All right. Good morning, everyone. My name is Brian Essex, a software analyst at JP Morgan, and with me, I have, Jim Kavanaugh, a CFO of IBM. So Jim, thank you very much for joining us.
Well, thanks for having us. I appreciate it.
So maybe what we'll do is we'll kick off into Q&A. I'll leave some time at the end of the session for some questions from the audience, if that's okay. When they do that, just I think there should be mics that are gonna wander around. But maybe to kick things off, again, thanks for, thanks for being here. You know, perhaps you could start with a recap of the first quarter and, you know, what were some of the key takeaways you'd like the audience to know?
All right, great place to start, and again, thank you very much for having us here today. You look at our first quarter, I think we had solid execution starting the year overall, and it's really about how we've repositioned the IBM company around the two most transformative technological shifts that we see about hybrid cloud and AI, and you see that strategy continue to play out. And that gave us confidence then to actually reiterate our full year guidance around acceleration of revenue to mid-single digit and around $12 billion of free cash flow for the year. But let's take a step back and talk a little bit about some of the highlights in the quarter.
First, we had pervasive growth across all of our major segments at constant currency, led by software, where we saw nice acceleration in revenue growth, up 6%, really driven by Red Hat and the re-acceleration of Red Hat, which delivered a very strong quarter, growing 9%. But more importantly, our third consecutive quarter of very solid double-digit bookings growth that fits that subscription model going forward. It gives us confidence in the double-digit growth of Red Hat overall. And we also had very good, solid, recurring revenue growth, of about a $14 billion book of business overall, growing 8%. So software was the highlight of the quarter. Well, underneath that, our GenAI book of business, which is off to an extremely well start overall.
Three quarters in since we announced our GenAI tech stack, watsonx, last July, we have now eclipsed a billion-dollar book of business overall. We grew sequentially from the fourth quarter to the first quarter, and our consulting book of business is actually, inception to date, doubled all of 2023's signings overall. So top-line profile, very strong acceleration in GenAI, good software, but more importantly, the fundamentals of our business are still playing out extremely well. You think about what we've been doing with scale and operating leverage, productivity, portfolio mix. Our gross profit margins are up 100 basis points. Our operating pre-tax margins are up 130 basis points. Our adjusted EBITDA margins are up 110 basis points. And you bring that all together, and we delivered very strong free cash flow in the first quarter.
That was $1.9 billion, our strongest first quarter free cash flow we've had in many years. That was up $600 million year-to-year. So I think what you're seeing is the confidence in a repositioned IBM around those two transformative technological shifts and a very different investment thesis for IBM. Higher revenue growth, higher operating margin, strong free cash flow yield, and a higher return on invested capital.
Great. And maybe to kind of move into macro a little bit, we're halfway through the quarter, a little bit more than halfway through the quarter. Can you give us a sense of what you're seeing at the macro level? How you think, you know, budgets and spending are panning out, particularly compared to last year, when many were concerned about maybe a bit of a higher probability of a recession happening by the end of the year?
Yeah. Well, I could tell you, today's environment, I would define by one word: dynamic, overall. If you take a look at it, you know, everyone is trying to figure out dealing with higher interest rates, inflation, demographic shifts, supply chain dislocations, geopolitical conflict uncertainty. There are many challenges facing the world today and enterprises today, and I would think it's forcing every company to rethink the traditional forms of competitive advantage. If you look at it, though, IT and technology's always been a form of competitive advantage. That's why IT has historically outgrown GDP by a couple points every single year for decades and decade, because it's a global economic and business growth driver overall.
But when you think about it, I've talked to many different of my peers across many industries, and today, you know, we entered 2024, and we expected about a similar macroeconomic environment as 2023, I would call stabilization. But I think what's happening right now is you're seeing a lot of dynamic IT reprioritization happening underneath that broad umbrella of stabilization. Why is that happening? Well, I think every enterprise, including IBM, ourselves, are looking at how to leverage technology for that competitive advantage. Technology allows businesses to scale. It allows you to create and seize new market opportunities, and most importantly, today, it allows you to drive efficiency and productivity in what I call the flywheel effect of driving that productivity to create investment flexibility to reinvest back into your business overall.
So I think when you look at 2024, it's playing out at a macro level, pretty similar to what we thought, but a lot of dynamic reallocation underneath. And that's why, at IBM, we constantly are driving the operational efficiencies of productivity, so we could create the investment flexibility in driving innovation in core areas of growth that we still foresee very strong: hybrid cloud, GenAI, digital transformation, automation, application modernization, and that's where our focus area is.
Got it. Very helpful. And maybe we could touch on the hiring environment. I know across IT, that's a point of focus. What are you seeing out there in terms of your ability to attract and retain talent? And what is your, I guess, your appetite for either greater or just stable hiring levels?
Yeah, I think the answer today is very different than what it was five years ago. Very different portfolio, very different fundamental company overall, all centered around that hybrid cloud AI and emerging technologies like quantum.
Mm-hmm.
I think today, we are a very attractive play to human capital overall. We've been doing extremely well about capturing talent in the marketplace, but more importantly, developing that talent and retaining that talent over time.
Mm-hmm.
I think a big chunk of that goes to the confidence that people have in the company, the strategic position, and the value, and what a culture stands for in a company, and that's what we've been proud about with regards to IBM. So we're doing quite well around attracting talent. We're growing talent this year overall, but it's growth in very strategic focus areas that we're gonna continue to hone in on for long-term sustainable value creation.
Got it. And then, I guess, you know, sticking on the macro theme for one more, based on what you see in the market today and the objectives you have for the end of the year in terms of growth and profitability, what are you either the most excited about or the most worried about between now and year-end?
I would tell you, as a CFO, you always have to be prepared for every different scenario from a macroeconomic perspective. I would tell you, the one thing that keeps me up at night, arguably the most important role for a CFO is capital allocation.
Mm-hmm.
We have to ensure that every marginal dollar of capital that we deploy is delivering the best economic return. But more importantly than that, the biggest thing that keeps me up at night is making sure we don't miss market shifts.
Mm-hmm.
We're going through a big one right now with regards to GenAI. So the investments that we're making around hybrid cloud architecture, which is synergistic with that GenAI application deployment, around automation, building out management layer portfolio and software, security, and consulting, are gonna be key differentiators to us overall.
Got it. Maybe if we can shift to software, kind of the jewel of the quarter. I mean, you delivered solid growth, and reiterated your guidance slightly above the high end of the mid-single digit model for 2024. Can you spend a few minutes talking about the positioning of your software business today, the key drivers within that portfolio, and what makes you confident in a 2024 growth acceleration, including, you know, that of Red Hat?
Absolutely. You know, software is an integral part of our hybrid cloud and AI thesis in a platform-centric model overall. It is a solid growth vector, and it capitalizes on that economic multiplier that we always talk about. For every dollar of platform we land, we get three to five dollars of software overall. Very pleased, as we talked about upfront, with our first quarter start. Re-acceleration of our software portfolio and very nice quarter overall around Red Hat. We now have a Red Hat OpenShift book of business that's $1.25 billion ARR. We grew our bookings in the first quarter on Red Hat OpenShift by over 40%, and we're bringing new innovation to market around our GenAI tech stack, around watsonx, and around acquisition scaling very nicely. Apptio off to an extremely well start and around...
We're very excited about closing StreamSets and webMethods from Software AG, hopefully here at the end of the second quarter, and the announced intention of acquiring HashiCorp, which we-
Mm
... expect to close by the end of the year. But if you take a step back and look at our software portfolio, there's really two components of our software portfolio. One, our hybrid platform and solutions. That is a growth vector. That's about 70% of our software book of business. That houses our hybrid cloud and AI platforms, that being Red Hat OpenShift and our watsonx technology, but it also has our software innovation areas that are optimized on those platforms to drive synergistic value. Everything from our data layer, data fabric, data management, to our management layer, that is Instana, Turbonomic, Apptio, Ansible, and soon to be HashiCorp Terraform, to our security layer that has both Guardium and soon to be HashiCorp Vault overall.
Mm-hmm.
The model for that part of our business growth vector is to grow high single digits, and that's really instantiated by our ARR, that's about $14 billion book of business, a strong flywheel NRR effect that we've been growing well north of 100%, and the new innovation that we continue bringing to market, along with acquisitions. The second component of software is around our transaction processing, and that is a value vector to us. That's about 30% of our portfolio. This runs the mission-critical software that sits on top of our hardware systems platform. This is a very strong profit and marginal cash generator, which provides us tremendous investment flexibility over time, but it also provides a good incumbency and moat position for us to go capitalize on that multiplier effect that I talked about earlier. The model for that is low single-digit growth.
We called that inflection point about 18 months ago-
Mm-hmm.
-and delivered significant growth in 2023, up 6%. In first quarter, we just finished up 4%, as we capitalize on very strong mainframe cycles that we've seen the last couple years. So we feel pretty good about how we reposition our software portfolio. We continue to invest there, and we expect a very strong 2024, guiding above our mid-single digit model-
Mm-hmm.
really led by Red Hat, about acquisition scaling, and about our recurring revenue, new innovation overall.
Got it. And then you touched on M&A a little bit. You recently announced a transaction with Palo Alto. Is there anything about that that you can kind of expand on, and what will be, I guess, what that transaction will entail, the impact to IBM?
Yeah, absolutely. I think what you're seeing here is, we've been building credibility over the last four or five years since Arvind's taken over, on really focusing our strategy about being all in on hybrid cloud and AI. This relationship with Palo Alto is about focus. The security market overall is very fragmented by definition. We have a very strong position in data security with our Guardium platform, around identity management overall, soon to be even stronger with HashiCorp and Vault, around secrets and identity. But the threat management piece, we had a great opportunity to partner with the strategic platform leader-
Mm-hmm
... in Palo Alto. So it's, one, about focus, two, around capital allocation, so we have more investment flexibility to invest in our hybrid cloud and AI strategy, and three, it's about enabling and partnering with a, industry leader around Fed, where we can actually drive synergistic value in addition to the transaction benefit overall.
Hmm.
About driving synergistic value around our GenAI technology stack, which is gonna be embedded on top of their platform, around our automation portfolio, and around our consulting book of business, which we expect to build a billion-dollar book of business over a few years on top of Palo Alto. So we're pretty excited about it.
Great. Maybe one last one on software. You know, can you touch on the dynamics of, I guess, the impact that the VMware acquisition's having on Red Hat? I mean, I've heard some people within the industry, and I think you see it in Nutanix's results that, you know, they're benefiting from that disruption. And, you know, it sounds like Red Hat might be as well. I mean, you know, do you have a sense of, you know, how much of a tailwind that could end up being for Red Hat?
Yeah. We're obviously very excited with the Broadcom acquisition of VMware overall. It's creating a compelling event for all of our large enterprise clients around determining what is their future architecture platform.
Mm-hmm.
I think what you're seeing here is a platform-based architecture strategy decision between virtualization and containerization.
Mm-hmm.
VMware, with vSphere, provides a tremendous platform with regards to virtualization. We think we have a tremendous opportunity with regards to Red Hat OpenShift, that brings together virtualization, containerization, and AI infrastructure, coupled with IBM around our GenAI tech stack, that's gonna deliver a compelling, differentiated value proposition to our clients. And I'll tell you, we are building significant pipeline in large enterprise space. This will be a long-term growth play, 'cause these platform architecture decisions do not happen overnight. They happen over a period of time. But when you think about a multiplier effect, if we can win that architectural control with Red Hat OpenShift, and the multiplier effect we get on our software book of business and our consulting book of business-
Mm-hmm
... it's gonna be a significant long-term growth vector for the IBM company, and we're excited about it.
Great. Great. I wanted to shift to consulting. You know, strength in your consulting business has been, you know, pretty notable over the past few quarters, particularly with regard to performance relative to peers. Last quarter was a little bit weaker than you expected. You know, can you talk about what you're seeing in that business? In particular, how is progress with GenAI, as you just alluded to a few minutes ago? How do you see this opportunity, like, near term and medium term? And, you know, finally, how to think about the disparity between, you know, IBM's consulting business, the growth of that business relative to its peers?
Okay, we'll try to take that. There's a lot packed in that question.
Three or so in one, yeah.
First of all, thanks for the question overall. A lot of questions around our consulting, both from an IBM perspective, but I would tell you more importantly, from an industry perspective on what's going on. We've done a lot of work over the last few years, through the pandemic, to really reposition our consulting business, both the portfolio and the operating model over time. And we've invested in differentiated set of capabilities and skills, around business transformation, hybrid cloud architecture, as we move forward. And that's led to your question, differentiated market share performance over the last, I would call it, 18 months to 2 years, and we're pretty excited about where that's at today. Now, in the first quarter, did we come in a couple points below what we expected overall? Yes.
But when you look at it, we actually had one of the most strongest signings quarter in a first quarter that we've had in many years, as we've been able to continue to capture good growth around digital transformation, GenAI, application modernization, and the strategic partnerships and Red Hat portfolio that we built this business on overall. So we feel pretty good. Our focus now, along with the entire industry, is around monitoring backlog realization. As clients are going back to this dynamic IT reprioritization, as clients are dynamically allocating, they're looking for productivity to fuel investments in GenAI and application modernization and digital transformation, and we continue to take share in that.
And that's building a book of business that today has a book-to-bill well north of 1.15, a backlog position that's up 7% year-over-year, a strategic partnership velocity that's growing double-digit signings and revenue, and that Red Hat book of business is about $3 billion ARR. So we feel pretty good about the growth trajectory and around the differentiated value overall. Now, to your question on GenAI, we're very excited about the secular growth opportunity that GenAI possesses. Just as the explosion of cloud years ago created the digital transformation market, and I would argue, era, for the last decade for consulting, we believe GenAI is gonna kickstart what I call Digital Transformation 2.0.
As clients are looking at how do they build and scale their businesses, create new sources of revenue and new market opportunities, and create new sources of efficiency and productivity to go reinvest overall? We feel pretty good. You'll remember we announced our GenAI tech stack last July, so we're three quarters in. And when we announced that, we said we expected about a similar ramp that we saw in our hybrid cloud platform with Red Hat OpenShift. That was about a $1 billion book of business over the first 12 months. Well, through three quarters, we are well in excess of that ramp on our consulting book of business. On our consulting book of business, for three quarters in a row, had doubling our book of business each quarter. So we're off to a very good start.
And then lastly, I think your last question was around what differentiates us versus competition. I think, first, consulting plays a very integral role in our strategy inside IBM around hybrid cloud and AI. It capitalizes on that multiplier effect, the $68. It also is the tip of the spear that drives scale and adoption of our platforms and to pull IBM's technology. But if you look underneath it, we've done a lot of work to reposition that business around business transformation services, hybrid cloud. Arguably, one of the most important things Arvind has done, amongst many things, is he's opened up IBM, and we've created multiple billion-dollar book of businesses around strategic partnerships that we've been able to capitalize on with regards to consulting. Next up will be Palo Alto over a few years as we go forward.
We've also initiated Consulting Advantage, which is a whole differentiated set of offerings around assetization.
Mm-hmm.
We feel pretty good about our differentiation. Our portfolio differentiates us. We are 5%-10% BPO, which arguably is gonna get disrupted the most, and what I think most of our competitors are dealing with right now, we don't have to deal with that. We are capitalizing on where the growth vectors are moving, and we feel pretty good about that going forward.
Yeah, it's interesting. I wanted to ask you about some of the weakness in the quarter. I think you called out application modernization services. I thought it was interesting it wasn't maintenance or more BPO-related services. What are the dynamics around the modernization softness that you saw in the quarter in, you know, with regard to the maintenance business, should we be worried about, you know, the risk of AI disrupting that business?
Yeah. If you look underneath our application operations, I think we're down 1% in the quarter overall. That was coming off of our strongest quarter last year, growing 13% overall. So some of this is compare-wise. But underneath it, I think you're seeing some of this dynamic reprioritization. One, away from revenue realization around custom on-prem-based application maintenance and modernization, but we're still seeing double-digit growth overall with regards to our cloud-based application modernization and migration. And I would just tell you, you know, our first quarter performance overall, we finished signings growing about 30% in application operations, with a book-to-bill about 1.30. So I think part of this was last year's compare. Part of this is about the dynamic realization that we've got to make sure we manage through.
But part of this is about capturing where those revenue and growth pools are in the future, so we stay the strategic partnership, and I think we executed on that well.
Got it. Okay. I wanted to touch on, you know, the next segment is mainframe. I think some are anticipating the next mainframe cycle soon, but your existing cycle has been stronger than expected. How should we think about the timing of the next cycle and the magnitude of, you know, the next generation of mainframe after the healthy performance that you've seen with the current one?
Mainframe, thank you for asking the question. We don't get too many of these. It's the most enduring platform, and the innovation that we've been providing is really making it even more relevant for a hybrid cloud and AI world. You know, a few cycles ago, we chose a very differentiated investment in innovation strategy about mainframe. And that is, when you look at a set of capabilities that we've been building inside our platform around pervasive encryption, the industry's only quantum safe, first quantum safe, encryption capability on the mainframe today. We've opened up mainframe to all cloud-native applications that are running on top of the platform, very different than where we were five, six years ago. We've actually put AI on the chip on mainframe. We've been running this for the last 2+ years on our Telum chip. And around sustainability.
Mm-hmm.
You know, it's the most energy-efficient transaction processing system in the world. So these new innovation capabilities are why 45 of the top 50 banks around the world run the mainframe, 9 of the top 10 retailers run mainframe, 4 of the 5 top airlines run mainframe-
Mm-hmm.
and over 70% of the Fortune 100 run mainframe. Why? Because of trust to run their mission-critical transaction processing systems on the platform. And the interesting dynamic with all that new innovation, we're seeing over 60% of our clients growing MIPS over time, which is a very fundamental change. And over the last handful of programs, our installed MIPS capacity on how you monetize value is up 3x. Very important because that actually creates a stack economics as we leverage, attach a hardware, software, maintenance, and financing, we feel pretty good, and we're gonna come out with a new mainframe here in the first half of 2025, and we feel pretty good about the new innovation we'll bring to market.
Got it. Thank you. I think we've got about eight minutes left, so I wanted to open it up and see if there's any questions from the audience. Oh, we got one in the back. We got a mic right there.
Hi. So, how does AI change your acquisition appetite? You made a big announcement with HashiCorp, which is multi-cloud, but just thinking about the other opportunities in AI. Thanks.
Yes, thanks for the question. I think I heard it around HashiCorp and M&A and acquisition strategy. We're extremely excited about the acquisition of bringing HashiCorp, IBM, and Red Hat together to really create the leading hybrid cloud and multi-cloud-based platform in the world, around application and infrastructure lifecycle management and around security lifecycle management overall. Strong strategic fit, aligns with our open source commitment overall around industry collaboration, developer community, and around AI innovation. If you think about the product synergy capability of bringing together Terraform, Red Hat Ansible, Red Hat OpenShift, our watsonx technology, and consulting, it brings a very powerful client value proposition. In addition to a security lifecycle management, or how we're gonna bring Vault and our Guardium technology with our consulting business to bring a very differentiated point of view.
We're extremely excited, strong strategic fit, synergistic value to a Hybrid Cloud and AI strategy. It has a very attractive financial profile, higher revenue growth company, adjusted EBITDA, accretive in the first 12 months, free cash flow accretive, in year two, and significant near-term operating efficiencies and cost efficiencies, that we see a business that's gonna be a 30%-40% free cash flow margin business over the next handful of years. So we feel pretty good about it.
Any others from the audience? Okay, I wanted to ask you about that. In terms of the, you know, cash flow dynamics expected from, I guess, on the back of the HashiCorp deal, how do you envision free cash flow to trend over the next few years? I mean, I think you noted, like, free cash flow accretive in year two.
Yep.
Is that kind of the target that we're locking on to and maybe some, you know, near-term—I guess, volatility or movement in free cash flow before that period of time?
Yeah. Thanks for the question, 'cause we're getting a lot of interest as we're doing some of our round tables upstairs before this. Let's put this transaction in perspective, right? Because really what you're asking about is the dilutionary effect of the acquisition.
Right.
First of all, the transaction stands on its own, and we're extremely excited, as I said, around the strategic fit, the synergistic value to our portfolio, and around the attractiveness of the financial profile overall. M&A has always been an essential element of our capital allocation strategy since Arvind has taken over, and it's also embedded in our financial model overall, taking into account that dilution, which we know how to deal with. You know, our business model with regards to M&A takes into account everything from the purchase revenue to the revenue and cost synergies, to the balance sheet and capital structure, implications around dilution. And that business model and financial model, as you know quite well, Brian, is centered around growing revenue mid-single digit-
Mm-hmm.
generating operating margin expansion each year, and around generating free cash flow generation of $750 million per year. And when you take a look at it, I think it talks to the breadth and diversification of our business model overall to deliver that financial investment thesis. And if you look at it, we've got multiple levers: portfolio mix, new mainframe next year. We've got, now, we took up our annualized productivity target to $3 billion, annualized exit run rate by the end of 2024. So we've got a lot of opportunity on how we manage dilution with regards to free cash flow in 2025. And I would tell you, given that, we feel very confident about our growth profile.
Great. Maybe last one from me. You know, just as a, as a wrap-up, you've made a lot of exciting announcements recently: HashiCorp, watsonx, Apptio, Software AG, Palo Alto. What excites you the most about the future of IBM?
Well, I think it starts right here this week in Boston, and I'm not talking about the Celtics. I'm talking about the JP Morgan conference, but more importantly, is we're hosting our annual Think conference that starts tonight with investors and tomorrow with all of our clients and partners, probably 5,000-7,000 partners and clients overall, where we're gonna unveil our next step in our GenAI strategy-
Mm-hmm
... around bringing the whole open source community to GenAI. And I think around what we're gonna announce around RHEL AI, OpenShift AI, our watsonx tech stack, our embedded software assistance and new innovation we're gonna bring to market, around our new strategic partnerships, we can go on and on and on, and around our consulting business. So GenAI is what we're all focused on right now, and the synergistic effect with hybrid cloud, and I couldn't be more happy. I think we're a very attractive AI investment play right now, and we're gonna share with the world starting tomorrow. So that's what excites me the most.
Sounds good. And I think you can walk there from here, can't you? Like-
It's right next door.
Pretty close. Yeah. Excellent. With that, thank you, Jim, for joining us. I appreciate it, and thank you all for joining us as well.
Thank you, Brian.