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IBM (IBM) Q4 2020 Earnings Call Transcript

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IBM (NYSE:IBM)
Q4 2020 Earnings Call
Jan 21, 2021, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

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 would like to turn the meeting over to Ms.

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

Patricia MurphyVice President, Finance and Operations

Thank you. This is Patricia Murphy, and I’d like to welcome you to IBM’s fourth-quarter 2020 earnings presentation. I’m here with Arvind Krishna, IBM’s chairman and chief executive officer; and Jim Kavanaugh, IBM’s senior vice president and chief financial officer. We’ll post today’s prepared remarks on the IBM investor website within a couple of hours, and a replay will be available by this time tomorrow.

Some comments made in this presentation may be considered forward-looking under the Private Securities Litigation Reform Act of 1995. These statements involve factors that could cause our actual results to differ materially. Additional information about these factors is included in the company’s SEC filings. Our presentation also includes non-GAAP measures to provide additional information to investors.

For example, we present revenue and signings growth at constant currency throughout the presentation. In addition, to provide a view consistent with our go-forward business, we’ll focus on constant-currency growth adjusting for the divested businesses for the impacted lines of total revenue, cloud, and our geographic performance. We have provided reconciliation charts for these and other non-GAAP measures at the end of the presentation and in the 8-K submitted to the SEC. So with that, I’ll turn the call over to Arvind.

Arvind KrishnaChairman and Chief Executive Officer

Hello, everyone. Thank you for joining today, and I’m pleased to be speaking with the investment community again. Over the next 15 minutes, I’ll talk about where we stand in the execution of our strategy as we begin 2021 and how we are running the company to align with the strategy. I’ll provide a perspective on the current environment and our results.

Then in the spirit of being as transparent with you as possible, I will speak to our expectations for the next two years. Jim Kavanaugh will then cover the quarter, give more detail on the separation process for our Managed Infrastructure Services business. I’ve also asked Martin Schroeter to join us to make a few comments as the recently named CEO of this business. Jim will conclude with additional color on our 2021 expectations, and then Jim and I will take your questions.

I’d ask you to please bear with us if we go slightly longer than usual on this call. When I was appointed CEO in April, I laid out my approach to growing the value of the company which is straightforward. We will significantly increase our focus on our hybrid cloud and AI capabilities, the two most important transformational journeys for our clients. In the nine months since then, we have taken a series of important actions to redefine our future as a hybrid cloud platform and AI company.

This is where we are focusing the bulk of our efforts, time, and investments. In spite of the many challenges in 2020, we have made good progress. In 2021, and we believe you will see that progress showing up in our results. With that said, we know it’s not necessarily going to be a straight line.

The operating environment remains difficult because of what clients are experiencing at the moment. We can see that in the quarter just past. Our revenue was slightly behind typical seasonality, but we finished strong in free cash flow, which is important as it’s the fuel for investments. Our performance reflects the fact that our clients continue to deal with the effects of the pandemic and broader uncertainty of the macro environment.

This puts additional pressure on larger software transactions this quarter and project delays in some services engagements. Our revenue growth was also impacted by IBM-specific headwinds of our product cycle and compare challenges. Notwithstanding the short-term market dynamics, we believe we have the plans in place and the focus inside the business to be able to grow in 2021. That said, in the midst of all this, I’m seeing an ever-greater need from clients to accelerate their digital transformation, and this bodes very well for us now and over the long term.

As I’ve told you before, the opportunity in hybrid cloud and AI is enormous. In fact, we see the hybrid cloud opportunity at $1 trillion, with less than 25% of workloads having moved to the cloud so far. Our approach is platform centric. Linux, along with containers and Kubernetes, provides the foundation of our hybrid cloud platform.

And Red Hat OpenShift is the core product that captures all this and more. Our hybrid cloud approach is also differentiated by a vast software portfolio, modernized to run cloud-native, and our GBS expertise which plays a key role in driving consumption and is currently helping hundreds of major clients on their own hybrid cloud journeys. With this foundation in place, we are successfully leveraging Red Hat as a unique platform to address what our global, complex and highly regulated clients need. A hybrid cloud platform that is open, flexible and secure.

Our hybrid cloud approach allows clients to connect their back office to their front office to modernize mission-critical workloads, to build cloud-native apps, and to securely deploy and manage data and applications across various clouds. We are confident that we have the right strategy for our clients and for IBM. Let me comment on some of the proof points we have seen over the last few months as we execute on our hybrid cloud platform and AI strategy. First, to drive leadership and focus as a hybrid cloud platform company, a key element of this strategy is to win the architectural battle in cloud.

And with our cloud foundation in place, client consumption continues to grow. We now have 2,800 clients using our platform, a number which has grown 40% over the last year. In the fourth quarter, clients such as Barclays, Walmart, GEICO, Airbus, Ford, ABB are all leveraging our hybrid cloud platform to accelerate their own digital transformation journeys. We’re also making good headway in our focus on industry clouds which are designed to tackle the specific needs of mission-critical and highly regulated industries.

Following the successful launch of our cloud for financial services last year with more than 75 IS suites and SaaS partners, including Adobe, Infosys Finacle, Persistent Systems, and many others, we launched our cloud for telecommunications in November. So far, more than 35 partners have joined our cloud for telecommunications. For example, Samsung is working with IBM and Red Hat to develop new user experiences for business. We’re also helping major companies like Verizon, Vodafone Idea, Bharti Airtel, and AT&T to transform their IT and telecom network operations.

Second, to be the trusted partner of clients for data and AI. The opportunity in AI is massive, while the current enterprise deployment rate is in the single digits. Clients are now at the point where they are moving from experimenting with AI to deploying it at scale. To seize this opportunity, our AI platform is focused on data, automation, and security and now includes more than 30,000 clients who have turned to IBM to unlock value from their data.

We’re helping clients across industries build intelligent workflows by infusing AI into their core business processes, such as hiring, supply chain, and customer service. When it comes to data and AI, trust is paramount. IBM is unique in that we make a hard commitment not to monetize or use our clients’ data. We also offer the industry’s strongest commercially available cryptographic technology.

And we give clients the ability to retain control of their own encryption keys. In the fourth quarter, clients such as Air Canada, Sprint T-Mobile, State Street, and Humana used our rich data and AI capabilities to drive business outcomes. As we look forward, we are also investing to develop and address future market opportunities, such as quantum computing. Quantum has the potential to unlock hundreds of billions of dollars of value for our clients by the end of the decade.

To seize this opportunity, we have a road map to build 1,000-plus qubit quantum computer by 2023, and we have expanded our suite of quantum computers on which our clients are working today. I want to now spend a couple of minutes on a series of significant changes we are making to the company, most since just the beginning of October. We know that a platform-centric strategy requires a fundamentally different way of doing business. This is why our operating model is to be quietly but substantially reshaped.

These decisive moves are all aimed at creating value through greater focus on our portfolio, our operating model, and the needs of our clients. And as they take hold, they will help us to deliver sustainable, mid-single-digit revenue growth post separation. To drive greater focus on our portfolio, we announced the separation of our Managed Infrastructure Services business in October. As I just mentioned, this month, we appointed Martin Schroeter as this new company’s CEO.

Martin has a unique understanding of the business, its global talent base and 4,600 clients. You’ll hear from him shortly. So much remains to be done. We are on track to complete the spin by the end of the year.

We are working closely with clients to ensure a smooth transition, while we are also renewing business and signing new deals. We have a comprehensive project management office to establish the new entity and to optimize the business. I can tell you, there’s a great deal of excitement among our employees about the opportunities ahead for this new company. To strengthen our hybrid cloud and AI portfolio, we have announced 10 acquisitions since I became CEO and seven acquisitions just since October.

This includes five in global business services, which add skills to help our clients with their journeys to cloud; Red Hat’s first acquisition as part of IBM that adds cloud-native security capabilities for OpenShift. Our investments in organic and inorganic growth and in our people will continue to be sharply focused on both hybrid cloud and AI. To accelerate consumption of our hybrid cloud platform, we are also rapidly expanding our ecosystem by adding hundreds of new partnerships with global system integrators, independent software vendors, and major third-party software partners and also elevating the role of partners. We’re investing $1 billion in our ecosystem so that our partners can play a much bigger role in fulfilling the many needs of our clients.

As an example, we recently teamed up with Salesforce to deliver a new strategic contact-tracing platform for the U.K. National Health Services to help them in their fight against COVID-19. Salesforce and IBM have also joined forces to address key challenges such as vaccine management using IBM’s Sterling supply chain solution, and our blockchain-based digital health pass together with Salesforce’s vaccine management and CRM capabilities. To simplify and transform the way we engage clients, earlier this month, we announced a new go-to-market model.

The first aspect is that we have simplified our sales model by adopting a single consistent segmentation which will make it easier for clients to work with us and unlock a great deal of productivity. In addition, we are providing clients with a more technical and experiential approach with investment in presales garages that allow us to co-create with our clients earlier in the sales process. And we’re ensuring our sales organization is fully incentivized toward our strategic growth areas. Finally, we’re investing in and elevating the role of our ecosystem partners to deliver more value to clients.

Let me say a few words about the changes we’re bringing to our culture. Since I became CEO, I’ve talked a great length about the importance of culture and the need to instill a growth and entrepreneurial mindset. As part of that, we are encouraging more business risk-taking and ensuring a higher tolerance for failure across the business. This should allow us to more quickly respond to clients, seize more opportunities and drive better business outcomes.

I’m only scratching the surface of all the actions we have taken to sharpen our focus. As a result, we are running the company differently as we begin 2021. I’m convinced that all these changes will allow us to deepen our client footprint and open up new avenues for growth. Now, let me speak to our expectations for the next two years.

All of the actions I’ve taken are designed to drive growth, and we expect to deliver sustainable mid-single-digit revenue growth post separation, with strong free cash flow performance. How do we achieve this? First, through the continued strong growth of Red Hat, which has grown 18% on a normalized basis in 2020 and will be an even larger contributor to revenue growth post separation. Second, with improvement in the Global Business Services trajectory, we expect GBS to return to its pre-pandemic growth rate by the middle of the year. Third, by leveraging our expanded ecosystem to further contribute to both GBS and software.

And we’ll finally start to see the benefit from the investments we are making, both organic and inorganic. These will all contribute to an improving software trajectory as well. In the first half of the year, we expect our results to continue to reflect some of our current challenges, as well as our product cycle dynamics. And of course, all year, we’ll be working on the separation of Managed Infrastructure Services.

But these are not long-term trends in the business, and these headwinds will dissipate. In 2021, the significant changes we have made to focus on hybrid cloud and AI will also begin to take hold. The company will look different at the end of the year, particularly with the execution of the spin out, but also with the operational changes to sharpen our focus. At a high level, in 2021, we expect to grow revenues at current spot rates, with better performance in the second half than the first half.

This is the first step toward achieving mid-single-digit revenue growth post separation. And we expect to generate between $11 billion to $12 billion of adjusted free cash flow. These are the measures we are focused on. This is where we stand today and how we will operate to achieve our growth goal.

Jim will cover all this in more detail. Over to you, Jim.

Jim KavanaughSenior Vice President and Chief Financial Officer

Thanks, Arvind. I’ll go through our performance and then wrap up with a perspective on how the actions we’ve taken in 2020 position us to deliver on these financial objectives. In the fourth quarter, we delivered $20.4 billion of revenue. We expanded our gross profit margin with a significant charge for structural actions that improve our go-forward position.

We reported operating earnings per share of $2.07. We generated free cash flow of $10.8 billion for the year, and we have strong liquidity with a cash position of over $14 billion. The fourth quarter is our seasonally largest transactional quarter. And I’ll remind you that a year ago, we had a very strong software performance and our first full quarter of z15 availability.

We knew that given our product cycle dynamics and the pressure from the current environment that the fourth quarter of 2020 would be our most challenging in terms of year-to-year revenue performance. 90 days ago, we expected revenue and operating earnings per share to be in line with historical third to fourth-quarter seasonality. In 2020, our fourth-quarter revenue came in slightly below our typical seasonality, while EPS was at the higher end of the historical range before the charge for structural actions. And we had a good finish to the year in free cash flow.

The challenging environment we’ve seen since March continued with the shift in clients’ buying behaviors and priorities. Given the level of macroeconomic uncertainty, more clients tended to move toward shorter-duration engagements impacting our software revenue. But we did have a good IBM Z relative to where we’re at in our product cycle. We also continue to see good demand in offerings that support our clients’ digital transformations, and we’re driving strong adoption of our hybrid cloud platform.

Arvind mentioned, we now have 2,800 clients using our hybrid cloud platform. For perspective, that’s more than 1,000 new enterprise clients since we acquired Red Hat. Red Hat continued its strong performance with normalized revenue growth of 17%. That’s slightly higher than the third-quarter rate, driven by subscription growth.

Strong subscription bookings contributed to over 20% backlog growth, and the Red Hat backlog is over $5 billion for the first time. Global Business Services continues to drive adoption of OpenShift and IBM Cloud Paks, and over the course of 2020, we accelerated the number of GBS engagements using Red Hat technology with 260 engagements for the year. We’ve discussed the economics of a platform model, with the software and services revenue multiple anywhere from 3x to 8x to platform revenue. Our full-stack cloud capabilities from infrastructure up through our cloud services generated over $25 billion of cloud revenue in 2020, which is up 20% over the prior year.

IBM is a high-value business, generating ample profit and free cash flow to invest for future growth and support our dividend policy. We again expanded our operating gross profit margin, up 70 basis points in the fourth quarter and 130 basis points for the year, with expansion across software, services, and systems. This operating leverage at the gross margin level enables higher investment in innovation, in skills, and an ecosystem. Our fourth-quarter pre-tax profit also reflects a charge of over $2 billion for structural actions to simplify and optimize our operating model and reinvest the savings to accelerate growth.

This charge is $260 million or about $0.25 of EPS less than what we discussed back in October, driven by a few countries, primarily in Europe, with government restrictions on certain employment actions in the current environment. This charge did not have much impact on our fourth-quarter cash flow. And we generated over $6 billion of free cash flow in the quarter and $10.8 billion for the year. Our free cash flow performance in 2020 was driven by working capital improvements and contribution from Red Hat, net of related interest.

This was offset by increases in net capital expenditures to scale our cloud infrastructure and workforce rebalancing payments from previous actions. We continue to have high free cash flow realization, which was well above 100%, as expected. We ended the year with a cash balance of $14.3 billion, which is up over $5 billion, while our debt was down $1.4 billion, with $4.5 billion of debt maturities in the fourth quarter. Now, let me turn to the segments, starting with Cloud & Cognitive Software.

Revenue was down 7% in the quarter, and gross margin was up 20 basis points. This year has proven to be a challenging transactional environment, especially in the fourth quarter, which is our largest transactional base. As I said, we have particularly strong software performance a year ago, when revenue was up 10%. The fourth quarter of 2019 was the peak of our enterprise license agreement or ELA cycle, which renew about every three years on average.

With the uncertainty our clients are facing in the current environment, we’re seeing many of them opt for shorter duration ELAs. This dynamic, in combination with the large seasonal volume of ELAs in the fourth quarter, pressured the fourth-quarter software revenue performance. At the same time, our renewal rates for subscription and support improved this quarter. In fact, it was the strongest year-to-year increase in some time.

This is evidence of our clients extending their commitment to our software solutions. In this environment, our hybrid cloud and AI solutions like Red Hat and Cloud Paks are resonating with clients. In Cloud & Data Platforms, revenue was up 6%. Red Hat delivered double-digit growth in both infrastructure and app development and emerging technologies.

We continue to gain share in both product areas, instantiating the importance of our hybrid cloud platform and the Linux Foundation to our clients. Earlier this month, Red Hat announced plans to acquire StackRox, a leader and innovator in container- and Kubernetes-native security. This further enhances Red Hat OpenShift, the industry’s leading enterprise hybrid cloud platform. Within Cloud & Data Platforms, we’re also building out our integration offerings, bringing AI-powered automation across the portfolio through key partnerships and new innovation.

During the quarter, we acquired Instana, an application performance monitoring, and observability company. We also expanded our partnership with ServiceNow to develop a joint solution around Watson AIOps, an IBM solution which helps enterprises to self-detect, diagnose and respond to IT anomalies in real-time. And we continue to enhance the Cloud Pak for Automation, which grew at a strong double-digit rate this quarter. Our Cognitive Application revenue was down less than 2%.

We had growth in security, fueled by our modernized Cloud Pak for security and services. This was offset by a weaker performance in solutions concentrated in industries more impacted by the current environment, like TRIRIGA, which is focused on commercial real estate. As expected, our software performance was most impacted by transaction processing platforms. Clients’ prioritization of opex over capex was amplified this quarter, with our strong seasonal mix toward transactional revenue and the ELA dynamics I just described.

In Cloud & Cognitive Software, we remain focused on our hybrid cloud and AI strategy, and we’ll continue to invest in our portfolio as we head into 2021. In Global Business Services, revenue declined 5%, which was about 1 point of sequential improvement from the third quarter. And we had gross margin expansion of 260 basis points. Our book-to-bill in the quarter was strong, contributing to backlog growth for GBS.

While there remains some market uncertainty, clients are looking to accelerate their digital reinventions by leveraging business transformation services built on hybrid cloud. Our offerings are aligned to this high-value opportunity with a clear focus on reimagining workflows using AI and modernizing the underlying application infrastructures through hybrid cloud. We see this in our GBS results. First, our GBS cloud revenue grew at a double-digit rate for the quarter and the year and is now almost $6 billion annually.

Second, our Global Process Services revenue returned to growth as we deliver efficiency and flexibility to our clients’ processes by infusing innovative technology and redesigning workflows. And third, our consulting signings grew 8%, driven by advisory work for application modernization and enabled by our unique and experiential garage methodology. In Application Management, our performance reflects a continued shift from traditional on-prem services to building and managing cloud applications. Our incumbency in Application Management creates the opportunity and trust to be the partner of choice for their digital journey.

This GBS incumbency plays an important role in driving adoption of Red Hat’s hybrid cloud platform. As I mentioned earlier, our GBS Red Hat engagements accelerated through the year. We had 75 engagements in the fourth quarter, with clients including BMW, Humana, Samsung Electronics, IKEA, and Costco. And similar to last quarter, approximately one-third of our quarterly Cloud Pak revenue resulted from GBS engagements.

To continue this momentum, we are investing in ecosystems, resources, offerings, and skills. Arvind mentioned, we have announced five GBS acquisitions in the last few months. Nordcloud and Thales provide cloud-native development, multi-cloud migration, and platform engineering solutions that advance our clients’ cloud journeys. And 7Summits, a leading SalesForce partner; Truqua, a leading SAP partner; and Expertus, a leading digital payments solutions provider, are collectively at the center of our clients’ digital transformations.

Finally, the investments we have made in our delivery capabilities, such as our innovative dynamic delivery model, have resulted in improved delivery quality, which are reflected in our Net Promoter Scores and our gross margin expansion. Turning to systems, revenue was down 19%, driven by product cycle dynamics, while our gross margin expanded 380 basis points. We saw the product cycle dynamics play out in IBM Z, power, and storage. Power revenue was down at a level consistent with last quarter.

And storage revenue was also down, driven by high-end storage tied to the IBM Z cycle. IBM Z revenue was down 24% as we’ve wrapped on a strong growth in the fourth quarter last year when we were up 63%. 90 days ago, I mentioned that clients and sectors like banking and financial markets made purchases early in the cycle to manage through robust market volatility. While those in select other industries focused on cash preservation, elongating z15 adoption.

We’ve made up ground in the quarter and improved adoption in some of the lagging industries. IBM Z delivered growth for the year despite a second-half wrap on the product cycle and within a challenging environment. This reflects the importance of this high-value, secure, and scalable platform with cloud-native development capabilities. Based on this performance, we expect z15 to be fairly consistent with prior cycles.

And looking back over a longer period of time, our installed base of MIPS is over 3.5 times the level of a decade ago, with 60% of our installed base now in new workload areas like Linux. The systems portfolio continues to deliver critical and lasting value to our enterprise client base in support of our hybrid cloud strategy. Turning to GTS. While revenue was down 8%, we expanded gross margin by 70 basis points.

We had strong contract renewals and added a number of new clients. As Arvind mentioned, at the beginning of October, we announced the spin-off of our Managed Infrastructure Services business into a separate public company, which we’re referring to as NewCo for now. We are making good progress on that work and remain on track to complete by the end of the year. As we discussed in October, this process is complex and includes working with clients to ensure a smooth transition to NewCo as the world’s leading infrastructure services provider; optimizing the business model to improve its financial profile; and executing upon the necessary financial, legal, and regulatory milestones to enable the transaction.

I’ll give you some additional color on each of these three areas. First, from a client perspective, we are deeply engaged with our clients that make up the $62 billion of backlog, and they are strongly supportive. We are seeing client confidence in NewCo’s long-term value proposition to manage and modernize mission-critical infrastructures. This quarter, we had wins at clients such as Dutch Ministry of Defense, PhoneGroup, and Bankinter.

In the fourth quarter, we signed 11 new logo deals, which is more than double the prior year and one of the highest in the last couple of years. Our renewal rates of existing contracts this quarter were also at the higher end of our historical performance. However, while we had a strong pipeline as we entered the quarter with the announcement, as expected, some negotiations were extended, resulting in some deals moving out of the quarter. Secondly, we are optimizing the NewCo business to have a leaner and more efficient operating model.

We continue to take a disciplined approach to improving our margins and overall financial profile. As part of this, a considerable portion of the $2 billion charge for structural actions was for GTS. We also have taken steps to restructure existing contracts and further reduce activity and lower-value offerings. These actions impacted our revenue performance this quarter but contributed to the gross margin expansion of 70 basis points.

All of this positions NewCo for an improved margin, profit, and cash generation profile. Lastly, NewCo has an unparalleled operational footprint. It has approximately 90,000 employees and operates in roughly 115 countries. And as you know, Managed Infrastructure Services is an integrated business, not only within IBM but within GTS.

We are executing on our detailed plan to achieve the milestones to create a stand-alone company. Today, we are working with works councils on employment terms, establishing NewCo’s legal entities across the world, drafting the agreements, which outlined the ongoing relationship between IBM and NewCo, and developing audited financials. We expect the Form 10 to be available in the fall, at which time we will conduct investor outreach. We will continue to update our progress as we move through the year.

This is a good place to pause and turn it over to Martin Schroeter, NewCo’s new CEO.

Martin SchroeterChief Executive Officer

Thank you, Jim. I’m delighted and honored to be briefly speaking with you today on IBM’s earnings call as the CEO of NewCo, and yes, we are working on a name. When Arvind and I began talking about this role, he let me speak with all the teams who are working on it. And as I did my due diligence, it became very clear to me that I absolutely wanted to be a part of this.

With the outstanding talent in NewCo, the nature of NewCo’s work for the leading companies in every industry, and the freedom of action or the mandate that NewCo will have, I could not be more excited about the future of this business. Of course, as Jim noted, we have a lot of work to do prior to NewCo being a separate publicly traded company. And as we put all of that together, I’ll tell you more of the story about what NewCo will look like. In the meantime, we do know what we have to get right in order to realize the tremendous potential we see.

First, we know that we must continue to serve our clients. These industry leaders, NewCo’s clients, trust us to deliver some of their most important workloads in challenging environments, and NewCo will continue to do that. It’s what our clients expect and deserve. It’s always been NewCo’s true north and will continue to be.

And over time, our clients will see our strong investments bring new capabilities into their environments to help their ongoing journey into a more digitized world. Second, we must continue to invest and develop our teams. The teams our clients see and need every day. To our clients, our people are the face of NewCo, and they are the people who know how to make these complex systems work.

So we’ll build the right inclusive culture around client service, innovation, and talent, so our clients continue to see how our team shine brighter than any other. Third, and in support of the other elements of our business, we must establish the financial model for NewCo that ensures our long-term success. IBM has already provided, at a high level, some of the characteristics of NewCo’s financial profile when it becomes independent, and we’re working on the specifics now in order to give you a complete and clear view of NewCo’s profile. But we know that NewCo’s long-term success requires the right starting point.

And we’ll make sure NewCo has launched the right way. And of course, we must build a strong relationship with our owners and the broader stakeholder community. To that point, I look forward to discussing the opportunities we see and how we intend to capture them in due course. As I said, I was not going to miss the opportunity to be a part of this with a sharper focus and broad freedom of action, we have a tremendous opportunity to drive client value and translate that into a compelling investment thesis.

Now, I’ll turn it back to Jim.

Jim KavanaughSenior Vice President and Chief Financial Officer

Thanks, Martin. Now, before the Q&A, I want to bring it back up to the IBM level with a summary of the actions we are taking and the resulting expectations for 2021. These actions span our portfolio, our operating model, and our capital structure. After building a foundation in hybrid cloud and accelerating Red Hat platform adoption, we are now separating Managed Infrastructure Services to better align to our platform strategy and improve the financial profile of both businesses.

At the same time, we are increasing investments, organic and inorganic, in innovation, expertise, and ecosystems. We’re investing in platform capabilities, including security and industry-specific clouds. We’re investing in data and AI and in technologies like Quantum to create future market opportunities. As we bring these innovations to market, we’re adding GBS’s skills and expertise.

We’re making changes to our go-to-market to engage our clients in a more technical and experiential way. And we’re expanding our ecosystem to drive platform adoption and broaden our reach. And in the fourth quarter, we executed structural actions to simplify and streamline our business. These actions will improve the EBITDA profile of NewCo, address stranded costs from the separation and generate savings that will be reinvested to extend our position in hybrid cloud and AI and accelerate our growth.

We have also taken actions to enhance our balance sheet and liquidity resulting in a stronger financial position. We have focused our captive financing business on IBM’s hybrid cloud and AI offerings. We’ve exited OEM commercial financing and have entered into an agreement to sell our IBM commercial financing receivables. As a result, our financing receivables have declined from $32 billion to $18 billion over the last two years, reducing our external debt needs.

Looking at our retirement-related plans, as you know, we have shifted our asset base to a lower-risk, lower-return profile. At the end of the year, our plans remain well funded. Our overall returns in 2020 were well ahead of expected returns, and the funded status of our worldwide qualified plans was consistent with last year. Bringing it all together, we feel good about the path we’re on moving into 2021.

And as Arvind said, we expect an improving financial profile throughout the year. For the full year, we expect to grow revenue at current spot rates. In the first half, we expect our results to continue to be impacted by the shift to shorter-duration software transactions as clients deal with uncertainty, and by our IBM Z product cycle dynamics. At the same time, we expect GBS to return to pre-pandemic revenue growth rates by midyear.

As I mentioned, we weren’t able to execute the structural actions in all countries in the fourth quarter. We anticipate the restrictions will be lifted over the next several months and are planning to execute the remaining structural actions in the first half of 2021, which will result in $260 million of pre-tax charges. Looking at our cash flows, we expect $11 billion to $12 billion of adjusted free cash flow in 2021. This reflects a year-to-year cash tax headwind of about $1 billion.

But to be clear, this adjusted free cash flow does not include the cash impact of the structural actions or the transaction cost associated with the spin-off of our Managed Infrastructure Services business. For perspective, at this point, we expect to pay about $4 billion for these items over the next 18 months, with about $3 billion in 2021. As we look to 2022, we expect to build on this with adjusted free cash flow in the range of $12 billion to $13 billion. I also want to comment on our balance sheet as we enter 2021.

We’re in a strong liquidity position with over $14 billion of cash on hand. Our plan is to continue to deleverage, and we expect debt reduction throughout the year aligned with our scheduled maturities. So we’ll have further progress in reducing debt since our peak debt balance when we financed the Red Hat acquisition in mid-2019. This, together with the actions to focus our financing business, give us confidence in operating at a single A credit rating, while we continue to delever.

In sum, we expect to continue our progress as a leading hybrid cloud and AI company in 2021 with an improving financial profile. So with that, let’s go to Q&A. I’ll turn it back over to Patricia.

Patricia MurphyVice President, Finance and Operations

Thank you. Before we begin the Q&A with Arvind and Jim, I’d like to mention a couple of items. First, we’ve included supplemental information for the quarter and the year at the end of the presentation. And finally, as always, I’d ask you to refrain from multi-part questions.

Operator, let’s please open it up for questions.

Questions & Answers:

Operator

Thank you. [Operator instructions] Our first question comes from Wamsi Mohan from Bank of America. Your line is open.

Wamsi MohanBank of America Merrill Lynch — Analyst

Yes. Thank you. Arvind, I was hoping you might be able to double-click a bit on your comments on the software turnaround. Realizing you had a tough compare in transaction processing, you still had Cognitive Apps decline.

What specifically is being done to turn that business around to growth as we get into 2022? And what are the assets that will drive the growth there? And if I could, Jim, could you just bridge the $12 billion to $13 billion in free cash flow in ’22 versus the $10.8 billion? It seems if you hit the mid-single-digit growth rate there, that’s an incremental maybe $3 billion in revenues versus the $1 billion to $2 billion in incremental cash flow, which seems like very high cash flow margins, so if you could clarify that bridge. Thank you so much.

Arvind KrishnaChairman and Chief Executive Officer

Hi, Wamsi. Thanks for the question. Look, we expect to see improving software performance through the year, both in ’21 and headed into ’22. As Jim said in the prepared remarks, a lot of the shortfall in software came from the TPP segment.

And in that segment, as you know, we intend to have very large deals that tend to come in the fourth quarter. So it was somewhat unique in 2020, and that is not something we expect to see at the same scale going forward. So the headwinds in some sense will reduce because of the reduction in that aspect. Then on the positive side, we expect to see continued Red Hat growth.

We expect to see continued growth from our Cloud Paks. We expect to see continued growth as the sales force changes we have made drive a much greater focus across IBM on this part of the portfolio, both in Cloud & Data Platform and on the AI applications. We also expect to see, as Jim mentioned, that as the security and the IoT assets within the applications become larger and larger with the growth there, they will more than compensate for some of the other pieces that may not be so big because just the law of compounding is going to get us there. And lastly, remember, other than all the organic actions, we are also doing inorganic actions.

You saw us announce both Instana and StackRox in the last couple of months. And these and other future acquisitions would also drive growth because they help the entire portfolio, not just acquired pieces. Jim?

Jim KavanaughSenior Vice President and Chief Financial Officer

OK. Thanks, Arvind, and thanks, Wamsi, for the question. Very important as many of our investors have been asking us about the free cash flow generation profile of this company. Why? It’s because it’s going to be the engine to fuel the investments for that growth that we committed here in 2021.

But let me take a step back because I think it’s important to understand coming off of a strong finish on free cash flow in 2020 delivering $10.8 billion, 143% free cash flow realization, first, how does that bridge go to 2021 at $11 billion to $12 billion of adjusted free cash flow. And then I think you’ll see how we then continue to accelerate that to $12 billion to $13 billion overall. So as we said in the prepared remarks, first, revenue growth, which is going to be essential here. Second, and I think you’ve seen this over the last couple of years, we have driven the productivity and operating leverage out of this business with our gross margin expansions, I think, now for about eight to 10 quarters in a row.

So not only are we going to now turn around to revenue growth, we’re going to get operating leverage. And that’s going to deliver a significant amount of operating profit contribution to free cash flow, coupled with Red Hat being accretive net of interest expense already as we achieve our accretion in third quarter. Now, what’s happening from 2020 to 2021? We’re going to get substantial operating profit, but we’ve got a big cash tax headwind in 2021. So while you’re seeing nice growth from $10.8 billion to $11 billion to $12 billion, we’re already overcompensating for $1 billion roughly of cash tax headwind.

Now, when you get to 2022, we’re going to get that same level of operating profit contribution that has good leverage, but we have a much more de minimis cash tax headwind in 2022, which makes us very confident in our ability to give guidance at those levels for the next two years.

Patricia MurphyVice President, Finance and Operations

OK. Thank you, Wamsi. Can we go to the next question, please?

Operator

Our next question comes from Amit Daryanani from Evercore ISI. Your line is open.

Amit DaryananiEvercore ISI — Analyst

Thanks for taking my question, and nice to hear your voice, Martin. I guess the question really is on the GTS side and the spin of NewCo. The revenue trajectory on GTS, the drop was sort of notable, I think, it went down to 8% decline versus the 4%, 5% trend line for the last few quarters. I’d love to understand from you, Arvind or Martin, what are you hearing from your customers? I mean, do you see this as a reflection that they’re perhaps pausing their decision until the spin is done or perhaps picking up calls from your competition as this is going on? I’d just love to understand what’s driving that dynamic there.

And then, Jim, if you could remind me when does the Form 10 get publicly disseminated, that would be great.

Arvind KrishnaChairman and Chief Executive Officer

OK. Hi, Amit. So in terms of the client feedback, we have talked about that we are going to do a lot of high-touch treatment of all these clients. These are really important clients for us.

As both Jim and Martin said, they are our most important clients in very important industries for the overall economy. As we have talked to all of the clients, we have, by and large, gotten very positive feedback. Over 98% of them are quite satisfied with our description of what will happen, both are in terms of their contracts, the service they’ll get from us and the assured guarantee of access to technical resources, both from the new company and from IBM over time. As that plays through, we see that.

As Jim mentioned, and he touched on it very briefly, we do measure how our clients think of us. We call it Net Promoter Score measurements, and we are seeing that those have gone up, not down. So we feel comfortable that the clients will go through it. Now, all that said, maybe a few clients are going to pause on certain project elements given their own business.

And so in that — in the GTS business, clients are allowed to dial volumes up a little bit or down a little bit based on their own performance. That is built into these contracts. So given, let’s say, what’s happening in the overall economy, you see some of that playthrough in both directions. And that is the large cause of that.

The other side of it, which is the new logos, gives us confidence that the performance should be on an improving trajectory going into 2021. So with that, let me give it to Jim, both to sort of add a little bit more color on the financials there and to just to repeat what he said about the Form 10.

Jim KavanaughSenior Vice President and Chief Financial Officer

Yes. Thanks, Arvind, and thanks, Amit, for the question. Just to put it in perspective, GTS $6.6 billion here in the quarter, to your point, down, what, 5.5% at actual, down 7.5%, give or take, at constant currency. It was though, up 2% quarter to quarter.

So we saw nice seasonality and by the way, pretty consistent with what our normal 3Q to 4Q would be in GTS. Now, with that said, in addition to what Arvind had talked about, which is what we’ve been dealing with for the last four quarters or so given the external economic environment with lower client base business volumes, we actually took, as I said in my prepared remarks, we took proactive actions to restructure some of our contracts to optimize our Managed Infrastructure Services business to get ready for the spin, which is what your second question is. As we talked about on October 8, we are going to create value through focus in both IBM and in NewCo. And in NewCo, the focus is on getting the fundamentals of this business in terms of value.

That’s margin, profit, and cash. And with these actions, we will improve on the financial profile as we prepare for the spin-off, leading to, again, an improved EBITDA profile, approaching double digits, post-spin, a solid balance sheet targeting investment-grade rating, and a strong free cash flow yield and dividend yield that should be attractive to a financial value-based investor overall. Now, with regards to your second question on the Form 10, I think I addressed that in the prepared remarks, a lot of work being done. The complexity of this as we learn each and every day, Arvind talked about the client transition, and we’re very pleased with where that’s going with our new logo signings and very strong renewal rates.

But if you think about the legal, regulatory, financial, the carve-out work, right now, I think we’re well on track to achieve what we said on October 8, which is the end of the year. And you should see the Form 10 sometime in the fall period.

Patricia MurphyVice President, Finance and Operations

Thank you, Arvind. Let’s go to the next question, please, Ivy.

Operator

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

Toni SacconaghiAllianceBernstein — Analyst

Yes. Thank you. If I just kind of stand back from the results this quarter, typically, your revenues are up $3.4 billion from Q3 to Q4. That’s the average of your last three years, and there’s very little movement off of that average.

This year, it was $2.8 billion. So at least in my eyes, it looks significantly worse. And I understand there are some issues around transaction processing. I understand year-over-year comps, but this is a sequential change, which seems to be notably below trend.

And I hear your assurances around the current spending environment. I guess the question is — and the elephant in the room is how do you know that there isn’t something more sinister afoot here. That there is an accelerated migration to the cloud that you are not — IBM is not participating in or your — particularly some of your software offerings in Cloud & Cognitive are not as competitive as you might think, and that’s ultimately what’s being reflected here. And I guess to that end as well, maybe, Arvind, you can directly address why the confidence in mid-single-digit growth in 2022? It sounds like at constant currency, IBM is going to be flattish or maybe slightly down in 2021.

So what drives the 500-basis-point improvement, which on a huge company like IBM, is really, really notable? How much of that do you expect to be inorganic? Thank you.

Jim KavanaughSenior Vice President and Chief Financial Officer

OK. Toni, thank you very much. Arvind, I’ll address the front-end piece, and then you could talk about the second part of Toni’s question overall. Toni, you are correct with regards to the last two to three years, when you look at the sequential normal seasonality of our business top line, it’s in the neighborhood of $3.3 billion, $3.4 billion.

But I think you know quite well, and many of our investors know quite well, that sequential trajectory has been distorted by a couple of things. One, the Red Hat deferred revenue and acquisition; and two, a major mainframe product cycle, as you know, which is why 90 days ago, I think when you asked the question to me, I answered it on a five-year CGR, and I was very specific, and that average is about $3 billion. Now, with that said, we delivered, to your point, $2.8 billion. And I think we’ve been open and transparent that we fell short against that expectation.

And we fell short, specifically in software. If you look at the balance of our portfolio, which is the remaining 65% of the revenue profile of the business, we were pretty much well within and some slightly above, given our strong mainframe finish to the year-end. And that software shortfall, as we talked about, was a culmination of the confluence of the wrap on the peak ELAs from last year. You, I think, all understand our ELA cycle, which has tremendous value to our clients and tremendous value to our financial equation.

On average, those are about three-year cycles. We had the peak cycle in 4Q ’19. We grew software revenue 10% off of that. And underpinning that, the transactional volume in that software was up close to 30% overall.

So we were in a trough year. We knew fourth quarter was going to be the most challenging quarter all year long, and we’ve been talking about that. Now, it’s really the confluence of, one, that peak cycle wrap, which we knew about because our volumes came in pretty much what we expected. But what you’re seeing to the second part of your question is, yes, is there shifts that are moving to the cloud? Yes.

And by the way, I think we’re capitalizing on that. We got a $25 billion cloud base of business that’s growing 20%. And we’ve got continued acceleration in our hybrid cloud platform with very good performance in Red Hat, which we could talk about later. But the confluence of what happened to software is really given the uncertainty in the environment.

Clients are reluctant to commit long-term duration of deals. And that really hurt our — what you would call an AUR or our deal value size. Now, there’s some positives to that, which I’m sure Arvind will get into. Number one, we got shorter-term durations now, so we have a much higher ELA pool in 2021.

Number two, we had a very strong, in fact, record renewal rates, which led to a record deferred income balance, $17.1 billion overall. And even stripping out Red Hat, we had the strongest quarter-to-quarter deferred income and renewal rate in our core software organic business that we’ve seen in 10 years. I think that’s a great instantiation of our clients committing to the value of our software portfolio overall. So with that, let me turn it over to Arvind.

You can address the second piece.

Arvind KrishnaChairman and Chief Executive Officer

Thanks, Jim. And, Toni, I’ll address some of the software pieces, but you asked a question about the mid-single-digit growth in 2022. So Toni, let me try and just deconstruct it a little bit. Red Hat continues to have very strong performance, mid- to maybe high-teens growth.

And as it gets bigger and bigger, that’s a bigger contributor to the total. Second, GBS is going to return to pre-pandemic levels by midyear, and we actually expect it to accelerate from there. But into 2022, we’ll see better growth from there. In systems, as you know, we are not going to see the product cycle dynamics as headwinds but as tailwinds going into 2022, albeit the absolute numbers are not necessarily that big.

Our ecosystem investments that we are making, they benefit both GBS and software. And by ecosystem, I mean, both small and big partners that we work with who are pulling both services and software. So when we see, for example, Salesforce, or Adobe, or ServiceNow, or Workday, they all tend to pull a lot of our services work. We also partner, by the way, with the other hyper-scaling clouds, both Microsoft and Amazon, and that tends to pull a lot of GBS work.

On the other side, we are also partnering with a lot of smaller software vendors, and they tend to pull a lot of our software along with it. So that is there. Now, you asked about the inorganic and organic. I’ll call it, the business as usual in organic is included in my mid-single-digit assessment.

So by business as usual, it’s just what we do. You’ve seen us do this for the last three quarters now. So deals like that would be included. And for example, we did Instana and StackRox in software.

Now, we did five others in services. They’re not very large, but they do tend to pull the overall business. That is what gives me confidence that as we get through all of this, we got one, two, three growth vectors and one kind of flat vector going into 2022. And that is what gives us confidence about the overall growth going there.

Patricia MurphyVice President, Finance and Operations

OK. Thank you, Toni. Can we please take the next question?

Operator

Our next question comes from Katy Huberty with Morgan Stanley. Your line is open.

Katy HubertyMorgan Stanley — Analyst

Thank you. Good afternoon. Can you just clarify whether you expect revenue growth at constant currency this year? And then you provided pretty specific commentary around the revenue trajectory and revenue growth on a reported basis for ’21, as well as normalized free cash flow, but you didn’t speak to EPS. So is there a reason that there’s less visibility into earnings this year? And can you talk just broadly about what some of the headwinds and tailwinds would be on the EPS line this year?

Arvind KrishnaChairman and Chief Executive Officer

Yes. So, Katy, why don’t I start on why we gave the guidance on revenue and on free cash flow? And then I think Jim will get into the details on your other parts of the question. Look, I’ve been sort of clear. I want to measure the company on revenue growth.

Revenue growth is the most important metric that I am focused on. And so we talked about the revenue growth, both for this year and for next year, which is unusual for us. The second part, in order to get revenue growth, we need to be able to do investments. Investments are driven by free cash flow.

And on free cash flow, it’s a very clean number. So you can see what that is. And we’ve talked about that with complete transparency, both on what it is going to be and why it will grow also from ’21 to ’22. That’s also what we’re going to measure our people on internally, and that will let then our investors know what we are measuring on.

So that’s why those are the two numbers that we are focused on driving. That’s the numbers we’re focused there on giving you, so you could hold us accountable to those. Jim?

Jim KavanaughSenior Vice President and Chief Financial Officer

OK. And, Katy, let’s talk a little bit about the revenue profile. I think Arvind just answered the two metrics. And by the way, I could tell you, we flipped the whole operational management system, Arvind spent a lot of time about the operating model changes, the actions he’s taken on how we drive signpost milestones to deliver on those two fundamental objectives, which, by the way, after the third quarter, Arvind and I did an extensive outreach to many of our investors, and we got unanimous feedback on what those two measures should be, which is sustainability of revenue and operating free cash flow to fuel the investment overall.

But let’s talk about revenue. So we talked about growth at current spot rates. You see in the supplemental charts, you see where the U.S. dollar has weakened.

Right now, at current spot rates, we expect the full year somewhere around 2 points of a tailwind overall. Pretty unique position on where we’ve been for the last 10 years. But underneath that, we did say that we expect the fundamentals of the business trajectory across our segments to improve, first half to second half. And that is going to be important because to an earlier question, that acceleration has to position us for an exit velocity to get into 2022 around having a credible path for a mid-single-digit growth which is what our objective is.

I would tell you, overall, we expect IBM RemainCo to grow both at actual rates and at constant currency. So that trajectory overall should give you a perspective right off the bat about where we should end go forward. NewCo, given where we ended in our backlog, we see improving trends but not getting back to growth. Because, again, as I said earlier, we are focused on the fundamentals of that business, margin, profit, cash, and the strong EBITDA profile to set it up with an investment-grade balance sheet to absorb and deliver a free cash flow yield and dividend yield overall.

Underneath that, you can imagine our two growth engines Arvind talked about, software and GBS. And by the way, both of them, we see growth accelerating throughout the year, software being driven by strong Red Hat. Red Hat, as we talked about, we exited over $5 billion of backlog. $2.8 billion of deferred revenue.

We already replenished more than what we acquired pre-acquisition. And by the way, that backlog of $5 billion is growing mid-20s. So the acceleration coming off the trough in third quarter, up 16. We just posted plus 17.

That should continue to accelerate as we move through. And then GBS, we exited our backlogs up. Our signings of small deals were up nicely and accelerated from 3Q to 4Q. We got acquisitions we’re going to continue to scale.

Our book-to-bill exiting fourth quarter was 1.3, the strongest it’s been in a long period of time. And we’ve got a nice backlog revenue run out in ’21 that shows that acceleration, which gives us confidence that we can get back to pre-pandemic growth as early as the midyear.

Patricia MurphyVice President, Finance and Operations

OK. Thank you, Katy. Ivy, could you please take the next question?

Operator

Our next question comes from Matt Cabral with Credit Suisse. Your line is open.

Matt CabralCredit Suisse — Analyst

Yes, thank you. I want to build on those last comments around GBS and just dig a little bit more. It looks like apps management was still the major drag despite a little bit of an easier compare versus the third quarter. Just wondering if you could unpack what’s going on underneath there.

And going forward, just how we should think about the potential of some pull-through from Red Hat-related work as you guys like to replatform and modernize some legacy on-prem apps. And just bigger picture, the path back to growth for apps management and what that looks like from here.

Jim KavanaughSenior Vice President and Chief Financial Officer

Yes. Thanks, Matt. I’ll take this one. To your question, Application Management Services overall is an integral part of our overall hybrid cloud platform thesis.

As Arvind talked about already and we shared even the prepared chart, that platform has an economic equation that has a multiplier effect. And we talked about, what, for every $1 of platform, we get $3 to $5 of software, we get $6 to $8 of services, both IBM and even as we scale with our ecosystem partnerships, that we’ve accelerated over the last six months, they get into that return also. But let’s talk about AMS. We’ve been speaking about this for the last few quarters, there definitely is a secular shift we know it.

A shift from on-prem enterprise application component. Clients are prioritizing stability of applications in this environment. And we all know the reduce in discretionary spend components. But there’s a flip side to that shift that’s happening overall.

And that’s exactly where you went, which clients are accelerating their digital transformation and journeys to cloud. And we participate in there. Look at GBS’s cloud business. We exited the year with almost a $6 billion book of business, accelerating throughout the year.

We finished the year up double digits overall, up 11%. And AMS underneath that is up almost 10%. So a very big component of that is it’s essential from a cloud transformation services as part of that hybrid cloud platform. Underneath that, what’s driving it is application modernization work.

That’s where we participate in the full spectrum from advice to build to move and to manage. The front end of that, advise and build, is predominantly a consulting-based play. Consulting’s up nicely, and our backlog, 17%. But as that journey continues, we’ll start seeing AMS come back.

And just a few data points for you. Number one, with that secular shift to the cloud, we are capitalizing, as I said, AMS, up 8% in our total cloud book of business. We returned AMS back in total to signings growth in the quarter. Our backlog improved 5 points quarter to quarter.

And to the heart of your question, 80% of our Red Hat and Cloud Pak placements are AMS incumbency enterprise clients. So it has tremendous value in leveraging that overall, which is why we think it’s essential to have a differentiated value proposition for our hybrid cloud platform.

Patricia MurphyVice President, Finance and Operations

Thank you, Matt. Can we please take the next question?

Operator

Our next question is from Tien-Tsin Huang from J.P. Morgan. Your line is open.

Tien-Tsin HuangJ.P. Morgan — Analyst

Thanks. Thanks for extending the call for us here. I think Katy asked about EPS. I’m not sure if I heard in your answer.

Any call-outs on EPS cadence first half versus second half beyond the $260 million in charges and normal seasonality? I know you’re not giving formal guidance, but I thought I’d ask anyway. But on the revenue side, just thinking about — I know you’ve said a lot again on revenue. But if you’re looking at revenue growth for fiscal ’21, I know you talked about revenue growth in fiscal ’20, but of course, COVID hit, and the world changed. So how was your outlook this year for growth different from this time last year in terms of your conviction? I heard some of the drivers, but just really here asking about conviction and visibility.

Arvind KrishnaChairman and Chief Executive Officer

Hi, Tien-Tsin. So maybe let me start about the conviction on revenue growth. So look, from what we can see, compared to what we saw last year, which is why we did not provide guidance in 2020, or rather, we pulled guidance back in April. We feel that the economy, while there is uncertainty, certainly better than it was last year, so we don’t expect to see anything worse compared to last year.

If anything, we talked about the second half being better because we expect as we get through that — there is going to be more demand. These projects are going to go forward. And as we look underneath because also in the questions that Matt had about Red Hat and modernization, you can also see that people are signing up for bigger and bigger projects around modernization because they need to move on to their businesses also. There’s only so long that you can belt tighten and not come out worse.

So they’re getting past their belt-tightening, we think, somewhere in the next six months. So that is why we have a lot more conviction. And that is why you heard Jim talk about the color from first half to second half and going forward into 2022 of an increasing trajectory, and he talked about that there is going to be growth for the remaining company at both current — both spot rates and at constant currency. So that is why we have conviction.

When we look at our underlying backlogs, when we look at our pipelines and we look at the demand profiles across those parts of the business, hence, the conviction in the revenue growth. Jim?

Jim KavanaughSenior Vice President and Chief Financial Officer

Yes. I would just add to that, Tien-Tsin. Thank you for the question. Again, as Arvind talked, this is a mindset change on how we want to operate the company.

We’ve defined the strategy all-in, focused, aligned our portfolio, aligned our operating model. Now, it’s about growth and it’s about driving that operating free cash flow, which is going to fuel that investment. So around that, we talked about the trajectory overall. First of all, I should have mentioned — I mean, as you could see in the supplemental chart, although we said revenue growth at current spot rates, you see that that’s predominantly a first-half discussion.

It’s about 3 to 4 points of tailwind in the first half, and that dissipates quickly in the second half overall, which is why the fundamentals of the underlying business by segment will have to improve, and we expected them to improve as we move through the year. The other thing I will tell you, underpinning, because it’s a fair question. As I stated, I think we’ve built the credibility over the last few years that we know how to drive operating leverage within this business. So you can expect, we grew gross margins this year, I think, about 130 basis points, 70 basis points in the fourth quarter.

You can expect that we’re going to continue to drive operating leverage in this business, and we’ll have margin expansion in ’21. And second, the other variable that you always ask me and we talk about and we try to be very transparent underneath it is our tax rate. And while we operate in 100-plus countries around the world, the geographic product mix can impact that dramatically, tax structures, audits, etc., can change it. From our perspective, we finished fourth quarter at what, I think, 10.4% from an operating tax rate.

Pretty consistent, by the way, of third quarter and pretty consistent last year. And just given what I said earlier one on a book tax rate, we’re going to have a headwind on cash taxes, I would expect our tax rate to go up a few points from that 10.4%. So it gives you a little bit more color underneath the revenue profile, the operating leverage, and tax. And again, we’re just trying to change a mindset here.

Patricia MurphyVice President, Finance and Operations

Thank you, Tien-tsin. Let’s go to the next question, please.

Operator

Our next question comes from David Grossman from Stifel Nicolaus. Your line is open.

David GrossmanStifel Financial Corp. — Analyst

Thank you. Arvind, perhaps you could be a little more specific about what you were seeing in the legacy sales and marketing structure, which precipitated the reorg. And maybe identify what changes you expect to be most impactful and why. And sorry for the two-part question, but Jim, perhaps you could reflect on whether there’s — or how much, if any, free cash tailwind you’re seeing in ’20 and ’21 and ’22 from the change in the IGF receivables.

Thanks.

Arvind KrishnaChairman and Chief Executive Officer

Hi, David. Look, this is something I’m deeply, deeply passionate about, so I’m happy to talk about this. Look, every model has its time, and then it’s time to evolve. So we are evolving in reaction to client needs.

And we had sort of operated with our, call it, a more homogeneous model that kind of went across all our segments, all our clients for a long time. So what are we doing? There is a set of clients who do tend to buy, I’ll call it, a lot of IBM. Let’s call them they need the integrated value of IBM. We’re calling that the first segment.

So in this first segment, we are also going to make extra investments in them being able to experience IBM technically. So we are using the term garages. We have people who go in there and work side by side with the client, well, virtually right now, as well as being able to have a lot of focus on deployment, and we’ll pay the people on deployment, not on selling. So this first segment is going to have that attention with extra assisting, so they should see a lot of positive, and we expect to see growth coming out of our garages and our deployment manages.

Then there is a segment which is largely going to be channel ready. So there, we do get, as Jim talked about, operational leverage, you don’t need the other people. The channel is quite capable, but rather put more money into the channel and work with them to go after that. That’s the other end of the spectrum.

Then there is a set of clients, let’s call it, between these two spectrums, they tend to buy mostly from one or two parts of IBM. So they deeply value the specialists, but they don’t need the generalists who were covering them. So we’re going to take that money and then pour it into more specialists who can then cover those clients. So there is a first segment which does have an integrated value.

There is the top half of the second segment, which is going to be much more specialists. You can think of them as being technology-led sales, by and large. And then there is going to be a large part, which is ecosystem-led, whether system integrators, resellers, distributors, etc. We believe that this simplicity is going to drive a lot more outcome for us and for our clients.

And by the way, we are also going to ensure that this is the structure that all parts of IBM have. So it’s not that different parts of IBM will have slightly different client segmentations. It’s completely consistent across all. This, we believe, unlocks a few points of revenue growth.

So you said impactful. I expect that this will unlock a few points of revenue growth, albeit, let me acknowledge that it probably takes six months to flow through the system.

Jim KavanaughSenior Vice President and Chief Financial Officer

David, let me address your good question around the IGF business and the tailwinds overall. First, just taking a step back. Within that overall IGF, consistent with our strategy, we are focusing this part of our portfolio directly aligned to be a captive financing aligned to our hybrid cloud and AI platform strategy overall. And you’ve seen us take a disciplined approach around both portfolio and financial management.

What am I saying? One, early in 29, we started winding down our OEM financing business. Then in 2020, as part of prudent austerity measures, as we prioritized liquidity, we actually announced, and you heard that in the fourth quarter, selling our IBM commercial financing receivables as part of our risk mitigation, cash, and liquidity management practices. So now, let me bring this all back together because I think these actions that we’ve taken have resulted in a more focused and healthier financing portfolio with a very much better overall debt level and refinancing requirements that are not going to be needed overall. So if you look at the strengthening of our balance sheet, our liquidity position exiting 2020, we talked about $14.3 billion of cash on the balance sheet.

We talked about $11 billion to $12 billion of adjusted free cash flow. We got about $4 billion to $5 billion in 2020 around leveraging and focusing that strategy about IGF. And I would assume probably something very similar to that overall. So when you take the power of those three buckets, $14 billion of cash, which I should tell you is about 2x the operating level that we need to run this company.

So the excess cash there, the strong free cash flow generation, and the IGF actions of $3 billion to $5 billion, let’s call it, you got about $30 billion of firepower. Now, that’s a source of cash view. Now, we all know in use of cash view. What do we know? One, I talked about the $3 billion, which will be cash out the door with regards to the structural actions and the cash taxes based on the transaction.

Second, we are very committed to our secure and modestly growing dividend policy. That’s about $6 billion. And then third, we continue to plan to delever, and our normal maturities are a little bit less than $7 billion this year. You add those up, you’re about $15 billion-plus.

So we’ve got firepower here that gives us the financial flexibility to continue to invest in our business, delever to get back to our targeted leverage ratios, and also support that secure and modestly growing dividend.

Patricia MurphyVice President, Finance and Operations

So we’ve gone pretty long here. Why don’t we just — Arvind, do you want to make just a quick comment to wrap it up?

Arvind KrishnaChairman and Chief Executive Officer

Yes. Thanks, Pat. So we covered a lot today, so let me just make a couple of really quick comments to wrap this up. We are confident in our strategy.

We’re taking the actions that will accelerate this change. We expect to grow in 2021 with an improving trajectory through the year. And with all of that, we will look different at the end of 2021 than we do today. I look forward to continuing this dialogue with you.

Thank you, everyone.

Patricia MurphyVice President, Finance and Operations

Ivy, I’m going to turn it back to you to close out the call, please.

Operator

[Operator signoff]

Duration: 86 minutes

Call participants:

Patricia MurphyVice President, Finance and Operations

Arvind KrishnaChairman and Chief Executive Officer

Jim KavanaughSenior Vice President and Chief Financial Officer

Martin SchroeterChief Executive Officer

Wamsi MohanBank of America Merrill Lynch — Analyst

Amit DaryananiEvercore ISI — Analyst

Toni SacconaghiAllianceBernstein — Analyst

Katy HubertyMorgan Stanley — Analyst

Matt CabralCredit Suisse — Analyst

Tien-Tsin HuangJ.P. Morgan — Analyst

David GrossmanStifel Financial Corp. — Analyst

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