International Business Machines Corporation (NYSE:IBM) Q1 2024 Earnings Call Transcript

International Business Machines Corporation (NYSE:IBM) Q1 2024 Earnings Call Transcript April 24, 2024

International Business Machines Corporation beats earnings expectations. Reported EPS is $1.68, expectations were $1.59. International Business Machines Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Welcome and thank you for standing by. At this time, all participants are in a listen-only mode. 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 Olympia McNerney, IBM’s Global Head of Investor Relations. Olympia, you may begin.

Olympia McNerney: Thank you. I’d like to welcome you to IBM’s first quarter 2024 earnings presentation. I’m Olympia McNerney, and I’m here today 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. To provide additional information to our investors, our presentation includes certain non-GAAP measures. For example, all of our references to revenue and signings growth are at constant currency. We provided reconciliation charts for these and other non-GAAP financial measures at the end of the presentation, which is posted to our investor website.

Finally, 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. So with that, I’ll turn the call over to Arvind.

Arvind Krishna: Thank you for joining us. In the first quarter, we had solid performance across revenue and cash flow. These results are further proof of the quality of our portfolio and our hybrid cloud and AI strategy. We had good performance in software at the high end of our model, continued strength in infrastructure above our model, while consulting was below model. On a relative basis, consulting outperformed the market. Our cash flow generation is the strongest first quarter level we have reported in many years. This performance speaks to the strength of our diversified business model. Before we get into more detail on the quarter, let me address the announcement of our agreement to acquire HashiCorp, a company we have partnered with for a long time and believe is a tremendous strategic fit with IBM.

Enterprise clients are wrestling with an unprecedented expansion in infrastructure applications across public and private clouds, as well as on-prem environments, making this the ideal time to pursue this acquisition. As generative AI deployment accelerates alongside traditional workloads, developers are working with increasingly heterogeneous, dynamic and complex infrastructure strategies. HashiCorp has a proven track record of helping clients manage the complexity of today’s infrastructure by automating, orchestrating and securing hybrid and multi-cloud environments. HashiCorp is a great strategic addition to our portfolio, extending Red Hat’s hybrid cloud capabilities to provide end-to-end automated infrastructure and security lifecycle management.

HashiCorp’s technology is foundational to enabling the transition to hybrid and multi-cloud, and Terraform is the industry standard for infrastructure automation for these environments. With security top of mind for every enterprise, Vault is a powerful secrets management offering to automate identity security across applications. The combination will also bolster our leading IT automation platform to address the sprawling complexity of AI-driven application and infrastructure growth. HashiCorp’s products have wide scale adoption in the developer community, highlighting the pervasive nature of their technology, used by over 85% of the Fortune 500 and downloaded over 0.5 billion times. The acquisition of HashiCorp builds on IBM’s commitment to industry collaboration, the developer community, and open source hybrid cloud and AI innovation.

Today’s acquisition is consistent with our M&A strategy. We have taken a disciplined approach to M&A and HashiCorp aligns well across all our key criteria to continue to focus and strengthen our portfolio on hybrid cloud and AI, deliver synergies with rest of IBM and be near-term accretive to free cash flow. I will now turn it to Jim to discuss the financial implications.

James Kavanaugh: Thank you, Arvind. Let me start with the details of the transaction. We have agreed to acquire HashiCorp for $6.4 billion in enterprise value to be funded by cash on hand. The transaction was approved by HashiCorp’s Board of Directors. Closing is anticipated by the end of 2024, subject to approval by HashiCorp’s shareholders, regulatory approvals and other customary closing conditions. We have been executing a disciplined capital allocation strategy and the acquisition of HashiCorp meets all of our criteria, including strategic fit, as Arvind just walked through, synergies across IBM and financial accretion. Let me start by addressing synergies. We see multiple drivers of product synergies within IBM and accelerating growth for HashiCorp.

Product synergies span across multiple strategic growth areas for IBM, including Red Hat, watsonx, data security, IT automation and consulting. For example, the powerful combination of Red Hat’s Ansible automation Platforms, configuration management and Terraform’s automation will simplify provisioning and configuration of applications across hybrid cloud environments. We are well positioned to drive growth for HashiCorp by leveraging IBM’s enterprise incumbency and global reach. With 70% of their revenue today coming from the U.S., the opportunity to scale HashiCorp across IBM’s operations in 175 countries is significant. We also believe we can accelerate HashiCorp’s adoption with IBM clients. To put this in perspective, only about 20% of the Forbes Global 2000 are HashiCorp customers, and just a quarter of HashiCorp customers result in more than 100,000 annual recurring revenue, underscoring the opportunity to better monetize and upsell their products.

Bringing it all together, the acquisition allows us to deliver a more comprehensive hybrid cloud offering to enterprise clients, enhancing IBM’s ability to capture global cloud opportunity. This will drive a higher growth profile over time. Finally, we expect to realize operating efficiencies and expect the transaction to be accretive to adjusted EBITDA within the first full year post close and to free cash flow in year two. Significant near-term cost synergies underpin the financial profile of the transaction, while product synergies represent further upside. We are very comfortable with our strong balance sheet, liquidity profile and solid investment-grade rating and remain committed to our dividend policy. I’ll now turn it back to Arvind.

Arvind Krishna: Now, turning back to the quarter, let me start with a few comments on the macroeconomic environment. We expect the global economy to behave similarly to last year, albeit with some uncertainty due to persistently high interest rates. There are reasons to believe technology will be even more important in 2024 as clients focus on productivity improvements and customer experience. AI-driven productivity in particular continues to be a top priority for businesses for both cost reductions and new revenue opportunities. I will now provide some details on the execution of our strategy around hybrid cloud and AI. Enterprise AI continues to gain traction. This year, we anticipate more clients moving from experimenting to deploying AI at scale to unlock productivity.

We are pleased with the solid progress of our AI offerings. Each quarter, we are winning more clients, expanding partnerships and introducing new innovations. Inception to date, our book of business related to watsonx and generative AI is greater than $1 billion with sequential quarter-over-quarter growth. Similar to last quarter, this remains weighted towards consulting. We believe our comprehensive AI strategy is well positioned to help clients scale AI. We developed our watsonx platform for clients to build their AI solutions, spanning from foundation model training to data preparation and governance. This includes both IBM Granite models and third-party models, giving our clients variety, as well as the efficiency and focus on enterprise domains that IBM brings.

We have leveraged watsonx to build AI assistance through our software portfolio. Our consultants are helping clients navigate the AI landscape. And finally, we are seeing our infrastructure segment play a larger role as clients leverage their hardware investments in their AI strategies. Let me touch on these infrastructure dynamics briefly. As AI becomes widely adopted, IBM Z is uniquely advantaged. We believe a lot of AI inferencing will happen where the data is for security, efficiency and latency reasons. Our full stack focus from on-chip AI processing to AI accelerator cards to watsonx platform support allows models to be built and [create] (ph) on any platform and easily deployed on IBM Z. The Telum chip is a unique differentiator, enabling real-time AI inferencing.

Generative AI is also driving lift for our storage offerings, where industry-leading performance and scalability is utilized for data curation, model building and fine tuning. For enterprises to deploy AI at scale, AI is not a one-size-fits-all proposition. It requires tuned, domain-specific models trained with quality data to maximize its impact. Clients value the flexibility of our approach. They appreciate having the ability to leverage a combination of AI models, whether they are IBM’s, their own models, open source models such as Llama from Meta and Mixtral from Mistral, and they can deploy these AI models across multiple environments. The flexibility we offer is resonating as there are use cases for both large and more efficient models.

We are committed to an open innovation ecosystem around AI to help our clients maximize flexibility and leverage skills. Let me spend a minute on our progress in this area. We see early parallels to Linux in making open source AI models performant for enterprise use. We believe that IBM with Red Hat can be a key driver of open source AI. As you know, we have done a lot of work with AI models and recently released a family of state-of-the-art open source code models from our Granite series. Red Hat and IBM also recently launched InstructLab to evolve and improve AI models through incremental community contributions much like open source software. This open strategy is resonating around the world. We recently announced a collaboration with the Spanish government to leverage IBM’s investments across the entire AI stack and open source to build the world’s leading suite of foundation models proficient in the Spanish language.

Enterprise use cases addressing code modernization, customer service and digital labor remain top of mind for our clients. This quarter, we signed a multi-year contract with Providence Health to reimagine talent and HR workflows with AI from IBM and partners. We’re also providing data-driven insights and enabling Spanish language narration for this year’s Masters Golf Tournament. Our partner ecosystem remains essential to both AI and hybrid cloud growth. This quarter, we progressed strategic partnerships with a number of industry leaders, consulting joint forces with Nvidia to accelerate clients’ AI journeys. ServiceNow will embed watsonx AI capabilities into the ServiceNow platform to accelerate enterprise digital transformation. We also expanded our relationship with Adobe around OpenShift and watsonx as it relates to the Adobe Experience platform.

We continue to invest in emerging technology as well, bringing new innovations to the market. Since we put the world’s first quantum system on the cloud in 2016, we have deployed over 80 quantum systems and our users have run over 3 trillion programs to date. We just installed a Quantum System One at Rensselaer Polytechnic Institute. This is the first IBM Quantum System on a college campus anywhere in the world. This installation will advance research in critical areas such as energy storage, material science and financial modeling. As always, focusing our portfolio remains a key priority. We closed the sale of The Weather Company in the first quarter and expect to close the announced acquisition of StreamSets and webMethods from Software AG by mid-year.

Overall, we had a positive start to the year, which gives us confidence in our next quarter and full year expectations. Jim will now take you through the details of the quarter. Jim, over to you.

James Kavanaugh: Thanks, Arvind. In the first quarter, we delivered $14.5 billion in revenue, $3 billion of adjusted EBITDA, $1.7 billion of operating pre-tax income and $1.68 operating earnings per share, and we generated free cash flow of $1.9 billion, up approximately $600 million year-over-year. Our revenue for the quarter was up 3% at constant currency. We saw an impact to our top-line performance from the closing of The Weather Company earlier than expected in the quarter. Software grew by 6% with growth across hybrid platform and solutions and transaction processing and continued strength in our recurring revenue base. Consulting was up 2%, reflecting organic growth. We continue to have solid signings performance and a trailing 12-month book-to-bill of over 1.15.

Infrastructure had strong performance, delivering growth across all of our hardware offerings. Looking at our profit metrics, we expanded operating gross margin by 100 basis points and operating pre-tax margin by 130 basis points over last year, inclusive of about 100 basis point currency headwind to pre-tax margin. At the end of January, we closed on the divestiture of The Weather Company, generating a pre-tax gain of $241 million in the quarter. Mitigating that benefit, we took charges of $374 million to address workforce rebalancing. Operating pre-tax margin was up 50 basis points, excluding the year-over-year impacts of workforce rebalancing and divestiture dynamics. We are pleased with this performance, in line with our guidance of roughly 50 basis points of operating pre-tax margin improvement in 2024.

Margin expansion was driven by our operating leverage, product mix and ongoing productivity initiatives. This allowed for continued investments to drive innovation, which you can see in our higher R&D expense. The timing of discrete tax items this quarter resulted in an operating tax rate of about 6%. We are still expecting a full year operating tax rate consistent with last year. Overall, the combination of our revenue and operating margin performance resulted in 7% growth in our adjusted EBITDA. This contributed to our free cash flow performance. For the quarter, we generated $1.9 billion of free cash flow, up $600 million year-over-year. This growth reflects the performance of our underlying business with adjusted EBITDA up $200 million year-over-year and about $400 million from timing of balance sheet dynamics and CapEx. Over the last 12 months, we generated free cash flow of $11.8 billion.

This puts us on track to deliver about $12 billion of free cash flow for the year, with the growth largely driven by adjusted EBITDA. Since our acquisition of Red Hat, excluding 2021, when we spun off Kyndryl, our operating net income to free cash flow realization averaged 120%. Two factors drive this. One is stock-based compensation, which today represents 15 points of realization. And two, given the shift in our portfolio to a growing software business, deferred income also contributes to our realization. In terms of cash uses, we returned $1.5 billion to shareholders in the form of dividends. From a balance sheet perspective, we have a very strong liquidity position with cash of $19.3 billion, up from $13.5 billion at year end 2023. Our debt balance at the end of the first quarter was $59.5 billion, including $9.9 billion from our financing business.

Turning to the segments. Software revenue grew 6% with good performance across both Hybrid Platform & Solutions and transaction processing. As mentioned in January, the Software revenue growth drivers for the year include Red Hat growth, acquisitions, strong recurring revenue and transaction processing. And this is just how the first quarter played out. Hybrid Platform & Solutions revenue was up 7%. Let me spend a minute on the various elements. Red Hat revenue grew 9%, reflecting solid performance across the three key solutions, RHEL, OpenShift and Ansible. Annual bookings growth was again in the mid-teens, with OpenShift up over 40% this quarter and RHEL and Ansible each up double digits. Beyond Red Hat, recent acquisitions contributed to the growth profile of Hybrid Platform & Solutions, as did new innovation areas including watsonx.

The combination of Apptio acquired mid last year and our IT automation portfolio has delivered strong results, unlocking the full benefits of a FinOps solution for technology investments across hybrid cloud environments. In fact, just this quarter, we partnered with Microsoft to bring Apptio to Azure and will co-sell to our joint customers and Microsoft has agreed to adopt Apptio’s capabilities in parts of their organization. Our revenue performance continues to reflect growth in our high-value recurring revenue base. Our ARR, after removing The Weather Company and security services, is now $13.9 billion, up over 8% since last year. Transaction processing, with its strong base of recurring revenue, delivered revenue growth of 4%. Clients continue to value this portfolio of mission critical software, supporting growing workloads on our hardware platforms.

And there’s an increasing interest in generative AI application modernization capabilities like watsonx Code Assistant for Z. Software segment profit was up 80 basis points, while absorbing both key investments in innovation and about 1 point of currency impact in the quarter. We continue to deliver operating leverage driven by our revenue performance this quarter. Our Consulting revenue was up 2%. We continue to see clients prioritizing large data and technology transformation projects focused on driving productivity with AI and analytics. These results reflect the organic performance of our business. Solid demand for our offerings led to signings growth of 4%, our highest absolute first quarter signings in recent history, and our trailing 12-month book-to-bill ratio remains over 1.15.

Our overall backlog remains healthy, up 7% year-over-year, and backlog erosion levels remain stable. At the same time, we saw both a lengthening of backlog duration driven by large scale digital transformations and a reduced level of revenue realization in the quarter as clients tighten discretionary spending. Contributing to growth across the business this quarter, our strategic partnerships continue to make up over 40% of our consulting revenue, with both AWS and Azure practices growing double digits. Additionally, our Red Hat practice grew revenue double digits. Expanding upon our partnerships, we are leveraging Microsoft Copilot to drive productivity for our clients. Just as we quickly ramped a meaningful book of business around Red Hat to address the hybrid cloud opportunity, we are ahead of pace at this stage with our generative AI book of business.

Turning to our lines of business. Business Transformation revenue grew 3%, led by supply chain and finance transformations. Customer experience transformations also contributed to growth. Technology Consulting revenue was also up 3% with double-digit growth in cloud modernization projects and both strategic partnerships and Red Hat engagements delivered double-digit growth. Application Operations revenue declined, reflecting weakness in on-prem custom application management projects, partially offset by strength in cloud-based application management offerings. Moving to consulting profit, we delivered over 8% of segment profit margin, which is flat year to year. Our segment profit margin was impacted by about a point of currency, offsetting improvements in pricing and productivity actions we have taken.

Moving to Infrastructure, revenue grew, reflecting growth in Hybrid Infrastructure of 6% and declines in Infrastructure Support of 7%. Within Hybrid Infrastructure, growth was broad based with strong demand from our hardware offerings across IBM Z, power and storage. In IBM Z, revenue was up 5% in the eighth quarter of z16 product availability. Now, two years in, this product cycle continues to resonate with clients and surpass z15 revenue performance. IBM Z is uniquely positioned for AI with the first processor design with on-chip acceleration for real-time AI inferencing. In fact, we are working with over 100 clients on the application of AI on z16. Use cases range from fraud detection to anti-money laundering to anomaly detection. This remains an enduring platform, driving not just hardware adoption, but also related software, storage and services.

Distributed Infrastructure delivered 7% revenue growth with strength in both power and storage. Power performance was fueled by demand for data-intensive workloads. Storage delivered strong double-digit revenue growth, including demand for high-end storage tied to the z16 cycle. And clients are also looking to our storage offerings for data curation, model building and fine tuning in support of generative AI. Looking at Infrastructure Profit, we deliver both gross profit and segment profit margin expansion. Segment profit margin expanded 20 basis points in the quarter, reflecting benefits from productivity while absorbing about a point of impact from currency. Now, let me bring it back to the IBM level to wrap up. More than two years into our mid-term model, we are a more focused business that has delivered sustained revenue and free cash flow growth.

Over this time, we’ve continued to invest organically and inorganically, bring new products and innovation to market, expand our ecosystem, and drive productivity across our business. Our first quarter performance is another proof point of this progress with constant currency revenue growth, operating gross margin and operating pre-tax margin expansion and the strongest first quarter free cash flow in many years. Looking to the full year 2024, we are holding our view on our two primary metrics, revenue and free cash flow. We see full year constant currency revenue growth in line with our mid-single-digit model, still prudently at the low end. And for free cash flow, we expect to generate about $12 billion, driven primarily by growth in adjusted EBITDA.

On the segments, in software, we had a solid start to the year and continue to expect growth slightly above the high end of our mid-single-digit model. In consulting, we continue to see strong demand for digital transformations. Though as I said, we are seeing some pressure on smaller, more discretionary projects. We now see mid-single-digit revenue growth in consulting with acceleration throughout the year. Given our ongoing productivity initiatives and investment in innovation, we expect to see about a point of segment profit margin expansion in both of these segments. And in Infrastructure, given product cycle dynamics, we expect revenue to decline, driving about a half a point impact to our overall growth. Given IBM Z cycle dynamics, we expect segment profit margin to be lower year over year.

With these segment dynamics, we continue to expect IBM’s operating pre-tax margin to expand by about a half a point year to year, consistent with our view 90 days ago, and we are maintaining our view of operating tax for the year to be consistent with last year in the mid teens range. We took a workforce rebalancing charge this quarter and, as I mentioned 90 days ago, we continue to see the overall amount this year consistent with last year. We expect this to pay back by the end of the year. On currency, given the strengthening of the dollar, we now expect a 150 basis point to 200 basis point impact to revenue growth for the year, which is about one point worse than 90 days ago. For the second quarter, I expect our constant currency revenue growth rate to be consistent with the full year.

Our tax rate is expected to be in the high teens. And for profit, we expect the first half skew of net income will remain a couple points ahead of the prior year. In closing, we are pleased with our performance to start the quarter. We are positioned to grow revenue, expand operating profit margin and grow free cash flow for the year. Arvind and I are now happy to take your questions. Olympia, let’s get started.

Olympia McNerney: Thank you, Jim. Before we begin the Q&A, I’d like to mention a couple of items. First, supplemental information is provided at the end of the presentation. And then second, as always, I’d ask you to refrain from multi-part questions. Operator, let’s please open it up for questions.

Operator: Thank you. At this time, we’ll begin the question-and-answer session of the conference. [Operator Instructions] Our first question comes from Amit Daryanani with Evercore. Please state your question.

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Q&A Session

Amit Daryanani: Thanks for taking my question. Good afternoon, everyone. I guess I was hoping you could talk a bit more on the consulting side of the business because revenues did decelerate rather notably in March quarter, but I think on the other side, your AI-centric backlog at over $1 billion is doing extremely well. So I’m hoping you could touch on the near-term side. What are you hearing from your customers? What are they telling you around the duration of this pause? Because I think the expectation of mid-single-digit growth would imply this business will recover rather quickly. So I’d just love to get a sense on what our customers consulting in terms of the duration of the pause? And then longer term, what does the opportunity look like given the AI-centric backlog appears a lot more robust versus what I think folks have expected beyond 2024? Thank you.

James Kavanaugh: Thanks, Amit. I appreciate the question. Let’s take a step back because I think you’re seeing some interesting dynamics in the consulting industry overall. And let’s bifurcate it between how you asked the question. Let’s look at real demand that being measured in bookings and then let’s talk about what’s happening with the revenue realization. On demand, we continue to see and capitalize on solid demand in key areas around digital transformation, application modernization and Gen AI. Our signings in the quarter, up 4%, were the strongest absolute first quarter signings we’ve had as far back as I can go. We have a strong book-to-bill over 1.15 on a trailing 12 months. Our backlog dynamic is in a very strong position, 7% overall with stable erosion, but our duration has been going up the last two quarters.

It’s been up a couple of months. But let’s talk about the underpinnings of what’s driving demand, because I think that’s what’s most important around the key growth focus areas. You talked about Gen AI. Gen AI for IBM, Arvind indicated, inception to date over a $1 billion book of business. Consulting in the first quarter, the book of business on Gen AI was 2 times all of last year. So I think we are winning in the marketplace. We’re taking share. And by the way, we’re well above that ramp we saw with regards to Red Hat. Our strategic partnerships still have great velocity, book-to-bill well north of 1.2, our Red Hat book of business is now $2.8 billion ARR around hybrid cloud, and we are seeing very nice acceleration in GenAI and digital transformation around core workflow use case areas of finance, supply chain, HR and talent.

So I think in the key focus areas, our demand profile still continues to be good. Now let’s translate that to revenue. Revenue, first of all, in the first quarter, as we indicated, it was all organic. We wrapped on our acquisitions, we continue to operate a very disciplined M&A process, and we continue to be opportunistic but that 2% revenue growth was all organic quarter to quarter. Second, in this marketplace, you look at competition, we’re taking share still. So when you look at it, 90 days ago, we talked about the year. We talked about the year was going to play out accelerating throughout the year. Why? Because, one, we knew we had a strong backlog and that backlog realization showed us that it was going to play out throughout the year with sequential improvement.

But second, Easter. Easter, we knew calendar was there, was at the end of March. That does impact a human capital-based business on a number of billing days. So when you look at first quarter, that backlog duration extending out a couple of months, we also saw though less revenue backlog yield and that really played out if you look at our subsegments and application operations. That’s centered around custom AMS applications, which, by the way, many of that, as you know quite well, is volume-based business. And that volume, like I said, backlog is stable overall. We are not losing the business that is moving out to the right. So with all that said, what are we focused on? We’re focused on capturing new client demand in areas around our key growth areas.

Two, we’ll continue to focus, and we are gaining share in the marketplace. Three, we’re driving that economic multiplier of consulting and technology across our hybrid cloud and AI platform. So in light of all that, that’s why you see the mid-single-digit growth. I think that’s prudent just given what every other consulting competitors come out with, by the way, that still drives 1.5 points of growth to IBM for the full year. And as I stated earlier, we see an accelerated growth profile as we move through the year.

Olympia McNerney: Operator, next question.

Operator: The next question comes from Wamsi Mohan with Bank of America. Please state your question.

Wamsi Mohan: Yes. Thank you. Arvind would love to get a little bit more of sort of a macro demand backdrop. I mean, I know Jim mentioned the tightened discretionary spending in some areas. How do you think about the risk of that sort of filtering more broadly as you go through the course of the year, especially given your guidance calls for an accelerating trend here. And if I could, quickly, Jim, the synergies relative to HashiCorp on the cost side, is there any way you can dimensionalize that, given that when you are defining accretion on EBITDA basis, I get that, but can you also help on the net income basis or from a free cash flow, how much it might be dilutive in year one and accretive on year two? Thank you so much.

Arvind Krishna: Thanks, Wamsi. So let me address your thought about the demand profile globally. So if I look at where we are right now and where we project for the rest of the year, demand is actually quite strong. I would put it as very similar to 2023. This is backed up by IMF GDP estimates, which are now north of 3% for the global business. If I look at it by geography, Japan remains very strong. I think that they are taking this opportunity to refresh the technology across their enterprise and government base. If you look at South Asia, extremely strong, even the Middle East, UAE, Saudi, very strong. Europe has remained consistent to last year, North and South America. So on a geography basis, we are seeing very, very strong demand.

Now interest rates are higher than people were expecting. I think we should acknowledge that. That means you get two effects going on. One, there is even stronger demand for software and infrastructure because people believe technology helps you in those environments and helps in an environment of increased labor costs and increased supply chain costs. Then when you look at the discretionary side, Jim answered this in the previous question, we are seeing a little bit, not across the board, not in all of the offerings in consulting, but where there is a little bit of discretionary labor, that is where we sense that pressure. What we are going to do is pivot into the areas around helping people become more productive, take more cost out, digital transformation, work with our partners where there is very strong demand in the market.

And as you pivot there, we believe that our growth rate in consulting will continue to accelerate. So I hope, Wamsi, that gave you a flavor on the demand vectors we have, both in software and infrastructure and in consulting and on a geography basis. Jim, over to you for part two.

James Kavanaugh: Okay. Thank you. Thanks, Wamsi, for the question. As Arvind indicated in the prepared remarks, we couldn’t be more excited about the powerful combination of HashiCorp with IBM and Red Hat together. We talked about in the prepared remarks, we’ve been very disciplined in our set of criteria around M&A. And this fits strategically. It has tremendous synergistic value to our hybrid cloud AI portfolio and it has an attractive financial return overall. And Hashi meets all three. One is, it’s a higher revenue growth profile company. so it accelerates IBM’s revenue growth over time. Two, to your question, adjusted EBITDA accretive in the first 12 months; and three, levered free cash flow accretive by the end of year two.

We think there are a potential for meaningful synergies overall. And when we look at it, significant near-term operating efficiencies, cost synergies and put that in perspective, we see this business profile moving from about a mid-single-digit free cash flow margin business to about a 30% to 40% free cash flow margin business in a handful of years. Free cash flow accretive by the end of year two. Now the multiple we paid on that fully supported by, one, the stand-alone revenue growth and the cost synergies that come out. All of the IBM revenue synergies around Red Hat, around data security, around watsonx, around consulting and IT automation are all upside potential. So let’s talk and conclude on the cost synergy. Cost synergies are where you would fully expect.

IBM runs a global operations in 175 countries. We run a very disciplined G&A efficient structure. We see significant G&A operating efficiencies that we are going to go capitalize on. Second, running the playbook on how we expand it globally, our go-to-market model that we did with Red Hat. And that has both global incumbency, global scale, global breadth and ecosystem leverage overall. And when you look at that, those significant synergies allow us to invest in product, R&D, innovation and capability that’s built into our case and also deliver our financial returns. So we feel pretty good about it.

Olympia McNerney: Operator, let’s go to the next question.

Operator: Our next question comes from Toni Sacconaghi with Bernstein. Please state your question.

Toni Sacconaghi: Yes. Thank you and good afternoon. Jim, just to clarify, you’ve taken down your consulting outlook for the year from 6% to 8% to 5%. I think that’s about 60 basis points to company growth. Is there anything offsetting that? Or is that just kind of a rounding error in the low-single-digit guidance? And then my question is, maybe you could just elaborate a little bit more on the AI book of business. Maybe just help clarify exactly how you define that. I think it’s both revenue recognized and your bookings and maybe partner bookings. Maybe you could just help define that? And last quarter, you said it doubled sequentially. This quarter, you just commented that it grew sequentially. Maybe you could add a little color with that double digits or 20% or 30% or 40%. And at least when I do the math, it sounds like it’s less than 5% of your consulting backlog. AI backlog. Could you help to mention that as well? Thank you.

James Kavanaugh: Okay, Toni. Many questions here. Let me see if I can get through them quick. You look at full year, full year, as Arvind indicated, we are maintaining our guidance on our model mid-single digit. I think prudently, just coming out of a first quarter, we’ve got a lot of work to do in the next three quarters, but I think prudently at the low end of that model. And by the way, that was very consistent with what we said 90 days ago. Now let’s unpack that. When you take a look at full year. First of all, we are dealing with a stronger U.S. dollar. So we’ve given you supplemental chart. Now, we’ve lost basically about a point more of headwind on currency. But let’s talk about the underlying fundamentals of our business across our segments because I think that’s at the heart of your question.

When you take a look at our growth at mid-single digit, one, we said software would grow slightly above the high end of our mid-single-digit model. We are very pleased with our software performance in the first quarter. We’ve accelerated growth from fourth quarter to 6% overall. We have a very strong recurring revenue base. We accelerated Red Hat to a very strong 9% with our third consecutive quarter of mid-teen booking growth, which positions our business extremely well for double-digit growth for the full year, and we are getting nice scale leverage on acquisitions. Software for the year will deliver over 3 points of that IBM mid-single digit by itself. Based on that Red Hat momentum, acquisitions, solid recurring revenue, TP, by the way, nice start off, up 4% and new innovation like watsonx.

Consulting, we said for the full year, appropriately in light of the market and still gaining share would be mid-single digits. That will deliver about 1.5 points of growth to IBM. Why didn’t we feel good about that? One, solid book to bill, winning in key focus areas, strategic partnerships, Gen AI scale overall. But like first quarter, we’re going to continue to monitor that backlog realization to see how that plays out. But between software and consulting over 3 points in software, about 1.5 points, now you get to Infrastructure. We started out well above what we expected here in the first quarter. Mainframe eighth quarter end grew 5%. Our distributed infrastructure, power and storage, both grew double digits as we’re capitalizing on distributed infrastructure and demand requirements for GenAI.

Full year, that’s a little bit better than what we thought 90 days ago off our first start. So we expect about a little bit less than half a point impact to IBM. You throw on top of that, we executed the closure of The Weather Company, that would be about a half a point. So that’s kind of how we build up our full year overall. So AI book of business, I think you nailed it in your question. It’s, one, on a consulting perspective, it’s our signings book of business overall. And on our software, it’s our subscription, our SaaS and perpetual licenses. Again, as you know, we offer clients flexibility on how they want to purchase that overall. And consulting backlog, yes, 5% overall. I would tell you, let’s put it in perspective. It’s probably mid- to high-single digits, but we’ve got, give or take, about a $30 billion book of business on backlog with consulting.

So coming from where we started, less than nine months ago, I think that’s a very good ramp. And let’s put it in perspective, when we drove the hybrid cloud platform-centric play with consulting, which has done extremely well, over the first four quarters, we did a $1 billion book of business. Right now, through less than three quarters, we are very damn close to that $1 billion book of business, so.

Olympia McNerney: Great. Operator. Let’s take the next question.

Operator: Our next question comes from Ben Reitzes with Melius Research. Please state your question.

Ben Reitzes: Yes. Hey, guys. Thanks. I wanted to ask about Red Hat. You accelerated it to 9% in the quarter from 7%. What is your confidence level you get to the mid teens, which kind of equals your bookings growth? So — and then on Red Hat, the follow-up would be how much can HashiCorp augment that growth rate? And what do you — can you clarify the synergies a little bit more between Red Hat and Hashi and was Hashi needed to help grow Red Hat? Or is it a bonus? How do you see that? Thanks very much.

Arvind Krishna: Ben, let me take the first part of those questions. We are very, very pleased with Red Hat. If I look at Red Hat now, we have had mid-teens or better bookings growth for the last three quarters, third quarter, fourth quarter and first quarter. That combined with the growth we are seeing in OpenShift, as well as in both Ansible and RHEL, OpenShift growing almost 40%, gives us a lot of confidence. So bookings growth plus OpenShift plus what we are seeing in the revenue now at 9% tells us that we should see that Red Hat growth continue or accelerate through the year. Two, let me just address the macro point. Hashi is a nice add for the Red Hat portfolio, but it’s not inside Red Hat, let’s just be clear. So when we talk about Red Hat growth numbers of 9% and accelerating, that is Red Hat as is.

Hashi will be measured in software, but in IBM software, not in Red Hat. Where the synergy comes is we believe there will be added demand because of a combined portfolio is more interesting. We think even more clients will talk to us. That is how Hashi she will help Red Hat. It’s not that the Hashi counts at all for the numbers we just mentioned. So we kind of want to be clear on that. Hashi, to us, is an accelerant for IBM strategy and for software strategy and Hashi helps in being offensive in terms of giving us an overall better portfolio, so even more clients want to do business with us in the environments they’re going to. That’s kind of how I pitch it. And people know Hashi really well for their infrastructure management, but the security pieces of Hashi are also very, very interesting and really important as people navigate these very complex environments with all the worries about people losing secrets and keys and that resulting in ransomware or hacking attacks.