IBM Q1 Results: Consulting Weakness, Software Strength And Investing In Enterprise AI

‘A lot of our software is running critical systems for our clients,’ IBM CEO Arvind Krishna says.

IBM CEO Arvind Krishna

IBM executives acknowledged “deceleration” and “weakness” in its consulting business during the first quarter of its 2023 fiscal year, but software demand remained “very steady” and the vendor detailed some of its investments in bringing more AI to enterprises, which could prove an opportunity for partners.

These were some of the highlights for the Armonk, N.Y.-based vendor’s quarterly earnings report, unveiled Wednesday. The quarter ended March 31.

“A lot of our software is running critical systems for our clients,” IBM CEO Arvind Krishna said. “And we don’t see those very subject to what we see in the current macroeconomic environment. And so that’s what gives us confidence.”

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IBM Q1 Results

Krishna added: “The movement toward hybrid cloud and the ability to take advantage of AI for enterprise productivity is perhaps going to be a tailwind as we enter the second half of the year – because I do think that clients are going to do a lot of automation and a lot of lot of cost cutting, which will likely benefit elements of our software portfolio.”

Software Spending ‘Very Steady’

An analyst on the call asked Krishna about overall IT spending, directly referencing CDW’s Tuesday report that the company – No. 4 on CRN’s 2022 Solution Provider 500 – expects the U.S. IT market to “decline at a high single-digit rate in 2023.”

CDW executives said in the report that the company saw “a period of intensifying economic uncertainty that led our customers to spend more cautiously and prioritize mission-critical initiatives,” resulting in “first-quarter performance below our expectations.”

Krishna said that in the U.S., IBM “did see some slowing down in consulting projects,” but no project cancellations.

“I want to caution that weaknesses are shrinking,” he added. “Double-digit rates just went down into 6 to 8 percent, which is still healthy.”

He believes the consulting slowdown could spread globally, but it should not spread into the software segment, whose demand remained “very steady.”

“We are not seeing any signs of weakness in software,” he said, noting that IBM sells only business-to-business software, nothing consumer-facing.

As for infrastructure, spending for IBM is more tied to product cycles than the greater economy, Krishna said.

Looking at the world economy, Krishna said that in his view, “a lot of the uncertainty that is in the media” in North America is not present in Japan, India, the Middle East and other parts of Asia.

Europe has “actually been stronger than I would have predicted six months ago,” he said.

“When we look at the mixture of interest rates, inflation, wage inflation, demographic – meaning labor shortages – supply chain resiliency, cyber, technology is actually the only answer companies have against all that. Now that does apply to the larger enterprises, who are our primary customers.”

IBM Focused On Enterprise AI

Although the current fervor over AI is focused on consumer-facing tools such as text-generator ChatGPT and image-generator Dall-E – both created by Microsoft-backed OpenAI – Krishna sees generative AI and large language models (LLMs) as having “a tremendous application to the B2B side of AI inside enterprises” – namely, in customer care, IT operations, digital labor and cybersecurity.

IBM is automating thousands of call center responses with AI, saving human resources (HR) and accounting teams thousands of hours in labor-intensive data entry tasks.

Krishna didn’t name Microsoft and Google – which unveiled its consumer-facing Bard text-generator this year.

But he said that consumer AI “is going to be a home run for those companies that are going down that path.”

By 2030, AI should add $16 trillion to the global economy, Krishna said. “We are seeing a lot more interest from businesses in using AI to boost productivity and reduce costs,” he said. “Productivity gains will come from enterprises turning their workflows into simpler automated processes with AI.”

For enterprises, generative AI users will “worry about the data” used to train models and “cannot have an answer that occasionally inserts some fiction into the answer – they need an answer that is from reliable sources only.”

IBM is in the race for enterprise AI, Krishna assured analysts on the call. In February, the vendor introduced Vela, an AI-optimized cloud-native supercomputer.

One of the benefits of LLMs is they can actually decrease the overall cost of an enterprise deploying AI, Krishna said.

“What we’re seeing is that a large language model can be trained and then do 100 tasks with very minor additional training,” he said. “So yes, the first screening is a lot more expensive, maybe four or five times. But then if you can do 100 tasks for almost no additional cost, you can see that the overall is a four-to-five times benefit in terms of time-to-value and productivity.”

IBM launched a preview for AI for ITOps in Ansible – called Project Wisdom internally – that yielded 60 to 80 percent of code written by AI instead of an IT worker, he said.

And for international businesses, they can create order taking programs in up to 20 spoken languages for the cost of one, he said.

Banking Crisis, M&A, Labor Costs

When asked about any effects on IBM from the March banking crisis – with the failures of Silicon Valley Bank, Signature Bank and Silvergate Bank, Krishna said that IBM faces a “second order impact” instead of a first order. That second order impact should be “very tiny” and “muted,” he said.

Tighter lending standards by smaller banks should affect small and midsize businesses, which are not direct IBM clients, he explained.

“When we are looking at our large banking clients – whether you think of the top five or 10 in the United States and think of the top 20 in Europe – we’re seeing pretty consistent demand right now because that is largely driven by payments, by retail accounts, by capital markets. And as you think about all of those, as long as you have reasonable employment and reasonable GDP (gross domestic product), we expect that that demand is going to continue for our first order of clients.”

When asked about potential mergers and acquisitions in the future, Krishna said that IBM is interested in buying companies involved in hybrid cloud, AI, data, cyber, automation and accelerating consulting.

“As asset prices adjust, this could be quite an opportunistic time” for acquisitions, Krishna said. “Now, is it going to be opportunistic in a month, or in three months, or 12 months, I can’t really predict.”

Krishna also told analysts that IBM faces “the same inflation that the rest of the world has seen” in employee wages.

“Our employees are expecting higher wages. As we hire new people, they get hired in at higher wages than their similar colleagues were a year ago,” he said. “We have to get a return on that back from our clients.”

IBM Q1 Results

IBM saw $14.3 billion in revenue for the quarter, an increase of 4.4 percent year over year ignoring foreign exchange.

The software segment – which includes hybrid cloud, Red Hat, automation, data, artificial intelligence and security – brought in $5.9 billion in revenue, an increase of 5.6 percent ignoring foreign exchange.

IBM did not break out the revenue figures for divisions within its software segment. But the vendor reported that hybrid platform and solutions’ revenue grew 5 percent year over year ignoring foreign exchange.

IBM Chief Financial Officer Jim Kavanaugh said that annual recurring revenue for the hybrid platform and solutions division was $13.5 billion.

Red Hat’s revenue grew 11 percent. Automation grew 2 percent. Data and AI grew 3 percent. Security grew 2 percent. And transaction processing grew 7 percent.

The consulting segment – which includes business transformation, technology consulting and application operations – saw revenue of $5 billion for the quarter, an 8.2 percent increase year over year.

Business transformation grew 6 percent ignoring foreign exchange. Technology consulting grew 4 percent. And application operations grew 13 percent.

The infrastructure segment – which includes zSystems and infrastructure support – saw revenue for the quarter of $3.1 billion, flat year over year ignoring foreign exchange rates.

Hybrid infrastructure grew 4 percent ignoring foreign exchange. Within this segment, zSystems grew 11 percent and distributed infrastructure was flat year over year.

Infrastructure support revenue for the quarter decreased 4 percent ignoring foreign exchange.

IBM Financing brought in $200 million for the quarter, up 31 percent year over year ignoring foreign exchange.

IBM generated $3.8 billion in net cash from operating activities during the quarter, up $500 million year to year. IBM had $1.3 billion of free cash flow, up $100 million year over year.

IBM’s stock traded at $129.11 a share after hours Wednesday, up 2 percent.

IBM’s Guidance

For the full year of 2023, IBM expects revenue growth between 3 percent and 5 percent, ignoring foreign exchange.

The vendor expects free cash flow of about $10.5 billion, up $1 billion year to year.

IBM expects Red Hat to grow 11 to 13 percent for the year, with OpenShift and Ansible helping the growth.

“We are seeing more demand coming up as we go through the year,” Krishna said. “We know our cycles of renewals and Red Hat – if you start to think that much like other software businesses, it’s about a three year cycle – if you go all the way back to 2020, which is a boom year, those are coming up in 2023.”

Kavanaugh said that OpenShift grew north of 40 percent during the quarter. “We’re seeing very good momentum in OpenShift as the leading hybrid cloud platform overall,” he said.

Almost four years since buying Red Hat, IBM has “quadrupled the Red Hat revenue from pre-acquisition … and around the multiplier effect, we’ve accelerated our software portfolio and we’ve accelerated our consulting portfolio to a high-mid to high single digit growth business overall,” he said.

“We’re very pleased overall,” Kavanaugh said.

IBM is wrapping on the introduction of z16, meaning 2023 infrastructure revenue should decline with a pre-tax margin in the low teens, Kavanaugh said.