International Business Machines Corporation (IBM) Second Quarter Earnings Conference Call 2018 Transcript – The Motley Fool

International Business Machines Corporation (NYSE: IBM)
Q2 2018 Call
July 18, 2018, 5:00 PM ET

Table of Contents:

• Written Comments
• Questions and Answers
• Telephone Participants

Prepared Notes:

Operator

Welcome, and thank you for your support. At this time, all participants are listening only. Today 's conference is being recorded. If you have any objections, you can disconnect for the moment. I will now give the floor to Patricia Murphy with IBM. Madam, you can start

Patricia Murphy – Vice President of Investor Relations

Thank you. This is Patricia Murphy, vice president of investor relations at IBM, and I would like to welcome you to our presentation of the second quarter results. I am joined today by Jim Kavanaugh, Senior Vice President and Chief Financial Officer of IBM

. Our remarks will be available in a few hours, and a replay of the webcast will be posted tomorrow.

I would also remind you that some of the comments made in this presentation may be considered forward-looking statements under the Private Securities Litigation Reform Act, 1995. These statements involve a number of factors that could materially affect actual results. Additional information regarding these factors is contained in the Company's filings with the SEC. Copies are available from the SEC, on the IBM website or from us in Investor Relations.

Our presentation also includes certain non-GAAP financial measures with the purpose of providing additional information to investors. All non-GAAP measures have been reconciled against their related GAAP measures in accordance with SEC rules. You will find reconciliation tables at the end of the presentation and in Form 8-K submitted to the SEC

So, with that, I will give the floor to Jim.

James J. Kavanaugh – Senior Vice President and Chief Financial Officer

Thank you Patricia, and thank you all for being with us.

In the second quarter, we delivered $ 20 billion in revenue, $ 3.4 billion in income tax, and $ 3.08 in operating earnings per share. Overall, it was a good quarter. We increased our revenue, gross operating margin, pre-tax profit and earnings per share, with a strong pre-tax performance. Our turnover grew by 4% in published data, with growth in the four main segments, and the growth of our constant currency business turnover was 2%. It's our best constant currency growth in 7 years. Our pre-tax profit increased by 11%, reflecting good operating leverage on net business growth.

If we consider our performance at constant exchange rate, the trajectory of income improves in both service segments. This is important for our overall revenue growth profile as services account for approximately 60% of our revenue on an annual basis.

In Cognitive, we performed well in analytics and in our industry sectors focused on financial services and IoT. Growth has been dampened by the same three areas I mentioned in our last call, as we continue to focus on repositioning these offers. In addition, we achieved strong performance and gained share in our Systems business, which grew more than 20% with the growth of the three hardware platforms.

In all our segments, we continued our momentum. Over the past twelve months, our strategic imperatives revenue has reached $ 39 billion, which represents 48% of IBM 's business revenue. And in this context, the cloud is now $ 18.5 billion.

Our strategic imperatives business rose 15% in the quarter to 13% at constant currency. This quarter's revenue performance was led by Security and Cloud. Security is up about 80% this quarter, driven by strong demand for widespread encryption from IBM Z and the growth of our integrated software and services business.

Cloud business revenue grew 20% or 18% at constant currency. offers as a service. We are leaving the second quarter with an annual run rate of more than $ 11 billion, which represents an increase of about 25%. This reflects our success in helping enterprise customers move to the cloud and we are becoming the destination of critical workloads in hybrid environments. We capture this high value growth through our unique differentiation of innovative technology coupled with in-depth industry expertise, supported by trust and security across our integrated model.

You have seen this quarter in a long-term partnership with Australia. Government valued at approximately $ 740 million to automate and digitize government services, leveraging IBM's cloud computing systems, software and solutions. We have extended our work to Crédit Mutuel, which uses IBM Cloud, security, IBM Z and Watson to drive its next wave of transformation across its businesses. We delivered the world's most powerful supercomputer to the US Department of Energy. We have won competitive contracts in leading companies like ExxonMobil, Amtrak and Telefónica de España

We have signed an agreement with Anthem, in which we will help them transform their digitization to offer an improved digital experience to millions of consumers. In total, we signed 13 service agreements worth more than $ 100 million this quarter. These are just a few of the new client assignments that will materialize over the coming quarters and years, and if we combine this with our first-half performance, we continue to expect operating earnings per share of 39, at least $ 13.80 for the year. 19659015] Before entering the detailed financial parameters, I want to give an overview of the growth drivers of our operating earnings per share for the quarter. What this shows is that we recorded a growth of 5%, despite a strong wind of fiscal backlash. So, let me break down.

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

Gross margin decreased by 60 basis points from year to year. About half was due to the combination and half of the ongoing investments we made to build our IBM Cloud. Productivity has been relatively neutral compared to the dynamics of gross margins from one fiscal year to the next and, as we discussed last quarter, benefit from the measures we took earlier in the year will increase in the second half. The remaining third of pre-tax earnings growth is attributable to the efficiencies we achieved in our expense structure. And then, as I said, taxation has been a headwind, mainly thanks to a low tax benefit last year.

Finally, a lower number of stocks contributed to the growth. In summary, we grew 5%, with a good contribution from revenues, an increase in pre-tax margins and, to a lesser extent, share buybacks.

Given our main financial indicators, revenues are up 4%. The currency contributed 2 points, about half of the rate-based contribution at the time of our first quarter earnings call. And I will remind you that the significant volatility of the currencies has repercussions on the profit and loss account, and not only on the income.

Constant currency revenues increased by 2%, which is essentially entirely organic. I will talk about constant foreign exchange earnings in the future. Our revenue growth has been widespread across geographies and sectors. We have experienced growth in more than 60 countries, accounting for more than 80% of IBM 's business figure. Growth in the EMEA region accelerated to $ 4, led by Germany, the United Kingdom, France and Spain, with widespread growth of 11%. was operating costs, which was better than 2%. This includes a 2-point impact on the currency, which is significantly lower than the impact of the first quarter due to the stronger dollar. While we continue to invest to build our pipeline of innovation in areas such as AI, security and block chain, we also realize acquisition synergies and improve the business. operational efficiency by streamlining our management system. , Agile scaling and implementation of new working methods. I've talked about some of them in our webcast in March, and we see the benefit not only in improving speed and responsiveness, but also in a more structure. effective.

In expenditures, we also absorbed a lower level. Revenues decreased by $ 115 million from one year to the next during the quarter and by about $ 240 million in the first quarter. semester. Our operating tax rate of 16% increased by almost 7 points, with just over one point compared to the underlying rate and the balance of the separate tax benefits of $ 170 million from last year.

free cash flow during the quarter and $ 3.2 billion in the first half, down $ 400 million from one year to the next. Our strong working capital performance was more than offset by headwinds related to cash taxes and growth in capital expenditures, consistent with what we discussed earlier in the year. year. Do not forget that there is a lot of seasonality in our cash generation, and over the past 12 months, we generated $ 12.6 billion, or 111% of GAAP net income.

Let's move on to our segments. Cognitive Solutions achieved a turnover of $ 4.6 billion, down 1% at constant currency. We continued to grow our revenue as a service, leaving the quarter with an annualized rate of $ 2 billion. Within the Solution software, we are scaling up new platforms and solutions, with growth in several key areas.

The growth of our underlying analytics platform has been driven by the DB2 portfolio, our data science offerings and our new IBM Cloud Private for Data offering, which prepares data for AI across all the clouds. ] In our Watson platform, the AI ​​platform for businesses, growth reflects strong demand for our new offering of virtual assistants with a three-figure growth in our use of Conversation Services . Customers using Watson Assistant include Bradesco, Orange Bank, Autodesk, Royal Bank of Scotland, Vodafone and LivePerson, to name a few. Watson is both an independent platform and an engine of growth and differentiation in many of our business sectors.

Our business segments continue to evolve, including IoT and Watson for Financial Services. The growth of IoT was driven by Maximo, which is Asset Management Solution # 1, and Tririga, the # 1 Facilities Management Solution. Financial Services reflect the strong performance of our business portfolio Risks and Regulations and Financial Crimes, leveraging our leadership skills and AI technologies. In Watson Health, we performed well in areas such as Pay and Life Sciences. And in emerging areas such as blockchain, we have now sown the market with more than 60 active blockchain networks.

This quarter we launched We.trade with 9 major banks, including Deutsche Bank, HSBC, KBC and Natixis. This is the first blockchain-based online banking platform. Growth in these areas is offset by a transition in some areas that I talked about in April, particularly Talent, Collaboration and Commerce, which are now a combination of bids to the request and SaaS. We are modernizing our offerings and making investments to cope with the age-old changes in the marketplace. Keep in mind that the time to value these investments is longer in SaaS.

Our transaction processing software has dropped by 2%, driven by decreases in storage software. At TPS, we had growth in IBM Z middleware and Power middleware. Looking at earnings this quarter, we increased pre-tax earnings by 9% and increased pre-tax margins by more than 2 points year-over-year, thanks to operational efficiencies and synergies. Acquisition, while continuing to invest in key strategic areas such as AI, Security and blockchain.

Before entering Global Business Services, let me give you an overview of our global services business, across both segments. We continue to make good progress. Our service signatures grew, the order book progression from one year to the next improved from the previous quarter, revenue from services returned to growth and we recorded a slight improvement in the trajectory of service gross margins. 6%, and in this context, we had 13 transactions of over $ 100 million. We are clearly winning in a competitive environment. We address fundamental changes in the industry, such as helping customers implement hybrid cloud and managed security services. This results in a change in the content of our backlog, with nearly 30% of our outsourcing backlog now in Cloud. And then looking at the gross margin of services, it was down just 25 basis points from year to year. I will remind you once again that we have most of the benefits of the productivity actions of the first quarter that are still waiting for us.

Let's move on to the two segments. Global Business Services returned to modest revenue growth, an increase in gross margin and an increase in gross margin. We are improving the trajectory of revenue from the liquidation of our opening order book for the year. Our Strategic Impacts business revenue grew 6% with strong performance in the offerings as a service, up 25%.

We explained how we realigned our practice model around three growth platforms. and cognitive processes. As everything progresses, we have a particular strength in the digital world, which has again experienced strong double-digit growth. This was carried by Digital Business Strategy and our mobile offers.

On all of these platforms, growth in Consulting business revenue accelerated to 4% year-on-year, driven by our Digital and Cloud offerings. Our consulting firm GBS combines business expertise with technological expertise to create value for our clients. For example, IBM Digital and Mediaocean have launched this quarter a blockchain consortium comprised of major advertisers and publishers, including Kellogg, Unilever, Kimberly Clark and Pfizer, to establish the new industry standard for the ecosystem of buying & selling. Digital announcements.

"continues to invest, announcing recently the acquisition of Oniqua Holdings, which adds technology and professional expertise in asset optimization. This reinforces our integrated IoT platform between Cognitive Solutions and GBS.

Application Management Services revenue decreased by 3%, reflecting continued declines in managed services from traditional enterprise applications. We are moving into strategic offerings such as Cloud Migration Factory and Cloud Application Development. The increase in demand in these areas has led to two consecutive quarters of growth in double-digit signatures in application management.

In terms of gross margin, GBS gross margin increased 130 basis points year-over-year. We have worked hard to transform our portfolio and reposition our offerings to get a better price for value, and we are also starting to see first contributions from our productivity actions around work patterns and structure.

We began to see the realization of our initiatives in our results.

In the technology services and cloud platforms business, revenue has returned to growth. Similar to GBS, this performance was primarily driven by our improved run dynamics of the opening backlog. The business segment strategic imperatives increased by 24%. This was led by Cloud, which grew by 27% and our in-service business grew by 30%, representing a sequential increase of 6 points and an annualized rate of $ 7.6 billion.

1% this quarter, as we continue to help customers in their journey to the cloud. IBM Cloud allows customers to migrate, modernize and create new cloud applications, is ready for artificial intelligence and secure at the heart of their business. This quarter, we completed the migration of Westpac's leading banking applications to IBM Cloud. This is just an example of how we are becoming the preferred destination for critical cloud workloads.

We continue to develop capabilities, recently announcing an 18-zone availability extension for IBM Cloud around the world. . The larger global footprint is important because customers are looking to maintain control over their data when implementing hybrids, especially given the increase in data regulation.

In technical support services, revenues are down 4%. As is always the case with a Z-launch, we are seeing a short-term impact on our maintenance flow as IBM Z sales move customers from maintenance to warranty for the first time. year. The impact on maintenance is becoming more pronounced now, with higher adoption rates by existing customers in the current strong Z cycle. This impact was moderated by continued growth in our multi-vendor support offer

Integration Software grew 1%. We had good performance in the offerings that modernize the applications and allow the adoption of the cloud. This includes offers such as IBM Cloud Private, which helps customers develop native cloud applications behind their firewalls. We added 100 new customers in the second quarter and now have more than 300 customers since the announcement of the product at the end of last year.

In terms of gross margin, the industry's margin decreased by one point compared to last year. Most of this decline is attributable to the combination of higher margin TSS revenues during the quarter, with the remainder attributable to the continued expansion of our cloud. We had some productivity advantages, but as I said earlier, the actions we took in the first quarter will be focused primarily on the second half of the year

. which address the most contemporary workloads of today. All three brands, IBM Z, Power and Storage, grew and we gained market share. In the second quarter, IBM Z recorded a 112% growth in revenue compared to the same period of the year thanks to growth of nearly 200% in MIPs, once again driven by new workload MIPs. The adoption of Z14 remained broad and, after four quarters, continues to follow the previous program. The added value benefits existing IBM Z customers who are developing and expanding workloads on Z14 this quarter, whether it is ecommerce sales, mobile banking volumes, the number of people in the business, the number of people in the business, and the number of employees. machine learning or emerging blockchain services. And we add new customers from all over the globe, from a managed care provider in the United States, to a university in Canada, to an electronics distributor in Italy, to a bank in Africa. We also welcomed our new Z14 Single-Frame designed specifically for cloud environments, launched earlier in the quarter.

Power business revenue grew 4% thanks to the adoption of our new POWER9 entry portfolio and the continued growth of Linux. . These cloud-ready systems provide leadership capabilities in advanced analytics, cloud environments, and data-intensive workloads in the AI, HANA, and UNIX markets. We continued to deploy our supercomputers in the US Department of Energy's labs. As part of our deployment, the US government recently unveiled Summit9, the world's most powerful supercomputer, ranked # 1 in the TOP 500 list of commercially available computers. This is the first time in 5 years that an American company has topped the list

Storage hardware has returned to growth this quarter, after facing some challenges of execution sales in a competitive market in the last quarter. This growth has been generalized geographically and driven by strong growth in All Flash Arrays. Flash experienced double-digit growth in the portfolio and took part. We are offering new offerings, including a new mid-range FlashSystem announced last week, featuring industry-leading technology.

The pre – tax profits of the systems increased by about $ 275 million from one year to the next. Turning to cash flow and the balance sheet, in the second quarter we generated $ 2.9 billion in cash from operations, excluding our financing receivables, and $ 1.9 billion in cash flow. cash available. Thus, in the first half, we generated free cash flow of $ 3.2 billion, down $ 400 million from last year. This reflects a strong working capital performance, offset by a $ 300 million increase in investment expenses as we build cloud data centers around the world and pay cash taxes of 700 millions of dollars more. We now have all the headwinds we expect for the year.

Regarding the use of money for half, we returned $ 4.6 billion to our shareholders. In April, we increased our dividend again, and we have now tripled our dividend per share over the past decade. In the first half, we repurchased nearly 12 million shares, ending the month of June with 913 million shares outstanding and $ 2 billion remaining in our redemption authority

. June. About two-thirds of our debt supports our financing activities, with leverage of 9 to 1, and the majority of our financing receivables, 54%, are of superior quality, 2 points better than last year. As a result, our balance sheet remains strong with plenty of flexibility to support our investments and long-term shareholder returns.

In summary, our performance this quarter highlights the extent to which we have repositioned our business in recent years. As I said, almost half of our revenue is in line with strategic imperatives, which represent the emerging, high value, high growth segments of our industry. This also reflects a major portfolio change for IBM, led, as we discussed during the investor webcast in March, by major changes in our investment and investment strategy. The IT industry, driven by Cloud, Data and AI. It is an innovative technology in emerging key areas, the expertise needed to apply this technology to industry-specific processes and workflows, and to bring it up to date. Commitment to manage their company's data responsibly. That's the differentiation of IBM, and it shows in our business and profits.

This quarter, we recorded 2% revenue growth in constant currencies, 11% pre-tax growth and 5% growth. We also recorded capital growth, closing first semester where we also increased our revenue, our operating profit and our earnings per share.

As always, we have headwinds and headwinds in the second half of the year. We continue to focus on conducting a consistent operational execution, we continue to expect to generate at least $ 13.80 of operating earnings per share and free cash flow from operations. order of $ 12 billion

.

Patricia Murphy – Vice President of Investor Relations

Thank you, Jim. Before starting the question period, I would like to mention a few points. First, we have additional tables at the end of the slide that provide additional information on the quarter. And secondly, as always, I would ask you not to ask questions of several parties

So, operator, let's open it for questions.

Questions and Answers:

Operator

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

Wamsi Mohan – Bank of America Merrill Lynch – Analyst

Yes, thank you. Jim, you've seen a steady deceleration of currency in cognitive earnings, but ITP margins have improved. Vous avez fait allusion à quelques facteurs. Je me demandais si vous pouviez donner plus de détails sur les facteurs d'accroissement des marges PTI entre les efficacités opérationnelles, les synergies d'acquisition que vous avez mentionnées [inaudible] et, deuxièmement, votre diminution de base a été assez importante au cours du trimestre. Pouvez-vous nous parler de la trajectoire de la deuxième moitié, surtout compte tenu de certaines des mesures de coûts dont vous avez dit qu'elles n'ont pas encore été prises en compte? Les actions de coût que vous avez prises dans 1Q qui doivent encore être reflétés dans la moitié arrière. Merci

James J. Kavanaugh – Premier vice-président et chef de la direction financière

Bien sûr, Wamsi. Merci beaucoup pour la question. Permettez-moi d'aborder d'abord le segment des solutions cognitives et de parler de la monnaie constante, puis d'en arriver à l'élément de levier d'exploitation. Ensuite, je vais aborder votre question de dépenses suivante. Cognitive Solutions, tout d'abord, comme vous le savez tous, notre modèle financier pour le segment des solutions cognitives est de générer de la croissance et de fournir un levier opérationnel compatible avec cette croissance. Ce que nous avons constaté au cours des deux derniers trimestres, alors que nous tirions les synergies d'intégration des acquisitions dans l'ensemble de nos activités, nous avons constaté que ce levier d'exploitation était bien en avance par rapport à la croissance de nos revenus réels dans ce secteur. Nous avons également stimulé l'efficacité opérationnelle et les synergies pour redéfinir notre façon de travailler, redéfinir l'optimisation du développement, appliquer les méthodologies Agile et améliorer la vitesse, la réactivité, le temps de cycle, le débit et la production au sein de notre organisation. Donc, nous obtenons plus de valeur pour l'ensemble des dépenses. Vous voyez que cela joue dans le levier d'exploitation dans ce segment au premier trimestre et vous l'avez vu jouer au deuxième trimestre, avec une forte croissance des bénéfices de 9% sur cette croissance des revenus en monnaie constante. Nous continuons donc de nous attendre à ce que nous continuions à tirer parti de cette activité et à en tirer profit.

En ce qui concerne la dynamique des dépenses, vous avez dit que nos frais d'exploitation étaient meilleurs de 2%. Mais il y a beaucoup d'éléments différents dans cette dépense d'exploitation de 2%. Tout d'abord, la devise a eu une incidence de 2 points sur nos charges d'exploitation. Je vous dirai que c'était environ la moitié de l'impact ou même un peu moins de la moitié de l'impact que nous avions prévu il y a 90 jours, vu la volatilité de ce qui se passe sur les marchés FX, en particulier autour de l'appréciation du dollar américain. 19659015] Ainsi, les deux derniers trimestres, la monnaie est impactée par les dépenses de 4 à 5 points. Maintenant, c'était seulement un impact de 2 points. Donc, notre productivité de base était d'environ 4% meilleure. Cette tendance s'explique par le fait que nous continuons de tirer parti de notre levier d'exploitation grâce à nos initiatives de productivité d'entreprise, qui consistent à réinventer IBM et à travailler efficacement. Changer notre système de gestion, s'attaquer à notre structure, attaquer les coûts et la complexité, aligner les droits de décision et stimuler la responsabilité.

Donc, ce 4% est un niveau de productivité de base que nous conduisons et nous prévoyons aller de l'avant. Ensuite, je vais ajouter un autre point. C'est sur le revenu IP. Vous voyez qu'au deuxième trimestre, notre revenu de PI a diminué de plus de 100 millions de dollars, 115 millions de dollars, je crois, pour être exact. Au cours de la première moitié, il est en baisse de près de 250 millions de dollars dans l'ensemble. Nous continuons donc de tirer parti de la valeur de nos dépenses en recherche et développement et nous continuons d'investir dans ces domaines. Nous optimisons cette possibilité de façon opportuniste grâce à de nombreux modèles de monétisation, mais la PI diminue actuellement de 115 millions de dollars. Lorsque vous réunissez tout cela, vous bénéficiez d'un effet de levier important sur nos activités, comme vous le voyez ici au deuxième trimestre

Patricia Murphy – Vice-présidente des relations avec les investisseurs

Merci, Wamsi. Pouvons-nous passer à la prochaine question, s'il vous plaît, Anne?

Opérateur

Merci. La question suivante vient de Steve Milunovich d'UBS. Votre ligne est maintenant ouverte

Steven Milunovich – UBS Securities – Analyste

Merci beaucoup. Une bonne partie de la croissance de votre chiffre d'affaires et même de votre bénéfice avant impôt provient du secteur matériel. Qu'attendez-vous dans la seconde moitié mainframe compare? Allons-nous être en baisse d'une année à l'autre au troisième, puis baisser assez sévèrement au quatrième? Et puis, pour faire suite à vos commentaires sur les devises, je suppose que vous perdez environ 2 milliards de dollars de revenus au second semestre par rapport à ce que vous attendiez en avril. Avez-vous pris des mesures pour compenser cela pour obtenir 13,80 $, pour obtenir votre flux de trésorerie disponible de 12 milliards de dollars?

James J. Kavanaugh – Premier vice-président et chef de la direction financière

Merci, Steve. Beaucoup de questions là-bas. Laissez-moi prendre chacun individuellement. Tout d'abord, oui, nous avons eu un très bon trimestre global des systèmes. À la fois sur le revenu et sur le levier d'exploitation, où nous avons augmenté le revenu avant impôt de plus de 10 points d'année en année. Mais mettons le trimestre en perspective. Nous avons généré 4% de chiffre d'affaires globalement, 2% à taux de change constant. Il s'agit de notre plus fort taux de croissance du chiffre d'affaires en devises constantes depuis plus de 7 ans. Il a été porté par notre accélération continue et nos impératifs stratégiques, qui étaient en hausse de 15% à taux réels, de 13% à taux de change constant. Il s'agit d'une accélération par rapport au premier trimestre et de 18,5 milliards de dollars dans notre secteur de l'informatique en nuage, en hausse de 23%.

Notre taux d'exécution annualisé augmente de plus de 11 milliards de dollars. C'est en hausse de 24%. Nos activités de services sont revenues à la croissance à taux de change constant. Les deux GBS, qui a eu un grand trimestre, et TS et CP. Mais même si vous intégrez notre activité systèmes à votre question autour de mainframe, et si nous prenons le mainframe, vous verrez la même dynamique dans l'accélération d'un trimestre à l'autre de nos activités stratégiques impératives et, comme vous le savez, accélération du service de plus de 11 milliards de dollars, en croissance de 24%, qui n'a pas de système d'affaires en son sein.

Le dernier point que je soulèverai au sujet de la première ligne, puis j'aborderai vos autres questions. croissance géographique et sectorielle dans l'ensemble de nos activités. Probablement la meilleure largeur et la croissance dans le nombre de pays que nous avons eu dans une période assez longue. Plus de 60 pays ont connu une croissance à taux de change constant, ce qui représentait plus de 80% du chiffre d'affaires d'IBM.

Si vous extrayez le cycle mainframe, nous avons toujours plus de 60 pays qui ont réellement augmenté. Those are large countries like Japan, like U.K., like Germany, France, Spain, Australia. Many which are not mainframe dominant. So, we see continued momentum. Now, with regards to mainframe. I'm not going to apologize. This is the most enduring platform that you've seen out there and we continue to capitalize on gaining new, emerging workloads onto that platform.

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

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

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

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

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

Patricia Murphy — Vice President of Investor Relations

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

Operator

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

Katy Huberty — Morgan Stanley — Managing Director of Research

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

James J. Kavanaugh — Senior Vice President and Chief Financial Officer

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

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

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

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

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

Patricia Murphy — Vice President of Investor Relations

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

Operator

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

Toni Sacconaghi — Bernstein — Analyst

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

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

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

James J. Kavanaugh — Senior Vice President and Chief Financial Officer

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

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

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

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

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

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

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

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

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

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

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

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

Patricia Murphy — Vice President of Investor Relations

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

Operator

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

Tien Tsin Huang — J.P. Morgan — Analyst

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

James J. Kavanaugh — Senior Vice President and Chief Financial Officer

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

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

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

Patricia Murphy — Vice President of Investor Relations

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

Operator

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

Jim Schneider — Goldman Sachs — Analyst

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

James J. Kavanaugh — Senior Vice President and Chief Financial Officer

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

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

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

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

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

Patricia Murphy — Vice President of Investor Relations

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

Operator

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

David Grossman — Stifel Financial Corp. — Analyst

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

James J. Kavanaugh — Senior Vice President and Chief Financial Officer

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

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

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

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

Patricia Murphy — Vice President of Investor Relations

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

Operator

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

Keith Beckman — Bank of Montreal — Analyst

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

James J. Kavanaugh — Senior Vice President and Chief Financial Officer

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

Keith Beckman — Bank of Montreal — Analyst

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

James J. Kavanaugh — Senior Vice President and Chief Financial Officer

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

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

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

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

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

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

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

Patricia Murphy — Vice President of Investor Relations

Let's go to the next question, please.

Operator

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

Jim Suba — Citibank — Analyst

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

James J. Kavanaugh — Senior Vice President and Chief Financial Officer

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

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

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

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

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

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

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

Patricia Murphy — Vice President of Investor Relations

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

Operator

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

Amit Daryanani — RBC Capital Markets — Analyst

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

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

James J. Kavanaugh — Senior Vice President and Chief Financial Officer

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

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

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

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

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

Patricia Murphy — Vice President of Investor Relations

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

Operator

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

Duration: 80 minutes

Call participants:

James J. Kavanaugh — Senior Vice President and Chief Financial Officer

Patricia Murphy — Vice President of Investor Relations

Wamsi Mohan — Bank of America Merrill Lynch — Analyst

Steven Milunovich — UBS Securities — Analyst

Katy Huberty — Morgan Stanley — Managing Director of Research

Toni Sacconaghi — Bernstein — Analyst

Tien Tsin Huang — J.P. Morgan — Analyst

Jim Schneider — Goldman Sachs — Analyst

David Grossman — Stifel Financial Corp. — Analyst

Keith Beckman — Bank of Montreal — Analyst

Jim Suba — Citibank — Analyst

Amit Daryanani — RBC Capital Markets — Analyst

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