Q4 2023 International Business Machines Corp Earnings Call
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 Olympia Mcnerney Ibm's Global head of Investor Relations Olympia you may begin.
Speaker Change: Thank you I'd like to welcome you to Ibm's fourth quarter 2023 earnings presentation, I'm Olympian Mcnerney and I'm here today with Arvind Krishna Ibm's, Chairman and Chief Executive Officer, and Jim Kavanaugh, Ibm's, Senior Vice President and Chief Financial Officer.
Olympia Mcnerney: We'll post today's prepared remarks on the IBM investor website within a couple of hours and a replay will be available by this time tomorrow.
Olympia Mcnerney: Provides additional information to our investors. Our presentation includes certain non-GAAP measures. For example, all of our references to revenue and signings growth or a constant currency. We've provided reconciliation charts for these and other non-GAAP financial measures at the end of the presentation, which is posted to our investor website.
Arvind Krishna: Finally, some comments made in this presentation may be 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 information about these factors is included in the company's SEC filings, so with that I'll turn the call over to Arvind.
Arvind Krishna: Thank you for joining us.
Arvind Krishna: A solid close to 2023 this growth across our businesses and strong cash generation.
Arvind Krishna: Fourth quarter and full year results demonstrate the strength of our portfolio and sustainability of our revenue growth.
Arvind Krishna: We are pleased with the progress we made in 2023, delivering revenue growth of 3% and over $11 billion of free cash flow.
Arvind Krishna: Two thirds of the way through our midterm model I am proud of our achievements.
Arvind Krishna: Since 2021 we delivered average revenue growth for IBM and for each segment at or above our model.
Toni Sacconaghi: The overall trends, we are seeing reinforce our views of the future.
Toni Sacconaghi: We are confident in achieving our midterm revenue model and the strength of our diversified business model allows us to make progress each quarter.
Toni Sacconaghi: We entered the year intent on enhancing our software portfolio and strengthening our consulting position.
Toni Sacconaghi: We have done both.
Toni Sacconaghi: Mid last year, we launched Watson ex our flagship AI and data platform and we're excited by the traction we are seeing.
Toni Sacconaghi: And salting is deliver durable revenue growth through the year, despite an uneven macro environment.
Toni Sacconaghi: Our expanding ecosystem skills and technical expertise global reach and co creation approach not only set us apart, but also contributed to our consulting performance outpacing that of our competitors.
Toni Sacconaghi: This year also underscored the enduring nature and relevance of our Z systems platform.
Before getting into the execution of our strategy I'll make a few comments about what we see in the current environment.
Toni Sacconaghi: I expect many macro trends to be similar to 2023.
Toni Sacconaghi: Technology demand will continue to be strong and serve as a major driving force behind global economic and business growth.
Toni Sacconaghi: It allows businesses to scale.
Offer better services drive efficiencies and seize new market opportunities.
Toni Sacconaghi: Every plant I speak with is asking about how to boost productivity with AI and how to manage their technology stack.
Toni Sacconaghi: Much of which is deployed across a hybrid environment public private and on premises.
Toni Sacconaghi: These trends continue to fuel demand for both hybrid cloud and artificial intelligence.
Toni Sacconaghi: I will now provide some color on the progress we are making in the execution of our strategy starting with AI.
Toni Sacconaghi: Our approach to AI, if a business is resonating.
Toni Sacconaghi: Earlier in 'twenty three we introduced what's the next.
Toni Sacconaghi: Ibm's core platform that enables clients to train dune validate and deploy AI models.
Toni Sacconaghi: We believe AI will be multi model with our clients leveraging a combination of models Ibms open source their own proprietary models.
Toni Sacconaghi: And those of other companies.
Toni Sacconaghi: Flexibility of deployment is key.
Toni Sacconaghi: <unk> report, we meet clients, where they are and allow clients to deploy AI models across multiple environments.
Toni Sacconaghi: In the fourth quarter, we released Watson ex Dart governance to help clients and partners Governor and instill trust in generative AI.
Olympia Mcnerney: This toolkit health organizations manage and monitor their AI and prepare for compliance with feature AI related regulation.
Olympia Mcnerney: IBM was recently named a leader in generative AI for governance platforms by IDC.
As I have mentioned before IBM was one of the first companies to announce the indemnification of all our models.
Olympia Mcnerney: Additionally, IBM and meta announced in December the formation of the AI Alliance a group of 70 industry and academic leaders Joy.
Joining together to advance open safe and responsible AI.
Joy Buolamwini: We continue to believe our consulting business will be an early beneficiary of AI.
Joy Buolamwini: The only provider today that offers both the technology stack with our what's the next platform and consulting services for deploying and managing generative AI.
Joy Buolamwini: The early work for clients around data architecture security and governance is critical.
Joy Buolamwini: Hard.
Joy Buolamwini: And we think consulting expertise is going to be crucial here.
Joy Buolamwini: Just as we quickly ramp to meaningful practice around red hat to address the hybrid cloud opportunity.
Joy Buolamwini: On a similar trajectory regenerative AI.
Joy Buolamwini: Consulting is a core driver of our value proposition for clients.
Joy Buolamwini: Last quarter I shared with you that our book of business in the third quarter, specifically related to regenerative AI and bots and X was in the low hundreds of millions.
Joy Buolamwini: Since then demand continues to increase and our book of business in the fourth quarter is roughly double the third quarter amount.
Joy Buolamwini: We've continued to have thousands of hands on client interactions, including an acceleration in pilots that were completed during the quarter.
Joy Buolamwini: Software transactional revenue and SaaS ACB was approximately one third of our book of business related to generative AI in the fourth quarter and two thirds was consulting signings.
Joy Buolamwini: There was a balance of both large and small transactions across both segments.
Enterprise use cases addressing core modernization customer service and digital labor continue to offer meaningful near term benefits to clients.
Joy Buolamwini: We've been collaborating with numerous clients choosing what's the next court assistant for Ansible.
This includes a successful pilot with city, but initial results point to substantial developer productivity and quality improvements that have led to plans for rapid expansion.
Joy Buolamwini: First on scaling for enterprise wide outcomes.
This is just one of many examples.
In other industries, we have done work with clients such as Natwest, Lockheed Martin and Boehringer Ingelheim.
Joy Buolamwini: We are working on an interesting use case that the <unk> football club choosing what's the next to find the right players to sign by describing attributes across the database of more than 200000 Scouting reports.
Joy Buolamwini: As clients build out their AI strategies and focus on driving ROI and productivity the importance of optimizing it spend and consumption is magnified.
Joy Buolamwini: <unk>.
Joy Buolamwini: Virtual command center for managing Technology investments comes up in nearly all of pipeline discussions the value proposition is clearly resonating.
Joy Buolamwini: Looking beyond AI, we had a number of important client wins in the fourth quarter for.
Joy Buolamwini: For example, we are helping NATO strengthen the cyber security posture and build out a customized solution to have greater visibility into cyber threats and respond to their more quickly.
Joy Buolamwini: We are working with <unk> air to help them drive their digital and technology strategy and establish a hybrid cloud integration platform.
Joy Buolamwini: We also saw meaningful consulting renewals, which combined with new wins highlights the focus and unique strengths of our capabilities.
Joy Buolamwini: Our strategic partnerships with companies such as S&P, AWS, Microsoft Salesforce, and Adobe continue to expand and thrive.
Joy Buolamwini: For instance, we are working together with Adobe to embed <unk> into their platform.
Joy Buolamwini: We also continue to deepen our partnership with SAP.
Joy Buolamwini: To further collaboration across what's the next and quantum.
We also have several new what's the next <unk> partners, what we see is clear.
Joy Buolamwini: Many isps are eager to work with us.
Joy Buolamwini: As a trusted provider that understands enterprise needs.
Joy Buolamwini: We continue to invest and bring new innovations to the market in other areas as well.
Joy Buolamwini: In the quarter Red hat enhanced it's ansible automation platform, introducing new offerings like ansible, Lightspeed and event driven ansible.
Joy Buolamwini: We announced the availability of Red hat device edge.
Joy Buolamwini: Manage of workloads and deliver automation at the edge.
Joy Buolamwini: And quantum computing, we introduced heron.
Joy Buolamwini: Most advanced quantum processor and the system do a model a quantum computer.
Joy Buolamwini: Focusing our portfolio remains a key priority.
Joy Buolamwini: We completed nine acquisitions this year.
Including <unk> and we recently announced the acquisition of stream sets and web methods from software AG, which we expect to close midyear.
Joy Buolamwini: With respect to divestitures, we announced the sale of other assets, which you expect to close in the first quarter.
Joy Buolamwini: We also announced the enterprise AI venture fund, a 500 million dollar fund with the goal of partnering with the startup community to tap into the latest innovations in the market and help them scale.
Joy Buolamwini: In summary.
Joy Buolamwini: I believe that the changes we have made to our business over the last couple of years.
Joy Buolamwini: Physician us for the evolving technology landscape.
Joy Buolamwini: As I reflect on our performance since we presented our midterm model in October of 2021 I.
Joy Buolamwini: I am pleased with the progress we have made internally and with our clients.
Joy Buolamwini: We have delivered average revenue growth for IBM in line with our midterm model and this is true for all our segments.
Software is delivered average growth at the high end of the mid single digit model.
Joy Buolamwini: Salting delivered average growth in line with the high single digit model and.
Joy Buolamwini: And infrastructure is well ahead of expectation.
Joy Buolamwini: This performance gives me confidence as we move into the new year.
Joy Buolamwini: For 2024, we expect performance in line with our midterm model with mid single digit revenue growth and about $12 billion of free cash flow.
Joy Buolamwini: This keeps us firmly on a path of sustainable growth.
Joy Buolamwini: Jim will now take you through the details of the quarter and our expectations for 2020 for.
Jim over to you.
Jim: Thanks, Arvind and the fourth quarter, we delivered $17 $4 billion in revenue.
Jim: $4 $2 billion of operating pre tax income and operating earnings per share of $3 87, and we generated $6 $1 billion of free cash flow.
Jim: This wrapped up another solid year, where we continued to deliver durable growth and our reposition business aligned with client priorities of digital transformation and driving productivity.
Arvind Krishna: Taking a step back let me touch on a full year before I go into additional details of the quarter.
Toni Sacconaghi: Our revenue for the year was nearly $62 billion up 3%.
Toni Sacconaghi: In line with our expectation 90 days ago.
Toni Sacconaghi: We generated $10 $3 billion of operating pre tax income and operating earnings per share of $9 62.
Toni Sacconaghi: Our free cash flow was $11 $2 billion, our strongest level of cash generation since 2019.
Revenue performance for the year was again led by software and consulting.
Toni Sacconaghi: Software grew by over 5% with good growth across hybrid platform and solutions and transaction processing.
Toni Sacconaghi: Consulting revenue was up over 6%.
Toni Sacconaghi: With solid growth every quarter and broad based growth across all three lines of business highlighting the durability of our results and differentiated client offerings.
Toni Sacconaghi: Infrastructure was down 4%, reflecting product cycle dynamics.
Toni Sacconaghi: Our revenue growth and productivity initiatives led to margin expansion and strong free cash flow generation.
Toni Sacconaghi: For the full year, we expanded operating gross profit margin by 130 basis points with every segment growing margin across every quarter.
Toni Sacconaghi: Our operating pre tax margin expanded by 40 basis points in line with our expectations and driven by strong productivity gains and operating leverage and this includes a 110 basis point headwind from currency dynamics.
Toni Sacconaghi: Now turning to a deeper dive on the quarter, our revenue was up over 3%.
Toni Sacconaghi: Software revenue was up 2%.
Toni Sacconaghi: Our fourth quarter performance reflects continued growth in our recurring revenue and a wrap on last year's seasonally strong transactional performance.
Toni Sacconaghi: Consulting had another solid quarter with five 5% revenue growth.
Toni Sacconaghi: Which is a sequential improvement in the growth rate.
Toni Sacconaghi: We had good signings performance in a trailing 12 month book to Bill ratio over 115.
Toni Sacconaghi: This continued momentum in consulting is reflective of how we work with clients. The investment we are making in skills and talent velocity and our strategic partnerships and our integrated value proposition.
Toni Sacconaghi: We had great infrastructure performance this quarter.
Toni Sacconaghi: Revenue was up 2% with growth in both Z systems and distributed infrastructure.
This performance is particularly notable given it's the seventh quarter of disease 16 cycle.
Toni Sacconaghi: In our seasonally largest quarter again, highlighting the innovation, we are bringing to this mission critical platform.
Toni Sacconaghi: Looking at our profit metrics, we expanded operating gross margin by 140 basis points and operating pre tax margin by 110 basis points inclusive of a 150 basis point currency headwind to pre tax margin.
Toni Sacconaghi: Currency impacted operating pre tax profit growth in the quarter by over $200 million.
Toni Sacconaghi: Margin expansion was driven by our operating leverage and ongoing productivity initiatives, which allowed for continued investments to drive innovation in our portfolio.
Toni Sacconaghi: You can see this in our higher R&D expense.
Toni Sacconaghi: Our operating tax rate was 14%, which is flat versus last year and our operating earnings per share of $3.87 was up 8%.
Toni Sacconaghi: We remain laser focused on our productivity initiatives as we digitally transform our business processes and scale AI within IBM.
Toni Sacconaghi: This includes simplifying our application and infrastructure environments streamlining our supply chain aligning our teams by workflow, reducing our real estate footprint and enabling a higher value added workforce through automation and AI driven efficiencies.
Arvind Krishna: Against a target of $2 billion in annual run rate savings by the end of 2024, which I mentioned back in April of last year.
Arvind Krishna: We have already achieved over $1 $5 billion.
Arvind Krishna: Our productivity initiatives have allowed us to increase our investments in innovation tactical and industry skills and go to market capabilities, including our ecosystem and.
Arvind Krishna: And we have accomplished this while simultaneously growing our profit margin and free cash flow, which in turn has increased our financial flexibility.
Arvind Krishna: This remains our playbook going forward and given our success to date. We now believe we can achieve at least $3 billion in annual run rate savings by the end of 2024.
Arvind Krishna: Overall, the combination of our revenue and margin performance, resulting in 9% growth in our operating pre tax profit for the quarter.
Arvind Krishna: This contributed to our free cash flow performance for the year, we generated $11 $2 billion of free cash flow up $1.9 billion year over year.
Arvind Krishna: The largest driver of this growth comes from $900 million of adjusted EBITDA.
For better transparency, we have included a view of our adjusted EBITDA performance in our supplemental slides.
Arvind Krishna: Our free cash flow growth also reflects benefits of about $400 million from working capital efficiencies, which is consistent with what we've been suggesting throughout the year.
Arvind Krishna: Capex was also down about $400 million, reflecting actions to optimize our real estate portfolio.
Arvind Krishna: These actions reduced our net capex, although had limited benefit to our profit performance.
Arvind Krishna: In terms of cash uses for the year, we invested over $5 billion to acquire nine companies and we returned just over $6 billion to shareholders in the form of dividends looking.
Arvind Krishna: Looking at the balance sheet, we ended the year with a strong liquidity position with cash of $13 $5 billion, which is up $4 $6 billion year over year.
Arvind Krishna: Total debt is up $5 $6 billion over the same period.
Arvind Krishna: And our debt balance ended the year at $56 $5 billion, including approximately $12 billion of debt associated with our financing business.
Arvind Krishna: Our retirement related plans remain in a strong financial position.
Arvind Krishna: At year end our worldwide tax qualified plans are funded at 111% with the U S at 123%.
Arvind Krishna: Turning to our segments software grew 2% with growth across both hybrid platform and solutions and transaction processing.
Arvind Krishna: This quarter's performance again reflects growth in our high value recurring revenue base, which is up mid single digits. I'll remind you. This comprises about 80% of our annual software revenue.
Transaction processing with its strong base of recurring revenue delivered revenue growth of 4%.
Arvind Krishna: Clients continue to value this portfolio of mission critical software supporting growing workloads on our hardware platforms like Z systems.
Arvind Krishna: This together with price increases contributed to growth in both recurring and transactional software revenue in transaction processing for the year.
Arvind Krishna: Hybrid platform and solutions revenue was up 1%.
Arvind Krishna: Within this performance Red hat revenue was up 7%.
Arvind Krishna: Automation was flat data and AI was up 1% and security declined.
Arvind Krishna: Looking across hybrid platform and solutions the strength of our recurring base of business is evident in our a R now $14 $4 billion and up over 7% since last year.
Arvind Krishna: We also faced a tough compare here in the fourth quarter wrapping on seasonally strong transactional performance, including strength in Elas as we discussed at the start of the year.
Arvind Krishna: What played out in our fourth quarter reflects just these dynamics and while transactional revenue overall was significant it was down year to year, a little more than expected.
Speaker Change: And Red hat revenue performance was similar to last quarter as we continue to see dampen growth and consumption based services, our future growth indicators are encouraging.
Speaker Change: Brad had annual bookings were up 17%, including double digit bookings growth across all three key offerings Rale open shift and ansible.
Joy Buolamwini: Renewals have been strong this quarter with our enter are up well over 100% and up six points over last year.
Joy Buolamwini: And open shift continued its strong performance with annual recurring revenue of $1 $2 billion.
Brad Smith: Beyond open shift our platform based approach is resonating with clients.
Speaker Change: We're seeing growing interest in our generative AI platform Watson X as Arvind touched on earlier.
Arvind Krishna: And we've been investing to both extend and expand our hybrid cloud and AI capabilities and software from new offerings in ansible and <unk>.
Arvind Krishna: Launch of Watson Nexstar governance is the announced acquisition of stream sets and web methods.
Arvind Krishna: Looking at software profit gross profit margin expanded and pre tax margin was flat with the latter reflecting key investments in innovation and about two points of currency impact in the quarter.
Arvind Krishna: In consulting our revenue in the quarter was up five 5%.
Arvind Krishna: We continue to see solid demand for data and technology transformation projects with a focus on AI and analytics.
Scientists are also prioritizing cloud modernization and cloud based application development projects.
Arvind Krishna: This focus on digital transformation and AI initiatives to drive productivity and cost savings has been consistent throughout the year.
Arvind Krishna: Our ability to address these client demands drove signings growth of 8% with a one three book to bill ratio in the quarter.
Arvind Krishna: That caps off a solid year, where signings grew at a high teens rate and with this our trailing 12 month book to Bill ratio remains over one that one five.
Arvind Krishna: There has been significant interest this year regarding our consulting outperformance relative to competitors.
Brad Smith: Let me give you my thoughts on what differentiates us.
Arvind Krishna: Our integrated value investments in skills, and strategic partnerships and focused execution.
Olympia Mcnerney: First we are the only technology company with the consulting business at scale. This.
Olympia Mcnerney: This unique integrated value proposition helps our clients implement digital transformations and generative AI solutions set.
Second we repositioned our portfolio to address our clients' top priorities through investments in skills capabilities and strategic partnerships.
Brad Smith: Consulting is even more powerful when working in collaboration with our partners or strategic partnerships now make up over 40% of our consulting revenue and delivered double digit growth in both signings and revenue for the full year.
Brad Smith: Within this performance, our AWS and Azure practices, each grew revenue more than 50% for the year.
Brad Smith: Finally, our solid results throughout the year demonstrate our focus on execution.
Brad Smith: When you look at our three lines of business and consulting we have consistently delivered solid revenue performance.
Business transformation revenue grew 5% for the third consecutive quarter again led by data and technology transformations, including AI and analytics focused projects.
Brad Smith: Finance is supply chain transformations also contributed to growth.
Technology consulting revenue was up over 4% with growth in cloud modernization projects and cloud based application development.
Brad Smith: Application operations revenue grew 6% driven again by cloud application management and platform engineering services with both strategic partnerships and red hat engagements contributing to growth.
Brad Smith: Moving to consulting profit, we expanded gross margin 30 basis points and delivered pre tax margin of 11, 5%, which is up 50 basis points year to year.
Brad Smith: Our pre tax margin performance continues to reflect the pricing and productivity actions, we have taken offsetting increased labor cost and nearly a point of currency impact.
And our infrastructure business revenue was up 2%.
Brad Smith: Hybrid infrastructure revenue grew 7% and infrastructure support declined 9%.
Brad Smith: Within hybrid infrastructure Z systems revenue was up 8%.
Now seven quarters into the product cycle Z 16 revenue performance has significantly outperformed prior cycles, including the successful Z 15 cycle.
Brad Smith: The <unk> 16 program incorporates a number of key innovations for our clients, including cloud native development for hybrid cloud embedded AI at scale quantum safe cyber resilience security energy efficiency and strong reliability and scalability.
Brad Smith: Clients are increasingly leveraging Z systems for more and more workloads and that translates to demand for more capacity, which we described in terms of Mips.
Brad Smith: In fact installed Mips have roughly doubled over the last two cycles.
Brad Smith: Putting this all together Z systems remains an enduring platform.
Diving not just hardware adoption, but also related software storage and services.
Brad Smith: Distributed infrastructure revenue was up 7% with growth across both power and storage.
Brad Smith: Power performance was fueled by demand for data intensive workloads and power 10, and storage traction was aligned to the success of the Z 16 cycle, We just mentioned.
Brad Smith: Infrastructure support revenue declined given our successful hardware performance.
Brad Smith: Looking at infrastructure profit, we deliver gross profit and pre tax margin expansion.
Brad Smith: Pre tax margin expanded 280 basis points in the quarter, reflecting benefits from productivity, while absorbing over a point of impact from currency.
Brad Smith: Now, let me bring it back up to the IBM level to wrap it up.
Brad Smith: As Arvind mentioned, we are now two thirds of the way through our midterm model.
Brad Smith: And so I'd say, it's a good time to reflect on what we have accomplished over this period.
Toni Sacconaghi: Let me start with the actions, we've taken to execute our strategy and deliver sustainable revenue and free cash flow growth.
Arvind Krishna: We aligned our business to our platform centric model focused on hybrid cloud and AI.
Arvind Krishna: Our go to market is based on more technical and experiential selling.
Arvind Krishna: We opened ibm's ecosystem and strategic partnerships to give our clients greater choice and technical depth and give IBM multiple ways to win across our portfolio.
Arvind Krishna: We have invested in innovation and skills and pursue strategic M&A.
Arvind Krishna: And we presented a simplified reporting structure to give increased transparency into our performance.
Arvind Krishna: These actions resulted in a fundamentally different company with an improved business mix and a higher value recurring revenue base today.
Arvind Krishna: Today, our growth vectors of software and consulting represents 75% of our revenue base up from about 55% in 2020.
Arvind Krishna: And our stable recurring revenue stream represents about half of Ibm's revenue.
Arvind Krishna: As Arvind said, our two year average revenue growth is in line with our mid single digit model.
Arvind Krishna: In our segments have delivered at or above the revenue models.
Arvind Krishna: With this backdrop, let me turn to 'twenty 'twenty four guidance and our two key measures of success revenue growth and free cash flow.
Arvind Krishna: We expect constant currency revenue growth in line with our mid single digit model as we start the year I think it is prudent to assume the low end of that model.
And for free cash flow, we expect to generate about $12 billion.
Arvind Krishna: Our revenue expectations are underpinned by solid growth in both software and consulting.
Arvind Krishna: And software given our pipeline of business investment in innovation and the contribution of acquisitions, we expect revenue growth slightly above the high end of our mid single digit model.
In consulting our solid signings and book to Bill ratio support revenue growth in a range of 6% to 8% with the acceleration throughout the year.
Arvind Krishna: Given this growth profile, coupled with our productivity actions, we expect to see well over a point of pretax margin expansion in each of these segments.
Arvind Krishna: And then in infrastructure as we are entering the year seven quarters into the <unk> 16 cycle, we expect 'twenty 'twenty four infrastructure revenue to decline.
Arvind Krishna: This should drive over a point impact Ibm's overall revenue growth and given the Z cycle dynamics, we expect infrastructure pretax margin to be lower year over year.
Arvind Krishna: Bringing it all together with these segment dynamics, we expect Ibm's operating pre tax margin to expand by about half a point.
Consistent with what we delivered in 2023.
Arvind Krishna: Our tax rate for the year should also be fairly consistent with 2023 and as always the timing of discrete items can cause the rate to vary within the year for.
Arvind Krishna: For free cash flow, we expect to generate about $12 billion in 'twenty 'twenty, four driven primarily by growth in adjusted EBITDA.
Arvind Krishna: We will have lower cash requirements driven by changes in our retirement plans, which will be offset by higher capex and other balance sheet dynamics.
Let me comment on a couple of items that are included in our guidance.
First we are seeing increased productivity in our business, which will lead to workforce rebalancing fairly consistent with 2023 levels.
Arvind Krishna: And second as we remained focus on portfolio optimization, we expect to close the sale of the weather company assets in the first quarter.
And a full year basis, we expect this to impact revenue growth by over a half a point and any pre tax gain from the transaction will be partially offset by foregone profit.
Arvind Krishna: In the first quarter of 2024, the company will realign its management structure to manage these assets outside of the software segment within other divested businesses, which will provide comparability within software on a year over year basis.
Arvind Krishna: Looking into the first quarter I would expect our revenue growth rate to be similar to the full year.
Arvind Krishna: For profit, we expect the first half to second half skew of net income to be fairly consistent with history and.
Arvind Krishna: And first quarter to be a couple of points better than last year's SKU.
Arvind Krishna: In summary, we have a durable growth business with strong free cash flow generation.
Arvind Krishna: We have made a lot of progress this past year and feel good about our position as we enter 2024.
Arvind Krishna: Arvind and I are now happy to take your questions.
Speaker Change: Olympia, let's get started.
Speaker Change: Thank you again.
As a reminder, supplemental information that is provided at the end of patent close on and please refrain from multi part question operator, let's please open it up.
Speaker Change: Thank you at this time, we'll begin the question and answer session of the conference. If you would like to ask a question. Please press star one on your telephone keypad.
Speaker Change: Confirmation tone will indicate that your line is in the question queue.
Speaker Change: You May press Star two if you would like to remove your question from the queue.
Speaker Change: Our first question comes from one <unk> Mohan with Bank of America. Please state your question.
Speaker Change: Hi, Thank you.
Speaker Change: If we look at your cash flow performance.
Speaker Change: Really very compelling at 12 billion on your guidance could you maybe help us bridge.
Speaker Change: Problem, probably 2023 2024, what are the items that are driving that 12 billion in free cash flow.
Speaker Change: What's happening with maybe cash taxes within that.
Speaker Change: Working capital and any other details that you can help parse out would be would be great. Thank you so much.
Speaker Change: Thanks, <unk> I appreciate it.
Olympia Mcnerney: Question overall, we're obviously very pleased the team has executed extremely well in 2023, our strongest free cash flow since 2019, and $11 $2 billion up $1 9 billion year to year I think it's important to your point before we get to 'twenty four to take a step.
Olympia Mcnerney: Back a year ago.
Olympia Mcnerney: Talk about how we guided the year and by the way we've been consistent every quarter about our guidance of about.
Olympia Mcnerney: $10 $5 billion. The reason I think it's important because it goes right at the heart of your question, which is the quality and sustainability and why we are here at IBM had the confidence in the guide of about 12 billion. We said a year ago about $10 5 billion. It was predominantly going to be driven by the improving.
Olympia Mcnerney: Fundamentals of our business readout sustainable revenue growth operating leverage and that by the way is our model $750 million year to year.
Olympia Mcnerney: On top of that remember, we had an opportunity gap coming out of fourth quarter 2022, We said, we would get working capital efficiency a $400 million.
Arvind Krishna: And then we would have modest structural action tailwind offsetting modest cash tax headwind.
Arvind Krishna: That kind of brought it altogether 750 ish from proving fundamentals of the business $400 million.
Now how did we added 2023 play out.
Toni Sacconaghi: One the improving fundamentals of our business, we had a very strong second half both on our topline revenue our portfolio mix, our productivity and we delivered $900 million of growth in adjusted EBITDA year to year, which by the way. We gave you as far as increased transparency.
Toni Sacconaghi: On top of that we got the 400 million worth of working capital efficient.
Toni Sacconaghi: <unk> very consistent.
Brad Smith: Then we've got and we capitalized on all of the productivity actions that we have done we capitalize on being opportunistic on some real estate rationalization. That's why our Capex was down about 400 million by the way full transparency that's the timing.
Brad Smith: It was a 2024 item we got that in 2023, so let's put that aside and then we've got about $100 million worth of cash tax that came in a little bit better. So I would say against that very strong high quality sustainability that sets the baseline for 'twenty four 'twenty four really as simple as we said in the prepared remarks.
Brad Smith: One we see very consistent growth and the fundamentals of our business around revenue profile margin and productivity that we will get.
Brad Smith: A similar level of growth year to year and adjusted EBITDA by the way that's above our model again is all state. So we did $900 million last year, we'll get it again with that we will also have benefits from the changes in retirement plans that many of you have written about.
Brad Smith: But offsetting that we got higher cash taxes year to year and.
Brad Smith: And we've also got Capex that we're going to continue to invest for the long term sustainable leadership of this company. So it's really in 2024 entirely driven by the business model of our adjusted EBITDA growth. So thank you again monitoring for the question.
Brad Smith: Thank you. Our next question comes from Amit.
Brad Smith: Question.
Amit: Our next question comes from Amit <unk> with Evercore. Please state your question.
Amit: Thanks, a lot and good afternoon, everyone. I guess my question really focuses on the software side you know when I think about the calendar 'twenty four guide off because I think slightly above the mid single digit long term medium term target you folks out can you maybe talk about how do I think about the split between organic versus inorganic in 'twenty four and if you could also perhaps unpack what.
Amit: What do you expect to see across the key segments like Red hat, which I think was somewhat below your expectations in 'twenty three and then also the TPP side would be really helpful. Thank you.
Amit: Okay.
Arvind Krishna: Thank you let me do some of the financial bridges year over year, then turn it over to Arvind and talk about the portfolio. The competitiveness the innovation and why we feel very confident overall when you look at our guide by the way an acceleration from 2023 I would first start with full year last year, we were very pleased with our software.
Arvind Krishna: Formats over 5% growth year over year and on a two year CAGR against our mid single digit model were at the high end of that model. So when you look at our guide we feel confident in the level of innovation, we've been bringing in but I would break that guide down mathematically until about three or four different buckets number one.
Arvind Krishna: I think we've proven over the last two years that we have rebuilt and reposition our portfolio and we now have a high value recurring revenue stream that can grow in this business. After the innovation and the success of our of our hardware platform business, that's about two points of growth.
Arvind Krishna: <unk> of slightly above the mid single digit model of software. So two points based on credibility of our sustained growth in our high value recurring revenue number two you talked about acquisitions, we are going to continue to invest in fuel investment into into our software portfolio to.
Arvind Krishna: Improve the innovation the synergistic value of the strategic fit the hybrid cloud and AI you saw we closed very excited after a great start with <unk> and we announced the acquisition of web methods and stream sets acquisitions will probably give us a little bit less than two points of that growth in 2024.
Arvind Krishna: So two points from high value recurring revenue a little bit less than two points of acquisition and then red hat to your point, we actually delivered about what we said in the fourth quarter. We said high single digit we still got impacted by consumption based services by the way we'll start wrapping on that later in 2024, but we're extremely excited.
Arvind Krishna: About the acceleration in demand and our single year bookings in our subscription book of business, 14% growth in third quarter, 17% growth in fourth quarter Red hat will give us about two five points of growth year over year and then the remaining half a point is our continued growth of our transaction.
Arvind Krishna: Processing and Thats about a half a point you add those up you're over 6% growth and I think we feel pretty good but let me turn it over to Arvind. Thanks, Jim.
Arvind Krishna: And the second part of that is all of the innovation that we're delivering and we play it up against the demands in the marketplace.
Arvind Krishna: Our AI platform is going to be a part of what fuels innovation and as I think you all understand when people like one part of the portfolio that tend to also leverage other parts of the portfolio.
Arvind Krishna: Other than the AI portfolio automation, which really helps our clients with productivity, Jim mentioned, <unk> <unk> and I'll make the whole category called AI ops in the market. We believe is going to be a big driver of demand for us.
Arvind Krishna: And on the mainframe.
Arvind Krishna: Remember TP does get driven by increased Mips and Jim talked about the increased Mips that are out there.
Arvind Krishna: <unk>, coupled with the innovation, we're doing that part of the portfolio drive the growth. So it's really very.
Jim: Very well balanced M&A, yes, right at innovation AI innovation automation innovation and DP innovation and that is really what comes together to give us that growth and give us the confidence of being able to deliver on all of that growth.
Jim: The next question.
Jim: Thank you. Our next question comes from Toni <unk> with Bernstein. Please state your question.
Jim: Yes. Thank you.
Speaker Change: One clarification.
Toni Sacconaghi: And one question. Please so just on the free cash flow Jim I'm wondering can you give us a bridge from net income, which I think the street is expecting is about 9 billion or a little over for fiscal 'twenty four and how you get to 12 billion in free cash flow not from 'twenty to 'twenty three levels, but from net income levels.
And maybe in that can you just clarify how much do you expect depreciation expense to be and how much do you expect capex to be and how big.
Toni Sacconaghi: A contributor is that and then secondly on the AI book of business I think he said the low hundreds of millions that doubled so we should we be thinking $3 million to $400 million and it sounds like a third was in software was that revenue recognized during the quarter and then the other couple of hundred millions were.
Brad Smith: We're consulting signings.
Can you just elaborate specifically on exactly what the book of business means thank you.
Brad Smith: Okay. So let me let me take the first piece and I. Appreciate the question is always in an urban can talk about the AI overall.
Brad Smith: For increased transparency by the way coming out of third quarter.
Brad Smith: We delivered free cash flow of 1 billion.
Brad Smith: <unk> dollars up year over year.
Brad Smith: And I and many other of the senior leaders, we've spent a tremendous amount of time with our investors and our investors were actually.
Olympia Mcnerney: Guiding us coaching us around giving increased transparency about the drivers right at the heart of your question. That's why we put them in both the press release and in the supplemental earnings chart, a breakdown from operating pre tax income down to adjusted PCI y.
Olympia Mcnerney: As I stated in <unk> question.
Brad Smith: Depicting the quality and sustainability of our free cash flow. So when you look at 2024, so to your point I'll leave 23, aside when you look at 'twenty four it's entirely going to be driven and more by the growth in adjusted EBITDA.
Brad Smith: And when you look at net income and you break it down.
Brad Smith: Not that much difference between net income overall and the adjusted EBITDA overall, so the $900 million is purely a function of the confidence we have in the portfolio the mix the scale, the operating leverage and the productivity, which you heard on.
Brad Smith: The prepared remarks, we took up the $3 billion here as an annual exit run rate by the end of 2024. So it's an entirely driven balance sheet will have dynamics going one way or the other cash tax modest headwind, but those all kind of wash out it's gonna be entirely driven by the business fundamentals.
Thanks, Jim So Tony on the <unk> book of business. This is not.
Tony: All revenue in the quarter and just begin with that statement to say that's right.
Tony: At this stage, we wanted to start looking at what is our momentum what are the sentiment from our clients.
Tony: Went to a measure that is more reflective of.
Toni Sacconaghi: I'll use the word signings what is the what are the commitments declined to making to us.
Toni Sacconaghi: So nothing is straightforward it is the signings.
Joy Buolamwini: <unk> signings are anywhere from 12 to 24 months on average how much time to play out over.
Joy Buolamwini: And on software.
Joy Buolamwini: What theyre committing to and we are using that ACB. So it's a 12 month commitment which is typical for as a service as well as since we do offer.
Joy Buolamwini: Our portfolio, both ways as license or as a service. It includes the license piece as well.
Joy Buolamwini: Now or.
Long term, let's call. It a couple of years more yes. The book of business should turn into a module revenue in a quarter, but that's going to take a bit of time to catch up further.
Joy Buolamwini: This gave the better.
Joy Buolamwini: Indicator right now.
Joy Buolamwini: What is our traction in what is our acceleration in that part of the business.
Joy Buolamwini: Operator, let's go to the next question.
Joy Buolamwini: Our next question comes from Ben Reitzes with Melius Research. Please state your question.
Joy Buolamwini: Yeah, great. Thanks, a lot.
Wanted to ask about consulting and.
Joy Buolamwini: Jim You just mentioned and disclosed high single high teens, sorry bookings growth in 2023.
Joy Buolamwini: And just 8% off a pretty difficult comp I was wondering how that's going to play out in terms of revenue yield in 'twenty four and into 25 does that give you more confidence.
Jim: The second half of 'twenty four is going to have a pickup in consulting revenue reported and then for RV and if I could just sneak more on consulting.
Jim: Your one of your top competitors your top competitor has much easier comps in terms of bookings and revenue over the next 12 months do you think easily and continue to outperform them.
Jim: In the next year. Thanks.
Jim: Thanks, Ben really appreciate it.
Jim: Yeah.
Jim: Belting based question I think the team is executing extremely well in the marketplace.
Jim: As we talked about in prepared remarks, theres real synergistic value of consulting and our hybrid cloud and AI platform centric company I think you've seen that play out when you look at it yes, we had a very strong year relatively speaking in the marketplace around consulting in 2023.
Jim: Signings growth, 17% book to Bill over one dot one five are absolute backlog is up 8%. The strongest we've had in quite some time by the way stable erosion.
Jim: Duration is up slightly which we expect as clients do more and more application modernization. Those are long tails. So when you look at that profile and you look at how we enter 2024, we take a look at that backlog, we do our backlog run out we look at how much of that comes out of our Wolf.
Brad Smith: All of the backlog realization and how much actual sell and bill activity you've got it during the year and that gives us confidence we guided full year to 6% to 8%. We also said that we expect just based on that backlog realization trends, albeit a lot of work still to get done in 'twenty four but based on those backlog.
Brad Smith: Realization trends, we see an acceleration growth path throughout 2024 and that tailwind into 2025 were well in front of our skis now, but when you just look at backlog and by the way backlog when you look at 2025.
Brad Smith: Predictor indicators only about a third of that backlog sits in 'twenty five as we enter right now in 'twenty for about two thirds is backlog driven so and that still looks pretty healthy growth compared to what our model looks like so we feel pretty good about our book of business and the strategic partnership velocity.
Brad Smith: The Red Hat's velocity.
Brad Smith: So I would leave it at that let me turn it over to Robyn Thanks, Jim.
Robyn: As opposed to trying to directly compare with one other or two other people can I take it back to the market if you don't mind.
Overall consulting market seems to be in the 4% to 6% range.
Robyn: So we benchmark there to make sure that we're trying to take share and then we have the offerings, which appeal to clients, which also allow us to keep a healthy margin in the business.
Robyn: So when we look at it from those two lenses.
Robyn: We are going to be absolutely focused on taking share which is why we are guiding to.
Robyn: Higher 6% to 8% number is maybe it'll be.
Robyn: And if you go back to do we have the bookings that justify that yes, the bookings ossified, but as you all know that has some but not all of the revenue in the year. So we feel it's prudent than guided into the six to eight.
Robyn: Not higher so you combine it with the offerings. We have we are also very very focused compared to many of the players out there who are much larger we are very focused on our strategic partners and we're very focused on digital transformation.
Robyn: Data and AI as opposed to a much broader swath of offerings that other people had that gives us confidence in our growth rate as Jim pointed out for our consulting business.
Robyn: Let's go to the next question.
Robyn: Our next question comes from Brent Thill with Jefferies. Please state your question.
Robyn: Thanks Art and I am just curious if you could just give us your view of the business climate, just how things are feeling in.
Robyn: The last quarter versus quarters before we're continuing to hear of other <unk> and the software budgets from CIO. So I'm. Just curious if you are you are hearing the same thing that we're seeing in our work.
Robyn: Yes, Brian So let me address that I'll begin by saying.
Robyn: 24, playing out similar to 'twenty three.
Brian White: While there has been a lot of talk about reduced software budgets and reduce technology budgets overall, we're not seeing that.
Brian: We are seeing that even out a bit more discriminating in what they're spending on but that is as a spending more AI more on digital transformation and I'll come to why it might be into the sort of focus on some other areas.
So why is that.
Brian: We see that there is a remarkably resilient economy, we can see that across south Asia from India to Japan to the Middle East Europe escaped remarkably resilient despite the conflict in eastern Europe.
Brian: And when we come to North America the economy it is resilient.
Brian: Can America. Despite some early predictions has actually done quite well.
Brian: You put that altogether.
Brian: Look we don't forecast GDP, we just look at what other people forecast and all of them are forecasting in the 2% range two to three.
Brian: The difference from our perspective.
Brian: And if you look at some of the pressures our CEO our clients face.
Brian: Whether it's interest rates, whether it's inflation, whether it's supply chain, whether it's the demographic shifts on population, whether it's geopolitical conflicts and uncertainty.
Brian: One answer that let them grow without taking on fixed costs of either labor or physical infrastructure is technology.
Brian: So we see every one of them leading into technology as a potential answer that helps them against all of those.
Brian: Potential headwinds and so we feel pretty good that technology budget should stay in line with 2023 going into 'twenty four.
Brian: Let's go to the next question.
Brian: Our next question comes from Erik Woodring with Morgan Stanley. Please state your question.
Speaker Change: Hey, good afternoon, guys. Thank you for taking my question.
Speaker Change: Wanted to dig into the software results a bit and that was you know.
Speaker Change: We maybe set aside red hat, which was which we've spoken about some of the other businesses continue to decelerate.
Speaker Change: Especially looking at something like a data and AI are automation, especially in this climate of AI and a focus on spending there I'm just curious what is driving the confidence that those businesses Reaccelerate is it customer conversations I'd love. If you could just give a bit more detailed one on again what happened in <unk> and kind of how you parse.
Speaker Change: Through some of that deceleration across those businesses and then to again, what's what's underscoring the confidence that some of these businesses then reaccelerate into next year. Thanks, so much.
Speaker Change: Okay.
Speaker Change: Yes.
Speaker Change: The bigger.
Speaker Change: We laid out a mid term model that our software portfolio with growth.
Other way commenting from a prior cycle that we were very low single digits overall.
Speaker Change: And we.
Speaker Change: We finished this year up over 5%.
Speaker Change: We finished two years CGI are already two thirds into our model at the high end of the model at 6%.
Speaker Change: Is that our aspiration absolutely not this is whats.
Speaker Change: Urban has the entire team focus on and that's why we continue to fuel investment into new innovation, both organically inorganically, but let's take a step back how we set the Europe.
Speaker Change: We set the Europe, we said the year was going to be predominantly driven.
By the strength of our recurring revenue annuity portfolio, which by the way high value, 80% of our software revenue that is our subscription based models. Our SaaS models, our TP software et cetera, and we said that was going to grow mid single digits.
Speaker Change: We actually delivered on that we said then second prudently coming off of a peak late cycle and you understand our OE cycle extremely well and <unk> 22 that we expected a headwind.
Speaker Change: Now, let's go back 90 days ago 90 days ago, we were sitting a year to date six 5% total software segment.
Speaker Change: Which gave us the confidence of taking up our guidance to the high end.
Speaker Change: Of the mid single digit model, what was driving that both HP and S was up 7% <unk> was up six and.
Speaker Change: And underneath that we were seeing very solid growth in our transactional business, both volume and NR with new clients now.
Speaker Change: Now, we get the fourth quarter and the early rap.
Speaker Change: Hit us by the way the Elas cycles give or take there in these ranges.
Speaker Change: They are on average about three years, they get probably somewhere around 40.
Speaker Change: 50, plus percent in year, one and then it tails off so it has the biggest impact we will see we got through that in the fourth quarter and we still delivered over 5% and two your CJR. We're at the high end of the model now when you look at full year performance Red hat up nine.
Speaker Change: Automation I'm Directionally, correct, four or five data and AI for five security, Yes, we got an execution gap on security, we got an opportunity to go fix in 2024, So I think it's actually glass half full innovation.
Speaker Change: Fueling in organically.
Speaker Change: M&A portfolio, which is scaling nicely with a strategic fit that gives us the confidence on why we're actually taking up and accelerating our growth.
Speaker Change: In light of Brents question in 2024.
Speaker Change: Operator, let's go to the next question.
Speaker Change: Our next question comes from Matt Swanson with RBC capital markets. Please state your question.
Speaker Change: Yes. Thank you guys. So much for taking my questions and congratulations on both the free cash flow and then also obviously the free cash flow going into next year maybe.
Matt Swanson: Maybe focusing even more so on the software side and just thinking solely on that two five points of growth Thats expected to come from the Red hat.
Matt Swanson: I mean, you've talked about the consulting strength that you're hearing around both cloud and application modernization are there any other signs youre hearing specifically from like pipeline your customer conversations about an improving demand environment for Red hat, specifically and then maybe just like a caveat how maybe some of the cloud cost optimization.
Matt Swanson: <unk> impacted red Hot in 2023.
Matt Swanson: Yes, Matt let.
Matt Swanson: Let me take that.
Matt Swanson: When we look at Red hat.
Matt Swanson: While there are many products in the portfolio of three other bulk that drive the forward performance.
Red hat Linux.
Matt Swanson: As we look at the overall usage of Linux as we look at.
Matt Swanson: Customers being even more concerned about batching security and making sure that hackathon break into their infrastructure.
Matt Swanson: And we look at share volatility that happens I'll call. It in the unfettered open source world.
Matt Swanson: It drives a lot of demand for Red hat, and we are beginning to see not just enterprise customers, but even many isps begin to embrace that.
As we look at open shift I'll go back to a fundamental.
Matt Swanson: Most of our clients are now acknowledged that a hybrid environment is the reality, meaning multiple public clouds and their own data centers are private.
Matt Swanson: That environment open shift is is the leading platform that gives them the flexibility to take an application and run it across all of those.
Matt Swanson: And in this day and age and people have thousands of applications that they want the ability to deploy without having people answer we will give them. The platform to go do that those three combined roll up into the 17% increase in bookings that Jim referenced on the call, but that's not all.
Matt Swanson: A leading indicator of that is actually already done now with 14 in the previous quarter that tells us is acceleration happening on that side and we feel confident given the client conversations that these are all going to lead to read out growth.
Brad Smith: The innovation, that's coming from the edge platforms from embedded Red hat and from other markets that is agile opens up will create yet again another additional market that has to come this gives us confidence that red hat will grow.
And provide that two to two and a half points for overall software.
Brad Smith: Operator lets take one last question.
Brad Smith: Thank you our last question comes from Brian Essex with Jpmorgan. Please state your question.
Hi, good afternoon, and thank you for taking the question maybe.
Jim: Maybe for Jim with regard to acquisitions could you maybe provide some color or an update on your pipeline and offer maybe an update on your philosophy behind M&A, how you assess transactions with regard to the level of accretion you might require what they might contribute your topline revenue growth or how they might improve ROIC stay long term.
Jim: Yes, sure I appreciate that Brian. Thank you very much I mean, I think arvin spend very clear.
Arvind Krishna: For the last three and a half four years since he's come on.
Brian: First of all let's talk criteria.
Brian: Right, we always get asked size. This size that size is not a criteria it is entirely.
Brian: In our complement him and the entire team.
Brian: Very focused on strategic fit.
Brian: Our hybrid cloud and AI platform centric company those targeted areas are always centered around hybrid cloud data automation security and Oh by the way both software IP asset and consulting expertise on both sides so strategic fit second.
Brian: We run this platform centric model to create a synergistic multiplier effect in our business.
Brian: So when we look at every single week, a set of targeted candidates we're looking at.
The synergistic effect because of the CFO when we deploy one dollar.
Brian: Looking for a multiplier of hardware software services on top of that and then third financial.
Brian: Attractiveness it has to be.
Brian: High growth recurring revenue highly profitable and free cash flow accretion in a quick period of time that will vary based on software the very based on consulting, but I think youre going to continue to see us.
Brian: Be opportunistic in the marketplace, we've got the right capital structure, we've got the right fin Flex we ended with $13 $5 billion of cash on the balance sheet. So we feel pretty good about our position and we will capitalize on that to the extent it hits and fits those criteria. So thank you for the question.
Brian: Thanks, Jim.
Brian: I'll wrap up the call.
Brian: In 2023.
Brian: Executed on our strategy to deliver sustained revenue growth and cash generation the.
Brian: The changes we have made to our business over the last couple of years and our performance reinforced my confidence as we move into 2024 I look forward to continuing this dialogue through the year.
Brian: Diego, Let me turn it back to you to close out the call.
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