Home / Business / International Business Machines Corporation (IBM) Q2 2018 Result Telephone Conference Transcript – The Motley Fool

International Business Machines Corporation (IBM) Q2 2018 Result Telephone Conference Transcript – The Motley Fool

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Source: The Motley Fool

International Business Machines Corporation (NYSE: IBM)
Q2 2018 Outcome Conference Call
July 18, 2018, 17.00 pm ET


  • Prepared Comments
  • Questions and Answers
  • Subscriber Call

Prepared Comments:


Welcome, and thank you for coming. At this point, all participants are in a pure list mode. Today's conference is being recorded. If you have any objections, you can disconnect at this time. Now I will hand over the meeting with IBM to Mrs. Patricia Murphy. Ma'am, you may start.

Patricia Murphy ̵

1; Vice President Investor Relations

Thank you. This is Patricia Murphy, Vice President of Investor Relations for IBM, and I would like to welcome you to our second quarter earnings presentation. I'm here today with Jim Kavanaugh, IBM's senior vice president and chief financial officer.

Our prepared remarks will be available within a few hours, and tomorrow a rerun of the webcast will be released.

I would also remind you that certain comments made in this presentation can be characterized as forward-looking under the 1995 Private Securities Litigation Reform Act. These statements include a number of factors that could cause actual results to differ materially. Additional information about these factors is contained in the Company's filings with the SEC. Copies are available from the SEC, the IBM Web site, or our Investor Relations section.

Our presentation also includes certain non-GAAP financial measures to provide investors with additional information. All non-GAAP measures have been reconciled with the corresponding GAAP measures in accordance with SEC rules. They will find matching charts at the end of the presentation and in the Form 8-K submitted to the SEC.

So, I'll hand over the call to Jim.

James J. Kavanaugh

Senior Vice President and Chief Financial Officer

Thank you Patricia and all of you for joining us.

In the second quarter, we generated $ 20 billion in revenue, $ 3.4 billion in revenue, and $ 3.08 in operating earnings per share. Overall, it was a good quarter. We increased sales, gross profit, earnings before taxes, and earnings per share, delivering a strong pre-tax margin. As reported, our sales increased 4%, with growth in all four major segments. Currency-adjusted sales growth was 2%. This is our best constant currency growth in 7 years. And our pre-tax profit increased 11%, reflecting good operational leverage on net sales growth.

Looking at our performance at constant exchange rates, revenue growth in both service segments improved and both returned to modest growth. This is important for our overall revenue growth profile as services account for approximately 60% of our revenue each year.

In Cognitive, we saw good performance in analytics and in our industries driven by financial services and IoT. Growth was mitigated by the same three areas that I mentioned on our last call as we continue to focus on repositioning these offerings. And we had a strong performance, adding to our Systems business, which grew more than 20% with growth across all three hardware platforms.

In our segments, we continued to see positive momentum in our strategic revenue prospects. For strategic reasons, our revenue has grown to $ 39 billion over the past 12 months. This represents 48% of IBM's revenue. And within that, the cloud is now $ 18.5 billion.

Our strategic imperative revenue increased 15% in the quarter and accelerated to 13% at constant exchange rates. Revenues this quarter were led by Security and Cloud. Security increased by about 80% during the quarter, driven by strong demand for IBM Z end-to-end encryption and the growth of our integrated software and services business.

Cloud revenue increased 20% or 18% at constant as-a-service exchange rates. We are closing the second quarter with an annual run rate of more than $ 11 billion, an increase of approximately 25%. This reflects our success in helping enterprise customers with their journey to the cloud, and we are becoming the target for mission-critical workloads in hybrid environments. We capture this high-quality growth with our unique differentiation of innovative technology combined with extensive industry expertise backed by confidence and security through our integrated model.

You Have Seen This Quarter in a Long-Term Australian Partnership The government has a value of approximately $ 740 million for the automation and digitization of government services using IBM's systems, software, and cloud-based solutions. We've expanded our work at Crédit Mutuel, which uses IBM Cloud, Security, IBM Z and Watson to drive the next wave of transformation in all business areas. We have delivered the most powerful supercomputer in the world to the US Department of Energy. We have been able to win competitive clouds from leading companies such as ExxonMobil, Amtrak and Telefónica de España.

We have signed a contract with Anthem to help them advance their digital transformation to provide millions of health plan consumers with an enhanced digital experience. In total, we signed 13 service deals over $ 100 million this quarter. These are just some of the new customer engagements that will come to fruition in the coming quarters and years. Together with our performance in the first half of the year, we continue to expect operating earnings of at least $ 13.80 per share for the year. 19659015] Before I turn to the detailed financials, I would like to give an outlook on the drivers of our operating earnings per share for the quarter. What it shows is that we have achieved 5% growth, despite a significant headwind. So, let me solve the problem.

Our 4% revenue growth contributed $ 0.10 earnings per share in constant margins. Against this backdrop, we achieved good pre-tax operating leverage on this revenue growth, with pre-tax profit up 11%, and our pre-tax margin up 110 basis points. About two-thirds of this pre-tax income growth came from dollars in gross profit, up 2% driven by earnings growth at Global Business Services and Systems.

The gross margin decreased by 60 basis points from year to year. About half of that should be mixed and half of the continued investment we made to grow our IBM cloud. Productivity was relatively neutral in the quarter over the previous year's gross margin, and as discussed in the last quarter, the benefits of our early-year measures will increase in the second half of the year. The remaining one-third of pre-tax profit growth comes from efficiency gains we made in our cost structure. And then, as I said earlier, the tax was a major headwind driven by a discrete tax benefit last year.

Finally, fewer shares contributed to growth. All in all, we delivered growth of 5%, with a good revenue contribution, margin expansion before taxes and, to a lesser extent, share buybacks.

If we look at our key financials, sales increased 4%. The currency contributed 2 points, which is about half of the contribution made on the spot rate at the time of our first quarter call. And I remind you that the significant volatility in currencies has an impact on the income statement, not just revenue.

Constant foreign exchange turnover increased by 2%, mainly due to organic growth. In future, I will talk about sales based on constant exchange rates. Our sales growth was broad in the different regions and sectors. We had growth in more than 60 countries, representing more than 80% of IBM's revenue. EMEA growth accelerated to $ 4, led by Germany, the UK, France and Spain, with strong growth in all businesses.

Looking at pre-tax operating profit growth of 11%, I said that about one-third of that was from operating expenses, which was 2% better. This includes a 2-point effect from the currency, which is significantly lower than the effect of the first quarter due to the dollar strengthening. Our base effort was 4% better.

As we continue to invest in our innovation pipeline in areas such as AI, security and blockchain, we realize acquisition synergies and increase operational efficiency by streamlining Agile's management system and implementing new ways of working. I've talked about some of these in our webcast back in March, and we see the benefit not only in improved speed and responsiveness, but also in a more efficient structure.

Within the cost, we have also absorbed lower IP levels, which decreased by $ 115 million from quarter to year, and about $ 240 million in the first half. Our operating tax rate of 16% has risen nearly 7 points, just over one point from the underlying rate and the balance of discretionary tax benefits of $ 170 million.

In terms of cash, we achieved $ 1.9 billion in free cash flow in the quarter and $ 3.2 billion in the first half, or $ 400 million year over year. Our solid working capital performance was more than offset by headwinds in cash tax and capital investment. This corresponds to what we discussed at the beginning of the year. Remember that our cash generation is very seasonal. Over the past 12 months, we have earned $ 12.6 billion, or 111% of our GAAP net income.

Now to our segments. Cognitive Solutions generated $ 4.6 billion in revenue, down 1% on a currency-neutral basis. We have steadily increased our revenue growth and ended the quarter at an annualized rate of $ 2 billion. Within the solution software we scale new platforms and solutions with growth in several key areas. I will name a few.

The growth of our underlying analytics platform was driven by the DB2 portfolio, our data science offerings, and our new IBM Cloud Private for Data offering that provides data for AI across all clouds. [19659015] In our Watson platform, the AI ​​platform for business, growth reflects strong demand for our new virtual assistant offering with a three-digit growth in our conversational service usage. Customers using Watson Assistant include Bradesco, the Orange Bank, Autodesk, the Royal Bank of Scotland, Vodafone and LivePerson, to name but a few. Watson is both a stand-alone platform and a driving force for growth and differentiation across multiple industries in our industry.

Our industry verticals continue to expand, led by IoT and Watson for financial services. IoT growth was driven by Maximo, the # 1 asset management solution, and Tririga, the leading facility management solution. Financial Services reflects the strong performance in our risk and regulatory business and financial crime portfolios and leverages our promontory capabilities and AI technologies. At Watson Health, we performed well in areas such as payer and life sciences. And in emerging areas like Blockchain, we've now equipped the market with over 60 active blockchain networks.

This quarter we started We.trade with 9 major banks, including Deutsche Bank, HSBC, KBC and Natixis. This is the first live blockchain-based bank-to-bank trading platform. Growth in these areas will be offset by a transition in some areas that I talked about in April, notably talent, collaboration and commerce, which today are a combination of on-prem and SaaS offerings. We modernize our offerings and invest to meet the secular changes in the market. Remember that the time to value of these investments in SaaS is longer.

Our transaction processing software was down 2%, driven by declines in storage software. Within TPS grew the IBM Z middleware and power middleware. In terms of profit for the quarter, we were able to increase our pre-tax profit by 9% and increase the pre-tax margin by more than 2 points from year to year. This is due to operational efficiencies and acquisition synergies, while we continue to invest at a high level in key strategic areas as AI, Security and Blockchain

Before joining Global Business Services, I would like to give you an overview of our entire service business in the Global Business Services give both segments. We continue to make good progress. Our service signatures grew, orders on hand improved from the previous quarter, and services revenue climbed, and we slightly improved gross margin year-on-year.

Our signings increased 6%, and within that we had 13 deals over $ 100 million. So we are clearly winning in a competitive environment. We address the fundamental changes in the industry, such as the implementation of hybrid clouds and managed security services. This results in a shift in our order book: nearly 30% of our outsourcing backlog is now in cloud. And then, looking at the gross margin of services, it has fallen by only 25 basis points from year to year. Let me remind you once again that we have the most benefits from the productivity measures of the first quarter ahead of us.

Let us now turn to the two segments. Global Business Services returned to modest revenue growth, increased the gross profit dollar and increased gross margin. We are realizing the improved sales performance from the run of our opening inventory for the year. Sales of our Strategic Imperatives increased 6%, with strong performance in as-a-services, up 25%.

We talked about how we reoriented our practice model to include three growth platforms – Digital Transformation, Cloud Application – and Cognitive Processes. As everyone progresses, we have a particular strength in Digital, which again grew at double-digit rates. This was driven by the digital business strategy and our mobile offerings.

On these platforms, Consulting's revenue grew year over year to 4%, led by our digital and cloud offerings. Our GBS consulting practice brings together business know-how and technology know-how to unlock value for our customers. For example, this quarter, IBM Digital and Mediaocean launched a blockchain consortium of leading advertisers and publishers, including Kellogg, Unilever, Kimberly Clark and Pfizer, to set the new industry standard for the digital ad-commerce ecosystem continue to invest and recently announced the acquisition of Oniqua Holdings, which adds technology and professional expertise in asset optimization. This strengthens our integrated IoT platform for Cognitive Solutions and GBS.

Application Management Services revenue declined 3%, reflecting the continued decline in traditional enterprise application managed services. We are growing in strategic offerings such as Cloud Migration Factory and Cloud Application Development. Increased demand in these areas resulted in two successive quarters of double-digit growth in Application Management.

Looking at gross profit, GBS's gross margin increased 130 basis points year on year. We've done a great deal to transform our portfolio and reposition our offer to get a better price for the value, and we also see early contributions from our productivity measures around work models and structure.

In summary, GBS delivered a solid quarter, and we see the implementation of our initiatives in our results.

Sales returned in Technology Services and Cloud platforms. Similar to GBS, this performance was mainly driven by our improved dynamics in the open-back run. The strategic imperative revenue in the segment grew by 24%. This was led by Cloud, which grew 27% and increased our service revenue by 30%, a sequential increase of 6 points, now at an annualized $ 7.6 billion.

Infrastructure Services revenue growth to 1% this quarter as we continue to support customers on their way to the cloud. The IBM cloud enables customers to migrate, modernize and build new cloud apps, AI-enabled and secure at the core. During the quarter, we completed the migration of core banking applications from Westpac to IBM Cloud. This is just one example of how we are becoming the target for mission-critical workloads in the cloud.

We are expanding our capabilities and recently announced an expansion to 18 availability areas for the IBM cloud around the world. The enhanced global footprint is important as customers want to retain control over their data when implementing hybrid data, especially given the increased data regulation.

Sales in Technical Support decreased 4%. As always with a Z product launch, there are short-term effects on our maintenance stream as IBM Z sales shift customers from maintenance to warranty in the first year. The impact on maintenance is now becoming clearer as existing customers achieve higher acceptance rates in the strong current Z cycle. This effect was mitigated by the continued growth of our multi-vendor support offerings.

Integration Software grew by 1%. We had good service on offerings that modernize applications and enable cloud usage. These include offerings such as IBM Cloud Private that allow customers to develop cloud native applications behind their firewall. We gained 100 new customers in the second quarter and have had over 300 customers since the announcement of the product at the end of last year.

The margin of the segment was one point lower than in the previous year in terms of gross profit. Most of this decline was due to the revenue mix that declined from the higher margin TSSs during the quarter. The rest was caused by the continued scaling of our cloud. We had some productivity benefits, but as I said earlier, the measures we took in the first quarter will mostly be in the second half of the year.

In Systems, we've increased sales again as we continue to deliver innovative technologies. This is the latest workloads of today. All three brands, IBM Z, Power and Storage, have grown and we have gained shares in total. In the second quarter, IBM Z increased sales year-on-year by 112%, with MIP growth of nearly 200%, which was due to new workload MIPs. The introduction of Z14 remained broad and continued to follow the previous program after four quarters. The value proposition will benefit existing IBM Z customers, who will increase and expand Z14's utilization this quarter, whether in e-commerce, mobile banking, machine learning or new blockchain services. And we're adding new customers from all over the world, from a managed care provider in the US to a university in Canada, an electronics distributor in Italy, and a bank in Africa. We also had good acceptance for our new single-frame Z14, which was specifically designed for cloud environments.

Power revenues increased 4% due to the launch of our new entry-level POWER9 portfolio and continued growth of Linux. These cloud-enabled systems provide leadership in advanced analytics, cloud environments, and data-intensive workloads in AI, HANA, and UNIX markets. We have continued the introduction of our supercomputers in the US Department of Energy Labs. As part of our effort, the US government recently unveiled the Power9-based Summit, the world's most powerful supercomputer, ranked # 1 on the TOP 500 list of commercially available computers. This is the first time in over 5 years that a US company led the list.

Storage hardware returned to growth this quarter after facing some sales-related challenges in a competitive market in the last quarter. This growth was geographically broad and was led by strong growth in All Flash Arrays. Flash grew double-digit throughout the portfolio and increased. We're coming up with new offerings, including a new mid-range Flash system announced last week, with industry-leading performance technology.

In terms of profit, Systems' pre-tax profit increased $ 275 million a year. The tax margin increased by more than 10 points, which is a solid performance.

In the second quarter, we achieved $ 2.9 billion in cash flow excluding our financing receivables and $ 1.9 billion in free cash flow. And so we generated $ 3.2 billion in free cash flow in the first half of the year, down $ 400 million from a year ago. This reflects solid working capital performance offset by a $ 300 million increase in investments in global cloud data center building and $ 700 million more in tax payments. We now have all the headwind for the tax relief we expect for the year.

If we consider the use of cash in half, we have reimbursed $ 4.6 billion to our shareholders. In April, we once again raised our dividend, tripling the dividend per share over the last ten years. During the first half of the year, we repurchased nearly 12 million shares and ended June with 913 million shares outstanding and $ 2 billion in our repurchase authorization.

Looking at the balance sheet highlights, our cash and total debt is fairly steady in June. About two-thirds of our debt supports our financing business, which is leveraged at 9 to 1, and the bulk of our funding requirements, 54%, are investment-grade, 2 points more than last year. Our balance sheet remains strong and offers a great deal of flexibility to support our investments and our shareholder returns in the long term.

In summary, our performance this quarter underscores the extent to which we have reoriented our business in recent years. As I said, nearly half of our revenue is aligned with the strategic directions that represent the emerging, high-value and high-growth segments of our industry. This also reflects a significant portfolio shift for IBM, which, as we discussed in our Investor Webcast in March, is characterized by significant shifts in our capital allocation and investment strategy.

These shifts reflect our idea of ​​what customers would value in a quick reorganization of the IT industry, powered by cloud, data, and AI. And that's innovative technology in key new areas, the know-how to use that technology in industry-specific processes and workflows, and the commitment that their corporate data is handled responsibly. This is the differentiation of IBM, and we see that it is reflected in our revenue and earnings performance.

This quarter, we achieved 2% constant currency sales growth, 11% pre-tax operating profit growth, and 5% EPS growth – sharing growth, a first half, including revenue, operating income and earnings per share could increase.

As always, we have tailwind and headwind in the second half, but with this performance and our We continue to focus on consistent operational execution and continue to expect operating earnings of at least $ 13.80 per share and a free one Cash flow of 12 billion US dollars.

Let me return this question to Patricia

Patricia Murphy Vice President Investor Relations

Thank you, Jim. Before we start with the questions and answers, I would like to mention a few points. First, at the end of the slide, we have additional graphics that provide additional quarterly information. And second, as always, I ask you to refrain from multi-part questions.

So, Operator, please open it for questions.

Questions and Answers:


Thank you. We will now begin the question-and-answer session of today's conference. If you would like to ask a question, please press * followed by the number 1. Our first question comes from Wamsi Mohan of the Bank of America Merrill Lynch. Please continue.

Wamsi Mohan Bank of America Merrill Lynch – Analyst

Yes, thank you. Jim, you've seen a steady slowdown in cognitive sales, but margins on profit margins have improved pleasingly. You have pointed out a few factors there. I was wondering if you could explain in more detail the drivers of this PTI margin expansion between the operational efficiencies, the acquisition synergies that you pointed out [inaudible] investments, and secondly, your base area decline in the quarter was quite significant. Can you talk about it in the second half, especially given some of the cost actions that you said were not taken into account yet? The cost actions that you took in the first quarter must still be reflected in the second half. Thank you.

James J. Kavanaugh Senior Vice President and Chief Financial Officer

Sure, Wamsi. Thank you for the question. Let me first address the "Cognitive Solutions" segment and talk about a constant currency and then move on to the "operating leverage" component. Then next I will address your spending issue. Cognitive Solutions As you all know, our financial model for the Cognitive Solutions segment is, first of all, growth and at the same time an operational leverage that is in line with this growth. As we saw in the past two quarters, as we accelerate the acquisition integration synergies in our business, we see operational leverage well ahead of our actual revenue growth in this segment.

In addition, we have increased operational efficiencies and synergies in redefining our workflows, redefining development optimization, applying agile methods, and achieving higher speed, responsiveness, cycle time, throughput, and output in our organization. So, we get more value for the dollar overall. As you can see, the operating leverage in this segment has impacted on the first quarter, and you saw it in the second quarter with strong 9% constant-rate earnings growth. So we continue to believe that we will evolve and we will continue to benefit from this business.

In Bezug auf die Kostendynamik haben Sie in den vorbereiteten Erläuterungen unsere Betriebsausgaben um 2% verbessert. Aber es gibt viele verschiedene Komponenten innerhalb dieser Betriebskosten von 2% besser. In erster Linie hatte Währung unseren Betriebsaufwand um 2 Punkte beeinflusst. Ich werde Ihnen sagen, dass dies ungefähr die Hälfte der Auswirkungen oder sogar etwas weniger als die Hälfte der Auswirkungen war, als wir vor 90 Tagen erwartet hatten, nur angesichts der Volatilität dessen, was an den Devisenmärkten passiert, insbesondere um die Aufwertung des US-Dollars. 19659015] So ist die Währung in den letzten Quartalen um 4 bis 5 Punkte belastet. Jetzt war es nur ein 2-Punkte-Einschlag. So war unsere Basisproduktivität um 4% besser. Dies wird vorangetrieben, da wir den operativen Hebel durch unsere Initiativen zur Produktivitätssteigerung von Unternehmen weiter treiben, um IBM neu zu erfinden und wie wir tatsächlich arbeiten. Ändern unseres Managementsystems, Angehen unserer Struktur, Angriff auf Kosten und Komplexität, Angleichen von Entscheidungsrechten und Förderung der Rechenschaftspflicht.

Also, 4% sind ein Basislevel für Produktivität, die wir fahren, und wir erwarten das in Zukunft. Dann füge ich nur einen weiteren Punkt hinzu. Das ist auf IP-Einkommen. Sie sehen, dass unser IP-Einkommen im zweiten Quartal um mehr als 100 Millionen Dollar gesunken ist, 115 Millionen Dollar, denke ich, um genau zu sein. In der ersten Hälfte sind es insgesamt fast 250 Millionen Dollar. Wir werden also weiterhin den Wert unserer Ausgaben für Forschung und Entwicklung nutzen und monetarisieren, und wir werden weiterhin in diese Bereiche investieren und dies opportunistisch über viele Monetarisierungsmodelle optimieren, aber das geistige Eigentum liegt derzeit bei 115 Millionen US-Dollar. Wenn Sie all das zusammenbringen, bringt es unserem Geschäft einen erheblichen operativen Hebel, wie Sie hier im zweiten Quartal sehen.

Patricia Murphy Vizepräsidentin für Investor Relations

Danke, Wamsi. Können wir bitte die nächste Frage stellen, Anne?


Danke. Die nächste Frage kommt von Steve Milunovich von UBS. Ihre Leitung ist jetzt offen.

Steven Milunovich UBS Securities – Analyst

Vielen Dank. Ein beträchtlicher Teil Ihres Umsatzwachstums und sogar des Vorsteuergewinns stammt aus dem Hardware-Bereich. Was erwarten Sie in der zweiten Hälfte Mainframe-Vergleiche? Werden wir im dritten und im vierten Jahr ziemlich hart im vierten Jahr sein? Und dann, nur um Ihre Währungskommentare zu verfolgen, gehe ich davon aus, dass Sie in der zweiten Jahreshälfte im Vergleich zu dem, was Sie im April erwartet haben, zwei Milliarden Dollar Umsatz verlieren. Haben Sie Maßnahmen ergriffen, um das auszugleichen, um Ihre 13,80 $ zu erreichen und Ihren freien Cashflow von 12 Mrd. $ zu erreichen?

James J. Kavanaugh Senior Vice President und Chief Financial Officer

Danke, Steve. Viele Fragen dort. Lass mich jeden einzeln nehmen. Zunächst einmal, ja, wir hatten insgesamt ein sehr starkes Systemquartal. Sowohl beim Umsatz als auch beim operativen Leverage haben wir im Jahresvergleich ein Ergebnis vor Steuern von mehr als 10 Punkten erzielt. Aber lassen Sie uns das Quartal relativieren. Wir haben insgesamt 4% Umsatz erzielt, 2% zu konstanten Wechselkursen. Es war unsere stärkste konstante Währung Umsatzwachstumsrate in über 7 Jahren. Sie wurde angeführt von unserer anhaltenden Beschleunigung und unseren strategischen Vorgaben, die zu aktuellen Wechselkursen um 15% und währungsbereinigt um 13% gestiegen sind. Das war eine Beschleunigung aus dem ersten Quartal, und innerhalb unseres Cloud-Geschäfts, $ 18,5 Milliarden, ein Plus von 23%.

Unsere Service-Jahresrate erhöht sich auf über 11 Milliarden Dollar. Das ist 24%. Unsere Servicegeschäfte sind währungsbereinigt wieder gewachsen. Sowohl GBS, die ein großes Quartal hatte, und TS und CP. Aber selbst wenn Sie unser Systemgeschäft in Ihre Frage rund um den Mainframe einbeziehen, und wenn wir den Mainframe herausnehmen, würden Sie diese Dynamik in der Beschleunigung unseres strategischen Imperativgeschäfts von Quartal zu Quartal sehen und, wie Sie alle wissen, in unseren Beiträgen Service-Beschleunigung von über $ 11 Milliarden, Wachstum von 24%, das hat kein Systemgeschäft darin.

Der letzte Punkt, den ich an die Spitze bringen werde, und dann komme ich zu Ihren anderen Fragen, die wir hatten geografisches und branchenspezifisches Wachstum in unserem Geschäft. Wahrscheinlich die beste Breite und Wachstum in der Anzahl der Länder, die wir in einer ziemlich langen Zeit hatten. 60+ Länder wuchsen zu konstanten Wechselkursen und das machte über 80% des Umsatzes von IBM aus.

Wenn Sie den Mainframe-Zyklus extrahieren, hatten wir immer noch über 60 Länder, die tatsächlich gewachsen sind. Those are large countries like Japan, like U.K., like Germany, France, Spain, Australia. Many which are not mainframe dominant. So, we see continued momentum. Now, with regards to mainframe. I'm not going to apologize. This is the most enduring platform that you've seen out there and we continue to capitalize on gaining new, emerging workloads onto that platform.

We delivered substantial growth in the second quarter, over 100% growth. We tripled our installed MIPs inventory that we ship. We're capturing over 60% of that MIP ship is in specialty workloads. So, through the first four quarters — now is the pertinent time to have the discussion — through the first four quarters, we are well in advance of what the prior cycle was.

With regards to your question about second half, I would expect that to continue in the second half as we move forward. We know in the fourth quarter that we've got a tremendous compare and I talked about that 90 days ago. We will have an impact, but we've got momentum in our services businesses returning the growth and, as you know, that's 60% of our business overall.

Now, with regards to currency. I'm glad you brought that up. We've seen dramatic volatility over the last 90 days since our last earnings call. To put it in perspective, we had stated here 90 days ago that we expected about a 4-point tailwind in the second quarter coming off of a 5-patient tailwind in the first quarter and you see that only ended up being a little bit over 2 points of a tailwind in the second quarter, as the U.S. dollar appreciated significantly against most currencies.

Now, when we look at the second half, we see about a 1 to 2-point headwind. Currency will flip. That's about somewhere in the neighborhood of $1.5 billion, including second quarter's $400 million that I talked about. Now, with that said, currency, you understand the top line dynamic of revenue. But currency also impacts margins, and they impact expense. From a margin perspective, if you look at, we've got two different businesses. We've got product-based businesses and we've got services-based businesses. On product-based businesses, you don't have a direct alignment of your sources of revenue and your sources of cost. So, that translation revenue impact that you see in our product-based businesses, the hardware, software, and services, you will see a gross margin impact on that at the GP line.

Services where you have a much more alignment of source of revenue and cost, you have basically a natural hedge. You won't see a gross profit impact on that revenue translation. But as you all know, we drive a hedging program to mitigate the foreign exchange volatility at a profit level. Why? Because it gives us time to adjust our pricing terms, our structure, and our sourcing strategies. So, at a PTI level, you see a very de minimis impact in period. Hedging doesn't eliminate, it only defers it. But at a profit level, it's a very de minimis impact, but it impacts the P&L differently as we move forward.

Patricia MurphyVice President of Investor Relations

Okay, Steve. Let's go to the next question, please.


The next question comes from Katy Huberty of Morgan Stanley. Your line is now open.

Katy Huberty Morgan Stanley — Managing Director of Research

Thank you. Good day. Jim, as was mentioned in an earlier question, investors are certainly worried about the tougher comps in the back half of this year and the 2% growth was a nice surprise this quarter, but you're not quite at consistent and meaningful growth across the businesses. And so my question is whether you and the rest of the management team would consider stepping up either M&A or divestitures to more meaningfully remix revenue and set the company on a path and a narrative around much more meaningful and sustainable growth?

James J. KavanaughSenior Vice President and Chief Financial Officer

Katy, thanks for the question overall. As you stated, we delivered a very solid quarter at 2% constant currency. I would tell you it's our third straight quarter of growth overall with an acceleration in terms of breadth and depth across geographies, across sectors, and across countries around the world.

But let's take a look at our portfolio. First and foremost, we are very confident in the portfolio lineup that we have here today around each of our segments. We talked about, at our investor day, the value differentiation of IBM. That value differentiation is built around innovative technology, around deep industry expertise, and around trust and security. All delivered through an integrated model.

If you take a look at it, we talked about the key value differentiators as we move forward. The value of bringing that together, I think you're seeing substantiated now here in the second quarter, with very strong growth overall in our systems platform, in the importance they play to our infrastructure, in our integrated model. You see our services base of businesses continue that trajectory improvement that we talked about starting in January of this year. We improved in the first quarter and now we've got both businesses back to growth and we delivered double-digit signings at actual rates in the first half, which positions us well as we move forward.

But you know our motto overall, we've done a lot of work around remixing our capital and investments to build out the portfolio that we have today. We're very disciplined in our capital allocation strategy. We said 70% to 80% of that capital and investment is going to go back to our shareholders in the form of share buy-back and dividend and you saw us raise our dividend here in April this year. Our 23rd straight year. But the remainder is for us to use internally to build out our differentiated capability around investments in R&D and capital to drive leadership in AI, leadership in blockchain, leadership in security, and leadership now in quantum as we move forward.

But acquisitions are an integral part. We're going to continue to evaluate our portfolio and how we capitalize the value of those acquisitions in light of the integrated, differentiated strategy of the IBM company going forward.

Patricia MurphyVice President of Investor Relations

Thank you, Katy. Let's go to the next question, please.


Our next question is from Toni Sacconaghi of Bernstein. Your line is now open.

Toni SacconaghiBernstein — Analyst

Yes, thank you. I'm wondering if you could comment a little bit more about the dynamics affecting Cognitive Solutions' revenue growth. It was down at constant currency versus a pretty easy comparison. It's the business that has the highest percentage of strategic initiatives in it, so it's obviously very important for you. Can you maybe comment specifically on what's happening with Watson Health? There were lots of press reports about the significant retrenchment in that business.

And I know you said the acquisitions take time, but you've had them all for at least a year. And so maybe you can comment on why you think we haven't seen better revenue progress or what specifically happened this quarter.

Then very quickly, if you could just confirm, you talked about flattish gross margins for the year. You're down in each of the first two quarters year-over-year, so should we be expecting gross margins to be up about 50 basis points year-over-year in the second half to hit that bogey of flattish?

James J. KavanaughSenior Vice President and Chief Financial Officer

All right, Toni. There's a lot to be compacted in a multiple-part question. But let me try to address each piece. We'll start with Cognitive. In terms of our Cognitive Solutions, we have a strong portfolio in the key strategic areas around analytics, around industry verticals, around security and around IoT and we continue to see good performance overall. But I'll remind you, this portfolio is a high annuity content. Over 80% of the business is annuity, with strong renewal rates. We continue to drive but that SaaS has a longer time to value, a longer time to realization.

But let me unpack the segment because you've got to understand the piece parts, because they each fit different purposes within the overarching IBM strategy in purpose. One is around TPS. TPS declined 2% overall and it's about what we would expect in this area. You've even commented on this the last couple quarters. We've been riding the wave of the mainframe product cycle over the last three quarters and saw pretty good growth that was unusual. Now, we're back to down 2%. This is high-value, high-profit, strategically important to our clients overall, but it's in stable to declining businesses and it wasn't unexpected.

When you look at our software solution portfolio, we've got growth in analytics as we revamp that portfolio coming off of a pretty disappointing fourth quarter. We grew in first quarter, we great again in second, and we got good, double-digit growth in our industry verticals like financial services and IoT and we're seeing good growth in Watson Health. We've got growth in Life Sciences segment, Imaging, Payer, and we're seeing good SaaS signings in our Government segments within that business.

Yes, we are driving acquisition synergies and you're seeing that play out. It's well in advance of a year. And you're seeing net operating leverage play out well in advance of our financial model around Cognitive Solutions. So, transaction processing software pretty much as expected, high-value based markets, software solutions, the key strategic areas that we have are growing. The focus that we've got, and we talked about this 90 days ago, are in three key segments around talent, around collaboration, and around commerce, where we are investing to modernize our portfolio to address the secular shifts that are happening in both client value and in consumption models.

As you know, this business today in these three segments are both a mixture of on-prem and SaaS. We are investing aggressively to revitalize this portfolio into a SaaS world around driving user interface improvements to make our offerings more digitally consumable, and also about shifting and investing to embed AI to deliver differentiated value for our clients overall. So, that's Cognitive Solutions.

Now, you asked about gross profit margins. So, let me take a step back and give you my perspective. Now that I've been on the job six months as CFO of IBM and I've spent a lot of time with our investors and also with many of you, the sell-side analysts, listening and also getting a perspective of our company, the sentiment, and the strategic positioning and what you would like to see. In each of those inevitably, the discussion around margin comes up. Warum? Because yes, we are a value-based stock. Our investment thesis is around value. Value driving profit growth at the end of the day that gives us the free cash flow flexibility to continue to return value to our shareholders and invest in our business.

But the discussion around gross profit margins always inevitably get at Services. Is Services deflationary and can you grow Services margins? I would tell you I think that's at the heart of your question around gross profit. I'll answer it in a couple ways. One, talking about our financial model, and two, talking about how we manage the business. But before I get into that, first and foremost, the net answer is as I stated 90 days ago, we expect our Services gross margin to expand in the second half and we still feel confident coming off of the trajectory improvement of what we saw in the second quarter really led by strong margin expansion in our GBS business and the productivity actions we have in front of us.

But when you look at this from an overall IBM perspective, our financial model, as we talked about, is low single-digit revenue growth, mid single-digit profit growth, and high single-digit EPS growth. In 2Q, you saw the instantiation of delivering that model. We grew revenue. We had PTI margin expansion of 110 basis points; the strongest we've had in years. And we drove operating leverage to deliver 11% profit growth, well in excess of our model.

So, for a full-year perspective, our view at an operating level in terms of profit growth has not changed. We're going to grow profit, we're going to grow PTI margins, and that supports our full-year guidance.

Now, let's talk about how we manage the business. Because I think it's important for our investors and it's important for each of you as analysts to understand this. No. 1, we got two distinct, different business models in our company. We got a product-based business model and we got a services-based business model. In a product-based business model, hardware, software and solutions, value is instantiated in delivering returns at a PTI level. Why? Because all the investment we make in a product-based business ends up below the gross profit margin line. And you see in our product-based business systems and Cognitive Solutions, we're growing substantial operating leverage and we're growing substantial return on investment.

Now, in services, as I said 90 days ago, in a human capital-based business, value is instantiated in gross profit margins. We manage our services business to get a return on our human capital at the gross profit level. As I said, as a gross profit level in services, we still expect to expand margins in the second half. The only thing that has changed in the last 90 days has been the extreme volatility in the FX world around the U.S. dollar appreciation. As I stated earlier, we have a hedging policy that mitigates the volatility of currency inter-IME at a profit level, but it does impact gross margins, in particular at a product level in our product-based businesses. It does not impact profit in the near-term. It allows you time to then go adjust your pricing terms, your cost structure, and your sourcing strategies as we move forward.

So, that's the only thing that's changed in the last 90 days. We feel confident we're going to grow revenue for the year at current spot rates, even in light of currency flipping to a headwind in the second half. We feel confident we're going to expand pre-tax margins similar to what we did in the second half. Within that, we feel confident we're actually going to deliver services gross profit margin expansion in the second half of the year.

Patricia MurphyVice President of Investor Relations

Thanks, Toni. Ann, can we please take the next question?


The next question comes from the line of Tien Tsin Huang of J.P. Morgan. Your line is now open.

Tien Tsin HuangJ.P. Morgan — Analyst

Thanks so much. Yeah, so consulting accelerated, which is encouraging. I'm curious, is that starting to pull in some other services revenue around it or behind it? I saw or you mentioned the [inaudible] were good again. So again, was it enough to drive positive effects mutual revenue growth in services for the second half? I'm just trying to piece all of those things together and think about [inaudible] revenue growth for services overall in the second half.

James J. KavanaughSenior Vice President and Chief Financial Officer

Yeah, if you take a look at GBS in second quarter, first of all, we're very pleased with our performance. The work that Mark and the team have done tirelessly to transform our structure, our business models, our growth platforms, the set of initiatives around productivity, we're very pleased. You saw that play out in continued trajectory improvement throughout the first half, returning to modest revenue growth and significant operating leverage and margin expansion, which we expect will be a big contributor in our second half services margin expansion that we talked about in the last question.

Now, with that said, if you look at that acceleration and what's been happening in the trajectory of our services business, first, as you all understand the dynamics of that business, you have to get signings that have to yield into backlog, which has to yield into revenue as we move forward. We're seeing tremendous momentum in our consulting base of business. We delivered 4% revenue growth as you stated in the second quarter, and that's leveraging momentum around how we redesign our growth platforms and how we resign our service lines and offerings and practices. We're capturing higher value. Value around digital transformation offerings that enable clients to move their journey to the cloud as we move forward. We're doing great in our CRM practice, our workday practice, and we're also capturing new emerging areas like blockchain, where we're seeing good growth in our services base of business.

As you know and we talked about extensively at our investor webcast in the beginning of the year, GBS has a very integral part in an integrated model strategy in the IBM company. They have the mission of bringing business and technology transformation together. So, the long answer to your question around is consulting in GBS a key leading indicator of dragging the rest of IBM? The answer is definitely yes.

Patricia MurphyVice President of Investor Relations

Thanks, Tien Tsin. Can we please take the next question?


The next question comes from Jim Schneider of Goldman Sachs. Your line is now open.

Jim SchneiderGoldman Sachs — Analyst

Good afternoon. Thanks for taking my question. I was wondering if you could maybe follow up on that prior question and talk about the ability of the tech services and cloud platform segment to start to return a growth in the back half. Clearly, we're starting to get a little bit better signings performance, but I'm wondering if that's a realistic expectation for that segment and whether you can achieve it at the same time as you're expanding margins there?

James J. KavanaughSenior Vice President and Chief Financial Officer

Sure, Jim. Good to talk to you again. Thanks for the question. Yes, on TS and CP, similar to our discussion around GBS, we're pleased with the trajectory improvement and the progress that we've been making within this business on the top line throughout the first half. We made sequential progress quarter-to-quarter. We have now returned to growth, delivering $8.6 billion of revenue.

Let's talk about a couple of the key components. First, we are capitalizing on tremendous momentum around enterprise hybrid cloud strategy. We are becoming the destination of moving and enabling our clients' journey to the cloud. Our GBS business is an instrumental part of that strategy as we move forward. So, we've got a lot of momentum in our enterprise hybrid cloud. That, as you see, is delivering an as-a-service annualized run rate of $7.6 billion. That's up 30% year-to-year. That has tremendous value as we move forward to continue getting scale efficiencies and the like.

But let's talk about then the core GBS business overall. If infrastructure services return to growth, 1% in the growth, and it's really been built off of a very strong first half where we delivered double-digit signings growth at the GBS and TS and CP segment level and now, you saw our backlog continues to improve. Our backlog now in total is $116 billion. Within that, 30% of that backlog now is cloud, as we continue to capitalize on the secular shift and deliver more and more value overall.

Our integration software business has grown 1% and continues to grow through the first half. What we've got to work on, and this is part of having an integrated portfolio and part of having success in other areas, our TSS business is down 4%, but that's a function of us significantly overachieving against our last program, our mainframe product cycles. We see a deceleration in TSS, but we're seeing the offset in our systems base of business going forward.

So, when you look at that trajectory improvement, we returned our backlog back to flat in the second quarter in TS and CP. And again, a lot of work ahead of us. We've got to fuel second half signings. We've got a good opportunity pipeline, but I see continued trajectory improvement and then our focus on margins as we move forward in the second half to deliver second half services gross profit margin expansion are going to be critical to our guidance.

Patricia MurphyVice President of Investor Relations

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


The next question comes from David Grossman of Stifel Financial. Your line is now open.

David GrossmanStifel Financial Corp. — Analyst

Thank you. Hi, Jim. This year, you're guiding to free cash flow roughly equal to net income, which is above your longer-term target. I know it's way too early to providing 2019 insight; however, are there are factors that are driving the '18 free cash flow that may not reoccur next year or even potentially reverse that we should be factoring into our thinking for next year?

James J. KavanaughSenior Vice President and Chief Financial Officer

Yes, David. Thank you very much and good to hear from you again. Before I get to the long-term view, I mean I think you kind of nailed it. Let's talk about our free cash flow guidance here through the second quarter and more importantly, through the first half. First of all, we talked about entering the year that we expected $12 billion of free cash flow. That was down about $1 billion. If you remember, at that point in time, we talked about we were going to continue to invest in our business in terms of capital, to build out our IBM cloud architecture, and oh, by the way, in the second quarter, I think you have seen the announcement where we expanded 18 new availability zones around the world, so we are committed to winning in the cloud space and we're investing to go do that. But we also said we were going to have a significant cash tax headwind here in 2018. Then our GAAP profit, as we start turning this business and deliver on our at least $13.80, was going to pretty much offset our strong working capital efficiency that we exited last year with our mainframe cycle.

So, through the first half, we delivered $3.2 billion of free cash flow. That's down $400 million. It's important to understand the underpinnings behind that. Within that, we've invested $300 million year-to-year, up 20% on capital already through the first half. We've had strong operational after-tax profit performance that delivered a positive contribution of $600 million to support that investment in capital as we move forward. So, when you do the net then, our entire year-to-year reduction through the first half is all driven by cash tax headwind. That cash tax headwind is $700 million through the first half and it's all behind us now.

So, our second half free cash flow, to your point, we've always said as a rule of thumb, free cash flow should follow our profit levels. When you look at our realization, you see it playing out in our realization. We're well in excess of 100%. Our trailing 12 months is at $12.6 billion and our attainment supports that $12 billion free cash flow level as we move forward.

So, it's too early to look at '19. We'll deliver that in January. But at least hopefully the answer gives you some of the dynamics of what's playing out in free cash flow.

Patricia MurphyVice President of Investor Relations

Thanks, David. Ann, can we please take the next question?


The next question comes from Keith Beckman of Bank of Montreal. Your line is now open.

Keith BeckmanBank of Montreal — Analyst

Thank you very much. Jim, I wanted to see if you could talk a little bit about the durability of services. You've talked about GBS and technology and cloud outsourcing growing constant currency in the second half of the year, yet backlog, total services backlog is down 1% in constant currency. So, once you recheck growth, are you still calling for durable growth in those businesses, even with backlog down? Then my follow-up — well, let me ask my follow-up question after that.

James J. KavanaughSenior Vice President and Chief Financial Officer

No, why don't you ask your follow-up question now.

Keith BeckmanBank of Montreal — Analyst

Well, just within GBS. Something I wanted to come back to, application management is still under pressure, as it is for most of the providers. Is that going to continue within the context of GBS or you actually see application management within the confines of GBS improving?

James J. KavanaughSenior Vice President and Chief Financial Officer

Okay, Keith. So, thank you very much for just getting it all and giving me a better perspective of the entirety of your multiple-part questions so we can put this in perspective. So, let's talk about, I'll drive you back to 180 days ago, when we were sitting here in January. We talked about the position where we were at. We talked about what's going on with the dynamics of our backlog overall, and we talked about the backlog realization and runout that we saw over the 2018 period.

We said entering 2018, that we had much stronger backlog realization or runout, I should say, we that were starting with than we did entering 2017. You're seeing that play out as we go through the first half, where we made sequential year-to-year improvement over the first quarter and now we turn both of our services businesses back to growth.

Now, within that, as we stated earlier, in a human capital-based services business, you've got to continue fueling those signings that delivers backlog. And more importantly, you've got to drive the right composition of backlog that drives your backlog realization in yield, and also drives duration. Obviously, what you're seeing over time is you're seeing, I think, a secular shift with regard to what's happening to duration and long-term contracts. You're not seeing that anymore.

So, we're getting higher yielding revenue. We're also, the composition of our backlog with consulting, which accelerated to 4%, that composition is much more shorter term and higher value as we move forward. So, over the long run, you're right. You've got to continue to fuel signings to fuel that backlog, but I would tell you, outer years of 6, 7, 8, 9, 10, in today's world are much less relevant than an in period your first year, your second year, your third year in the composition.

So, we do feel confident with that trajectory improvement. We came off the first half delivering good growth, double-digits and signings in the first half, and the composition of those signings, as I said, we already have 30% of our backlog that's sitting in cloud. By the way, over 40% of our backlog is now in key, strategic, imperative workloads overall. So, that's kind of your first question.

Your second question, AMS. We talked about AMS. Obviously, that's going through a secular shift in the industry. You're seeing that play out against all the competitors that are in the space today. But I would tell you what differentiates IBM with regards to AMS? One, it's our value of incumbency. The integrated play, the integrated model of IBM, the value of incumbency and the reason we're in the AMS business is we understand our clients' operating models, our client's workloads, and our clients' business processes. We said entering this year that we were seeing success in us leveraging that value of incumbency to be the destination to help our clients with the journey to the cloud and move to the cloud.

We're seeing that play out in the first half. We're not only in the first quarter, but also in the second quarter we had double-digit signings growth in our AMS business over time. Again, backlog yes is still down overall. Our revenue is down 3%, but we see this inflection point as we move forward and we continue to leverage and deliver that value for our clients as they move on their journey overall.

Patricia MurphyVice President of Investor Relations

Let's go to the next question, please.


The next question comes from Jim Suba of Citibank. Your line is now open.

Jim Suba Citibank — Analyst

Thanks very much. Jim, I just have one question for you. As you sit there in the CFO seat and you're calling now for margins to accelerate or improve or expand year-over-year in the second half of the year, what are the milestones that are hitting that kind of make you call that out? The happiness behind it, the confidence. What's the milestones that we can look back and say that made a lot of sense and it has long-term durability to it? Thank you.

James J. KavanaughSenior Vice President and Chief Financial Officer

Jim, thank you very much for the question. It's a good question overall. If you take a look at it, I've said from January, we obviously have multiple scenarios. How do we make at least $13.80? What I looked at and the team, and the entire management team looks at is the trajectory of our business, the operational indices, and the drivers as we see going forward of headwinds and tailwinds on that guidance for our shareholders of at least $13.80.

But when you take a look at revenue growth, I said we would have revenue growth at current spot rates for the full year, and that we would have pre-tax operating margin expansion and operating leverage in our business. So, to your question, what do we look at and what are the trends that are driving that? So, let's unpack it. I've talked about this the last couple calls. The way I look at margin expansion really centers around three or four major areas.

No. 1, margin expansion is going to be delivered through us continuing to leverage the momentum in our enterprise cloud and our as-a-service-based business. Why? Because it's going to generate scale efficiencies for us to deliver on what we said at our investor day, which is margin accretion as we move through to the cloud. So, scale efficiencies, we are seeing that improvement in the first quarter. We're seeing improvement in the second quarter, and it's all being built off of the momentum around our cloud and our as-a-service-based business.

Second, we talk about mix. Mix being another lever. So, you look at the mix of one within each of our segments and how we're shifting to higher value, which we're making good progress. The best instantiation of that is GBS, where they're getting better price realization and better value around remixing their offerings to sell better value. But also across segments, we have a big mix headwind as we talked about 90 days ago, with regard to the mainframe cycle. So, we take that into account.

The third bucket is around productivity. This is around how you transform the way you work. It's predominantly led by our services-base of business. But it's also about how we reinvent and how we run our company around our infrastructure and enterprise productivity. Both are giving us operating leverage as we move forward. We're seeing the latter play out in our expense efficiency structure here in the second quarter and in our services-base of business, we talked about the work we're doing around our workforce optimization, the significant actions we took in the first quarter. I said it's predominantly the yield on that is in the second half. That should accelerate significantly.

But we're also transforming the way we actually deliver service. Redesigning it, applying Agile methodologies, infusing AI and automation, and driving a differentiated value to our clients to improve the quality in addition to the efficiently and margin.

Finally, the last point, which given services is 60% of our business, human capital based business, you have to generate revenue to generate operating leverage. It's tough generating operating leverage when revenue is down. We're seeing, as that revenue trajectory improves and we're seeing as we play out here in the second quarter returning services back to growth, that we're going to get the operating leverage as we move forward. That's what makes us confident in delivering at least $13.80.

Patricia MurphyVice President of Investor Relations

Great, thanks. Ann, let's take one last question, please.


The last question comes from Amit Daryanani of RBC Capital Markets. Your line is now open.

Amit DaryananiRBC Capital Markets — Analyst

Thanks. Glad I made it under the line there. Maybe to start, cognitive revenue is down in constant currency in the quarter and really there's some amount of transactional business there, but just help me understand what tempered the growth there and then do you think cognitive will actually grow in the back half of the year because your compares start to get fairly difficult in that business I think in the back half of the year.

And then, Jim, just on gross margins, what's leading you to start talking about [inaudible] aggregate total IBM gross margins will be flat to stable and now it sounds like it's on the in-services, so what's the degradation in cognitive or systems that's changing that statement on gross margins from a corporate level to only services now?

James J. KavanaughSenior Vice President and Chief Financial Officer

Okay, so on each of them, Amit, first of all, thanks for getting into the queue. It's good to hear from you again. But on each of these, I think I answered them already. But let me just give the synopsis. On cognitive, we talked about the different dynamics within our portfolio around TPS, which had been growing, leverage the mainframe cycle. Now, it's more in line with what our expectations are. In solutions software, we've got strength in key strategic areas of our portfolio, analytics industry verticals, both FSS, in health, in security, in IoT, but we've got work to do on modernizing those key three segment areas of talent, collaboration, commerce. And that, as those secular shifts move much more aggressively to SaaS, that time to value gets realized over a longer period of time.

So, we do we strength in certain components. We're making investments in others to transform, as I talked about, and modernize those offerings. That will play out over time. But with that said, we've done all the work and we're driving the acquisition integration synergies, the operational efficiency savings. We feel confident even at this level of revenue we can drive operating leverage within that business.

Then finally, back to your question on margins. As I talked, first, I think the way we manage this business, value is instantiated in the services-base business in gross profit margin. Value is instantiated in the product-based business in pre-tax income because you've got to recoup the return on investment of your go-to-market and your development. So, I would not say I'm changing. I would say our operating view of the year of our financial model of revenue growth, of profit growth, of earnings per share, is exactly the same. The only thing that's different within that is the FX change in the last 90 days, with the significant U.S. dollar appreciation.

Now, we hedge. We hedge that mitigates that profit variability. But when you look at currency around the element of the I&E, you see how it plays out differently. That transparency and credibility is what I feel is important for you and investors to understand, but it has no impact on our bottom line profit contribution and our delivery of our free cash flow and our at least $13.80 for the year. So, thank you, Amit.

With that said, let me wrap up the call where I started by saying this was a good quarter. We're pleased. We had solid revenue growth and profit performance. This reflects the work we've been doing to reposition our business in terms of our offerings, our people, the way we work, and reinventing IBM. Now, as always, there's more work to do. I look forward to continuing the dialog over the course of the year. Thank you all for joining us on the call here this evening.

Patricia MurphyVice President of Investor Relations

Ann, I'm going to turn it back to you to close up the call.


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

Duration: 80 minutes

Call participants:

James J. KavanaughSenior Vice President and Chief Financial Officer

Patricia MurphyVice President of Investor Relations

Wamsi MohanBank of America Merrill Lynch — Analyst

Steven MilunovichUBS Securities — Analyst

Katy Huberty Morgan Stanley — Managing Director of Research

Toni SacconaghiBernstein — Analyst

Tien Tsin HuangJ.P. Morgan — Analyst

Jim SchneiderGoldman Sachs — Analyst

David GrossmanStifel Financial Corp. — Analyst

Keith BeckmanBank of Montreal — Analyst

Jim Suba Citibank — Analyst

Amit DaryananiRBC Capital Markets — Analyst

More IBM analysis

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