Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Patricia Murphy -

Mark Loughridge - Chief Financial Officer of Finance & Enterprise Transformation

Analysts

A.M. Sacconaghi - Sanford C. Bernstein & Co., LLC., Research Division

Bill C. Shope - Goldman Sachs Group Inc., Research Division

Benjamin A. Reitzes - Barclays Capital, Research Division

Keith F. Bachman - BMO Capital Markets U.S.

Joseph D. Foresi - Janney Montgomery Scott LLC, Research Division

Katy Huberty - Morgan Stanley, Research Division

David Grossman - Stifel, Nicolaus & Co., Inc., Research Division

Edward Maguire - Credit Agricole Securities (USA) Inc., Research Division

Robert Cihra - Evercore Partners Inc., Research Division

Chris Whitmore - Deutsche Bank AG, Research Division

International Business Machines (IBM) Q1 2012 Earnings Call April 17, 2012 4:30 PM ET

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, Vice President of Investor Relations. Ma'am, you may begin.

Patricia Murphy

Thank you. This is Patricia Murphy, Vice President of Investor Relations for IBM. I'm here with Mark Loughridge, IBM's Senior Vice President and CFO, Finance and Enterprise Transformation. Thank you for joining our first quarter earnings presentation.

The prepared remarks will be available in roughly an hour, and a replay of this webcast will be posted to our Investor Relations website by this time tomorrow.

Our presentation 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 and in the Form 8-K submitted to the SEC.

Let me remind you that certain comments made in this presentation may be characterized as forward-looking under the Private Securities Litigation Reform Act of 1995. 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.

Now I'll turn the call over to Mark Loughridge.

Mark Loughridge

Thank you for joining us today. In the first quarter, we have reported $24.7 billion in revenue, expanded gross pretax and net operating margins and delivered operating earnings per share of $2.78, which is up 15% year-to-year. And now, 90 days into the year, we're increasing our full year 2012 expectation for operating EPS to at least $15. This is up $0.15 from our previous view of at least $14.85.

Looking at the results by segment. We continued our strong performance in software as we aggressively address opportunities in analytics, cloud and Smarter Planet. Our software profit was up 12%.

In services, we expanded margins and increased Total Services profit by 11% as we leverage our productivity initiatives and mix to higher margin offerings in markets. Services revenue growth was again led by growth markets, which were up 10% at constant currency. And our backlog in growth markets was up 14% at constant currency.

As expected, our hardware business declined as compared to a very strong growth of 19% in the first quarter of last year. This quarter, we extended our leadership in the UNIX market as we continued our competitive displacements in POWER.

And just last week, we announced PureSystems, the first new class of computing in over 20 years. This solution leverages IBM's decades-long investment in innovation and radically simplifies enterprise computing. This should start to contribute to the systems performance in the second half of the year.

Turning to profit. Our ongoing focus on productivity, together with the relative strength of our software business, drove strong margin performance. We expanded operating gross margin by over a point, led by services. And our operating net margin was up a similar amount, 1.1 points. Within net income, this quarter, we had a couple of unique items that impacted the dynamic between operating pretax income and our tax rate.

You'll recall that in the first quarter of last year, our workforce rebalancing was essentially offset by one-time investment gains. This quarter, our workforce rebalancing was very similar to last year. But this year, the charge was offset by a one-time tax benefit associated with a tax restructuring in Latin America. Excluding this one-time benefit, we expect our full year annual effective tax rate to still be in the range of 25%.

So a very similar dynamic to last year: with a gain offsetting our workforce rebalance charges, though, this year, the offset is included below the PTI line in tax. So through margin expansion, together with effective use of cash, we delivered operating EPS of $2.78, which was up 15% year-to-year.

Turning to cash flow. We generated almost $2 billion of free cash flow in the quarter, really strong performance. In addition to returning value to shareholders through a combination of share repurchase and dividends, our cash flow is enabling the ongoing transformation of the business, acquiring key capabilities and focusing our portfolio on the areas where we can add the most value.

This quarter, we closed 5 acquisitions for a total of $1.3 billion. The acquisitions increased our capabilities in analytics and cloud and our Smarter Planet initiatives. Now we'll get into the first quarter details starting with revenue by geography, where, as always, I'll discuss the results on a local currency basis.

In the first quarter, revenue at constant currency was very consistent with the fourth quarter and in line with our expectations. Revenue in our major market countries was essentially flat year-to-year. Within the Americas, performance was led by Canada, which was up 9%. The U.S. was flat, off of last year's strong growth of 7%. Europe, again, grew at 1%, in line with the fourth quarter, so we're seeing some stability there.

The most consistent performance has come from the U.K. and Spain. With 10% growth, the U.K. has delivered 10 consecutive quarters of growth. And Spain continues to leverage its global relationships, now growing in each of the last 6 quarters. Germany posted modest growth, while France declined.

Our growth markets outpaced the major markets by 10 points of revenue growth. Even with a tough compare, the BRICs had another good quarter. Combined, they were up 11%. And with about 60% of our growth markets business outside the BRICs, altogether, we had double-digit growth in 40 growth markets countries. This is our seventh consecutive quarter of share gains in the growth markets, and we're accelerating our market expansion initiative to continue that success.

Turning to revenue and gross margin by segment. Global Technology Services constant currency revenue growth rate was very consistent with the last few quarters. And Global Business Services growth rate continued to be impacted by weakness in Japan and public sector. Our software business had another great quarter, driven by our offerings in business analytics, Smarter Commerce and storage management.

In Systems and Technology, last year, we had a very strong first quarter, driven by product cycles in mainframe and POWER. So our growth rate this quarter reflects that difficult compare, though we continued to take share in UNIX.

Turning to gross profit. Our operating gross profit margin improved 1.2 points, driven by a combination of good margin expansion in both services segments and an improving segment mix due to the relative strength in software. Now let's take a look below the gross profit line to our expense and spending profile.

Our total operating expense and other income was up 3%. Acquisitions over the last 12 months contributed 2 points of the increase. Currency from both translation and hedging dynamics reduced expense growth by 2 points, and our base expense, excluding currency and acquisitions, was up 3 points. I'll comment on a couple of expense items that had larger year-to-year impacts to our profit.

First, in last year's results, we had investment gains of over $200 million, primarily for the sale of Lenovo shares. This gain effectively funded the $220 million of workforce rebalancing charges in last year's first quarter. This year, we had a one-time tax benefit from a tax restructuring in Latin America, and the tax benefit offset the workforce rebalancing charges, which, again, were about $220 million. So the net effect to net income was negligible, both within the period and year-to-year.

Another expense item I'll comment on is a year-to-year help from our hedging programs. We hedge our major cross-border cash flows to mitigate the currency volatility in global cash planning. Last year, hedging programs generated losses in the quarter. This year, our hedging was down $125 million year-to-year, as you would expect, given the year-to-year changes in currencies. Of this, about $85 million year-to-year is an expense, most of which is in other income and expense. Now keep in mind that you can't look at hedges in isolation. They mitigate the translation impacts across the P&L.

So now let me go into the segments. The 2 Services segments delivered $14.7 billion in revenue, grew pretax profit by 11% and expanded pretax margin by 1.3 points. Backlog was $139 billion, down 2% at actual rates and up 1% at constant currency. We started 2012 with continued momentum in our growth initiatives, margin expansion and strong profit growth.

Revenue in the growth markets was up double digits at constant currency again this quarter, driven by strong backlog growth. Total growth markets' backlog was up 14% year-to-year at constant currency, reflecting strong demand for both our outsourcing and transactional services in these markets. We also had strong performance in business analytics, cloud and Smarter Planet offerings.

Moving on to the 2 segments. In Global Technology Services, revenue was $10 billion, up 2% or 3% at constant currency. GTS outsourcing revenue was up 2% or 3% at constant currency, and we gained share again this quarter. Integrated Technology Services revenue grew 3%. We had great performance in the growth markets, up 14% year-to-year at constant currency. Global Technology Services delivered very strong profit and margin this quarter, with pretax income up 20% and pretax margin up 2.2 points.

There were 3 primary drivers of this margin expansion. First, we continued to benefit from efforts to deliver productivity and efficiency within GTS and in conjunction with the enterprise productivity initiatives. Second, we continued to get higher margins in the faster growing growth markets. And finally, GTS has done a tremendous amount of work managing their large portfolio of outsourcing contracts. Within that portfolio, there's a mix of contracts with different profit characteristics. We have taken a systematic and disciplined approach to solving problems in a select set of lower margin contracts, and we're seeing the yield from these efforts in our margin.

Turning to Global Business Services. Revenue was $4.6 billion, down 2% or 1% at constant currency. We had modest declines in both Application Outsourcing and consulting and systems integration. I previously mentioned the strong results in business analytics and Smarter Planet, where GBS is leading many of the engagements across IBM. Within GBS, business analytics grew 16% and Smarter Planet grew 18%. These are very important initiatives for IBM.

From a geographic perspective, the growth markets continued to perform well, with double-digit growth again this quarter, while the major markets continued to be weighed down by Japan and by public sector, which declined more sharply this quarter. Japan and public sector, which represent over 1/3 of total Global Business Services revenue, impacted the overall GBS constant currency growth rate by 6 points. GBS pretax income was also impacted by Japan this quarter. Two large contracts in Japan impacted our profit by almost $60 million. So Japan impacted both our profit growth and revenue growth in GBS this quarter.

But as you know, we have a good track record of managing a broad portfolio of contracts. This quarter, our Total Services business delivered double-digit profit growth, and we feel confident that we can continue throughout the year.

Software had another strong quarter, with revenue of $5.6 billion, up 5% or 7% at constant currency. Key branded middleware gained share for the 18th straight quarter as our software revenue mixes to the faster-growing branded middleware. This quarter, branded middleware accounted for 62% of our total software, up a point from the same period last year. Gartner once again named IBM the worldwide market share leader in the application infrastructure and middleware segment, an announcement that marks the beginning of the second decade of software leadership for IBM.

Segment pretax income was $1.9 billion, up 12% from last year. Now let me take you through the drivers by brand. WebSphere had another excellent quarter, growing 16% and gaining share for the 14th consecutive quarter. Within WebSphere, we had a strong contribution from our application server products and continued momentum in Smarter Commerce.

In the first quarter, we strengthened our Smarter Commerce integrated portfolio by completing the acquisition of DemandTec, a leader of pricing and promotion optimization solutions and our acquisition of Emptoris, which helps clients reduce procurement costs and risks.

With 5% growth, Information Management continues to perform well and gain share. Business analytics had a very strong quarter, with double-digit growth in Cognos. Our acceleration in Cognos is driven by the successful integration of our predictive capabilities into recent product launches spanning both business intelligence and financial performance management.

We continue to expand our global Netezza footprint, with about 2/3 of our new clients outside of North America. For the quarter, Netezza had a win rate of nearly 80% and head-to-head proof of concepts engagements.

Tivoli software was up 5%, and we held share. Within Tivoli, our storage portfolio was up double digits once again. Security, including Q1 Labs, contributed to our Tivoli growth, as clients turned to IBM for intelligence, integration and expertise across our comprehensive framework of solutions.

Rational grew 1%, and we gained share. Performance was driven by another quarter of double-digit growth in Telelogic. Overall, software had another terrific quarter, with revenue up 7% at constant currency, pretax income up 12% and pretax margins up 1.9 points. With this performance, software was a strong contributor to our growth initiatives.

Systems and Technology revenue of $3.7 billion was down 7% following the very strong growth a year ago. System z revenue declined 25% versus last year's first quarter growth of over 40%. MIPS declined 5% this quarter, and we mixed towards specialty engines. System z gross profit margin was up again, which is typical at this point in the product cycle.

POWER was flat and up 1% at constant currency. We had particular strength this quarter in POWER high-performance computing solutions. In POWER, we had over 250 competitive displacements, which resulted in over $200 million of business. Roughly 60% of this business came from HP, with most of the balance from Oracle Sun. This is the 16th consecutive quarter of share gains in POWER.

System x revenue was flat, and we held share. The System x revenue in the growth markets was up 17% at constant currency. This is the 10th consecutive quarter of double-digit revenue growth in these emerging markets. The storage hardware revenue was down 4%. The value continues to shift to software. And this quarter, storage software was up 18%.

Last week, we established a new category of computing with the introduction of PureSystems, a new family of expert integrated systems that leverages decades of IBM's innovation with market-leading software to help clients address the economics and complexity of deploying new IT infrastructure. These revolutionary systems will enable clients to implement and manage new IT capabilities quickly and efficiently.

Currently, companies spend 70% or more of IT budgets on simple operations and maintenance. PureSystems has the potential to lower total IT costs by more than 50% over 3 years, allowing the business to reinvest these savings towards new projects and innovation. These new expert integrated systems demonstrate the breadth of our innovation and the value we bring to our customers. This will start to contribute to our performance in the second half.

Also, you may have seen we just announced the sale of our retail store solutions business to Toshiba TEC and the creation of a partnership to address the Smarter Commerce opportunity. The financial implications will be outlined on our investor website, including commentary on the expected gain and how we expect to offset it with additional workforce rebalancing activity, primarily outside the United States. But what's really important is the relationship going forward. We're partnering with the world leader in point-of-sale systems. At the same time, we'll continue to build out our Smarter Commerce capabilities and our sweet spot, managing transactions and data and applying analytics. Combined, we'll have the best platform in the market for commerce.

Moving on to cash flow in the quarter. We generated $1.9 billion of free cash flow, up $1.1 billion year-to-year. In the first quarter of last year, our free cash flow was impacted by income tax payments, driven by audit settlement activity. Even if you adjust for the prior year tax impact, we had double-digit growth in free cash flow. The growth was driven by net income and working capital efficiencies.

Looking at the uses of our cash. We spent $1.3 billion to acquire 5 companies: Platform Computing, Green Hat, Emptoris, Worklight and DemandTec. These acquisitions add to our capabilities in analytics and cloud and Smarter Planet.

We returned $3.9 billion to shareholders, including almost $900 million in dividends, and we bought back 15.5 million shares for $3 billion. At the end of the first quarter, we had $5.7 billion remaining in our buyback authorization.

Turning to the balance sheet. We ended the quarter with a cash balance of $12.3 billion, up $400 million from year-end. Total debt was $32.1 billion, of which $23.6 billion was in support of our financing business, which is leveraged at 7:1. Our non-financing debt was $8.5 billion, up from $8 billion at year-end. At these debt levels, non-financing debt-to-cap was 33%, up 1 point from year-end. We continue to have a high degree of financial flexibility, and our balance sheet remains strong to support the business over the long term.

So now let me start to wrap up with a summary of the drivers of our operating earnings per share performance this quarter. Our ongoing focus on productivity, together with the relative strength of our software business, drove strong margin performance, with gross pretax and net margins all up year-to-year. And the lower share count contributed $0.15, fairly consistent with last quarter.

In fact, when you look at this quarter, it's really very similar to the fourth quarter in terms of the revenue growth, margin expansion and contribution from share repurchase. Even at the segment in geography level, revenue growth was similar to the fourth. Once again, our growth initiatives led the performance. Our growth markets' initiatives is based on expanding into new markets, building out IT infrastructures and leading in targeted industries. We have consistently delivered powerful performance and share gains. This quarter, growth markets revenue was up 9%, with 40 countries delivering double-digit growth at constant currency.

In business analytics, we have a broad portfolio of analytic solutions to help our clients deal with the massive amounts of structured and unstructured data. Our solutions are built on decades of organic investments, 30 acquisitions since 2005 and more than 9,000 consultants in GBS. This quarter, IBM's business analytics revenue was up 14%.

Cloud provides an efficient and flexible delivery platform that improves the economics of IT. Our smart cloud portfolio addresses the full scope of enterprise client requirements. Total cloud revenue doubled over last year, with strong contribution from all areas: private cloud, public cloud and our industry-based solutions. This all comes together in our Smarter Planet solutions. With over 25% growth this quarter, Smarter Planet continues to deliver strong growth driven by our new Smarter City solutions and continued strength in Smarter Commerce offerings. When you look at our offerings in business analytics, cloud and Smarter Planet, about half of the revenue is software, so the success we're having in our growth initiatives is improving our business mix and margin.

At the same time, we're continuing to invest in R&D, capital and acquisitions in support of these key areas. This investment is enabling us not only to expand existing markets, but actually create new markets and new categories of computing. Last week's announcement of PureSystems was a great example of how we're leveraging our organic research and development to create a game-changing solution for our clients.

So looking at our first quarter performance and all of these factors, we're increasing our full year 2012 expectation for operating earnings per share to at least $15.

Now Patricia and I will take your questions.

Patricia Murphy

Thank you, Mark. Before we begin the Q&A, I'd like to remind you of a couple items. First, we have supplemental charts at the end of the deck that complement our prepared remarks. Second, I'd ask you to refrain from multipart questions. When we conclude the Q&A, I'll turn the call back to Mark for final comments.

Operator, please open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from Toni Sacconaghi with Sanford Bernstein.

A.M. Sacconaghi - Sanford C. Bernstein & Co., LLC., Research Division

I was wondering if you could comment on the services business. I look at GBS and on a reported basis, it was down 2%, and I realize its public and Japan contributing very negative growth overall. But do you actually see that getting any better going forward? And in fact, it seems like it's getting marginally worse. And when I look at the outsourcing side, your backlog is now down 5% relative to a year ago. And backlog is a good leading indicator, especially in the outsourcing business. So perhaps you can help us understand how things get better from here. And on an as-reported basis, can GBS grow this year? And with a minus 5% backlog in outsourcing, how does that grow from here for the remainder of the year?

Mark Loughridge

Okay, Toni, a very good question. Let's start from first principles. First of all, when we started the quarter, we told you that the backlog run out we expected would be up 3% year-to-year. So in other words, we're looking at one, at the backlog for total services that it should influence revenue this year. And that backlog should affect about 70% of the revenue, so 70% of that 3% will drive about 2% revenue. And we had indicated that we felt confident that at that level of revenue, we could drive double-digit profit growth for the year. So let's look at it now by the individual units. If you look at GTS, I would argue they're right on track. This is the fourth consecutive quarter of 2.6% performance from our GTS team, and I think it's an indication that we do have that model specified correctly. And with that 2.6%, what did they do? They drove 20% profit growth and 2 points of margin improvement. So again, very consistent with our indication. When you look at GBS, actually the mechanics underneath that more on track, but we did get clipped by a couple of contracts that were more challenging for us. I gave you an example of a couple in Japan that impacted our profit by $60 million. Now outside of those 2 contracts, frankly, GBS would have grown their profit on a year-to-year basis. So if you consider those 2 contracts, I would tell you, number one, I think from a financial standpoint, we had the bulk of that behind us. And I don't expect and I don't see contracts in the distribution that will have that kind of impact going forward. Now I can't predict the future, but I do have a pretty good purview to the contracts that we're working on. Secondly, I'll tell you that GBS has, generally, over a longer period of time, been pretty good at managing these challenging contract elements. So I think from my perspective, this is a bit of an anomaly, and GBS should get these 2 contracts behind them in the first and improve their performance to more typical levels as we go into the second quarter. By the way, just as an aside I'd add, that if you look at IBM's revenue growth for services, up 1%, we were shy of 2% by $7 million. That's $7 million on a $15 billion base, so obviously, very close to the 2% level to begin with. I would also reiterate that even in the face of that, we had double-digit profit growth in services for the quarter, and we feel quite confident, given all of the elements that we see in the business equation for Services, we should be driving double-digit profit growth for the year.

Operator

The next question comes from Bill Shope with Goldman Sachs.

Bill C. Shope - Goldman Sachs Group Inc., Research Division

I have a question off of the profit comment you just made on services. How should we think about the drivers of pretax margin this year and frankly, beyond this year? You've had some pretty substantial improvements here. So how do we think about how much room you have left, a steady state on pretax services margins, which are certainly approaching record levels on an annualized basis? And frankly, where do you have room left to enact further savings?

Mark Loughridge

Sure. If you look at -- let's look of the drivers underneath the performance in our GTS business, again, profit up 20%, 2 points of margin. How did we achieve that and what do they have as far as sustainability going into the future? So number one, they -- GTS business, and frankly GBS as well, but GTS on a large part is a beneficiary of all the work that we're doing on productivity. Now you remember, at the Investor Day, Linda Sanford defined that and how we were managing that across those elements. The objective is about $8 billion over the roadmap period. We felt that we did quite well on that base last year. And I'll tell you that our view is that we're right on track in the first quarter. GTS once again benefits from that work. And they are really part and parcel of all the elements that we drive for productivity and spend management. Number 2, with those advanced tools and intellectual property, we're also working on not only the margins in the overall distribution but also the margins in the products that I would call the tail of the distribution, so more challenging contracts. And this year, the GTS team did a great piece of work on those contracts in the low-margin tail in the distribution of thousands of contracts and generated a very meaningful improvement in profitability that we know analytically extends throughout the year. And then lastly, I'll tell you, as we look at the dynamics in that business, our backlog growth for Total Services was up 14% in the growth markets. And in the growth markets, what we're seeing is we have 2 points better margin actually in those deals as well. So those 3 are ongoing dynamics, in my mind, and give us confidence that we have a strong play going forward.

Operator

The next question comes from Ben Reitzes with Barclays.

Benjamin A. Reitzes - Barclays Capital, Research Division

Mark, by guiding to $15-plus from $14.85-plus in effect with the $0.13 of upside versus the street, it would seem like you're backing where the street is for the rest of the year in EPS perhaps by quarter, at least for the 3 quarters of the year. And I was wondering if you agree with that comment. And then otherwise, what would be the upside drivers to those? Would there be cost-cutting? And/or is there any potential for revenues to start beating expectations as you go throughout the year with this IT environment?

Mark Loughridge

Sure, Ben. Very good point. If you look at the performance in the quarter, EPS up 15%, a very strong performance in our overall net income. Our cash flow -- free cash flow in the business, up $1.1 billion year-to-year. Even if you take into consideration last year's tax payment, that was up $300 million or 16%. So to me, the characteristics of this first quarter are quite strong. And really, it was based on our confidence in characteristics of the quarter and the going-forward equation that encouraged us to take our view of the business up $0.15. Now remember, taking your view of the business, up $0.15 only 90 days into the quarter, I think is a real show of confidence. If you look at the next 3 quarters, we see them up about 10%. And that 10% is the underpinnings to what we view is an at least $15 for the year. Now that 10% across those quarters is reasonably uniform. I do think the third quarter is probably a little tighter for us, but reasonably uniform. And at 10%, given a $15 base of performance on -- at the least basis for 2012, that's all the trajectory we need to get to $20 by 2015. So to me, I would say that to build base of the business looks like it's in pretty darn good shape and on track to achieve our longer-term objective in 2015. Now to your point, what do we see going forward? There's a couple of dynamics that I would remind you of. Number one -- and maybe a way to look at this is kind of headwinds, tailwinds. So as we look at it going forward for the second quarter or third quarter, we still will see the headwind from currency at about 3 points. We will still, as we go through the second quarter, have the compares challenged for us in the hardware base of business. As well, we will still be wrestling with the issues that we see in Japan in the second quarter. But I think, when we go to the second half, first of all, we have very strong software momentum. Second of all, we have a stable base of profitability and margin performance in our services business. But when you get to the hardware base of business, we have new announcement content that should drive that performance. We should regain revenue growth in the second half based on those new announcement, PureSystems being the first installment. And with that, we should see double-digit profitability in the second half from our hardware base as well. Rolling through all of that is the strength of our operating model and the strength of our growth initiatives. But I think stabilizing Japan in the second half and seeing the new announcement contribution from our hardware base of business, that's going to be a significant dynamic.

Operator

The next question comes from Keith Bachman with Bank of Montréal.

Keith F. Bachman - BMO Capital Markets U.S.

Mark, on the PureSystems, could you give us a little better sense about where you think the opportunities set is? And I'll rephrase the question a different way. IT departments have fixed budgets a year, so if they use or buy PureSystems, what are they not going to buy either of your portfolio and or competitor's portfolios?

Mark Loughridge

Yes, I think that's a very good question. When you look at -- let's look at our IT budget within IBM. If we were sitting here in the meeting with the RCIO and Linda Sanford working on it, what do we work on? We work on the percentage of our IT budget that we're able to move into new content and new opportunity, as opposed to just maintaining our existing base of business. That's how we run it, and we've been doing this year after year after year. Why is that relevant in PureSystems? Well, if you look at it, in a typical IT department, you could be spending about 70% of that budget on these kinds of simple operations and maintenance. We think with the PureSystems content, you'll have the opportunity to reduce that over a 3-year period by over 50%. That's an enormous contribution to your productivity. And as we would interpret that, if we were having that meeting today in my conference room, we would drive even more of our spend into new announcement content and new categories of IT spend. So I think it's a very powerful opportunity for us on a financial base. That doesn't even get to the unique capabilities and patterns of expertise that it has, built-in expertise, then the complex of business, integration by design. I mean, this can be up and running in as little as 4 hours. So to us, PureSystems is a first new system in 2 decades to hit this kind of an industry rollout, and we're very confident that it would go into the second half and as a big element of our game plan going into 2015.

Operator

The next question comes from Joe Foresi with Janney Montgomery Scott.

Joseph D. Foresi - Janney Montgomery Scott LLC, Research Division

I know you talked about Japan. I wonder if we could get the same type of color on what your expectations are for the public sector and Europe in the second half of 2012.

Mark Loughridge

Yes, sure. Let's talk about public sector first. As you could see, within public sector, we had 3% growth. In the quarter, if you break that down, the real strength in public sector was driven by 1, education. And frankly, within education, we have research laboratories as an example. We have a lot of very strong performance on our high-performance computing in our research centers. And secondly, we had real strength in health care and life sciences. They've had their 20th consecutive quarter of growth. So those 2 elements of overall public sector carried the business. On the government base of business, it's still pretty flat. And we see government spending, really globally, more challenged within that base of business. Your second question, really on Europe. Again, I would point out, as I think we've discussed before, Europe is not just a homogenous breakdown of countries. In the U.K., we had 10% growth, U.K. That's the 10th consecutive quarter of growth in the U.K. So it's not as if that's 10% on an easy compare. That's 10% on 2 years of real performance out of the U.K. business. So I think they've done a great job. Spain, we had growth for the sixth consecutive quarter. In Germany, we had growth for the second consecutive quarter. On the flip side, we're still down in France and down in Italy, but I think on balance, Europe to me, looks pretty stable. So if I would characterize it on a global basis going forward, I look at the major markets, we think they're relatively stable on a forward-looking basis. And the growth markets, I think, are showing some real strength.

Operator

The next question comes from Katy Huberty with Morgan Stanley.

Katy Huberty - Morgan Stanley, Research Division

Mark, you mentioned gain on sale from the point-of-sale business. Can you just give a little more clarity on the potential size and timing of that gain flowing through the P&L? And more importantly since the sale of POS gives you more confidence and flexibility to step up acquisitions and prepare for better top line growth and more mix benefits going into 2013?

Mark Loughridge

Yes. So if you look at the point-of-sale transaction, first of all, let me describe that as really a partnership between IBM and Toshiba TEC. So our objective with this is on a combined basis, to have the best commerce offering on the planet, so this is a real partnership for us. The gain associated with this is in the range of $450 million to $550 million. And we would expect to complete the transaction either late in the second quarter or early in the third quarter. Within that, we're going to maintain, for a 3-year period, a 19.9% equity again as a partner, and we're very confident about this combined offering going forward. Now with that gain, Katy, it gives us the opportunity, 1, to continue the workforce transformation and productivity initiatives we have going. And to your questions on acquisitions, I mean, look at the base free cash flow performance in this business. I mean, $1.9 billion in a first quarter, up $1.1 billion year-to-year. Admittedly, even if you took the tax payment of $300 million, believe me, we have sufficient free cash flow in the evidence of the base business we have today to continue to drive our priorities in our own internal capital, our acquisitions, share repurchase and dividends.

Operator

The next question comes from David Grossman with Stifel, Nicolaus.

David Grossman - Stifel, Nicolaus & Co., Inc., Research Division

Mark, I'm just going to back to the GBS gross margins. If we add back the $225 million of rebalancing back to the GBS number, and I don't know if that's right but just assume you do, and take the $60 million, I guess my math is coming out that the margins in GBS would be up modestly year-over-year. And I guess, number one, is that math right? And if so, what really drives the GBS numbers up beyond that in the second half of the year?

Mark Loughridge

Well, first of all, all of that does not apply just within GBS, when you look at the workforce rebalancing number, so that's implied across IBM. And so you can't really look at it that way. You can however -- if you look at those 2 contracts that I described that were more challenging in Japan, that $60 million, if you strip that out, it would have grown on a year-to-year basis and obviously, given the revenue characteristics, that would have been expanding margin. Now on a go-forward basis, we expect them in the second quarter to get a lot of those large challenging contracts, that we had in Japan behind us from a financial perspective, get back to more normal operating conditions. But to your question on the robustness of our margin performance, I would look at the total services base of business. I mean, this was a very powerful aggregate margin performance from services. And again, as I went through those characteristics that were driving the workforce productivity initiatives with Linda Sanford, the systematic approach to deal with low margin content, the higher margins that we're seeing in Total Services, not just GTS but Total Services and our growth markets unit put all those together, we feel quite confident that we will see margin expansion for the year and generate double-digit profit growth for services.

Operator

The next question comes from Ed Maguire with CLSA.

Edward Maguire - Credit Agricole Securities (USA) Inc., Research Division

You've referenced an 80% win rate on Netezza proof of concepts. Could you provide a bit more color on what you're seeing competitively elsewhere in the software division, as well as some of the dynamics around your contract renegotiations on the GTS side?

Mark Loughridge

Yes, well, software -- first of all, Netezza, since the acquisition, if you look at that combined effect over a longer period of time, what a success that's been, and that offering provides a more integrated approach to deal with our customer buying patterns. It's been a real win for us. In a way, I kind of look at it and say, what a good proof of concept that is not only its application in current deal pools, but as an indicator of the kind of opportunity we have with PureSystems going forward. So I think that's been very, very successful. On the software base of business, they had a great quarter. I mean, if you look at that performance, the profitability in the first quarter, $1.9 billion profit, up 12%; the base software content, up 7%; real double-digit strength in that WebSphere platform. I think we have a very, very competitive offering. So the software base of business is doing very, very well competitively. I think Netezza on that kind of integrated offering, really good proof point for us since the acquisition and again, gives us a lot of confidence on this integrated offering of PureSystems, which is not just hardware but hardware, software and services going forward into the second half.

Operator

The next question comes from Rob Cihra with Evercore Partners.

Robert Cihra - Evercore Partners Inc., Research Division

I was actually hoping if we could go back just to the acquisitions discussion. And just the -- you spent sort of, whatever, $1.3 billion year-to-date, but you only spent $1.8 billion, I believe, last year. So as part of your 2015 roadmap, you had, I believe, earmarked, call it, around $20 billion for acquisitions. But you're sort of 25% of your way time-wise there and you only spent about 15% on acquisitions. Does that signal any change in your view? Or is it simply that the reality of the math is never that linear and we should be still thinking about similar acquisitions strategy in something around $20 billion?

Mark Loughridge

Well, my advice to you is that the best indicator to use now is $20 billion for acquisitions through 2015. Now let's just go back to the math and the way we've describe this in the investment meetings that we've had in the last couple of years. As you look at it, if you look at that kind of $4 billion a year run rate -- and by the way, this is not going to be linear because it's dependent on how frothy the market or attractive the market is and how it integrates with our initiatives. But if you look at that, we frankly exited 2010 in a very strong position. Remember, we did well over $6 billion in 2010. So when we went through the model at that time, we said, we frankly have a pretty substantial head start. And if you have considered that we don't expect this to be linear. If you look at those -- that 2-year period of 2010 and 2011, $6 billion and $2 billion . On average, we did about $4 billion. So I think that run rate, on average, is a good indicator. I don't think it's going to be $4 billion every year. This year, $1.3 billion just for the first quarter, I would say we're kind of a hit pace [ph] on a run-rate basis. The second point I would make is given that we did get ahead of the profile in 2010 with a very successful set of acquisitions, 17 in total, that, frankly, put us ahead of the game as we looked at our EPS objective for acquisitions as part of the 2015 roadmap. Remember, we're looking for about $0.90. And given that the head start that we had coming out of 2010, we had to be able to hit that $0.90 at a spend rate of between $10 billion and $15 billion as opposed to $20 billion. So that provides, I think, opportunity for us. But from my perspective, I'd tell you from what I'm doing, I am viewing this as an opportunity for $20 billion in our treasury and our capital planning processes, believe me, we're reserving about $20 billion over the roadmap.

Operator

The last question comes from Chris Whitmore with Deutsche Bank.

Chris Whitmore - Deutsche Bank AG, Research Division

Mark, you alluded to applying the funds from the point-of-sale to your workforce rebalancing. So that, combined with the $225 million you took this quarter implies $700 million, $750 million of workforce rebalancing charges. Can you talk about the payback on those efforts, the timing on the execution and when we should start to expect that to flow through?

Mark Loughridge

Yes, sure. If you look at the overall view, I would use the 2010 as kind of a guide here. Now this year, it could be a little richer than that, as you correctly pointed out. On a full year basis, the vast majority is going to be spent outside the U.S. So we'll have slightly longer payback periods. But in the dollars that we spent on workforce rebalancing at the first quarter, we expect that to payback in the year. So I think we have a good plan. We still have a lot of work to do. We just signed a deal. We've got a lot of work to do if you get to closing that deal. But I think I would use that as kind of a guide on the workforce rebalancing charges.

So let me now just take a few moments to wrap up the call. From my perspective, the first quarter had a similar characteristic to the fourth and was a strong start to the year. We had great margin and profit and cash performance and continued the momentum in all of our growth initiatives. Remember, last quarter, I said that in 2012, we'll take a number of actions that position us to achieve our 2015 roadmap objective, including acquisitions and divestitures, investing in key growth initiatives and rebalancing our workforce to where we see the best opportunities. In the last 90 days, we've made great progress. We have a couple of strategic announcements that demonstrate our focus on higher value and ongoing transformation of our business. Our PureSystems announcement is a result of $2 billion of R&D and leverages decades of technology innovation and know-how. It's a new platform, and we believe it's a game-changing event for our clients. And we announced today a strategic partnership with Toshiba TEC that better positions us to address the important Smarter Commerce opportunity. So all of this gives us confidence to take up our expectation for the full year to at least $15 of operating EPS for the year. That's up almost 12% from last year and puts us on a good track to deliver at least $20 in 2015. So thanks for joining us. And now, as always, back to work.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: International Business Machines Management Discusses Q1 2012 Results - Earnings Call Transcript
This Transcript
All Transcripts