The following is excerpted from the question-and-answer section of the transcript.
(Questions from industry analysts are provided in full, but answers are omitted - download the transcript to see the full question-and-answer session)
Question: Amit Daryanani - Evercore ISI - Analyst
: Good afternoon, everyone. Thanks for taking my question. I guess, Arvind you talked towards the end of your comments about how
IBM portfolio is delivering (technical difficulty) organically in '25, I assume. And if I think about the segments, I think the interest on
your side is somewhat easy to see with the Z17 cycle, but I'd love to hear your thoughts on how does that inflection pan out on soft
print consulting especially consulting after a few quarters of muted growth? Thank you.
Question: Toni Sacconaghi - Bernstein - Analyst
: Thank you for the question. I just wanted to follow up largely along those lines, Arvind. IBM is a portfolio of many different things.
And some years, things go really well, like TPP this year and other things don't go very well like Consulting this year. But if I look back
at the last 4 years, and maybe that's not the right time frame, you may correct me. growth this year will be 3% or less, and growth
has been 3% in three of the last four years. And so I understand that the setup for 2025 is good because of the mainframe cycle and
acquisition.
But why is -- why should that not be viewed as a one-off just like this year, maybe as a one-off and being below your 4% to 6% model
of less than 3% growth? And specifically, for next year, do you think Consulting signings will inflect positively in Q4? Because they've
been negative the last two quarters. So if they don't start to pick up, then the leading indicator for consulting actually does not point
to growth necessarily for 2025. So if you can address those questions, that would be great. Thank you.
Question: Wamsi Mohan - BofA Global Research - Analyst
: Yes. Thank you so much. Jim, in your comments, you noted no change in client buying behavior and consulting. But if we look at
what happened with your AI book of business, which is up meaningfully a meaningful part of that being in services, it would indicate
that the underlying Consulting business ex that kind of deteriorated. So I was wondering if you could reconcile that comment with
what's happening in Consulting.
And secondarily, you noted year-to-date PTI margin performance of 150 bps improvement, but the fiscal year has guided to about
100 basis points, but you also noted sort of realizing $3.5 million of annual run rate savings. So can you just talk about some of the
profit dynamics in the fourth quarter? How we should think about some of the puts and takes over there? Thank you so much.
James Kavanaugh - International Business Machines Corp - Chief Financial Officer, Senior Vice President - Finance and Operations
Sure, Wamsi. Thank you for the question overall. As Arvind and I said in the prepared remarks, we're obviously operating in a very
dynamic, uncertain macroeconomic environment around the entire Consulting market overall. Yes, we posted flat revenue growth
Question: Ben Reitzes - Melius Research - Analyst
: Yeah. Hey, thanks, guys. Jim, we previously spoken about high single-digit growth potential for free cash flow at this company. I was
wondering, you've made a lot of comments about 2025, do you think that's possible still in 2025 given the Hashi acquisition? And I
want to also see if you can address it. If consulting were to remain flat, does the mix shift still support that. Thanks a lot.
James Kavanaugh - International Business Machines Corp - Chief Financial Officer, Senior Vice President - Finance and Operations
Yes, Ben. Thanks very much for the question. A lot of interest, as you know quite well from our investors on this particular question
of our model. I'm not going to get into the specifics as you would probably not expect me to about actual quantification. I think
Arvind and I have both said, we feel very confident about our strategy, our portfolio and our growth opportunities heading forward
into 2025.
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OCTOBER 23, 2024 / 9:00PM, IBM.N - Q3 2024 International Business Machines Corp Earnings Call
But let's take a step back, right? Three years ago, when we laid out our midterm model, Arvind transitioned this company from a
no-growth company to a mid-single-digit company, a company that was roughly about 10 points of pretax margin to a company
that's going to exit this year in the high teens, growing 700 to 800 basis points over three years and a company that was stagnant
to declining free cash flow, and we'll probably grow free cash flow, by the way. exiting 2024, pretty much on top of the absolute
number we set in 2022. So I think we made a lot of progress.
Now, when you talk about going forward, we talk about upward growth inflection. All of you understand the portfolio mix composition
in this business, the productivity mindset of what we drive in this company and the competitive business model positioning which
I would argue we still have a lot of headroom to continue to grow.
Our model has always been to drive operating leverage that enables us to drive free cash flow faster than revenue. And I would fully
expect that even with the Hashi dilution that we all acknowledge. We are very excited. We're hoping to close that still by the end of
the year, but that transaction stands on its own, strategic value, the attractive financial model and the synergistic value we get across
our portfolio of Software and Consulting. And we've got that embedded in our model, and we still feel very confident growing free
cash flow faster than revenue.
Question: Jim Schneider - Goldman Sachs - Analyst
: Thanks for taking my question. I was wondering if you could maybe comment on the rate at which you're seeing consulting work
and the consulting signings you do have translate into revenue and sort of the time to commence then. Is that what's giving you a
bit of increased confidence on the inflection in Consulting or the slow improvement in Consulting going to next year?
And then maybe just kind of separately, talk about, if you could, the types of M&A targets you're thinking about in Software and how
that might be different than what you've done in the past? Are you thinking of things that are in any way different from the sort of
open source in Infrastructure and DevOps type of deals that you've done in the past and how that might be changing? Thank you.
James Kavanaugh - International Business Machines Corp - Chief Financial Officer, Senior Vice President - Finance and Operations
Great, Jim. Thank you. I'll take the first part of your question, and Arvind can handle the second part about the targeted areas around
M&A.
As we stated, we feel very good about the strong start in our Gen AI book of business around Consulting. Let's just put some numbers
to it, right? IBM north of $3 billion, growing over $1 billion quarter-to-quarter, The Consulting book of business is approaching $2.5
billion. You put that in perspective against the last technological shift that we can see within our business, that being hybrid cloud
and Red Hat, and we're about 2 times that run rate, because we did about $1 billion in the first 12 months.
So we're seeing a very nice acceleration, and we've talked enough about this being very early in the cycle. But that $2.5 billion book
Question: Brent Thill - Jefferies - Analyst
: Thanks, Jim. Really good margin on software 30%, well above past Q3s. How sustainable is this 30% margin and any way to frame
that going forward? Thanks.
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OCTOBER 23, 2024 / 9:00PM, IBM.N - Q3 2024 International Business Machines Corp Earnings Call
James Kavanaugh - International Business Machines Corp - Chief Financial Officer, Senior Vice President - Finance and Operations
Yeah, Brent. Thank you very much for the question. We're obviously very pleased with our software performance. It's core to our
strategy overall. Software being about 45% of IBM's revenue composition, and two-third of our profit. And most importantly, to
Arvind's last question here that he just answered, integral to our hybrid cloud and AI platform centric model. It's all built around
software overall.
By the way, you probably noticed, we did hit the Rule of 40 here in the third quarter. We feel confident that we continue to strategically
reposition our business. And by the way, the margin inflection we've seen over the last three years in software has been both a
combination of that revenue inflection and getting into more end markets with the strategic focus both organically and inorganically,
that Arvind talked about, hybrid cloud, automation, data and by the way, the inflection of transaction processing which I'll remind
all of you, is a high margin, high profit contribution overall.
So that, coupled with the productivity initiatives are enabling us with the financial flexibility to continue to invest in innovation while
still generating margin and operating leverage going forward. So we feel pretty confident about that continuing. Similar to how I
answered the earlier question, we see a lot of headroom in front of us on operating margin continuing both for IBM and for software.
Question: Erik Woodring - Morgan Stanley - Analyst
: Great. Thank you very much for taking my question. Jim, I wanted to maybe ask the Consulting AI question maybe a different way,
which was last quarter, you had noted that Consulting AI projects were largely cannibalizing other areas of Consulting spend. And
I'm just curious at what stage do you think these long-duration signings turn into recognized revenue and some materiality that,
that could really impact the trajectory of the consulting business?
And then second, in what situation or environment would we see AI consulting projects turn from cannibal, -- is it -- cannibalizing
the traditional business to becoming incremental to traditional Consulting?
James Kavanaugh - International Business Machines Corp - Chief Financial Officer, Senior Vice President - Finance and Operations
Yeah. Great. And thanks, Erik, for the question overall. As we talked about, the maturity of Gen AI were very early in the cycle. The
key for us is to win this early leadership position to be the Gen AI strategic provider of choice. And I think we are carrying our own
to say the least right now, given the $2.5 billion book of business.
Now, with that, higher duration, lower revenue yield, there is revenue yield in the quarter. I don't want to leave anyone without the
impression. It's just about 3 to 4 points below what our traditional are because of the longer duration. If I just do some of the
mathematics around it, very quick.
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OCTOBER 23, 2024 / 9:00PM, IBM.N - Q3 2024 International Business Machines Corp Earnings Call
First, we're going to start wrapping on the pullback when we started talking about the short-term pause in discretionary spending
as clients are looking at cost productivity to fuel investment into Gen AI projects that have longer duration. We'll start wrapping on
that as we kind of get through the first half of next year, that's point number one.
Point number two, that inflection curve, when we just look at what we experienced historically with the Red Hat generation, because
in every technological shift human capital and consulting-based business, you're always going to see reprioritization. We've seen it
with cloud technology shift. We've seen it with the Internet. We've seen it with globalization. And we've seen it when we went
through the hybrid cloud side on Red Hat.
That kind of puts it in as Arvind and I have been talking here while we feel very confident in that upward growth inflection in consulting
is going to be more of a second half '25 play as we move forward. And by the way, with that upward inflection, the key is backlog.
We got to get the volume and demand here in the fourth quarter to Tony's question. and we got to still continue building that
volume and demand in the first half because then that will build a multiplier effect that will be a nice, healthy consulting growth
orientation like we were at about a year ago.
Question: Matt Swanson - RBC Capital Markets - Analyst
: Yeah. Thanks for taking my question. Arvind, you talked about the latest addition of the Granite models being 90% more cost efficient,
may be trained in weeks. You've taken a really pragmatic kind of ROI-focused approach to Gen AI. Could you just talk a little bit about
what you're hearing from enterprises and customers that are kind of supporting that direction of development?
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