Q1 2021 International Business Machines Corp Earnings Call
It began.
Thank you this is Patricia Murphy and I'd like to welcome you to Ibm's first quarter 2021 earnings presentation, I'm here with Arvind Krishna Ibm's, Chairman and Chief Executive Officer, and Jim Kavanaugh, Ibm's, Senior Vice President and Chief Financial Officer.
We'll post today's prepared remarks on the IBM investor website within a couple of hours and a replay will be available by this time tomorrow. Some comments made in this presentation may be considered forward looking under the private Securities Litigation Reform Act of 1995.
These statements involve factors that could cause our actual results to differ materially.
Additional information about these factors is included in the Companys SEC filings.
Our presentation also includes non-GAAP measures to provide additional information to investors. For example, we present revenue and signings growth at constant currency throughout the presentation and.
In addition to provide a view consistent with our go forward business, we'll focus on constant currency growth adjusting for the divested businesses for the impacted lines of total revenue cloud and our geographic performance. We've provided reconciliation charts for these and other non-GAAP measures at the end of the presentation and in the 8-K.
<unk> submitted to the SEC.
So with that I will turn the call over to Arvind.
Hello, everyone. Thank you for joining us today I'm pleased to be speaking with all of you again.
And on last call, we shared our financial expectations for the year.
Our revenue growth.
On $11 billion to $12 billion of adjusted free cash flow.
While it's still early in the year on a lot remains to be done we are confident enough to say that we are on track.
Last quarter I also talked about how the events of the last year have increased the needs for our clients to accelerate their digital transformations.
This is continuing and the overall spend environment is improving while there are some clear differences by geography and industry with that as a backdrop.
In the first quarter, we reported revenue growth at actual rates and grew free cash flow.
We can see signs of progress in a number of areas on our results in cloud and cognitive software and global business services revenue show that on on improved project Cree, including a return to growth in consulting IBM.
IBM Z again demonstrated its value as an enduring platform. Meanwhile, we improved margins in our global technology services led by managed infrastructure services.
As Jim will explain to you all of this helped to deliver a free cash flow improvement, which is a key focus area.
As we move through the year, we will continue to execute on the important changes, we're making to the company.
From the acquisitions, we are making to the investments to expand our partner ecosystem to the significant overhaul of our go to market model that we announced back in January to the changes you are bringing to our culture to instill more of a growth mindset.
As you know we are also executing the separation of our managed infrastructure services business now branded <unk>, which is on track to be completed by the end of the year. This.
These changes are all well underway.
You would expect it will take some time to see the full benefit.
I have immense confidence in our strategy around consummated power of hybrid cloud and AI.
On the decisive moves we are making provide a solid foundation for us to unlock future growth.
As I've told you before we see the hybrid cloud opportunity at a trillion dollars.
With less than 25% of workloads, having moved to the cloud so far.
We are reshaping our future as a hybrid cloud platform an AI company.
For us the case for hybrid cloud is clear.
Businesses have made massive investments in their it infrastructure.
Dealing with specific constraints, such as compliance data sovereignty and latency needs in their operations.
They need an environment that is not only hybrid but a hybrid platform that is flexible secure and built from open source innovation.
This gives them a credible path to modernizing legacy systems with advanced cloud services and building cloud native apps. This.
This is what we have built a platform for and why we have such confidence in our strategy.
Ibm's approach to platform centric.
Linux containers and Kubernetes other foundation of our hybrid cloud platform, which is based on Red hat open shift.
I have a vast software portfolio cloud backs.
Modernize to run cloud native anywhere.
Our GBS expertise is a key factor in driving consumption and in helping our clients accelerate their digital transformation journeys.
And our systems and industrial specific public cloud provide differentiated infrastructure.
The economics of a platform designed to drive growth across all of IBM.
Latam itself contributes.
But then for every dollar of platform spend.
On spend three to $5 on software and six to $8 on services.
IBM together with a growing ecosystem partners are positioned to capture that value.
Let me now turn my attention to some other progress on proof points, we have seen in the fourth quarter as we execute on our hybrid cloud platform and AI strategy.
In the last quarter more companies chose IBM to help them realize the potential of hybrid cloud.
That includes PNC bank by not day and Egyptair.
We're also helping Siemens re platform mindset, there Iot software on top of it read out open shift that makes it possible for them to deploy on both public and private clouds.
We now have 3000 clients using our hybrid cloud platform.
We are also focused on helping companies use our rich AI capabilities to drive business outcomes.
In the past quarter, we have forged important partnerships with companies like volunteer to simplify our business build and deploy AI applications across public cloud private cloud and on premise.
As part of this collaboration IBM and volunteer are creating a new offering called volunteer for IBM cloud Pak for data, allowing clients to scale AI with confidence.
In addition to volunteer we've continued to expand our AI ecosystem building on partnerships with companies like box, Claudia and Mongo DB.
In March the global research firm Gartner positioned IBM as a leader in three Gartner Magic Quadrant report.
I'm, making IBM a leader in <unk> Magic quadrant.
This recognition highlights the important work we have been doing to bring new innovations from our research teams and core areas, such as natural language processing crust and automation.
To facilitate our clients' adoption of our focused hybrid cloud and AI solutions as.
As I said in January we announced significant changes in our go to market model.
We drastically simplified our sales model by adopting a single consistent segmentation.
<unk> client with the more technical and experiential approach and are investing in and elevating the role of our ecosystem partners to deliver more value to clients.
Finally, we have adjusted the consensus structure for our sales teams to better align our reward system with our strategy.
While it will take time for these changes to yield results.
We're seeing some green shoots from our transformation.
We're investing in and scaling what we call pre sales garages to co create with our clients a lot earlier in the sales process.
We've added around 200 of our top clients experienced new use cases for our solutions.
And on ecosystem strategy and approach with strategic partners is already opening new areas of growth in GBS.
I wanted to spend a minute on innovation.
Strong pipeline of innovation and some of these are already differentiating our portfolio.
As I said earlier IBM Z again demonstrated its value this quarter.
This is thanks to the critical innovations, we bring to each new generation of IBM Z, which continue to spur renewed interest and drive client demand and.
In fact day 15 is now shipping the largest capacity in the platform's history.
Another innovation, we recently put on the market relates to Red hat open shift the cornerstone of our hybrid cloud platform <unk>.
Often shifts now includes new capabilities around security and scalability, both of which are critical to enterprise needs.
Next up on new Linux Kubernetes based innovations that will help businesses extend hybrid cloud to the edge scale and secure cloud native applications and consume technologies on open shift as a managed service.
Let me now turn to other opportunities we are seizing that will play out over the longer term.
We announced that we are embarking on a decade long partnership with the Cleveland Clinic, who will tap into the power of AI hybrid cloud high performance computing and quantum computing to accelerate the process of scientific discovery.
As part of this collaboration IBM will install the first on premises IBM Q system, one in Ohio within the United States.
As you know this is an area of incredible promise.
Quantum has the potential to unlock hundreds of billions of dollars of value for our clients by the end of the decade.
To seize this opportunity we announced a roadmap to build on housing plus qubit quantum computer by 2023.
We remain excited by these developments.
You May also have seen the partnership we announced with Intel to advanced next generation logic and packaging technologies.
This collaboration will be key in accelerating innovation and enhancing the competitiveness of the semiconductor industry.
As we reshape our future as a hybrid cloud platform and AI company we.
We are continuing to use our scale scope and cost to make an impact on important societal issues.
For instance to help tackle the climate crisis, IBM announced a net zero pledge by 2030.
We have been transparent in that our efforts are focused on reducing actual emissions without the use of carbon offsets.
We also intend to use emerging technologies to remove emissions equal to our residue low emissions leveraging IBM research to help accelerate the discovery of materials for these technologies.
Fundamental to our business growth is fostering a culture of conscious inclusion where innovation can drive an individual's progress.
Last year, we made a commitment to be more transparent in how we report diversity and inclusion.
And last week, we released our 2020 diversity and inclusion report.
What you will see is that we have increased our diversity representation and achieve best in class inclusion scores from our employees.
We are leveraging our industrial leading hiring practices skills development and advancement opportunities to continue our progress.
I'm happy to expand on our ESG efforts in the Q&A.
Before I turn it over to Jim I will close with a comment on our future our.
Our objectives are clear.
Sustainable mid single digit revenue growth post separation and strong cash generation.
We are taking actions investing and aligning compensation to achieve this.
And our first quarter results are another step in the right direction towards our future.
Jim over to you.
Thanks, Arvind I'll get right into the numbers in the first quarter, our revenue of $17 7 billion grew 1% as reported with.
We expanded our gross profit margin and grew gross profit dollars, we reported operating earnings per share of $1 77.
Our adjusted free cash flow was up resulting in $11 $6 billion over the last year and our balance sheet and liquidity position remains strong as.
As Arvind said, we made progress but more to do.
You can see this progress in our revenue with an improvement in the trajectory of our constant currency results are.
Our revenue was up in cloud and cognitive software and systems and consulting returned to growth.
We're capitalizing on clients' digital transformations and journeys to cloud we.
We take a platform approach to hybrid cloud and AI with capabilities and infrastructure software and cloud services across these are cloud revenue was up 18% in the quarter and over the last 12 months and now stands at over $26 billion for the last year.
Fundamentals in our business model also continued to improve we expanded operating gross profit margin. This quarter by 110 basis points I'll remind you how we manage our business we manage our services businesses at the gross margin level, while we look to capture the value of our product.
Based businesses at the pre tax margin level, we had good margin expansion across our segments on those spaces.
This operating leverage enables a higher level of investment.
We're investing in innovation and skills and in our ecosystem as we execute on our hybrid cloud and AI strategy.
Our hiring was up year to year with thousands of people hired in the quarter, we closed six acquisitions since mid December.
We're building out pre sales garages, adding go to market and delivery capabilities in GBS and technical skills and Red hat.
And were increasing R&D in areas like AI and quantum to drive innovation.
Our year to year expense dynamics reflect this investment, though it was offset by lower workforce rebalancing charges year to year and lower travel expense in the current environment.
Let me round out the financial highlights with some color on our strong free cash flow and balance sheet and liquidity position.
We had a good start to the year with $2 $2 billion of adjusted free cash flow at 11 $6 billion over the last year.
This adjusted view excludes the cash impact of over $600 million for the structural actions initiated in the fourth quarter and transaction charges associated with the separation of our manage infrastructure services business.
This $2 $2 billion of adjusted free cash flow is up $800 million year to year.
Driven by profit growth and continued working capital efficiencies, we had both strong cash collections and renewal rates in software.
The software renewal rates drove our total deferred income to over $18 billion, which is an all time high.
Our free cash flow performance in the quarter contributed to our cash balance of $11 $3 billion. While this is down $3 billion from year end, our debt was down $5 billion. We've now reduced our debt by about $17 billion from the peak.
So we've made good progress in deleveraging without sacrificing investments in our business or our solid dividend policy.
Now, let me turn to the segments cloud and cognitive software grew 1% driven by cloud and data platforms and cognitive applications are cloud revenue in this segment was up 34%.
This reflects the investments and actions we've taken to capture the hybrid cloud opportunity with solutions like Red had opened shift and cloud packs.
Our cloud software is now $7 $5 billion over the last year, which is about a third of our segment revenue.
Across cloud and cognitive software, we continue to increase our subscription and support renewal rates driving the record deferred income levels I just mentioned.
Looking at our software performance by business area.
Loud and data platforms, which is about half of our segment revenue grew at a double digit rate.
Had continued solid performance with normalized revenue growth of 15% led by Red Hat Enterprise Linux and open shift both of which continued to gain share.
With about 3000 hybrid cloud platform clients, we've now tripled the revenue base of open shift since we acquired Red hat on.
I'll remind you we wrapped on the acquisition of Red hat in the middle of last year, and this quarter cloud and data platforms delivered 2% normalized growth.
In cloud and data platforms. We also improved the year to year trajectory across a number of key areas, including integration data science and AI ops.
In cognitive applications revenue grew 2% this quarter led by strength across security software and services, our security solutions like cloud Pak for security helped enterprises to manage threats and protect their digital workloads data and identities across hybrid.
Good environments and.
And clients opted for accelerated time to value and ease of operation with Q radar on cloud to rapidly detect cyber security attacks and network breaches.
As expected our transaction processing platforms revenue declined.
We provide flexibility to our clients and how they purchase our software.
Clients buying behaviors have been shifting towards more consumption based models.
As a result, we are seeing a continued preference for opex over capex, putting pressure on perpetual licenses. So this quarter, we had strong renewals in our TPP software, which I'll remind you provides mission critical capabilities to our clients.
Looking at the profit for this segment, we expanded pre tax margin, while continuing to invest in new innovation and our software ecosystem.
Turning to GBS or year to year revenue trajectory improved about four points with consulting returning to growth were.
We're capitalizing on the market trends clients are digitally transforming their businesses using hybrid cloud and AI to capture new growth opportunities increased productivity and create operating flexibility.
Our revenue performance this quarter reflects this.
GBS cloud revenue growth accelerated to almost 30% doubling its growth rate from the prior quarter with strong growth across the portfolio.
We see this in consulting where we had strong growth in our advice and build offerings.
This reflects expanding practices with ecosystem partners like Salesforce, and Adobe and strong momentum in our Red hat practice in fact, we doubled the number of Red hat client engagements for the prior year to over 150, working with companies such as H B O Marriott.
Vodafone and Honda.
We've now signed $2 billion of business in a red hat practice inception to date.
Within application management, we had growth in offerings, which build and move applications to the cloud. This growth was offset by declines in on premise activity.
Our application incumbency enables GBS to be the partner of choice for our clients' digital transformation.
It is high value to our clients and to IBM.
And as an important component of Ibm's hybrid cloud strategy and platform adoption.
For example, GBS continues to drive one third of our cloud Pak revenue and all of those engagements roughly 80% or with application management clients.
We are also capturing the opportunity in business transformation services or what we call intelligent workflows.
We think consulting we had double digit growth in offerings, which leverage data and AI to transform client processes in areas like finance and supply chain.
And then global process services revenue growth accelerated to 19%.
We had broad based growth in areas, such as finance and talent and transformation as clients leverage hybrid cloud to scale their activities to capture productivity and gain insights.
Turning to profit we continue to expand GBS gross margin, which was up 100 basis points this quarter.
This was driven by our shift to higher value offerings increased productivity and improving delivery capabilities, which results in better margin realization.
And this quarter, we still had some margin benefit from reduced client related travel.
At the same time, we're continuing to invest in GBS organically and Inorganically to accelerate the revenue performance. We closed two acquisitions in the quarter, we are building and expanding practices and supportive ISP partners and we continue to hire adding more sales and delivery.
Capacity contributing to an increase of more than 5% and our go to market resources since last year.
Systems revenue was up 2% led by strong performance in IBM Z product cycle dynamics continue to play out across power and storage.
Our IBM Z revenue was up 49%.
That's very strong growth, especially more than six quarters into the <unk> product cycle.
We had traction in areas like financial services were robust market volatility drove demand for increased capacity.
It's also purchased <unk> for its enterprise grade security and unmatched reliability for regulatory requirements simply put this platform is secure scalable and reliable.
<unk> is an enduring platform developed and optimized to support enterprises most mission critical applications.
The IBM Z platform is also an important element in our hybrid cloud strategy.
Tracking new workloads, integrating cloud native capabilities, including Red hat.
Supporting our industry specific cloud solutions.
And with this quarter's performance. The Z 15 program to date has now outpaced the strong performance of the Z 14 program.
This further demonstrates the lasting value of the IBM Z platform.
With solid gross margin performance in IBM Z and power on.
Our systems segment improved gross and pretax margins year to year.
In global Technology services revenue declined, 5%, which is about a three point improvement from last quarters rate over the last few quarters, we've talked about and the impact of GTS revenue from lower client business volumes. This quarter, we saw on improved trajectory and project activity.
And client base business volumes, including in some of the industries most affected by the pandemic such as retail and consumer products. We're encouraged by this trend.
Our year to year signings performance reflects a difficult compare.
Last year GTS had strong signings growth driven by large renewals at anthem and cash a bank that said our midsized deals grew this quarter.
Enterprises continue to see the long term value for GTS to design run and manage the most modern efficient and reliable technology infrastructures.
We see this on both the renewal rates this quarter, which were consistent with history and in the new logo wins at clients, such as Generali and Pitney Bowes.
Let me now provide an update on the progress, we're making to separate kindred or manage infrastructure services business.
Like last quarter I'll quickly touch on three areas client engagements actions to optimize the business model and the execution of the necessary milestones to enable the transaction.
From a client perspective, we're continuing to work with our clients to ensure a smooth transition.
We have done extensive client outreach and over 90% have had a very positive reaction.
See the long term value and benefit for Ken drove to help them build a strong secure resilient and adaptive digital capabilities.
Regarding the business model, we have taken several actions to position the business for an improved margin profit and cash generation profile.
This quarter, we expanded GTS segment gross margin by 60 basis points with contribution from infrastructure services.
The project activity and client base business volumes have a higher margin profile as they utilize existing resources and so as these volumes recover we get operating leverage. Additionally.
Additionally, the contract and productivity actions, we have taken are just starting to contribute to gross margin improvement.
Finally in addition to establishing a name headquarters location and expanding the leadership team. We continue to make good progress on executing the necessary financial legal and regulatory milestones to enable the transaction.
We remain on track to close by the end of the year and still expect the form 10 to be available in the fall.
Now I'll bring it back up to the IBM level with a quick summary of the quarter and our view of the full year.
Our revenue trajectory improved on our first quarter, driven by cloud and cognitive software global business services and strong IBM Z performance late in the product cycle.
We continue to improve the fundamentals of our business model with operating leverage enabling a higher level of investment and we have a strong balance sheet and liquidity position.
We're off to a good start but as we said more to do over the course of 2021.
We're investing in skills ecosystem and innovation as we execute our hybrid cloud platform and AI strategy.
We've redesigned our go to market model and expect to yield benefits as we move through the year.
We're executing the structural actions initiated in the fourth quarter and are continuing through the first half of this year.
Some of this will improve the profit profile of our infrastructure services business, but more of the savings will be reinvested in ibm's remaining business.
And does that just mentioned, we'll be working to complete the separation of kindred <unk> by the end of the year.
As we look forward, we're focused on revenue growth and cash generation.
For the year, we continue to expect revenue growth at current spot rates and to deliver $11 billion to $12 billion of adjusted free cash flow.
I'll remind you adjusted free cash flow expectations exclude the $3 billion of cash impacts this year associated with both structural actions initiated in the fourth quarter and the transaction charges for the spin off.
I'll make a couple of comments on revenue and free cash flow for the next quarter.
As you've seen the U S. Dollar has strengthened over the last 90 days, which impacts us by about a point of revenue growth for the year.
Despite this the average of analysts' revenue estimates for the second quarter look reasonable.
And as I said, we're maintaining our expectations for revenue growth for the year.
We also had a strong start to free cash flow with good profit and working capital performance.
<unk> growth will continue to contribute to our cash performance, but we also expect over half of the $1 billion full year cash tax headwind I mentioned in January to hit in the second quarter.
And looking at our book tax rate in the second quarter, we expect our rate to be similar to second quarter last year or a couple of points higher.
Bringing all of this together, we expect to make incremental progress in the second quarter as we deliver on our full year expectations.
So with that let's go to Q&A I'll turn it back over to Patricia.
Thank you before we begin the Q&A with Arvind and Jim I'd like to mention 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 multipart question.
So operator, let's please open it up for questions.
Thank you.
We will begin the question and answer session of the conference can I ask a question. Please press star one and record your name clearly you need to withdraw your question Press Star Q again to ask a question. Please press star one our first question will come from Matt Cabral with Credit Suisse. Your line is open.
Yes, thank you very much.
Good to see cloud and cognitive returned to growth in the quarter. Just wondering if you could update us on what youre seeing in terms of the underlying demand environment in software and just where you are in dealing with some of the issues that weighed on the more transactional side of the business in Q4, and then software going forward just wondering how we should think about the cadence of revenue.
For the balance of the year from here.
Oh, hi, thanks for the question.
Look I think that the spend environment overall is improving Matt I think I can say that definitely compared to the fourth quarter and were talking on the fourth quarter about various pauses in buying we didn't really see that in the first quarter.
That said I do have to acknowledge that also on differences by geography and industry. When you look at the underlying results you can see the Americas was stronger debt.
Pockets in Asia that depends very much by country.
And we can all guess, which ones are doing better which ones are doing worse. It does depend upon both COVID-19 rate and the pauses that happened then beauty business circumstances, we do sense a bit of caution in Europe and you can see that in the numbers. So you can sort of expect that you can also see that there are going to be differences.
By industry those most impacted.
The obvious ones travel tourism.
And all other that then get touched by those.
So that's the color on what's happening however.
As I've indicated before we do see our clients accelerate their digital transformation.
And as they accelerate their digital transformation, our hybrid cloud thesis comes to play very strongly on a multi cloud bitches multiple public clouds as well as private come into play all the reasons that I mentioned around sovereignty and choice come into play and you can see that then in on.
I'll read out results. So then expected to be addressing your cloud and cognitive software, we expect red hat to maintain itself in the mid to high teens.
That will show through in the cloud and data platform results being strong we expect our AR applications, our AI applications to remain in the single digits of growth and we can see that we've talked about the strong demand for security.
There I do expect to see continued declines in our TPP software, but it doesn't really worry us I mean, those are things, where if I look at it two or three year CAGR, we expect to see mid to high single digit declines, but in any given period. It can be a little bit lumpy and we see that debt and so we expect this took a carry on.
On a.
Through this year.
Second quarter.
I would be somewhat optimistic, but we gotta go deliver it Matt.
Thanks, Matt can we go to the next question.
Our next question will come from Katy Huberty with Morgan Stanley You May proceed.
Thank you good afternoon, Arvind you talked about increased investments in sales resources technical skills R&D, we saw M&A pick up this quarter and all of this is meant to drive that mid single digit sustainable revenue growth that you've talked about which I believe you said that you can achieve next year can you just help us at a high.
High level bridge, how you get to the 4% to 5% revenue growth what are the primary sources of growth acceleration at the segment level, how much M&A contribution should be cant be contemplating and also in in next year's growth rate are you baking in the the revenue benefit that you'll see as some of the.
Internal revenue becomes reported as external opposed to spend thank you.
Thanks Katie.
It's pretty clear you are a good student of what we say and publish so let me try to unpack. Your question. Let me first talk about how do all these investments result in mid single digit revenue growth.
So.
If you look at it we keep saying right at at mid to high teens.
Leading to overall software in the mid single digits that will include the TPP might decline, but the overall will be mid single digit.
That could include I'll call it any business as usual acquisitions, but you know the current market value I don't see acquisitions.
Adding a significant amount of ibm's topline.
You can do the math with what we can put in.
It'll be well less than a point overall, we can just I think we can say that then if I look at our go to market.
Investments, whether that technical resources garage as our client success managers our segmentation.
That has not yet really paying off we see some early signals on the 200 clients doing the things I do expect that that can contribute a couple of points.
Maybe a bit more for next year, but you will see that inside our software and GBS number it's not a.
Additive to those we are also investing about $1 billion in our ecosystem that will contribute to improving gbs's growth rate to be on the pre pandemic rates. So that then takes me to G. B S. Well this year come back to the pre pandemic growth rates of two to four but the mixture of the.
<unk> on the go to market changes, so take them higher than that by the end of the year into next year.
Now.
You asked also about well internal revenue contribute to this can't even though revenue was a one time change. So we have talked about sustainable mid single digit revenue growth not just for one year. So while it might help next year, we're not counting on that to be a contributor because that's the only one so it's not every.
Here, so hopefully hum red hat contributing.
Together with acquisitions of software in the mid single digits GBS with all the changes we are describing perhaps better than mid single digit.
Systems, if I take a two to three year view kind of flattish, but in any given year it might increase.
Or decrease but not by a whole lot it doesn't impact the topline a lot and that's how I sort of get to the mid single digit sustainably. So you might get a one year benefit from the from internal going to external but not not permanent. So that's why I don't really count on that hopefully that gives you an answer to.
You have different parts of the question and as we complete the form 10 process, which we're well on our way right now Katie I would tell you one as you know quite well we will be transparent about the strategic commercial relationship we have between IBM and Ken drill going forward and we will.
Disclose what those relationships are and how we will treat that revenue, but more work to be done and we will come back to you at the appropriate time.
Thanks, Katy Sheila can we please go to the next question.
Absolutely next we will hear from Tony <unk> with <unk>.
Bernstein Your line is open.
Yes. Thank you for taking my question.
I guess, just as a clarification or maybe two clarifications.
I'm wondering if you can just comment I think you said that you think consensus revenue estimates for Q2 are reasonable.
There are up about 500 million sequentially from Q1.
If I look back at normal seasonality typically revenue was up about $1 billion and it sounds like it spend is improving so if anything one would expect better than normal seasonality.
So I'm wondering whether your.
Being conservative or there were some one time.
Things that happened in Q1, but why wouldn't you underwrite normal or better than normal seasonality, which I have is about a $1 billion sequential increase in revenues.
And then separately Arvind could you just clarify when you talk about.
I B M as a.
AI come.
Company.
What role does Watson play on that I don't think that name was really mentioned on the call. There's speculation about Watson health, maybe you can give us an update on how Watson fits into IBM S. An AI company and specifically.
What's happening with Watson health and Watson financial Thank you.
Okay. Tony Thank you for your question and I'll handle the first part provide some clarity around our forward looking guidance and then turn it over to urban for your second part of the question, but as we said in prepared remarks.
Similar to 90 days ago in fact, we're even more confident in the position that we put in place with regards to our two most important measures one revenue growth and second adjusted free cash flow, which is going to provide the fuel for the investments needed for us to capture that hybrid cloud one trillion dollars.
Tam.
Now, we reiterated that we're gonna grow revenue overall for the year.
And that is despite currency volatility again with the U S. Dollar appreciating 90 days ago, and we lost about a point of revenue for the year and we lost about a point of revenue in the second quarter. So now go on to your math with regards to our historical quarter to quarter.
Very close I mean, the math I got my head is somewhere around $900 million 950 give or take quarter to quarter, we see normal historical Ah.
Attainment across <unk> in both our software base of business as Arvind said, we're feeling even more confident given the rebound here in the first quarter and also in both of our services based businesses, we see normal historical attainment to that roughly nine to 950.
Now given our first quarter performance of driving a very strong mainframe cycle growing 49% in the first quarter in the seventh quarter of the program, which is unheard of coming off a 60% growth last year.
Arvind and I, both believe it's very prudent for us as we go forward with our guidance to not count on continued acceleration of our mainframe. We're very pleased with the performance. We're pleased with the value proposition, but I would say against that 900 to 950 I would.
A couple of hundred million dollars off of that number just based on first quarters. So very strong performance on mainframe and that not concluding going forward. So let me turn it over to Arvind for the second part.
<unk>.
So Tony.
Watson remains critically important to us.
To be absolutely clear Watson is the brand product name for our AI capabilities Youll see it in the market as Watson conversational agent, but you'll also see it as for example.
Our security products with Watson is embedded inside a cloud Pak for data and called out as Watson.
Let me give you a quick example of where we are seeing a huge amount of success. So let me take one of the large entities doing vaccine administration in the United States. When they were when they realized in December they could do this suddenly began to realize that they could get tens of millions of calls every quarter.
Uh huh.
And then how other handle them.
Staff up tens of thousands of people all perhaps deploy Watson.
And so far at one of these places and we have deployed on a lot more than one 5 million calls handled on the quarter with over 70% handled by Watson.
Do you not think about extrapolating this over the year, so that would make it $20 million in four quarters and with the confidence building up on one program you could imagine it going to others.
This is a lot more straightforward to do and where I think <unk> excels in handling issues in both improving client satisfaction, because you've got an instantaneous answer but also on taking cost out and those are rare in our industry, where you get both together, we see lots and lots of opportunities.
Here, we also see a lot of Watson being embedded on how to automate data cleansing on how to do AI operations on dramatically.
A dramatically improving the resilience of peoples infrastructure, so turning to net about Watson remains really important.
He is in the early part of his journey I'm not US consultants have estimated 16 clearly on a global productivity over the decade, maybe 5% of our way into that journey Watson will be the tool that unlocks that for our clients, albeit in areas like IP and data.
And conversation and call handling and in all of these areas, where we excel and we have a large footprint with our clients.
Thank you Tony can we please take the next question.
Our next question comes from Bonnie.
<unk> with Bank of America. Your line is open.
Yes. Thank you Arvind you said the go to market changes have not yet had an impact.
Should we expect to see some benefit in the second half of 2021, and if you could maybe address what the cadence of.
The benefit would be across the business segments, where it would play out first and later that'd be helpful. And then separately maybe you can just.
Help us think through what's going on with bookings and backlog on the signings numbers were quite weak relative to the confidence you're expressing on consulting world is there a pause given the upcoming spend on maybe maybe if you could just dig down into that a little bit that would be great. Thank you.
Thanks, Amit look go to market changes on them. They always have I'll call. It a bit of a hit as terraces. They take time to take impact we rolled them out in the beginning of January but then you have to this is a human thought to this you have to assign people to account there is some level off.
There's some level of changes and all of that just takes months to flow through I wish I could do it quicker, but but I got to acknowledge it takes months. That's why you hear me say it will take time for us to see the benefit.
Will we see the benefit we would expect to see.
Proved productivity for our sales teams that cover a large account that will result in better software growth and in better GBS growth.
I do expect to see that in the second half I expect to see even more of it going into 2022.
We are also investing in our what we're calling our ecosystem to be clear that is investments, whether it's in schlumberger or Siemens a balance here just to name some from this last quarter.
Quarter, but before that relationships, we had with box and slack and Adobe and Salesforce and SAP.
You you expect to see all of those play out in the improved growth both in software and in GBS. So you kind of sort of unpack those and you see that now when I talk about why would I see more productivity and on top accounts, while the 200 garage.
Engagements that I mentioned, you expect that all of those will build pipeline oftentimes, we might that would've had in the past. So that is why you begin to see improve yield in the top accounts. So I expect to see some definite you'll see it in our in on numbers in the second half and then more going into next year.
For the second part of the question I'll hand, it to Jim to talk a little bit about sidings.
Thanks for the question, let me let.
Let me unpack some of this for you.
First of all printed numbers signings down 27% to your point entirely driven by our large deal renewal comparison, the last first quarter in GTS. If you remember we signed two massive deals last year with anthem in case show well in excess of $1 billion a piece.
And each other.
But I think this goes to the Testament that I've talked about many times on this call and that is all signings are not created equal the duration the mix the offering the content all impact how signings translate into backlog and how backlog then translates.
Into revenue realization overall, so let's talk a little bit about the GTS portfolio, because that's where it really centers around here in the quarter. When you look at GTS I think theres a couple of different dynamics, playing out first we yes greater than $100 million deals, we were down substantially compared to last year just off on.
That very tough compare on I'll remind you we grew GTS signings north of 40% last year.
Second, though is our midsize deals readout kind of $10 million to $100 million, we were up high teens and embedded in that we also had another nice quarter on new logos, which means we are out there winning new business.
Capturing new clients value.
Even in light of the announced separation with Kindle the second component of that the heart of your question. I think is are we losing business or is business getting paused I would think one with the new logo wins and second we have consistent high renewal rates in this business. This business is very.
Sticky from a managed infrastructure services perspective, and we have high 90, plus percent renewal rates and we have not seen that change since the announcement now with that said are there pipeline that has built up that naturally some clients are pausing.
Wait to see what our form 10 is yeah, I and I don't think we expected anything different overall, but when you take all that together our backlog position overall in GTS and our backlog run out we actually see continued sequential improvement nice improvement on.
For fourth quarter, three points, better and we see that continuing on.
Modestly here from <unk> to <unk>, and that's a reflection of those new logos that are going to start ramping up and that's a reflection of our midsized deals which by the way it's changed the duration in that part of the portfolio by one month overall, which is impacting the revenue realization. So.
We still feel very very good and very comfortable we've got a very good pipeline in front of us and we see better revenue realization.
Thanks, Malmsey, let's go to the next question. Please.
Next you will hear from Amit.
With Evercore.
Good afternoon, Thanks for taking my question.
I was hoping if you could touch a little bit more on the GBS performance and we saw a nice improvement I think from what we saw on December quarter. It was still down but you know.
A nice four basis points improvement Nonetheless, and consulting I think it was notable that we started to see growth over there. So I was hoping you could just help us understand.
You'd think about consulting growth as a leading indicator to what GBS can do.
And would we expect this to be positive growth for GBS in calendar 'twenty one.
And then it depends on also have you clarify this for me as you go through the process of splitting up these long term contracts between IBM and newco.
Why would customers agreed to do this without repeating the contract or getting a price concession from either IBM on new Coke.
Okay. Amit this is Jim let me take your question and I. Appreciate the point, we are pretty pleased with the trajectory improvement overall with regards to our GBS business, we improved by four points quarter to quarter, and we talked about 90 days ago as we went through the pandemic and Arvind.
Here on the call Tonight, what we have seen is our clients' acceleration in their digital transformations in their journey to cloud and we expected to capitalize on that as we move forward. So if you take a step back and just look at our first quarter performance and then I'll translate that into what we see what our GBS.
Business going forward, our first quarter performance really reflects.
And the confidence in the value of our portfolio, our cloud book of business in GBS doubled its growth rate to 28% here on the first quarter. We have over a 6 billion dollar book of business in cloud in GBS alone leveraging our strength in application modernization.
Nation, and our cloud transformational services built on top of our Red hat hybrid cloud platform, our Red hat engagements. We increased 150 day, let alone just in the first quarter overall and our cloud book of business is up double digits across all three subset.
Now to your point about consulting very pleased of that leading indicator, we returned back to growth and we've been talking about the last handful of quarters, how the whole journey of the cloud with our value proposition about advise move build and manage that the front end of that.
<unk> as clients go through around application modernization really shows up on our consulting base of business and then translates into our application management business overall, and our global processing services business overall, which we saw very nice growth as clients are re imagining.
How they run their companies and we're capitalizing on what we call intelligent workflows. So we definitely believe that consulting is a leading indicator now going forward. We are very confident in getting back in second quarter, two our pre pandemic levels of growth by the way our backlog run out in the next.
90 days already shows that but let me give you a little bit of some quantitative components behind why we're so confident number one our book to bill over the last 12 months is well north of one led by consulting to your point, which we believe is the front end of that curve that will lend itself into GPS and it's a M S.
Second we continue to have very good momentum in small and mid size deals that you know has immediate revenue realization in the near term, which is led third so our overall backlog level of growth strong growth in GBS consulting in GP.
An improving trend in our Ams business going forward and then fourth we talked about upfront we closed on five acquisitions here in the last handful of months, we are very focused on ramping scaling and in driving that business. So we feel comfortable.
Getting back to pre pandemic growth here in second quarter, we feel very confident in the full year GBS delivering growth and most importantly is that exit velocity in 2021 heading into 2022 GBS is an integral part of that mid single digit growth objective that arvind.
Talked about.
Thanks, Amit let's go to the next question. Please.
Our next question comes from Tien Tsin Huang with Jpmorgan. Your line is open.
Okay. Thank you. So I think that just maybe a stupid question clarification, just the strength in system Z at this point in the cycle. What can you maybe go through that a little again whats.
Whats changed whats different is it different.
Our selling motion just.
Trying to understand that a little bit better and then just on the ecosystem strategy Arvind opening new areas of growth is there.
Our pipeline for more deals like a balance here and others I'm, just curious where worthy effort is there today and how close you are to to to adding more partners there or if that's more of a midterm expectation for us to manage or watch for.
Okay. Thanks, Tien Tsin, I'll I'll handle the IBM Z discussion and then turn it over to Arvind for the ecosystem. We're very pleased seven quarters in two ways Z cycle growing 49% on a 60 plus percent growth here in the first quarter.
Of last year, a very strong comparison overall and really kind of breaks the cycle from what we've typically seen but we saw growth. When you look at it one are we capitalizing on the overall encouraging trend from a macroeconomic perspective, yes. We're also capitalizing on robust trading based volumes on.
On our traditional FSS space industry, so capacity needs are driving some parts of our industry.
<unk>, but I'll tell you. We're also seeing you know changing regulatory requirements clients needing backup and recovery is various central right. Now we saw that play out in the first quarter and then beyond the FSS industry, we start seeing some good adoption and we talked about this.
As in prior calls, where we see elongated cycles, just given some industries are more impacted by the pandemic, but we see now our value proposition of cloud native applications, where we have red hat enterprise Linux Red had open shift that runs on our mainframe platform and also pervasive incur.
<unk> security is at the top of every CIO and CTO priority list and the mainframe by definition is the most secure most scalable most reliable platform out there and I think you're seeing all of that play out yeah.
Yeah on the second part of your question Tien Tsin.
On ecosystem, yes, we have a long pipeline I expect this number to go into the high teens maybe.
Maybe not on Android, but definitely into into very many more.
But let me caution, though when you say mid term, it's not multiple years. Each of these takes about six months to become real and then another few months to become into real revenue. So I would not expect that new ones. We announced now will have an impact much before the end of the year. However, they will have a big impact.
At the very end of this year on into next year. So I was sort of a pause position it like that but expect that we should be announcing these at a regular cadence.
Thanks, Tien Tsin, let's go to the next question.
Our next question comes from David Grossman with Stifel. Your line is open.
Thank you very much.
So you've made some high level, but very consistent comments about sustaining the dividend as we approach the spin and I think most of us on the call understand the reasons for that.
That said in the past there have been some criticism that the company has prioritized on returns to shareholders at the expense of growth and I know you've talked a lot about reinvestment net cost savings along with several other actions. However.
You know in software cloud and services, you're going up against some pretty big companies that really don't return capital at your rates. So how do you want us to reconcile that dynamic as you look to reaccelerate and sustained growth in 2022 and beyond.
So David this is Jim. Thank you for your question, let me I'm.
I'm not going to talk to other competitors, but I would go check some of those about how much share buybacks that theyre all doing overall, but with that said you know.
I'm only going to talk about IBM, and we feel very confident in our capital allocation process and our disciplined financial management system. Overall, let me remind you 90 days ago. How we entered the year. We entered the year I think I talked about the sources and uses of our cash we think.
Entering the year, we had 14 over $14 billion of cash on the balance sheet. We said, we were going to generate adjusted free cash flow of 11% to $12 billion in the year.
And that we were going to continue to optimize our IGF portfolio on set of offerings to be a captive aligned to our hybrid cloud and AI strategy and that would give us another three to 5 billion. So we had from a source perspective about $30 billion overall.
When you take that against the uses in the year, we talked about a $3 billion charge for the structural actions in 2021.
And our onetime charges for the separation that goes against that 30 billion, we talked about $8 billion of debt maturities against that and we talked about our dividend being 6 billion overall, so that you know.
Comes up to be about what 16 $17 billion. So we think from a cash source and use perspective that we've got flexibility to continue to invest and compete in the market both organically and inorganically.
While delevering to support a very strong balance sheet overall with a single a rating and also deliver given our investor base deliver a secure and modestly growing dividend overall and what you've seen in the first quarter I think only strengthens that position we still ended the quarter.
With over $11 billion of cash on the balance sheet and I'll remind you that we took into account.
$5 billion of debt maturity.
On a half a dividend in the quarter roughly $600 million on the one time charges and another billion plus on acquisitions and still ended with $11 billion. Overall, so we feel very confident and we will capitalize whether theres any inorganic opportunities and you're seeing what 11 acquisitions.
<unk> since Arvind has taken over and we will continue to capitalize where it makes the right client value and the right IBM value at the right economic equation going forward, but we're not constrained by sources and uses of cash.
Thanks, David Sheila we're past the top of the hour, but why don't we take one more question.
Thank you.
Last question will come from Keith Bachman with Bank of Montreal. Your line is open.
Oh, thanks, so much for fitting me in Patricia Krishna.
Jim.
On that follow up on that question, if you could talk a little bit about.
The drivers of the change in underlying cash flow for this year what are the key metrics on how should that how should that make us think about.
Your ability to generate cash in the next fiscal year, obviously I'm eliminating.
The charges associated with the separation.
If you could just talk about that and then Arvind since I'm last I wanted to sneak on one more you've talked repeatedly about GBS growing in mid single digits, probably just talk about you know pick a number like 1% if you could just clarify.
How much is on M&A within that kind of number one in particular, when you talk about the application maintenance.
Are you assuming that application maintenance growth within GBS because it's it's.
I think it's pretty clear that the industry is struggling for growth.
If you're assuming that application maintenance can grow within the envelope of GBS I'd like to understand why when I when I think the industry places challenges. Many thanks for taking my questions.
Thanks Keith.
For the question overall, so let me handle the free cash flow in an urban can talk about GBS.
As we said 90 days ago, which we reiterated here Tonight on the call. We feel confident in the forward looking guidance of $11 billion to $12 billion of adjusted free cash flow on 'twenty, one and if you remember 90 days ago day.
Give the investor a perspective on the sustainability just given the the $3 billion worth of charges. We will have from the structural actions in the fourth quarter and the upcoming spin separation charges. We gave a perspective on 2022 that that would accelerate to 12 to 30.
$14 billion of adjusted free cash flow when you look at the underpinnings of both 'twenty. One and then 2022 I think you start seeing the fundamentals of our business model and that is returning back to revenue growth.
The operating leverage that this business can generate with some level of sustainable level of revenue growth the underlying mix contribution of that and the continued productivity that this business drives.
You will see profit growth and also I remind you red hat, which we achieved free cash flow accretive in the first year. We will continue to drive improvements now we've been making great progress on working capital efficiency and I would tell you our collections rate, we didn't talk about it although.
On the prepared remarks, I talked about our record deferred income given the strength of our software renewal position overall all of those will continue to generate improvements going forward, but that is going to be needed in 2021, because we got about $1 billion cash tax headwind with all.
That in front of us with I would say, probably 60% to 70% will hit in the second quarter. So once we get through that cash tax headwind here, we feel pretty comfortable and confident in that cash generation machine leveraging sustainable revenue growth and operating leverage in the business.
On our way to 12 to 13 billion next year.
Thanks, and keep you all spot on my favorite questions. How does GB is going to grow on how much will it grow. So when you look at the mid single digits, that's actually on near term forecast.
Our goal certainly ought to make it grow even above that if you look at the M&A component look I mean, M&A could contribute at most a couple of points to that growth. It's just would be that would be sort of.
The upper bound and we wouldn't necessarily see all of that even this year, but but who knows it because it's hard to predict how much those properties can grow at ones that are inside Ivy.
As well, but you shouldn't expect more than that but that's part of our box to make GBS growth faster even than the mid single digits.
Sales of Ams English is really important for a number of reasons.
It all depends on how you define it if you define it as this is application management and maintenance of those applications that were in place five years ago by definition that'll shrink because everybody expects massive productivity and they don't expect those to grow and you kind of see that in the numbers.
Why is that incumbency irrelevant as you have knowledge of that application based on you know help declined on their cloud transformation journey than what was that.
Older application estate now becomes a brand new application estate and yogurt growth, because you're helping them transform it using AI using workflows using cloud and so that contributes to growth whether that shows up in consulting near term and then Ams longterm, whether that shows up as global processes.
Business services in the medium term, that's the kind of mix that goes on but that is why EMS is critical to giving UBS. It's got a fuel in order to growth, but that is why we are confident in the mid to single mid.
Mid to high single digit growth in the longer term for GBS.
So so Keith banks, but since we are well past the hour. Let me just make a couple of comments to wrap up the call.
We had a good start to the year.
We expect to continue on our progress over the course of the year as we execute our strategy and realize benefits from the investments and actions we are taking.
We will exit 2021 in a stronger position than we started the year and I look forward to continuing the dialogue with you.
Thanks, Arvind Sheila let me turn it back to you to close out on the call.
Thank you. Thank you for participating on today's call. The conference has now ended you may disconnect at this time.