 401(k)s.

Looking at the usage of cash in the first half, we acquired three smaller companies -- StoredIQ, Star Analytics and UrbanCode.

In the first week of July, we closed the larger SoftLayer acquisition.

We returned just over $8 billion to shareholders.

Of that, $6.1 billion was in share repurchases, and at the end of June we had $7.7 billion remaining in our buy-back authorization.

We took our dividend up 12% in April, and through June we paid out $2 billion.

This is the 18th consecutive year that we raised our dividend, and the 10th year in a row of double-digit increases.

Turning to the balance sheet, we ended the quarter with a cash balance of $10.4 billion.

Total debt was $34.1 billion, of which nearly $25 billion was in support of our financing business, which is leveraged at a ratio of 7.2 to 1. Our non-financing debt was $9.3 billion, and our non-financing debt to cap was 39%.

We continue to have a high degree of financial flexibility, and our balance sheet remains strong to support the Business over the long term.

Let me wrap up the quarter.

We had a good performance in our higher-margin businesses, like Software and System z mainframe; and we had continued strong performance in our growth initiatives at Smarter Planet, Business Analytics, and Cloud.

We returned to growth in Global Business Services, led by consulting and systems integration.

And for total Services, we had the strongest backlog growth at constant currency in years.

At the same time, we took actions to better position our Business for the future.

We rebalanced the workforce to align resources to the best opportunities.

And we announced and recently closed the acquisition of SoftLayer to enhance our capabilities in Cloud.

As we move into the second half, we expect to continue our progress in areas like Analytics and Cloud and Smarter Planet, leverage the benefit from our workforce rebalancing activity, capture additional opportunities in cost and expense through net income, and of course, continue to return value to shareholders.

At the same time, we are dealing with a more challenging currency environment.

Taking all of this into consideration, we are increasing our full-year view of operating EPS, excluding the $1-billion workforce rebalancing charge, to at least $16.90.

This is a $0.20 increase from our previous view.

And because we are no longer counting on a gain from a large divestiture in the second half, our all-in view of operating EPS is now at least $16.25.

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'd like to remind you of a couple of items.

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

Second, I'd 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.

Thank you.

At this time, we'd like to begin the question-and-answer session of the conference.

(Operator Instructions)

The first question comes from Ben Reitzes with Barclays.

You may ask your question.

Yes, thanks a lot.

Mark, what gives you confidence in the second half?

It would seem that basically without the benefit of the tax rate, the operational increase is really $0.05 or so from what you thought previously.

I just wanted to also be clear on that.

What gives you confidence that you can hit those numbers, perhaps specifics around how the charge flows through in terms of cost saves, and then what segments could possibly grow, -- where you see some leverage?

Thanks a lot.

Okay Ben, very good question.

Maybe the best way for me to answer that is to take a look at kind of a head winds, tail winds basis.

If you look at the second half of the year, obviously we have a head wind on currency, and more specifically within that, the yen.

We pointed out in the attachment that even though currency was an impact of 2% from the first half, we see it about 3% in the second half.

Our hardware business has been an impact to us in the first half of the year, and we're obviously dependent on the Asian GMU economy, which have been challenging the first half.

But I'll tell you, as we look at the second half, we have some very distinct tail winds that we have driven to drive our performance.

First of all, software pipeline -- we've got a very good software pipeline going into the second half of the year, and if you look at that software performance in the second quarter, boy, they really hit the ball.

So not only did software grow the total by 5%, but that key branded middleware was up 10%, and we gained share in every single one of the sub-brands in that software business.

We see real momentum going from that second quarter into the second half of the year.

Secondly, very important -- we have Services backlog growth on a constant currency basis of 7%.

That is the best backlog growth positioning we've had in four years, going into the second half.

3% at actual, but that 7% at constant currency, the best we've seen in four years.

Now against that, in the second quarter -- break it down by service lines, GBS returned to growth in the second quarter.

They should further profit on that improvement in the entering backlog, and I would expect GBS to be firmly in that mid-single digit revenue growth in the third quarter.

Likewise on our GTS business, GTS was down in the second quarter about 2%, but they had about a point and a half impact from those restructured contracts last year that we spent a lot of time talking about in last year's earnings call.

If you adjust for that, they came very close to a neutral performance in the second quarter.

With that I would expect GTS to return to low-single-digit revenue growth in the third quarter as well.

Now we've had good performance, flow-through to the second half from our Software business, better performance from our GTS and GBS business is driving performance.

Our work force rebalancing yield -- we did a great job closing that right on the billion dollars that we had advised you of as we closed the first quarter.

That will begin to yield in the third quarter of the year, and we'll get a full quarter's benefit in the fourth quarter.

I think that is quite significant.

I clearly alluded to the potential tax settlements that we would see being a positive impact in our fourth quarter.

But along with that we've had real strength in our growth initiatives.

Cloud through the first half of the year, up very strong.

We had very good positioning at Business Analytics in the second quarter, up 11%.

Strong performance in our Smarter Planet content, and we've taken a very tough position on spending.

You put all that together, I think we have ingredients for that second of the year.

With base of all of that in aggregate that gave us the confidence, along with the second- quarter performance, to drive that additional $0.20 to $16.90, excluding the second-quarter work force rebalancing charge.

Thanks, Ben.

Can we go to the next question, please?

The next question comes from Toni Sacconaghi from Sanford Bernstein.

You may ask your question.

Yes, thank you.

Historically you have provided EPS guidance, including all rebalancing charges and any one-time gains, whether they be from IP or from dispositions.

I'm hoping you can clarify, because it's a little nebulous, about whether you're changing your guidance definition of operating earnings or not.

So the traditional metric of operating earnings would include the rebalancing charge in there, and then guidance would be $16.25, at least for the year?

Is that what we should be putting our models, or are you changing the definition and saying well, we're going to exclude these kinds of charges this year and on a go-forward basis, and $16.90 should be what analysts put in your model?

If you could address that.

I'd also like to understand to the degree that -- what checks and balances to the degree that you may include -- continue to include them, but not match them in a given quarter -- what checks and balances are there going to be that offsetting that gains and charges are ultimately offsetting, as they have been historically?

Okay.

Very good question, Toni.

First of all, I want to be very clear that when we attach our objective for 2015 of $20, that at least $20 is on an all-in basis.

I think in this earnings announcement, I hope to be very clear on the basis for performance in the year.

If you look at the performance that we would view for the year, we've been clear on the all-in basis, and we've also been clear excluding the gains and charge.

Now let me provide some distinction on that base and why I think both of those are very important.

First of all, on an all-in basis, we had said that that second-quarter work force rebalancing charge would be offset by a future divestiture gain.

Frankly, as we look at it now, we are in active discussions but very likely on a time line basis it's unlikely that that simply closes in 2013.

So that would impact that original view of our business on an all-in basis of at least $16.70 by $0.65, and then you would add the improvement of $0.20 to that.

That gives us the $16.25.

But I want to say that on the other view of our business, excluding gains and charges, that now would be $16.90, and I am reassuring you and the investors that it's at $16.90 that we will be using as our starting point to set our objectives for 2014 on an all-in basis, and 2015 on an all-in basis.

In other words, as if we had closed that divestiture.

Now, why do I think that's important?

I think that's important because whether we close that divestiture this year or not, would not impact that operational performance exactly as we always defined it in 2014 and 2015.

Number two, I wanted to be very clear to investors that when we start to position that trajectory for performance going from '13 to '14 to '15, that number starts at $16.90, not $16.25.

From my perspective, the view of our business to best establish the trajectory we're on going from '13 to '14 to '15 is an end state of $16.90, increased by $0.20 from our original $16.70 view of the business.

Given that that large divestiture has moved out of the year, we would assess the all-in at $16.25.

We're certainly working on other divestiture content, and as that lands, we will be adding that to our basis as well.

To reiterate, assessing the trajectory for this year I think is best evaluated excluding the second-quarter charge, and at $16.90, that will now be the basis for establishing that trajectory for 2014 and 2015, and achieving our objective of at least $20 in 2015 on an all-in basis.

Thanks.

Mark, if --

Can we go to the next question, please?

The next question comes from Steve Milunovich with UBS.

You may ask your question.

Steve, do you have it on mute?

We can't hear you if you're speaking.

Check your mute button.

Can you hear me now?

Yes, we can now.

Can't now though, Steve.

Sorry.

Steve, are you there?

The next question comes from Scott Craig with Bank of America-Merrill Lynch.

You may ask your question.

Thanks, good afternoon.

Mark, can you maybe elaborate a little bit more on the Services business, as far as the impacts that you see going forward of sort of renegotiating contracts, or maybe even exiting some of the contracts -- and sort of the impact on the profitability that we should see as you move forward?

You mentioned in your prepared remarks that you start to run into the comps issue where you're sort of getting beyond all that in the back part of the year.

I'm just curious as to sort of how you see the impact of that playing out for the rest of the year?

Thanks.

I think on that view of the business on our contract negotiations with customers, the biggest reference point is really those restructured contracts that we drove in 2012.

As I said for GTS, that was an impact of about a point and a half to their growth rate.

Outside of that, it would have been down about half a point.

Now with the improved backlog performance and starting point going into the third quarter, we would expect that our GTS business should be returning to growth in third quarter in low single digits.

If you're looking at the impact of those restructured businesses on our year-to-year growth rate this year, by the third quarter it's less than a point, and it's fully wrapped by the time we get to the fourth quarter.

The really strong signings performance we've seen from our two Services business, and the positive impact that's had on backlog -- now as I'd said earlier, up 7% on a constant-currency basis, 3% on actual, should give them a very good point as we go into the third quarter.

That restructured contract impact on growth rates should start to ameliorate in third quarter and fully wrap in the fourth.

Thanks, Scott.

Can we go to the next question, please?

The next question comes from Chris Whitmore with Deutsche Bank.

You may ask your question.

Thanks very much.

Mark, I was curious to get an update on the $400 million worth of Mainframe and Software deals out of Q1.

Did those close in Q2?

Just looking at some simple math, assuming half of those deals did close in the Software business in Q2 -- or assigned to Software -- it implies the underlying demand of growth in Software really wasn't all that robust, was pretty tepid, maybe flat to up 1% or so?

Can you comment on how those deals closed, and what the underlying demand looks like for your Software products, excluding the timing of those deals?

Thanks a lot.

Yes, very good question.

If you look at those roll-over deals that we had as we've exited the first quarter, they frankly distributed across the months within the quarter on kind of a typical roll-over basis; and we closed a little less than half of them, which is also kind of a typical closure rate.

It really did not provide within the quarter kind of a spike, if you will, and assumed kind of a normal profile for roll-over deals as we went through the quarter.

As you look at it going into the third quarter, especially within that Software business, which is very high-margin content for us, we actually had even more roll-over content going to our Software business from the second quarter to the third quarter.

If you just looked at kind of the firm pipeline that we've had for the third quarter compared to the second, we're actually in a little better shape going into the third than we were even in the second.

I think that the performance that we saw out of Software in the second quarter is a good indication of the kind of performance we had are to from our Software business going into the third quarter.

I think that when you look at the mainframe business that we also had a very strong performance from in the quarter, we should expect another double-digit quarter from mainframe in the third, as well.

Thanks, Chris.

Can we go to the next question, please?

Next question comes from Jim Suva with Citi.

You may ask your question.

Thank you, Mark.

Congratulations to you and your team there at IBM.

I know this is just one metric, but when you look at the signings number, which was quite strong and healthy at 16.4 and last quarter was 16.9 -- I mean, very, very strong there.

Shouldn't that equate to some pretty meaningful revenue growth for IBM, and if so, when?

Or am I missing something about are there some larger contracts that are rolling off?

How should we think about multiple quarters of back-to-back strength you've had in that metric that we use, along with others?

Thank you.

Well, good -- very good question.

When you look at that Services content, the great thing about our Services business is you sign those contracts that give you lift and that give you lift over many years, right?

An advantage, I think, that we built into our business equation is that long string annuity content from a Services base of business, so you're not so dependent on the volatility of that transactional business.

When you look at that improvement in backlog entering a given quarter, that is distributed over a number of years.

But you started to see the impact and the benefit of that even in the second quarter.

Again, I'd reiterate in the second quarter our GBS business returned to growth.

As we look at the additional backlog performance we have going into the third, they should now be back to mid-single-digit growth.

Our GTS business was impacted by the restructured contracts in the rear view mirror, but adjusting for that we think they were very close to kind of flat performance on an adjusted basis.

So that gives us confidence as we go into third quarter that our GTS business should also return to growth in low single digits.

Now, we did sign in the second quarter 15 deals over $100 million, and we signed a multi-billion dollar mega out-sourcing deal in Europe.

Now, the European deal is a very interesting one in itself, because IBM for this customer will transform the underlying technology, including new analytics and Cloud models, enabling business innovation for the client.

So this is great example of how the outsourcing business is evolving as clients look to IBM for supporting leveraging new technologies such as Cloud.

As you pointed out, two quarters of very good signings performance.

As we've always said, the proof in the pudding is going to be in the backlog; and sure enough, the backlog did show up as we entered the second half.

We're going to see that revenue impact as we start to move that glacier north with positive revenue performance on GTS low single digits, and mid-single-digit revenue performance on GBS.

Thank you, Jim.

Can we go to the next question, please?

The next question comes from Bill Shope with Goldman Sachs.

You may ask your question.

Okay, thanks.

I hate to ask a tax rate question, but I really want to try and understand the guidance as best I can.

Mark, you had mentioned that you had tax benefit, as well, coming in the second half.

Is that additional to the tax benefit you had this quarter?

I believe your guidance before was pointing toward roughly a 25% rate, and that's within most models.

How do we think about the tax rate in the second half relative to that, and how that drives the earnings guidance for the full year?

Okay.

I would still look at our books tax rate in 2013 to be in the range of 25%, excluding any discrete tax benefits or charges.

Now, we did get a tax benefit in the second quarter that we recognize, which will relatively improve that rate.

If you look on a forward-looking basis regarding tax settlements, we do have a number of audits and disputes around the world, including the 2008 to 2010 US federal tax audit.

We expect this to conclude some of these audits and disputes later this year that could result in a favorable settlement in the fourth quarter.

Thanks, Bill.

Could we go to the next question, please?

The next question comes from Katy Huberty with Morgan Stanley.

You may ask your question.

Yes, thanks Mark.

Given the cash flow was down considerably in the first half of the year, can you do a similar walk-through of the head winds and tail winds you see that could help improve cash flow?

Also, talk about whether the weaker cash generation impacts your flexibility to step up buy-backs or make acquisitions to help hit the $20 2015 target, if needed?

When you look at the first half of 2013, our cash flow was down $1.1 billion.

Now within that decline, we did a substantial increase in our cash tax payments of $700 million.

In addition, we had a deterioration of our accounts receivables, days outstanding by over a day and a half, and that comes at a metric of about $250 million per day.

So we should have done better there, and we certainly could have done better in our profit performance from the business.

Now we go look on a forward-looking basis -- I fully expect that we'll improve on that receivables equation, and pull that cash back into the business.

We should have better profitability from unit performance as we go into the second half, as well.

But I've got to say that on a full-year basis, we do have a cash tax headwind of $2 billion, and I don't think we're going to overcome that on a year-to-year basis.

Now, even with that positioning, however, I feel very confident in the overall positioning for the road map of $50 billion in share repurchase, $20 billion in dividends, and the opportunity for $20 billion in overall acquisitions.

If you kind of gauge our performance against those metrics, given this is kind of the half point of the model, we've done $33 billion of share repurchase of the 50.

We've done six of the 20 in overall acquisitions, nine of the 20 in dividends, which puts us just reasonably ahead of pace.

I think we're in good position there.

We do have a cash tax head wind this year, but I do not think it's going to impact our ability to complete the expenditures on share repurchase, acquisitions, and dividends through the 2015 road map.

Thank you, Katy.

Can we go to the next question, please?

The next question comes from Mark Moskowitz with JPMC.

You may ask your question.

(inaudible - no audio) terms of all-in EPS is, in terms of what it was historically, and what you're going to do going forward, maybe you could help us out on one piece.

Can you kind of quantify, Mark, what the quarterly EPS benefit in the fourth quarter is going to be, due to the work force restructuring?

Well, if you look at the work force restructuring, let me give you a little -- that work force rebalancing -- let me give you a little color behind that.

If you look at the work force rebalancing, as we pointed out, that concluded about $1 billion.

In that $1 billion, the vast majority of that is spent overseas, outside the US, that has longer pay-backs.

Now, from a business unit standpoint, you could see that in the math that we've provided for you.

About $600 million of that would be benefiting the Services business, and about $200 million each for the Hardware and Software businesses.

That will distribute across the third quarter and fourth quarter, as well as the first two quarters of 2014.

Now, given that it's generally world trade driven, we're not going to pay that $1 billion in the year, but we will see the first increment of contribution from it in the third quarter, and we're going to see a full quarter of contribution in the fourth quarter this year, and then ongoing contribution in the first and second quarters of 2014.

Thanks, Mark.

Can we go to the next question, please?

The next question comes from Brian White with Topeka.

You may ask your question.

Mark, I want to get kind of a big picture view of what you're seeing in the IT spending landscape.

Sales are obviously a little light, did well on margins.

But just what are customers spending on now, and how are they feeling about spending in the second half of the year?

Thanks.

Yes, I think if you look at overall spending, let's look at it from a couple of perspectives.

First of all, just based on the dynamics we see in our business, the major markets performance actually improved for IBM in the second quarter compared to the first quarter by about 2 points within that.

As I've said earlier, Japan did a great job in this, but I thought Europe as well did a pretty good job in a difficult environment.

But we do see when you look at the growth markets business, they are moving more from kind of infrastructure-based offerings to offerings with real solutions capability like business analytics and Smarter Planet capabilities as they improve performance.

As we see that spending profile, and as it exhibits itself for IBM, we see improved prospects for our Services revenue base as we go into the third quarter, ongoing strength in our Software base.

We do think that hardware will still be a challenging equation.

But it certainly will be a mix of demand patterns mapped to our capabilities to support our objectives for the third and fourth quarter.

Right now we would look at the third quarter that analyst models are reasonable.

We see higher double-digit performance in the fourth, on our way to achieve that $16.90 at least for the year, excluding the second- quarter work force rebalancing charge.

Thanks, Brian.

Operator, could we take one last question, please?

The last question comes from David Grossman with Stifel Nicolaus.

You may ask your question.

(inaudible - no audio) in the GMUs and the corresponding impact on the three different business units --

I'm sorry, David, can I get you to start again?

We missed the beginning of the question.

Sure.

I was wondering if you could just expand on the last question a little bit, and help us understand the relationship between the growth and weakness in the various GMUs and the corresponding impact on the growth of the three business units as we go through the second half of the year and into 2014?

Yes, absolutely.

So if you look at our GMU performance in the second quarter did prove to be more challenging.

Again, 1% growth in the second quarter as we saw in the first quarter, but underneath it was a mix.

We actually had very strong performance, I think, in Latin America, up 12%.

Within Latin America, Brazil was up 15%.

The whole Latin America content I would count as a real plus for us.

Middle East, Africa likewise, we had 11% growth.

Good performance there, as well.

The areas that we had more difficulty in our growth markets, frankly, can be I think best attributed to kind of three large countries -- China, Australia, and Russia.

They account for about 40% of the GMU base of business.

Without those three countries, GMU frankly would have been up 7%.

Now within those three countries, I'll tell you that China and Russia, who are both down in the second quarter of '13, had a very big comp to overcome.

Last year China achieved 24% growth in the second quarter of 2012, and Russia had 39% growth in the second quarter of 2012.

So very big compares.

Now, that said, we will remain cautious as we go into the second half of the year in GMU, until we start to see more demand pattern driving that more typical performance level that we've seen in the past.

Let me -- with that, let me wrap up the call.

First of all, we're exiting the quarter stronger than we entered, with good growth in our high margin businesses, a better book of business in Services, and we executed a work force rebalancing action that will start to yield in the third quarter.

We had some opportunities I mentioned earlier, but also some headwinds.

But all of this was considered in our decision to take up our expectation for EPS by $0.20, excluding the work force rebalancing charge, with the second half increase in the fourth quarter.

Now earnings per share of $16.90 will provide the base for operational trajectory into 2014, consistent with our objective of at least $20 in 2015 on an all-in basis.

Once again, thanks again for joining us today, and now as always, it's back to work.

Operator, can I turn it back to you, please?

Thank you for participating on today's conference call.

The conference is now ended.

You may disconnect at this time.