The operator introduces the conference call for IBM's Third Quarter 2023 Earnings Presentation. Patricia Murphy, IBM's Vice President of Investor Relations, introduces the speakers and discusses the availability of the presentation and a replay. Non-GAAP measures and forward-looking statements are also mentioned. IBM's Chairman and CEO, Arvind Krishna, addresses the recent outbreak of war in Israel before discussing the company's business performance.

In the third quarter, IBM saw growth in revenue, profit, and free cash flow while focusing on innovation and positioning themselves for future opportunities. Technology continues to be a source of competitive advantage, and businesses are looking to address demographic shifts, improve sustainability, and deal with uncertainty through technology. Despite some headwinds, technology spending is expected to outpace GDP. IBM has seen growth in software and consulting, and good adoption of their z16 product. They are also investing in new products, partnerships, and talent, and focusing on productivity in their own business. Overall, IBM is aligned with their clients' needs and has a strong financial profile.

IBM is focusing on AI and its potential in the market, specifically with the concept of generative AI. They believe that this approach will be multi-model, similar to their hybrid approach to cloud. IBM's generative AI software stack includes Red Hat OpenShift, data services, and the watsonx platform with various AI assistants. They have recently introduced new AI capabilities, including a multi-billion parameter model and a code assistant for mainframe modernization. IBM plans to launch a governance tool for AI before the end of the year.

IBM has over 20,000 data and AI consultants who help clients with AI strategy, understanding, and deployment. These consultants also provide feedback to product teams. The top AI use cases include code modernization, customer service, and digital labor. IBM has seen success with AI internally and externally, with hundreds of millions of dollars in business related to generative AI. IBM has worked with clients like Dun & Bradstreet and EY to create AI solutions. IBM continues to innovate in areas beyond AI.

In the fifth paragraph, the speaker discusses the company's recent innovations, including their hybrid cloud platform and the acquisition of Apptio. They also mention their progress in building quantum computers and their confidence in the future of the company. The speaker then hands it over to Jim for a more detailed financial overview, where he highlights the company's revenue, operating income, and earnings per share. They also mention that currency translation had a small impact on their revenue growth.

Arvind discusses the growth of IBM's Software and Consulting offerings, which make up three quarters of their revenue. Software revenue increased by 6%, driven by clients using data for insights and automating IT in a hybrid environment. The Consulting business also had a strong quarter with 5% revenue growth. IBM's Infrastructure revenue was down 3%, but there was growth in zSystems as more clients embrace IBM Z in their hybrid cloud environments. Despite a currency impact, IBM saw strong margin, profit, and free cash flow performance due to a good portfolio mix and productivity initiatives. These initiatives also allow for reinvestment in the business and contribute to margin expansion.

The company is on track to achieve its goal of $2 billion in annual savings by the end of 2024. They have seen strong profit growth and generated a significant amount of free cash flow. They have also made investments and returned money to shareholders, resulting in a strong balance sheet. In terms of revenue, the software segment saw a 6% increase, driven by growth in both transactional and recurring revenue. The Hybrid Platform & Solutions segment saw a 7% increase, with growth in Red Hat, Automation, and Data & AI. Red Hat specifically saw an 8% increase in revenue.

In the quarter, clients have shown a strong commitment to the company's hybrid cloud approach, resulting in a 14% increase in annual bookings. Automation and data & AI are top priorities for clients, leading to growth in these areas. The company also saw growth in Transaction Processing and Consulting, resulting in an overall increase in Hybrid Platform & Solutions ARR and expansion of gross and pre-tax margins.

IBM's strong quarter of signings has resulted in a trailing 12-month book-to-bill ratio of over 1.15. Clients are prioritizing transformation projects, and IBM's hybrid cloud and AI strategy is a differentiator. The company's strategic partnerships, which account for 40% of Consulting revenue, have continued to grow double digits. Revenue from hyperscaler partnerships was up over 40%, and signings doubled year-to-year. The Red Hat practice, which helps clients optimize their hybrid cloud environment, also saw double-digit growth. Overall, Consulting revenue performance reflects market demand, positioning and partnerships, and investments for growth. Across the three lines of business, Business Transformation revenue grew 5%, led by data and technology transformations, while Technology Consulting revenue was up 1%.

The growth in cloud-based application development and modernization was partially offset by declines in on-prem application projects. In the Application Operations division, revenue increased by 7% due to both cloud application management and platform engineering services. Consulting profit expanded with a 150 basis point increase in gross margin and a 40 basis point increase in pre-tax margin. In the Infrastructure segment, revenue decreased by 3%, with flat revenue in Hybrid Infrastructure and a 7% decline in Infrastructure Support. The zSystems division saw a 9% growth, driven by enterprise workload requirements and the economic value of the platform. Distributed Infrastructure revenue decreased by 6%, with growth in Power offset by declines in Storage. The Infrastructure segment had strong gross and pre-tax margin performance, with a 350 basis point expansion in pre-tax margin. These results were impacted by currency exchange rates. Overall, IBM expects positive results for the quarter.

IBM has made significant progress in the past two years, focusing on a platform-based approach to hybrid cloud and AI. They have continued to invest and bring new products to market, resulting in 3.5% revenue growth, margin expansion, and strong free cash flow. The company is confident in meeting their full year financial goals of 3-5% revenue growth and $10.5 billion in free cash flow. They have seen solid performance in their Software and Consulting sectors, and expect Infrastructure revenue to be on the low end of their target range. IBM is also making strides in productivity through digital transformation, leading to improved margins and free cash flow. They anticipate a 0.5 point margin improvement and a mid-teens tax rate for the year.

The company has seen a strong year so far, with a $1 billion increase in revenue and on track to reach $10.5 billion for the year. The fourth quarter is expected to have similar revenue growth to the third quarter, despite currency headwinds and tough comparisons to last year. The company's business is well-positioned for the future and the executives are ready to take questions. The moderator reminds participants to refrain from multi-part questions. The first question is about the company's customer conversations regarding macro concerns.

Arvind Krishna discusses how the macro environment is impacting the allocation of IT budget dollars towards generative AI. He explains that clients are prioritizing investments in code, customer service, and digital workers, with a focus on productivity and cost takeout. Clients also recognize the long-term competitive advantage of increased productivity and the potential for improved customer satisfaction with AI. The expected productivity improvements range from 4-10%, with the highest potential in customer service.

The speaker discusses the macro headwinds facing the industry, such as higher interest rates, geopolitical uncertainty, and difficulty in finding skilled employees. They mention that the AI and hybrid cloud sectors offer a way through these challenges without compromising growth ambitions. They also note a shift in focus from employee satisfaction to more fundamental processes. The next question asks about the deceleration of Red Hat in the third quarter, which the speaker attributes to weaker consumption-based services. They confirm their expectation for Red Hat growth in the 11-13% range for the year and mention growth across the board in their Software segment, with Automation leading at 8%.

The paragraph discusses IBM's strong recurring revenue base, with 80% of their portfolio growing mid-single-digit growth. The company acknowledges that their Red Hat business fell below expectations due to execution issues, particularly in the consumption-based services and offering side. However, the remaining 80% of the portfolio, which includes their subscription-based business, had a strong performance with mid-teens growth and a renewal rate of over 110%. Within this, Red Hat OpenShift and Ansible saw growth of over 40%, while RHEL grew in double digits.

The speaker believes it is wise to only build high single digit growth into their model for the fourth quarter. They will continue to monitor the effect of the third quarter and focus on execution. Despite this, they are confident in Red Hat's long-term growth potential. The speaker also confirms that the guidance for the fourth quarter is around $17.3 billion, which is lower than normal seasonality. They mention the strong services signings and potential transactional pull forward from mainframe.

The speaker is explaining their company's expected performance in the fourth quarter, which they believe will be similar to the third quarter. They mention that historically, they generate around $2.9 billion in revenue each quarter, but last year they did $2.6 billion. This year, they expect to reach a similar revenue number, but there has been a change in currency exchange rates that will affect the overall revenue. Despite this, the company is confident in achieving a 3-5% growth rate, led by their software division and consulting services. They also mention the company's strong operating leverage and expected profit range.

The speaker addresses concerns around generative AI, including accuracy, liability, and governance. There are also concerns around the use of private data in models and potential for others to learn from it.

IBM is confident in their ability to stand by the data used to train their models and provide indemnification for them. They are excited about their code and customer service and believe that it will help mitigate risks and uncertainty around governance and long-term deployment. They expect to see a lot of deployment in 2024 and are not worried about risks for quick website responses. There may be some concerns with Consulting, but they are not mentioned in this paragraph.

The speaker is surprised by the 32% growth in bookings compared to the previous quarters and asks Jim about the reasoning behind it. Jim credits the strong fundamentals of the business, good operating leverage, and cash contribution for the success. There is still high demand for digital transformation and application modernization, but there is also pressure on discretionary-based activity. However, this has not affected the overall client buying behaviors and the company has a strong trailing-12 month book-to-bill of 1.16.

The speaker is addressing a question about IBM's software consulting guidance for the year. They note that the company did not change their guidance ranges, but they expect full year constant currency revenue growth to be at the lower end of the range. They suggest that software consulting may grow at the lower end of the ranges previously provided, due to factors such as the early closure of Apptio and comments about Red Hat.

IBM CFO Jim Kavanaugh explains that the company's 3-5% revenue growth guidance for the year has been adjusted to the low end of the range due to changes in the different segments. The recent acquisition of Apptio, which closed earlier than expected, is expected to contribute 0.5 points to the full year growth. The company's software segment has performed well, with recurring revenue and transactional business both showing strength. The new innovation being brought to market has resulted in an increase in new ELA content and contributed 1.5 points of growth above expectations.

The speaker discusses the company's strong performance in the third quarter, including a high net revenue retention rate and expectations for similar results in the fourth quarter. They also mention their guidance for software and consulting, as well as their focus on free cash flow generation.

The company has reported a $1 billion free cash flow growth, with $700 million coming from operating profit. The CEO has been transparent about this growth throughout the year and expects most of it to come from profit and improved efficiency in working capital. While there may be some offsetting factors, the growth is fundamentally driven by revenue growth and operating leverage. In 2024, the company will focus on cash tax and is confident in their actions to maintain strong cash flow. The last question asked about the adoption of AI by customers and how it may impact the Consulting business and the watsonx platform.

Arvind Krishna responds to a question about adoption rates and explains that while consulting will be the "tip of the spear" in driving adoption, it will not be the only approach. He gives two examples, one where IBM works with a financial services company to augment their model using their proprietary language and data, and another where consulting leads the partnership with Dun & Bradstreet to help them monetize their data better. He emphasizes the importance of consulting in landing deals like these.

The paragraph discusses the success of the company's Consulting team in using Azure OpenAI and Amazon's Braket platform to win deals. It also mentions the growth of both the Consulting and Software units, with a couple of points coming from generative AI. The company is confident in its strategy and expects further growth in the future. The call has now ended.

This summary was generated with AI and may contain some inaccuracies.