IBM Q1 Earnings: CEO Krishna Calls HashiCorp A Red Hat ‘Help’ And Strategy ‘Accelerant’

“We believe there will be added demand because a combined portfolio is more interesting,” IBM CEO Arvind Krishna said on an earnings call.

IBM executives painted the planned $6.4 billion purchase of cloud infrastructure tools vendor HashiCorp as complementary to multiple business segments – including fellow open-source tools provider Red Hat – even as IBM reported quarterly results that came in below Wall Street’s expectations.

On the tech giant’s earnings call Wednesday for the fiscal 2024 first quarter (ended March 31), Chairman and CEO Arvind Krishna called HashiCorp “a tremendous strategic fit.” IBM announced its intention to buy HashiCorp minutes ahead of the call and expects to close the deal before year’s end.

“We believe there will be added demand because a combined portfolio is more interesting,” Krishna said on the call. “We think even more clients will talk to us. That is how Hashi will help Red Hat. … Hashi to us is an accelerant for IBM strategy and for [IBM’s] software strategy. And Hashi helps in being offensive in terms of giving us an overall better portfolio so even more clients want to do business with us in the environment they are going to. That is kind of how we’ll pitch it.”

IBM 1Q 2024 Earnings

As for missing revenue expectations – IBM reported revenue of $14.5 billion for the quarter up 3 percent year over year ignoring foreign exchange but below Wall Street figures closer to $14.6 billion. Krishna and IBM Chief Financial Officer Jim Kavanaugh pointed to weakness in the consulting business and high interest rates as factors.

Kavanaugh described a “lengthening of backlog duration driven by large-scale digital transformations and a reduced level of revenue realization in the quarter as clients tighten discretionary spending” during the call.

“We are seeing some pressure on smaller, more discretionary projects,” Kavanaugh said.

His comments sounded similar to ones made by Accenture on its own March quarterly earnings call. The consulting giant lowered its revenue guidance for the current fiscal year to between 1 percent and 3 percent growth after originally forecasting 2 percent to 5 percent growth.

Accenture CEO Julie Sweet attributed the lower guidance to further limited “discretionary spending, particularly in smaller projects” and “continued delays in decision-making and a slower pace of spending,” according to a transcript of the consulting giant’s March quarterly earnings call.

The solution provider still sees “clients continuing to prioritize investing in large-scale transformations, which convert to revenue more slowly,” Sweet said on the Accenture call.

Accenture ranks No. 1 on CRN’s 2023 Solution Provider 500. IBM Consulting ranks No. 7.

More HashiCorp Deal Details

Krishna said that Armonk, N.Y.-based IBM has been a long-time HashiCorp partner and that the acquisition will help customers with applications across public clouds, private clouds and on premises. Heterogeneous and dynamic infrastructure strategies that become possible with HashiCorp will also help developers interested in deploying generative artificial intelligence (GenAI).

Kavanuagh said that about 70 percent of HashiCorp’s revenue comes from the U.S., with IBM’s international presence a “significant” opportunity for the Terraform creator.

About 20 percent of the Forbes Global 2000 are HashICorp customers and a quarter of HashiCorp customers bring in more than $100,000 in annual recurring revenue, with IBM a helpful resource “to better monetize and upsell their products,” he said.

For IBM, buying HashiCorp would result in “a more comprehensive hybrid cloud offering to enterprise clients, enhancing IBM's ability to capture global cloud opportunity,” Kavanaugh said.

As for other asset sales and purchases, IBM’s executives told analysts on the call that IBM expects to close on its purchase of two Software AG platforms – StreamSets and webMethods – by the middle of 2024.

While HashiCorp is best known for cloud infrastructure management, its security offerings “are also very, very interesting and really important as people navigate these very complex environments with all the worries about people losing secrets and keys, and that's resulting in ransomware or hacking attacks,” Krishna said.

When asked about potential future acquisitions by IBM, Kavanaugh said that “we will remain in the market prudently evaluating complementary tuck-in opportunities that fit our M&A strategy and we have got the capability of doing that.”

IBM Consulting Confidence

IBM Consulting brought in $5.2 billion in revenue during the quarter, up 1.7 percent year over year ignoring foreign exchange, according to the vendor. Backlog was up 7 percent year over year, but the vendor expects consulting revenue of “mid-single digit” growth “with acceleration throughout the year.”

Kavanaugh suggested that IBM Consulting fell victim to larger trends rather than internal hiccups, saying, “I think you're seeing some interesting dynamics in the consulting industry overall.”

The CFO also blamed Easter’s late appearance on the calendar, which “does impact a human capital-based business on the number of billing days,” he said.

Within the consulting segment, business transformation and technology consulting each grew 3 percent year over year. Application operations decreased 1 percent, “reflecting weakness in on-prem custom application management projects, partially offset by strength in cloud-based application management offerings,” the CFO said.

“We're not losing the business – that is moving out to the right,” he said.

Kavanaugh told analysts on the call that IBM continues “to see clients prioritizing large data and technology transformation projects focused on driving productivity with AI and analytics.” Consulting’s 4 percent signings growth was “our highest absolute first-quarter signings in recent history,” with a “trailing 12-month book-to-bill ratio” above 1.15.

Strategic partnerships made up more than 40 percent of the consulting revenue, with consulting’s Amazon Web Services and Azure practices growing double digits, Kavanaugh said. The Red Hat consulting practice and cloud modernization projects also grew by that amount.

The CFO said that consulting’s GenAI book of business is “ahead of pace at this stage.” He also said that IBM Consulting has been using Microsoft’s Copilot GenAI tool “to drive productivity for our clients.”

When asked by an analyst about positive signs for consulting and AI, Kavanaugh said that “in the first quarter, the book of business on GenAI was 2x all of last year.”

“We're winning in the marketplace,” the CFO said. “We're taking share. And by the way, we're well above that ramp we saw with regards to Red Hat.”

The Red Hat book of business is $2.8 billion in annual recurring revenue around hybrid cloud, Kavanaugh said. The vendor is “focused on capturing new client demand in areas around our key growth areas” and “driving that economic multiplier of consulting and technology across our hybrid cloud AI platform."

On the call, Krishna expressed confidence in consulting’s growth rate accelerating despite its first-quarter issues. “We are seeing a little bit – not across the board, not in all of the offerings in consulting, but where there is a little bit of discretionary labor, that is where we sense that pressure,” the CEO said.

Red Hat’s VMware Opportunity?

When asked whether VMware’s acquisition by Broadcom has presented an opportunity for Red Hat, Krishna said that Red Hat growth “is not so much directly related to VMware per se, but clients are all beginning to say … which is a platform they want to bet on for the next 10 to 20 years on which they will write their applications, deploy them both in their own data centers and on public clouds.”

Red Hat’s capabilities in containers, automation and virtualization and with HashiCorp coming, “all of this plays in,” he said.

The mid-teen bookings growth on Red Hat subscriptions “speaks to the demand in terms of not only is there demand, but we are realizing that demand in the book of business that we are getting clients to commit to on Red Hat,” Krishna said.

Red Hat revenue, part of IBM’s software business, grew 9 percent year over year during the quarter, according to the vendor, which does not break out exact revenue figures for its Raleigh, N.C.-based subsidiary.

Kavanaugh told analysts on the call that Red Hat saw “solid performance across the three key solutions” of Red Hat Enterprise Linux (RHEL), OpenShift and Ansible. Opportunities with AI and Watsonx helped drive the growth.

“Annual bookings growth was again in the mid-teens, with OpenShift up over 40 percent this quarter and RHEL and Ansible each up double digits,” he said.

When asked by an analyst about Red Hat, Krishna said that he is “very, very pleased with Red Hat” with “mid-teen or better bookings growth for the last three quarters.”

AI Growth Ripple Effects

Krishna told analysts on the call that IBM’s “partner ecosystem remains essential to both AI and hybrid cloud growth,” highlighting a deeper consulting relationship with Nvidia and ServiceNow embedding Watsonx.ai capabilities into its platform.

IBM’s Watsonx and GenAI book of business grew quarter over quarter and surpassed $1 billion since Watsonx’s launch last year, Krishna said. A large share of money from AI is in IBM Consulting. “We believe our comprehensive AI strategy is well positioned to help clients scale AI,” he said.

AI has proven to be an opportunity for IBM infrastructure offerings such as its “uniquely advantaged” Z mainframe servers and software, Krishna said. Customers will want to conduct AI inference “where the data is for security, efficiency and latency reasons.” And IBM’s full-stack focus “allows models to be built and trained on any platform and easily deployed on IBM Z.”

Clients have turned to IBM AI because of “the ability to leverage a combination of AI models, whether they are IBM’s, their own models, open-source models … and they can deploy these AI models across multiple environments,” Krishna said.

While 2023 saw a lot of excitement and experimentation around GenAI, in the first quarter of 2024, “a lot of people have woken up” to issues around return on investment (ROI), Krishna said.

“If I run this model just for this one business process, the infrastructure costs alone could be $300 million a year,” Krishna gave as an example. “That doesn't close ROI.”

Customer exploration of more cost-effective models that still provide good answers has been an opportunity for IBM’s own Granite series, he said. Krishna said that he has advised clients to not try multiple small experiments, instead trying a few use cases that can scale to help a large fraction of employees or customers.

“That's kind of a conversation shift from simply, ‘Oh, this is a nice new tool. Let me try it out to see what I can do. Not what I should do, but what I can do,’” he said. “And I think that is a big change in terms of helping the organization scale.”

Krishna told analysts on the call that the economy, with its “persistently high interest rates,” has actually fueled “demand for software and infrastructure because people believe technology helps you in those environments and helps in an environment of increased labor costs and increased supply chain costs.”

Q1 In Detail

The vendor generated $4.2 billion in net cash from operating activities during the quarter, up $400 million year to year. It saw $2.3 billion in net cash from operating activities excluding IBM Financing receivables and $1.9 billion in free cash flow, up $600 million year to year. It ended the quarter with $19.3 billion in cash and marketable securities, up $5.8 billion from the end of 2023.

Over the past 12 months, IBM generated $14.3 billion in net cash from operating activities and $11.8 billion in free cash flow. IBM restated its projected $12 billion free cash flow for the 2024 fiscal year and revenue growth around mid-single-digits, ignoring foreign exchange.

IBM’s software business segment brought in $5.9 billion for the quarter, an increase of about 6 percent year over year ignoring foreign exchange. Within this segment, hybrid platform and services grew 7 percent with automation up 13 percent.

Apptio, which IBM bought last year for about $4.6 billion, helped the automation business grow, Kavanaugh said. IBM and Microsoft have reached a deal to bring Apptio to Azure and co-sell to joint customers while Microsoft adopts Apptio capabilities internally.

Data and AI revenue grew 1 percent. Security revenue fell 3 percent, according to IBM. IBM’s transaction processing business grew 4 percent year over year, ignoring foreign exchange.

IBM’s infrastructure business brought in $3.1 billion for the quarter, about flat year over year, ignoring foreign exchange. Within this segment, IBM Z revenue grew 5 percent year over year, ignoring foreign exchange, and distributed infrastructure revenue grew 7 percent. Power revenue “was fueled by demand for data intensive workloads.” Storage “delivered strong double-digit revenue growth, including demand for high-end storage tied to the z16 cycle,” Kavanaugh said.

AI has helped spur interest in Storage “for data curation, model building and fine-tuning,” he said.

Infrastructure support revenue fell 7 percent year over year. The z16 has been available for about two years and surpassed z15 revenue performance, Kavanaugh said. IBM is “working with over 100 clients on the application of AI on z16,” he said, with use cases including anti-money laundering, anomaly detection and fraud detection.

IBM’s FY2024, Q2 Predictions

Looking ahead, Kavanaugh said that full-year revenue growth should be “in line with our mid-single-digit model – still prudently at the low end.”

IBM expects software growth “slightly above the high end of our mid-single-digit model,” the CFO said. Infrastructure revenue should decline due to “product cycle dynamics,” which will drive “about a half-a-point impact to our overall growth.”

He said the second fiscal quarter’s revenue growth rate should “be consistent with the full year.”

“For profit, we expect the first-half skew of net income will remain a couple points ahead of the prior year,” Kavanaugh said.

This morning IBM shares were trading around $165.50, down more than 10 percent from Wednesday’s $184.10 close. HashiCorp shares were trading just above $33, up from their $31.41 close Wednesday.