Q2 2026 International Business Machines Corp Earnings Call

Speaker #1: 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.

Speaker #1: Olympia, you may begin.

Speaker #2: Thank you. I'd like to welcome you to IBM's second quarter 2026 earnings presentation. I'm Olympia McNerney, and I'm here today with Arvind Krishna, IBM's Chairman, President, and Chief Executive Officer, and Jim Kavanaugh, IBM's Senior Vice President and Chief Financial Officer.

Speaker #2: We'll post today's prepared remarks and a replay of today's webcast on the IBM investor website within a couple of hours. The earnings presentation is already available.

Speaker #2: To provide additional information to our investors, our presentation includes certain non-GAAP measures. For example, all of our references to revenue and signings growth are at constant currency.

Speaker #1: Welcome, and thank you for standing by. At this time, all participants are. Good. Today's conference is being recorded. If you have any objections, you may disconnect at this time.

Speaker #2: We provided reconciliation charts for these and other non-GAAP financial measures at the end of the presentation, which is posted to our investor website. Finally, some comments made in this presentation may be considered forward-looking under the private securities litigation reform act of 1995.

Speaker #1: Now, I will turn the meeting over to Olympia McNerney, IBM's global head of investor relations. Olympia, you may begin.

Speaker #2: Thank you. I'd like to welcome you to IBM's second quarter 2026 earnings presentation. I'm Olympia McNerney, and I'm here today with Arvind Krishna, IBM's chairman, president, and chief executive officer, and Jim Kavanaugh, IBM's senior vice president and chief financial officer.

Speaker #2: 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.

Speaker #2: So, with that, I'll turn the call over to Arvind.

Speaker #3: Thank you for joining us today. As you saw in our pre-announcement, our second quarter performance fell short of expectations. Consistent with our commitment to transparency, we shared the results as soon as our financial close process was substantially complete.

Speaker #2: We'll post today's prepared remarks and a replay of today's webcast on the IBM Investor Website within a couple of hours. The earnings presentation is already available.

Speaker #2: To provide additional information to our investors, our presentation includes certain non-GAAP measures. For example, all of our references to revenue and signings growth are at constant currency.

Speaker #3: I won't revisit the details from the pre-announcement, as Jim will provide additional context. Instead, I will focus on the positioning of our business, the growth opportunities we see ahead, and actions we are taking to address execution in the quarter.

Speaker #2: We provided reconciliation charts for these and other non-GAAP financial measures at the end of the presentation, which is posted to our investor website. Finally, some comments made in this presentation may be considered forward-looking under the Private Securities Litigation Reform Act of 1995.

Speaker #3: Our conviction in the strength of our business and our ability to grow and drive shareholder value remains unchanged. We recognize that the technology spending environment remains dynamic, and we must continue to evolve how we engage clients, bringing the full breadth of IBM's innovation to bear on their most important priorities.

Speaker #2: These statements involve factors that could cause our actual results to

Speaker #3: As clients determine how and where to deploy AI, we believe our portfolio is well-positioned to help them realize value in a secure, cost-effective, and scalable way.

Speaker #3: Over the last 5 years, we have transformed our business, improved the durability of our revenue growth, and strengthened our operating model. Those fundamentals remain intact.

Speaker #3: Software is nearly 45% of our total revenue, and has been repositioned to higher growth end markets across hybrid cloud, data, automation, and mission-critical transaction processing software running on mainframe.

Speaker #3: Our offerings help clients build and run applications and AI anywhere. Unlock the value of their data, orchestrate and govern AI at scale, and operate more efficiently, securely, and resiliently.

Speaker #3: Our second quarter software shortfall was limited to a CapEx-sensitive area of the portfolio. The vast majority of our software business, about 80% of that revenue, is recurring in nature and delivered healthy growth in the quarter, reflecting the demand for our offerings and giving us confidence in our growth opportunity.

Speaker #3: Our AI strategy is the right one for IBM. An alliance to what we are known for: hybrid, sovereignty, and trust. We have held the view for a while that the unprecedented investment in AI infrastructure and models will increase pressure on enterprises to generate meaningful returns from that spend.

Speaker #3: Value will increasingly shift toward the orchestration and data layers so that clients can optimize outcomes, cost, and governance across multiple models and agents, and keep control of their proprietary data.

Speaker #3: IBM's differentiation lies in our neutrality and enterprise-grade operational control. The ability to orchestrate agents across models—clouds, and on-premises environments—while also providing built-in observability, evaluation, governance, identity management, and security.

Speaker #3: What's the next orchestrate is the control plane that helps clients build, manage, and govern agents, which, combined with Red Hat, gives clients a foundation to run inference and applications on any infrastructure.

Speaker #1: Both opportunities. Our AI strategy is the right one for IBM: an alliance to what we're known for—hybrid, sovereignty, and trust. We've held the view for a while that the unprecedented investment in AI infrastructure and models will increase pressure on enterprises to generate meaningful returns from that spend.

Speaker #3: Bob is our entry point into the developer ecosystem, helping clients build enterprise-ready AI applications and agents, while creating a natural pathway to adoption of what's the next orchestrate and IBM's broader AI platform.

Speaker #3: Confluent delivers real-time governed data to models, and agents across their control plane. Concept provides enterprises with a unified view of application health, security, compliance, and operational performance.

Speaker #1: Value will increasingly shift toward the orchestration and data layers, so that clients can optimize outcomes, cost, and governance across multiple models and agents, and keep control of their proprietary data.

Speaker #3: Clients remain in the early stages of AI adoption, making our combination of consulting expertise and technology a key differentiator. We are helping move clients to deployment and that's translating into growing demand across consulting, led by generative AI.

Speaker #1: IBM's differentiation lies in our neutrality and enterprise-grade operational control. The ability to orchestrate agents across models, clouds, and on-premises environments—while also providing built-in observability, evaluation, governance, identity management, and security.

Speaker #3: In infrastructure, despite challenges this quarter, Z17 is having the best refresh cycle in reported history. Transaction volumes cyber requirements and resilience continue to drive growth for the mainframe.

Speaker #1: What's next, Orchestrate is the control plane that helps clients build, manage, and govern agents, which, combined with Red Hat, gives clients a foundation to run inference and applications on any infrastructure.

Speaker #1: Bob is our entry point into the developer ecosystem, helping clients build enterprise-ready AI applications and agents, while creating a natural pathway to adoption of what's next in Orchestrate and IBM's broader AI platform.

Speaker #3: While clients continually evaluate workload placement, we see no evidence of clients moving off the mainframe. Z17 remains at nearly 130% programmed-to-program, well ahead of Z16, which was our strongest on record.

Speaker #1: Confluent delivers real-time governed data to models and agents across that control plane. Concept provides enterprises with a unified view of application health, security, compliance, and operational performance.

Speaker #3: IBM Z runs over 70% of the world's transaction volume in terms of value. To give you perspective on our reach, there are over 140 million installed MEPs, running mission-critical transactions across every industry.

Speaker #1: Clients remain in the early stages of AI adoption, making our combination of consulting expertise and technology a key differentiator. We're helping move clients to deployment, and that's translating into growing demand across consulting, led by generative AI.

Speaker #3: Clients representing 85% of these installed MEPs are either maintaining or growing capacity. Earlier this month, we introduced a smaller Linux 1 system that allows clients to address data center space and cost constraints while offering security, resiliency, and real-time inferencing the Z platform can deliver.

Speaker #1: In Infrastructure, despite challenges this quarter, Z17 is having the best refresh cycle in reported history. Transaction volumes, cyber requirements, and resilience continue to drive growth for the mainframe.

Speaker #3: This innovation expands our addressable market. Distributed infrastructure just delivered its best quarter of revenue growth on record, growing 37%. We see this as an increasingly important growth vector for IBM, driven by AI adoption and the rapid growth of enterprise data.

Speaker #1: While clients continually evaluate workload placement, we see no evidence of clients moving off the mainframe. z17 remains at nearly 130% program-to-program, well ahead of z16, which was our strongest on record.

Speaker #3: We have been investing across power and storage, AI infrastructure, to position ourselves for this market opportunity. Power continues to gain momentum, as the value proposition of power 11: resiliency, performance, and Linux modernization resonates with clients.

Speaker #1: IBM Z runs over 70% of the world's transaction volume in terms of value. To give you perspective on our reach, there are over 140 million installed MEPs, running mission-critical transactions across every industry.

Speaker #3: We are gaining share in storage through differentiated offerings across flash, fusion, and tape, including AI-enabled capabilities that help clients scale and manage data for AI.

Speaker #1: Clients representing 85% of the installed MEPs are either maintaining or growing capacity. Earlier this month, we introduced a smaller LinuxONE system that allows clients to address data center space and cost constraints while offering the security, resiliency, and real-time inferencing the Z platform can deliver.

Speaker #3: Demand remains strong, owning a robust pipeline and positioning us well for the second half of the year. We are acting decisively to capture new market opportunities as they arise.

Speaker #1: This innovation expands our addressable market. Distributed infrastructure just delivered its best quarter of revenue growth on record, growing 37%. We see this as an increasingly important growth vector for IBM, driven by AI adoption and the rapid growth of enterprise data.

Speaker #3: The Mythos release in early April has accelerated the discovery of security, vulnerabilities for clients. This creates a multi-billion dollar TAM for IBM and Red Hat, to help clients secure their open-source software through our new capability Lightwell.

Speaker #1: We have been investing across power and storage, and AI infrastructure, to position ourselves for this market opportunity. Power continues to gain momentum, as the value proposition of Power 11—resiliency, performance, and Linux modernization—resonates with clients.

Speaker #3: IBM offers a differentiated value proposition as a leader in open-source through Red Hat and also recent acquisitions of Confluent and Hashi. Clients can subscribe to Lightwell for a million dollars per year to access open-source packages that have been remediated or validated.

Speaker #1: We're gaining share in storage through differentiated offerings across flash, Fusion, and tape, including AI-enabled capabilities that help clients scale and manage data for AI.

Speaker #3: In the first two weeks of availability, we have already made more than 7,500 package versions available. Early adopters of Lightwell include organizations like Bank of America, BNY, Citi, Goldman Sachs, JPMorgan Chase, Mastercard, Morgan Stanley, Royal Bank of Canada, State Street, Visa, Wells Fargo, and more.

Speaker #1: Demand remains strong, driving a robust pipeline and positioning us well for the second half of the year. We're acting decisively to capture new market opportunities as they arise.

Speaker #1: The Mythos release in early April has accelerated the discovery of security, vulnerabilities for clients. This creates a multi-billion dollar TAM for IBM and Red Hat, to help clients secure their open-source software through our new capability Lightwell.

Speaker #3: Finally, quantum computing is no longer decades away. It is upon us, and we are investing aggressively. Recently, with the US Department of Commerce, we announced a letter of intent to build Anduron the world's first pure-play quantum foundry, supported by a billion dollars in chips incentives provided by the Department of Commerce, and a billion dollar cash contribution by IBM.

Speaker #1: IBM offers a differentiated value proposition as a leader in open source through Red Hat, and also recent acquisitions of Confluent and Hashi. Clients can subscribe to Lightwell for $1 million per year, to access open-source packages that have been remediated or validated.

Speaker #3: Shortly after that, we disclosed plans to invest more than $10 billion in quantum over the next five years, spanning R&D, CAPEX, manufacturing scale-up, M&A, and ecosystem expansion.

Speaker #1: In the first two weeks of availability, we've already made more than 7,500 package versions available. Early adopters of Lightwell include organizations like Bank of America, BNY, Citi, Goldman Sachs, JPMorgan Chase, Mastercard, Morgan Stanley, Royal Bank of Canada, State Street, Visa, Wells Fargo, and more.

Speaker #3: This supports our roadmap to stalling in 2029, the world's first large-scale fault-tolerant quantum computer. Recently, IDC evaluated 11 quantum computing vendors and ranked IBM first overall, citing our ecosystem readiness for quantum advantage, our track record of delivering the roadmap on time, and our quantum-classical integration.

Speaker #1: Finally, quantum computing is no longer decades away. It is upon us, and we're investing aggressively. Recently, with the U.S. Department of Commerce, we announced a letter of intent to build Anduron—the world's first pure-play quantum foundry—supported by $1 billion in chip incentives provided by the Department of Commerce, and a $1 billion cash contribution by IBM.

Speaker #3: With the portfolio we have, and the opportunities ahead, it comes down to execution. That is where we fell short in the second quarter. We have engaged with clients on the transactions that slipped and have a clear understanding of what needs to change.

Speaker #3: We are adapting to deliver greater business value to clients around our innovation, and greater economic value to better align with client priorities. At the same time, we are accelerating productivity actions across the company spanning both spend reduction initiatives and actions designed to drive growth.

Speaker #1: Shortly after that, we disclosed plans to invest more than $10 billion in quantum over the next five years, spanning R&D, CapEx, manufacturing scale-up, M&A, and ecosystem expansion.

Speaker #3: These include leveraging AI to improve software development productivity, increasing the effectiveness of our sales and marketing organization, and accelerating our supply chain. Together, these actions help enhance our margin and free cash flow commitments, while improving our ability to capture the growth we see ahead.

Speaker #1: This supports our roadmap to scaling in 2029, the world's first large-scale, fault-tolerant quantum computer. Recently, IDC evaluated 11 quantum computing vendors and ranked IBM first overall, citing our ecosystem readiness for quantum advantage, our track record of delivering the roadmap on time, and our quantum-classical integration.

Speaker #3: For this growth, we are also accelerating changes to our go-to-market model. The goal is to expand coverage across thousands of additional clients where our portfolios highly relevant and where we see significant wallet share opportunities.

Speaker #1: With the portfolio we have, and the opportunities ahead, it comes down to execution. That is where we fell short in the second quarter. We have engaged with clients on the transactions that slipped, and have a clear understanding of what needs to change.

Speaker #3: While IBM has a strong presence within the Fortune 1000, there is a lot of opportunity beyond this. These changes are aligned with the areas of our business demonstrating strong momentum.

Speaker #1: We're adapting to deliver greater business value to clients around our innovation, and greater economic value to better align with client priorities. At the same time, we're accelerating productivity actions across the company, spanning both spend reduction initiatives and actions designed to drive growth.

Speaker #3: Including Red Hat, HashiCorp, Confluent, Watson X, and storage. As AI adoption moves from experimentation to enterprise-scale deployment, we are also investing in more specialized technical and client-facing talent including forward deployed engineers.

Speaker #1: These include leveraging AI to improve software development productivity, increasing the effectiveness of our sales and marketing organization, and accelerating our supply chain. Together, these actions help enhance our margin and free cash flow commitments while improving our ability to capture the growth we see ahead.

Speaker #3: Our conviction in the strength of our business and our ability to capture the growth opportunities ahead remains unchanged. We now expect revenue growth for the full year in a range of 4 to 5%.

Speaker #3: We continue to expect to grow free cash flow by about $1 billion this year, as we accelerate our productivity initiatives. With that, let me hand it over to Jim to go through the financials.

Speaker #1: For this growth, we're also accelerating changes to our go-to-market model. The goal is to expand coverage across thousands of additional clients, where our portfolio is highly relevant and where we see significant wallet share opportunities.

Speaker #1: Thanks, Arvind. In the second quarter, we delivered 1% revenue growth, 30 basis points of operating pre-tax margin expansion, and 5% diluted operating earnings per share growth.

Speaker #1: While IBM has a strong presence within the Fortune 1000, there is a lot of opportunity beyond this. These changes are aligned with the areas of our business demonstrating strong momentum.

Speaker #1: And through the first half, we generated 4.8 billion dollars of free cash flow. Let me go through what played out in our segments in more detail.

Speaker #1: Including Red Hat, HashiCorp, Confluent, WatsonX, and storage. As AI adoption moves from experimentation to enterprise-scale deployment, we're also investing in more specialized technical and client-facing talent—including forward-deployed engineers.

Speaker #1: Software revenue grew 5% this quarter, with flat organic revenue growth. As Arvind discussed in our pre-announcement, in the final weeks of June, we saw a shift in client spending priorities.

Speaker #1: Our conviction in the strength of our business and our ability to capture the growth opportunities ahead remains unchanged. We now expect revenue growth for the full year in a range of 4 to 5%.

Speaker #1: Many clients redirected spending towards servers, storage, and memory purchases to secure supply constraint infrastructure ahead of expected price increases. As a result, tens of large deals failed to close on the timelines we expected, accounting for the majority of the shortfall.

Speaker #1: We continue to expect to grow free cash flow by about $1 billion this year, as we accelerate our productivity initiatives. With that, let me hand it over to Jim to go through the financials.

Speaker #1: To understand these dynamics, it is important to recognize that many clients purchase mainframe and the associated software stack through our enterprise license agreements. Which create a strong incumbency moat for IBM, and are generally treated as capital investments.

Speaker #2: Thanks, Arvind. In the second quarter, we delivered 1% revenue growth, 30 basis points of operating pre-tax margin expansion, and 5% diluted operating earnings per share growth.

Speaker #2: And through the first half, we have free cash flow. Let me go through what played out in our segments in more detail. Software revenue grew 5% this quarter, with flat organic revenue growth.

Speaker #1: These agreements typically contain a high concentration of transaction processing software, although they may also include data and automation products. As clients prioritize other CAPEX investments, the timing of these deals shifted, resulting in transaction processing revenue declining 9%.

Speaker #2: As Arvind discussed in our pre-announcement, in the final weeks of June, we saw a shift in client spending priorities. Many clients redirected spending toward servers, storage, and memory purchases to secure supply-constrained infrastructure ahead of expected price increases.

Speaker #1: While data grew 18% and automation grew 3%. In contrast, we continue to see strong underlying demand in our subscription and consumption-based software. Because these are generally purchased as operating expenditures, they were largely unaffected by the CAPEX dynamics that impacted some of our ELA transactions during the quarter.

Speaker #2: As a result, tens of large deals failed to close on the timelines we expected, accounting for the majority of the shortfall. To understand these dynamics, it is important to recognize that many clients purchase mainframe and the associated software stack through our enterprise license agreements.

Speaker #1: Let me take a step back and discuss the composition of our software revenue. We offer customers flexible purchasing options, that align technology investments with their business needs.

Speaker #2: These create a strong incumbency moat for IBM and are generally treated as capital investments. These agreements typically contain a high concentration of transaction processing software, although they may also include data and automation products.

Speaker #1: Making it easier to adopt and scale solutions across their business. About 80% of our annual software revenue is recurring, and is made up of subscription and consumption-based revenue, like our Red Hat, HashiCorp, and Confluent products.

Speaker #2: As clients prioritize other CAPEX investments, the timing of these deals shifted, resulting in transaction processing revenue declining 9%, while Data grew 18% and Automation grew 3%.

Speaker #1: It also includes subscription and support revenue that provides customers with ongoing access to software enhancements, and support. This revenue grew nicely in the quarter, and our ARR was 24.6 billion dollars, up 8% since last year.

Speaker #2: In contrast, we continue to see strong underlying demand in our subscription and consumption-based software. Because these are generally purchased as operating expenditures, they were largely unaffected by the CapEx dynamics that impacted some of our ELA transactions during the quarter.

Speaker #1: The other 20% of software revenue is transactional in nature. And is predominantly related to the incumbency with mainframe, and the associated enterprise license agreements, with transaction processing and other software products in data and automation.

Speaker #2: Let me take a step back and discuss the composition of our software revenue. We offer customers flexible purchasing options that align technology investments with their business needs.

Speaker #1: ELAs are highly valuable to IBM, because they establish long-term, strategic client commitments that expect adoption across our software products creating a multiplier effect. Transactional revenue was down high single digits in the quarter, given the shift in buying patterns we have discussed.

Speaker #2: Making it easier to adopt and scale solutions across their businesses. About 80% of our annual software revenue is recurring and is made up of subscription and consumption-based revenue, like our Red Hat, HashiCorp, and Confluent products.

Speaker #1: On the subscription side of the business, HashiCorp had another record bookings quarter and accelerated revenue growth through the first half of the year. And Confluent is off to a strong start, and on track with our expectations after its first full quarter post-close.

Speaker #2: It also includes subscription and support revenue that provides customers with ongoing access to software enhancements and support. This revenue grew nicely in the quarter, and our ARR was $24.6 billion, up 8% since last year.

Speaker #1: Red Hat growth accelerated 1. sequentially to 11%. Driven by improvement in the subscription piece of the business, and stable growth in consumption-based services. OpenShift ARR is now 2.2 billion dollars, with strong growth, reflecting demand of our containerization and virtualization products.

Speaker #2: The other 20% of software revenue is transactional in nature, and is predominantly related to the incumbency with mainframe and the associated enterprise license agreements, with transaction processing and other software products in data and automation.

Speaker #2: ELAs are highly valuable to IBM because they establish long-term, strategic client commitments that expand adoption across our software products, creating a multiplier effect. Transactional revenue was down high single digits in the quarter, given the shift in buying patterns we have discussed.

Speaker #1: Where we now have about 680 million dollars of contracts signed since early 2024. NREL performance continue to be impacted by constrained hardware availability, similar to last quarter.

Speaker #1: Infrastructure revenue declined 7% this quarter, while Z performance was below our expectations through the first five quarters of Z17 availability revenue as well ahead of the prior cycles at nearly 130% program-to-program.

Speaker #2: On the subscription side of the business, HashiCorp had another record bookings quarter and accelerated revenue growth through the first half of the year. And Confluent is off to a strong start and on track with our expectations after its first full quarter post-close.

Speaker #1: As Arvind said, we see no evidence of clients moving off mainframe. Clients continue to invest in IBM Z to modernize mission-critical workloads. With a focus on resiliency, security, and increasingly enabling AI on the platform.

Speaker #2: Red Hat growth accelerated 1 point sequentially to 11%, driven by improvement in the subscription piece of the business and stable growth in consumption-based services.

Speaker #2: OpenShift ARR is now $2.2 billion, with strong growth reflecting demand for our containerization and virtualization products. We now have about $680 million of contracts signed since early 2024.

Speaker #1: AI is driving incremental capacity growth, and new workloads as clients look to run AI closer to their most sensitive data. We are seeing strong early adoption of our AI innovations.

Speaker #1: With nearly 50% of Z17 customers investing in AI capabilities with spire accelerator. And clients deploying Watson X Code Assistant for Z are growing MIPS capacity three times faster than those who are not.

Speaker #2: In Rel, performance continued to be impacted by constrained hardware availability, similar to last quarter. Infrastructure revenue declined 7% this quarter, while Z Performance was below our expectations, though the first five quarters of Z17 availability revenue was well ahead of prior cycles at nearly 130% program-to-program.

Speaker #1: In a world where infrastructure costs are rising, and efficiency matters more than ever, IBM Z offers a compelling economic advantage. Depending on the size and complexity of workloads, clients can realize a 2 to 15x total cost of ownership benefit versus moving these workloads off the platform.

Speaker #2: As Arvind said, we see no evidence of clients moving off mainframe. Clients continue to invest in IBM Z to modernize mission-critical workloads, with a focus on resiliency, security, and increasingly enabling AI on the platform.

Speaker #1: Reinforcing why the platform remains central to their operations and positioning us to capture additional value as AI workloads grow. And adding to Arvind's comments on the strength in distributed infrastructure, we exited the quarter with approximately 500 million dollars of backlog.

Speaker #2: AI is driving incremental capacity growth and new workloads, as clients look to run AI closer to their most sensitive data. We are seeing strong early adoption of our AI innovations.

Speaker #2: With nearly 50% of z17 customers investing in AI capabilities, which spire accelerator, and clients deploying watsonx Code Assistant for Z are growing MIPS capacity three times faster than those who are not.

Speaker #1: Our highest on record supporting continue momentum. In consulting, signings grew 6%, marking our second consecutive quarter of growth and reflecting continue client investment in business transformation initiatives.

Speaker #2: In a world where infrastructure costs are rising and efficiency matters more than ever, IBM Z offers a compelling economic advantage. Depending on the size and complexity of workloads, clients can realize a 2x to 15x total cost of ownership benefit versus moving these workloads off the platform.

Speaker #1: Revenue grew 1%, driven by demand for application modernization, data transformation, and cybersecurity services, as clients balanced the needs to increase productivity through AI, with the need to strengthen resiliency and manage risk.

Speaker #1: Revenue growth was balanced, with both strategy and technology and intelligent operations 1%. Generative AI represented about 50% of our signings in the quarter. And now makes up over 30% of our backlog, underscoring the demand for AI-powered transformations that extend beyond technology modernization into core business operations.

Speaker #2: Reinforcing why the platform remains central to their operations and positioning us to capture additional value as AI workloads grow. And adding to Arvind's comments on the strength in distributed infrastructure, we exited the quarter with approximately $500 million of backlog, our highest on record, supporting continued momentum.

Speaker #1: As clients move from pilots to enterprise-wide deployment, they are increasingly turning the consulting to re-engineer business processes and unlock productivity and new business value through AI, automation, and digital labor.

Speaker #2: In Consulting, signings grew 6%, marking our second consecutive quarter of growth and reflecting continued client investment in business transformation initiatives. Revenue grew 1%, driven by demand for application modernization, data transformation, and cybersecurity services, as clients balanced the need to increase productivity through AI with the need to strengthen resiliency and manage risk.

Speaker #1: Let me now discuss profitability. Operating gross profit margins were down 70 basis points. Largely driven by our revenue shortfall and MIPS. Despite this shortfall, productivity actions were ahead of plan.

Speaker #2: Revenue growth was balanced, with both Strategy and Technology and Intelligent Operations up 1%. Generative AI represented about 50% of our signings in the quarter, and now makes up over 30% of our backlog, underscoring the demand transformations that extend beyond technology modernization into core business operations.

Speaker #1: Providing the flexibility to absorb Confluent-related dilution, continued investing for growth, and expanded adjusted EBITDA and operating pre-tax margins by 20 and 30 basis points respectively.

Speaker #1: Segment profit margin expanded by 160 basis points in consulting, and 110 basis points in software, driven by ongoing productivity actions. Infrastructure segment profit margin declined, 150 basis points, reflecting the IBM Z MIPS headwind mitigated somewhat by strong distributed infrastructure margins.

Speaker #2: As clients move from pilots to enterprise-wide deployment, they are increasingly turning to consulting to re-engineer business processes and unlock productivity and new business value through AI, automation, and digital labor.

Speaker #1: Through the first half of the year, we generated 4.8 billion dollars of free cash flow. Flat year-over-year. Driven by about 700 million increase in adjusted EBITDA, offset by inventory, higher cash taxes, and net interest expense.

Speaker #2: Let me now discuss profitability. Operating gross profit margins were down 70 basis points, largely driven by our revenue shortfall and MIPS. Despite this shortfall, productivity actions were ahead of plan.

Speaker #2: Providing the flexibility to absorb Confluent-related dilution, continued investing for growth, and expanded adjusted EBITDA and operating pre-tax margins by 20 and 30 basis points, respectively.

Speaker #1: Given the constrained infrastructure supply environment, we proactively took actions through the first half to strengthen our supply chain and support anticipated customer demand in the second half.

Speaker #1: Reflecting the strength we see in our infrastructure business. We exited the second quarter with a strong liquidity position and a solid investment-grade balance sheet.

Speaker #2: Segment profit margin expanded by 160 basis points in Consulting and 110 basis points in Software, driven by ongoing productivity actions. Infrastructure segment profit margin declined 150 basis points, reflecting the IBM Z MIPS headwind, mitigated somewhat by strong Distributed Infrastructure margins.

Speaker #1: With cash of 8.2 billion dollars. We returned 3.2 billion dollars to shareholders, in the form of dividends through the first half of the year.

Speaker #1: Our debt balance ending the quarter was 62 billion dollars. Including debt of 13 billion for our financing business, with the receivables portfolio that is 80% investment-grade.

Speaker #2: Through the first half of the year, we generated $4.8 billion of free cash flow, flat year-over-year, driven by about a $700 million increase in adjusted EBITDA, offset by inventory, higher cash taxes, and net interest expense.

Speaker #1: Over the last five years, we have repositioned our business to higher growth and margins, improved the durability of our revenue, and expanded operating pre-tax margins and free cash flow through disciplined execution and laser-focus on productivity.

Speaker #2: Given the constrained infrastructure supply environment, we proactively took actions through the first half to strengthen our supply chain and support anticipated customer demand in the second half.

Speaker #1: As Arvind mentioned, we are confident in our portfolio and strategy, and the growth opportunities we see ahead. Let me now address our expectations for the remainder of the year.

Speaker #2: Reflecting the strength we see in our Infrastructure business, we exited the second quarter with a strong liquidity position and a solid investment-grade balance sheet.

Speaker #1: We now expect revenue growth for 2026 in the range of 4 to 5 percent, and our maintaining our expectation to grow free cash flow by about 1 billion dollars.

Speaker #2: With cash of $8.2 billion, we returned $3.2 billion to shareholders in the form of dividends through the first half of the year.

Speaker #1: We believe the low end of the revenue range appropriately reflects the current environment and is our base case. Given the second quarter shortfall, we are revising our software growth expectation to a range of 6 to 8 percent for the full year.

Speaker #2: Our debt balance at the end of the quarter was $62 billion, including $13 billion of debt for our financing business, with the receivables portfolio that is 80% investment-grade.

Speaker #1: While several of the deal sets from the second quarter have already closed in the first few weeks of the third quarter, the low end of the software range assumes that recent spending dynamics persist through the second half.

Speaker #2: Over the last five years, we have repositioned our business to higher-growth end markets, improved the durability of our revenue, and expanded operating pre-tax margins and free cash flow through disciplined execution and a laser focus on productivity.

Speaker #1: The high end assumes a more typical conversion of our pipeline. In light of the strong demand environment and power in storage, we now expect infrastructure to grow low single digits in 2026, driven by growth in distributed infrastructure and continued strong program-to-program performance in IBM Z through the second half of the year.

Speaker #2: As Arvind mentioned, we are confident in our portfolio and strategy, and the growth opportunities we see ahead. Let me now address our expectations for the remainder of the year.

Speaker #2: We now expect revenue growth for 2026 in the range of 4 to 5%, and are maintaining our expectation to grow free cash flow by about $1 billion.

Speaker #1: Demand across storage and power remains strong. And we continue to secure inventory and accelerate our supply chain to capitalize on the opportunities we see in front of us.

Speaker #2: We believe the low end of the revenue range appropriately reflects the current environment and is our base case. Given the second quarter shortfall, we are revising our software growth expectation to a range of 6 to 8% for the full year.

Speaker #1: In consulting, the quality of our backlog and momentum in Gen AI continue to support and acceleration in revenue growth to low to mid single digits for the year.

Speaker #2: While several of the deals that slipped from the second quarter have already closed in the first few weeks of the third quarter, the low end of the software range assumes that recent spending dynamics persist through the second half.

Speaker #1: We continue to see strong fundamentals of our business play out in the second half of the year, as we accelerate our productivity initiatives to help enhance our margin and free cash flow commitments while continuing to invest in growth.

Speaker #2: The high end assumes a more typical conversion of our pipeline. In light of the strong demand environment and power in storage, we now expect infrastructure to grow low single digits in 2026, driven by growth in distributed infrastructure and continued strong program-to-program performance in IBM Z through the second half of the year.

Speaker #1: These actions include deploying AI and automation at greater scale across the company, reducing third-party spend, improving sales and marketing efficiency, using AI to drive more efficient software development, optimizing our supply chain, and enhancing services delivery.

Speaker #2: Demand across storage and power remains strong, and we continue to secure inventory and accelerate our supply chain to capitalize on the opportunities we see in front of us.

Speaker #1: While revenue dynamics are creating margin pressure for the year, the pace of our productivity actions have exceeded our expectations. As a result, we now expect to deliver 100 basis points of operating pre-tax margin expansion.

Speaker #2: In Consulting, the quality of our backlog and momentum in Gen AI continue to support an acceleration in revenue growth to low to mid single digits for the year.

Speaker #1: With productivity more than offsetting the revenue-related headwinds. Our operating tax rate for the year should be in the mid-teens. And the timing of discrete items can cause the rate to vary within the year.

Speaker #2: We continue to see the strong fundamentals of our business play out in the second half of the year, as we accelerate our productivity initiatives to help enhance our margin and free cash flow commitments, while continuing to invest in growth.

Speaker #1: For the full year, we continue to expect to grow free cash flow by about 1 billion dollars. The primary driver of this growth will be adjusted EBITDA, offset by cash tax headwinds, higher capex, and higher net interest expense, the majority of which is behind us.

Speaker #2: These actions include deploying AI and automation at greater scale across the company, reducing third-party spend, improving sales and marketing efficiency, using AI to drive more efficient software development, optimizing our supply chain, and enhancing services delivery.

Speaker #1: Looking to the third quarter, we expect constant currency revenue growth consistent with the full year. Given the strengthening of the dollar, we now expect currency to be a 1.5-point headwind to revenue growth in the quarter.

Speaker #2: While revenue dynamics are creating margin pressure for the year, the pace of our productivity actions has exceeded our expectations. As a result, we now expect to deliver 100 basis points of operating pre-tax margin expansion, with productivity more than offsetting the revenue-related headwinds.

Speaker #1: And for operating pre-tax margin, we expect similar performance to the second quarter. Our third quarter operating tax rate should be in the mid-teens. Let me close by saying that our strategy has not changed.

Speaker #1: We are a leader in hybrid cloud, we opportunity, that plays directly to IBM's strengths in data, orchestration, and enterprise trust, and we continue to build leadership in quantum.

Speaker #2: Our operating tax rate for the year should be in the mid-teens, and the timing of discrete items can cause the rate to vary within the year.

Speaker #2: For the full year, we continue to expect to grow free cash flow by about $1 billion. The primary driver of this growth will be adjusted EBITDA, offset by cash tax headwinds, higher capex, and higher net interest expense—the majority of which is behind us.

Speaker #1: We remain confident in the growth opportunities ahead of us, and our ability to capture them. Arvind and I are now happy to take your questions.

Speaker #1: Olympia, let's get started.

Speaker #2: Thank you, Jim. Before we begin Q&A, I'd like to mention a couple of items. First, supplemental information is provided at the end of the presentation.

Speaker #2: Looking to the third quarter, we expect constant currency revenue growth consistent with the full year. Given the strengthening of the dollar, we now expect currency to be a 1.5-point headwind to revenue growth in the quarter.

Speaker #2: And second, as always, I'd ask you to refrain from asking multi-part questions. Operator, let's please open it up.

Speaker #3: Thank you. At this time, we will begin question-and-answer session of the conference. If you would like to ask a question, please press star 1 on your telephone keypad.

Speaker #2: And for operating pre-tax margin, we expect similar performance to the second quarter. Our third quarter operating tax rate should be in the mid-teens. Let me close by saying that our strategy has not changed.

Speaker #3: A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue.

Speaker #2: We are a leader in hybrid cloud. We are investing behind an AI opportunity that plays directly to IBM's strengths in data, orchestration, and enterprise trust, and we continue to build leadership in quantum.

Speaker #3: For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. And our first question comes from Amit Daryanani with Evercore ISI.

Speaker #3: Please state your question.

Speaker #2: We remain confident in the growth opportunities ahead of us and our ability to capture them. Arvind and I are now happy to take your questions.

Speaker #4: Yep. Thanks for opening my question. Good afternoon, everyone. I guess Arvind, your commentary strongly suggests that the headwinds we saw in June quarter were a result of customers just reallocating spend towards AI infrastructure rather than reducing overall IT budgets.

Speaker #2: Olympia, let's get started.

Speaker #1: Thank you, Jim. Before we begin Q&A, I'd like to mention a couple of items. First, supplemental information is provided at the end of the presentation.

Speaker #4: And, you know, I think the biggest debate everyone's had since the pre-announcement has been, you know, is this demand deferred or destroyed for IBM?

Speaker #1: And second, as always, I'd ask you to refrain from asking multi-part questions. Operator, let's please open it up.

Speaker #4: So I'd love to understand, you know, what gives you the confidence that this is more a timing issue versus structural shift in enterprise spending?

Speaker #3: Thank you. At this time, we will 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 #4: And, you know, what milestones should we all be watching for over the next couple of quarters to gauge if demand truly starts to normalize for you folks?

Speaker #4: That would be really helpful. And, Jim, I have to acknowledge the very impressive free cash flow guide from you folks, despite the June quarter blip.

Speaker #3: A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue.

Speaker #4: Maybe just unpack a little bit on the building blocks behind your ability to maintain the free cash flow target as well. Thank you very much.

Speaker #3: For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. And our first question comes from Amit Daryanani with Evercore ISI.

Speaker #5: Arvind, thanks for the question. Well, given that you used the word impressive, I'm going to ask Jim to address the impressive part first, and then I will address your question on the priorities.

Speaker #3: Please state your question.

Speaker #1: Thanks, Arvind. And thanks, Arvind, for the question. I think it's a great place to start this call here tonight. Free cash flow, as you all know, has been one of the two key leading indicators of our financial investment thesis and our shareholder value creation model inside IBM.

Speaker #4: Yep, thanks for taking my question. Good afternoon, everyone. I guess, Arvind, your commentary strongly suggests that the headwinds we saw in the June quarter were a result of customers just reallocating spend towards AI infrastructure, rather than reducing overall IT budgets.

Speaker #4: And, you know, I think the biggest debate everyone's had since the pre-announcement has been, you know, is this demand deferred or destroyed for IBM?

Speaker #1: And I appreciate the word impressive. Because the team has worked extremely hard over the last four years. Put this in perspective. Over the last four years, we have grown our free cash flow over 6.5 billion dollars in this company and grown free cash flow margin 700 basis points.

Speaker #4: So, I'd love to understand, you know, what gives you the confidence that this is more a timing issue versus a structural shift in enterprise spending?

Speaker #4: And, you know, what milestones should we all be watching for over the next couple of quarters to gauge if demand truly starts to normalize for you folks?

Speaker #4: That would be really helpful. And Jim, I have to acknowledge the very impressive free cash flow guide from you folks, despite the June quarter blip.

Speaker #1: That gives us a lot of confidence here within the company. But when you look at first half, we produced roughly about 5 billion dollars of free cash flow.

Speaker #4: Maybe just unpack a little bit on the building blocks behind your ability to maintain the free cash flow target as well. Thank you very much.

Speaker #1: That was flat year to year. The underpinnings really are driven by the fundamentals. The productivity mindset in this company and the ability to generate operating leverage is extremely strong overall.

Speaker #2: Amit, thanks for the question. Well, given that you used the word "impressive," I'm going to ask Jim to address the impressive part first, and then I will address your question on the priorities.

Speaker #1: Adjusted EBITDA was up, high single digit, and as I said in the prepared remarks, it was offset by higher inventory, cash taxes, and net interest.

Speaker #5: Thanks, Arvind. And thanks, Amit, for the question. I think it's a great place to start this call here tonight. Free cash flow, as you all know, has been one of the two key leading indicators of our financial investment thesis and our shareholder value creation model inside IBM.

Speaker #1: Which, by the way, the latter two I've been talking about all year long. Let's take a step back. We entered this year with extreme momentum.

Speaker #1: And confidence in what we guided. We guided free cash flow up about a billion dollars year to year, with record free cash flow margins.

Speaker #5: And I appreciate the word "impressive" because the team has worked extremely hard over the last four years. To put this in perspective, over the last four years, we have grown our free cash flow by over $6.5 billion in this company and grown free cash flow margin 700 basis points.

Speaker #1: And we said that was going to be entirely driven by the quality and sustainability of the fundamentals of our business, adjusted EBITDA. What some headwinds on cash tax, capex, to invest in our business, and net interest.

Speaker #1: Through the first half, there are some unique dynamics that drive that free cash flow flat. Which, by the way, attainment-wise, we're in a very similar position that we were during the last similar point in time of Z16 mainframe cycle.

Speaker #5: That gives us a lot of confidence here within the company. But when you look at the first half, we produced roughly about $5 billion of free cash flow.

Speaker #5: That was flat year over year. The underpinnings really are driven by the fundamentals. The productivity mindset in this company and the ability to generate operating leverage is extremely strong overall.

Speaker #1: Right about 30% attained overall, albeit our free cash flow margins are up 300 basis points from that period of time. But the first thing is, I said in the prepared remarks, given the infrastructure supply dislocation that's happening in the market, we took very conscious and proactive actions to strengthen our supply chain and address the explosive.

Speaker #5: Adjusted EBITDA was up high single digits, and as I said in the prepared remarks, it was offset by higher inventory, cash taxes, and net interest.

Speaker #5: Which, by the way, the latter two I've been talking about all year long. But let's take a step back. We entered this year with extreme momentum.

Speaker #5: And confidence in what we guided. We guided free cash flow up about $1 billion year to year, with record free cash flow margins.

Speaker #1: Growth we see happening in our business around our distributed infrastructure power and storage, which we exited the quarter with 500 million dollars of backlog.

Speaker #5: And we said that was going to be entirely driven by the quality and sustainability of the fundamentals of our business, adjusted EBITDA, with some headwinds on cash tax, capex to invest in our business, and net interest.

Speaker #1: This was done at economically prudent prices, with buy-aheads. Our inventory exiting the first half is up 600 million dollars year to year. Given the confidence we have and our guidance in the second half, we will flush through a major portion of that inventory headwind.

Speaker #5: Through the first half, there are some unique dynamics that drive that free cash flow flat. Which, by the way, attainment-wise, we're in a very similar position to where we were during the last similar point in time of the z16 mainframe cycle.

Speaker #1: So that will become a tailwind in the second half. Second, the headwinds I've been talking about all year long, capex and cash taxes, they were front-end loaded.

Speaker #1: So they're predominantly behind us. So where does this leave us? It leaves us with a position to have the conviction and confidence to maintain growing free cash flow at least 1 billion dollars, expanding record free cash flow margins, with free cash flow realization, important point, free cash flow realization consistent to where we were in January and throughout the year.

Speaker #5: Right, about 30% attained overall, albeit our free cash flow margins are up 300 basis points from that period of time. But the first thing is, as I said in the prepared remarks, given the infrastructure supply dislocation that's happening in the market, we took very conscious and proactive actions to strengthen our supply chain and address the explosive demand growth we see happening in our business around our distributed infrastructure power and storage, which we exited the quarter with $500 million of backlog.

Speaker #1: That is going to be driven by the fundamentals of the adjusted EBITDA, that productivity, that operating leverage in the company. So we believe with the focus portfolio that we have, with a very disciplined capital allocation, the diversity of our business model as you see in our guide, with a relentless focus on productivity, we drive the durability of that free cash flow engine that, by the way, enables that flywheel to invest for growth.

Speaker #5: This was done at economically prudent prices, with buy-aheads. Our inventory exiting the first half is up $600 million year to year. Given the confidence we have and our guidance in the second half, we will flush through a major portion of that inventory headwind.

Speaker #5: Thanks, Jim. So Arvind, let me address the first part of your question. I have to start by first describing the nature of what it was that didn't happen.

Speaker #5: So that will become a tailwind in the second half. Second, the headwinds I've been talking about all year long—capex and cash taxes—they were front-end loaded.

Speaker #5: The majority of what didn't happen in the second quarter was large capex deals at large clients. So I had said previously that the volume or the number of those deals was in the low tens.

Speaker #5: So they're predominantly behind us. So where does that leave us? It leaves us with a position to have the conviction and confidence to maintain growing free cash flow of at least $1 billion, expanding record free cash flow margins, with free cash flow realization—important point—free cash flow realization consistent with where we were in January and throughout the year.

Speaker #5: We have been very pleased to see that about. Heard of those, have already closed. To give you a perspective, normally we would not expect all of them to close, but we would expect maybe two-thirds to three-fourths of them to close over the next six months.

Speaker #5: That is going to be driven by the fundamentals of the adjusted EBITDA, that productivity, that operating leverage in the company. So we believe, with the focused portfolio that we have, with a very disciplined capital allocation, the diversity of our business model as you see in our guide, and with a relentless focus on productivity, we drive the durability of that free cash flow engine that, by the way, enables that flywheel to invest for growth.

Speaker #5: So the fact that a third have already closed in the first three weeks, gives us a indication, not yet full evidence, but a good indication that this was deferral and not destruction.

Speaker #5: The second part that is really important, there was a lot of points as both Jim and I pointed out in the prepared remarks, where there was a lot of double-digit growth strength also.

Speaker #2: Thanks, Jim. So, Amit, let me address the first part of your question. I have to start by first describing the nature of what it was that didn't happen.

Speaker #5: A lot of that is in the consumption part of the portfolio. And we are going to be doubling down on the demand there, because the pipelines are strong and the signals from our clients are strong about where that is happening.

Speaker #2: The majority of what didn't happen in the second quarter was large capex deals at large clients. So, I had said previously that the volume or the number of those deals was in the low teens.

Speaker #5: So when I couple that together, those I'll call them factoids, together with what we are seeing in our pipelines, together with what we are seeing in terms of signals from clients in terms of what they're purchasing and putting in, then I come to the conclusion that a lot of the demand is deferred, not destroyed.

Speaker #2: We have been very pleased to see that about a third of those have already closed. To give you a perspective, normally, we would not expect all of them to close, but we would expect maybe two-thirds to three-fourths of them to close over the next six months.

Speaker #5: Albeit it's sometimes hard to predict exact timing in a month-to-month basis. But the fact that a third of the deals closed is a strong signal.

Speaker #2: So the fact that a third have already closed in the first three weeks gives us an indication—not yet full evidence, but a good indication—that this was deferral and not destruction.

Speaker #5: In terms of what are the milestones that we expect or the KPIs, I'm going to ask Jim to comment on that.

Speaker #2: The second part that is really important—there were a lot of points, as both Jim and I pointed out in the prepared remarks, where there was also a lot of double-digit growth strength.

Speaker #2: Yeah. I think it's plain and simple. Arvind's been running this company for the last six years around two key components of KPIs. We just talked about one, free cash flow.

Speaker #2: A lot of that is in the consumption part of the portfolio, and we are going to be doubling down on the demand there, because the pipelines are strong and the signals from our clients are strong about where that is happening.

Speaker #2: Because that's the engine that provides the financial flexibility for growth. The first is revenue growth. We've taken this company from a no-growth company to a low single-digit company to a mid-single-digit company.

Speaker #2: And our future aspirations have always been to continue to increase. So the first thing is, we just posted one. Revenue growth in Q2. The first indicator, we have to show acceleration as we get into the second half of the year.

Speaker #2: So when I couple that together—those, I'll call them factoids—together with what we are seeing in our pipelines, together with what we are seeing in terms of signals from clients in terms of what they're purchasing and putting in, then I come to the conclusion that a lot of the demand is deferred, not destroyed.

Speaker #2: Our guidance range four to five percent should be noted right up front. That low end of the range, we put in as an anchor.

Speaker #2: Albeit, it's sometimes hard to predict exact timing on a month-to-month basis. But the fact that a third of the deals closed is a strong signal.

Speaker #2: An anchor so that we can show the investment community the level of productivity and operating leverage we have in this company that allows us to maintain earnings and maintain free cash flow at that low level.

Speaker #2: In terms of what the milestones are that we expect, or the KPIs, I'm going to ask Jim to comment on that.

Speaker #3: Yeah, I think it's plain and simple. Arvind's been running this company for the last six years around two key components of KPIs. We just talked about one—free cash flow.

Speaker #2: That low level says we take a business that just produced 1% up to mid-single digits, give or take, in the second half. That's not our aspiration.

Speaker #2: But that is an anchor as a range on how we put this in place. The high end, that five percent, that says we accelerate growth into the second half.

Speaker #3: Because that's the engine that provides the financial flexibility for growth. The first is revenue growth. We've taken this company from a no-growth company, to a low single-digit company, to a mid-single-digit company.

Speaker #2: Overall. Now, two key components, KPIs underneath that, I would say getting right back at the core of second quarter. Number one, the strength and confidence we have in our mainframe platform cycle.

Speaker #3: And our future aspirations have always been to continue to increase. So the first thing is, we just posted 1% revenue growth in Q2. The first indicator is, we have to show acceleration as we get into the second half of the year.

Speaker #2: If we can maintain this at a high 120% plus program-to-program, that is a tremendous indicator that will lead us to the high end of that guide range.

Speaker #3: Our guidance range of 4% to 5% should be noted right up front. That low end of the range, we put in as an anchor—an anchor so that we can show the investment community the level of productivity and operating leverage we have in this company that allows us to maintain earnings and maintain free cash flow at that low level.

Speaker #2: The second is our software. And that software, when you look at it, at the high end of the range, at 8%, that is the second half that's approaching double digits.

Speaker #2: Based on what Arvind said, the strength of our 80% high-value recurring revenue accelerating, and a return to some normal level of closure rates of a strong pipeline in the second half.

Speaker #3: That low level says we take a business that just produced 1% up to mid-single digits, give or take, in the second half. That's not our aspiration.

Speaker #2: So those are two KPIs.

Speaker #3: But that is an anchor as a range on how we put this thing in place. The high end, that 5%, that says we accelerate growth into the second half.

Speaker #1: Great. Arvind, let's take the next question.

Speaker #3: Your next question comes from Wamsi Mohan with Bank of America. Please state your question. Wamsi Mohan, your line is open. Please go ahead and unmute yourself.

Speaker #3: Overall, now, two key components—KPIs underneath that—I would venture to say, getting right back at the core of the second quarter. Number one, the strength and confidence we have in our mainframe platform cycle.

Speaker #3: We'll move on to the next question. The next question comes from Brent Thill with Jefferies. Please state your question.

Speaker #3: If we can maintain this at a high 120% plus, program-to-program, that is a tremendous indicator that will lead us to the high end of that guided range.

Speaker #4: Oh, thanks. Jim, I just want to go through the guidance for the rest of the year. So your prior guide was five plus percent.

Speaker #4: You're guiding now four to five if you take a one-point guide, the cut to the guide, I think it's like 650 million you missed Q1 by approximately 675.

Speaker #3: The second is our software. And that software, when you look at it, at the high end of the range, at 8%, that is the second half that's approaching double digits.

Speaker #4: So that just assumes that some of the slip deals aren't coming back yet. Arvind said that some of those deals have closed. Can you just kind of square up the guide to what this means?

Speaker #3: Based on what Arvind said, the strength of our 80% high-value recurring revenue is accelerating, and we're seeing a return to some normal level of closure rates with a strong pipeline in the second half.

Speaker #5: Absolutely, Brent. Thanks for the question. Let me just frame the components about the guide overall. One, we said revenue guide now four to five.

Speaker #3: So those are two KPIs.

Speaker #1: Great. Aapar, let's take the next question.

Speaker #4: Your next question comes from Wamzi Mohan with Bank of America. Please state your question. Wamzi Mohan, your line is open. Please go ahead and unmute yourself.

Speaker #5: On low end, it's about a point plus takedown. On the high end, give or take, it's pretty damn close to where we were at.

Speaker #5: I talked about maintaining free cash flow in either case because we have built this around prudently the low end of the range to show the operating leverage and productivity and, by the way, the investment capacity we have in the company to drive that level of profit, that level of cash, which, by the way, both will be in high single-digit level overall with record margins.

Speaker #4: We'll move on to the next question. The next question comes from Brent Thill with Jefferies. Please state your question.

Speaker #5: Oh, thanks. Jim, I just want to go through the guidance for the rest of the year. So your prior guide was 5-plus percent.

Speaker #5: You're guiding now four to five. If you take a one-point guide to the cut to the guide, I think you missed Q1 by approximately 675.

Speaker #5: And that basically says we're taking up our operating PTEX margins by 100 basis points. Well, let's unpack the four to five percent. Number one, underneath it, we see tremendous momentum playing out in infrastructure overall.

Speaker #5: That just assumes that some of the split deals aren't coming back yet. Arvind said that some of those deals have closed. Can you just kind of square up the guide to what this means?

Speaker #5: That infrastructure guide, 90 days ago, we said was going to be down low to mid-single digit. Coming out of first half, given the mainframe, albeit fell short, the mainframe is still at 129 to 30 percent of the prior program.

Speaker #2: Absolutely, Brent. Thanks for the question. Let me just frame the components of the guide overall. One, we set revenue guidance now at $4 to $5 billion.

Speaker #2: On the low end, it’s about a point plus takedown. On the high end, give or take, it’s pretty damn close to where we were at.

Speaker #5: It assumes the confidence that we see in all the demand indicators and we can get into that later, that we maintain that level. And that we continue to see the tremendous growth opportunity that we have prudently protected the supply chain to optimize on distributed infrastructure.

Speaker #2: I talked about maintaining free cash flow. In either case, because we have built this around, prudently, the low end of the range to show the operating leverage and productivity, and, by the way, the investment capacity we have in the company to drive that level of profit, that level of cash—which, by the way, both will be in the high single-digit level overall—with record margins.

Speaker #5: So guide to guide, we're up about two points there. In software, six to eight percent for the year. The lower end was an anchor.

Speaker #5: That says nothing changes. And I'll get in that in a minute. The high end says that we basically are approaching double digits in the second half.

Speaker #2: And that basically says we're taking up our operating PTEX margins by 100 basis points. Well, let's unpack the 4% to 5%. Number one, underneath it, we see tremendous momentum playing out in infrastructure overall.

Speaker #5: So let me break down those two. Because we can get into consulting later but there's basically no change there. When you take a look at the scenarios that we ran on software, one, as I talked about and prepared remarks, and we think this is a competitive differentiation, we have a software portfolio that plays at the heart of infrastructure software that we allow our clients flexibility in how they want to buy.

Speaker #2: That infrastructure guide, 90 days ago we said was going to be down low- to mid-single digit. Coming out of first half, given the mainframe—albeit fell short—the mainframe is still at 129–130% of the prior program.

Speaker #5: They could buy perpetual license models. They can buy subscription models. They could buy consumption models. And albeit although it's very small percentage, we offer SaaS-based components, right?

Speaker #2: It assumes the confidence that we see in all the demand indicators—and we can get into that later—that we maintain that level, and that we continue to see the tremendous growth opportunity. We have prudently protected the supply chain to optimize on distributed infrastructure.

Speaker #5: Underneath that, we have our business is roughly 80/20. 80% high-value recurring revenue and that is think of our portfolio Red Hat, subscriptions, our acquisitions that are mostly subscription consumption-based, our Gen AI portfolio and Watson X, and parts of our data automation portfolio that operate on consumption models.

Speaker #2: So, guide to guide, we're up about two points there. In software, 6% to 8% for the year. The lower end was an anchor—that says nothing changes.

Speaker #2: And I'll get into that in a minute. The high end says that we basically are approaching double digits in the second half. So let me break down those two, because we can get into consulting later, but there's basically no change there.

Speaker #5: Our remaining 20%, that's the piece transactional revenue that leverages perpetual license sales enterprise license agreements that that is our mainframe moat and incumbency. Provides tremendous value to IBM because it creates that multiplier effect I always talk about with every dollar of hardware revenue we land, we get $3 plus of software with long-term commitments.

Speaker #2: When you take a look at the scenarios that we ran on software—one, as I talked about in prepared remarks—we think this is a competitive differentiation.

Speaker #2: We have a software portfolio that plays at the heart of infrastructure software, and we allow our clients flexibility in how they want to buy.

Speaker #2: They could buy perpetual license models. They can buy subscription models. They could buy consumption models. And, albeit it's a very small percentage, we offer SaaS-based components, right?

Speaker #5: Now, how do we construct the ranges? On the high end, at 8%, we said that that 80% revenue we see continuing accelerate. We accelerated from 7% in first quarter, 8% in second quarter, and we see this going to about 10% in the second half.

Speaker #2: Underneath that, we have our business is roughly 80/20—80% high-value, recurring revenue. And that is—think of our portfolio: Red Hat subscriptions, our acquisitions that are mostly subscription or consumption-based, our Gen AI portfolio and WatsonX, and parts of our data automation portfolio that operate on consumption models.

Speaker #5: That is good acceleration. And that talks to the value in innovation we bring to clients in that part of the portfolio. In the transactional piece of the business, make it very clear the second quarter slip deals we have, by the way, typically we only close about 75%.

Speaker #2: Our remaining 20%, that's the piece—transactional revenue that leverages perpetual license sales, enterprise license agreements. That is our mainframe moat and incumbency. It provides tremendous value to IBM, because it creates that multiplier effect I always talk about, where every dollar of hardware revenue we land, we get $3-plus of software with long-term commitments.

Speaker #5: Arvind stated already in three weeks, we're about a third 40% already closed of those deals. Our high-end range says we close all of them, which, by the way, we haven't really lost, maybe one of the deals, maybe two.

Speaker #5: But we close all those deals. Then we've taken a look at all of our demand indicators, propensity to buy models, our pipeline closure rates.

Speaker #2: Now, how do we construct the ranges? On the high end, at 8%, we said that for 80% of revenue, we see continued acceleration. We accelerated from 7% in the first quarter, 8% in the second quarter, and we see this going to about 10% in the second half.

Speaker #5: We enter the second half with a relatively robust net new business pipeline. That's growing double digits. We have Brent, to your question, we've taken a discount off of our traditional historical rates.

Speaker #5: That's why we're sitting at eight. I think that's prudent. But back to Amit's question, the KPIs will tell how we finished third quarter, how we get in the fourth.

Speaker #2: That is good acceleration. And that speaks to the value and innovation we bring to clients in that part of the portfolio. In the transactional piece of the business, to make it very clear, the second quarter slipped deals we have—by the way, typically, we only close about 75%.

Speaker #5: The low end of the range, like I said, I can't stress it, it's the anchor to get profit and cash stable. To our last guide and maintain that level of profitability.

Speaker #5: That basically assumes we get modest acceleration in our high-value recurring revenue. And our 20% transactional, we see similar buying behavior in yields. Right? That's not what we're saying here, but we're basing our framework of our business model so we can drive the right management actions, the right level of productivity, to create incremental financial flexibility to go invest, to capture that growth opportunity.

Speaker #2: Arvind stated, already in three weeks, we're about a third—40%—already closed of those deals. Our high-end range says we close all of them, which, by the way, we haven't really lost—maybe one of the deals, maybe two.

Speaker #2: But we closed all those deals. Then we have taken a look at all of our demand indicators, propensity-to-buy models, and our pipeline closure rates.

Speaker #5: Hopefully, that helps you.

Speaker #2: We enter the second half with a relatively robust net new business pipeline—that's growing double digits. Brent, to your question, we've taken a discount off of our traditional historical rates.

Speaker #1: Great. Operator, let's take the next question.

Speaker #3: Your next question comes from Ben Reitzes with Melius Research. Please state your question.

Speaker #4: Yeah, thanks. First, just wanted to see if you guys could clarify there's two lines that are really bothering folks in the guidance. It's TPP and then the mainframe.

Speaker #2: That's why we're sitting at eight. I think that's prudent. But back to Ahmed's question—the KPIs will tell how we finished the third quarter, and how we get into the fourth.

Speaker #4: And how you're going to improve from negative nine and negative 42. I think if you could explain that, that'll make us feel a lot better about the four to five.

Speaker #2: The low end of the range, like I said—I can't stress this enough—is the anchor to get profit and cash stable to our last guide and maintain that level of profitability.

Speaker #4: And then Arvind, this is a question for you. What do you are you still looking for double-digit growth in software long-term? Do you still think you have this kind of portfolio or does the transactional stuff keep you from having a 10% long-term guide for software?

Speaker #2: That basically assumes we get modest acceleration in our high-value recurring revenue. And our 20% transactional—we see similar buying behavior and yields. Right? That's not what we're saying here, but we're basing our framework of our business model so we can drive the right management actions, the right level of productivity, to create incremental financial flexibility to go invest, to capture that growth opportunity.

Speaker #4: And what you saw in the quarter. Thanks.

Speaker #5: Yeah. Ben, thanks for the question. Let me actually address your question first. We and I have complete conviction in the double-digit long-term software growth.

Speaker #2: Hopefully, that helps you.

Speaker #5: Let me be clear about that. As you heard Jim describe, 80% of our business is already I'll use the word annuity or in some sense subscription-based.

Speaker #1: Great. Operator, let's take the next question.

Speaker #3: Your next question comes from Ben Reitzes with Melius Research. Please state your question.

Speaker #4: Yeah, thanks. I first just wanted to see if you guys could clarify—there are two lines that are really bothering folks in the guidance. It's TPP and then the mainframe.

Speaker #5: That piece, we have grown from extremely low numbers, I would say it was low single-digit seven years ago, to eight and approaching 10%. We already got that there.

Speaker #4: And how you're going to improve from negative nine and negative forty-two. I think if you could explain that, that'll make us feel a lot better about the four to five.

Speaker #5: We have a few different paths on how to get to 10%, not just one. We can creep growing that part faster and that can approach not just 10, but above 10%.

Speaker #4: And then, Arvind, this is a question for you. Are you still looking for double-digit growth in software long-term? Do you still think you have this kind of portfolio, or does the transactional stuff keep you from having a 10% long-term guide for software?

Speaker #5: That means that the other 20% has to grow smaller. By the way, every single year, that mix of 80/20 used to be 60/40. So as we go over time, that mix is going to climb up and more and more is annuity as opposed to transactional.

Speaker #4: And what you saw in the quarter. Thanks.

Speaker #5: And both organically and inorganically, we are investing in capabilities that are much higher growth than this mix. We are investing in capabilities that grow more at 15% to 20%.

Speaker #2: Yeah. Ben, thanks for the question. Let me actually address your question first. We, and I, have complete conviction in the double-digit long-term software growth.

Speaker #2: Let me be clear about that. As you heard Jim describe, 80% of our business is already—I'll use the word annuity, or in some sense, subscription-based.

Speaker #5: So that helps that overall growth rate. As an example, we brought Hashi in and we accelerated it. We brought Confluent in and we accelerated it.

Speaker #2: That piece, we have grown from extremely low numbers—I would say it was low single digits seven years ago—to eight and approaching 10%. We already got that there.

Speaker #5: Our organic Watson X portfolio is also growing at much higher rates than the aggregate. So that is the point that we are going to and we are not going to back off from our commitment of long-term double-digit for software, despite the two Q hiccup.

Speaker #2: We have a few different paths to reach 10%, not just one. We can continue growing that part faster, which could get us not just to 10%, but even above 10%.

Speaker #5: And I'll let Jim comment on the TP and mainframe growth rates, including the cycles that we see there.

Speaker #2: That means that the other 20% has to get smaller. By the way, every single year, that mix of 80/20 used to be 60/40. So as we go over time, that mix is going to climb, and more and more is annuity as opposed to transactional.

Speaker #2: Yeah. The question's kind of go together, right? Because we run this as a mainframe stack platform economic multiplier, as we talk about. Every dollar we land on mainframe, we get $3 plus of software.

Speaker #2: And, both organically and inorganically, we are investing in capabilities that are much higher growth than this mix. We are investing in capabilities that grow more at 15% to 20%.

Speaker #2: Mainframe overall, yeah, down 42%. Software 70% growth last year in the launch quarter overall. You look at the historical seasonality of mainframe, it's always down in the fifth quarter as we wrap around the launch.

Speaker #2: So that helps that overall growth rate. As an example, we brought Hashi in, and we accelerated it. We brought Confluent in, and we accelerated it.

Speaker #2: Now, with that said, I think we were very open transparent. It was below our expectations. But with that said, let me put this in perspective.

Speaker #2: Our organic Watson X portfolio is also growing at much higher rates than the aggregate. So that is the point that we are going to, and we are not going to back off from our commitment of long-term double-digit growth for software, despite the Q2 hiccup.

Speaker #2: One, we're still at nearly 130%. The record across the history of IBM of a program to program. Put that in dollar figures. From our most successful program, P16, to now P17, five quarters in, we're at nearly 130%.

Speaker #2: And I'll let Jim comment on the TP and mainframe growth rates, including the cycles that we see there.

Speaker #2: That is a billion dollars more a mainframe revenue. That is three plus billion more of software stack on top of that versus where we were at a similar point in time in the Z16 cycle.

Speaker #5: Yeah. The questions kind of go together, right? Because we run this as a mainframe stack platform economic multiplier, as we talk about. Every dollar we land on mainframe, we get $3-plus of software.

Speaker #2: And I would tell you that's the value that we bring around innovation in mainframe. Unmatched in terms of reliability, security, resiliency, scalability, AI on the chip.

Speaker #5: Mainframe overall, down 42%. That's coming off 70% growth last year in the launch quarter. If you look at the historical seasonality of mainframe, it's always down in the fifth quarter as we wrap around the launch.

Speaker #2: That's why the mainframe handles over 70% of the world's transaction volumes in terms of value. 140 million MIPS in the marketplace that we run core mission-critical systems across every industry.

Speaker #5: Now, with that said, I think we were very open and transparent. It was below our expectations. But with that said, let me put this in perspective.

Speaker #5: One, we're still at nearly 130%. That's a record across the history of IBM for a program-to-program comparison. To put that in dollar figures, from our most successful program, P16, to now P17, five quarters in, we're at nearly 130%.

Speaker #2: 45 of the top 50 banks, four to five top airlines, seven of the top 10 retailers, over 70% of the Fortune 100 run on mainframe.

Speaker #2: Now, Ben, to your question, how do we get confidence? Because our guide says we stay at that high 120 plus percent throughout 2026 overall.

Speaker #5: That is a billion dollars more of mainframe revenue. That is $3-plus billion more of software stack on top of that versus where we were at a similar point in time in the Z16 cycle.

Speaker #2: We have looked at key indicators: install base, upgrade cycles, propensity models. But what drives demand and purchasing requirement in mainframe? I would boil it down to three areas.

Speaker #5: And I would tell you that's the value that we bring around innovation in mainframe—unmatched in terms of reliability, security, resiliency, scalability, and AI on the chip.

Speaker #2: One, capacity workload. It's the most important determinant. 85% of the install MIPS capacity out there in the marketplace today running all those core mission-critical workloads are either stable or growing.

Speaker #5: That's why the mainframe handles over 70% of the world's transaction volumes in terms of value. There are 140 million MIPS in the marketplace, running core mission-critical systems across every industry.

Speaker #2: Clients are adding capacity and workload to mainframe. The viability. And by the way, that's coming in new AI workloads, analytics workloads, Linux-based workloads. And those MIPS are growing program to date over 15 to 20 percent install capacity.

Speaker #5: Forty-five of the top 50 banks, four to five top airlines, seven of the top 10 retailers, and over 70% of the Fortune 100 run on mainframe.

Speaker #2: So that's number one. Two, economic factors. We don't talk a lot about this. But I think it's important for our investors to understand. Things like TCO, total cost of ownership, consolidation, lease propensity.

Speaker #5: Now, Ben, to your question: How do we get confidence? Because our guide says we stay at that high 120-plus percent throughout 2026 overall. We have looked at key indicators—install base, upgrade cycles, propensity models.

Speaker #2: Depending on the size and complexity of the workload, we have anywhere from a two to a 15x TCO advantage running on the mainframe. That's why Arvind said in the prepared remarks, we do not see any evidence of clients migrating off mainframe.

Speaker #5: But what drives demand and purchasing requirements in mainframe? I would boil it down to three areas. One, capacity workload—it's the most important determinant.

Speaker #2: And lease propensity, which is a great indicator, we're actually in a very nice sweet spot as we enter second half from an upgrade. And then finally, AI-driven value.

Speaker #5: Eighty-five percent of the installed MIPS capacity out there in the marketplace today, running all those core mission-critical workloads, are either stable or growing. Clients are adding capacity and workload to mainframe.

Speaker #2: When you look at it, applications, data, security, all on the platform, we do 450 billion inferences per day at one millisecond with eight nines availability.

Speaker #5: The viability. And by the way, that's coming in new AI workloads, analytics workloads, Linux-based workloads. And those MIPS are growing, program-to-date, over 15% to 20% installed capacity.

Speaker #2: We've got clients that have already purchased over 50% of our spire inferencing. And those clients that have purchased that are growing MIPS capacity, the way we monetize value by over three times faster than others.

Speaker #5: So that's number one. Two, economic factors. We don't talk a lot about this, but I think it's important for our investors to understand. Things like TCO—total cost of ownership—consolidation, lease propensity.

Speaker #2: So then you get to TP. The reason I went through that on mainframe how do you monetize the value of that 3x multiplier in TP?

Speaker #5: Depending on the size and complexity of the workload, we have anywhere from a 2x to a 15x TCO advantage running on the mainframe. That's why Arvind said in the prepared remarks, we do not see any evidence of clients migrating off the mainframe.

Speaker #2: The more capacity that's in the marketplace, the more monetization opportunity, the more price opportunity, the more value creation opportunity. That performance, we have all the confidence in the world in Z in the second half.

Speaker #5: And lease propensity, which is a great indicator—we're actually in a very nice sweet spot as we enter the second half from an upgrade. And then finally, AI-driven value.

Speaker #2: But when we look at TP, in the models that we have done, given how much MIPS capacity is out there, the first thing that we should all remember, that is a great future indicator of monetization and revenue growth opportunity for us to go capitalize on that.

Speaker #5: When you look at it—applications, data, security—all on the platform, we do 450 billion inferences per day at one millisecond, with 89% availability.

Speaker #2: The key question then becomes, timing. And when you look at it, unlike the high value innovation we bring in many of our data automation, etc., the client has capability around their purchases of MLC, they could run on an OPEX model without doing a big purchase for three years for quite some time.

Speaker #5: We've got clients that have already purchased over 50% of our Sphere inferencing. And those clients that have purchased that are growing MIPS capacity—the way we monetize value—by over three times faster than others.

Speaker #5: So then you get to TP. The reason I went through that on mainframe—how do you monetize the value of that 3x multiplier in TP?

Speaker #2: But eventually, that technology upgrade cycle, catches them, and it moves in IBM's favor. And the economics is you can imagine the price differential moves in IBM's favor.

Speaker #5: The more capacity that's in the marketplace, the more monetization opportunity, the more price opportunity, the more value creation opportunity. That performance—we have all the confidence in the world in Z in the second half.

Speaker #2: So when you look at that, we have all the confidence in the world around a growth vector of TP. But when we look at the guidance in the second half, I think prudently, when we're looking at six to eight percent, six being the anchor, eight approaching double digits in the second half, we've got TP down low single digits to mid single digits overall because we're going to look at that as a 2027 growth vector opportunity for us.

Speaker #5: But when we look at TP, in the models that we have done, given how much MIPS capacity is out there, the first thing that we should all remember is that this is a great future indicator of monetization and revenue growth opportunity for us to go capitalize on.

Speaker #5: The key question then becomes timing. And when you look at it, unlike the high-value innovation we bring in many of our data, automation, etc., the client has capability around their purchases of MLC. They could run on an OPEX model without doing a big purchase for three years, for quite some time.

Speaker #1: Operator, let's take the next question.

Speaker #3: Your next question comes from Fatima Boulani with City. Please state your question.

Speaker #4: Good afternoon. Thank you so much for taking my questions. Arvind, this is a question for you. And I want to flip the some of the commentary on its head a little bit.

Speaker #4: So clearly, 11th hour, you had the deal slippage on the 10th of the large deals. It's very encouraging to hear that you've been able to recoup and recapture these deals.

Speaker #5: But eventually, that technology upgrade cycle catches them, and it moves in IBM's favor. And the economics—as you can imagine, the price differential—moves in IBM's favor.

Speaker #4: In such a short amount of time into the third quarter. So what I wanted to ask you, what exactly changed in the last three to four weeks that catalyzed pushing some of these large transactions that did slip to a successful finish line?

Speaker #5: So when you look at that, we have all the confidence in the world around the growth vector of TP. But when we look at the guidance in the second half, I think prudently, when we're looking at 6% to 8% — 6% being the anchor, 8% approaching double digits in the second half — we've got TP down those single digits to mid-single digits overall, because we're going to look at that as a 2027 growth vector opportunity for us.

Speaker #4: And were there any internal or IBM-specific efforts or initiatives that you maybe took a more assertive stance with to recapture these transactions? And as a follow-up, Jim Jeff mentioned and you also mentioned this in your prepared remarks.

Speaker #4: 85% of the installed MIPS capacity is still growing in your installed base. So conversely, what is actually happening to the 15% that is not stable to growing?

Speaker #2: Operator, let's take the next question.

Speaker #4: Your next question comes from Fatima Boulani with Citi. Please state your question.

Speaker #6: Oh, good afternoon. Thank you so much for taking my questions. Arvind, this is a question for you, and I want to flip some of the commentary on its head a little bit.

Speaker #4: Thank you very much.

Speaker #2: Yeah. So Fatima, thanks for the question. And let's talk about this a little bit. So first, it's important to understand why this slipped. I actually believe that even our clients had every intention till about a month before that they were going to consummate these deals.

Speaker #6: So clearly, at the 11th hour, you had the deal slippage on 10 of the large deals. It's very encouraging to hear that you've been able to recoup and recapture these deals.

Speaker #6: In such a short amount of time into the third quarter. So, what I wanted to ask you is: What exactly changed in the last three to four weeks that catalyzed pushing some of these large transactions that did slip to a successful finish line?

Speaker #2: You can imagine, we do have a lot of discipline, and we do a lot of work to make sure it's a good business case, budgets exist, etc.

Speaker #6: And were there any internal or IBM-specific efforts or initiatives that you maybe took a more assertive stance with to recapture these transactions? And as a follow-up, Jim just mentioned—and you also mentioned this in your prepared remarks—85% of the installed MIPS capacity is still in your installed base.

Speaker #2: I think that our clients themselves had not really thought through that some of the alternate purchases they were doing were increasing 30% in dollar value quarter to quarter.

Speaker #2: When they were faced with that issue, then they decided to move budget to those areas where they were having that extreme price. Now, as we have gone through and done we have actually held our price so far in the month of July.

Speaker #6: So conversely, what is actually happening to the 15% that is not stable to growing? Thank you very much.

Speaker #2: We have not taken increases. I think that our teams are a bit more reluctant and less aggressive than others in portraying some of those increases and hardware that are coming into the market.

Speaker #5: Yeah. Oh, so Fatima, thanks for the question. And let's talk about this a little bit. So first, it's important to understand why this slipped.

Speaker #2: As they become more aware, that they cannot hold these prices for more than a few weeks, then that itself is going to make an impact where we play into that part as well.

Speaker #5: I actually believe that even our clients had every intention, until about a month before, that they were going to consummate these deals. You can imagine, we do have a lot of discipline, and we do a lot of work to make sure it's a good business case, budgets exist, etc.

Speaker #2: Albeit, we are nowhere near as aggressive as some of the alternate infrastructure providers. Now, on the software side, that becomes coupled often to that hardware purchase.

Speaker #5: I think that our clients themselves had not really thought through that some of the alternate purchases they were making were increasing 30% in dollar value, quarter to quarter.

Speaker #2: Because they definitely want to leverage that hardware, that they're getting from us, and then they will couple the software purchases into it. But I actually believe that the biggest part is the deferred it, and then they realized, well, this is mission critical.

Speaker #5: When they were faced with that issue, they decided to move budget to those areas where they were experiencing that extreme price. Now, as we have gone through and done, we have actually held our price so far in the month of July.

Speaker #2: All I'm doing is taking on tech debt. I better actually act on this once the kind of got over the compression of time they were in at the end of the quarter, and said, I don't really want to get into tech debt on a platform that I'm keeping for the long term.

Speaker #5: We have not taken increases. I think that our teams are a bit more reluctant and less aggressive than others in portraying some of those increases in hardware that are coming into the market.

Speaker #2: So if I'm not going to do that, then I've got to go find the money and get this done. And so my teams can go get the work done, and give us all of those abilities that Jim talked about so eloquently in the last question of the innovation we do both on Z and in other platforms.

Speaker #5: As they become more aware that they cannot hold these prices for more than a few weeks, then that itself is going to make an impact. We play into that part as well.

Speaker #1: Great. Let's take the next question, Operator.

Speaker #5: Albeit, we are nowhere near as aggressive as some of the alternate infrastructure providers. Now, on the software side, that often becomes coupled to that hardware purchase.

Speaker #3: Your next question comes from Erik Woodring with Morgan Stanley. Please state your question. Erik Woodring, your line is open. Go ahead, try it again, Erik, please.

Speaker #5: Because they definitely want to leverage that hardware that they're getting from us, and then they will couple the software purchases into it. But I actually believe that the biggest part is they deferred it, and then they realized this is mission-critical.

Speaker #5: Can you hear me? Can you hear me?

Speaker #3: Sorry about that, guys. So thank you for taking my questions. Arvind, I want to touch on the data segment within software and specifically, I think if you take your really bullish comments on Confluent Accelerating, you get to organic data revenue growth that was down year over year, maybe mid single digits in the second quarter.

Speaker #5: All I'm doing is taking on tech debt. I better actually act on this once they've kind of gotten over the compression of time they were in at the end of the quarter, and said, I don't really want to get into tech debt on a platform that I'm keeping for the long term.

Speaker #3: And that just stands out from the rest of the portfolio. The non-TP portfolio. So can you maybe just help us better understand exactly why that kind of organic data part underperformed the rest of non-TP software?

Speaker #5: So, if I'm not going to do that, then I've got to go find the money and get this done, so my teams can go get the work done and give us all those abilities that Jim talked about so eloquently in the last question—the innovation we do both on Z and in other platforms.

Speaker #3: And why IBM's data software of all things, maybe got deprioritized this specific quarter this early in the AI build-out? Thank you so much.

Speaker #2: Great. Let's take the next question, Operator.

Speaker #4: Your next question comes from Eric Woodring with Morgan Stanley. Please state your question. Eric Woodring, your line is open. Go ahead and try again, Eric, please.

Speaker #2: So Erik, thanks for the question. First, let's understand. As we said, in aggregate, about four to five hundred of the MIPS was in software overall.

Speaker #2: And when we think of those large capex deals, while it is majority, but think majority is being 50 to 60 percent TP software, there is a lot of data also in there.

Speaker #7: Can you hear me? Can you hear me?

Speaker #4: Sorry about that, guys. Thank you for taking my questions. Arvind, I want to touch on the data segment within Software, and specifically, I think if you take your really bullish comments on Confluent accelerating, you get to organic data revenue growth that was down year-over-year, maybe mid-single digits in the second quarter.

Speaker #2: It actually has less of automation because a lot of the automation portfolio has already moved to being subscription-based with things like Hashi and Apptio.

Speaker #2: So as you think about that, data takes what I would call maybe the run-by shooting. So in the run-by shooting, data gets hurt because people are buying less of it, and that impacts that.

Speaker #4: And that just stands out from the rest of the portfolio—the non-TP portfolio. So can you maybe just help us better understand exactly why that kind of organic data part underperformed the rest of non-TP software?

Speaker #2: Now, if I take the next 12 months and if I look at what both I talked about and where we see the demand signals, I fully expect data to perform well and to give us that tailwind that we are wanting there.

Speaker #4: And why IBM's data software, of all things, maybe got deprioritized this specific quarter, this early in the AI build-out? Thank you so much.

Speaker #2: Also, at the end of the day, clients have a certain number of dollars. So if Confluent looks more attractive than other things, they are going to buy more of what is the thing that gives them the most near-term value.

Speaker #5: So, Eric, thanks for the question. First, let's understand—as we said, in aggregate, about 400 to 500 of the MIPS was in software overall.

Speaker #2: And we are fine with that. It gives us incumbency. It gives us a footprint, and we can go back in there in the next quarter and the quarter after to get other things in case that there is aggregate budget pressure.

Speaker #5: And when we think of those large capex deals, while it is the majority—but I think the majority is about 50 to 60 percent TP software—there is a lot of data also in there.

Speaker #2: After all, we do have a large share of wallet at many of these clients. So there is a question of how much they will spend here.

Speaker #5: It actually has less of automation because a lot of the automation portfolio has already moved to being subscription-based, with things like Hashi and Apptio.

Speaker #2: But I fully expect that we will do well in the data portfolio.

Speaker #1: Great. Operator, let's take one last question.

Speaker #5: So as we think about that, data takes what I would call maybe the run-by-shooting. So in the run-by-shooting, data gets hurt because people are buying less of it, and that impacts that.

Speaker #3: I think you're in our last question. Comes from Matt Swanson with RBC. Please state your question.

Speaker #4: Great. Thank you so much for taking my question. Arvind, you've been really deliberate about the areas of security that you've invested in over the last few years.

Speaker #5: Now, if I take the next 12 months and if I look at both what I talked about and where we see the demand signals, I fully expect data to perform well and to give us that tailwind that we are wanting there.

Speaker #4: When we're looking at project Lightwell, could you just talk about, I guess, post-MIPS, kind of the breakdown of one, how big of an opportunity this is, as obviously an area open source that you have a lot of expertise, but also how important solutions in this area in general are for you as the largest enterprise provider of open source software?

Speaker #5: Also, at the end of the day, clients have a certain number of dollars. So if Confluent looks more attractive than other things, they are going to buy more of what is the thing that gives them the most near-term value.

Speaker #5: And we are fine with that. It gives us incumbency; it gives us a footprint, and we can go back in there in the next quarter and the quarter after to get other things, in case there is aggregate budget pressure.

Speaker #4: What kind of protecting the ecosystem you guys have worked so hard to build out?

Speaker #2: Yeah. So Matt, thank you. Look, if I look at this first, let's step back and look at open source versus proprietary. If I look at the amount of running code out there, I would posit to you that open source is now larger than all proprietary code in terms of the volume of software that is there.

Speaker #5: After all, we do have a large share of wallet at many of these clients, so there is a question of how much they will spend here.

Speaker #5: But I fully expect that we will do well in the data portfolio.

Speaker #2: Great. Operator, let's take one last question.

Speaker #4: I think you're on our last question. It comes from Matt Swanson with RBC. Please state your question.

Speaker #2: At the same time, the number of people who have been able to commercialize it or monetize it is limited. I think also, Matt, we should be careful.

Speaker #3: Great. Thank you so much for taking my question. Arvind, you've been really deliberate about the areas of security that you've invested in over the last few years.

Speaker #2: We say that, but a lot of the hyperscalers, a lot of the infrastructure out there, does actually run on open source. Albeit, with modifications by those providers.

Speaker #3: When we're looking at Project Lightwell, could you just talk about—post-MIPS—kind of the breakdown of, one, how big of an opportunity this is? Obviously, this is an area—open source—that you have a lot of expertise in, but also, how important are solutions in this area in general for you, as the largest enterprise provider of open source software?

Speaker #2: So now the question comes, open source is quite good at remedying the last version. Maybe the version minus one, but those movements are a six-month cycles.

Speaker #2: Once an enterprise is getting value from an application, that tends to run for seven to 10 years. We looked at this historically, and we said that is a place that we want to go play.

Speaker #3: What kind of protections for the ecosystem have you guys worked so hard to build out?

Speaker #5: Yeah. So, Matt, thank you. Look, if I look at this—first, let's step back and look at open source versus proprietary. If I look at the amount of running code out there, I would posit to you that open source is now larger than all proprietary code in terms of the volume of software that is there.

Speaker #2: Five years ago, it would have required an army of people to be able to go do it. You would have required people with expertise in each of those pieces of open source.

Speaker #2: You would have had to build those build environments. You had to keep those committers engaged and productive. And so you look at that and you say, not clear that there is an economic return.

Speaker #5: At the same time, the number of people who have been able to commercialize it or monetize it is limited. I think also, Matt, we should be careful.

Speaker #2: So the same tools that are being used to attack all code, both proprietary and open source, can also be used to effectively be those experts and build those out.

Speaker #5: We say that, but a lot of the hyperscalers—a lot of the infrastructure out there—does actually run on open source, albeit with modifications by those providers.

Speaker #2: So what we did was we built kind of a factory using AI models to be able to patch open source even when it is not one that we have human expertise in.

Speaker #5: So now the question comes: open source is quite good at remedying the last version, maybe the version minus one, but those movements are on six-month cycles.

Speaker #2: But as we do that, we actually are not just patching it. We are running test harnesses against it. We're being able to evaluate it in the environments that our clients need and want.

Speaker #5: Once an enterprise is getting value from an application, that tends to run for seven to ten years. We looked at this historically, and we said that is a place that we want to go play.

Speaker #2: So we can do all of that. Your question on what is the addressable opportunity? Look, this is early days. How about if I characterize it?

Speaker #5: Five years ago, it would have required an army of people to be able to go do it. You would have required people with expertise in each of those pieces of open source.

Speaker #2: We believe that it's in the multiple billions of dollars. Whether it turns out to be that the TAM or the open source protection here is five or 10 or 15, it's in that range of billions of dollars.

Speaker #5: You would have had to build those build environments. You had to keep those committed and engaged, and productive. And so you look at that and you say, it's not clear that there is an economic return.

Speaker #2: And here, I will tell you, we are going to measure ourselves in terms of how many hundreds of clients we can get signed up over the first many months.

Speaker #5: So the same tools that are being used to attack all code, both proprietary and open source, can also be used to effectively be those experts and build those out.

Speaker #2: That is how aggressive we want to get. And we believe that that becomes a flywheel that multiplies. Because as we get more and more clients signed up, we learn a lot more also about what they want as remedies.

Speaker #5: So what we did was, we built kind of a factory using AI models to be able to patch open source, even when it is not one that we have human expertise in.

Speaker #2: And as we learn what they want as remedies, that makes our network effect on this grow more and more. Let's remember, we put out 7,500 packages of remediations in the first three weeks.

Speaker #5: But as we do that, we actually are not just patching it. We are running test harnesses against it. We're able to evaluate it in the environments that our clients need and want.

Speaker #2: We believe by the way, that's not counting the 30,000 packages we already do with Linux and Hashi and Confluent and Kubernetes and OpenShift, et cetera.

Speaker #5: So we can do all of that. Your question on what is the addressable opportunity? Look, this is early days. How about if I characterize it?

Speaker #2: So in aggregate, we believe that this is a multiple billion dollar opportunity which we're going to go after really fast and hard. Leveraging expertise in AI and open source both.

Speaker #5: We believe that it's in the multiple billions of dollars. Whether it turns out that the TAM or the open source protection here is $5 or $10 or $15 billion, it's in that range of billions of dollars.

Speaker #2: So thank you all for these questions. I thought it's very fair and very appropriate questioning. Is the business coming back? Is the cash flow there?

Speaker #5: And here, I will tell you, we are going to measure ourselves in terms of how many hundreds of clients we can get signed up over the first many months.

Speaker #5: That is how aggressive we want to get. And we believe that that becomes a flywheel that multiplies, because as we get more and more clients signed up, we learn a lot more also about what they want as remedies. And as we learn what they want as remedies, that makes our network effect on this grow more and more.

Speaker #2: How are you going to grow in the various parts? What's your long-term commitment? How strong is the mainframe incumbency? So I do really thank you all on these questions.

Speaker #2: We remain confident in the growth opportunities ahead of us and the actions we are taking to improve execution. I look forward to sharing our progress with you.

Speaker #2: As we move through the rest of the year.

Speaker #5: Let's remember, we put out 7,500 packages of remediations in the first three weeks. We believe by the way, that's not counting the 30,000 packages we already do with Linux and Hashi and Confluent and Kubernetes and OpenShift, etc.

Speaker #1: Thank you, Arvind. Operator, let me turn it back to you to close out the call.

Speaker #5: So, in aggregate, we believe that this is a multi-billion dollar opportunity, which we're going to go after really fast and hard, leveraging expertise in AI and open source both.

Speaker #5: So look, thank you all for these questions. I thought it was very fair and very appropriate questioning. Is the business coming back? Is the cash flow there?

Speaker #5: How are you going to grow in the various parts? What’s your long-term commitment? How strong is the mainframe incumbency? So, I do really thank you all for these questions.

Speaker #5: We remain confident in the growth opportunities ahead of us and the actions we are taking to improve execution. I look forward to sharing our progress with you as we move through the rest of the year.

Speaker #2: Thank you, Arvind. Operator, let me turn it back to you to close out the call.