International Business Machines Corp Q1 2025 Earnings Call Transcript

The following is excerpted from the question-and-answer section of the transcript.

Question: Jim Schneider - Goldman Sachs - Analyst : I was wondering if we could maybe start off with sort of framing the macro impact that you're seeing on both Software and Consulting. You talked about some of the potential drivers, but I'm sort of curious at this point, are you seeing any kind of significant softening in say, the consumption portion of the portfolio, either Red Hat or otherwise? And do you see any slowdown in specifically, Transaction Processing for the year that will allow you to not sort of hit the target you laid out at the Investor Day? Similarly on Consulting, are you seeing the DOGE impact sort of significantly impacting the near-term results? Or is this more of an expectation of a slowdown in a broader sort of enterprise mix of business? And then just broadly speaking, if you could address the sort of subsegment guidance you had provided at Investor Day approaching double digits in Software and low single digits in Consulting and whether we expect either of those to change very much.

Question: Wamsi Mohan - BofA Global Research - Analyst : Maybe just to follow on in terms of just the way to get to your 5%-plus guide for the full year. It'd be helpful if you could maybe just give us some sense both on Red Hat which is going to face tougher comps, and Transaction Processing, which is starting off at 2%, how we get to sort of this

Question: Amit Daryanani - Evercore ISI - Analyst : I guess I was hoping you'd talk a bit more on the Consulting side, and you've talked about there's a lot of notes happening on Consulting, especially from the federal and DOGE exposure. So I'd love to understand, how big is the federal business for you folks? And how do you think about the discretionary part of your Consulting business stacking up in the back half of the year, given some of the macro noise? Just anything on the Consulting side would be really helpful. And then, Jim, if I could just follow up. You folks normally don't give a quarterly explicit revenue guide. You're doing it this time around for June quarter. So I'm just curious, what led to the decision to give a more explicit June quarter guide other than you were afraid we were all going to mismodel it? James Kavanaugh - International Business Machines Corp - Chief Financial Officer, Senior Vice President - Finance and Operations Yeah. Let me -- first of all, thanks, Amit. Let me take the second question first, and then I'll go into the DOGE specifics to ground us in numbers, and then if Arvind has any of the client pieces back as we've been actively engaged with the administration as you can quite imagine. REFINITIV STREETEVENTS | www.refinitiv.com | Contact Us consent of Refinitiv. 'Refinitiv' and the Refinitiv logo are registered trademarks of Refinitiv and its affiliated companies. APRIL 23, 2025 / 9:00PM, IBM.N - Q1 2025 International Business Machines Corp Earnings Call Well, let's take a look at on currency in particular and given our quarterly guide, why did we do that? Full transparency, we feel obligated with our credibility on what we see in the near term, given we're operating, as we talked about, in a very dynamic and uncertain macroeconomic environment, our best visibility right now is probably in the next 90 days. And given that credibility and transparency to investors and also in light of the significant US dollar devaluation that's happened over the last three weeks. So let's put that in perspective. The rate, the magnitude and the breadth of the US dollar depreciation, we have not seen in quite some time, like 8% to 9% devaluation. So what did we do? We gave you both. We always guide on constant currency and we guided on constant currency, and we could talk about the underpinnings a little bit later. Second, just given the extreme volatility in the market, we guided on an absolute dollar range, all in. Why did we do that? Because at 4% constant currency growth, if you just dial back to where the FX rates were as we entered April 1, that would put you at $16.4 billion. If you actually take that same 4% and you look at today's -- actually, today's spot rate devalued or actually appreciated about 1 point, so we already gave 1 point back. But if you look at it from yesterday, we'd be at $16.75 billion. So we're not in the business of predicting the FX volatility. We're giving you a range, but we're saying, as always, what we can control, which is the underlying dynamics of the operational performance of our business, we feel confident of at least 4%. So hopefully, that gives you that. On DOGE, let me ground some data and facts here. One, as Arvind said, no one's going to be immune from this. But our US federal business is less than 5% of IBM's total annual revenue. About 60% of that is Consulting, which is more susceptible to discretionary efficiency type programs. 40% of it is technology, which is all high-value annuitized revenue under contract. Let's put that off to the side. In Consulting, our US federal is less than 10% of the total. By the way, we have less than 3% market share overall. Now when you look at it, Arvind indicated, and by the way, all this data is public. We've had a handful of contracts, either statement of work that have -- or canceled. And on our annualized backlog of over $30 billion in total Consulting, this is like less than $100 million of backlog over a duration of multiple years. So while no one's immune, we are absolutely focused on monitoring the dynamic process. And I think back to Wamsi's question, we're prudently cautious around Consulting for the year.

Question: Ben Reitzes - Melius Research - Analyst : If you can hear me now, I wanted to talk about the Red Hat business. It decelerated, I guess, 300 basis points sequentially. And I was wondering if we could just talk a little bit more about the dynamics, why that occurred. I think you said the consumption business didn't get hit. And then it looks like it's going to reaccelerate because of the great bookings. And then you mentioned virtualization. I don't know if you've mentioned that before in the conference calls, but wondering how much of a driver that is for Red Hat, given some of the changes going on at VMware. James Kavanaugh - International Business Machines Corp - Chief Financial Officer, Senior Vice President - Finance and Operations Thanks, Ben. Let me take some of the numbers around Red Hat, and then Arvind can add some of the color around the portfolio, et cetera. I would tell you, we're very pleased with our Red Hat performance entering the year. Very different profile than where we were a year ago, by the way, when we were trying to accelerate to get to double digits for the year. Yes, it decelerated but let me unpack some of this for you. One, we grew 13.5%. I think well within our guidance range of where we wanted to start the year. Underpinning that, the most important thing, as you called out, Ben, thank you, our seventh consecutive quarter of strong ACV signings bookings, high teens overall. The way I'd like to look at this business, you've got to break it out between the different compositions. One, 80% of our portfolio is subscription-based businesses. We continue to see strong performance, high mid-teens level overall. Pervasive double-digit growth across the portfolio, as I stated earlier, in gaining share, RHEL up 13%, Red Hat OpenShift up 23%. By the way, $1 billion ARR business overall, capitalizing on virtualization, hybrid cloud application modernization. Ansible up strong mid-teens overall, capitalizing on clients, cost efficiency, productivity and GenAI, and by the way, very strong synergistic value of the IBM portfolio overall. So a very healthy profile. And within it, as we always do, we give you a cRPO next six months. We only see that actually accelerating overall. Now to Arvind's earlier point, the 20% of the business on consumption base, we did not see a decline, we saw a moderation. We remember, 90 days ago, we actually were

Question: Erik Woodring - Morgan Stanley - Analyst : Jim, I just want to dig into your free cash flow guide. Just you reiterated the full year revenue guide in constant currency, but FX just went from a 2 point headwind to a 1.25 point tailwind, so an incremental, call it, $2 billion of rev from FX alone. You maintained your full year PTI margin expansion target, so obviously, really strong flow-through to the bottom line. And so I guess my question is, why aren't we seeing that necessarily show up in higher free cash flow guide for the year? Are we just being conservative because it's early in the year? Or are there any new kind of incremental free cash flow offsets that we now need to think about? James Kavanaugh - International Business Machines Corp - Chief Financial Officer, Senior Vice President - Finance and Operations Yes. Thanks, Erik. I really appreciate the question. As we talk about, we've got two key measures in this company. One is to continue to accelerate the top line growth profile of this company, which we committed to 5% plus and second is that free cash flow generation engine. We're very pleased about the start of the first quarter, $2 billion free cash flow print, highest free cash flow margin in a first quarter in the history of our company overall. And by the way, historically, compared to where we're at attainment-wise, we're a few points ahead. Now to your point, we're 15% of our free cash flow attained through first quarter. I think it's prudent for us right now. We feel even stronger about our position around the $13.5 billion. But why take that up right now in this environment doesn't benefit us at all. We're focused on the durability, resiliency, and driving the disciplined execution overall. Now with regards to currency overall, as you know, we spent a lot of time, both through the last recession of COVID about when we see fundamental unprecedented rate magnitude and breadth changes in currency, it's always good to refresh our investors about how we handle currency. Number one, per GAAP, you can't hedge revenue. That revenue is going to flow whether the dollar is appreciating or devaluing. But I think a couple of important points overall. We have a very robust hedging program. But around that, we hedge only cash flows as a proxy for earnings. That's all you can do. We don't hedge all 100-plus currencies we operate in today. We only hedge about 30 because it's not economically viable to hedge more than 30. So when you take a look at it today, we don't also hedge out more than 12 months because we don't speculate. So when you look at it, the interesting thing is we have to overcome an operating pretax margin headwind when the dollar actually devalues because we have to wrap around on the hedges from last year, right? You'll get absolute profit dollars, yes, but it's mitigated because we try to hedge as much as we can in quarter, read at about 100%. In outer quarters, we hedge about 75%. So around that, do we have some tailwinds on free cash flow? Absolutely. But the most -- biggest driver of our free cash flow continues to be the same thing we talked about 90 days ago. The driver of high-quality adjusted EBITDA, which, by the way, we grew 12% in the first quarter, up 240 basis points of margin in adjusted EBITDA in the first quarter. Our free cash flow is going to be driven by double-digit EBITDA for the year, and it's going to be driven by a 100 basis points plus margin overall. That hasn't changed. So nothing changed overall. I would say net more conservative, but prudently, given we have 85% of our free cash flow to go. REFINITIV STREETEVENTS | www.refinitiv.com | Contact Us consent of Refinitiv. 'Refinitiv' and the Refinitiv logo are registered trademarks of Refinitiv and its affiliated companies. APRIL 23, 2025 / 9:00PM, IBM.N - Q1 2025 International Business Machines Corp Earnings Call

Question: Brian Essex - JP Morgan - Analyst : Arvind, I know it's super early here with regard to the mainframe cycle, but given the experience that you have with previous cycles, what do you anticipate from a macro perspective on -- for an impact on the mainframe cycle? And would you consider taking on more balance sheet risk maybe to ease the pain of any customer CapEx for that business this year?

Question: Matthew Swanson - RBC Capital Markets - Analyst : Arvind, across 2024, every time we had new GenAI product announcements, it was always really centered on this ROI-focused approach, and that was in a much better macro. Now we're in a more challenging macro. I'm just interested, are you seeing in any spaces, whether it be through the Consulting arm or just more customer interest in this ROI-driven approach, whether it be to hybrid or to GenAI? And does that make your product set a bit more defensive?