Olympia McNaney, Global Head of Investor Relations at IBM, presided over the second quarter 2024 earnings conference, which was attended by IBM's Chairman and CEO Arvind Krishna and CFO Jim Kavanaugh. The meeting discussed the company's performance, mentioned the use of non-GAAP financial metrics, and cautioned about forward-looking statements that could potentially impact actual results. The recording and materials from the meeting will be made available to investors in the future.

IBM's performance in the second quarter exceeded expectations, with revenue reaching $15.8 billion, operating pre-tax income of $2.8 billion, and diluted earnings per share of $2.43. Revenue grew by 4% year-on-year, mainly driven by strong growth in software and infrastructure. IBM's investment in innovation strategy in software, infrastructure, consulting, and other areas has achieved significant results, driving organic growth. At the same time, the company continues to invest in AI and hybrid cloud areas, improving productivity and profitability, demonstrating its solid performance in the technology spending environment.

In the second quarter, IBM's software business performed strongly, driven by factors such as the growth of Red Hat, the combination of innovation and recurring revenue, transaction processing, and acquisition strategy. Red Hat's annual bookings grew by over 20%, with OpenShift's annual bookings growing by over 40%, reflecting high demand for hybrid cloud solutions. IBM's subscription-based business accounted for 80% of annual software revenue and showed double-digit growth. Transaction processing revenue grew by 13%, demonstrating innovation and value in key hardware stacks such as IBM Z, Power, and storage. Additionally, IBM's M&A strategy, such as acquiring Aptio and StreamSets, contributed significantly to annual bookings and recurring revenue growth. In terms of software profits, both gross margin and segment profit saw significant improvements, reflecting operational leverage from revenue scale and structure. In consulting services, IBM maintained stable demand for large projects, particularly in AI and analytics projects aimed at improving productivity, despite customers exercising caution in small project spending. This complements the software business.

With its unique advantages in technology and consulting, IBM is playing a leading role in the transformation of artificial intelligence technology, helping clients design and expand AI solutions, while also driving new ways of working to improve productivity and delivery efficiency. This transformation has become a catalyst for the growth of the company's business, not only driving revenue growth in business and data transformation, but also promoting revenue growth in infrastructure, especially with significant performance in the IBM Z platform and distributed infrastructure. IBM is becoming a strategic partner in AI technology applications for many companies such as WPP and Elevons Health. Despite facing challenges such as rising labor costs and currency fluctuations, IBM has achieved margin expansion through efficiency improvement and pricing strategies.

IBM is optimistic about its performance in 2024, with revenue growth in the first half of the year reflecting the effectiveness of the company's organic growth and acquisition strategies, as well as a strong business foundation. Full-year revenue is expected to maintain mid-single-digit growth, with free cash flow expectations raised to over $12 billion, primarily driven by growth in adjusted EBITDA. The software sector is performing well, with full-year growth expected to increase to high single digits, while the consulting sector is facing low single-digit growth. The infrastructure sector is expected to show neutral performance for the year. Despite expectations of a strong US dollar impacting full-year revenue growth by 100 to 200 basis points, IBM remains confident in its full-year revenue growth, operating profit expansion, and free cash flow growth.

Before the meeting started, the host reminded attendees to pay attention to the additional information at the end of the presentation and to avoid asking multiple questions at once. Subsequently, the meeting entered the Q&A session, with the first question coming from Bank of America. Attendees who wish to ask questions need to follow the instructions on the telephone keypad.

IBM is confident in the long-term growth model of its transaction processing business, despite initially setting it for low single-digit growth, it has achieved on average mid-single-digit or better growth in recent years. This shift has been facilitated by continued investment and optimization of the mainframe platform, resulting in over 80% of customers increasing their MIPS (Millions of Instructions Per Second) usage on the mainframe. IBM has transitioned this business from declining mid-single-digit growth to low single-digit growth and expects to achieve mid-single-digit growth by 2024. To continue driving growth, IBM is introducing new capabilities such as Watson X Code Assistant for Z to further enhance platform value and customer satisfaction. Looking ahead to 2025, IBM will discuss its growth expectations in detail under future guidance.

The discussion is focused on the impact of AI investment on the consulting services industry. Currently, most AI demand is seen as a transfer within the consulting business rather than a completely new incremental market. Although recent AI-related business contracts have seen significant growth, this growth is seen as a replacement for traditional consulting business rather than a supplement. However, as businesses shift from exploring AI to scaling its application, it is expected that AI investments will gradually become incremental contributions to consulting services rather than simply internal transfers. In addition, the proactive deployment of companies in AI technologies such as the Watson X platform and open innovation strategies demonstrates confidence in the future growth of the AI market.

IBM's consulting business plays a key role in the current early cycle, aiming to become the preferred strategic partner for enterprise digital transformation 2.0. As businesses seek strategic suppliers and partners to drive large-scale enterprise transformation projects, IBM's consulting business has shown strong growth, especially in the area of business transformation services, such as operational model transformation in human resources, finance, and supply chain. In addition, IBM's software business has also performed well, with subscriptions and SaaS models dominating, contributing approximately one percentage point to the company's overall growth.

Darian Anni inquired about the low single-digit growth of consulting business in 2024, specifically whether the non-AI consulting part, excluding M&A contributions and AI business revenue, may perform worse in the second half of the year. The respondent believed that current macroeconomic uncertainty, such as geopolitical tensions and ongoing inflation, had impacted client decision-making, leading to temporary weakness in consulting business. However, they were optimistic about the medium to long-term business growth, believing that these short-term challenges will gradually ease in the coming months, and consulting business is expected to once again become a growth driver.

IBM predicted 90 days ago that the annual growth of its consulting business would remain in the mid single digits, with large-scale business transformation becoming a major growth driver. In the past quarter, IBM has achieved better-than-expected results in the field of artificial intelligence (AI), and strategic partnerships and Red Hat's business have continued to grow. Despite short-term spending priorities and certain market uncertainties affecting current business performance, IBM has made good progress on its path to becoming the preferred provider, especially in the general AI field, which will have a positive multiplier effect on future revenue growth.

IBM emphasizes that its merger and acquisition (M&A) strategy remains unchanged, focusing on investment in the hybrid cloud and artificial intelligence fields, with the requirement that acquisitions bring synergies and increase free cash flow. Regarding current market valuations, IBM believes that although valuations are high, they are still within a reasonable range. Public market valuations fluctuate greatly, while private market valuations are relatively stable but also with lower risk. IBM states that it will continue to use M&A as part of its growth strategy and maintain a strong financial position to support this goal, but also emphasizes the need to digest acquired companies at an appropriate pace and speed.

In the discussion, IBM expressed satisfaction with its current financial performance, particularly the growth in free cash flow and exceeding EBITDA, which gave them confidence to raise their financial guidance. At the same time, the company mentioned the strategic deal with Palo Alto Networks and its impact on the cost structure, as well as expectations for future revenue contributions from Hashicorp and possible per-share earnings dilution.

The discussion focused on the strategic fit of mergers and acquisitions, emphasizing the synergistic effects of the target platform in terms of product technology and market promotion, as well as its attractive financial performance, including high revenue growth, adjusted EBITDA, and increased free cash flow. The speakers also analyzed in detail the potential dilution effects, cost savings, and operational synergies of the M&A transaction, and how these factors would affect the overall revenue growth, operating leverage, and free cash flow growth of the company, demonstrating a deep understanding of M&A operations and long-term growth plans.

In the past few quarters, despite the healthy growth of Red Hat's business bookings, staying between 15% and 20%, recent growth has slowed down by 100 basis points. Red Hat's business model is a pure consumption model, where customers pay on demand, and bookings reflect future demand. About half of annual revenue can be predicted based on the previous year's bookings, and as the quarters progress, this proportion gradually increases from 50% to 80%. Currently, based on booking conditions, it is expected that Red Hat's business growth will be in the low double digits, with signs of demand continuing into the current quarter and the next six months. In terms of products, demand for Openshift, Linux, and Ansible is growing significantly, especially Openshift in the areas of containerization and virtualization, as well as Linux and Ansible showing growth in the low double digits, bringing positive signals to the business. In addition, the open source AI projects Red AI and Openshift AI that Red Hat is developing are expected to contribute to business growth in the coming years.

IBM explained in detail the reasons for its decision to open source its AI models and code library, primarily based on technical and economic considerations, as well as the desire to attract more developers to participate through open source code, enhance market adaptability, and improve the customization capabilities for enterprise customers. In addition, IBM highlighted its early progress in the generative AI field and looks forward to future performance in revenue growth and cash generation.