Q3 2020 International Business Machines Corp Earnings Call

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Welcome and thank you for standing by at this time all participants are in a listen only mode. Today's conference is being recorded if you have any objections you may disconnect. At this time now I will turn the meeting over to Ms., Patricia Murphy with IP Ma'am you may begin.

Thank you. This is Patricia Murphy I want to welcome you to <unk> third quarter 2020 earnings presentation, I'm here with urban Krishna <unk>, Chief Executive Officer, and Jim Cavanaugh, I B M Senior Vice President and Chief Financial Officer.

We'll post today's prepared remarks on the idea of Investor website within a couple of hours and a replay will be available by this time tomorrow.

Some comments made in this presentation, maybe considered forward looking under the private Securities Litigation Reform Act of 1995.

These statements involve factors that could cause our actual results to differ materially additional.

Additional information about these factors is included in the Companys SEC filings.

Our presentation also includes non-GAAP measures to provide additional information to investors forwards.

For example, we present revenue m. signings growth at constant currency throughout the presentation in it.

In addition to provide a view consistent with our go forward business, while we have ramped on the majority of the impacts of the divestitures in 2019, we'll continue to focus on constant currency growth adjusting for the divested businesses for the impacted lines of total revenue cloud and our geographic performance.

We have provided reconciliation charts for these and other non-GAAP measures at the end of the presentation and in the 8-K submitted to the SEC.

Finally, consistent with our last few quarters I'd be EMS year over year revenue profit and earnings per share reflect the impact of purchase accounting and other transaction related impacts associated with the acquisition of Red hat. So.

So with that I will turn the call over to art.

Thanks Patricia.

I'm pleased to be speaking with you again just.

Just a week and a half of took a strategic update on October eight.

So do we.

Focus on our third quarter performance.

Which you will see is unchanged. So that's good.

<unk> results.

Well they want to start with a summary of our strategic discussions.

We.

All redefining all future 'cause it harbored blog platform on it I'd company or.

Well the last few years, we have built a solid foundation for Hubbard blog.

This acceleration of the red blood flow adoption.

The changes to blondes needs for complications losses infrastructure services we.

We are separating harmonic infrastructure services into a new publicly traded company.

The result is two market leaders focused strategy.

Okay strategies admissions.

And improved growth trajectories.

I B M is the number one harbor glaad from companies.

You goal will become the number one managed infrastructure services companies.

A separate businesses.

Each can capitalize on the respective missions.

It will have more agility to focus on their core operating and financial models.

Oh, but how greater freedom to Walter with autos.

Oh, well aligned it investment and capital structure to this strategic focus areas.

All of this will create value for clients and.

And for you the investors with an improved financial profile of both companies.

Since the announcement, we've had a comprehensive outreach to our clients.

In fact, we have spoken to hundreds of our top clients and I have personally spoken to doesn't.

The vast majority understand the strategy.

So I did about what it means for them.

Whether they'll be predominantly future IB employment, all new clients.

Our board knows have also had a positive response as they see this as an opportunity to further strengthen our go to market initiatives into hybrid cloud data and AI spaces.

<unk> RPM as we look forward the case, what hybrid cloud is clear.

Wind fleet, two and a half times more value in a hybrid cloud approach works is a public orderly its a.

It's a tremendous opportunity.

You had a trillion dollars.

Most of the enterprise opportunity ahead of us.

Auto approaches platform centric.

It is differentiated by Red hat, Openshift, which is our market leading global platform.

A vast software portfolio modernized to run cloud native.

And our GBS expertise that drive platform adoption and meet clients, where they are on their cloud journey.

Over the coming months will further advance our strategy, but.

By taking actions to simplify and optimize our model in.

Increased investments in key areas.

And fostering much more of a growth mindset.

All of this will contribute to accelerated growth for our company in the future.

And we expect to deliver sustainable mid single digit revenue growth upon completion of the separation of newco.

Let me shift to some of the recent progress we have made against our hybrid cloud platform strategy for the.

From the perspective of our clients our ecosystem and the innovations we are bringing to market.

Yeah, Great recent examples of clients, making large scale architectural commitments to our hybrid cloud platform.

Bloomberg Jay is using our platform to make the MP environment accessible across any infrastructure led the global clients use on premise private and public clouds.

Well enabled a broader energy community to leverage data analytics and AI to unleash the power of digital innovation in the oil and gas industry.

We're also extending our relationship with Delta to.

To transform their talent and modernize their IP environment.

Using red hat cloud box and leveraging DBS his expertise will operate with greater speed and realize longer term business benefits.

We're continuing to expand our ecosystem.

Last week I talked about how we have added hundreds of partners to drive workloads to our platform.

Gluing best.

Best of breed GSR and ice cream.

As an example, Olson young is our leveraging our open hybrid cloud platform and air solutions to help clients transform their businesses.

Our teams are also providing joined consulting capabilities to drive business outcomes for clients.

Late last week, we announced expansion of our partnership with service now to bring the power of Watson AI ops to their market, leading our platform.

We're also bringing new innovations to market on high.

Ill highlight just two areas red hat and quantify.

Red Hot extended its open hybrid cloud portfolio with several new technology introductions.

Including Openshift virtualization.

Enables clients to migrate and run their virtual machines natively with the Red hat Openshift.

And advanced cluster management for Kubernetes, which delivers the industry's most robust multek Gloucester policy based compliance and application management system.

These capabilities are furthering our clients abilities to build once deployed anywhere with a hybrid cloud architecture.

In quantum we announced our roadmap to reach per thousand plus cubits by 2023.

The roadmap aims to take todays noisy mall scale devices, two words the million plus Cuba devices of the future.

This kind of progress is essential to help industry and research organizations Stockel important real world problems that even today's most powerful classical computers cannot tackle.

And in making our roadmap public we are committing to meet a series of aggressive benchmarks that will help our company maintained its leadership in quantum computing and.

And place our clients on the path to groundbreaking achievements.

So we made good progress with clients, our ecosystem and innovation.

Regarding todays environment clients continue to balance short term challenges and opportunities for transformation.

In the short term we have.

We have focused on operational stability and cash preservation.

We see this especially in our largest software license transactions and delays in some services projects.

But more of my conversations.

With Ceos are around how they become digital businesses.

How do they tap into open source innovation.

Okay, and the security deploy and manage their data and applications across various cloud.

That's what we call hybrid cloud.

We see this is a continued momentum and red hat and the.

And the large client engagements that enable for journey to cloud leveraging both openshift and application modernization.

Now I'll turn it over to Jim Cavanaugh, who is going to take you through the results and then we'll come back at the end for Q and a.

Thanks, Arvind I'll start with a view of our overall performance we did.

We delivered $17.6 billion of revenue.

Expanded gross and pre tax margins repo.

Reported operating earnings per share of $2.58 and generated solid free cash flow.

While increasing investments are.

Our balance sheet remains strong and we continue to have ample liquidity are.

Our revenue and gross profit performance was fairly consistent with the second quarter and reflects little change in the macroeconomic environment and client demand.

As we previously discussed our broad geographic footprint and client and portfolio mix provides some stability to our revenue profit and cash flow.

As Arvind just mentioned clients near term priorities continue to include operational stability flexibility and cash preservation, which tends to favor opex over Capex. This has.

This is resulting in some project delays and purchase deferrals, which we see and perpetual software licenses and project oriented and volume based services.

Our transactional performance. This quarter also reflects product cycle dynamics and our systems business.

At the same time the last several months have made it very clear that companies need to modernize their businesses to succeed in this new normal this is leading to an acceleration in digital transformations.

Cloud and they are at the center of these transformations.

In our open platform centric model delivers greater innovation higher productivity and more strategic optionality to our clients.

In the third quarter client adoption of our platform continued to grow with approximately 2600 clients now using our container solutions.

We anniversaried the acquisition of Red hat in early July and Red.

And Red hat again delivered strong results in the period were normalized revenue growth of 16%.

Red hat, Leverages, IB EMS global reach and large account incumbency none.

Not only are the number of large deals increasing but also the sizes. These engagements is increasing as well with a total value of these deals doubling over the last 12 months.

Within services this quarter, we added about 125 services clients utilizing red hat technology and.

And our GBS cloud related signings were up over 25%.

The platform model delivers compelling economics are full stack capabilities drove over $24 billion of cloud revenue over the last 12 months, which is up 25%.

We're investing to expand our capabilities in GBS skills centered on the hybrid cloud and intelligent workflows.

In Red hats go to market to drive hybrid cloud adoption.

In software hybrid cloud and they I capabilities, including those for new go and W. DG automation acquisitions.

In IBCM cloud capital per MCR, Buildouts and in our ecosystem to drive adoption of Openshift and our broader cloud capabilities. These.

These investments will accelerate in 2021, given the additional flexibility from our structural actions.

This quarter, our portfolio mix with strong software contribution together with our focus on productivity drove our operating gross margin expansion of 160 basis points and operating pre tax margin expansion of 140 basis points.

With a 10 point year to year headwind in our operating tax rate. Our net income margin was essentially flat.

Our cash and liquidity positions remain strong fueled by our cash flow we.

We generated $1.1 billion or free cash flow in the quarter.

And $4.8 billion year to date, which is down over a $1 billion year to year.

We continue to have strong working capital performance and contribution from Red hat net of related interest.

These were offset by higher net capital expenditures and workforce rebalancing payments.

Over the last year, we generated $10.8 billion or free cash flow, which is 136% of GAAP net income.

We ended September with a cash balance of $15.8 billion, which is up $6.7 billion since year end, while our debt was up $2.5 billion I'll.

Ill remind you we issued debt earlier this year out of an abundance of caution and taking advantage of attractive market dynamics.

We're in good shape to fund, our upcoming maturities, including $4 billion to $5 billion in the fourth quarter, we will.

We will end 2020 with debt down for the year.

Now I'll turn to the segment performance, beginning with cloud and cognitive software.

Revenue was up 6% driven by cloud and data platforms. This.

This is a sequential improvement in the year to year performance. Despite a four point headwind from the wrap of the Red had acquisition in early July.

Software has a seasonally smaller transactional base in the third quarter and it.

In a challenging transactional environment this benefited us.

Our cloud and data platforms delivered 19% revenue growth.

This was led by Red had strong performance with double digit growth across both infrastructure software and application development and emerging technologies.

A couple of weeks ago Red hat was recognized as the leader in multi cloud container development platforms in Forresters latest wave report.

Leveraging this openshift container platform, our AI powered cloud packs provide clients with ease of use and the ability to scale and secure operations across a variety of environments.

We're expanding and leveraging the IBCM and red hat ecosystems.

It's over 180 partners now selling IBCM cloud packs.

We're seeing good penetration in our large accounts, we've now more than tripled the number of clients adopting club packs versus a year ago and added nearly 200 clients to our container platforms in the third quarter.

Cognitive applications revenue trajectory improve the flat year to year led by strength in security and supply chain.

In security, we had good demand for our threat management software and services as clients transform and manage their security operations.

We're driving adoption of our club pack for security in Q radar on the cloud.

And identity and Trust services also had good performance as we're helping clients with their secure digital transformations.

Forrester and ITC, just named our managed security services as an industry leader.

Based on our integrated product and services capabilities.

We also had good performance in our supply chain software.

Supply chain order management enables the shift to more flexible and scalable digital channels, which is a great value prop to our clients during the pandemic.

Looking at the profit for this segment, we had strong profit and margin performance driven primarily by Red hat contribution.

Turning to global business services revenue declined 6% consistent with last quarter.

As you'll recall prior to the pandemic GBS was growing revenue and signings.

March our revenue has reflected the economic environment and a change in client priorities, leading to project delays and less demand for more discretionary offerings.

But as we pivot our offerings and delivery to address these client needs GBS posted double digit signings growth in the third quarter and return its backlog to growth.

This was driven by cloud strategy application development, and modernization and offerings that use data and AI to transform workflows.

As I mentioned earlier, our GBS cloud signings were up over 25%.

We signed a number of large transformational contracts with a total value greater than $100 million, which will yield revenue overtime.

Our small deal performance generally follow the pandemic curve by geography, but returned to growth overall for the quarter.

With the expertise and process knowledge gained through our application management incumbency.

Clients Trust us to guide them through architectural decisions and facilitate their transformations.

With that particular expertise and application modernization at scale across all on Prem private and public cloud environments.

PBS drives adoption of IB EMS hybrid cloud platform and is.

And as a gateway to bring the wider set of IP m. capabilities to enable a client's digital journey for exam.

For example, about one third of cloud Pac revenue results from GBS engagements.

And this quarter, we added another 60 red hat client engagements, which such clients as Delta Airlines, which Arvind mentioned earlier, but also a world Bank of Canada, I T Ergo, Florida power and light and Telefonica Spano.

As our clients are transforming we're also investing in our GBS business to position for growth in the future.

We are continuing to invest in skills resources offerings and ecosystems.

We have implemented a virtual sales engagement model.

And are delivering nearly all of our more than 1500 active paid garage engagements virtually.

And we are taking the learnings from our initial shift to remote delivery to establish a new delivery model.

Dynamic delivery integrates technical foundations with Virtualized methods and practices enhanced with AI and automation to drive productivity pace and quality.

As we apply the dynamic delivery principles across our client base in the third quarter, we delivered more than 90% of our services remotely, while maintaining stable quality and increasing net promoter score.

Looking at the profit dynamics with our focus on high value offerings productivity and strong operational discipline, we expanded GBS gross margin by 190 basis points.

In global Technology services revenue was down 4% fairly consistent with last quarter.

Infrastructure services continues to experience lower client base business volumes in the more economically sensitive industries.

And TSS performance reflects hardware product cycles, and continuing volume impacts due to the pandemic.

But many clients are taking a longer term view and are looking to modernize their infrastructure to create agility and operational efficiency.

They turned the GTS is manage infrastructure services business for its deep expertise in managing mission critical infrastructures and its next generation service delivery capabilities infused with AI and automation.

Coca Cola European Partners is a great example.

We recently signed a multiyear agreement to accelerate their modernization journey.

Well have them to reduce operational expenses increase I T resiliency and leverage AI to bring enhanced insights and deliver greater service to their customers.

Dts the signings were down 1% this quarter, but up 12% year to date with nine.

With 19 deals over $100 million, including eight this quarter.

In addition to new work clients continue to make long term commitments with significant contract renewals as we deliver new value.

This has resulted in the backlog year to year trajectory improving by approximately two points from the beginning of the year.

Turning the GTS profit gross margin declined by roughly 80 basis points. This.

This was driven by the investments we are making in public cloud and the volume impacts which come at a high margin.

Turning to systems revenue was down 16% driven primarily by product cycle dynamics.

Idmc revenue was down 20%.

We launched the Z 15 toward the end of the third quarter last year.

We've had widespread adoption of both see 15 analytics, one across many industries and countries in support of clients hybrid cloud journeys.

I B M Z is seeing record setting volumes on Linux as clients leverage Red hat Openshift.

Ansible, and our cloud native Dev ops offerings.

At the same time this pandemic has impacted our historical idmc cycle dynamics, which is playing out differently by industry.

This platform has proved invaluable to our clients in areas like banking and financial markets, helping.

Helping them rapidly and remotely scale up capacity and respond to unprecedented market volatility.

As a result, these clients accelerated their adoption of Z 15 within the cycle that.

That said in many other industries clients remain focused on cash preservation during this pandemic.

This dichotomy and client buying behaviors impacted our performance in the third quarter and will lengthen the adoption curve of the Z 15 cycle.

But by the end of this cycle, we have an opportunity to be fairly consistent with prior cycles.

I'll remind you in the fourth quarter will be wrapping on a very strong performance from last year, when we were up 63%.

These cycle dynamics impacted our storage revenue as well where performance driven by declines in high end storage.

Now as always before the Q and eight I'll bring it back up to the IB m. level.

We're seeing tremendous opportunity to help our clients become digital businesses are.

Our technology centric hybrid cloud platform.

The industry expertise and growing ecosystem are enabling us to accelerate these transformations that.

The value we provide clients is evident this quarter and our cloud revenue growth in our continue momentum in red hat and in our strong GBS signings driven by cloud and application modernization offerings.

And now we're accelerating IB EMS hybrid cloud platform strategy.

With increased focus and investments to drive future growth.

Or taken structural actions to simplify and streamline our business and as we discussed earlier. This month, we expect a fourth quarter charge to our operating results of about $2.3 billion.

The savings from these actions will be reinvested in areas like hybrid cloud data and AI security and emerging technologies.

With our focused hybrid cloud platform strategy and the increase investment starting now we expect to drive sustainable mid single digit growth. After the separation of Newco is complete.

In the near term the rate and pace of recovery remains uncertain.

And as a consequence, we have not seen a fundamental shift in overall demand levels.

Given this uncertainty and consistent with our direction for most of this year, we are not going to provide guidance, but I.

But I will remind you from an historical perspective, the fourth quarter seasonally is our strongest quarter in terms of revenue and operating earnings per share due to our high value software and hardware transactions.

Looking at our year to year dynamics at the end of 2020, we are.

We're wrapping on a strong fourth quarter of 2019 when.

When we had a very strong software performance, our first full quarter Z 15 availability and our first full quarter of Red hat contribution.

So going into this fourth quarter as always we have a lot of work to do.

It's our largest transactional quarter, we'll be focusing our investments in hybrid cloud and AI and of course, we're starting the detailed work to separate our managed infrastructure services business.

We're confident in the focus and direction of our business and what it means for our future.

Kevin Let me turn it back over to you.

Thanks, Jim.

Im going to add just one final topic before the acuity.

We are managing for the long term.

We are making strategic decisions, taking actions and increasing investments to date to better position, our business and accelerate our top line growth on a sustainable basis.

Patricia let's go to the acuity.

Thank you Arvind before we dig into queue and I would like to mention a couple of items.

First we've included supplemental information at the end of the presentation and finally as always I'd ask you to refrain from multi part question.

Operator, let's please open it up for questions.

Thank you at this time, we will begin the question and answer session of the conference to ask a question. Please press star one and record your name clearly if you need to withdraw your question Chris Stark you again to ask a question. Please press star one hour.

Our first question comes from that coupled with credit Suisse. Your line is open.

Thank you very much Arvind you touched on this briefly during your prepared remarks I was wondering if you could expand a little bit more on the health of the wider IP spending landscape, you're seeing around the world and you mentioned delays you are seeing in a couple areas where in the portfolio. Just wondering when you think those deals will start coming through particularly as we're starting to think.

About the puts and takes heading into 2021.

Hi first.

Thanks for the question, Matt So a few comments on because you asked about portfolio, whereas you also asked about clients and you also asked about geography.

And it's all very we're seeing first.

From.

Offline deals as well as services projects, let me just to reiterate put out a little bit of color to laud, both Jim and I said in our prepared remarks.

While we are seeing very healthy growth in some parts of both software and systems.

It's kind of it's a frantic what we'd also seeing people fall, maybe they're pausing because of that industry because of geography, well because they're into a cash conservation mode.

We think its a pause we don't believe it's a decline forever. We do believe that some of those deals come back and we tend to see that we saw that from the first of the second second to the third quarter et cetera.

So thats one part now we have also talked about it there is about 70.

70% off the industries that we are in we are not seeing any pauses VC funds that are healthy we see that their business on a healthy a lot.

About 30% and that should not be a surprise to anybody on this call reduced indices some temporary.

Temporary softness and maybe think about a brick and mortar retail you think about airlines you think about hospitality I think it's not a surprise that some of those now we also tend to be with larger clients. So we don't believe that they have a sustainability issue by and large it will tend to come.

Tend to come back so that.

So thats out of the flavor under it by then.

But then as I begin to look forward Mad because you're asking that question also it's really hard to predict the fourth quarter, that's why hi, Jim and I are pausing on giving guidance here. However, when we look at our people interested in these parts of the software portfolio, whether its supply chain and security as Jim mentioned, whether it's cloud and data platform.

Which is inclusive of both of Red hat, and our cloud facts and other technologies. They find essentials, we find that those will come back we find our transaction processing platform with DVB, it's somewhat aligned to the mainframe capacity.

Capacity increases so as those go through you tend to see I'll call. It an alignment is not necessarily identical, but there's some alignment there.

There Ed and then let's not forget that as a global business services and other at size do transformation projects. They also tend to pull through software more in a crowded in a platform than in other areas. So outside of a gain.

Give you that color sort of across the mindset across the industries and across different parts of the portfolio Matt.

Thank you Matt Kelly. Please go to the next question.

Absolutely. Our next question comes contingent along with JP Morgan Your line is open.

Hi, Thank you so much looks like services signings did bounce back nicely a little bit here. So it sounds like some larger transactions coming back, but I want to understand maybe.

Maybe if you don't mind just this transition from going you know with a tighter integration of GBS in GTS to the to the separation now could.

Could we see services results in bookings maybe weekend in the short term before taking.

Picking up again I know the signings were good here, but just trying to.

Think about this fourth quarter and first quarter transition given the given the change over but that makes sense. Thank you.

Yeah. Its engine. This is Jim I'll I'll take that one lets talk a little bit about the quarter and what we just finished with regards to services signings were pretty pleased given the overall macroeconomic environment and the rate and pace and the continued uncertainty the teams executed very well nine and a half billion dollar.

As the signings up 5%, we got a 108 billion dollar backlog right now that's flat at actual rates down 1% at constant currency and to your point, we saw actually very good progress in large transformational deals I think 11 in the quarter in excess of a one.

Hundred million dollars.

And eight of those in our GTS manage infrastructure services business, which saw a very strong renewal rate that talks to the value of innovation that they bring to our clients said overall and that has led to a year to date I think we said in the prepared remarks, GTS up 12% signings.

And I'll I'll remind you that was off of a third quarter last year, where we grew 20%. So we're pretty pleased there and that's led to a two point backlog improvement in our GTS business since January but where we really have seen a marked inflection ups of of some signs of demand change is in g.

Yes, and you know while the revenue kind of played out consistent with Twoq you. Our signings were up double digits. I think it was our third largest signings quarter almost in history and are both large and small deals overall and that was really a testament to our GTR Jeep.

Yes capability around application modernization and being our clients provider of choice for digital transformation journey to cloud. So we're.

We feel pretty good about that it's got good early trends, we got a very nice pipeline a transformational deals here in the fourth quarter and again, given our announcement 10 days ago, we're spending a lot of time with our clients to make sure we minimize disruption ensure stability and provide that client value going forward.

Thank you tinge, and let's go to the next question.

Our next question comes from Toni Sacconaghi with Bernstein. Your line is open.

Yes. Thank you I know you're not commenting on Q4 guidance, but maybe you can tell us how to think about it typical seasonality might be for revenue up about $3 billion. If demand is not really changing why shouldn't we assume normal seasonality and is that kind of the right.

Number our framework and then Arvind I'm wondering if you could just comment on capital allocation going forward. Your dividend is $6 billion a year, it's basically been 100% of your free cash flow year to date in the last.

He hadn't pay down any debt you haven't done any deals.

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Without taking on incremental debt. This year. So if you really are managing the business for the long term and growth is a priority.

Or are you considering lowering our suspending the dividend or is the dividend safe and if it is why wouldn't you be more aggressive in allocating more cash to growth going forward. Thank you.

Okay. Tony This is Jim Thanks for the question Multipart, but let me take the first piece around color on fourth quarter, and then Arvind can handle the capital allocation discussion around the strategy and I, obviously can handle some of the numbers overall, but what.

But first as we talked about in prepared remarks or in you.

And you indicated the rate and pace of the recovery, we still don't see is uncertain.

And you know there's no real fundamental change in client buying priorities around cash preservation around operational stability and consistent with prior quarters that has led us to to not give guidance, but let me give you. Some color first we talked about at the onsite of COVID-19 that.

This is only accelerated our clients' digital transformation journey to the cloud and you see that playing out in our results over the last few quarters with continued very good Oh.

Momentum in our cloud business and in our Red hat business and when we look at fourth quarter, we see very healthy pipelines and hybrid cloud AI solutions at modernization cloud transformation services within GBS Red hat actual backlog growth is accelerating up 23%.

At four 4.7 billion and we see pretty healthy pipelines in our cloud and data platform and in our cognitive apps business led by cloud packs and security the two things that we called out though in our prepared remarks that we've talked about the last few quarters and those are headwinds in from.

First in particular around TPP, you know our clients committed to that platform. We had a very strong 2019 and given the environment in this in the focus on cash preservation, we do we don't see that coming back in the fourth quarter, it's going be pretty similar to the first half and the second is our mainframe side.

Cool.

Coming off with a significant portion of the growth last year up 63%, but when you look at skew overall in the fourth quarter, you know threeq to Fourq you. Yeah. I mean, there will be no no reason not to expect a normal skew with regards to revenue you know some slight improvement in our software portfolio.

Offset by TPP, and we'll wrap on the a and the hardware piece now in terms of as you saw the very strong fundamentals in third quarter coming off a strong two Q operating gross margins up 160 basis points operating pre tax margin up 140 basis points.

We feel very confident in the strength of our balance sheet, our cash and liquidity position to make sure that we can continue to invest in our business. We're starting that immediately here in fourth quarter around technology around innovation around skills around capabilities and you'll see that play out in addition to.

The 2.3 billion dollar structural charge. So when you look at S. you all know the numbers as well as I do over the last X number of years, our Threeq to Fourq you pre the $2.3 billion charge is been a nice growth of about 50 mid fiftys.

We should do maybe a little bit better than that but I don't think anything substantial above that so we see pretty similar dynamics Arvind over to you. Thanks, Thanks, Jim and Tony. Thank you for asking the capital allocation question really important piece of our growth strategy going forward.

A couple of points there for context, one when we acquired and close on Red hat, we did commit to pausing share repurchases until we had de leverage and gotten back to our target ratios of debt to EBITDA. We are on track to do that we fully intend to do that and.

We had said that we will get there by 2022, so thats part one and so some of the cash in the balance sheet will be used towards that BOPUS. Because he said you are not paying down debt, but you'll see us begin to pay that down to get towards those those ratios bought one.

I'll do a we are committed to a stable and growing dividend.

Given our investors given that how much they depend upon that and how much worry a lot about that on feedback we intend to keep a stable and growing dividends.

That means everything else is up for what is prudent for managing for the long term.

And so when we talk about increased investments and on October eight that was clear we are going to both increase expenses organically in order to be able to grow in both the welfare and GBS, but we're also going to be a quite acquisitively in the areas that we have called out.

He will be Acquisitively, and GBS and we will also be acquisitively in the software areas around hybrid cloud data AI security and in emerging technologies, such as quantum so so when you see us do that I think we are going to be doing exactly what you're asking.

Allocating more cash for growth going forward I think the simple answer to that is yes with no qualifications therein.

Thank you Tony can we go to the next question. Please Sheila.

Thank you. Our next question will come from Wamsi Mohan with Bank of America. Your line is open.

Hi, yes. Thank you.

The second half was going to Delaware, some strong margin uplift from the productivity actions and we saw some of that.

Through in the third quarter can you help us with how much more productivity benefit is yet to come in the fourth quarter and as you talk about the reinvestment of the savings associated with the actions, we just announced last week.

Can you give us a segment view on dock reinvestment. Please thank you.

Yes, so wamsi. Thank you very much for the question overall, if you if you look at the structural actions. We took as we entered 2020 member we talked a lot about this in January pre co vid on how we were going to reposition our businesses as we move forward you see you see.

That actually playing out in our results I mean, our margins in the second quarter were up roughly 150 basis points at gross margin level and then third quarter. We just came off margins that are up 160 basis points at the gross level and operating margins that are up 140 basis points at the peak.

The tax level, so I think you're seeing that productivity and the fundamental change in the way, we're actually driving and running the business now adapting to given the onset of COVID-19, and the implications to the economic environment. If you take a look at the fourth.

Quarter actions overall, we talked about 10 days ago, the strategic action around separating out in creating two market, leading companies and creating an independent publicly traded company around our manage infrastructure services business that was going to be about a $2.3 billion charge and if you remember.

What I said at the time and you can kind of think of this is in in one third buckets. The first is about a third of that is going to go to help improve the EBITDA growth profile in our new co business to be on a trajectory to achieve post separation a double digit EBITDA.

Growth profile, the second bucket or second third of that was in it in any business. When you separate out you're going to create stranded costs and inefficiencies and we're committed to addressing that in 2021 with discharge and then the third piece is we are making significant investments.

To capitalize on the one trillion dollar hybrid cloud market opportunity and the third bucket is going to be used for additional fin flex that is going to be centered around technology innovation people skills capability ecosystems and also as Arvind just answered around.

Inorganic place overall, so I'll take that one and then Arvind you want to take the second one.

Yeah. So when you look at the different segments that we are in Bombay.

So this is straight away and the four areas that we had outlined.

Number one we.

We are going to be increasing investments in GB es and.

In order to get more skills in the areas that maybe are seeing demand.

Second we are going to be increasing investments in our ecosystem.

Ecosystem that a large partners, we just announced service now last week, we announced it will be a couple of months before that you've seen us with sales force CNS with others. So we are going to be increasing our investment and how we work with those but they're also hundreds of highest ways not just the very large ones.

With whom we are also looking to get them on on hybrid cloud platform on our cloud properties and so how do we invest in that in order to drive growth down. The road is a second piece I'd put that in the ecosystem bucket.

We are going to be increasing investments in our core buffered areas in terms of the hybrid car platform itself and you saw that in some of my prepared remarks on the innovations we are driving into the Red hat technologies, but in addition to that in terms of data on AI in security and others. We go to drive.

Innovation in there.

And as you put all those areas together, let's not also forget Nucor is also going to be seeing increased investments around automation around infrastructure modernization against looking the different cloud partners. When you think of those four buckets. If now goes pretty much across all of our OEM segments.

If you think about it because we want it to be outstanding balances not identical growth, but we want all of the segments to be contributing to growth and so we are going to be driving in terms of organic R&D in terms of working with certain areas, where there is a lot of demand. So you got to get skills in there and of course as we add M&A.

Okay, that's not quite directly from these buckets of money, but the M&A, but also add to added expenses eventually while the woman to complete an acquisition its expense in these different.

In these different segments.

Thank you Wamsi, let's go to the next question. Please.

Next we'll hear from Katy Huberty with Morgan Stanley You May proceed.

Thank you Arvind <unk>, just looking at the cloud and cognitive softer business before you closed on the Red hat acquisition that was a growing business today on a pro forma basis with Red Hot it's declining mid single digits, you would love your thoughts on why we're not seeing a strong.

Our growth rate is it entirely macro driven and what are the steps and timeline for getting that software business back to pro forma growth given how important it is to hitting that mid single digit.

Longer term growth target.

Thanks, Katie and and you you you got it right. It is a critical part of us getting towards a mid single digit growth target. So that is essential.

As they begin to go onto it and you look at it for the last few months out.

I would tell you that some of it is indeed, a macro maybe the wrong word, but I think there's two elements in there people up all the sudden lot software license transactions and that is perhaps the macro environment and then there is the TPP piece, which is a inside of the software segment, which is.

Driven more as I've said before in terms of the alignment of the mainframe capacity. That's in the ground. We saw very good growth in the fourth quarter of last year. We saw that are tied to that as you begin to see that a slowdown in the third quarter of this year, we do expect to I think see that continue for sometime.

But within that when I look at or.

Cognitive applications and we look at cloud and data platform, we do see healthy growth there, but I expect to see it continue.

As we invest more into that and as we invest more into red hat I would expect that as we get through the next then.

The next year.

We are going to see that that is should be able to more than offset anything that happens inside TPP and just to give a sense of that Katy when you begin to look at red hat by itself.

And we see the growth there in the mid to high teens, and we expect that that should be able to continue and accelerate and that in turn will give a added growth to the whole portfolio more than enough to offset any weakness in DPP and then as we are increasing our investment in our ecosystem as well as in.

Internal R&D as well as an acquisition what I'll acknowledge that those lives do take multiple quarters to play out I wish it was quicker, but it is multiple orders, but I'm a fully expect that at the same time as you complete the spin we should be able to see those growth or return in those parts of the portfolio and you've got.

A sense of how we'll do it across those various elements.

Thank you Katie she'd like we take the next question. Please.

Sure absolutely. Our next question comes from a net Daria 19 with Evercore. Your line is open.

<unk>.

Thanks for taking my question I guess, all I would love to do so.

New customers over the last one for online mobile home Oh, what am I think about it.

Good cause.

Finally, along with them.

On that one as well.

Oh pardon me.

Bob over that would be helpful.

Yeah, Great question on that so as you can imagine this is something in which I think the only walk and uses we are obsessive about this topic Oh, we we had all list. So we knew exactly what clients might this might be concerned about and I wouldn't say that we are 100% perfect but.

I think we feel very very good.

That veeva correcting our estimations of a level of consent to give me a sense, we sort of internally. This is not something that we have we Oscar Phil decline, but based on the reaction I mentioned that we have already spoken to 100 and you could think that.

Another 10 days in we've already spoken to at least between two and 300 of the topline, but there is a strong intersection or whether it is a very heavy spend call revenue base or deals that could be on the table.

And from there we have gotten back over 80% out called it out in the greater good do not really concerned.

And I'll come back and give some color on why we believe that's true then that off.

And there are some who do enough on both sides that they do have some concerns.

Most of the concerns that around who is the team that really providing service who is the person who is going to be on the ground and we should be very clear.

That's been cool is going to head out on day one with.

With $19 billion the same management team on the ground, who runs that from the client up is going to be the team that does it get to the corporate structure that we put in place, but that's not the team on the ground just to be clear.

They have very high satisfaction with the majority of that line that is because they bring both of us.

Service excellence in terms of the service and have tended to provide but also the bring very deep technical skills, which is kind of Ah gives them permission and across the play so when I put all of that together I think that there's a couple of dozen clients, where we just have to make sure that we can tell them what the team that's going to be so.

We're seeing them and and as they begin to get confident that I can see the level of anxiety reviews, but as I said, well what 80%. They understood what was happening and also many clients to a majority on one or the other of naturally for them, there's going to be less of a concern now but to your point.

So why would they then completed the deal look most of the larger deals onto a client's benefit I don't do something unless they are going to get a business benefit from that and in this environment. If you want to go up all of that for three or six months, you're going to do for your benefit for three to six months I think want drives things.

And Luckily they have a month do sort of ER on both sides. Both all deemed other client to sort of understand each other and the soon enough time in the water to go get those deals done. So the order will tell us whether we're right or not but based on everything I can see I am confident that actually.

He will be able to see most of the deals progress to to a satisfactory conclusion.

Thank you on that let's go to the next question. Please.

Our next question comes from David Grossman with Stifel. Your line is open.

Hi, Thank you.

So you know I know the end markets is shifting quickly and and think I understand the challenges associated with repositioning GTS.

That said I am having a harder time calibrating, how you're thinking about the longer term growth prospects for this business can you.

Can you give us any insight into your analysis of the longer term growth to the business and and wouldn't really means to run it for cash flow guidance that simply mean that it continues to decline at a modest rate and generate cash or does that mean something totally different.

Hi, David the <unk>.

The market is a 500 billion dollar market from what we can see from what I'd see shows us as well as lot of many other third party consultants of daughter.

A couple of things in there within that if I find whereas our portfolio and our clients today, it's probably more heavily weighted in about 60% of the total as opposed to all of it and we think that the ability to form many more partnerships as a stand alone is going to allow.

Yes, the much more fully participate in the complete market do we have.

We have stated pretty consistently that we are going to start them off at the investment grade balance sheet.

That would allow them to also make targeted acquisitions as appropriate we can speak for that it will be up to the management team a post spin, but that is a place where always in a market where I read it's a scale game, that's definitely a way that you can both grow and gain market share.

And so two three.

Jim mentioned that a third of the restructuring.

Restructuring charge is four also improving the EBITDA profile of a of the spin company that is going to allow them to also invest in new offerings in areas, such as a cloud modernization as well as added offerings and aspects of comply.

Lines and security and resilience and also in much more automation, which is go to allow them to deliver even higher service delivery excellence.

To that to their clients. So when I look across all those opportunity is certainly there and freeing them up to do deals, which we might not do because the margin may be dilutive to us, but it's going to be accretive towards.

Towards the new company to possibly.

Possibly M&A down the road, but that's not for some time and three in terms of leveraging new offerings and partnerships with other companies who might be doing it but maybe not as wholeheartedly as they would do it with an independent company.

Great. Thank you David lets go to the next question. Please.

Our next question comes from Keith Bachman with Bank of Montreal, You May proceed.

Oh, hi, many thanks for taking the questions and congratulations on the ongoing success of Red hat I actually wanted to ask a clarification question on a clarification I wanted to come back to M&A you seem to be talking more about M&A on this call than in previous calls and.

Previous question I'm, just not sure the financial resources now that you have to be aggressive about M&A in that you.

Games typically generate between 12 and 13 being free cash flow on NCS explain.

Dividend payment it just doesn't leave a lot of room for M&A. So is the message that you may look to get.

Away from an investment grade rating I'm, just not sure how to make the math work when you say impactful and then I'll just ask my question of Jim If I could Jim you talked about GBS and how you're confident of growth there I.

Certainly thank consulting business can improve particularly next year as we get into well, presumably better economic cycles, yet application management and global process have.

We're a week before the pandemic head impact has not been growth challenges throughout 19.

And so just wanted to hear a little bit about those two businesses.

What are your expectations on an organic basis, when you think about GBS for roughly half the revenues that frankly, we're pretty close challenge before the pandemic that many thanks.

Okay, Keith actually urban if you don't mind, let me, let me take both because I think part of the first question you've already answered from the strategic capital allocation perspective on what we want to do with regards to our investment profile, both organically and Inorganically, but Keith you know the heart of your.

The heart of your question gets to a mathematical equation and I think one first you got to recognize that there's always been seasonality in our free cash flow, albeit we delivered $4.8 billion year to date in in free cash flow overall, you as you all know quite well well over 50%.

Of our free cash flow in this business comes in the fourth quarter that coupled with.

We talked about two quarters ago at the onset of COVID-19, how the business model composition of IBCM with its geographic diversification its industry composition, it's client segmentation being more large enterprise focus and its annuity.

Content of both high value software high value hardware platform and high value services piece provides a natural hedge in this environment to stability around revenue profit and cash now yes over the last couple of years, we've been driving around $12 billion or.

Free cash flow in light of the economic challenges due to COVID-19 that number just trajectory wise will be less this year, we'll see how fourth quarter plays out, but we're very confident in our portfolio in fact, even more confident given the decision that are have been in the end.

Tire I.B.M. team and our board made on October eight around repositioning two market leading companies one with an I.B.M. on an accelerated growth profile with an already very strong EBITDA margin business that is going to generate significant cash and then too.

Ooh I'm a lead in the market leading infrastructure services business that is two x.

The next competitor and in that business as you all understand quite well is a scale economics business. So from that aspect I think when you look at our fin flex our fin flex only gets better and with our disciplined financial capital allocation policy that this company operates on.

We feel very comfortable that we got ample free cash flow to invest in our business organically and inorganically.

To de lever and hit our those targeted leverage ratios and also to maintain our return to shareholder program with a secure dividend and sustainable dividend growth policy. Overall. So that's the first question second question. When you look at GBS as I talked about we did see signs of demand improvement.

Here in the third quarter and if you remember 90 days ago, we talked about the first half of second quarter and the second half a second quarter in the month of June and we saw some nice growth in June well that continued into the third quarter were double digit signings growth overall and by the way Keith.

That was pretty pervasive that was good growth in consulting, but it was led by large transformational deals around application services in this environment to capitalize on our clients' journey to cloud that then drags with it our global process services.

Says where clients are now digitally reinventing themselves and how they run their companies around intelligent workflows. So we're seeing that demand inflection move now to your question that revenue is more long term as you play out, but when we look at our current backlog and our current back.

Well I would run out for our GBS business in 2021, we see GBS getting back to pre at pre covert growth rates by mid year and a big chunk of that is improvement across all of the three sub segments.

Thank you Pete Shannon, let's take one last question. Please.

Thank you our last question will come from Jim Suva with Citigroup investment Research. Your line is open.

Thank you very much a pretty clear easy question. Here is you talk in highlighted IB and significant cash flow strength and I believe that the high priorities that paying down debt to get closer to investment grade and then spin out of the company and get it well positioned post all that is.

Focus mostly on dividend and M&A, and we should think about stock buyback as being less and that feature compared to past history of IBCM, where a lot of EPS growth has been driven by stock buyback when it seems like perhaps maybe the view is that the management the board thinks that the stock buyback isn't generating heating.

Shareholder return, so maybe shifting more towards M&A is that the way to kind of read last holiday, we heard through the queue and <unk>.

Yeah. Jim This is Jim let me take that and then I could wrap it up with with Arvind overall is you know quite well, our our disciplined capital allocation process first and foremost focus is on how we reinvest back in our business, both organically and Inorganically and.

We are focused now with the strategic move that we announced we laid the foundation we talked on October eight we laid that foundation over the last couple of years instantiated in the Red hat acquisition, which was a bold move we have been building an accelerating that growth now we want to capital.

Lies on that one trillion dollar hybrid cloud opportunity now with that said just given our investor mix.

Outside of allocating capital and investment to our own business. When we have excess cash we're going to return it back to shareholders that priority right now is our secure dividend and sustainable dividend growth policy and as we get back to our targeted leverage ratios at that point and.

Time, we'll re evaluate share repurchase, but there is no need talking about that right now.

Okay. Thanks, Jim.

Just to reiterate we have talked about growth.

We have talked about a maniacal obsession on hybrid cloud and ally as the engines of growth for the company, but let me just make a couple of comments to wrap up the discussion.

We have certain on direction, even in these uncertain times and we.

And we are laser focused on helping our clients with their digital transformation leveraging.

Leveraging our hybrid cloud technology platform, our incumbency and our expertise.

And the actions we are taking starting now in the fourth quarter will enhance our focus and accelerate our future growth and I know.

And I look forward to continuing this dialogue with you.

Sheila can we turn it back to you to close out the call. Please.

Absolutely. Thank you. Thank you for participating on today's call. The conference has now ended you may disconnect at this time.

[music].

[music].

Welcome and thank you for standing by at this time, all participants are in a listen only mode.

This conference is being recorded if you have any objections you may disconnect. At this time now I will turn the meeting over to Patricia Murphy with I.B.M. Ma'am you may begin.

Thank you. This is Patricia Murphy I want to welcome you to <unk> third quarter 2020 earnings presentation.

Arvind Krishnan Chief Executive.

She's executive officer, and Jim Cavanaugh, I'd be I'm, senior Vice President and Chief Financial Officer.

Today's prepared remarks on the idea of Investor website within a couple of hours and.

And a replay will be available by this time tomorrow.

Some comments made in this presentation, maybe considered forward looking.

The private Securities Litigation Reform Act of 995 these.

Statements involve factors that could cause our actual results to differ materially.

Additional information about these factors is included in the Companys SEC filings.

Our presentation also includes non-GAAP measures to provide.

Additional information to investors for <unk>.

For example, we present revenue m. signings growth at constant currency throughout the presentation and it.

In addition to provide a view consistent with our go forward business, while we have dropped on the majority of the impact of the divestitures in 2019, well continue to focus on constant currency growth adjusting for the divested businesses.

Impacted lines of total revenue cloud and our geographic performance we have.

We have provided reconciliation charts for these and other non-GAAP measures at the end of the presentation and in the 8-K submitted to the FCC.

Finally, consistent with our last few quarters I'd be EMS year over year revenue profit and earnings per share.

What the impact of purchase accounting and other transaction related impacts associated with the acquisition of Red hat.

With that I will turn the call over to art.

Thanks Patricia.

Pleased to be speaking with you again.

Just a week and a half.

A strategic update on October eight.

Today.

Focus on our third quarter performance.

What you'll see is unchanged.

The movie results.

Well I want to start with a summary of our strategic discussion.

We.

Already defining all future Harbor.

Hybrid cloud platform and AI company.

Well the last few years, we have built.

Solid foundation for Hubbard blog.

With this acceleration of the Red hat smartphone adoption and.

The changes to blondes needs for applications lots of infrastructure services.

We are separating a modest infrastructure services.

To a new publicly traded company.

The result is.

Market leaders.

Strategies admissions and improved gross profit growth.

Hi, Jim is the number one hybrid cloud platform and company.

You cool will become the number one managed infrastructure services company.

A separate businesses each.

Each can capitalize on the respective mission.

It will have more agility to focus on their core operating and financial models.

But how greater freedom to partner with others.

Oh, well aligned that investment and capital structure do their strategic focus areas.

All of this.

Good value for clients.

Good for you the investors with an improved financial profile of both companies.

Since the announcement.

Our comprehensive outreach to our clients.

We have spoken to hundreds of our top clients and I have personally spoken to doesn't.

The vast majority understand the strategy.

Cited about what it means for them.

They'll be predominantly future IB implants or nickel glide.

Our automotive also had a positive response.

As they see this as an opportunity to further strengthen our go to market initiatives in the hybrid cloud data and AI spaces.

As we look forward the case, one hybrid cloud is clear.

Wind fleet to want to have times more value.

Hybrid cloud approach versus a public only its a.

It's a tremendous opportunity.

You had a trillion dollars.

Most of the enterprise opportunity ahead of us.

Auto approach a smartphone centric.

It is differentiated by Red hat Openshift.

Which is our market leading open platform.

A vast software portfolio modernize around cloud native.

And our GBS expertise that drive platform adoption and meet clients, where they are on their cloud journey.

Over the coming months will further advance our strategy by taking actions to simplify and optimize our model.

Increased investments in key areas.

For spring.

More of a growth mindset.

All of this will contribute to accelerated growth for our company in the future.

And we expect to deliver sustainable mid single digit revenue growth upon completion of the separation of newco.

Let me shift to some of the recent progress we have made against our hybrid cloud platform strategy.

Perspective of our clients our ecosystem and the innovations we are bringing to market.

Yes, Great. Recent example.

Clients, making large scale architectural commitments to our hybrid cloud platform.

Bloomberg Jay is using our platform to make their DMP environment accessible across any infrastructure that the global client to use.

On premise private.

The cloud.

Dale enabled a broader energy community to leverage data analytics and AI to unleash the power of digital innovation in the oil and gas industry.

We're also extending our relationship with Delta.

Transform their talent and modernize their IP environment.

Using red hat lockbox, and leveraging DBS his expertise.

Operator, with greater speed and realize longer term business benefits.

We are continuing to expand our ecosystem.

Last week I talked about how we have added hundreds of partners to drive workloads to our platform including.

The breed GSR and ice cream.

As an example, Olson young is our leveraging our open hundred Dart platform and air solutions to help clients transform their businesses.

Our teams are also providing joint consulting capabilities to drive business outcomes for clients.

Late last week, we announced expansion of our partnership with service now to bring the power of Watson iops to their market, leading our platform.

We're also bringing new innovations to market.

Ill highlight just two areas red hat and quantify.

Red Hot extended its open hybrid cloud portfolio with several new technology introduction.

Including Openshift virtualization.

Enables clients to migrate and run the virtual machines natively within Red hat Openshift.

And advance cluster management for Kubernetes, which.

Delivers the industry's most robust multek Gloucester policy based compliance and application management system.

These capabilities of furthering our clients abilities to build once deployed anywhere with a hybrid cloud architectures.

In London, we announced our roadmap to reach positive loss cubits by 2023.

The roadmap aimed for take todays noisy mall scale devices, two words the million plus Cuba devices of the future.

This kind of progress is essential to help industry and research organizations tackled important real world problems that even today's most all for classical computers.

Tackled.

And in making our roadmap public we are committing to meet a series of aggressive benchmarks that will help our company maintained its leadership in quantum computing.

Place our clients on the path to groundbreaking achievements.

So we made good progress with clients, our ecosystem and innovation.

Regarding todays environment clients continue to balance short term challenges and opportunities for transformation.

In the short term.

We have focused on operational stability and cash preservation we.

We see this.

Especially in our largest software license transactions and delays in some business projects.

But more of my conversations.

Ceos are around how that become digital businesses.

I'll do the top into open source innovation.

Okay, and the securely deploy and manage their data and applications across various cloud.

Thats, what we call hybrid cloud.

We see this as a continued momentum and red hat and the.

And the large client engagements that enable for journey to cloud leveraging both openshift.

On application modernization.

Now I'll turn it over to Jim Cavanaugh, who is going to take you through the results and then we'll come back at the end of Q and a.

Thanks, Arvind I'll start with a view of our overall performance we did.

We delivered $17.6 billion of revenue.

Spend a gross and pretax margins repo.

Reported operating earnings per share of $2.58 and generated solid free cash flow.

While increasing investments are.

Our balance sheet remains strong and we continue to have ample liquidity are.

Our revenue and gross profit performance was fairly consistent with the second quarter refer.

Reflects little change in the macroeconomic environment and client demand as.

As we previously discussed our broad geographic footprint and client portfolio mix provides some stability to our revenue profit and cash flow.

As Arvind just mentioned clients near term priorities continue to include operational stability flexibility and cash preservation, which tends to favor opex over capex. This.

This is resulting in some project delays and purchase deferrals, which we see and perpetual software licenses and project oriented and volume based services.

Our transactional performance. This quarter also reflects product cycle dynamics in our systems business.

At the same time the last several months have made it very clear that companies need to modernize their businesses to succeed in this new normal this is leading to an acceleration in digital transformations.

Cloud and they are at the center of these transformations.

And our open platform centric model delivers greater innovation higher productivity and more strategic optionality to our clients.

In the third quarter client adoption of our platform continued to grow with approximately 2600 clients now using our container solutions.

We anniversaried the acquisition of Red hat in early July and Red.

And Red hat again delivered strong results in the period were normalized revenue growth of 16%.

Red hat Leverages IBCM global reach and large account incumbency none.

Not only are the number of large deals increasing but also the sizes. These engagements is increasing as well with a total value of these deals doubling over the last 12 months.

Within services this quarter, we added about 125 services clients utilizing red hat technology and.

And our GBS cloud related signings were up over 25%.

The platform model delivers compelling economics are full stack capabilities drove over $24 billion of cloud revenue over the last 12 months, which is up 25%.

We're investing to expand our capabilities in GBS skills centered on hybrid cloud and intelligent workflows.

In Red hats go to market to drive hybrid cloud adoption.

In software hybrid cloud and AI capabilities, including those for new go and Wttg automation acquisitions.

PM cloud capital for MCR build outs and in our ecosystem to drive adoption of Openshift and our broader cloud capabilities. These.

These investments will accelerate in 2021, given the additional flexibility from our structural actions.

This quarter, our portfolio mix with strong software contribution together with our focus on productivity drove our operating gross margin expansion of 160 basis points and operating pre tax margin expansion of 140 basis points.

With a 10 point year to year headwind in our operating tax rate. Our net income margin was essentially flat.

Our cash and liquidity positions remain strong fueled by our cash flow we.

We generated $1.1 billion or free cash flow in the quarter.

And $4.8 billion year to date, which is down over a $1 billion year to year.

We continue to have strong working capital performance and contribution from Red hat net of related interest these were.

These were offset by higher net capital expenditures and workforce rebalancing payments.

Over the last year, we generated $10.8 billion or free cash flow, which is 136% of GAAP net income.

We ended September with a cash balance of $15.8 billion, which is up $6.7 billion since year end, while our debt was up $2.5 billion are we.

Ill remind you we issued debt earlier this year out of an abundance of caution and taking advantage of attractive market dynamics.

We're in good shape to fund, our upcoming maturities, including $4 billion to $5 billion in the fourth quarter will.

We'll end 2020, what debt down for the year.

Now I will turn to the segment performance, beginning with cloud and cognitive software.

Revenue was up 6% driven by cloud and data platforms. This.

This is a sequential improvement in the year to year performance. Despite a four point headwind from the wrap of the Red hat acquisition in early July.

Software has a seasonally smaller transactional base in the third quarter and up.

In a challenging transactional environment this benefited us.

Our cloud and data platforms delivered 19% revenue growth.

This was led by Red had strong performance with double digit growth across both infrastructure software and application development and emerging technologies.

A couple of weeks ago Red hat was recognized as the leader in multi cloud container development platforms in Forresters latest wave report.

Leveraging this openshift container platform, our AI powered cloud packs provide clients with ease of use and the ability to scale and secure operations across a variety of environments.

We're expanding and leveraging the IBCM and Red hat ecosystems with over 180 partners now selling IBCM cloud packs.

We're seeing good penetration in our large accounts, we've now more than tripled the number of clients adopting cloud packs versus a year ago and added nearly 200 clients to our container platforms in the third quarter.

Cognitive applications revenue trajectory improved the flat year to year led by strength in security and supply chain.

In security, we had good demand for our threat management software and services as clients transform and manage their security operations.

We're driving adoption of our club pack for security in Q radar on the cloud and identity and Trust services also had good performance as we're helping clients with their secure digital transformations.

Forrester and ITC, just named our managed security services as an industry leader.

Based on our integrated product and services capabilities.

We also had good performance in our supply chain software.

Supply chain order management enables the shift to more flexible and scalable digital channels, which is a great value prop to our clients during the pandemic.

Looking at the profit for this segment, we had strong profit and margin performance driven primarily by Red hat contribution.

Turning to global business services revenue declined 6% consistent with last quarter.

As you'll recall prior to the pandemic GBS was growing revenue and signings. Thanks.

March our revenue has reflected the economic environment and a change in client priorities, leading to project delays and less demand for more discretionary offerings.

But as we pivot our offerings and delivery to address these client needs.

EPS posted double digit signings growth in the third quarter and return its backlog to growth.

This was driven by cloud strategy application development, and modernization and offerings that use data and AI to transform workflows.

As I mentioned earlier, our GBS cloud signings were up over 25%.

We signed a number of large transformational contracts with a total value greater than $100 million, which will yield revenue overtime.

Our small deal performance generally follow the pandemic curve by geography, but returned to growth overall for the quarter.

With the expertise and process knowledge gained through our application management incumbency.

Clients Trust us to guide them through architectural decisions and facilitate their transformations.

With that particular expertise and application modernization at scale across all on Prem private and public cloud environments.

DBS drives adoption of IB EMS hybrid cloud platform.

And as a gateway to bring the wider set of IP capabilities to enable a client's digital journey. For example, about one third of cloud Pac revenue results from GBS engagements and this quarter. We added another 60 red hat client engagements, which such clients as Delta Air.

Airlines, which Arvind mentioned earlier, but also a world bank of Canada.

Ergo, Florida power and light and Telefonica Spano.

As our clients are transforming we're also investing in our GBS business to position for growth in the future.

We are continuing to invest in skills resources offerings and ecosystems.

We have implemented a virtual sales engagement model and are delivering nearly all of our more than 1500 active paid garage engagements virtually.

And we are taking the learnings from our initial shift to remote delivery to establish a new delivery model.

NAMIC delivery integrates technical foundations with virtualized methods and practices enhance with AI and automation to drive productivity pace and quality.

As we apply the dynamic delivery principles across our client base in the third quarter, we delivered more than 90% of our services remotely, while maintaining stable quality and increasing net promoter score.

Looking at the profit dynamics with our focus on high value offerings productivity and strong operational discipline, we expanded GBS gross margin by 190 basis points.

In global Technology services revenue was down 4% fairly consistent with last quarter.

Infrastructure services continues to experience lower client base business volumes in the more economically sensitive industries and.

And TSS performance reflects hardware product cycles, and continuing volume impacts due to the pandemic.

But many clients are taking a longer term view and are looking to modernize their infrastructure to create agility and operational efficiency.

They turned to GTS is manage infrastructure services business for its deep expertise in managing mission critical infrastructures and its next generation service delivery capabilities infused with AI and automation.

Coca Cola European Partners is a great example.

We recently signed a multiyear agreement to accelerate their modernization journey.

Well help them to reduce operational expenses increase resiliency and leverage AI to bring enhanced insights and deliver greater service to their customers.

Dts the signings were down 1% this quarter, but up 12% year to date.

19 deals over $100 million, including eight this quarter.

In addition to new work clients continue to make long term commitments with significant contract renewals as we deliver new value.

This has resulted in that backlog year to year trajectory improving by approximately two points from the beginning of the year.

Turning the GTS profit gross margin declined by roughly 80 basis points. This was.

This was driven by the investments we are making in public cloud and the volume impacts which come at a high margin.

Turning the systems revenue was down 16% driven primarily by product cycle dynamics.

Idmc revenue was down 20%.

We launched the Z 15 toward the end of the third quarter last year.

We've had widespread adoption of both see 15 analytics, one across many industries and countries in support of clients hybrid cloud journeys.

Idmc is seeing record setting volumes on Linux as clients leverage Red hat Openshift.

Ansible, and our cloud native Dev ops offerings.

At the same time this pandemic has impacted our historical IBM Z cycle dynamics, which is playing out differently by industry.

This platform has proved invaluable to our clients in areas like banking and financial markets, helping them rapidly and remotely scale up capacity and respond to unprecedented market volatility.

As a result, these clients accelerated their adoption of Z 15 within this cycle.

That said in many other industries clients remain focused on cash preservation during this pandemic.

This dichotomy and client buying behaviors impacted our performance in the third quarter and will lengthen the adoption curve of the Z 15 cycle.

But by the end of this cycle, we have an opportunity to be fairly consistent what prior cycles.

I'll remind you in the fourth quarter will be wrapping on a very strong performance from last year, when we were up 63%.

These cycle dynamics impacted our storage revenue as well where performance driven by declines in high end storage.

Now as always before the Q and eight I'll bring it back up to the IBCM level.

We're seeing tremendous opportunity to help our clients become digital businesses are too.

Our technology centric hybrid cloud platform deep industry expertise and growing ecosystem are enabling us to accelerate these transformations device.

The value we provide clients is evident this quarter and our cloud revenue growth in our.

And our continued momentum in red hat and in our strong GBS signings driven by cloud and application modernization offerings.

And now we're accelerating IB EMS hybrid cloud platform strategy with.

With increased focus and investments to drive future growth.

Were taken structural actions to simplify and streamline our business.

And as we discussed earlier this month, we expect a fourth quarter charge to our operating results of about $2.3 billion.

The savings from these actions will be reinvested in areas like hybrid cloud data and AI security and emerging technologies.

With our focused hybrid cloud platform strategy and the increase investment starting now we expect to drive sustainable mid single digit growth. After the separation of Newco is complete.

In the near term the rate and pace of recovery remains uncertain and asset.

And as a consequence, we have not seen a fundamental shift in overall demand levels.

Given this uncertainty and consistent with our direction for most of this year, we are not going to provide guidance, but I.

But I will remind you from an historical perspective, the fourth quarter seasonally is our strongest quarter in terms of revenue and operating earnings per share due to our high value software and hardware transactions.

Looking at our year to year dynamics at the end of 2020, we are.

We're wrapping on a strong fourth quarter of 2019 when.

When we had a very strong software performance, our first full quarter and see 15 availability and our first full quarter of Red hat contribution.

So going into this fourth quarter as always we have a lot of work to do.

It's our largest transactional quarter will be.

We will be focusing our investments in hybrid cloud and AI and of course, we're starting the detailed work to separate our managed infrastructure services business.

Confident in the focus and direction of our business and what it means for our future.

Arvind, let me turn it back over to you.

Thanks, Jim.

I'm going to add just one final thought before the acuity.

We are managing for the long term we.

We are making strategic decisions, taking actions and increasing investments to date to better position, our business and accelerate our top line growth on a sustainable basis.

Patricia let's go to the Q and a.

Thank you Arvind before we begin the Q and I would like to mention a couple of items.

We've included supplemental information at the end of the presentation and finally as always I'd ask you to refrain from multi part question.

Operator, let's please open it up for questions.

Thank you at this time, we will begin the question and answer session of the conference to ask a question. Please press star one and record your name clearly if you need to withdraw your question, Chris Stark Q.

Can I ask a question please press star one hour.

Our first question comes from Matt Cabral with Credit Suisse. Your line is open.

Thank you very much.

You touched on this briefly during your prepared remarks I was wondering if you could expand a little bit more on the health of the wider IP spending landscape, you're seeing around the world and you mentioned delays you are seeing in a couple areas within the portfolio. Just wondering when you think those deals will start coming through particularly as we're starting to think about the puts and takes heading into 2021.

Hi first.

Thanks for the question, Matt So a few comments on because you asked about portfolio, whereas you also asked about slots and you also asked about geographies.

And it all varies we're seeing first.

From.

Offline deals as well as services projects, let me just.

Reiterate but out a little bit of color to what Jim and I said in our prepared remarks.

While we are seeing very healthy growth in some thoughts Paul both software and systems.

It kind of gives a frantic what we'd also seeing people fall, maybe they're pausing because of that industry because of geography or because they're into a cash conservation mode.

We think its a pause we don't believe its decline forever. We do believe that some of those deals come back and we tend to see that we saw that from the first of the second second to the third quarter et cetera.

So thats one Fox now we have also talked about that there is about 70.

70% of the industries that we are in we are not seeing any pauses VC funds that are healthy we see that business on a healthy.

30% and that should not be a surprise to anybody on this call reduced indices.

Temporary softness and maybe think about brick and.

Brick and mortar retail you think about airlines you think about hospitality I think it's not a surprise that some of those now we also tend to be with larger clients. So we don't believe that the our sustainability issue by and large it.

It will attend.

Tend to come back so.

So thats part of the flavor under it but then as I begin to look forward not because you're asking that question also it's really hard to predict the fourth quarter Thats why I, Jim and I are pausing on giving guidance here. However, when we look at our people interested in these parts of the software portfolio, whether its supply chain and secure.

And Jim mentioned, whether it's cloud and data platform, which is inclusive of both of Red hat and our cloud facts and other technologies defined essential we find that those will come back we find our transaction processing platform with DVB get somewhat in line to the mainframe.

Capacity increases so as those go through you tend to see I'll call. It an alignment is not necessarily identical this alignment.

And then.

Let's not forget that as our global business services and other as size do transmission projects. They also tend to pull through software more in cloud data platform than in other areas so outside of.

Give you that color sort of.

Cost the mindset across the industries and across different parts of the portfolio Matt.

Thank you Matt Kelly. Please go to the next question.

Absolutely. Our next question comes contingent along with JP Morgan Your line is open.

Hi, Thank you so much looks like services signings did bounce back nicely a little bit here. So.

I was like some larger transactions coming back what I want to understand.

Maybe if you don't mind, just this transition from going with a tighter integration of GBS in GTS to the to the separation now could.

Could we see services results in bookings maybe weekend in the short term before picking up again.

Picking up again I know the savings were good here, but just trying to.

Think about this fourth quarter in the first quarter transition given the given the change over but that makes sense. Thank you.

Yes. Its engine. This is Jim I'll take that one lets talk a little bit about the quarter and what we just finished with regards to services signings were pretty pleased given the overall macroeconomic environment and the rate and pace and the continued uncertainty the teams executed very well $90.5 billion.

Versus signings up 5%, we've got $108 billion backlog right now thats flat at actual rates down 1% at constant currency and to your point, we saw actually very good progress in large transformational deals I think 11 in the quarter in excess of one.

Hundred million dollars.

Eight of those in our GTS manage infrastructure services business, which saw a very strong renewal rate that talks to the value of innovation that they bring to our clients said overall and that has led to a year to date I think we've said in the prepared remarks, GTS up 12% signings.

And I'll remind you that was off of a third quarter last year, where we grew 20%. So we're pretty pleased there and that's led to a two point backlog improvement in our GTS business since January but where we really have seen a marked inflection ups of some signs of demand change is in jail.

Yes, and you know while the revenue kind of played out consistent with two Q. Our signings were up double digits. I think it was our third largest signings quarter almost in history and are both large and small deals overall and that was really a testament to our GTR Jeep.

Yes capability around application modernization and being our clients provider of choice for digital transformation journey to cloud. So we're.

We feel pretty good about that it's good early trends, we got a very nice pipeline, our transformational deals here in the fourth quarter and again, given our announcement 10 days ago, we're spending a lot of time with our clients to make sure we minimize disruption ensure stability and provide that client value going forward.

Thank you tinge, and let's go to the next question.

Our next question comes from Toni Sacconaghi with Bernstein. Your line is open.

Yes. Thank you I know you're not commenting on.

Q4 guidance, but maybe you can tell us how to think about it typical seasonality might be for revenue up about $3 billion. If demand is not really changing why shouldn't we assume normal seasonality and is that kind of the right.

Number our framework and then Arvind I'm wondering if you could just comment on capital allocation going forward your dividend to $6 billion a year, it's basically been 100% of your free cash flow year to date in the last.

Hadn't pay down any debt you haven't done any deals.

[music].

Without taking on incremental debt. This year. So if you really are managing the business for the long term growth as a priority.

Are you considering lowering our suspending the dividend or is the dividend safe and if it is why wouldn't you be more aggressive in allocating more cash to growth going forward. Thank you.

Okay. Tony This is Jim Thanks for the question Multipart, but let me take the first piece around.

Color on fourth quarter, and then Arvind can handle the capital allocation discussion around the strategy and obviously.

Obviously can handle some of the numbers overall.

But first as we talked about prepared remarks.

And you indicated the rate and pace of the recovery, we still don't see is uncertain.

And.

No real fundamental change in client buying priorities around cash preservation around operational stability and consistent with prior quarters that has led us to not give guidance, but let me give you. Some color first we talked about at the onsite of COVID-19 that this is only.

We accelerated our clients' digital transformation journey to the cloud and you see that playing out in our results over the last few quarters with continued very good.

Momentum in our cloud business and in our Red hat business and when we look at fourth quarter, we see very healthy pipelines and hybrid cloud AI solutions at modernization cloud transformation services within GBS Red hat actual backlog growth is accelerating up 23%.

At four $4.7 billion, and we see pretty healthy pipelines in our cloud and data platform and in our cognitive apps business led by cloud packs in security. The two things that we called out though in our prepared remarks that we've talked about the last few quarters and those are headwinds in for.

First in particular around TPP, our clients committed to that platform. We had a very strong 2019 and given the environment in this in the focus on cash preservation, we do we don't see that coming back in the fourth quarter, it's going be pretty similar to the first half and the second is our mainframe so.

Michael.

Coming off with a significant portion of the growth last year up 63%, but when you look at skew overall in.

In the fourth quarter Threeq to Fourq you, yes, I mean, there will be no no reason not to expect a normal skew with regards to revenue.

Some slight improvement in our software portfolio offset by TPP and we'll wrap on the on the hardware piece now in terms of as you saw the very strong fundamentals in third quarter coming off a strong two Q operating gross margins up 160 basis points operating.

Pre tax margin up 140 basis points, we feel very confident in the strength of our balance sheet, our cash and liquidity position to make sure that we can continue to invest in our business. We're starting that immediately here in fourth quarter around technology around innovation around skills around capable.

Ladies and you'll see that play out in addition to the 2.3 billion dollar structural charge. So when you look at EPS you all know the numbers as well as I do over the last X number of years, our threeq to Fourq Q.

The $2.3 billion charge is been a nice growth of about 50 mid fiftys.

We should do maybe a little bit better than that but I don't think anything substantial above that so we see pretty similar dynamics Arvind over to you. Thanks, Thanks, Jim and Tony. Thank you have a asking the capital allocation question really important piece of our growth strategy going forward.

A couple of points there for context, one when we.

Acquire inflows on Red hat, we did commit to closing share repurchase until we had de leverage and gotten back to our target ratios of debt to EBITDA. We are on track to do that we fully intend to do that and we had said that we will get there by 22 ready too so thats part one and so.

All the cash you see as the balance sheet will be used towards that BOPUS. Because you said you are not paying down debt, but you'll see us begin to pay that down to get towards those those ratios bought one thought to how we are committed to a stable and growing dividend.

Given our investors given that how much they depend upon that and how much of your thought about that on feedback we intend to keep a stable and growing dividends that.

That means everything else is up for what is prudent for managing for the long term and so.

And so when we talk about increased investments and on October eight that was clear we are going to both increase expenses organically in order to be able to grow in both software and.

Well fair and GBS, but we're also going to be.

Why dock was active in the area that we have called out we will be acquisitively and GBS and we will also be acquisitively and the software areas around hybrid cloud data AI security.

Security and in emerging technologies, such as quantum so so when you see us do that I think we are going to be doing exactly what you're asking reallocating more cash to growth going forward I think the simple answer to that is yes.

No qualifications there.

Thank you Tony can we go to the next question. Please Sheila.

Thank you. Our next question will come from Wamsi Mohan with Bank of America. Your line is open.

Hi, yes. Thank you.

Second half was going to deliver some strong margin uplift from the productivity actions and we saw some of that.

Through in the third quarter can you help us with how much more productivity benefit is yet to come in the fourth quarter and as you talk about the reinvestment of the savings associated with the actions, we just announced last week.

Can you give us a segment view on dock reinvestment. Please thank you.

Yes, so wamsi. Thank you very much for the question overall, if you if you look at the structural actions. We took as we enter 2020 member we talked a lot about this in January pre co bid on how we were going to reposition our businesses as we move forward you see you see that.

Actually playing out in our results I mean, our margins in the second quarter were up roughly a 150 basis points at gross margin level and in third quarter. We just came off margins that are up 160 basis points at the gross level and operating margins that are up 140 basis points.

At the pre tax level, so I think you're seeing that productivity and the fundamental change in the way, we're actually driving in running the business now adapting to given the onset of cold and 19 and the implications to the economic environment. If you take a look at.

The fourth quarter actions overall, we talked about 10 days ago, the strategic action around separating out and creating two market leading companies in creating an independent publicly traded company around our manage infrastructure services business that was going to be about a $2.3 billion charge and if you remember.

What I said at the time and you can kind of think of this as and one third buckets. The first is about a third of that is going to go to help improve the EBITDA growth profile in our new co business to be on a trajectory to achieve post separation a double digit.

EBITDA growth profile, the second bucket or second third of that was in it in any business. When you separate out youre going to create stranded costs and inefficiency and we're committed to addressing that in 2021 with discharge and then the third piece is we are making significant investments.

Wants to capitalize on the one trillion dollar hybrid cloud market opportunity and the third bucket is going to be used for additional fin flex that is going to be centered around technology innovation people skills capability ecosystems and also as Arvind just answered.

Around inorganic place overall, so I'll take that one and an urban you want to take the second one.

Yes, so if you look at the different segments that we're in so.

So this is straight away and the four areas that we had outlined.

Number one.

We are going to be increasing investments in.

GBS and.

In order to get more skills in the areas, where we're seeing demand.

Second we are going to be increasing investments in our ecosystem.

Ecosystem that a large partners, we just announced service now last week, we announced.

We announced Adobe a couple of months before that you've seen us with Salesforce CNS with others, but we are going to be increasing our investment in how we work with those but there are also hundreds of highest weve not just the very large ones, whom we are also looking to get them on on hybrid cloud platform on AWS.

Cloud properties and so how do we invest in that in order to drive growth down. The road is a second piece I'll put that in the ecosystem bucket third we are going to be increasing investments in our core software areas in terms of the hybrid car platform itself and you saw that in some of my prepared remarks on the innovation.

Since we are driving into the Red hat technologies, but in addition to that in terms of data on AI in security and others go to drive enough.

Innovation in there.

And as you put all those areas together, let's not also forget Nucor is also going to be seeing increased investments in automation around infrastructure modernization against looking the different cloud partners. So when you think of those four buckets. If now goes pretty much across all of our OEM segments.

If you think about it because we want it to be outstanding balances not identical growth, but we want all of the segments to be contributing to growth and so we are going to be driving in terms of organic R&D in terms of working with certain areas, where there is a lot of demand. So you got to get skills in there and of course as we add M&A.

Okay, that's not quite directly from these buckets of money, but the M&A, but also add to added expenses eventually while the moment to complete an acquisition its expense indeed.

In these different segments.

Thank you Wamsi, let's go to the next question. Please.

Next we'll hear from Katy Huberty with Morgan Stanley You May proceed.

Thank you Arvind just looking at the cloud in cognitive software business before you closed on the Red hat acquisition that was a growing business today on a pro forma basis with Red hat, it's declining mid single digits. It would love your thoughts on why we're not seeing a stronger.

Our growth rate is it entirely macro driven and what are the steps in timeline for getting that software business back to pro forma growth given how important it is to hitting that mid single digit.

Longer term growth target.

Thanks, Katie and and you you you got to correct. It is a critical part of us getting to a mid single digit growth target. So that is essential.

As the big into gone direct and you look at it for the last few months out.

I would tell you that some of it is indeed.

Macro maybe the wrong word, but I think there's two elements in there people up all things certain lot software license transactions and that is perhaps the macro environment and then there is the TERP piece, which is the inside of the software segment, which has driven more as I've said before in terms of the alignment to demand for.

Ram capacity that's in the ground, we saw very good growth in the fourth quarter of last year, we saw that tied to that.

You begin to see that slowdown in the third quarter of this year, we do expect to I think see that continue for some time.

But within that when I look at our.

Cognitive applications and we look at cloud and data platform, we do see healthy growth there and I expect to see it continue.

As we invest more into that and as we invest more into red hat.

I would expect that as we get through the next the.

The next year, we are going to see that that is should be able to more than offset anything that happens inside TPP and just to give a sense of that kt media begin to look at red hat by itself.

And we see the growth there in the mid to high teens, and we expect that to be able to continue and accelerate that in turn will give added growth through the whole portfolio more than enough to offset any weakness in DPP and then as we are increasing our investment in our ecosystem as well as in.

Internal R&D as well as an acquisition, while I will acknowledge that those lives due to take multiple quarters to play out I wish it was quicker, but it has multiple quarters, but I would fully expect that at the same time as we complete the spin we should be able to see those growth return in those parts of the portfolio and you've got to.

A sense of how we'll do it across those various elements.

Thank you Katie and likely take the next question. Please.

Absolutely. Our next question comes from Nick Daria Nani with Evercore. Your line is open.

Thanks for taking my question I guess I would love to do so.

Regardless, we will come from over the last one.

Non mobile.

What am I think about a couple of quick Paul.

Well I will long look when deal almost done and this is Bob.

Pardon me.

Although that would be helpful.

Yes, great question on that so.

As you can imagine this is something in which I think the only walk and uses we are obsessive about this topic. Our we we had our list we knew exactly what clients might this might be concerned about and I wouldn't say that we are 100% perfect, but I think we feel very very good.

At Viva corrected our estimations.

This level of concessions to give me a sense.

We sort of internally. This is not something that we have we also declined but based on the reaction.

I mentioned that we have already spoken to one hundreds so you could think that.

Another 10 days in we've already spoken to at least between two and 300 of the tough lines, but there is a strong intersection or whether it is a very heavy spend global revenue base or deals that could be on the table.

And from there we have gotten back over 80% out called it out in the great too good to not really concerned.

And I'll come back and give some color on why.

We believe that's true then there are some who do enough on both sides of that they do have some concerns most of the concerns that around who is the team that really providing service who is the person who is going to be on the ground and we should be very clear.

That's been coal is going to head out on day one.

$19 billion, the same management team on the ground, who runs that from the client up is going to be the team that does it get to the corporate structure that we put in place, but thats not the feet on the ground just to be clear.

They have very high satisfaction with the majority of their clients and that is because they bring both service excellence in terms of the service and the upper end of that provide but also the bring very deep technical skills, which is kind of gives them permission and across the play so when I put all of that together.

I think that there's a couple of dozen clients, where we just have to make sure that we can tell them with the team that is going to be servicing them and and as they begin to get comfort on that I can see the level of anxiety reviews, but as I said over 80%.

They understood what was happening and also many clients are majority on one or the other of naturally for them. There is going to be less of a concern now the topline to why would they then completed the deal look like.

Most of the larger deals onto a client's benefit on don't do something unless they are going to get a business benefit from back and in this environment. If you want to go above that for PS six month, you're going to deploy a benefit for three to six months I think want drives things and Luckily the have a month to sort of.

On both sides, both our teams on the client to sort of understand each other this isn't enough time in the quarter to go get those deals done. So look the quarter will tell us whether we're right or not but based on everything I can see I am confident that actually will be able to see.

Most of the deals progress.

Due to a satisfactory conclusion.

Thank you on that let's go to the next question. Please.

Our next question comes from David Grossman with Stifel. Your line is open.

Hi, Thank you.

So the end markets a shift to quickly and I think I understand the challenges associated with repositioning GTS that says I mean.

That said I am having a harder time calibrating, how you're thinking about the longer term growth prospects for this business.

Can you give us any insight into your analysis of the longer term growth to the business and and what it really means to run it for cash flow and Thats simply mean that it continues to decline.

As a modest grade and generate cash or does that mean something totally different.

Hi, David.

The.

The market is a 500 billion dollar market from what we can see from water ITC shows us as well as lot of many other third party consultants to filter.

A couple of things in that within that if I find whereas our portfolio and our clients today is probably more heavily weighted and about 60% of the total as opposed to all of it.

And we think that the ability to form many more partnerships as a stand alone is going to allow is the much more fully participate in the complete market do.

We have stated pretty consistently that we are going to start them off at the investment grade balance sheet.

That would allow them to also make targeted acquisitions as appropriate we can't speak for that it will be up to the management team.

Post spin, but that is a place we are always in a market where I read it's a scale game, that's definitely a way that you can both grow and gain market share and so two three.

Jim mentioned that a third of the.

Restructuring charge is floor also improved.

Improving the EBITDA profile off of the spin company that is going to allow them to also invest in new offerings in areas such as cloud.

Cloud modernization as well as added offerings and as.

Aspects of compliance and security and resilience and also in much more automation, which is go to allow them to deliver even higher service delivery excellence.

To that to their clients, but when I look across all of those.

Opportunity is certainly there and freeing them up to do deals, which we might not do because the margin may be dilutive to us, but it's going to be accretive towards.

Towards the new company.

Two.

Possibly M&A down the road, but thats not for some time and three in terms of leveraging new offerings and partnerships with other companies who might be doing it but maybe not as wholeheartedly as they would do it with an independent company.

Great. Thank you David lets go to the next question. Please.

Our next question comes from Keith Bachman with Bank of Montreal, You May proceed.

Oh, hi, many thanks for taking the question and congratulations on the ongoing success of Red hat.

I actually wanted to ask a clarification question and Jim are going on a clarification I wanted to come back to M&A you seem to be talking more about M&A on this call than in previous calls and per our previous question I'm just not sure. The financial resources now that you have to be aggressive about M&A in that you.

I am, particularly generate between 12 and 13 being free cash flow and you can explain again.

Dividend payment it just doesn't leave a lot of room for M&A. So is the message that you may look to get.

Away from an investment grade rating I'm, just not sure how to make the math work when you say impactful and then I'll just ask my question of Jim If I could Jim you talked about GBS and how you're confident of growth there.

Certainly think consulting business can improve particularly next year as we get into presumably better economic cycles, yet application management and global process have world.

Well week before the pandemic hit impact.

That had been growth challenges throughout 19.

And so just wanted to hear a little bit about those two businesses what are your expectations on an organic basis.

You think about GBS for roughly half the revenues that frankly, we're pretty close challenge before the pandemic that any thanks.

Okay, Keith actually urban if you don't mind, let me, let me take both because I think part of the first question you've already answered from the strategic capital allocation perspective on what we want to do with regards to our investment profile, both organically and Inorganically, but Keith.

The heart of your question gets to a mathematical equation and I think one first you got to recognize that there's always been seasonality in our free cash flow.

Albeit we delivered $4.8 billion year to date in in free cash flow overall as you all know quite well well over 50% of our free cash flow in this business comes in the fourth quarter that coupled with.

We talked about two quarters ago at the onset of COVID-19, how the business model composition of IBCM with its geographic diversification its industry composition, it's client segmentation being more large enterprise focus and its annuity.

Content of both high value software high value hardware platform and high value services piece provides a natural hedge in this environment to stability around revenue profit and cash now yes over the last couple of years, we've been driving around $12 billion or.

Free cash flow in light of the economic challenges due to COVID-19 that number just trajectory wise will be less this year, we'll see how fourth quarter plays out, but we're very confident in our portfolio in fact, even more confident given the decision that are have been in the end.

Tire IBCM team and our board made on October eight around repositioning two market leading companies one with an I.B.M. on an accelerated growth profile with an already very strong EBITDA margin business that is going to generate significant cash and then too.

Uhhuh.

Lead in the market, leading infrastructure services business that is two x.

The next competitor and in that business as you all understand quite well is a scale economics business.

So from that aspect I think when you look at our fin flex our fin flex only gets better and with our disciplined financial capital allocation policy that this company operates on we feel very comfortable that we got ample free cash flow to invest in our business organically and inorganically.

To de lever and hit our those targeted leverage ratios and also to maintain our return to shareholder program, what a secure dividend and sustainable dividend growth policy overall, so thats. The first question second question. When you look at GBS as I talked about we did see signs that demand is.

Movement here in the third quarter and if you remember 90 days ago, we talked about the first half of second quarter and the second half a second quarter in the month of June we saw some nice growth in June well that continued into the third quarter were double digit signings growth overall and by the way.

Keith.

That was pretty pervasive that was good growth in consulting, but it was led by large transformational deals around application services in this environment to capitalize on our clients' journey. The cloud that then drags with it our global process services work.

Clients are now digitally reinventing themselves and how they run their companies around intelligent workflows. So we're seeing that demand inflection move now to your question that revenue is more long term as we play out but when we look at our current backlog and our current backlog.

Right now for our GBS business in 2021, we see GBS getting back to pre at pre covance growth rates by midyear and a big chunk of that is improvement across all the three sub segments.

Thank you Keith let's take one last question. Please.

Thank you our last question will come from Jim Suva with Citigroup investment Research. Your line is open.

Thank you very much a pretty clear are easy question here is on mute.

Talking highlighted IBCM significant cash flow strength in I believe it's the high priorities that paying down debt to get closer to investment grade and then spin out to the company and get it well positioned post all that is the focus mostly on dividend and M&A and we should think about stock buyback as being less.

And that feature compared to past history of IB and more a lot of EPS growth has been driven by stock buyback, but it seems like perhaps maybe the view is that the management the board thinks that the stock buyback isn't generating beating shareholder return. So maybe shifting more towards M&A is that the way to kind of lead the last half hour, we heard through the Q.

Right.

Yes, Jim This is Jim let me take that and then us could wrap it up with with Aravind overall.

As you know quite well, our our disciplined capital allocation process first and foremost focus is on how we reinvest back in our business both organically and Inorganically and we are focused now with this strategic move that we announced we laid the foundation we talked on October.

Great we laid that foundation over the last couple of years instantiated in the Red hat acquisition, which was a bold move we have been building and accelerating that growth now we want to capitalize on that one trillion dollar hybrid cloud opportunity now with that said just given our investor mix.

Outside of allocating capital and investment to our our own business. When we have excess cash we're going to return back to shareholders that priority right now is our secure dividend and sustainable dividend growth policy and as we get back to our targeted leverage ratios at that point.

In time, we'll reevaluate share repurchase, but there is no need talking about that right now.

Thanks, Jim let's just.

Just to reiterate we have talked about growth.

I've talked about a maniacal obsession on hundred clout in AI as the engines of growth for the company, but let me just make a couple of comments to wrap up the discussion we.

We have a certain on our direction even in these uncertain times and.

And we are laser focused on helping our clients with a digital transformation leveraging our hybrid cloud technology platform, our incumbency and our expertise and the.

And the actions we are taking starting now in the fourth quarter that enhance our focus and accelerate our future growth and I look.

And I look forward to continuing this dialogue with you.

Kayla can we turn it back to you to close out the call. Please.

Absolutely. Thank you. Thank you for participating on today's call. The conference has now ended you may disconnect at this time.