IBM's Global Head of Investor Relations, Olympia McNerney, welcomes participants to the Second Quarter 2024 Earnings Presentation, which is being recorded. She introduces IBM's Chairman and CEO, Arvind Krishna, and Senior VP and CFO, Jim Kavanaugh. Non-GAAP measures and forward-looking statements are mentioned. Arvind highlights the company's strong performance in software and infrastructure, driven by investment in innovation, and mentions that consulting was below expectations. He attributes the success to IBM's hybrid cloud and AI strategy and diversified business.

The macroeconomic environment continues to support technology spending, with AI being a key competitive advantage for businesses. IBM has infused AI across all segments of their business, including software, transaction processing, infrastructure, and consulting. The company's enterprise AI strategy is resonating with clients, and their Granite models, ranging in size and trained on multiple programming languages, have consistently achieved top performance for various coding tasks.

IBM's fit-for-purpose AI models are significantly less expensive than large models, making them a top priority for clients. The company is committed to open innovation and has open-sourced its Granite family of models. They believe that AI will follow a similar trajectory as Linux in the enterprise space. IBM also offers tools for more efficient model tuning and customization using client data. Their AI strategy includes a comprehensive platform with various components, including consulting services and infrastructure. The company's generative AI business has reached over $2 billion.

IBM's strong results in the technology and consulting industry highlight their momentum and leadership position. They continue to innovate and invest, with a focus on automation and optimizing IT spend. The recent acquisition of HashiCorp and IBM Concert, as well as the completion of the StreamSets and webMethods assets acquisition, further enhance their automation portfolio. IBM Z, their mainframe solution, is also seeing continued strength, with its latest cycle z16 offering clients security, scalability, and resilience. The z16's Telum processor is a unique feature that allows for real-time AI inferencing at unprecedented speed and scale.

IBM's storage offerings are benefiting from generative AI and the company is investing in emerging technology like quantum computing. They have expanded their quantum computing software and announced new AI partnerships with industry leaders. IBM has also strengthened their ecosystem through partnerships and announced a new partnership with Palo Alto Networks for AI-powered security solutions. They are raising their expectations for free cash flow for the year and will continue to deliver strong results.

In the second quarter, IBM reported strong financial results, including a 4% increase in revenue, 17% growth in operating pre-tax income, and 11% growth in operating diluted earnings per share. The company also generated $4.5 billion in free cash flow, the highest first-half level in many years. Revenue growth was driven by software and infrastructure, with investments in innovation yielding positive results. IBM also saw margin expansion through operating leverage, product mix, and productivity initiatives. The company continues to prioritize investment in innovation through increased R&D spending.

The company has made investments in AI, hybrid cloud, and infrastructure to support their Nexi program in 2025. This has resulted in strong growth in revenue, operating pre-tax income, adjusted EBITDA, and free cash flow. The company has also returned a significant amount of cash to shareholders and has a strong balance sheet. In terms of segments, software revenue growth has accelerated, driven by investments in both organic growth and acquisitions. The company expects continued growth from Red Hat, recurring revenue, and transaction processing.

In this paragraph, the speaker discusses the different elements that contributed to Red Hat's strong performance in the past quarter. These include accelerated annual bookings growth, particularly in OpenShift, RHEL, and Ansible, as well as demand for hybrid cloud solutions and new innovations such as generative AI offerings. The majority of revenue is under contract for the next two quarters, and the company's CRPO metric is growing in the mid-teens. The speaker also highlights the growth in recurring revenue and transaction processing, driven by demand for capacity, client renewals, and strong large deal performance. The company's focused M&A strategy, including the recent Apptio acquisition, also contributed to its revenue performance.

The company has seen accelerated bookings and growth in annual recurring revenue since the acquisition of Apptio. The recent acquisitions of StreamSets and webMethods are expected to further drive growth. The gross profit margin and segment profit have also increased significantly. However, there has been a pullback in discretionary projects due to clients prioritizing spending. The company has seen solid demand for large transformational offerings, leading to a backlog growth of 5%. The company's expertise in generative AI has helped them secure a book of business worth over $2 billion.

IBM is well-equipped to help clients with the technology shift towards generative AI, as they have both technology and consulting capabilities. This is a significant opportunity for the company, as AI is driving growth for businesses. IBM is partnering with clients to design and scale AI solutions and also developing new ways of working through their Consulting Advantage platform. In terms of revenue, business transformation and data transformation are driving growth, while application operations revenue declined. Consulting profit margins improved, but segment profit margin was slightly down due to labor inflation and currency. In infrastructure, revenue increased due to strong demand for IBM's hardware platforms, particularly IBM Z.

IBM Z revenue was up 8% in the hybrid infrastructure segment, driven by increasing workloads and demand for cloud-native development, AI, and security features. Distributed infrastructure also saw growth, with power and storage both performing well. The company is making investments in areas such as AI, hybrid cloud, and quantum, which contributed to solid gross profit margin expansion and increased segment profit. Overall, IBM is pleased with their performance in the first half of the year, with strong revenue growth, margin expansion, and profitability.

The company is maintaining its revenue growth expectations for the full-year 2024, with a focus on mid-single-digit growth. They are confident in their free cash flow expectations, which have been raised to over $12 billion due to strong performance in the first half. The company expects growth in the software segment to be in the high-single-digits, with an increase in profit margin. However, they anticipate lower growth in the consulting segment due to spending pressures and expect the infrastructure segment to be neutral for the year. The company is also maintaining its expectations for operating pre-tax margin expansion and operating tax rate. Due to the strengthening of the dollar, they expect a 100 to 200 basis-point impact on revenue growth for the year. The third quarter is expected to have consistent revenue growth with the full-year.

The company expects its net income to remain ahead of last year due to strong business performance, but gains from a recent transaction will be offset by related costs. The company's leaders are pleased with the performance and updated expectations for the year. The Q&A session will begin and the first question is about the company's long-term model for transaction processing, which had a strong quarter with 13% growth. The company notes solid client renewals and strong large deal performance, but there may have been some unusual or episodic factors. Overall, the company is pleased with its transaction processing performance and it has been converted into a growth vector.

IBM's growth has been strong in recent years, with mid-single-digit growth or better. This is significant because it brings in high profits and cash, allows for investment flexibility, and strengthens their incumbent base. The mainframe cycle has been a major contributor to this growth, with an increase in MIPS and a majority of clients growing their MIPS on the mainframe. IBM has invested significantly in their mainframe portfolio and has shifted from a declining portfolio to one that capitalizes on stack economics. They are confident in their ability to continue growing and are investing in new capabilities like watsonx Code Assistant for Z, which has been well received. In terms of AI signings, IBM sees them as incremental rather than a shift in client spending, as evidenced by their $1 billion increase in AI business.

IBM CEO Arvind Krishna and CFO Jim Kavanaugh discuss the company's strong consulting signings in the quarter, which totaled over $700 million. However, they acknowledge that there is pressure on discretionary spending in consulting and believe that a significant portion of the demand for AI is a shift from other areas of consulting. They do not see this as cannibalistic to consulting spend, but rather as a potential for future accretive and additive benefits. They are pleased with the early momentum of their GenAI business, including their watsonx platform and open innovation strategy.

IBM Consulting is important in the early part of the cycle because it establishes them as the strategic provider for enterprises going through digital transformation 2.0. They have seen a strong start with over $1.5 billion in business in the first 12 months. However, they expect clients to shift and reprioritize spending in the future, but this will lead to long-term growth opportunities. The business transformation services segment has seen doubled and accelerated growth as clients make dynamic spending decisions.

The speaker discusses the importance of their client base and the growth of their software business, which has contributed positively to their overall growth. They then address a question about the Consulting side of their business, stating that there is no secular macro trend causing weakness, but rather it is due to temporal factors such as geopolitical uncertainty. They do not believe this weakness will last long-term and mention specific regions that are impacting the business.

The speaker discusses the current state of inflation and its impact on interest rates, wage inflation, and the bottom-line of clients. They express optimism for the medium and long-term future of Consulting, but acknowledge that the next six months may still be challenging. The speaker then turns the question over to Jim to address specific numbers and factors affecting the Consulting sector, highlighting the company's solid book-to-bill ratio, GenAI momentum, strategic partnerships, and future acquisitions.

The speaker discusses the company's recent success with GenAI and strategic partnerships, and emphasizes the importance of becoming the strategic provider of choice. They also mention a shift in spending priorities and the need to win in the long term. In response to a question about M&A, the speaker reaffirms the company's disciplined and focused strategy and mentions the attractiveness of the public market.

In this paragraph, Arvind Krishna discusses IBM's approach to acquisitions, stating that they focus on hybrid cloud and artificial intelligence and expect synergy and accretion to free cash flow. He mentions the recent acquisition of StreamSets and webMethods, as well as smaller deals in the consulting and technology space. He also talks about the current valuations in the market, which he considers to be reasonably rich but not as high as they were 18 months ago. He notes that public markets are variable, with multiples ranging from six to ten times, while small deals are more about technology and people. In the private markets, IBM was pleased with the deals for StreamSets and webMethods, and multiples depend on factors such as growth profile and attractiveness to the buyer.

The speaker expects valuations to be slightly lower on the private side due to the lack of risk involved in going public. However, they remain committed to M&A as a growth strategy and have a strong balance sheet for this purpose. They are waiting to complete a major deal before making any further moves. The questioner asks about the sustainability of margin progress and the impact of the HashiCorp deal on revenue and dilution.

The company is pleased with their strong start to the year, with record-breaking free cash flow and increased confidence for the second half. The improved adjusted EBITDA and EPS overachievement are driving the guidance increase for free cash flow. Other factors, such as retirement plans and cash tax, will have a minimal impact. The company expects to close the Palo Alto transaction in the third quarter, which will generate a gain that will be offset by structural actions to address stranded costs and accelerate productivity initiatives. The HashiCorp acquisition is seen as a strategic fit for their hybrid cloud platform.

The speaker discusses the synergistic value of the Red Hat acquisition, highlighting its potential for financial growth and cost savings. They also mention their understanding of dilution and their experience with M&A. The company's model is to grow mid-single-digit revenue and increase operating leverage to grow free cash flow quicker than revenue. They mention the diversity of their business model and their ability to handle the acquisition. The speaker then addresses a question about Red Hat's business, noting their healthy bookings growth of 15-20% in recent quarters.

The speaker discusses the dynamics of the Red Hat business, explaining that bookings are a signal of demand and typically account for half of the revenue, with the other half coming in over the quarter. They mention that the previous year saw double-digit demand and that this points to low double-digit growth for the second half of the year. They also mention CRPO or revenue performance obligations, which are expected to be around mid-teens for the second half of the year.

The company is seeing early signs of demand continuing into the current quarter and expects to see low double-digit growth going forward. The growth is driven by the success of OpenShift, containerization, virtualization, and hybrid solutions. The company is also excited about their two open-source AI projects, which are expected to contribute to the business in the future. The decision to open up the Granite models and code base was driven by market demand and a focus on fit-for-purpose models for developers.

The question at hand is whether one or two very large models will dominate the market, but this is unlikely due to the high cost of running them on public clouds. By reducing the model size, costs can be decreased by 90%, and using Red Hat technologies on-premise can reduce costs even further. If you have a specific task in mind, a smaller model tailored to that task is more efficient than a large, all-encompassing model.

The company is proud of their models that can understand programming languages and business language. These models are much smaller than other large models but perform just as well. The company also works with other models if clients prefer. They open-source their models under the Apache license to allow clients to add their own unique language without giving it away. This also opens up a market for developers to experiment with models.

In paragraph 28, the speaker addresses concerns about giving away their intellectual property and explains that the open-source nature of their product allows them to tap into a larger market of developers. They are confident that their focus on patching, security, and backward compatibility will continue to attract enterprise customers. The call concludes with the speaker expressing excitement about their progress in generative AI and thanking participants for joining.

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