IBM (IBM) Q1 2018 Earnings Conference Call Transcript

IBM (NYSE: IBM) Q1 2018 Earnings Conference CallApril 17, 2018 5:00 p.m. ET

Prepared Remarks:

Operator

Welcome, and thank you for standing by. [Operator instructions] Today's conference is being recorded. If you have any objections, you may disconnect at this time. Now I will turn the meeting over to Ms.

Patricia Murphy with IBM. Ma'am, you may begin.

Patricia Murphy -- Vice President Investor Relations

Thank you. This is Patricia Murphy, vice president of investor relations for IBM, and I'd like to welcome you to our first-quarter earnings presentation. I'm here today with Jim Kavanaugh, IBM's senior vice president and chief financial officer. Before we get into the call, I want to make you aware that the third-party that hosts our event is having technical issues this afternoon.

If you're having trouble accessing the webcast, we provided an alternate link to the audio webcast just below as well as a PDF of the presentation that you can download and follow along with Jim's comments. So with that, I'll get back to my stated opening comments. As usual, prepared remarks will be available within a couple of hours, and a replay of the webcast will be posted by this time tomorrow. I'll also remind you that certain comments made in this presentation may be characterized as forward-looking under the Private Securities Litigation Reform Act of 1995.

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Those statements involve a number of factors that could cause actual results to differ materially. Additional information concerning these factors is contained in the company's filings with the SEC. Copies are available from the SEC, from the IBM website or from us in Investor Relations. Our presentation also includes certain non-GAAP financial measures in an effort to provide additional information to investors.

All non-GAAP measures have been reconciled to the related GAAP measures in accordance with SEC rules. You'll find reconciliation charts at the end of the presentation and in the Form 8-K submitted to the SEC. So with that, I'll turn the call over to Jim.

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

Thanks, Patricia, and thanks to all of you for joining us. As we wrapped up 2017 and in our investor briefing webcast in early March, we talked about the work we've done to reposition our business to lead in the high-value segments of IT, our differentiated value proposition and how our financial strategy and model is built to deliver value to our clients and our shareholders over the long term. We made progress in our financial performance in the second half of last year, and now our first-quarter results demonstrate further progress toward our model, so we're clearly moving in the right direction. In the quarter, we delivered $19.1 billion of revenue, $2.3 billion of operating net income and $2.45 of operating earnings per share.

And with this start to the year, we continue to expect at least $13.80 of operating earnings per share in 2018. Our revenue in the quarter was up 5% year to year. Without currency tailwind, our revenue was up modestly, though you'll see on the chart, constant currency rounds to flat. Now turning to profit.

Our operating gross profit was up 3% with broad-based improvement in our year-to-year gross margin performance versus last quarter. Our operating net income was up 2%, and earnings per share was up 4%. Those are inclusive of a year-to-year headwind from the actions we took in the first quarter to continue better positioning our business for the long term. I'll expand on this in a minute, but what you'll see in the underlying operating dynamics is that we improved our gross margin trajectory, expanded our PTI margin and had solid growth in earnings per share.

Looking at the year-to-year dynamics. Let me start with revenue. As I said, we're up 5% at actual rates with 6% growth in cognitive solutions, 4% in global business services, 5% in technology services and cloud platforms and 8% in Systems. Let me add some color by segment.

And from here on, I'll focus primarily on constant currency performance. Cognitive solutions revenue was up 2% year to year, with continued strength in security software and industry platforms and a return to growth in our analytics revenue. These cognitive results contributed to growth in our total software revenue for this quarter with strong transactional performance and continued growth in SaaS. In our Services businesses, we had an improvement in our revenue trajectory from last quarter, driven by revenue from the runout of our backlog.

In addition, both segments grew signings this quarter, contributing to double-digit growth in total Services signings, driven by cloud content. Our systems revenue was up 4%, with very strong revenue growth again in IBM Z and our second consecutive quarter of growth in power. Our storage-hardware revenue declined this quarter. We were disappointed in our storage performance, and it contributed to a modest shortfall to our own expectations of IBM's revenue growth in the quarter.

Our first-quarter results reflect much of the work we've done to reposition our portfolio and our skills to address the secular trends in the market led by the phenomenon of data. We've been building new platforms and solutions while modernizing existing ones, embedding cloud and AI into more of what we offer. And so IBM is now a cognitive solutions and cloud platform company focused on the high-value areas of IT. Our strategic imperatives revenue is an indication of our success in addressing these secular trends.

Over the last 12 months, our strategic imperatives revenue of $37.7 billion represents 47% of revenue. Our strategic imperatives revenue in the first quarter was up 15% at actual rates or 10% at constant currency led by security, which was up 60%, and cloud. Our cloud revenue is now $17.7 billion over the last year, which is up 22% as reported. Cloud growth in the quarter was driven by our as-a-service offerings, and we're exiting the first quarter with an annual run rate of $10.7 billion, which is up 20% at constant currency.

Our cloud success reflects our ability to help our clients run hybrid environments with our one-cloud architecture across public, private and multiclouds. The continued scaling of our strategic imperatives, together with focus on efficiency and productivity, is contributing to our improved margin trajectory. So bringing it all together, we grew revenue, operating net income and operating earnings per share and improved our year-to-year gross margin trajectory as compared to the fourth quarter. Before moving to our key financial metrics, we have a few significant items in our results this quarter, so I want to take a minute to walk through these.

And I'll start by reminding you of what we said 90 days ago in our discussion of our 2018 expectations. We said we expected to deliver between 17% and 18% of the full-year earnings per share expectation in the first quarter. Our first-quarter operating earnings per share of $2.45 is 17.8% of $13.80, so consistent with the range we provided. We said we expected an ongoing tax rate of 16% for the year, plus or minus 2 points, and that's excluding discrete items.

We also said that just like in each of the last two years, we anticipated discrete tax benefits in the first quarter, and we'd likely take actions that would offset some portion of the benefit. In the quarter, we took actions to continue the transformation of our business. These actions drove pre-tax charges of about $610 million, with the majority of this in SG&A and some in costs. First, with the repositioning of our portfolio, we have emerged as a leader in the high-value segments of the enterprise IT industry.

This requires revitalization of our skill base. And this quarter, we took actions to further align our skills to these high-value areas. And then second, we took actions that will better position our systems cost structure over the long term. In addition, we settled a number of U.S.

and foreign tax audits, which drove discrete non-cash tax benefits of $810 million in the quarter. Let me remind you that this benefit reverses charges that were reflected in prior years. As always, we've included these charges and benefits in our operating results. Today, we laid out a year-to-year bridge of our operating earnings per share, isolating what I'll call these significant items, so that you can better see the underlying dynamics of our business.

Looking at the drivers of our $2.45 of operating earnings per share on a year-to-year basis. We had contribution from revenue growth at constant margin as well as from operating leverage. The operating leverage was driven by pre-tax margin expansion mitigated by a higher underlying tax rate year to year. A lower share count contributed to growth.

And then you could see the year-to-year impact of the significant actions, which was a headwind to our earnings-per-share growth. So this is a good start to the year and, as I said earlier, our underlying operating dynamics show an improved gross margin trajectory, expansion of our pre-tax margin and solid growth in our operating earnings per share. I want to mention one other item that we discussed in the context of our 2018 expectations. In January, we implemented two new accounting standards, revenue recognition and the presentation of pension costs.

The net effect of the two was a modest reduction in our operating earnings per share in the first quarter with effectively no impact year to year. Regarding the implications to revenue. Adoption of the new revenue standard had a de minimis benefit to our revenue in the first quarter, and we expect any full-year contribution to be immaterial. So now let me talk about the key financial metrics for our operating performance and show you the impact these significant items have on our results.

As I've said, our revenue was $19.1 billion, and the year-to-year performance is essentially all organic. From a geography perspective, revenue in the Americas was flat year to year. A decline in the U.S. was offset by solid growth in Canada and Latin America, which was led by Brazil.

Asia Pacific was also flat. This is a 2-point improvement over the year-to-year performance in the fourth quarter. Our Europe revenue trajectory also improved and, in fact, returned to growth. We had strong growth in France and Spain.

And while Germany and the U.K. declined, they had marked improvement in their year-to-year trajectory. Looking at our margin performance globally. Our operating gross margin was down 70 basis points, though that includes a 40-basis-point impact associated with the significant item I just mentioned to improve our long-term systems cost structure.

This is good improvement in our year-to-year margin dynamics, driven by mix and productivity led by services. Our operating expense was up 9%, driven by currency and the actions to continue repositioning of our business. Without these, our expense was better by 1%, reflecting a high level of investment and our continued focus on productivity. As we discussed in the past, when currency helps the top line, it also hurts the expense line due to both translation and the impact of hedging losses.

And so in the first quarter, currency drove 5 of the 9 points of expense growth. And then a higher level of workforce transformation activity drove another 6 points of expense growth. I will also mention that we had a lower level of IP income, which drove 2 points of expense growth. Our operating tax rate for the quarter reflects an underlying rate of 16% as well as the discrete tax benefits of $810 million.

The 16% is in line with the range we discussed in January and is up over a point year to year. The operating net income was up 2%, and operating earnings per share of $2.45 was better by 4%. And those include the year-to-year impact of the significant items. Looking at the cash metrics.

We generated $1.3 billion of free cash flow in the quarter and $13.3 billion over the last 12 months. That's nearly 120% of GAAP net income. I'll come back to the drivers of our cash performance after I walk through each of the segments. Now turning to our segments.

Cognitive solutions revenue was up 2% as we continue to scale our new platforms and solutions and grow our SaaS offerings. Solutions software revenue also grew 2% led by offerings in analytics and security. Within analytics, growth this quarter was driven by strong transactional performance. We saw broad-based growth across both our on-prem analytics platforms and our SaaS offerings as clients look to use their data for competitive advantage.

And so from a portfolio perspective, we had continued growth in offerings that allow our clients to better manage their data in hybrid environments like our integrated analytics systems. We also had strong growth in our data science offerings where we introduced new capabilities that allow data developers to leverage open source tools in a secure, collaborative environment. You'll remember, last quarter, we talked about the weakness in the data integration space due to new offerings introduced very late in the quarter. These new offerings are resonating with our clients and contributed to growth this quarter.

Also within analytics, we continue to scale our industry platforms. Let me focus this quarter on financial services. Watson Financial Services had another strong quarter led by Promontory's risk and regulatory business as well as our financial crimes portfolio. We are seeing a real synergy opportunity in combining Promontory's industry expertise with our AI technologies.

Watson remains the AI platform for business with continued strong demand for our offerings, particularly around virtual assistance where conversation service usage increased triple digits year to year. In the first quarter, we introduced several new offerings to accelerate client journeys to AI such as the enhanced Watson Assistant, with conversational offerings tailored to specific industries like automotive and hospitality. Orange Bank and Autodesk are two examples of early adopters of our latest technology. And just last week, Forrester recognized IBM Watson Assistant as the only leader in its new Wave report on conversational computing platforms.

Security had great growth this quarter, and we continue to gain share. We are well-positioned in this market with our extensive security portfolio, which is enhanced with AI to address the needs of our clients. There is obviously a lot of demand here, given the importance of cybersecurity risk and data privacy concerns, especially in an environment where security talent is at a premium. We had good performance in areas like data security with GDPR as a driver, endpoint management and orchestration.

And we had strong revenue growth in our SaaS offerings in security as we continue to increase our AI capabilities across the portfolio. We also continue to make progress in emerging areas like blockchain. We've grown to over 50 active blockchain networks since the release of our IBM Blockchain platform in the third quarter last year. And last month, we announced the beta version of our IBM Blockchain platform starter plan designed for start-ups, developers and companies of any size that want to quickly stand up a blockchain network.

In the first two weeks, we had over 750 networks provisioned. Turning to transaction processing software. Revenue was up 1%, so another good quarter. Growth was driven by Z middleware as our clients continue to invest and grow their high-value mission-critical workloads on the Z platform.

Looking at profit. This quarter, pre-tax income from the segment grew 5%, and pre-tax margin was roughly flat year to year even with a nearly 2-point impact from workforce actions. Margins were driven by strong transactional performance in high-value areas, offset by ongoing investment into strategic areas and business mix. Moving on to services.

Global business services revenue was down 1% at constant currency, which is a modest improvement in trajectory from the fourth quarter, and we again grew signings. Our strategic imperatives revenue reflects the ongoing shift to areas of higher client value, with growth across multiple areas like cloud and analytics. Turning to the lines of businesses. Consulting revenue grew for the third consecutive quarter, and our backlog was up year to year.

Revenue growth was led by strong double-digit growth in our digital strategy and iX business, which implements end-to-end digital transformation strategies for our clients. GBS is uniquely positioned to bring together IBM's first-mover advantage in the most promising emerging technologies like blockchain with their industry expertise to develop solutions, which help clients unlock value. Looking at application management. Our revenue was down 2% this quarter, a 1-point sequential improvement from fourth quarter.

Application management signings grew at a double-digit rate as we leverage our incumbency to help clients modernize their critical applications and migrate to the cloud. Turning to profit. GBS gross margin stabilized this quarter, a 2-point improvement in trajectory from the fourth quarter. This includes about 0.5 point impact from currency.

The improvement was driven by productivity, revenue mix and pricing improvements. Pretax margin was down 3.5 points year to year, including an impact of nearly 2 points from the workforce-rebalancing charges. This reflects our ongoing investments in the next generation of offerings, skills and enablement and the reshaping of our pyramids for each of our core service lines, which will drive operating leverage in the long term. Turning to technology services and cloud platforms.

We had good execution this quarter with trajectory improvement in revenue and profit and strong double-digit growth in signings. Revenue of $8.6 billion this quarter was down 1%, representing a 3-point improvement in year-to-year performance compared to last quarter. Signings grew double digits as clients continue to recognize the long-term value of our offerings and capabilities. At this level of signings growth, the TS&CP backlog trajectory improved 2 points with approximately 40% of that backlog now in key strategic workloads.

Across the segment, the strategic imperatives revenue grew double digits, and the as-a-service exit run rate for this segment is now $7.4 billion. We got a lot of momentum in our enterprise cloud value prop. And this quarter, our cloud signings in infrastructure services grew over 40% year to year. Infrastructure services revenue was flat, which is nearly a 5-point improvement from the fourth-quarter rate.

This was driven by improved revenue from backlog realization as expected. We are helping clients drive efficiencies and gain agility in their IT environments through hybrid cloud. Our clients entrust us with their mission-critical foundational systems and rely on us to navigate the complexities of disparate IT environments, along with data and regulatory frameworks as they move to the cloud. Technical support services revenue declined 4% due in part to the dynamics of our hardware product cycle.

Within TSS, our core multi-vendor support offerings continue to grow. Integration software grew 1% with continued strong growth in SaaS across the portfolio and the adoption of the new IBM Cloud Private offering, where we now have over 200 clients using the platform. The integration software portfolio remains essential to clients as they connect multiple environments through a single architecture. Turning to profit.

Gross profit margin for this segment was down 60 basis points year to year, a 140-basis-point sequential improvement from fourth quarter, driven by services where we had productivity and scale improvements and a better mix within integration software. Pretax income margin was down 3 points year to year where, similar to GBS, workforce-rebalancing charges had a 2-point impact. Adjusting for this, the pre-tax income margin dynamics were consistent with our gross margin dynamics. In systems, revenue grew again this quarter, as we modernize our systems for the most contemporary workloads.

Performance was driven by both strong z14 momentum and growth in power, mitigated by the decline in storage. This quarter, IBM Z revenue grew 54% year to year, a more than 100% growth in shipped MIPS, and margins expanded. The z14 adoption was again broad-based. We added new clients to the platform across several countries this quarter, including a services provider in Thailand who chose our LinuxONE for its blockchain solutions.

So we're continuing to address the emerging workloads across the Z platform like blockchain but also machine learning, DevOps and payments, with new workloads MIPS growing 4x as fast as our traditional MIPS. And last week, we announced the new z14 design specifically for cloud environments. Its industry standard, single-frame design allows for easy placement into public cloud data centers and private cloud deployments. These latest systems bring the power of IBM Z to an even broader set of clients.

Overall, the mainframe continues to deliver a high-value, secure and scalable platform that is critical in managing our clients' complex environments. Power grew for the second consecutive quarter with revenue up 3%, driven by our entry-level portfolio and our cloud-enabled offerings. Power remains vital to many workloads, including artificial intelligence, high-performance computing, UNIX and Linux, and we grew in all four this quarter We started transitioning to POWER9 in the fourth quarter, with the first installment of our supercomputers at U.S. Department of Energy.

And late this quarter, we started shipping our POWER9 entry systems designed for AIX, IBM i and Linux workloads. These cloud-ready systems provide leadership capabilities in advanced analytics, cloud environments and data-intensive AI workloads. Storage hardware was down after four consecutive quarters of growth, driven by an increasingly competitive environment and continued pricing pressures, though we expanded margins. We also had some sales execution challenges, which impacted performance.

Remember, what we are talking about here is just the hardware element of storage. Clearly, we've seen some of the value shift to software. In this quarter, we had strong growth in software-defined storage and cloud object storage, which are reported in transaction processing software. Looking at profit for systems.

Gross margin was down about 4 points year to year, including nearly a 5- point impact for the charge I referenced earlier in systems cost. Without that, gross margins expanded due to the relative strength in our higher-margin business and cost-efficiency actions. Pretax margin was roughly flat year to year even with the impact associated with the significant items in cost and expense. So in our underlying performance, we expanded margins while successfully delivering innovation in support of our clients' evolving workload needs.

Turning to cash flow and the balance sheet. We had another strong quarter. We generated $2.2 billion of cash from operations, excluding our financing receivables. And after investing another $900 million in capital expenditures, we generated $1.3 billion of free cash flow, which is up year to year.

Our cash realization remains very strong, at nearly 120% over the last 12 months. This performance puts us on track to achieve our full-year expectation of free cash flow of approximately $12 billion. Our results in the quarter were driven by performance in working capital, partially mitigated by higher cash taxes and higher capex, both headwinds we talked about back in January. Looking at uses of cash in the quarter.

We returned $2.2 billion to our shareholders, including $1.4 billion in dividends. We bought back almost 5 million shares and had $3 billion remaining in our buyback authorization at the end of the quarter. On the balance sheet highlights, you can see we ended the quarter with $13.2 billion in cash, and total debt was $46.4 billion. About two-thirds of our total debt was in support of our financing business.

Our financing leverage remains at 9:1, and the credit quality of our financing receivables is strong at 53% investment grade. That's consistent with December and a point better than a year ago. So our balance sheet is strong. We got flexibility we need.

And with a strong quarter and the cash flow, we are on track for the year. So let me make a few summary comments on the quarter and the year before we go to Q&A. We've been building and transforming our portfolio, our skills, our operating model to address what our enterprise clients need and what they value. Our results over the last few quarters reinforce that our clients value the integration of our innovative technologies, together with our industry expertise to help them in their journey to AI, their journey to cloud.

And they value our approach to the protection of their data and their privacy. In the first quarter, we built on the progress we made in the second half of last year. We improved our year-to-year revenue trajectory in cognitive solutions, in GBS, in technology services and cloud platforms, and we continue to grow our Systems revenue. We improved our year-to-year trajectory and operating gross margins.

It's better by 70 basis points compared to the fourth-quarter performance and better by 110 basis points when you adjust for the actions we took. The margin trajectory improvement was broad-based, with operating leverage coming from mix and from improved productivity. We continued our investments in our one-cloud architecture in emerging areas like blockchain and, more broadly, in skills and talent development. All together, we grew our revenue, operating net income, operating earnings per share and free cash flow.

With this performance, we continue to expect to deliver at least $13.80 of operating earnings per share, with about 40% of that in the first half. To put that in perspective, that's about a point ahead of our first half skew in 2017. And so this was a good start to the year, and going forward, we're focused on delivering consistent operational performance. And with that, let me turn it back to Patricia to kick off the Q&A.

Patricia Murphy -- Vice President Investor Relations

Thank you, Jim. Before we begin the Q&A, I'd like to mention a couple of items. First, we have supplemental charts at the end of the slide deck that provide additional information on the quarter. And second, as always, I'd ask you to refrain from multipart questions.

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

Questions and Answers:

Operator

Thank you. We will not begin the question-and-answer session. [Operator instructions] Our first question comes from Katy Huberty Morgan Stanley. Your line is now open.

Katy Huberty -- Morgan Stanley -- Managing Director

Yes. Thank you. Jim, as you noted, storage was the disappointment in the quarter. Can you just talk a bit more about what drove the change in the pricing environment, your execution and some of the actions that you had to take to reposition that business? And then just more broadly, can you talk about the expected payback on the actions that you took in the quarter, both in terms of the amount and timing of the return on the workforce rebalancing?

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

OK, Katy. Thank you for the questions. So going two parts, let me address storage first. As I stated in the prepared remarks, we were disappointed in our storage performance.

Especially after four quarters of growth, our 1Q fell below our own expectations. But I'll tell you, we have a great team with a proven track record. This is the same team that has proven that they've revitalized the portfolio in the past, took market share for four consecutive quarters, and now we had an impact in the first quarter predominantly just due to execution of transactions at the end of the quarter. This market in storage is -- continue to be very competitive and very aggressive.

It is a battle right now on market share, but we feel comfortable that we've got new portfolio offerings that are coming out later in the year as we get through the latter half of the second quarter and then to third quarter and fourth quarter, and we've already taken significant actions on how our routes to market and our economic equation with all of our channel partners are put in place. And with that great team that has executed in the past, we have all the confidence in the world that we can get our storage business back to where it needs to be as we move forward in the second half of 2018. Now let me talk about your second question because, as you stated, there are a lot of dynamics that have played out this quarter, many of which we talked about 90 days ago. And so let me spend a couple of minutes to unpack this because I think we should spend our time on the fundamental underlying business performance when you take a look at our significant items that I talked about.

So in January, during our guidance, we talked about we would have tax discretes. And in this quarter, as I stated, it was $810 million. As I stated, the largest driver of this was the conclusion of the 2013 and 2014 U.S. IRS audit.

And I'll remind you, this reverses provisions previously taken in our tax rate in prior years, and it's noncash. So in addition to that, we took actions around continuing to reposition our business to revitalize our skill base to higher-value areas and also to better position our systems cost structure over the long term as we continue to look for ways to make a more variabilized model versus fixed-cost model. So as always, we included the charges and the benefits in our operating results. But in order to understand the underlying dynamics, and some of you have given me very good advice, we put in place a year-to-year bridge of our operating earnings per share to show you the implication of the net effect of those two events on a year-to-year basis.

And as you saw in the chart, it was a headwind to us of $0.05 that we had overcome. So without those impacts, we improved the trajectory of our gross margin. Our gross margin was down 30 basis points. And in my books, that's stabilization.

We expanded our pre-tax margin. We had solid earnings-per-share growth and free cash flow growth, and we delivered what we said in the quarter. Now in terms of savings, just wrapping it up, as you see, we took about a $610 million action to continue repositioning our business. We expect that to deliver two times the investment and maybe a little bit more on an annualized basis.

And we expect about half of that to be driven in second half of 2013. So I'd tell you, when you cut through it and you look at that operating earnings per share bridge year to year, we are focused on delivering consistent operational performance in this business to deliver value to our clients and our shareholders as we move forward.

Patricia Murphy -- Vice President Investor Relations

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

Operator

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

Toni Sacconaghi -- Sanford Bernstein -- Analyst

Yes, thank you. Good afternoon. So, Jim, you had talked about growing revenues in the first quarter, and you fell short of that this quarter with flat revenue growth. You highlighted storage.

Was that really the only area of disappointment in where you thought you were 90 days ago? And if we kind of look forward, I suppose critics could say the IT spending environment's very robust. You're benefiting from a mainframe cycle. Comparisons are relatively easy. Isn't this about as good as it gets? And when we look forward, should we be thinking about the high watermark for revenue growth being this quarter? Or what might change that?

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

Yes, Toni. Thanks for the question. A pretty long question, I'll try to make sure I can answer each component. First of all, as you stated, we did post revenue growth, $19.1 billion, up 5% at actual rates, up modestly at constant currency, which, as you saw in the chart, rounds to flat.

And as I stated upfront, being transparent, we fell short to our own expectations. And I talked about storage already, and I'm not going to repeat that. We have confidence in the team, we have confidence in the portfolio and we know we're going to get back on the field and turn that business back to growth as we get into second half. But let's just play out a little of the dynamics of our first quarter in the profile of our revenue.

We had strong growth, and let's start with the strategic imperatives, which are the signposts of us capturing the value and the secular shift so we can lead in the high-value IT segments moving forward, which are instrumental to our overall financial model. Our strategic imperatives were up 15% at actual rates and up 10% at constant currency. And on a trailing 12 months, we're at $37.7 billion, 47% of IBM. That trajectory, if you just play that out, says we will deliver our $40 billion signpost before the end of 2018.

Now unpacking that strategic imperative, let's talk about the fundamental drivers of that. One, our cloud business. Our enterprise cloud continues to resonate from a strategy value prop, and we're continuing to gain momentum. Over the last 12 months, $17.7 billion of revenue, up 22% at actual rates.

Our as-a-service component underneath that, $10.7 billion. That's up $400 million on an annualized exit run rate just from three months ago, and it's up 20% overall. In security, we have a leadership market-share position. We're taking share.

We're up 66%, $3.4 billion. So I would tell you the underlying dynamics of how we changed our portfolio, we are capitalizing on those secular shifts, and we're gaining market share overall. Now with regards to IBM's model, as we talked about a month ago when I spent time with you in Las Vegas at our website -- our investor webcast, our model is 1% to 3% low single digit. We have a composition of our portfolio that delivers revenue contribution, operating leverage to deliver that investment thesis of being a high-value based company, delivering profit at mid-single-digit and high single-digit earnings per share and delivering free cash flow to deliver 70% to 80% back to our shareholders.

So we feel confident that we've got the right portfolio lineup. We're well on pace to deliver that $40 billion earlier than 2018, and we've got the right team in place to go execute. Now just concluding, you asked about disappointments. Obviously, when you look at our performance, we said what we were going to go do.

We returned cognitive solutions back to growth coming off of fourth quarter flat. It grew 2% at constant currency, and we had a great software quarter, returning analytics back to growth after last quarter, we talked about 90 days ago, we were disappointed. So great work on that end, and we continue to have momentum with regards to our security business and our industry verticals. Our services business, we talked about 90 days ago, an improved backlog trajectory runout.

And I -- you could see in our first quarter, that has played out, great improvement. TS&CP went from down 4 points at constant currency to down 80 points at constant currency. And we're making very good progress. We delivered double-digit signings growth.

And our backlog improved in TS&CP. GBS, we made modest improvement. And that would be the second area that we got to pick up the rate and pace in addition to storage. We did improve the trajectory from down two to down one.

We improved our backlog by growing signings again. But our backlog's still down 5%, but our backlog trajectory runout still points to improving trajectory throughout the year, it would -- should enable us to get to revenue growth in the second half of the year if we continue to drive the required signings that fuel the backlog, that fuel the revenue. So there was a lot packed in there, but I appreciate the question, Toni. Thank you.

Patricia Murphy -- Vice President Investor Relations

OK. Operator, could we please go to the next question?

Operator

Our next question comes from Wamsi Mohan from Bank of America Merrill Lynch. Your line is now open.

Wamsi Mohan -- Bank of America Merrill Lynch -- Analyst

Yes, thank you. Jim, you obviously had very strong revenue growth here in the quarter, but the PTI margins are really masked by the impact of these significant items you called out. Can you give us some color on, in the underlying businesses, where you saw the most underlying improvement in PTI trends, if you ex out these significant items, some color on the confidence that you expect that they should improve materially from 2Q through the end of the year? And if I could just ask a clarifying question as well. What specifically were the significant items that impacted cognitive PTI margins? It seemed that you called out the skill-based transfer, the high-value areas, and systems cost structure, but not quite sure what specifically impacted cognitives.

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

Sure. Thank you, Wamsi, and thank you for the compliment upfront. We are pleased with our performance here in the first quarter in its first instantiation as we make continued progress in delivering that consistency of operational performance I talked about in 2018. So let me first talk about the clarification question with regards to the significant items.

As we talked about, we have repositioned our portfolio over the last couple of years, you know quite well. We continue to create new offerings to address new value in the market from a client perspective, and we'll continue to adapt that overall. And we -- to compete in that line of business, we got to continuously revitalize our skill base. And within parts of our cognitive solutions portfolio, in particular around areas of talent, collaboration and commerce, we are modernizing our set of offerings to address shifts in client value and address shifts in consumption models.

And we need to revitalize our skills to compete in that area. So in cognitive solutions, that was predominantly a workforce remixing revitalization charge that was taken to SG&A. Now let's go to your overarching question and talk about what we see with regards to the fundamental trajectory of our business. And you asked the question in terms of pre-tax margins and how it's distorted.

And that's why I'm glad Katy asked that question upfront because I think we got to get clarity on the underlying dynamics and the fundamentals of our business exiting first quarter. So let me just take a minute by each segment because I think each segment should be looked at a little differently. From a gross-profit-margin perspective, it is very appropriate to look at your services base of businesses just given the overarching cost structure and how you drive utilization and return on investment in a cost of service delivery model. So in services, I'll talk gross margin, but I'll start with cognitive solutions.

Cognitive solutions, our model is a model that looks at PTI margin expansion because our model is to deliver single-digit or mid-single-digit revenue growth and mid-single-digit pre-tax growth, i.e. no operating leverage. And when you take a look at our first-quarter performance, all-in printed charges, we delivered revenue growth at actual rates at 6%, 2% at constant currency, and we delivered pre-tax income at 5%. So we are generated on that constant currency operating leverage.

And at actual rates, we delivered our model. Now that's with all the charges in. Excluding the charges, we delivered 12% pre-tax income growth, so 2x the revenue growth, as we continue to generate significant value out of our high-value base offerings and making great progress from where we were 90 days ago. Now let's look at our services business, one in GBS.

GBS, we improved the trajectory of our gross margin quarter to quarter by 200 basis points, and that is all the great work the GBS teams are doing all around the world, around driving mix and value out of a whole new set of offerings. Our SI business has greater margins than our core business. And you know almost two-thirds of our in GBS business is now in SI as we continue to generate momentum with double-digit growth. But also, we are seeing price margins in our signings every quarter going up 2 to 3 points.

Now, we got a lot of work to do, and we're driving that work around workforce optimization, productivity. Mark talked about refining our skill pyramid and getting the utilization and infusing AI and automation to improve delivery to go realize those margins. And we're starting to see some improvement, and we fully expect that trajectory to continue as we move into second half. Now TS&CP.

TS&CP improved their gross margin, which is the right way of looking at that business as we invest in our cloud to build out our leadership capability, and we continue to drive the effective utilization of our GTS business. We improved our margins almost 150 basis points from fourth quarter. We printed down 60 basis points. So we made substantial trajectory improvement.

That is being driven based on continued scale efficiencies with our cloud momentum and our as-a-service momentum, but it's also being driven by the tough work in redesigning our delivery models, infusing automation. The IBM Service Platform with Watson now covers over 1,250 clients, and we're scaling that every single day. And we're driving actions around our workforce optimization and structure. So great trajectory improvement in our GBS and our GTS, and we fully expect that to continue to move forward in second half.

And we expect our services margins to be accretive in the second half, not just talking about trajectory improvements. And then finally, in systems. Our systems, we repositioned our portfolio through continuous reinvention of our platforms and capitalizing on secular shifts in new workloads. We had good growth in the quarter.

Our margins were down, but that was driven based on the charge we took to better position the long-term structure of our systems business. Ex that charge, our margins were up, and they were up in almost every segment of that to business. So thanks, Wamsi, for the question.

Patricia Murphy -- Vice President Investor Relations

OK. Let's take -- go to the next question, please.

Operator

Our next question comes from Steve Milunovich from UBS. Your line is now open.

Steve Milunovich -- UBS -- Managing Director

Great. Thank you. I just wanted you to indicate whether you expect to see the 16% tax rate report at the balance of the year or whether you think there will be further discretes. And similarly, are we done with the workforce balancing charges for the year?

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

Yes, thanks, Steve, for the question. As we discussed 90 days ago, we said that we would expect in 2018 that our ongoing underlying operating tax rate will be in the range of 16%, plus or minus 2 points, before discretes. I would tell you that that still remains today. We executed on what we disclosed 90 days ago but expecting tax discretes in the first quarter.

But as you know, these tax discretes, by definition, they're unknown in timing and in scope. And we're continuing to drive the tax optimization as you would expect of us because it's a critical element of our underlying operating leverage in our company and our financial strategy. But right now, I would fully expect 16%, plus or minus 2%, as we move forward. And one last thing, consistent with what I said 90 days ago is that on a full-year basis, all-in, we still expect tax to be a headwind.

Patricia Murphy -- Vice President Investor Relations

OK. Good luck. So the next question, please.

Operator

Our next question comes from Tien-tsin Huang from J.P.Morgan. Your line is now open.

Tien-tsin Huang -- J.P.Morgan -- Analyst

Thanks so much. Just wanted to dig into the services a bit. Just with the signings, that was encouraging, right? It was -- it sounds like signings were double-digit in some key areas, including app maintenance. It sounds like -- you mentioned price margin was also up, Jim.

So I'm just trying to reconcile the signings commentary with the actions to reposition, the workforce rebalancing, which I presume will include services headcount. So are you going to see any negative revenue impact from the actions on the services side? Again, just trying to reconcile the actions and the potential revenue loss with the strong signings and what it means for the outlook, if that makes sense.

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

Yes, Tien-tsin, thank you very much. Yes, we were definitely pleased with our signings performance in the quarter. As I indicated, we delivered over $9 billion of signings, up double digits and up across each of our businesses. And that has positioned our backlog now at $120 billion, and that's up 4%.

I would argue, 4% at actual rates is the right way of looking at backlog because that's what's going to play out as time goes on at current spot rates. So we're pleased with that overall. But the underpinnings, when you get underneath signings and backlog, in GTS, we grew signings 20% year over year, with over 40% in cloud. And then our Infrastructure Services or our outsourcing business backlog is now about a point better where it was a quarter ago.

And we improved our overarching GTS backlog quarter to quarter. And as I talked about on March 8 at the Investor Day webcast, remember, we've kind of held our outsourcing backlog pretty consistent over a decade. And now we've changed and capitalized on the secular shifts, and about 40% of that underlying backlog now sits in strategic imperative areas of which cloud makes up the biggest piece. And the other important point around signings I will talk about is when you look at the good growth in signings we had in the first quarter, over 40% of that was driven by cloud-based signings.

So we are capitalizing or winning, and we're improving the trajectory of our business. Now let me talk a little bit about margin because I spent on the last answer the trajectory improvement, substantial trajectory improvement we saw quarter over quarter, 200 basis points in GBS and 150 basis points in TS&CP. The way I'd like to look at these margins as we spent in the last two earnings calls, I look at the fundamental drivers of how you operate that business, both from a human-capital-base perspective. You got to drive scale efficiency, you got to drive mix through value and price, you got to drive productivity, your fundamental human capital.

And then as you get operating leverage -- you should be able to get growth through operating leverage, excuse me. So those four buckets, and we -- and you look at our first-quarter performance, we made progress across the board. Now we got work to do going forward. But based on the trajectory and the actions we took to reposition our business, that makes me comfortable stating that in the second half, our services margins will be accretive.

Patricia Murphy -- Vice President Investor Relations

Thanks, Tien-tsin. Let's go to the next question, please.

Operator

Our next question comes from Amit Daryanani from RBC Capital Markets. Your line is now open.

Amit Daryanani -- RBC Capital Markets -- Analyst

yes. Thanks a lot for taking my question, guys. I guess, Jim, if I get my math right, adjusting just in the one-time items, gross margins were down 30 basis points in the March quarter. Could you just walk me through what you think are the top two, three things, levers, that can help you go from gross margins declining in Q1? Just since you assumed the stabilization for calendar '18, which has implied margins that lets you go up for the next three quarters, including Q3 where I think compares get tougher, so just what are the two, three things that give you confidence margins could improve for the remainder of the year?

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

Yes. So let's talk about this. So I gave guidance of maintaining at least the $13.80. And as we talked about, there's always many scenarios.

The team, we drive them like crazy here in a very short period of time to get ready for this call. But we look at the trajectory of our business, we look at all of our operational indices. And that positions how we can triangulate around the guidance that we give externally across our financial model strategy we talked about in Investor Day, revenue contribution, that is growth, mix, scale; and around operating leverage, that is productivity. And that is, as we get that growth, what's that operating leverage we're going to get on human capital.

So it positions both top line and overall margins. So let me just give you a perspective of what we see underpinning the $13.80 in terms of gross margin. 1Q, as you talked about, we printed, all-in, down 70 basis points. If you exclude the significant items so that you can understand the underlying trajectory of our business going forward, our margins were down 30 basis points.

That's coming off of fourth quarter being down 140. In my book, that's stabilization, and that's what we guided to in first quarter, and that's what we delivered. Now with that trajectory improvement that we saw, and it being pervasive across continuing to get scale, continuing to get improvements in productivity, which we missed, by the way, if you remember our discussions 90 days ago, and around mix, we do see that trajectory improvement to move forward. But our full-year guidance only requires stabilization of margin.

And the actions that we took in the first quarter, I would tell you, positions us better than when I sat here 90 days ago on how we can deliver the fundamental dynamics across multiple scenarios of delivering at least that $13.80. And if you play out those drivers, since you asked, first, we are going to continue to invest capital to build out our enterprise cloud and build on that momentum in as-a-service, and we're going to continue getting scale efficiencies. We made significant investments historically. That has been a headwind to us.

And we are minimizing that headwind every single quarter as we get scale efficiencies. And I expect that to continue. Second, as I just talked about, the increased yield in services productivity, we expect that to play out. Workforce optimization, a mix of higher value in capture and price, infusing AI in automation on our delivery platforms, we expect that to play out and deliver significantly in the second half.

Now both of these pieces, the efficiency and the productivity and scale-out are required because we all know, as we enter the second half, we have a significant headwind on mix because we are not counting on more than a typical mainframe cycle. Our mainframe, we are very pleased with the performance so far. Program to date, we're above our prior program. We are capitalizing on secular shifts with the value of our pervasive encryption in blockchain.

But it would not be prudent right now to predict or to predicate our $13.80 guidance on breaking a mainframe cycle. So that mix headwind is facing us in the latter half of 3Q and 4Q, and we need to overcome it with the scale-out efficiencies and with the increased productivity and based on the actions we took in the first quarter to better reposition the business for the long term, I feel more confident than I did 90 days ago.

Patricia Murphy -- Vice President Investor Relations

Thanks, Amit. Let's go to the next question, please.

Operator

Our next question comes from Mark Moskowitz from Barclays. Your line is now open.

Mark Moskowitz -- Barclays Investment Bank -- Analyst

Yes, thank you, good afternoon. Just continuing that thread in terms of trying to understand how the revenue component will help drive that margin expansion of the overall equation. Is there anything you can give us in terms of how we should think about the legacy outsourcing business at IBM, all those three- and five- and seven-year outsourcing deals that were consummated before IBM became a bigger and better cloud vendor in the last couple of years? Is there any sort of cycle forthcoming whereas those deals on one we could see conversion or transition to more of a cloud-like workload for those customers and, therefore, you achieve better scale out of your 58 data centers? Is that something that could happen this year? Or is it something more 2019 or '20?

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

Yes, thank you, Mark. I appreciate the question. I would tell you, we're seeing that already. I mean, the secular shifts that have happened in the marketplace and are happening and will continue to happen are right in front of us.

And that's why I thought it was very interesting and why we shared some of the signpost data about our outsourcing composition and our backlog and how we've been able to maintain it over a decade-long period while continuing to capture those secular shifts in cloud. Today, as we exit first quarter, a total backlog of $120 billion, our outsourcing backlog is somewhere around that $80 billion number. And within that, our shift to cloud is somewhere in the neighborhood of 25% to 30% already. That is providing us tremendous scale efficiency as we leverage in the 58.

Actually, I think now we're north of 60 data centers in -- cloud data centers around the world. And we'll continue to differentiate ourselves as we move forward. So we have been focused. I think it's an attestation to the value of incumbency, the value of trust.

And we talked about the differentiators, about our innovative technology, about our deep industry expertise and about the trust and security of our clients. Our GTS business are managing the critical workflows and critical business processes of our clients. And as they look for efficiency in delivering a new model around cloud, we are actually capitalizing on that as we move forward. So not only will it help our revenue, it will help, at the end of the day, our margin and our scale efficiencies as we go forward.

Patricia Murphy -- Vice President Investor Relations

OK. We've covered a lot of topics today. I fear we're going a little long, so I am going to take one last question, please.

Operator

Our last question comes from David Grossman from Stifel Financial. Your line is now open.

David Grossman -- Stifel Financial Corp. -- Managing Director

Thanks. So, Jim, I'm wondering if we could just follow up on a few of the earlier questions. You did a good job of explaining the dynamics by business unit. That said, we have this issue of comping the mainframe cycle later this year.

And you just stated we probably shouldn't count on an elongated cycle. So are the improving service metrics that you shared sufficient to give you more confidence that these businesses will be sufficiently positioned to offset those headwinds that'll be created by the anniversary of the cycle whenever it may happen? And then just secondly, a point of clarification. Should we expect the margin benefit from the significant items to benefit both the second half of this year and the first half of next year on a year-over-year basis?

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

OK, David, thank you very much for your question. So let me address the second one first, because I think that's a short answer. As I stated, both in the prepared remarks and the Q&A, we expect the annualized savings to be 2x the investment, and we'd get about half in the second half, so obviously, yes, that also strategically positions us for the first half plus going forward into 2019, cause remember, we took these actions to better reposition our business for the long term, and what's required to continue to generate and create client value and shareholder value as we move forward. So that's the first question.

The second, as I, that's why I specifically, with regards to your wraparound fourth-quarter mainframe, etc., that's why I specifically walked through the margin dynamics of what we see playing out throughout the year. We realize, and I think it's prudent based on what we've done with our guidance of at least $13.80, we know we've got a mix headwind. Now, believe me, we've got an entire mainframe team in 170 countries around the world that are driving like crazy to deliver the value to our clients to make this a secular shift versus cyclical. We'll put that aside for right now, that's for tomorrow, as we go drive the operational execution in 17 days already into the second quarter.

But we do see scale efficiencies based on the momentum trajectory of our cloud business and [Inaudible]. We see productivity played out very nicely for us in the first quarter, and with the actions we took in the first quarter, it positions us for the second half as we move forward to get our services business to accretive margins to help us overall. And lastly, when you take a look at it, we turned out cognitive solutions back to revenue growth at top line, that carries high-profit, high value-based activity. We expect that trajectory to continue, and again, that backlog runout is playing out, and we gotta just continue to drive the signings to fuel that backlog, to get revenue in the second half, and we feel comfortable with that.

Now, with that let me wrap up the call by again saying we're very pleased with the start of the year. We gave you guidance 90 days ago. We said we'd deliver at least $13.80, 17% to 18%. We delivered at the high end of that earnings-per-share guidance of 17% to 18%.

We made substantial progress across many parts of our business, we took significant actions to reposition the long-term position of our company, and we are on track to deliver our full-year objective of at least $13.80 and deliver revenue growth at current spot rates, stable margins -- which is all we need to deliver that $13.80 -- and free cash flow of at least $12 billion. The first quarter was an instantiation of that. We delivered revenue growth, we delivered operating-profit growth, we delivered free cash flow growth, we delivered earnings-per-share growth, all in. And that positions us now, as we're focused, as I started this call, on delivering consistent operational execution in this business as we move forward.

So thank you all for joining the call.

Patricia Murphy -- Vice President Investor Relations

Operator, let me turn it back to you to wrap this up.

Operator

[Operator signoff]

Duration: 71 minutes

Call Participants:

Patricia Murphy -- Vice President Investor Relations

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

Katy Huberty -- Morgan Stanley -- Managing Director

Toni Sacconaghi -- Sanford Bernstein -- Analyst

Wamsi Mohan -- Bank of America Merrill Lynch -- Analyst

Steve Milunovich -- UBS -- Managing Director

Tien-tsin Huang -- J.P.Morgan -- Analyst

Amit Daryanani -- RBC Capital Markets -- Analyst

Mark Moskowitz -- Barclays Investment Bank -- Analyst

David Grossman -- Stifel Financial Corp. -- Managing Director

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