Q2 2020 International Business Machines Corp Earnings Call
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Welcome and thank you for standing by at this time all participants are in 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 Miss Patricia Murphy with I'd be ma'am you may begin.
Thank you [laughter], Patricia Murphy and I want to welcome you to IB and second quarter 2020 earnings presentation.
I'm here with Orban Krishna I'd be a chief Executive officer, Jim capping off I'd be M., senior Vice President and Chief Financial Officer <unk>.
Post today's prepared remarks on the I'd be on Investor website within a couple of hours and the replay will be available by this time tomorrow.
I'm comments made in this presentation, maybe considered forward looking under the private Securities Litigation Reform Act of 1995.
These statements involve factors that could cause our actual results could differ materially.
Additional information about these factors is included in the company's FCC filings.
Our presentation also includes non-GAAP measures.
Divided there's no information to investors.
For example, we present revenue and signings growth at constant currency throughout the presentation. In addition to provide a view consistent with our go forward business will focus on constant currency growth adjusting for the divested businesses.
Impacted lines of total revenue.
Wow and our geographic performance.
We provided reconciliation charts for these and other non-GAAP measures at the end of the presentation and in the 8-K them into the FCC.
Finally, consistent with our last few quarters I'd be EMS revenue profit and earnings per share reflect the impact of purchase accounting and other transaction related adjustments.
Associated with the acquisition of Red hat.
These adjustments and charges are primarily non cash.
With that I'll turn the call over to Arvind.
Hello, everyone.
I'm pleased to be speaking with you again.
<unk> goal adaptable to embark on the global public health crisis, and I told you about <unk> to help the shifting needs of our clients.
I also told you about the confidence I had been on strategy and our portfolio.
Which is focus on hybrid cloud as well as they don't Andy.
All of this continues.
Today, there are two topics I'd like to callable.
Well.
I want to tell you about what you're seeing in the market.
And then I wanted to scroll saw priorities and actions we've taken to move them forward.
From a market perspective, while the problems in bottom unfolded build and short term challenges.
Also presents long term opportunities that I'd be you will see.
I got Florence accelerate the shift to hybrid cloud I'd.
The essential walk good redo in terms of running our clients mission critical processes continues.
More profoundly receipt of the digital transformational businesses is accelerating.
Our second quarter results demonstrate this with an increase of or pinpoint it our cloud revenue growth over last quarter.
The trend we've seen the market is clear.
Well I just want to modernize apps.
More workloads to the cloud and automate Heidi daus.
They want to infuse into their workflows unsecured that idea infrastructure to fend off growing cyber security threats.
As a result, we're seeing it increased opportunity a large transmission projects.
These are projects, where I'd be has a unique value proposition.
Well there also projects that take time to shape and therefore to close.
At the same time, we're feeling the impact of austerity measures that businesses have put in place to preserve cash and capital.
Our software and services results reflect this reality.
Jim will take you through this in more detail.
Taken altogether. This is a backdrop off our results for this quarter.
The reflects the immediate challenges.
And long term opportunities of this environment.
Now, let me move on and discuss my priorities moving forward.
As I touched upon in a loss calls I'd be them is focused on helping our clients in the two major transformational journeys there on hybrid cloud as well as data on <unk>.
Hybrid cloud is the dominant force robbing change in our industry.
But as far from Universal adoption.
Only 20% of the workloads have moved to the cloud.
The other 80% a mission critical workloads that are far more difficult to move.
There's a massive opportunity in front of us to capture these workloads.
What I see a hybrid cloud I'm talking about an inter operable I'd environment across on premise private and publicly operated cloud environments in most cases from multiple windows.
Why do we believe this is a future rather than a pit stop along the way.
Barnes find the choosing a hybrid cloud approach is doing to half times more valuable and relying on public cloud alone.
This consider those factors such as innovation development time.
Portfolio optimization.
Let me spend a minute to describe our hybrid cloud platform.
It starts with Linux.
Which is the de facto operating system standards.
We have a tremendous advantage with red Hot clinics, which is a market share leader.
Linux along with containers and Kubernetes provides the architectural foundation of our platform.
Openshift is our older products that captures all this and more.
I'd be has a vast software and little bit portfolio.
Which has now been containerized and runs on Openshift and Red hat Linux.
The family of fraud box be introduced into second half of last year.
Allows our middleware to run in a cloud native environment and bridge our clients from the faster the future.
This means clients can now deploy our software anywhere openshift runs it is infrastructure agnostic across not just public and private clouds, but also our mainframes and ball mill system platforms.
Openshift is also what makes it possible to develop and consume software in the new way.
It wasn't able to deficit cops and all the subsequent boost productivity security and speed of deployment.
Our hybrid cloud platform also includes a set of advanced technologies.
Such as Watson analytics encryption.
D and many others.
What gives or hybrid cloud platform the fuel it needs to accelerate adoption.
And become pervasive is the large ecosystem of partners we are building.
We have gone to great lengths to forge a global coalition of best of breed I suites.
This includes the recent additions like Adobe sales force SMP box and slack.
All are using our hybrid cloud platform to help clients Borden Nice mission critical workloads.
We have done the same with major system integrators.
And some young Infosys Wipro thought our consultancy services.
Tech Mahindra assistance systems, all our examples that are helping expand the reach of ideas hybrid cloud platform.
Finally, you'll recall that nearly half the Hubbard thought opportunity lies in services.
An important part of our platforms value lies in the expertise we provide to help clients on their journey.
Whether that's modernizing perhaps building cloud native apps migrating to the cloud or managing these applications on the public and private cloud infrastructures.
We are currently helping hundreds of major clients on these journeys.
I believe that our strategic vision is taking hold in the marketplace.
I mentioned the acceleration in our cloud growth this quarter to over 30%.
Hybrid cloud platform generated over $23 billion of revenue over the last 12 months.
I just described the importance of Red hat, Linux and Openshift <unk> platform.
And Red hat continued its momentum in the <unk>.
Combination of IB him and Red hat, driving strong revenue and bookings growth.
Across the board, we are seeing greater demand for red hat products.
Clients are eager to tap into open source innovation.
They want the freedom to securely deployed run and manage their data and applications on the part of their choice and retaining that choice is critical.
Grind such as Bharti Airtel American Express Vodafone Broadridge financial solutions, Banco Sabadell, and Carshop Bank, all see the value in a hybrid cloud architecture build the IB EM and Red hat.
As part of our hybrid cloud strategy, a key focus is to help clients talk a complex and highly regulated workloads.
Last year, we launched the financial services ready public cloud with Bank of America.
And we recently created a new program highest fees and SAP software as a service providers.
I'm happy to share that we now have 30 ice we signed up this happens with great speed and I'm confident that more will join soon.
So let me pause for a moment and remind you of the three priorities I shared with IB EMOS on my first their CEO.
One.
Help our clients under journey to cloud and they.
Do.
When the architectural battles and cloud with Red hat.
We continually delight our clients.
These priorities remain the same.
And you can see Javier made progress in all of them.
At the same time, we have continued to deliver a series of new innovations in the last quarter.
We launched a new edge and telco network cloud solutions.
On Red hat, Openstack and Red hat Openshift.
That enables clients to run workloads anywhere.
From a data center to multiple clouds to the edge.
We also launched our AI for I'd offering to give every CIO.
Ability to automate their IP infrastructure that immediately reduces cost and becomes more resilient.
Yeah I for idea runs across any cloud and works in collaboration with an ecosystem of partners that include Slacking box.
On quantum computing, we added an additional four systems, which expands our fleet to 22 quantum computing systems.
That includes eight systems that have demonstrated a quantum volume of 32.
Your artistic arguments proposed to measure the relative power and usefulness of quantum computers.
I've talked previously about the importance of both organic and inorganic investment to drive innovation.
We recently announced do acquisitions that will enhance our hybrid cloud.
And AI capabilities.
In June.
We acquired a new go to boost our compliance and cyber security capabilities for the hybrid cloud.
And in early July we agreed to acquire WD G automation.
That advances, yeah, infuse automation capabilities into our cloud facts.
Needless to say this is a unique and challenging time product lines.
To continue to be that most trusted partner, we're spending a lot of time and energy to drastically simplify how our teams go to market.
We are doing a lot of work on the backend to bring our portfolio together in a more cohesive fashion or teams can come but simpler and more relevant proposals.
We're also focused on changing our culture and operating model.
We can make decisions will quickly and make our interactions with clients a lot more experience shows.
It will take you through a few of our more recent actions.
Moving forward, we will continue to take actions that improve our operating model.
And accelerate our strategic priorities, so that we can emerge stronger.
Before turning to Jim Let me end by saying a few words on our commitment to corporate social responsibility.
This is always been important Robbie EM.
But as you know with the current events in the United States, there's been a renewed focus to do more.
As I became CEO I'm fully committed to ensuring that <unk> will continue to lead in this area.
But this is also about skills and creating opportunity.
Since 2011, I'd be remiss held to develop and expand and new public education model called feet thick.
We did provide high school students from underserved background with the skills and credentials the need for competitive jobs in stem.
To that end, we recently made a commitment to hire 1000 interns will come from pretax.
To put this in context, we have between five and 10000 interns that IB m. each year. So this represents more than 10% of our intern base.
I'm always happy to expand later on this and other topics relating to our he or she efforts.
Now back to the quarter and the business.
Jim is going to take you through our results Jim over to you.
Thanks urban during our first quarter earnings call I talked about how we're prepared for a wide range of outcomes given the economic uncertainty.
Our second quarter results for within that range, we delivered $18.1 billion a revenue expanded gross margin reported operating earnings per share of $2, an 18 cents and continue to generate solid free cash flow.
Our balance sheet remains strong and we continue to have ample liquidity.
The external dynamics, we saw in March continued into the second quarter with varied impacts by region and industry.
As we discussed in April we are not immune to the macroeconomic environment.
But our client and our portfolio mix provide some stability in our revenue profit and free cash flow, we saw that again this quarter.
Let me remind you of how our business mix provides the stability.
I'm a client perspective, our business is more concentrated in large enterprises, which in total have been relatively more stable throughout the pandemic.
Though as you would expect we saw more weakness on smaller enterprises this quarter.
About 70% of our revenue comes from industries that run the world's most critical processes and those industries have been less impacted by the current economic and health crisis.
We saw that in our results again this quarter and in fact grew revenue in financial markets government and education.
From a geographic perspective, we have a global footprint of more than 170 countries. This provides a bit of a natural hedge as we continue to see markets experienced different impacts from the pandemic overtime.
And then finally, when you look at our portfolio about 60% of our revenue comes from recurring revenue streams.
While we've adapted quickly to conduct business virtually around the world as expected we did have disruptions in transactional performance and volume reductions.
Many clients continue to delay projects the for purchases and favor opex over capex spending in this environment.
This pause in large purchases and discretionary spending was most evident in our perpetual software licenses and project oriented services.
Well clients remain focused on near term priorities running mission critical processes operational stability and cash preservation as urban mentioned the last few months also highlighted the need for clients to accelerate their digital transformations, leveraging hybrid cloud and AI.
Across I B M. Our cloud revenue grew 34%, which is up from the 23% growth in the first quarter.
I'd be EMS hybrid cloud platform generated more than $23 billion of revenue over the last 12 months.
With Red hat, we are positioned to win the hybrid cloud architectural battle and have deployed the most secure open hybrid cloud platform underpinned by Openshift.
We brought red hat and I'd be M. technology together in our modernize club pack software solutions, providing the leading hybrid cloud platform.
We now have over 2400 clients using our container solutions and nearly 600 I'd be m. services clients utilizing red hat technology.
Red hat delivered strong results in the period would normalize revenue growth of 18% driven by the synergistic effect of IB EM and Red hat.
Last August we talked about how red hat would benefit from IB EMS incumbency, and large accounts and leverage our global reach to expand into new markets.
We're seeing that where I b M and red hat come together clients are making larger scale architectural commitments and longer term and more strategic purchases.
This quarter, we had a significant increase in the number of red hat large deals and expanded red hat's presence in Underpenetrated focus markets.
In the second quarter, we took additional steps to better position I B M. In this environment and emerge stronger.
We announced new offerings, including AI for I T and Fiveg edge, and we recently added key capabilities and our PPA and cloud security through two acquisitions.
We're also working to fundamentally shift our operating model.
We're simplifying the geographic dimension of our go to market by consolidating our operations and moving to a streamlined structure for sales teams to be more flexible and responsive to our clients.
We've enhanced our virtual selling capabilities, including co creation, what clients on virtual platforms addressing client needs and solutions with real time data and shifting to contact list delivery even for the most complex transformation projects.
We've created a virtual dynamic delivery model to effectively reimagine services delivery, including improved access to expertise and enhance business resiliency and security.
We're transforming key business support functions to simplify our organizational structure and refuse AI into our workflows to deliver faster better insights.
And we're expanding our developer and I SB centric ecosystem to drive workloads to our hybrid cloud platform.
The last dimension of our business model I want to spend a minute on is all liquidity and balance sheet profile.
We further strengthened our cash and our balance sheet in the second quarter fueled by solid free cash flow and we took additional measures to improve our liquidity position.
We ended June what a cash balance of over $14 billion.
Up over $5 billion for the end of last year.
We remain opportunistic in the capital markets issuing $4 billion a debt across multiple tenors with very favorable economics.
This provides us with additional liquidity in the short term, while we remain committed to our longer term deleveraging plans.
Our debt of just under $65 billion was consistent with March as our bond issuance was offset by $4 billion in term debt and commercial paper reductions.
Our debt includes $22 billion of global financing debt, which is primarily in support of by being products and services and has a stable credit portfolio.
Recently, we also successfully completed our annual renewal abide becomes global credit facilities.
We're maintaining over $15 billion, an undrawn credit one of the largest corporate facilities in the S&P.
Our high value business model and strong balance sheet and cash flows gave us the confidence to increase our dividend in this environment, the 25th consecutive year with an increase.
Looking at the key highlights in the quarter I mentioned, our strong growth in cloud and our continued momentum in red hat.
The combination of Red hat, our focus on productivity and operational efficiencies and our cloud scale out drove significant operating gross margin expansion up 160 basis points.
Our balance sheet strength was enhanced by $2.3 billion, a free cash flow this quarter.
We had strong working capital performance driven by stable collections and good financing attach rates, primarily an I.B.M. zee.
This was offset by higher net capital expenditures and workforce rebalancing payments.
The Capex increase was driven by the Buildout of our cloud infrastructure and lower proceeds from real estate sales, while deemphasizing lower value services content.
In the quarter. We also continued to have free cash flow contribution from red debt net of interest expense overall, we generated $11.5 billion or free cash flow over the last year, which is about 145% of GAAP net income.
These results show solid free cash flow performance and the strong financial profile.
Now I'll turn to the segment performance, beginning with cloud and cognitive software, where revenue was up 5% driven by growth in cloud and data platforms.
90 days ago, we highlighted how software transaction stalled in March as clients quickly shifted their focus the resiliency efforts that focus on resiliency continued into the second quarter and impacted software performance, especially in the first part of the quarter.
Later in the quarter demand improved for critical priority areas, such as hybrid cloud solutions and some AI applications.
We had a sequential improvement in software renewal rates as clients favored subscription models perpetual software licenses continued to be impacted particularly in some of the more trouble industries.
In cloud and data platforms revenue was up 30%.
This reflects the synergy upbringing, IBM and Red hat together as we standardize on Red hat Openshift as our hybrid cloud platform and modernize our software portfolio to run on it.
This quarter, we had good performance across red hat, including amplified bookings growth in the 30, Underpenetrated countries, where I'd be remiss help red hat expand go to market efforts over the last year.
And with further cloud pack traction this quarter clients are embracing a hybrid cloud strategy and increasingly leveraging the openshift container platform.
These actions all contributed to growth in the number of clients using our container platform to over 2400.
Cognitive applications revenue declined as clients in some of the more impacted industries deferred transformational or discretionary spending.
We saw this play out in I O T Engineering lifecycle management, we're demand from automotive electronics and aerospace clients soften this quarter.
These industries remain focused on core operations, rather than transformational purchases.
And our weather consumer business was impacted by general weakness in the advertising market.
In transaction processing platforms client focus on Opex versus Capex continued to impact transactions this quarter.
Looking at a profit for this segment the decline in pre tax margin was primarily driven by the purchase accounting impacts from the Red hat acquisition.
Now turning to our services segments Global business services revenue declined 6%.
As we entered the year GBS had good momentum and we expected revenue to accelerate throughout the year, but as a pandemic intensified and the macroeconomic climate worsen clients quickly shifted their focus the operational stability in cash preservation.
This resulted in a delay in both the existing projects and new commitments, especially in projects that are more discretionary over this longer time to value.
Such as next generation enterprise applications.
The delays impacted the revenue coming out of backlog, which is about 80% of the quarterly revenue as well as the smaller in period signings, which yield revenue more quickly.
While declines continued in these smaller signings from March through May the trajectory improved and we returned to modest growth in June.
For the quarter GBS cloud signings grew at a double digit rate as clients are prioritizing their digital transformations.
Offerings, such as cloud strategy consulting application development and modernization continue to grow revenue in the second quarter.
These offerings standardize on red hats, openshift platforms enable clients in their cloud journeys.
We are working with an additional 60 clients such as bank of America, Medtronic Loblaws Bank of England credit mutual and Deutsche Telecom to utilize red hat technologies to transform their businesses.
Looking at profit, we expanded gross margin in GBS by 240 basis points.
We manage the business well in this environment by leveraging our variable and global delivery resource model, improving price margin realization and optimizing utilization.
We also had a currency benefit which is fairly consistent with the last couple of quarters at the same time, we're continuing to invest building skills and practices through education and hiring.
Overall, weibo dealing with some near term macro challenges GBS his deep industry expertise combined with IB Adams and now Red Hat's innovative technology play a critical role in the acceleration of clients digital transformations.
In global Technology services revenue declined 5% fairly consistent with the first quarter's performance.
We had signings growth in the quarter and strong growth in cloud revenue, but this was offset by continued declines in client business volumes.
As we talked about in the past about 90% of GTS. This quarterly revenue comes from contracts in our backlog.
While this business has a high mix of recurring revenues there is some variability in that revenue stream.
We provide clients with flexibility in their capacity to deal with volume changes due to their business needs and macroeconomic environment.
As a pandemic intensify through the end of March and into the second quarter, we experienced lower client base business volumes, reflecting challenges across industries.
While performance in some of these industries like financial services was consistent quarter to quarter. Other industries had a more significant decline.
We saw this especially in retail automotive consumer goods and travel and transportation.
This impacted the revenue coming out of our backlog in the second quarter.
At the same time clients are continuing their infrastructure transformations. The hybrid multi cloud environments. For example at Daimler we have expanded our relationship to migrate their global after sales platform as the IB M. cloud.
And this quarter, we announced Sabadell, Mexico, the first 100% mobile bank in Mexico will host its infrastructure on the IB M. cloud and use Red hat enterprise Linux to modernize its applications.
Hey, Joe and other financial institutions like Bank of America, BMP parabolic Banco Santander Latte card and cash of bank among others as they move forward on their cloud journey.
These commitments contributed to the signings growth for GTS and in fact in the first half signings grew at a double digit rate.
This results in improved backlog trajectory for more we entered the year.
Given the overall duration of the backlog this will convert to revenue over a longer term horizon.
Looking at gross profit GTS margin declined 30 basis points.
This was driven by mix as the high value TSS business is impacted by the current product cycle.
Ill remind you we have not yet realize the benefits from our first quarter structural actions.
Turning the systems revenue was up 6% this quarter and gross margin expanded over 400 basis points.
We again had good growth in both IBCM Z and storage.
Clients value the new innovation of the Z 15, mainframe and high end storage.
Similar to first quarter, Dizzy 15 offered enterprises valuable capabilities, including remote management security and importantly scalability.
This quarter clients also increasingly look to IB MZ for resiliency and business continuity to keep mission critical workloads running smoothly.
We continue to offer additional hybrid cloud capabilities on C. 15.
We release Red hat answer both certified content bribe DMZ and launched a new cloud native development offering waze worked spaces, which allows developers to use industry standard tools from I.B.M.C., the multi cloud platforms optimized on openshift.
The growth in Z and storage was partially offset by weaker performance in power reflective of where we are at in our product cycle empowers client base of smaller enterprises, which are impacted more during this pandemic.
Now, let me bring it back up to the I'd be m. level I.
We have a business profile and business model that provide some stability in the current environment.
We have also recently taken a number of actions that strengthen our operating model for today and for the future.
We built a robust hybrid cloud platform based on what we firmly believe is the winning architecture.
This technology centric platform together with our deep industry expertise and ecosystem partners will enable us to accelerate client digital transformations and move more of our clients mission critical workloads to the cloud.
As we entered the second half we have a compelling set of offerings and a strong pipeline across software services and systems.
How that pipeline yields to revenue will ultimately be tied to the rate and pace of the economic recovery and the resulting client spending confidence.
Given the uncertainty in the environment and consistent with our direction from last quarter, we're not going to provide guidance for 2020.
But I do want to remind you of a few specific dynamics systems performance reflects where we are in our product cycle and we wrap on the IB MZ launch in September.
In software our transaction versus annuity mix varies by quarter.
Historically, we have a lower mix of transactions in the third quarter and our largest transactional based is in the fourth quarter.
And that for Red hat, we Anniversaried the acquisition in early July.
We're wrapping on a large part, but not all of the impact of the deferred revenue adjustment and transaction charges.
We also wrap on the divestitures completed in the second quarter of last year.
And the savings from our structural actions will start to yield in the second half, providing better cost competitiveness and margin performance, especially in GTS.
Finally, we remain confident that we have ample free cash flow and liquidity to invest in our business and return value to shareholders through dividends Arvin any final comments.
Jim What's most important to me and two IBCM is that we emerged stronger from this environment with a business positioned for growth.
Im confident we can do that.
My focus will be on investing and maintaining flexibility to take actions.
Not just to strengthen our operating model, but also to advance our strategic priorities.
Now older Patricia for acuity.
Thank you Arvind before we begin acumen and I'd like to mentioned a couple of items.
First we've included supplemental information at the end of the presentation and finally as always I'd ask you to refrain from multi part question.
Ila, let's please open it up for questions.
Thank you at this time will begin the question and answer session at the conference to ask a question. Please press star one in record your name clearly if you need to withdraw your question Press Star Q.
When you ask the question. Please press Star one our first question will come from that coupled with credit Suisse. Your line is open.
Thank you very much.
Understanding you guys I'm not going against formal full year guidance at this point, but just wondering if you spend a little bit more time about how we should think about moving into the third quarter versus seasonality, where I think typically you're down a little bit over $1 billion sequentially and maybe just dig a little bit deeper into some of the biggest swing factors. We just thinking about by segment going from two hearing that review.
Thanks, Matt for the question, let me start and then I will give it to Jim for adding a bit more color on a bit more detail.
As both of those set on the call we're seeing that there is.
It's it's two sided we see opportunity in hybrid cloud, we see opportunity in digital transformation, we see opportunity in people as they're doing a return to the workplace and projects that all advance those things some of those give them long term benefits some give them.
Brought them benefit.
That said, we are seeing that there is in negative on things that required capex things that have very long term pay offs and project based businesses.
If we think about the difference between third and fourth quarter. So there's a bit of lighter on transactions fourth is very heavy on transactions. If we also look at some of those project based businesses will likely and this is where it's tough to give guidance, but it's likely that we see that the economic recovery is looking to build.
Longer and more protracted and we might have hoped for back in March and as we see that bouncing ball and economic recovery, whether it's in the United States in Brazil, and India that has an impact on all of these elements, but the other thing that was important and saw the.
Remarks that Jim made.
We kind of have a two third one third mix, maybe a bit more than that in industries, which are less impacted was industries that are more impacted and that of course will play out in our results as well, but let me give it to Jim due to mix all those things oversized.
Thanks Urban and thank you very much for the for the question overall.
As we stated the wrapping up the prepared remarks, we do have a very strong pipeline.
Across our offering portfolio around systems around soffer around services.
But as Arvind just indicated the yield will be tied directly to the rate and pace of the recovery of the pandemic curves, which by the way vary based on market around the world and industry.
Tied directly to client spending confidence overall, if you look at just macro level dynamics of our business profile. There's a couple things that I think will play out as we look forward. One is we're going to wrap on divestitures. That's been a two point headwind to the I'd be M. company for the last four quarters, we were.
Wrap as we enter second second half number two we're dealing with actually a weaker dollar.
And you'll see in the currency back up a you know that is now flat to about one point of the headwind, where we were dealing with about a two to two and a half point headwind over the last few quarters.
Three the dynamics of client buying behavior is really shifting that acceleration the digital transformation and to cloud you see a play out in our results and we actually have a strong pipeline red hat had another very good quarter, good pipeline set up our hybrid.
Justin offerings around cloud packs with good momentum, we got a good annuity base a business that we're going to continue to build on what renewal rates and we've got a systems business that we refreshed with new innovation.
When you look at services to your point, we've got structural actions that are going to start yielding as we exit or excuse me as we enter second half and we've got a strong pipeline as urban stated on the call of large transformational deals now those are always binary as to when they close but they were.
Will reposition the emerging stronger theme of our backlog in services overall in the meantime, we're going to continue to deal with the economic impact around discretionary projects in particular around GBS.
Okay. Thank you Matt can we please go to the next question.
Yes next we'll hear from Amit Daryanani with Evercore ISI you May go ahead.
Thanks, a lot good afternoon, and thanks for taking my question guys. I guess my questions will be around the cloud revenue growth, which I think it was about 34%. This quarter was it really impressive acceleration from I think given what you guys said in the March quarter up it's a way to think about just how sustainable do you think this growth is as we go forward and then when I think of this.
Number 34% is there way to see how much of this growth is from new logos and new wins on the customer side or says, perhaps taking existing customers from on premise to a hybrid off premise journey.
Okay I'd, let let me start this is often and then and we had asked Jim due to add a lot of Okada.
So I mean, it's a fairly a since this is the last quarter, where red hat was Oh God inorganic that clearly had an impact on this that said, we're still actually quite happy with the results despite that that had accelerated quite a bit.
From earlier and from both the fourth quarter and last year. So I, just they'd like that and and leave it at that the second part you asked was I was just moving our people from one side to the other obligating view when I'm in the vast majority of this it is a big core of Red hat as I describe I haven't thought platform.
That's not a left to right chip that is actually net new.
When we think about all wins in telecom actually those are places, we would never present actually either of us not just quantify.
If you think about modernizing people's applications, that's not a shift that's actually net new work for us.
You asked about new logos that may apply to a little bit of services, but for the company at large look we have a lot of clients I mean like.
Almost any enterprise of any size is already outlined.
Especially on the product side of the house, so talking about them being new logos would be unfair, but I'll be getting into areas of it then them that we previously did not have access to I would say, we had have absolutely doing that and that's a big part why you see that 34% growth so with that let me give it to Jim.
For adding to that yes, just some color around how that 34% was actually delivered overall arvind talked about it from a from a client perspective in the value we bring around our hybrid cloud differentiated value proposition, but the 34% amid as you indicated is up.
About 11 points sequentially quarter to quarter with regards the growth profile that was driven pervasively across all four segments of our business and in fact, though a 11 point sequential year to year improvement quarter to quarter improvement was entirely organic.
Red hat contributed significantly to the 34% overall, but even on a pro forma organic perspective, we are growing right around 20%, we gotta GTS business that has over a 9 billion dollar book of business in our cloud portfolio that grew 20%. This.
Quarter.
An accelerated from first quarter, our GBS business, which is about five and a half billion on a trailing 12 months grew in the mid teens and our software business, which is about a five and a half billion dollar book of business grew well in excess of 100%, but grew around 20 plus percent pro forma organically.
So I think we're seeing broad base.
Acceleration really driven by the client buying behavior shifts that are happening in the marketplace into arvin's prepared remarks overall, we feel pretty confident about the offering portfolio and the differentiated architecture on our hybrid cloud platform that positions us to continue to capitalize on that going forward.
Thank you on it let's go to the next question. Please.
Our next question will come from Toni Sacconaghi with Bernstein. Your line is open.
Yes. Thank you I was wondering if you could comment on linear parity in the quarter relative to sort of normal a normal linear patterns. It sounded like softer was a little worse than the first half a quarter and then got a little bit better I think there was one other Vince.
And that's where you referenced.
Things may be looking a little better as the quarter progressed.
So could you comment on whether that's a fair observation and if it is why shouldn't we be thinking about modeling normal are better than normal seasonality from Q2 to Q3, and then separately could you just comment on GBS signings. It sounds like they were down perhaps a 20%.
Year over year and what that.
Might suggest.
For the GBS business trajectory over the next couple of quarters. Thank you.
Hi, Tony so.
Your various skewed to the your observations about the Lady attitude in second quarter. So let me just not a little bit of color to that.
We finished the first quarter, we've acquired transparent as saying that March was a lot worse than we expected compared to what we see I wouldn't use the word linear because of the transactional side. The last month of the quarter is a lot more so I'll just compared to normal maybe as opposed to linear.
When we entered a second quarter.
The energy side of the business, but he is pretty evenly other than the slight I'll call. It maybe 4% to 5% in volume that goes up and down.
With that side is Lydia approximately and that Didnt change. If you look at the transactional side of the business I would tell you that the month of May was significantly worse than we would normally expect and we saw that begin to come back in June, but not really to recover to normal levels. That's why I for them, saying, let's see cube.
Better because since the me was worse than June but June will still worse than be might have expected last year. So that tells us something about that and then I'll, let me give it to Jim goals or comment on the impact of the signings as well as more on the.
Importantly reality question, yeah. So thanks, everyone and thanks, Tony for the question, but as you indicated it with the heart of your question overall, you know the dynamics in March that we saw generally played out as we entered the first part of second quarter clients are really continued focused on mission critical.
Operational stability cash preservation as any company as we were in the midst of the worst pandemic, we've seen in quite a period of time and then I could even tell you as CFO. The I'd be EMP company, we were maniacal focus on liquidity. So there was not unexpected.
But what we see play out as we move through the quarter is really the demand profile is really correlating to the curves of the pandemic.
And that plays out differently around markets around the world around industries around the world and that's why we tried to give some color about our geographic diversification, which we believe provides a natural hedge in this environment as many markets are going through different curves in our industry concentration.
The and 70% in industries that are minimally or moderately impacted.
By the pandemic overall per Gartner and I'd see.
But when you look at at the rate and pace of that economic recovery as we said when we concluded prepared remarks is really going to follow that pandemic, but when you look at our performance in the second quarter and not the repeat Arvind, but just give a little color by by unit, our GBS business really stalled.
In the month to March after starting very strong through two months that continued through the first two months of this quarter and actually June we saw our small transaction volume, which has high yielding revenue content going forward actually come back to growth and it was led by.
Europe would stabilize with their pandemic curves and there was led by Asia Pacific actually the Americas was the exact opposite both Latin American U.S., we started out pretty strong as the US was getting the pandemic in curve underway and then when it started bouncing in June we took a big step back.
Back so that's what happened in GBS CNC software very strong conclusion, where value in hybrid cloud solutions certain AI specific red hat very strong closure the quarter, but I'll tell you. One we came off a very strong second quarter.
Large deal closure last year. So we had a very tough compare but we didn't grow into month to June we were just much better than March and April and May.
Systems finished pretty strong, which a testament to our value prop and GTS I'll tell you test was kind of a mixture 90 plus percent of that business is annuitized. We are we are dependent on client base business volumes that 70% of industry, we actually saw stability and for the first time away.
Now some growth in like financial markets government et cetera, but we are getting impacted in GTS by client base business volumes in particular around airline travel transportation and retail.
Okay. Thank you Tony healing can we please go to the next question.
Thank you. Our next question comes from Wamsi Mohan with Bank of America. Your line is open.
Yes. Thank you are when do you noted that the hybrid cloud opportunities half and services.
Do you see for IBCM, a larger opportunity at that GBS or GTS and any additional color on the GDS GBS mix of those large transformational deals you alluded to in your prepared remarks will be helpful and if I could Jim could you maybe also talk about the seasonality relative to cash flows in second half.
Versus first half this year, given the red hat contribution in the first half. Thank you.
Hi, Thanks Wamsi no.
No so.
As mentioned explicitly that half the opportunities services, but we look at the market. That's a 1.2 trillion dollar market for hybrid cloud and about 550 billion you could say maybe a touch more is the services opportunities. So that's the almost.
Within that the bulk of the opposite opportunity is in application modernization and improving the end to end workflows off walked lines or processes. So when you look at those elements and then you look at both private and public cloud the nature of those operations is much more.
Automated and much more captured in cord than traditional infrastructure.
Yes, that's my I guess, my technologist way of saying that the opportunity will be larger in GBS and GTS all those opportunities. However, I'll just put a caution but that said the run component does remain important it's not that it goes away, but in terms of pure dawn it off.
Attunitys, it's shifting more towards the GBS side, what that side of the market as opposed to the traditional infrastructure.
And we're seeing that play out in the mix of the opportunities.
Because people need to get the worked on first in terms of transforming that applications and I'm not innovation is what is driving that interest and that's why you see us keep using the word transformational because that is better people see the huge opportunity of these of these.
Projects and so with that Jim on.
Well wamsi. Thank you for the question overall around free cash flow to seasonality.
Through the first half, we delivered $3.6 billion, a free cash flow and $5.1 billion of cash from ops.
Cash from ops was about flat year over year, our free cash flows down about 400 million that positions us on a trailing 12 month, Lebron and a half billion dollars I think.
In a in a very strong free cash flow realization, let me give you some of the underlying dynamics and then I'll give you some color given we're not giving forward looking guidance, we're not going to give a free cash flow guidance here on the call but to your question I'll give you some color about seasonality and what were some of the headwinds tailwinds.
As we stated when we enter January very similar we talked about capital we're going to continue to invest in this business capital through the first six months was a headwind of almost a half a billion dollars our workforce rebalancing payments were a headwind predominantly a in the first.
Half that will diminish as we get into second half in cash tax was a headwind through the first half are ready and that would should be pretty consistent as we move forward offsetting some of that here in the first half is we've had very strong working capital efficiency very strong collection rates even in this.
Environment talking to the test and then I think of the value in how essential we are to our clients and delivering mission critical value and also we're in a mainframe cycle. So our I GF attach rates are doing quite well and that is helping our free cash flow overall, so I assume as we move.
The second half will have similar dynamics around the headwinds we start now in the second half as we Anniversaried Red hat.
The the profitability a red hat will start accelerating as we get into the second half that should help us we'll start reducing the amount of tailwind on working capital efficiency as we get through our Z cycle overall.
And I think with regards to cash taxes, I've stated pretty similar.
Thanks, Wamsi can we please go to the next question.
Next we'll hear from Katy Huberty with Morgan Stanley You May go ahead.
Thank you good afternoon and number of your parents Accenture Sep Oracle have recently provided guidance is there something different about your business exposure or what you see in the market that is holding you back from providing guidance and what is it that you're looking for in order to return.
To the prior framework of giving annual outlook.
Hi, Kt thanks for the question.
I think has to deal.
I can comment on that business different.
Differently I can comment on what we see.
We have a lot of uncertainty and the economic environment around the globe.
And when we look at it by geography by content and all by industry.
Just.
So much variability that we got to answer it in April then we said that we live reevaluated 90 days.
Maybe a little bit optimistic that we will get more stability on on the health, which in turn leads to the economic conditions that over the begin to flatten in three to four months because at that time, a reasonable but turned out to be a misplaced expectation.
So we just contel, whereas those go and because those have an impact not in a month or two about almost six to nine months, even on portions of the energy business as.
Jim as it be very clear that is planned to do that the ability to dial volume's up and down in some range.
Creates for us the inability to really want to give guidance that we are confident about and so that makes sense of confidence and uncertainty the economics that makes us.
Unwilling to provide guidance.
Yeah, the only thing I would add Kt is that.
It's not a statement of the confidence we have in our portfolio our offerings, our strategy and our platform or what Arvin's trying to drive is the new CEO. The I'd be M. company overall, we feel pretty confident in that in urban articulated that in his prepared remarks around our hybrid cloud strategy our platform architecture.
Okay and components of our business as we see play out in the second quarter. This demand profile and the resulting clients spending confidence is going to follow the pandemic curbs around markets and around industries and we saw that play out in the second quarter and we'll see how the world.
Deals with the overall pandemic the crisis and how we enable our clients and our employees and our communities to move forward. So it is not prudent right now in this environment as we're still dealing with it the tied down our flexibility moved to move forward, we're going to continue to invest in our bid.
This and we gave them the right liquidity strength of our balance sheet and investment in fin flex profile. It take the right actions in this environment to advance our strategic priorities going forward.
Thanks, Katy let's go to the next question. Please.
Our next question will come from 10, Jen Wong with JP Morgan Your line is open.
Hey, Thank you. So much often you you mentioned, you're seeing large transformational projects in the pipeline I think Jim you underline that.
A couple times I'm, just curious how meaningful could this be I wonder if you can compare it to past cycles I recognize it's going to.
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Sure a little bit on the world healing, but I'm just trying to get a perspective on the sizing here and then also just as a a second clarification you talked about trading.
The the trade off of Opex versus Capex.
Do you had pretty good line of sight at this point on your annuity business looks like transaction processing. For example is pretty stable quarter to quarter. It in terms of the on your trends. So just wanted to make sure I didn't Miss anything there. Thank you.
Thanks, Thanks engine for the question.
Oh meaningful kind of the large transformational projects be.
So when we say large these are typically projects that measure in the multiple hundreds of millions of dollars.
Contract value.
Engine you do the Pete as you say you know pick a number that C. Four or 500 million in total contract value and you do that and you say those typically will give that full yield or five to seven years.
That's the kind of nature. They take and then he said how many of those are going to get done we have a fairly large number of them in the pipeline.
We are evident to say as well the takes these six 912 months to get closed fleet.
Well, we have been added for a few months already and so I think it is quite meaningful if you begin to close that he will absolutely see that either move on our services business as those big into flows and yield.
Relative to past cycles, I think as we came out of past recessions, our as it came out of different prices I'm not sure I can call. The dog Combusted wasn't quite maybe you'd rather minor recession, but it wasn't there for the back of the tech industry for sure and we saw the impact of those kinds of projects different nature.
Oh that about move into the cloud journey to cloud hybrid cloud transformation than they were more more about perhaps the off a nature of outsourcing and beginning to create out of efficiency and infrastructure management to the nature of these projects has changed.
So let me, let Jim add color to it and also talk about the affinity business. Yeah I would just the thanks to engine for the question I would just add to your last point I think the nature and the rate and pace of those large transformational deals right now feel much quicker than when.
We were sitting back in 2008.
Moving through this it was a very different recessionary time that impacted industries differently and markets differently. This is more so have a consumer based small media market based industry specific base that is getting impacted at least immediately right now.
But that time the value will shift overtime as we move forward. So I think 10, Jim when we went back and we've done many different stress tests of our business model to ensure our balance sheet, our liquidity position scenarios, we looked at Pryor recessions.
We don't see anything different the only difference is where that client behavior and now shifting from a managed services years ago to more of a hybrid cloud asset base differentiation last thing on your annuity.
You know, we feel pretty confident about our annuity basis over 60% of our revenue today, it's pretty stable.
TPP is a mixture of or some annuity most annuity I should say some transactional I think from in a annuity perspective were poor performing pretty consistent with the market overall and we see that continue to play out here in the set in the second half.
Thanks tension here recently, please go to the next question.
Yes, Hi, My next question will come from David Grossman with Stifel. Nicholas Your line is open.
Hi, Thank you good afternoon.
The GTS business since appears to be all these different moving pieces, you know year significantly impacted by volumes, but it looks like you had pretty good signings.
In the first half a year durations up in the backlog et cetera. So is there anyway, you could kind of sift through this for us in the cyclical impacts so that we can get a better sense of how the transformation that business is trending particularly giving.
The ongoing revenue challenges, we've had over the last several quarters and and perhaps you could reconcile this because I've heard you made a comment you know seeing a shift.
The applications, where from GE Ts to GBS and and meeting its.
More informative to look at it on a combined basis I mean, your managed chicken under one person now you're trying to nail the two together. So so maybe you see more acceleration in GBS coming out of it since GTS, maybe flattens out so just trying to get a better sense of how to think about the health of that business now and how it's trending.
Okay. The David Let me start and then I lost him to add color.
So if we should acknowledge that.
We have never happy when a business is a declining even at mid single digits.
Lets us we acknowledge that and then say, but then what are the elements underwrite, which is what you're asking about what it all the moving parts.
And given the large annuity nature of that business that does it reflect a signings and commitments for the past not just within the quarter.
So so that is there and that means that you're looking at the revenue impact that even if you have good signings that have any impact takes a long time to sort of make its way.
Through the.
And with that business and also in terms of backlogs that are in that business.
So when I look for the cyclical impacts there I think that.
We want to be careful about trying to say that the trends is dramatically quarter to quarter I think that those are places where it is going to take a while.
For the revenue tragically that business.
To change.
And I'm not sure that looking at it combined.
It is important to be able to leverage.
The parts of the business with each other and there are some elements that can be leveraged and that is why you refer to more cost as old.
As both of those teams.
However, they are very different business isn't that different business models, so I'm not sure that I would.
Say that looking at them combined is a better indicator of how that's trending.
Yeah Yeah.
David I would just add to the last point you just me they are fundamentally different business models, while they're both.
Human capital base, one is a data center managed services based business model that is highly capital intensive the other is a strategic capability.
Industry lens project base business that is fundamentally human capital not physical capital dependent so they have different economic equations different growth profiles. One is a growth engine GBS. The other is a value based platform in GTS overall.
Now with all that said, we've said all along that we've got to leverage at least from an offering a capability. It to some extent had a client lens.
Leverage between those two because clients are making architectural decisions that are application first in infrastructure second, but the the GTS business model overall in on I'll Echo Arvin's point.
We've been doing a tunnel work around the portfolio looking at this backlog, which by the way in any year, David as you know quite well about 80 plus percent of a years out of that business is under contract.
Now, we do have variability collars within that of about 30% of our clients today have that.
But this is long and new with ties based contracts that has the duration of probably five plus years as you don't turn that.
Overnight. So when you take a look at that business, we've been looking at it by offering by client by industry by contract type and we've been trying to determine how do we won reposition and leverage the value of incumbency and then also to invest in new transformational services, which is.
Where the growth is coming in managed services building off of the back of the application side of GTS ER dubious I should say and that is things like cyber security managed services data managed services compliance services.
And the like so.
We've got our arms around this but it's going to take time to turn this business overall, especially in the pandemic.
Thank you David you know we're already at top 10 minutes. After the hour. So why don't we take one more question.
Thank you our last question will come from Keith Bachman with Bank of Montreal. Your line is open.
Hi, Thank you very much Jim alternatives to you I Wonder if he can you talk about cloud and talking to them a little bit and my question is.
Hello, how should we be thinking about away what I really wanted to dig into is you're going to anniversary red hat for the first time, albeit you had some dior write offs, it's not all complete anniversary you're going to go ex mainframe cycle too so.
Is there some impact on the transaction processing side or any other part of it but no all else equal the I would think that the growth rate.
Over the next couple of quarters is going to drop pretty meaningfully just given the anniversary red hat, perhaps combined with the mainframe cycle as well, but what are the puts and takes you want us to think about over the next couple of quarters and quad antagonists.
Yes. Thank you very much for the question is as we wrap up right now.
So let's take the cloud in cognitive business overall, right I think first from a cloud and data platform perspective, we're seeing very good growth overall, yes, albeit very strong momentum on red hat and we couldn't be more pleased with the synergistic value, we're bringing to our clients with regard to I.B.M. and red hat better together to your.
Question, we Keith we actually anniversary that Anja on July nine.
So we will now wrap around on the operational performance a red hat going forward, it's still growing nicely at an 18% historically normalized basis here in the second quarter. So we'll still get growth off of that but second to your other point, we've been dealing with this deferred.
Revenue noncash purchase accounting adjustment for the last four quarters.
Now starts lessening overtime.
So when you look at cloud and cognitive software with regards to Red hat contribution in the first half of what we've seen to the second half of where we're going forward, it's about a point or give or take of a headwind compared but still a positive contribution the cloud.
Out in cognitive software overall, you know the other dynamic I'd bring up and I think urban talked about this earlier you got to make sure that this business, while 75% annuity, 25% give or take any in a year transactional that transactional skew varies very differently between the third quarter in the fourth quarter.
Second quarter in fourth quarter, or more like 25% to 35% of a transactional skew first and third quarter or more like a 15%. So just based on that dynamic when you look at Twoq to Threeq, you will get more of a tailwind and now as we get into fourth quarter, if that pandemic curves.
Do not less than overtime, then we're still gonna have to deal with this large perpetual license opex versus capex phenomenon overall, so with that I'll turn it back over the Arvind.
Thanks, Jim So let me make a couple of comments to wrap up this discussion.
Hope than what do you have taken away from this call is that while these challenging times. We are excited about the opportunity that we have moving forward I hope you got that from the remarks, both Jim and I made in the queue in a handed the prepared remarks.
We have aligned our offerings to the opportunity the opportunity being down of hybrid cloud as well as a guy.
And I am certain we will continue to pick the right steps.
It's stronger as a company.
And I look forward to continuing this dialogue as a third quarter in the meantime, I hope all of you stay safe and productive.
Thank you.
Okay, she'll I'm going to turn it back to you to close out the call.
Thank you. Thank you for participating on today's call. The conference has now ended you may disconnect at this time.
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Welcome and thank you for standing by at this time all participants are in listen only mode. Today's conference is being recorded.
Any objections you may disconnect at this time now I will turn the meeting over to Miss Patricia Murphy with I'd be ma'am you may begin.
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Thank you.
And I want to welcome you to I'd be a second quarter 2020 earnings presentation.
I'm here with Orban Krishna.
Chief Executive Officer, Jim Cavanaugh, I'd be in senior Vice President and Chief Financial Officer.
Today's prepared remarks on the I'd be I'm investor website within a couple of hours and the replay will be available by this time tomorrow.
Some comments made in this presentation, maybe considered forward looking.
Under the private Securities Litigation Reform Act of 1995.
These statements involve dr. they could cause our actual results could differ materially.
Additional information about these factors is included in the company's SEC filings.
Our presentation also include non-GAAP measures.
Additional information to investors.
For example, we present revenue and signings growth at constant currency throughout the presentation. In addition to provide a view consistent with our go forward business.
Focused on constant currency growth adjusting for the divested businesses.
Packed and lines of total revenue cloud and or geographic performance.
Provided reconciliation charts for these and other non-GAAP measures at the end of the presentation and in the 8-K them into the FCC.
Finally, consistent with our last few quarters.
The EMS revenue profit and earnings per share reflect the impact of purchase accounting and other transaction related adjustments.
Associated with the acquisition of Red hat.
These adjustments and charges are primarily non cash.
With that I'll turn the call over to Arvind.
Hello, everyone.
We used to be speaking with you again.
In April goal I talked about the embark on the global public health crisis.
I told you about the important book, we're putting out to help the shifting needs of our clients.
I'd also told you about the confidence I haven't our strategy and our portfolio.
Which is focused on hybrid cloud as well as data on daily.
All of this continues.
Today, there are two topics I'd like to Cabo.
First I want to tell you about what we're seeing in the market.
And then I wanted this cross top priorities and actions we've taken to move them forward.
From a market perspective, while the bottom to environment for the third and short term challenges.
Also presents long term opportunities that you will see.
As our clients accelerate the shift or hybrid cloud and AI.
The essential work that we do in terms of running our clients mission critical processes continues.
More profoundly receipt of the digital transformation of businesses.
Accelerating.
Our second quarter results demonstrate this with an increase of over 10 points in our cloud revenue growth over last quarter.
The trend we've seen the market is clear.
I just want to modernize apps.
Move more workloads to the cloud.
Automate I'd das.
I want to infuse AI into their workflows.
Secure that I'd infrastructure to fend off growing cyber security threats.
As a result, we are seeing it increased opportunity or large transformational projects.
These are projects were IB has a unique value proposition.
Also projects that take time to shape and therefore to close.
At the same time, we're feeling the impact of austerity measures that businesses have put in place to preserve cash and capital.
Our software and services results reflect this reality.
Jim will take you through this in more detail.
Taken altogether. This is the backdrop of our results for this quarter.
Reflects the immediate challenges and long term opportunities of this environment.
Now, let me move on and discuss my priorities moving forward.
Touched upon in our last call.
He is focused on helping our clients in the two major transformational journeys there on hypercloud as well as data on AI.
Hybrid cloud as the dominant force robbing change in our industry.
But as far from Universal adoption.
Only 20% of the workloads have moved to the cloud.
The other 80% our mission critical workloads that are far more difficult to move.
As a massive opportunity in front of was to capture these workloads.
What I say hybrid cloud I'm talking about an inter approval I'd environment across on premise private and publicly operator cloud environments in most cases from multiple vendors.
Why do we believe this is a future rather than a pitstop along the way.
Barnes find the choosing a hybrid cloud approach is doing to half times more valuable and relying on public cloud alone.
Considers factors such as innovation development time.
And portfolio optimization.
Let me spend a minute to describe our hybrid cloud platform.
It starts with clinics.
Which of the de facto operating system standards.
We have a tremendous advantage with red hat clinics, which of the market share leader.
Linux along with containers and Kubernetes provides architectural foundation of our platform.
One shift is our oil products that captures all this and more.
IB and has a vast software and little bit portfolio.
Which has now been containerized and Ron Openshift and Red Hat Linux.
The foundry applaud box space introduced in the second half of last year.
Allows our middleware to run in a cloud native environment and bridge our clients from the faster the future.
This means clients can now deploy our software anywhere openshift runs it is infrastructure agnostic across not just public and private clouds, but also our mainframes and pharmacists and platforms.
Openshift and also what makes it possible to develop and consume software into new way.
It's what enabled Jeff SEC cops and all the subsequent boost productivity security and speed of deployment.
Our hybrid car platform also includes a set of advanced technologies.
Such as Watson analytics encryption.
And many others.
What gives our hydropower platform to fuel it needs to accelerate adoption.
And become for laser is the large ecosystem of partners we are building.
Got a great Glenn to forge a global coalition of best of radar screen.
This includes recent additions like Adobe Salesforce SFP box and flat.
All using our hybrid cloud platform.
Clients modernized mission critical workloads.
We have done the same with major system integrators, Onsen young Infosys Wipro Tata consultancy services.
Tech Mahindra assistance systems, all our examples that are helping expand the reach of IB is hybrid cloud platform.
Finally, you'll recall that nearly half the hopper car opportunity lies in services.
An important part of our platforms value lies in the expertise we provide to help clients on the journey.
Whether thats modernizing apps building cloud native apps migrating to the cloud or managing these applications on the public and private cloud infrastructures.
Certainly, helping hundreds of major clients on this journey.
I believe that our strategic vision is taking hold in the marketplace.
I mentioned the acceleration in our cloud growth this quarter to over 30%.
This hybrid cloud platform generated over $23 billion of revenue over the last 12 months.
I just described the importance of Red hat, Linux and Openshift platform.
And Red hat continued its momentum in the form.
Combination of high beam and Red hat, driving strong revenue and bookings growth.
Across the board, we are seeing greater demand for red hat products.
Lines are eager tap into open source innovation.
They want the freedom to securely deploy run and manage that data and applications on the part of their choice and retaining that choice is critical.
Brian such as Bharti, Airtel American Express Vodafone Broadridge financial solutions, Banco Sabadell, and cash our bank all see the value in a hybrid cloud architecture built by IBM and Red hat.
As part of our hybrid cloud strategy, a key focus is to help clients Taco complex and highly regulated workloads.
Last year, we launched the financial services ready public cloud with Bank of America.
And we recently created a new program highest fees and SaaS software as a service providers.
I'm happy to share that we now have 30 ice we signed up this happened with great speed and I'm confident that more will join soon.
So let me pause for a moment and remind you of the three priorities I shared with IBM has on my first day as CEO.
One.
Help our clients under journey declared an AI do.
When the architectural battles and cloud with Red hat.
Three continually delight our clients.
These priorities remain the same.
And you can see Javier made progress in all of them.
At the same time, we have continued to deliver a series of new innovations in the last quarter.
We launched our new edge and telco network cloud solutions.
On Red hat Openstack Hundredd I'd open shift.
That enables clients to run workloads anywhere from a data center to multiple clouds to the hedge.
We also launched our AI for I'd offering given every CIO.
Billy to automate their I'd infrastructure that immediately reduces cost and becomes more resilient.
Hi for I'd runs across any cloud and walks in collaboration with an ecosystem of partners that includes slacken box.
On a quantum computing, we added an additional four systems, which expands our fleet to 22 quantum computing systems.
That includes eight systems that have demonstrated wanton volume of 32.
Got sick arguments proposed to measure the relative power and usefulness of quantum computers.
I've talked previously about the importance of both organic and inorganic investment to drive innovation.
We recently announced do acquisitions that will enhance our hybrid cloud.
And our capabilities.
In June we acquired a new go to boost our compliance and cyber security capabilities for the hybrid cloud.
And in early July we agreed to acquire Wttg automation.
That advances.
Views automation capabilities into our cloud facts.
Needless to say this is a unique and challenging time for our clients.
To continue to be that most trusted partner, we're spending a lot of time and energy to drastically simplify our teams go to market.
We doing a lot of work on the backend to bring our portfolio together in a more cohesive fashion.
Teams can comment simpler and more relevant proposals.
We're also focused on changing our culture and operating model.
So we can make decisions will quickly and make our interaction with clients lot more experiential.
It will take you through a few of our more recent actions.
Moving forward, we will continue to take actions that improve our operating model.
And accelerate our strategic priorities, so that we can emerge stronger.
Before turning to Jim Let me end by saying a few words on our commitment to corporate social responsibility.
This has always been important driver.
But as you know with the current events in the United States Theres been a renewed focus to do more.
As I became CEO I'm fully committed to ensuring that Hybean, we'll continue to lead in this area.
But this is also about skills and creating opportunity.
Since 2011.
Jim has helped to develop and expand new public education model called feedback.
Peter provides high school students from underserved background with the skills and credentials the need for competitive jobs in stem.
To that end, we recently made a commitment to hire 1000 interns will come from pretax.
To put this in context, we have between five and 10000 interns that IBM each year.
This represents more than 10% of arent on base.
Im always happy to expand later on this and other topics relating to our efforts now back to the quarter and the business.
Jim is going to take you through our results Jim or do you.
Thanks Arvind.
Our first quarter earnings call I talked about how we're prepared for a wide range of outcomes given the economic uncertainty.
Our second quarter results for within that range.
We delivered $18.1 billion of revenue expanded gross margin reported operating earnings per share of $2.18 and continue to generate solid free cash flow.
Our balance sheet remains strong and we continue to have ample liquidity.
The external dynamics, we saw in March continued into the second quarter with very impacts by region and industry.
As we discussed in April we're not immune to the macroeconomic environment.
But our client and our portfolio mix provide some stability in our revenue profit and free cash flow, we saw that again this quarter.
Let me remind you of how our business mix provides the stability.
From a client perspective, our business is more concentrated in large enterprises, which in total have been relatively more stable throughout the pandemic.
So as you would expect.
We saw more weakness from smaller enterprises this quarter.
About 70% of our revenue comes from industries that run the world's most critical processes and those industries have been less impacted by the current economic and health crisis.
We saw that in our results again this quarter and in fact grew revenue in financial markets government and education.
From a geographic perspective, we have a global footprint of more than 170 countries. This provides a bit of a natural hedge as we continue to see markets experienced different impacts from the pandemic overtime.
And then finally, when you look at our portfolio about 60% of our revenue comes from recurring revenue streams.
While we've adapted quickly to conduct business virtually around the world as expected we did have disruptions in transactional performance and volume reductions.
Many clients continue to delay projects the for purchases and favor opex over capex spending in this environment.
This pause in large purchases and discretionary spending was most evident in our perpetual software licenses and project oriented services.
While clients remain focused on near term priorities running mission critical processes operational stability and cash preservation as Arvind mention the last few months also highlighted the need for clients to accelerate their digital transformations, leveraging hybrid cloud and AI.
Across IBCM, our cloud revenue grew 34%.
Which is up from the 23% growth in the first quarter.
I'd be EMS hybrid cloud platform generated more than $23 billion of revenue over the last 12 months.
With Red hat, we are positioned to win the hybrid cloud architectural battle and have deployed the most secure open hybrid cloud platform underpinned by Openshift.
We brought red hat and IBM technology together in our modernized club pack software solutions, providing a leading hybrid cloud platform.
We now have over 2400 clients using our container solutions and nearly 600 IBM services clients utilizing red hat technology.
Red hat delivered strong results in the period with normalized revenue growth of 18% driven by the synergistic effect of IBCM and Red hat.
Last August we talked about how red hat would benefit from IBM since commencing a large accounts and leverage our global reach to expand into new markets.
We're seeing that were IBCM and red hat come together clients are making larger scale architectural commitments and longer term and more strategic purchases.
This quarter, we had a significant increase in the number of red hat large deals and expanded red hat's presence in Underpenetrated focused markets.
In the second quarter, we took additional steps to better position IB in this environment and emerged stronger.
We announced new offerings, including AI for ITC, and Fiveg edge, and we recently added key capabilities and our PPA and cloud security through two acquisitions.
We're also working to fundamentally shift our operating model.
We're simplifying the geographic dimension of our go to market by consolidating our operations and moving to a streamlined structure for sales teams to be more flexible and responsive to our clients.
We've enhanced our virtual selling capabilities, including co creation with clients on virtual platforms addressing client needs and solutions with real time data and shifting to contact list delivery even for the most complex transformation projects.
We've created a virtual dynamic delivery model to effectively reimagine services delivery, including improved access to expertise and enhance business resiliency and security.
We're transforming key business support functions to simplify our organizational structure and a fuse AI into our workflows to deliver faster better insights and we're expanding our developer and I SV centric ecosystem to drive workloads to our hybrid cloud platform.
The last dimension of our business model I want to spend a minute on is all liquidity and balance sheet profile.
We further strengthened our cash and our balance sheet in the second quarter.
Fueled by solid free cash flow and we took additional measures to improve our liquidity position.
We ended June what a cash balance of over $14 billion up over $5 billion for the end of last year.
We remain opportunistic in the capital markets issuing $4 billion of debt across multiple tenors with very favorable economics.
This provides us with additional liquidity in the short term, while we remain committed to our longer term deleveraging plans.
Our debt of just under $65 billion was consistent with March as our bond issuance was offset by $4 billion and term debt and commercial paper reductions.
Our debt includes $22 billion of global financing debt, which is primarily and supported by BM products and services and has a stable credit portfolio.
Recently, we also successfully completed our annual renewal of IB EMS global credit facilities.
We are maintaining over $15 billion in Undrawn credit one of the largest corporate facilities in the S&P.
Our high value business model and strong balance sheet and cash flows gave us the confidence to increase our dividend in this environment, the 25th consecutive year with an increase.
Looking at the key highlights in the quarter I mentioned, our strong growth in cloud and our continued momentum in red hat.
The combination of Red hat, our focus on productivity and operational efficiencies and our cloud scale out drove significant operating gross margin expansion up 160 basis points.
Our balance sheet strength was enhanced by $2.3 billion, our free cash flow this quarter.
We had strong working capital performance driven by stable collections and good financing attach rates primarily on IBM zee.
This was offset by higher net capital expenditures and workforce rebalancing payments.
The Capex increase was driven by the Buildout of our cloud infrastructure and lower proceeds from real estate sales, while deemphasizing lower value services content.
In the quarter. We also continued to have free cash flow contribution from red debt net of interest expense overall, we generated $11.5 billion or free cash flow over the last year, which is about 145% of GAAP net income.
These results show solid free cash flow performance and the strong financial profile.
Now I'll turn to the segment performance, beginning with cloud and cognitive software, where revenue was up 5% driven by growth in cloud and data platforms.
90 days ago, we highlighted how software transaction stalled in March as clients quickly shifted their focus to resiliency efforts that focus on resiliency continued into the second quarter and impacted software performance, especially in the first part of the quarter.
Later in the quarter demand improved for critical priority areas, such as hybrid cloud solutions and some AI applications.
We had a sequential improvement in software renewal rates as clients favored subscription models perpetual software licenses continued to be impacted particularly in some of the more troubled industries.
In cloud and data platforms revenue was up 30%.
This reflects the synergy bring an IBM and red hat together as we standardize on Red hat Openshift as our hybrid cloud platform and modernize our software portfolio to run on it.
This quarter, we had good performance across red hat, including amplified bookings growth in the 30 Underpenetrated countries, where IBCM has help red hat expand go to market efforts over the last year.
And with further cloud packed traction this quarter clients are embracing a hybrid cloud strategy and increasingly leveraging the openshift container platform.
These actions all contributed to growth in the number of clients using our container platform to over 2400.
Cognitive applications revenue declined as clients in some of the more impacted industries deferred transformational or discretionary spending.
We saw this play out in I O T Engineering lifecycle management, we're demand from automotive electronics and aerospace clients soften this quarter.
These industries remained focused on core operations rather than transformational purchases.
And our weather consumer business was impacted by general weakness in the advertising market.
In transaction processing platforms client focus on Opex versus Capex continued to impact transactions this quarter.
Looking at the profit for this segment the decline in pre tax margin was primarily driven by the purchase accounting impacts from the Red hat acquisition.
Now turning to our services segments Global business services revenue declined 6%.
As we entered the year GBS had good momentum and we expected revenue to accelerate throughout the year, but as a pandemic intensified and the macroeconomic climate worsen clients quickly shifted their focus the operational stability in cash preservation.
This resulted in a delay in both the existing projects and new commitments, especially in projects that are more discretionary over the longer time to value.
Such as next generation enterprise applications.
The delays impacted the revenue coming out of backlog, which is about 80% of the quarterly revenue as well as the smaller in period signings, which yield revenue more quickly.
While declines continued in these smaller signings from March through May the trajectory improved and we return to modest growth in June.
For the quarter GBS cloud signings grew at a double digit rate as clients are prioritizing their digital transformations.
Offerings, such as cloud strategy consulting application development and modernization continue to grow revenue in the second quarter.
These offerings standardize on Red Hat's, openshift platforms enable clients in their cloud journeys.
We are working with an additional 60 clients such as bank of America, Medtronic Loblaws Bank of England credit mutual and Deutsche Telecom to utilize red hat technologies to transform their businesses.
Looking at profit, we expanded gross margin in GBS by 240 basis points.
We managed the business well in this environment by leveraging our variable and global delivery resource model, improving price margin realization and optimizing utilization.
We also had a currency benefit which is fairly consistent with the last couple of quarters at the same time, we're continuing to invest building skills and practices through education and hiring.
Overall, weibo dealing with some near term macro challenges GBS his deep industry expertise combined with IB Adams and now Red Hat's innovative technology play a critical role in the acceleration of clients digital transformations.
In global Technology services revenue declined 5% fairly consistent with the first quarter's performance.
We had signings growth in the quarter and strong growth in cloud revenue, but this was offset by continued declines in client business volumes.
As we talked about in the past about 90% of GTS. This quarterly revenue comes from contracts in our backlog.
While this business has a high mix of recurring revenues there is some variability in that revenue stream.
We provide clients with flexibility in their capacity to deal with volume changes due to their business needs and macroeconomic environment.
As a pandemic intensify through the end of March and into the second quarter, we experienced lower client base business volumes, reflecting challenges across industries.
While performance in some of these industries like financial services was consistent quarter to quarter. Other industries had a more significant decline.
We saw this especially in retail automotive consumer goods and travel and transportation.
This impacted the revenue coming out of our backlog in the second quarter.
At the same time clients are continuing their infrastructure transformations. The hybrid multi cloud environments. For example at Daimler we have expanded our relationship to migrate their global after sales platform as the IB IBM cloud.
And this quarter, we announced Sabadell, Mexico, the first 100% mobile bank in Mexico will host its infrastructure on the IBM cloud and use Red hat enterprise Linux to modernize its applications.
Hey, Joe and other financial institutions like Bank of America, BNP Paribas, Banco Santander, Latte card and cash and bank among others as they move forward on their cloud journey.
These commitments contributed to the signings growth for GTS and in fact in the first half signings grew at a double digit rate.
This results in improved backlog trajectory for more we entered the year.
Given the overall duration of the backlog this will convert to revenue over a longer term horizon.
Looking at gross profit GTS margin declined 30 basis points. This was driven by mix as the high value TSS business is impacted by the current product cycle.
Ill remind you we have not yet realize the benefits from our first quarter structural actions.
Turning the systems revenue was up 6% this quarter and gross margin expanded over 400 basis points.
We again had good growth in both IBCM Z and storage.
Clients value the new innovation of the Z 15, mainframe and high end storage.
Similar to first quarter, Dizzy 15 offered enterprises valuable capabilities, including remote management security and importantly scalability.
This quarter clients also increasingly look to idmc for resiliency and business continuity to keep mission critical workloads running smoothly.
We continue to offer additional hybrid cloud capabilities Unsi 15.
We release Red hat answer both certified content Fry BMC and launched a new cloud native development offering was the work spaces, which allows developers to use industry standard tools from IBM Z multi cloud platforms optimized on openshift.
The growth in C and storage was partially offset by weaker performance in power reflective of where we are at in our product cycle and powers client base of smaller enterprises, which are impacted more during this pandemic.
Now, let me bring it back up to the I'd be on level I.
I think garvin summed it up well the current environment presents some near term challenges for our clients, but it also provides some longer term opportunities for us.
We have a business profile and business model that provide some stability in the current environment.
We have also recently taken a number of actions that strengthen our operating model for today and for the future.
We built a robust hybrid cloud platform based on what we firmly believe is the winning architecture.
This technology centric platform together with our deep industry expertise and ecosystem partners will enable us to accelerate client digital transformations and move more of our clients mission critical workloads to the cloud.
As we enter the second half we have a compelling set of offerings and the strong pipeline across software services and systems.
How that pipeline yields to revenue will ultimately be tied to the rate and pace of the economic recovery and the resulting client spending confidence.
Given the uncertainty in the environment and consistent with our direction from last quarter, we're not going to provide guidance for 2020.
But I do want to remind you of a few specific dynamics systems performance reflects where we are in our product cycle and we wrap on the IBM Z launch in September.
Software, our transaction versus annuity mix varies by quarter.
Historically, we have a lower mix of transactions in the third quarter and our largest transactional based is in the fourth quarter.
And that for Red hat, we Anniversaried the acquisition in early July.
We're wrapping on a large part, but not all of the impact of the deferred revenue adjustment and transaction charges.
We also wrap on the divestitures completed in the second quarter of last year.
And the savings from our structural actions will start to yield in the second half, providing better cost competitiveness and margin performance, especially in GTS.
Finally, we remain confident that we have ample free cash flow and liquidity to invest in our business and return value to shareholders through dividends Arvin any final comments.
Jim What's most important to me and to IBM is that we emerge stronger from this environment bits of business positioned for growth.
Im confident we can do that.
My focus will be on investing and maintaining flexibility to take actions.
Not just to strengthen our operating model, but also to advance our strategic priorities.
Now, we'll go to Patricia for acuity.
Thank you Arvind before we begin to Q today I'd like to mention a couple of items.
First we have included supplemental information at the end of the presentation and finally as always I'd ask you to refrain from multi part question.
Taylor Please open it up for questions.
Thank you at this time will begin the question and answer session. At the conference you ask a question. Please press star one and record your name clearly if you need to withdraw your question Prestart Q.
When you ask a question. Please press star one how our first question will come from that Kabral with credit Suisse. Your line is open.
Thank you very much.
Understanding you guys are looking to give formal full year guidance at this point, but just wondering are you spend a little bit more time about how we should think about moving into the third quarter versus seasonality, where I think typically you're down a little bit over $1 billion sequentially and maybe just take a little bit deeper into some of the biggest swing factors, we just thinking about by segment and going from Twoq to Threeq.
Thanks, Matt for the question, let me start and then I will give it to Jim for adding a bit more color on a bit more details.
As both of US said on the call we're seeing that there is.
It's two sided we see opportunity in hybrid cloud, we see opportunity in digital transformation, we see opportunity in people as they're doing a return to the workplace and projects that all advance those things some of those give them long term benefits some give them.
All of them benefit.
That said, we are seeing that there is in negative on things that require capex things that have very long term pay offs and project based businesses.
Pete think about the dividend in third and fourth quarter code is a bit lighter on transactions forces very heavy on transactions. If we also look at some of those project based businesses.
Likely and this is where it's tough to give guidance, but it's likely that received at the economic recovery is looking to be longer and more protracted than we might have hoped for back in March and as we see that bouncing ball and economic recovery, whether it's in the United States in Brazil, and India that has.
An impact on all of these elements.
The other thing that as important and saw the.
Oxygen made.
We kind of have a two third one third mix, maybe a bit more than that in industries, which are less impacted was industries that are more impacted and that of course will play out in our results as well, but let me give it to Jim due to mix all those things more precise yes. Thanks Arvind.
Thank you very much for the for the question overall.
As we stated wrapping up the prepared remarks, we do have a very strong pipeline.
Across our offering portfolio around systems around soffer around services.
But as Arvind just indicated the yield will be tied directly to the rate and pace of the recovery of the pandemic curves, which by the way vary based on market around the world and industry.
Which tied directly to client spending confidence overall, if you look at just macro level dynamics of our business profile Theres a couple of things that I think will play out as we look forward. One is we're going to wrap on divestitures. That's been a two point headwind to the add them company for the last four quarters.
Wrap as we enter second second half number two we're dealing with actually a weaker dollar and you'll see in the currency backup.
That is now flat to about one point of the headwind where we were.
Dealing with about a two to two and a half point headwind over the last few quarters three the dynamics of client buying behavior is really shifting that acceleration that digital transformation into cloud you see a play out in our results and we actually have a strong pipeline.
I'd had had another very good quarter, good pipelines set up our hybrid cloud solution offerings around cloud packs with good momentum we got to good annuity base of business that we're going to continue to build on what renewal rates and we've got a systems business that we refreshed with new innovation when.
You look at services to your point, we've got structural actions that are going to start yielding as we exit or excuse me as we enter second half and we got a strong pipeline is urban stated on the call of large transformational deals now those are always binary as to when they close but they will.
To reposition the emerging stronger theme of our backlog in services overall in the meantime, we're going to continue to deal with the economic impact around discretionary projects in particular around GBS.
Okay. Thank you Matt can we please go to the next question.
Yes next we'll hear from Amit Daryanani with Evercore ISI you May go ahead.
Yes.
Thanks, Good afternoon, and thanks for taking my question guys.
I guess my questions will be around the cloud revenue growth, which I think was about 34%. This quarter was it really impressive acceleration from I think given what you guys said in the March quarter up it's a way to think about just how sustainable do you think this growth is as we go forward and then when I think of this number 34% isn't going to see how much of this growth is from new law.
Well as a new wins on the customer side or says, perhaps taking existing customers from on premise to a hybrid off premise journey.
Okay.
Let me start this is Arvind and then.
I will ask Jim to to add a lot more color.
So I am it so the clearly a since this is the last quarter of a red hat laws Alcott inorganic that clearly had an impact on this that said we are still actually quite happy with the results. Despite that that had accelerated quite a bit.
Earlier and from both the first quarter and last year. So I'll, just say it like that and and leave it at that the second part you AOS was I was just moving our people from one side to the other obligating deal win.
But the vast majority of this there is a big core of Red hat as I describe our hybrid car platform.
Not a left right shift that is actually net new when do you think about our wins and telecom actually those are places we will never present actually either of us not just quantify.
If you think about modernizing people's applications, that's not a shift that's actually net new work for us.
You asked about new logos that may applied to a little bit of services, but for the company at large look we have a lot of compliance I mean like.
Almost any enterprise of any size is already offline.
Especially on the product side of the house, so talking about them being new logos would be unfair, but I'll be getting into areas within them that we previously did not have access to I would say, we had have absolutely doing that and Thats a big part why you see that 34% growth so with that let me give it to Jim.
For adding to that just some color around how that 34% was actually delivered overall arvind talked about it from us from a client perspective in the value we bring around our hybrid cloud differentiated value proposition, but the 34% amid.
As you indicated is up about 11 point sequentially quarter to quarter with regards to growth profile that was driven pervasively across all four segments of our business and in fact, so 11 point sequential year to year improvement quarter to quarter improvement was entirely organic.
Nick.
Red hat contributed significantly to the 34% overall, but even on a pro forma organic perspective, we are growing right around 20%, we got to GTS business that has over a 9 billion dollar book of business in our cloud portfolio that grew 20%. This.
Quarter.
An accelerated from first quarter, our GBS business, which is about five and a half billion on a trailing 12 months grew in the mid teens and our software business, which is about a five and a half billion dollar book of business grew well in excess of 100%, but grew around 20 plus percent pro forma organically.
So I think we're seeing broad base acceleration really driven by the client buying behavior shifts that are happening in the marketplace into our Vince prepared remarks overall, we feel pretty confident about the offering portfolio and the differentiated architecture run our hybrid cloud platform that.
Visions us to continue to capitalize on that going forward.
Thank you on it.
The next question please.
Our next question will come from Toni Sacconaghi with Bernstein. Your line is open.
Yes. Thank you I was wondering if you could comment on linearity in the quarter relative to sort of normal normal.
Linear patterns it sounded like softer was a little worse than the first half a quarter and then got a little bit better I think there was one other business, where you referenced things may be looking a little better as the quarter progressed.
So could you comment on whether that's a fair observation and if it is why shouldn't we be thinking about modeling normal are better than normal seasonality from Q2 to Q3, and then separately could you just comment on GBS signings. It sounds like they were down perhaps 20%.
Year over year.
And what that.
Might suggest.
For the GBS business trajectory over the next couple of quarters. Thank you.
Hi, Tony so.
Your various due to your observations about the Lady out at the in second quarter. So let me just out a little bit of color to that and we finished the first quarter, we've acquired transparent and saying that March was a lot worse than we expected compared to what we see I wouldn't use the word linear because of the transactional side. The last month of the quarter is a lot.
More so I'll, just compared to normal maybe as opposed to linear.
When we entered second quarter.
The energy side of the business, but it's pretty evenly other than the slight I'll call. It maybe 4% to 5% in volume that goes up and down.
So that side is Lydia approximately and that Didnt change, we look at the transactional side of the business I would tell you that the month of May was significantly worse than we would normally expect and we saw that begin to come back in June, but not really to recover to normal levels. That's why I falls on saying.
Thank you be better because since.
Me was worse than June but June will still worse than we might have expected last year. So that tells us something about that and then I'll. Let me give it to Jim to also comment on the impact of the signings as well as more on the.
Importantly reality question, yes, so thanks Arvind Thanks, Tony for the question, but as you indicated that with the heart of your question overall.
Dynamics in March that we saw generally played out as we entered the first part of second quarter clients are really continued focused on mission critical operational stability cash preservation as any company as we were in the midst of the worst pandemic, we've seen in quite a period of time.
And then I could even tell you as CFO. The IBCM company, we were maniacal focus on liquidity. So there was not unexpected.
But what we see play out as we move through the quarter is really the demand profile is really correlating to the curves of the pandemic.
And that plays out differently around markets around the world around industries around the World Thats why we tried to give some color about our geographic diversification, which we believe provides a natural hedge in this environment as many markets are going through different curves in our industry concentration.
Being 70% in industries that are minimally or moderately impacted.
By the pandemic overall per Gartner and you see.
But when you look at at the rate and pace of that economic recovery as we said when we concluded prepared remarks is really going to follow that pandemic, but when you look at our performance in the second quarter and not to repeat aravind, but just give a little color by by unit, our GBS business really stalled.
In the month the March after starting very strong through two months that continued through the first two months of this quarter and actually June we saw our small transaction volume, which has high yielding revenue content going forward actually come back to growth and it was led by.
Europe, which stabilized with their pandemic curves and it was led by Asia Pacific actually the Americas was the exact opposite both Latin American US we started out pretty strong as the US was getting the pandemic in curve underway and then when it started bouncing in June we took a big step back.
So thats what happened in GBS CNC software.
Very strong conclusion, where value in hybrid cloud solutions certain AI specific red hat very strong closure the quarter, but I'll tell you. One we came off a very strong second quarter.
Large deal closure last year. So we had a very tough compare but we didn't grow in the month to June we were just much better than March and April and May.
Systems finished pretty strong, which a testament to our value prop and GTS updated GTS was kind of a mixture 90 plus percent of that business is annuitized. We are we are dependent on client base business volumes that 70% of industry, we actually saw stability and for the first time away.
Now some growth unlike financial markets government et cetera, but we are getting impacted in GTS by client base business volumes in particular around airline travel transportation and retail.
Okay. Thank you Tony Sealant can we please go to the next question.
Thank you. Our next question comes from Wamsi Mohan with Bank of America. Your line is open.
Yes. Thank you are when do you noted that the hybrid cloud opportunities half and services do you see for IBCM, a larger opportunity at GBS or GTS and any additional color on the GDS GBS mix of those large transformational deals you alluded to in your prepared remarks will be.
Helpful and if I could Jim could you maybe also talk about the seasonality relative to cash flows in second half versus first half this year given the red hat contribution in the first half. Thank you.
Hi, Thanks Wamsi so.
No so.
As mentioned explicitly that have the opportunity services, but we look at the market. That's a 1.2 trillion dollar market for hybrid cloud and about 550.
Early and you could say, maybe a touch more is a services opportunities so thats the almost app.
Within that the bulk of the opposite opportunity is in application modernization and improving the end to end workflows off all clients processes, but when you look at those elements and then you look at both private and public cloud the nature of those operations is much more.
Automated and much more captured in court than traditional infrastructure.
Yes, that's my I guess, my technologist way of saying that they're opportunity will be larger in GBS and GTS. All those opportunities. However, I'll just put a caution but that said there are uncomfortable and does remain important it's now that it goes away, but in terms of pure dollar it off.
Attunitys, it's shifting more towards the GBS side, what that side of the markets as opposed to the traditional infrastructure.
And we are seeing that play out in the mix of the opportunities.
Because people need to get the worked on first in terms of transforming that applications and that innovation is what is driving that interest and thats why you see us keep using the word transformational because out of the better people see the huge opportunity of these of these.
Projects and so with that Jim on.
Wamsi. Thank you for the question overall around free cash flow seasonality.
Through the first half, we delivered $3.6 billion of free cash flow and $5.1 billion of cash from ops.
Cash from ops is about flat year over year, our free cash flows down about 400 million that positions us on a trailing 12 month, Lebron and a half billion dollars I think.
In a very strong free cash flow realization, let me give you some of the underlying dynamics and then I'll give you some color given we're not giving forward looking guidance, we're not going to give a free cash flow guidance here on the call but to your question I'll give you some color about seasonality and what were some of the headwinds tailwinds.
As we stated when we entered January very similar we talked about capital we're going to continue to invest in this business capital through the first six months was a headwind of almost a half a billion dollars, our workforce rebalancing payments or a headwind predominantly.
In the first half that will diminish as we get into second half in cash tax was a headwind through the first half for ready in that which should be pretty consistent as we move forward offsetting some of that here in the first half is we've had very strong working capital efficiency very strong collection rates.
Even in this environment talking to the test demand I think of the value in how essential we are to our clients and delivering mission critical value and also we're in a mainframe cycle. So our I GF attach rates are doing quite well and that is helping our free cash flow overall, so I assume.
As we move into the second half will have similar dynamics around the headwinds we start now in the second half as we anniversary Red hat.
The the profitability a red hat will start accelerating as we get into the second half that should help us we'll start reducing the amount of tailwind on working capital efficiency as we get through our Z cycle overall.
And I think with regards to cash taxes, I've stated pretty similar.
Thanks, Wamsi can we please go to the next question.
Next we'll hear from Katy Huberty with Morgan Stanley You May go ahead.
Thank you good afternoon and number of your appearance Accenture Sep Oracle have recently provided guidance is there something different about your business exposure or what you see in the market that is holding you back from providing guidance and why do you did that you're looking for in order to return.
To the prior framework of giving annual outlook.
Hi, Kt thanks for the question.
I think is to deal.
I can comment on.
Business the friend.
Good to see it differently I can comment on what we see.
We have a lot of.
Uncertainty and the economic environment around the globe.
And when we look at it by geography by content and all by industry.
Just.
So much variability that we got to answer it in April when we said that we live reevaluated 90 days.
Maybe a little bit optimistic that we will get more stability on on the health, which in turn leads to the economic conditions that over the begin to flatten in three to four months because at that time, a reasonable, but undoubtedly misplace expectation and so we just cantels well.
Those go and because those have an impact not in a month or two about almost six to nine months, even on portions of the additive business as.
Jim as we very clear that is planned to do that the ability to dial volume's up and down in some range.
Creates for us inability to really wants to give guidance.
Confident about.
That makes sense of confidence and uncertainty the economic that makes us.
Unwilling to provide guidance.
Yes, the only only thing I would add Kt is that.
It's not a statement of the confidence we have in our portfolio our offerings, our strategy and our platform or what arvin's trying to drive as the new CEO. The IBCM company overall, we feel pretty confident in that in urban articulated that in his prepared remarks around our hybrid cloud strategy our platform architecture.
In components of our business as we see play out in the second quarter. This demand profile and the resulting clients spending confidence is going to follow the pandemic curbs around markets and around industries and we saw that play out in the second quarter and we'll see how the world.
Deals with the overall pandemic the crisis and how we enable our clients in our employees and our communities to move forward. So it is not prudent right now in this environment as we're still dealing with it the tied down our flexibility move to move forward, we're going to continue to invest in our busy.
Yes, and we'll get.
The right liquidity strength of our balance sheet and investment in fin flex profile to take the right actions in this environment to advance our strategic priorities going forward.
Thanks, Katy let's go to the next question. Please.
Our next question will come from 10, Jen Wong with Jpmorgan. Your line is open.
Hey, Thank you so much often you mentioned youre seeing large transformational projects in the pipeline I think Jim you underline that.
And then just curious how meaningful could this be I don't know if you can compare it to past cycles.
Recognize is going to hinged a little bit on the world healing, but just trying to get a perspective on the sizing here and then also just as a second clarification you talked about trading off the trade off of Opex versus Capex.
Do you have pretty good line of sight at this point on your annuity business looks like transaction processing. For example is pretty stable quarter to quarter in terms of the on your trends I just wanted to make sure I Didnt Miss anything there. Thank you.
Thanks, Thanks for the question.
How meaningful kind of the large transformational projects be.
So when we say large these are typically projects that measure in the multiple hundreds of millions of dollars.
Contract value.
And you do have the feet as you say.
Pick a number as a C four or 500 million total contract value and you do that as you say those typically will give that full yield or five to seven years.
Thats the kind of nature that take and then you say how many of those I was going to get done we have a fairly large number of them in the pipeline.
We are hesitant to say as well that takes the six 912 months to get closed fleet.
Though we'd be an added for a few months already and so I think it is quite meaningful if you begin to close that.
Absolutely see that either move on our services business as those big into flows and yield.
Relative to past cycles, I think as we came out of Bostra sessions are as we came out of different processes.
Not sure that going to call the dotcom.
Right, maybe low the might a recession, but it was a defer the impact of the tech industry for sure and we saw the impact of those kinds of projects different nature now that about move into the cloud journey to cloud hybrid cloud transformation.
And they were much more about perhaps the.
Nature of outsourcing and beginning to create out of efficiency.
In infrastructure management to the nature of these projects has changed.
So let me.
Jim add color to it at all to talk about the affinity business, Yes, I would just thanks engine for the question I would just add to your last point I think the nature and the rate and pace of those large transformational deals right now feel much quicker than when we were sitting back in 2008.
Moving through this it was a very different recessionary time that impacted industries differently and markets differently. This is more so of the consumer based small medium market base industry specific base that is getting impacted at least immediately right now.
But that time to value will shift over time as we move forward. So I think 10, Jim when we went back and we've done many different stress tests of our business model to ensure our balance sheet, our liquidity position scenarios, we looked at Pryor recessions.
We don't see anything different the only differences where that client behavior and now shifting from a managed services years ago to more of a hybrid cloud asset base differentiation last thing on your annuity.
We feel pretty confident about our annuity basis over 60% of our revenue today.
Pretty stable.
TPP is a mixture of or some annuity most annuity I should say some transactional I think from an annuity perspective were poor performing pretty consistent with the market overall and we see that continue to play out here in the in the second half.
Thanks tension here recently, please go to the next question.
Yes, Hi, where next question will come from David Grossman with Stifel. Nicholas Your line is open.
Thank you good afternoon.
The GTS business Thats appears to be all these different moving pieces.
Were significantly impacted by volumes, but looks like you had pretty good signings.
In the first half a year durations up in the backlog et cetera. So is there anyway, you could kind of ciscura. This for us in the cyclical impact so that we can get a better sense of how the transformation that business is trending particularly given.
The ongoing revenue challenges, we've had over the last several quarters and and perhaps you could reconcile this because I've heard you made a comment seeing a shift.
The applications, where from GE Ts to GBS and and maybe it's.
More informative to look at it on a combined basis under their brand and chicken under one person that when you're trying to build the two together. So so maybe you see more acceleration in GBS coming out of this and GTS, maybe flattens out so just trying to get a better sense of how to think about the health of that business now and how it's trending.
Okay. The David let me start and then.
Asked him to add color.
But we should acknowledge that.
We have never happy when a business is a declining even at mid single digits.
Lets us we acknowledge that.
I would say, but then what are the elements underwrite, which is what you're asking about what it all the moving parts.
And given the large annually in nature of that business that does reflect signings and commitments from the fast not just within the quarter.
So that is there and that means that you're looking at the revenue impact.
Even if you have good signings that revenue impact takes a long time to sort of make its way through.
Through the.
And with that business and also in terms of backlogs that are in that business.
So when I look for the cyclical impacts there I think that.
We want to be careful about trying to say that the trends change dramatically quarter to quarter I think that those are places where it is going to take a while.
For the revenue tragically in that business.
To change.
And im not sure that looking at it combined.
It is important to be able to leverage.
The parts of the business with each other and there are some elements that can be leveraged and that is why you refer to more cost as old where he as both of those teams.
However.