International Business Machines Corporation (IBM) Earnings Call Transcript & Summary

Hello. Good morning, everyone, and welcome back to our View from the Top call Series. Before we get started, I need to mention the conflict disclosures relating to the individual companies and securities mentioned on this call can be found on the call invitation. With that, I have to say, I'm really honored to welcome back Chairman and CEO of IBM, Arvind Krishna on this View from the Top Series. We were really lucky to have him last year as well. And Arvind really needs no introduction, but for those of you who have met him, you know he's amongst the top thought leaders in our time. And in his distinguished career, Arvind has driven innovation across AI, Quantum computing, blockchain and so many other areas at his time at IBM as head of IBM Research. He's also served as SVP of Cloud & Cognitive Software, where he pioneered the company's hybrid cloud business, which is a key focus now. Arvind also led the transformational Red Hat deal, $34 billion Red Hat deal a few years ago, and then most recently engineered the spin-off of Kyndryl as well, so he's driving significant change at IBM. We just got back from IBM's Think in Boston. And I have to say that I have not seen this level of energy and excitement from IBM's senior leadership probably in the 17 years I've known the company. So Arvind, welcome. Truly an honor to host you today for this call.

Wamsi, it's a pleasure to be here with you, and I have to say your remarks are too kind and too generous.

No, not at all. Well, welcome, Arvind. So let's jump right in, I guess. As we talk to investors, there's a lot of questions about your midterm model that you laid out last year of mid-single-digit revenue growth and generating cumulative free cash flow of $35 billion over 3 years. And in our conversation, it appears that investors are not really giving you credit for these goals, given maybe some of the historical performance of the company. So what gives you confidence in this model? And what are some of the changes that you're driving to accomplish this model?

Yes. So Wamsi, great question. And I'll look at it as the glass half full, which is to say, if they have not yet given us credit, which I don't believe they have and maybe it will show through in more uptake, more people interested, a better multiple as we go forward. So I look forward to that outcome. But to answer your question directly, I'm going to answer it through 2 lenses. First lens, I'll do it in the lens of our business, and then I'll do it in the lens of changes made and why those changes are driving the growth that we're talking about. So the medium-term model is mid-single-digit revenue growth, and that comes together with the $35 billion of free cash flow cumulative over '22 through '24, okay. So if I look at it in our business thing, we have software, we have consulting and we have infrastructure. I'll sort of quickly say on infrastructure, we expect this to be, I'll call it, flat. There may be a plus/minus 1 in a given year, but over the 3-year period, let's call that flat. And if I look in there, there are some vectors which you would say are looking good and there are some vectors which are a slight drag. But I think that flat there is appropriate as opposed to trying to lean into anything more aggressive there. And the next, which is, I think, relatively easier to speak of is on consulting, where we have said high single-digit growth in the midterm model. Well, if I look at it there right now, our book-to-bill is 1.1, to that point to 10% growth but we are seeing high single digits. In the first quarter this year, we turned in 17% on the back of a good fourth quarter as well. Now compares do get harder as we go forward, I'll acknowledge that because the second quarter was growth for consulting in '21 but not the first quarter. So as we get going there, but that's why we dropped ourselves to high single digits as opposed to overall double digit. We did point to very, very low double digit for 2022, which we can kind of see because in consulting with the annuity stream in there, looking at where we finished in 1Q, that really points to a pretty good slowdown, by the way, in the second half, if I begin with 17% and I say I finished the year at a full year at 10%, 11%, right, double -- low double digits, okay. So that leaves software. Software has 1 vector, which is Red Hat. Red Hat turned in 21% last year, 17%, 18%, if I look at it over the last 3 years. And so we point to the upper teens on Red Hat. So if I look at consulting at high single digits, that gives you sort of 2 points or a bit more at the IBM level, 0 from infrastructure. Red Hat in the upper teens gives you somewhere in the upper ones. [ 1 3/4 ], maybe 2% growth. So that leaves you for the final 1% on the revenue growth. And that is then coming from acquisitions that we do in software, organic software growth itself. And given the increasing annuity mix there, the annuity, recurring revenue within software, getting into the 60s, 70s percent, that itself moving to growth makes the task, I'll call it, not easy but easier than it has been in the past. And when I look then at the first quarter and a bit of the fourth quarter for some evidence that, that's true, automation is sitting at 5%, data and AI at 4%, security at 8% in the first quarter, are not so good in '21. But that gives us some confidence that there's some this thing in there. So that's if I go through the business. Then if I instead turn to the changes made, okay, we've got Red Hat in. That's maybe 1.5 points for the top line. We took Kyndryl out, so that's 1.5 of a headwind that has gone away. I mean, it's hard to call out a growth but it's a headwind that has gone away. We have returned to, I'll call it, M&A activity. We've done 20 over the last 2 years or so. That's about 1.5 points on average each year. We're really leaning into our ecosystem, whether it's Salesforce, Adobe, Microsoft, SAP, AWS. And you can see -- and Oracle, and you can see the growth there, which is we had almost $2 billion of signings in the first quarter for consulting. So you kind of package that altogether in terms of the changes, other than the changes being driven by internal culture, people's positivity, appetite to take risk, simplification of the company, but when you have 5 or 6 things, maybe let's only count on 4 of them. And then I'll say, okay, so that's the mid-single-digit revenue growth. By the way, the free cash flow almost follows from the revenue growth because as we go from '21 to '22, you would sort of say, look, 8-ish or thereabouts, $1 billion of free cash flow is kind of where maybe 8.4 is the fair number for '21. 7.9 is what we said but I'm saying there are some things we did. As the structural actions go away, as the payments for getting Kyndryl down kind of completely go away and all that, we sort of get up to 9. And then you sort of say, okay, from the revenue growth, you go generate the $1 billion because the revenue growth is going to contribute to 3/4 of the incremental cash flow coming from software and 1/4 from consulting, nothing from infrastructure. And so it is really based on the revenue growth. If we give you the mid-single-digit revenue growth, then we'll get the free cash flow growth over this time. So sorry Wamsi, really long answer to your question, but I wanted to break it down in a way that people can then sort of verify, eyeball and agree with.

Yes. No, that's a great level of detail, actually. And I think that's exactly what investors are looking for to understand what the underlying moving pieces are, and that's a super helpful bridge to your growth factors. Arvind, as every conversation we're having is getting dominated by macro, there's just been a lot of concern, right, about weakening consumer demand and worries that, that will be followed by weaker enterprise demand, especially given the Russia-Ukraine situation and faster tightening by the Fed and the China supply chain situation. And so I guess, firstly, like what are the customers saying about the sustainability? And what are they saying about the demand? And in your conversations, as I'm sure you're starting to travel more and meeting customers, what's the feedback that you're hearing? What are the key priorities they're focused on?

Yes. So Wamsi, I'll begin with the following. For me, unlike prior slowdowns, this is one where there are some very interesting differences. Number one, technology is now a source of competitive advantage. The implication of that on spending is it will be one of the last things to get cut because it's no longer just a cost of doing business. It's actually a source of advantage. And in a world of inflation, in a world of supply chain scarcities, in a world of demographic shifts where talent is hard to get, technology offers you a way through all of those headwinds. And so people are going to spend on it. I wouldn't say it's immune if there's something significant and major. But I think it is going to be pretty muted in terms of any reduction if there's only a small slowdown or a mild recession, I'll call it, mild or quick, you can dig here -- a kind of pick on those things. So that's sort of just a big macro color rate. Then if I look at it in detail, all the things you're talking about today, many of them are due to a supply shock, right? I mean, there's a reduction in supply, not necessarily a demand decrease. Inflation is actually being driven by demand increase. So if you say we have got demand increase, supply decrease then that actually points to more growth on technology because technology offers you a way to get more efficient about whatever supply there is, and it gets you more efficient in terms of your labor shortages. So we got those things going on. So my observation also is technology growth is ahead of GDP growth, and we can sort of see that in the data. If you say GDP growth is 3%, then technology was 6%, 7%, 8%. So even if GDP slows down, I think technology still stays at 4% to 5%. Now on color, I'm not seeing really any significant or any hesitancy in the Americas. And the Americas was a wide swath, right, from Canada to the U.S. to Mexico, Brazil, Chile, Argentina. But if I take the aggregate, it's pretty similar to what it's been. If I go to Asia, I'm going to put China aside because it's just very hard to say what's going on with the lockdowns, what will the impact be if they don't produce, they've got to consume less, right? I mean, I think that's pretty straightforward. Russia, we don't do any business in. We quantified our business in Russia as $300 million for the year. But we are holding firm to our full year growth forecast regardless of Russia. Now I'll say we are luckier than some others. We didn't have any global operations out of Russia, so there's no second-order impact for us. I think Asia is coming back kind of in the growth mode like what it used to be. I think they have kind of gone past COVID and inflation. And they -- I think I'll speculate. I'm not an expert on this. Unlike some prior crisis, I don't see the exchange rates or inflation kind of locking them down. And so as you go across this, that leaves sort of Western Europe. So I do expect Western Europe to sort of think a little bit. But now that it will be -- the more critical projects are going to get done. But if there is a huge impact in terms of a slowdown because of the supply chain from Eastern Europe into Western Europe. Maybe there's a slight slowdown but it's not enough to stop us on a global basis. But I do expect that only the more critical projects will get done in Europe until they sort of get through this whole crisis, especially probably around energy prices and the supply chain issues from Eastern to Western Europe.

Okay, that's super helpful color, Arvind. We published a note a couple of weeks ago on saying like if you really head into a recession, there's no place to hire an IT hardware, but there are a few people who do better than others. And I would say Apple and IBM are the 2 companies that really stood out in their ability to weather recessionary impacts. And so it would be helpful to hear from you how you think about the variability or the sensitivity to the model in terms of either, A, an economic slowdown or B, a more full-fledged recession. How should we expect or investors expect the portfolio to perform?

Well, first if I look at it, over half the business is now recurring revenue, right, or anodized. If I look inside consulting, I think if I remember my math right, it's a 22-month average contract length. So that means you have good visibility from now until the end of next year. So the hit there can only be people say, "Well, I want to not do the project." We tend to be in the more critical projects, not so much in the totally discretionary, so I'll call it in a mild, maybe in the expected range of any slowdown or recession, I don't really see a big issue on the consulting side. On software, well over 2/3, into the 70s is also recurring revenue and annuitized. Now the same way as we did not get a big boost in the pandemic spending because we are not on the consumer side, we don't expect to see any big headwind because of consumer spending, which is the first thing to get hit in any recession, right? I mean, I think we all will recognize that, that's the more quick side to go up, but it's also the quick side to go down. But because we didn't get any tailwind there, we don't expect much of a headwind there. Now let me acknowledge, I mean, for our audience here, will there always be some impact? Probably, because I mean, in the end, our customer could be an airline or an industrial company or a financial institution. Their customer in turn is the end user, but we found even during COVID times, many of our customers actually kept their spending pretty stable because they saw the end coming quickly, and they wanted to be stronger coming out. So I think that it could be that if there is something that is more protracted, maybe will come down to the lower end of our forecast as opposed to the upper end of our forecast. For this year actually, I know you know but in audience might not, we took ourselves from '22 to the upper end of our forecast on revenue. But it could be that if there is something more protracted in '23, I don't actually see that right now. So right now, I would say we're kind of in the middle, given what we are seeing in our contracts, in our demand generation activities. Talking about that, we just had our first, I'll call it, major in-person event, Think, which you referenced in the beginning in Boston, this thing. And we're all wondering, all of us, where people come and we were sold out. We set our limit at 1,000 and we were at 1,000 people. But more than that, Wamsi, because the energy of the clients, they're all talking about how do they make our progress, how do they put automation in, what did they do around cyber, the worries around how do you begin to do responsible AI, how do you use hybrid platforms. And so I think the themes you were on resonated with what they needed to do both in the short term and the medium term. I think that helps give us some confidence that we can ride these out. And I got to say it, you haven't yet but we are pretty committed to our dividend. We have decent headroom on the dividend. So that lets you also weather out a storm from an investor perspective.

Yes. No, absolutely. And I think it was really good to see that IBM maintained the entire dividend despite the Kyndryl spin-off and that was something that I think investors appreciated as well. If I could just touch really quickly on one of the points you made, Arvind, about the consulting portfolio and doing more mission-critical projects that probably don't -- or maybe not as economically sensitive. Can you give us just some little flavor on sort of what sort of projects are those, and why people are still so focused on executing down those lanes.

Sure. So look, I'll begin with the ecosystem. We are really good partners with SAP, with Salesforce, with Adobe and with the cloud players, Azure, AWS and Oracle. I'll just take a couple of quick examples here. If you're going to use this time period to do a big SAP transformation, leveraging S/4, leveraging HANA, maybe going from 120 instances, I'm thinking of 1 particular global CPG client going from 120 instances down to a few, you're not going to pause that work. It is so significant. It causes so much more efficiency. It causes so much better speed and nimbleness in the business. And then you couple into it, you take advantage of that transformation to say, "Look, it's not just a movement from one to the other. I'm also going to use this to simplify my supply chain. I'm going to get much more friendly with my distributors. I'm going to get much more direct with small distributors, not just large distributors." As you begin to do these business transformations, I'll look at you and say, even if I was on the other side trying to make that decision. I'm not going to slow that project down because I fully expect that even if there is a recession or a slowdown in a year or 2, we are done, I want to be in a place to take advantage of all that capability at the end. If I look at what Salesforce, I look ourselves, we went through our Salesforce experience together with Slack over the last 2 years. The productivity is driving on the front end for the sales teams and the service teams is so much that I'm not going to slow those down. I mean, I looked at our service team's productivity, and it really -- I mean, well over 3/4 of everything we do can now be deflected and done in 1 touch. That was not possible before. It was always taking multiple calls and multiple chats and interactions. So it really is helping drive what we call an enterprise workflow or rethinking of the business processes. I don't see those slowing down just to be straightforward. It would have to be something catastrophic for those to slow down. Then if I look at the cloud transformations, somebody who says, "Look, I want to shut down 4 data centers. Yes, I'm going to maintain some critical applications, so hence, my term on hybrid." Maybe a mainframe on my own premise or maybe in some rented data center space. But I do need to move these next 2,000, 3,000 onto either AWS or Azure. Well, they're not going to slow down that work because getting there, the quicker you get to the endpoint, the quicker you get both the business benefits and the cost savings. It's an and. So the moment you see those you're going to say, okay, let's go do that because if I slow it down and go to instantly left with extra labor costs, both in the interim and at the end. And when you all are expecting that the inflationary rates are not going to go away, you don't really want extra labor cost. I mean, a great example is the work we are doing with McDonald's. We had the Watson automated orders on the floor actually, I think. And what it's allowing them to do is go into a McDonald's restaurant and really offer that the drive-through can become a lot more automated than before. You can only think and speculate on the advantages you bring in a tight labor environment into those things. So you can see from my exact win, I just see so many examples around these topics. And maybe it's our luck but that's kind of the space that we play in, not some of the more consumer-facing applications.

No. I mean, I wouldn't say it's a lot. Clearly, I mean, you guys have made the investments, and I guess like that just brings me to my next question around as you think about investments, I think we've gone through different phases of the companies like history where investors would argue maybe investments were not prioritized as much as they should have in the past. And would love to get your take on the focus on investments. I think you have very clearly stated that revenue growth and free cash flow growth are the key priorities that's not really centered around EPS per se, but really on longer-term profitable growth trajectory. So can you help us think through what are the key priorities from an investment perspective, both in sort of the short term and longer term, like some of the elements like Quantum?

Yes, I'll begin on the more immediate investment, which come in both forms, organically increasing expenses so that we can begin to grow revenue as well as M&A. The key question is actually not which of those 2 it is because you can use increasing cash flow to help power both of those, not just one. So that is why the cash flow is critical, right, because it helps fuel the growth, okay. So then what are the areas for growth? So I really believe in focus. As somebody told me the other day, if you can do 2 things, do 1. But we'll do a few more than 1 but we're not going to do 2 dozen things either. So we said it's hybrid cloud and artificial intelligence. Then within that, we said that we want to invest in software and we want to invest in consulting capabilities. So we're going to invest in the software areas. It's going to be hybrid cloud, so think of things around Red Hat, around management, around security, around automation and around artificial intelligence. To the point you made, Wamsi, I know it's not luck. We've been predicting and calling that the shift on demographics is going to come. You're going to need more technology to substitute for labor. Both automation and artificial intelligence help you there. Cyber is clearly the issue of this decade. I mean, everything you hear from every government around the globe, including our administration here, and I have a lot of respect for some of the players there, right? I mean, and Jen Easterly, Anne Neuberger, Chris Inglis, really do know what is happening. And I would take their advice if I'm in the audience, but cyber is a clear issue, right? I mean, I think there's more reputational risk from cyber than from any other things for all of us, I mean, me and the audience included. So if you take that those are the areas, and we're going to keep increasing our capability there and then ditto on consulting. Consulting is going to be around these things. And you see that play out. So our acquisitions, whether it's around Neudesic, which is Azure capability or Taos or Salesforce capability, our Workfront and Adobe Experience capabilities, is sort of doubling down on the lanes we are in, right, the SAPs, the Oracles and these new ecosystem partners. And then that shows up in the 50% signings growth, which becomes revenue growth for the next quarter on for consulting. So that's sort of there. And people have heard me say, look, I want to do some but not just a set a moonshots. So I kind of put what I just called out in the area of we're doing some singles and some maybe homeruns to use a baseball analogy but not try to go over the stadium wall. Then we go to bet on some -- an area which I think is worth tens of billions by the end of the decade. And like all such things is going to go kind of very slow and then really begin to boom near the end, which is around Quantum, which we're at 100 cubits now, December '21. We said 1,000 cubits by end of '23 so that's not very far. And then 4,000 in '25, which point I think you begin to solve some commercial problems. And so that opens up commercial avenues around that in that time frame. And then you got to simplify the company. You've got to make it more nimble, more risk-taking and incredible ability to do partnerships. I talked about McDonald's, McDonald's, Schlumberger, Worley, ABB are all examples where you lean in. And then as you succeed together, there is revenue. It's not only an upfront sale. So as we think about that, that's kind of the fuel. You get revenue growth that gives you more cash flow. You fuel all these things that gives you more revenue growth. So hopefully, that's the virtuous cycle we're kind of into now.

Yes. No, I think that, that strategy makes a ton of sense. Arvind, maybe just pivoting to the most recent quarter here. You delivered very strong revenue growth but margins were a little bit more mixed. Can you maybe comment on what is weighing down the margins? And what are the key drivers that investors should focus on to understand what is the recovery path in these margins?

Yes. look, and I'll try to be straightforward about it. So first, we are very focused on driving absolute margins, not just percentage. And I'll take some pride in, we did improve, I think on a PTI basis, 280 basis points, on a net income basis, 130 basis points. But then I'll go into the different areas, infrastructure, consulting and software. And I won't even keep the audience waiting. I'll tell them that consulting is where we have some work to do, okay. So on infrastructure, when you're at the end of a product cycle, you expect to see some pressure on margins. So I kind of say that will sort of go up and down as we get into the end of this year with the Z cycle, I'll expect margins to improve. Then probably end of next year or maybe 18 months from the middle of this year, you can see them come down again as you reach the end of the product cycle. So it kind of goes through sinusoidal wave. So I'll kind of park that to the side. On software, we actually did improve margins. We improved margins by over 200 basis points. And that goes together with revenue growth, as you'd expect in the software business. You improve revenue, you're going to -- it's more -- there's increasing returns typically. And since we are kind of at scale, then you get those increasing returns and that kind of began to show through. That left consulting. Look, in consulting, we got some work to do. When you're sitting at 7 points -- 700 basis points of margin, I think low double digits is the better place to be. But then you sort of say, is this something fundamental? Or is this something that you're going to sort of get through? So one, look, when we saw the demand for consulting picking up, we decided to put in more capacity. So as the revenue comes, then you'd expect to see that capacity utilized. So over this year, we'll expect to see some of the margin come back from not having excess capacity. Two, definitely, inflation on labor wages does play a role there. Now that may take a bit more time to go through because as you sign new contracts, you kind of put in that new labor rate, but the older contracts is very hard to pass that on. So that will play through but it will take probably 12 months to sort of play through. We're also leaning into M&A. Now our M&A amount of consulting is kind of constant. But because we started only in early -- late '20, early '21, that sort of will wean through and you kind of get some contraction of margins because of that. But then that stops being a headwind because it's just in your base as you go forward. It's not an extra expense, all the integration expense and scaling impact of those things. And lastly, as we sort of get into areas where there is more and more demand that allows you to have better pricing, better automation, better technology. So all those things will sort of go through. So I would tell you that expect that we get from 7 points of margin in consulting at a PTI basis, up into the lower double digits. But that may take a bit of time, maybe the rest of this year and part of next year before we really begin to see that. So I sort of put it into those 3 buckets, and I'm acknowledging, yes, we got some work to do in consulting. But on the other hand, I think we're in a good place where we have the demand. People like our skills. We have the expertise in a tight market. So another way at that side and on the other side, where we didn't have all that and had the demand and didn't know how to fulfill it.

Yes. No, absolutely. And there's been a lot of effort that's gone into reskilling your consulting base over the years, and you're seeing that show up now transform into revenue growth. Arvind, you've been very clear about sort of the focus on hybrid cloud, and we still get questions from investors around why is this the right model? Why would the world gravitate towards a hybrid cloud model? And what assets within the IBM portfolio benefit the most when you think about the success of the hybrid cloud? And lastly, sorry to throw so many things at 1 time, but what does the ecosystem play here as well?

Okay. So let me try to do it in pieces. First, sort of why is hybrid cloud attractive to a client, I think, is your first part of the question. Look, I think that it comes down to, our clients all going to use only 1 public cloud, each of them, or are they going to use multiple public clouds and also have some on-premises, aka private infrastructure. In the industries we play in financial, telecom, public sector, health care, life sciences, a lot of it is going to be multiple public clouds and private. So yes, they may take some applications, let me say half, and be completely willing to have them locked into 1 public cloud because it is going to be locked in if you go natively into only 1. But for some, there want flexibility, whether it's resilience, whether it's sovereignty, whether it's the economics of not moving something from private. So you say, okay, there is this set of applications that could be in private, could be on a cloud, but I'd want to move them to a different one. And then to have fungibility of skills because the skills becomes the biggest issue we got. If you have a hybrid cloud kind of abstraction layer, it lets you go across those difference, still consume from the public clouds but have the ability to be fungible, not -- I don't ever mean in an hour or in a month or probably even a year. But if I take a multiyear framework, I definitely get fungibility of skills, but I also get the fungibility of deciding where I want to deploy this over time. And so that drives the value. Probably the data shows that. I mean, Forrester says 80% of people, other service say 75% degree, yes, that is the target architecture. Then it's up to us to prove that the engineering of our capabilities plays a role if that is the architecture people are picking. So that's sort of the first part of your question. Now what benefits? Well, Red Hat benefits, number one, because with both Red Hat Linux and OpenShift is the foundation of how you do many of the things that I'm describing. But then if you get that, then all the software we have that runs on OpenShift are sort of "the cloud packs", just to give it a name, they benefit because they drive. By the way, consulting benefits, and that's a nice virtuous circle because of consulting benefits and gets things deployed quicker, then you're going to get more consumption of Red Hat and the cloud packs. If cloud packs get going then they go there by their partners. So we have many of these capabilities. We just announced with AWS extending from where we already had the ROSA, which is the Red Hat OpenShift on AWS. We extended that into many of the cloud packs and other software, I think things like Maximo and Cloud Pak for Data and Cloud Pak for Automation. So those are going there. So they benefit. And by the way, AWS benefits. We have similar exact programs at Azure with ARO, A-R-O, for Azure Red Hat/OpenShift. So similarly, they benefit as we benefit. By the way, we do integrations with Salesforce and MuleSoft. We do integrations around AI and OpenShift, with Adobe and ditto with SAP. So it becomes an ecosystem where we all pull each other if that makes sense. So first part, why I believe the hybrid cloud architecture is the right one and the data seems to point to it is for many of our clients. Two, what parts of the portfolio benefit. And then three, how in an ecosystem, look, the phrase I always use, Wamsi, and I know it's a little bit cliche but maybe not too much, it's a win-win-win. When you work with the ecosystem first, there's got to be a win for the client. It is a win for the client. You got to make sure your partner is going to win. And the outcome is there a win for us. So it's a win-win-win, all 3. And thinking of these things as a win-lose, I think, is the wrong mental image. When you work together, you got to expand the size of the pie. So it's not about, hey, my size of the pie has a smaller angle. Well, wait, the pie is a lot bigger. So yes, it may have a smaller angle but the total pies are a lot, lot bigger.

Yes. No, that's an interesting analogy there. Arvind, to maybe pivot from that to maybe -- I don't know if it's proper to characterize it as win-lose, but in terms of consulting, you're clearly driving much stronger growth than you have before. It's probably coming at the expense of companies that possibly were taking advantage of, I want to say maybe lack of focus in the past from an IBM perspective, or lack of as much partnerships or just the go-to-market style, which has changed immensely. What would -- who would you say that you are taking share from, if that is the right way to characterize the trajectory of consulting?

Look, Wamsi, I want to first begin with that even in consulting, we have partnerships with what people may have regarded historically as competitive, but I want to call them partners. For example, we work with EY many areas around hybrid cloud, mainframe modernization, security, compliance, talent, which is a big topic. And maybe, again, we were lucky or smart to have picked that 2 or 3 years ago. We work with Deloitte on AI projects and driving AI, kind of deep into some of their embedded offerings. So I want to, first of all, say that is partnerships that are going on. Look, if I think about taking share, first of all, I think consulting itself is a market in the areas we play in, where it is higher single-digit growth for the market itself. So the market there is not a 2%, 3%, 4% market. The market in the areas we're in, with sort of the managed infrastructure no longer here, is a 6% to 8% market. So in a 6% to 8% market, if we say our aspiration is to grow, let's call it, low double digit, you're taking a little bit of share from others, but maybe more than anything else, you're maintaining your share in a really interesting market going forward. And then if I think about from whom we are taking share, look, I mean, there are people always who are weaker, not stronger. There are people who are more boutique-y. There are people who have not got some of the, I'll call it, business process consultant skills. They're much more around infrastructure. I think that is where we're taking share from because as we get to more automation and as we get to more cloud-like deployment, private or public, the amount of services work you need for the infrastructure side is just going to decrease. It's just a reality. So that goes back to your -- I think you made the statement in passing, that the focus and selection of what are the offering areas and where the skills are, that helps. Actually, doing partnerships help because you're playing in the areas where there is a natural 20% growth in the market. So if you play in an area where there's 20% growth, you can go get. Maybe that's why our 17% kind of makes sense in Q1. And we are willing to lean in to do a few acquisitions that gives us the nucleus on how to grow skills also as we go forward. So focus, some of my team will say, okay, they're picking 8 areas, no longer 20, not say yes to everything but staying in those areas, picking areas where there is well into double-digit growth in the real markets and then being true to your partners, along with the M&A and the expertise all plays in. And we really like to delight our clients, by the way. I think if you go survey outside, you'll find our NPS has been increasing. And the clients like our delivery methodologies of both being global but also garages, which is co-creation.

No, that's great. I appreciate that. Maybe pivoting to software. And when we think about the software portfolio, what are some of the products or developments that you're most excited about? And I have a few more things on software I'd like to touch on.

So first, of course, I got to start with Red Hat. We just announced new capabilities at Red Hat around taking the OpenShift capabilities to the edge. There's a hidden jewel in there around Ansible, which is a great automation platform but automation for IT. Then if I come into the core IBM areas around data and AI, automation and cyber, I'll begin with automation. Look, I think there is so much here to be gotten. And along with the, I'll call it, the acquisitions we have done, like Turbonomics and Instana, but our own organic Watson AIOps plays, if I come to an IT manager and they're running maybe partly on IBM Cloud, maybe partly on AWS or could be Azure and they're running some things on-premise, maybe an infrastructure from Dell or HP or Cisco, there's a network in there. Now you're sort of looking, okay, what resources am I consuming? If you draw the spaghetti diagrams of how a really complicated application works, after you've drawn your 450 touch points, you kind of give up and say, "This looks like -- that's why I called it the bowl of spaghetti, right?" So okay, so can I help put in technology that tells you was all this part of a real end-to-end application? What's getting consumed? What's your response time? Can I observe this? How can turn down and fix it in an automated way? I'll look at you in the eye and say, look, over time, this is a 6:1 improvement in labor productivity because of complexity in AI and automation. But maybe you take 2:1 in the short term, even if you're not going to go full loop. I think there's magic in there as this really redefines both the management and a monitoring and observability and a runtime environment. And this is really, I think, what enterprises are looking for. So I'm super excited about what we're doing there, and we are seeing the pull in the numbers there. On data and AI, look, we are very much about enterprise AI. What do I mean by enterprise AI. I'll use McDonald's but maybe a little bit dive deeper into the technology. If you're in a drive-thru, you're not doing general purpose Q&A. This is not Siri or Alexa. You're trying to say, "I want to order a quarter pounder. I want no onions but I want extra tomato sauce. And I want a Coke with that but I want no ice." So A, you're not doing general. It has to be against the menu, which makes sense then to their ordering system. You've got to understand the variations in the menu. Sometimes it's a meal, so there are 3 combinations and each one has this thing. So understanding how the menu evolves, understanding how in that environment, I mean, like we don't get the option to say, there shouldn't be a truck down the street or well, the train shouldn't be tooting its horn. You got to live in that environment. But the advantage is you know what the menu is. So you know that it's against those things. And having the capacity to go into 120, that's not such a random number of countries, they operate in with the team that can even help install microphones, if needed, is a big advantage in sort of an AI and what we play there. So I'm calling that enterprise AI as opposed to consumer AI. And that's kind of what we are good at. And if I look at cyber at the end, we are very focused on threat management, XDR identity not sort of firewalls and antivirus and those things. We don't do those. I think there are great players out there who do that. We're happy to partner with them and we do. But on threat management, this is really a landscape where if you can begin to use AI, again, you sort of see me use that recursively to say, can we predict where the bad actors might be? Can we kind of take that triage? I mean, like -- if I look at 1 sporting event, they got attacks over the 4 days the event went on. I mean, even if you say, okay, 1% you've got to look at, that's 400,000. You need a team of 2,000 security analysts. You said you could use AI to filter that down to a few hundred that are really meaningful because this is not duplication. There's a lot of false alerts because you want to tune these systems to be sensitive, not kind of coarse. And so applying all the data techniques, AI techniques is why I think there is so much interest. So those are the areas of software that we are very, very focused on and where we are putting our investments, both organically and inorganically.

So on that point, Arvind, on inorganic, right, we've seen a lot of valuation multiples compress in high-growth software SaaS stories. And so as you look at the market from an inorganic perspective, clearly, there's a lot more assets that are maybe more reasonably priced than the very expensive assets a year ago. And so as you look at that landscape, what do you think is interesting? Do you think valuations have re-rated to the point that it's actually interesting for IBM to engage in some software M&A?

Look, so there is the -- I'll call it, so we've been doing software M&A, right, $2 billion to $3 billion a year for the last 2, acknowledged less before that. But we did do Red Hat, so maybe that you can amortize over time. The $2 billion to $3 billion, we can afford to pay very high multiples because that, in this sense, is a tuck-in. It comes into our Salesforce. It is adjacent to some existing product, it helps drive those products faster. But I think you're asking me the question, and I'll be direct. You're asking, are you willing to do something larger than a tuck-in, which may be a few hundred or maybe around $1 billion or so? Look, valuation is now definitely much more attractive than they were 6 months ago. So let me just say that. So our criteria would be, it's got to fit in the lanes that are described, so that either it can work with our existing Salesforce, it's adjacent to our existing product. It's a similar buyer. It's not a brand-new industry that we know nothing about. So you've got to kind of put the strategic fit in. The next criteria I would put if it is going to be larger because I've said size is not really a question for us, but it's got to make sense. And I'll come to how much flexibility we do have. So I'll try to answer it directly. It's got to be something which is going to become cash flow accretive, call it, in the short term. So maybe not in the first month or 6 months, but it's going to very quickly become cash flow accretive for us. So now there's lots of properties that I think will meet that criteria, right, that they do get cash flow accretive within maybe the second year, if not the first year, et cetera. Now how much flexibility do we have? So I always say you can borrow forward in your cash flow, not like infinitely, but for a year or 2. And that is kind of why we put out a $35 billion free cash flow number. So if you say, I got to take 18 and put it away for the dividend that leaves you adjusted cash flow, a certain amount over 3 years. Then that added cash flow does give you a bit more debt facility even at the current rating. And then if you're willing to take maybe a notch that gives you another 5 to 10. So if you put that together, you get sort of 17 just from the $35 billion minus $18 billion. You say, okay, I can choose to spend that once or I can rule it out over years. Even if you say, look, I do want some in each year, that does give you a substantial, let's call it, 10-ish, you can sort of borrow more against the cash flow that gives you 5-ish. If you're willing on either look at investment grade or maybe look at some equity. You've got a fair amount of firepower. Now when things are not cash flow positive, people are looking at multiples of 15 or 20, that didn't make a lot of sense to us. Now that multiples are more reasonable, but I think it will take a few more months before people will accept that these are the multiples that are going to stay as opposed to that they are already there. And I think that's human nature. I don't think it's years by the way, I do think it's months.

No, that's super interesting perspective. But should I also interpret your comment as it's not about the size. I mean, if there was a strategic fit, you are willing to sort of pull forward some of those cash flows, you have the financial flexibility in the balance sheet to sort of do that and the strength of the portfolio that is continuing to generate very strong cash flow. So should I interpret that as you're not opposed to it and if the right opportunity presented itself like that you would be willing to look at something like that?

Wamsi, that's correct. And that is why we sort of couched it as $35 billion of free cash flow over 3 years last October to see if that is the direct flexibility. And we did say at the current debt rating, there is some added debt capacity because we're down to our current ratios by next year, so then that sort of reopens that up. And one can look at maybe a not or so, I wouldn't try to go too crazy on debt. So the reason for saying all that is that size is not the criteria. But with the newer multiples that are there, now things could be interesting because there is a return for our shareholder and in terms of what it can bring in terms of revenue growth. If it helps accelerate our plan, right, there's going to be an outcome. So if it helps accelerate our total plan, then it could be interesting. You've seen me pause on the would because I think there's got to be -- there's 2 sides in that equation.

Yes. No, absolutely. And not to go too deep down this sort of element around M&A, but I think that investors would love to get your thoughts around the integration risks surrounding M&A, right? So I mean, doing 1 large deal, typically, there are some added risk, both in terms of does that converting ultimately into being a very successful deal versus doing what you have done now over the last couple of years. I mean, you've done a tremendous number of smaller M&A, and you've been super successful with that, and you're seeing that in the results already, to some degree. So as you think about balancing those elements, do you think that although size is not sort of a limitation for you in any way, how do you think about the integration risk side of things?

Yes. Look, so on smaller ones, the integration risk is smaller. It's not 0. You got to make sure that there is a cultural fit. You got to make sure that people are aimed at enterprise customers, not at a different kind. You got to make sure they're aimed at all kind of enterprise customers who all want to get their capabilities to be critical. They all look at us and say, hey, four nines and five nines of reliability. I want an assurance from you that you're never going to misuse my data. I'm calling that all a cultural fit, right? It has to go together. We're very good at doing that. That is a formal part of our due diligence process. And we try to make our own assessment that the bulk of the engineering team is going to stay for a length of time or in consulting and the delivery leaders are going to stay, but it's based on our own AI-based assessments. Now if it's much larger, then yes, of course, there are added risks. Let me acknowledge that because the added risks are that we missed a part of the value proposition or a critical set of people who walk out. So then you sit down and you do more. You've got to be assured that the critical people are going to stay for a longer length of time. You got to be sure and you've got to decide, I go to run it somewhat independently like we ran Red Hat or I got to run it integrated? You got to make a decision, and you got to have that discussion with the other side before you close on the deal. Because if we think we're going to integrate it and they think they're going to be independent, that's where you get integration risk. So we have a pretty thorough checklist that you go determine. And look, I'm not really looking to create yet another independent vector like Red Hat. I won't rule it out but I wouldn't say that's preference #1. So it's probably got to fit in 1 or the other of those lanes. And that -- if you know that, that helps reduce your risk because you're going to be upfront about that. I actually don't think that there's a fundamental risk that is bigger or smaller. Big things tend to also get a lot more attention so you're trying to make sure there's less of a risk. And you try to make sure that there is a lot of client demand if you're going to do something big because now it's about scaling that business, right? It's not about trying to get more mature and to get it to a place where you can create the demand for it like you would do with a smaller acquisition. So yes, but I think I'm telling you that there's a lot of levers. And by the way, because of those reasons, you might walk away from 1 out of 2 deals that look interesting in paper because you quickly realize that there is something there that's just very hard to work around.

Yes. No, I really appreciate the color there, Arvind, and that's super clear. And maybe just conversely, right, like you've obviously orchestrated a lot of portfolio change. You've orchestrated at the spin-off of Kyndryl. You got the -- some of the Watson Health assets that got flatout sold. So as I think about the portfolio today or as you think about the portfolio today, are there other pieces of the portfolio that you think are maybe noncore? Or if you maybe put a different vector on it and say, there's a certain revenue criteria or growth criteria that you would like for these assets to meet and you give it some time, and if it doesn't meet that criteria, then it's up for sale or up for a spin? Is that the right way to think about it?

Look, we've always got to be running a business. So we've always got to be looking at, is there a contribution of margin and cash flow? And we always think it be pretty good about optimizing. And you mentioned a few and there's a few more, over the last 3, 4 years, we have always done with that lens. Now I believe, though, that we are in more or less the portfolio that we want for the medium to longer term. So I don't anticipate any more major significant action. That said, will there always be fine-tuning and optimization? Yes, that will always happen on a portfolio of our size. But I don't really anticipate a major one because you didn't mention both Kyndryl and Watson Health also. I call those major.

Yes, okay. No, that's helpful. Arvind, we briefly touched on Quantum. We didn't talk much about blockchain, but just sort of curious to get your take on -- I know the blockchain is a lot more than crypto and the crypto market is sort of imploding from its recent highs. But at the same time, you guys have been leaders in using blockchain for enterprise commercial reasons, partnerships with Maersk. I mean, you guys have already proven this technology out. What's the option been on blockchain? How are you looking at that over the next few years?

Look, I'm still convinced that blockchain, not for crypto, as you mentioned, so put us on mining in cryptocurrencies. And I'll just say, look, digital fiat currencies is the preserve of central banks and governments and they'll go ahead and do those or not. Now that said, in supply chain, if I really want to be able to share information in a confidential way but not all of it and only some of it, but I want immutability, meaning nobody else can go modify the information and also keep it confidential, I think there is a lot of use for blockchain in those markets. That's why you see us talk about Maersk and supply chain and shipping and food costs and all those because I still do believe that there is value in those applications. Now they have not come as quickly as we would like. But I think neither of us is giving up, Maersk is carrying on. We are carrying on. We have TradeLens that's the name of that asset that is sitting out there. We have a joint venture with Maersk on that, taking that to market. And I do believe that there is a lot of value still in there. But the value is going to come from transparency, taking away physical paper, allowing faster processing, lowering costs around delays, detention, demurrage on the other end. Now there's always going to be a set of people, as we all know, in the physical world. Not every process that can be transparent is because there are people who get value from it not being transparent. So there are forces that are going to fight to you. But all that said, I think in the end here, transparency is going to win. But it might take a bit of time. Then you also mentioned Quantum. Look, I'm super, super excited on Quantum. I think that Quantum -- if we kind of think of it visually, here's a set of problems that can be solved by classical computing. I think the world's done a wonderful job at leveraging classical computing, right, all the way from our consumer and social media engines to what we do with our enterprises and financials and automation and CRM and all that. But there's a vast set of problems that cannot be touched around materials, the physical world, around financial risk that just are not touched by these because it's infeasible. You would need massive classical computer. By the way, when I say massive, I'm talking Earth planet-sized, so I'm trying to say that's not feasible. Even with all the space technologies we're dreaming of, this is not going to happen in the next 100 years. Okay. Quantum offers a chance to solve some of those problems. That means you are taking problems that you just couldn't solve and can now begin to attack them. That opens up a lot of value. That's why I'm so excited about Quantum. And by the way, the Quantum I'm talking about is room-sized Quantum, consuming [ a few tens ] of kilowatts. And it can take and answer one of those problems that I'm saying you need an Earth-sized computer for. Okay, that's interesting. And I think that this is what is going to open up for the industry as a whole, hundreds of billions in value by the end of the decade and multiple tens of billions for those of us who provide the capability. And that's a pretty good ratio. 10% to 20% of the value for the vendors is a good estimate. And then you say sort of, okay, what's needed to open that up? Well, you need Quantum computers that have a bit more scale, so I'll say, thousands of cubits, not tens or hundreds. You need a bit better error than where we are today. But I'm still saying these will be noisy and error-prone. These are not perfect Quantum computers. And you need a bit better coherence, meaning they kind of can run computations for a bit longer than they do now. And we see there is vectors converging in terms of what can get done over the next 3 to 4 years. And that's why it's so, so exciting.

No, that really is super exciting. And I'm realizing that we're just over the top of the hour, and we want to be respectful of your time. Maybe, Arvind, just to wrap it up. As we look out over the next several years, what's just the key message around the IBM story that you think investors should walk away with? And we really appreciate you taking the time to be here today. It's been a pleasure. Always enjoy to hear your insights and you've been very generous with your time, so thank you so much.

Well, very simple. 70% of our business is now in growth areas based on consulting and software. Within that, more and more recurring revenue, leading to mid-single-digit growth for now, the immediate future and a cash flow growth that exceeds the revenue growth. I think that's a great model because it provides fuel for the machine to keep going faster and faster, but also to point to, we got the growth portfolio. We're going to give you the growth in both revenue and cash flow, and that'll allow more fuel down the road.

Fantastic. Arvind, thank you so much. We really appreciate you being here. This was super insightful. Always appreciate the color you bring both around the demand vectors and what you're doing and it's a great story to look at where we're excited to follow this transformation that you're driving.

Good to be here with you, Wamsi.

Thank you so much, Arvind. Thank you. Thank you, everyone, for joining us today. That does conclude our call. If you have any follow-up questions, please shoot me an e-mail or give me a call, and we'll try our best to get those answered. Thank you so much.