International Business Machines Corporation 2026 Q3 Earnings Call

I'd like to welcome you to IBM's third quarter 2026 earnings presentation. I'm Olympia McNerney, and I'm here today with Arvind Krishna, IBM's Chairman, President, and Chief Executive Officer, and Jim Kavanaugh, IBM's Senior Vice President and Chief Financial Officer. We'll post today's prepared remarks and a replay of today's webcast on the IBM investor website within a couple of hours. The earnings presentation is already available. To provide additional information to our investors, our presentation includes certain non-GAAP measures. For example, all of our references to revenue and signings growth are at constant currency. We provided reconciliation charts for these and other non-GAAP financial measures at the end of the presentation, which is posted to our investor website. Finally, some comments made in this presentation may be considered forward-looking under the Private Securities Litigation Reform Act of 1995.

These statements involve factors that could cause our actual results to differ materially. Additional information about these factors is included in the company's SEC filings. With that, I'll turn the call over to Arvind.

Thank you for joining us today. Revenue growth in the third quarter accelerated to 6% above the base case we laid out in July. This performance reflects acceleration across our segments, led by software growth of 9%, infrastructure growth of 5%, and modest improvement in consulting. We entered the quarter focused on disciplined execution, which also drove strong performance in profitability and free cash flow. These results demonstrate the strength of our portfolio, the continued value clients place in mission-critical platforms, and our confidence in both our strategy and the outlook for the balance of the year. Technology innovation in both hybrid infrastructure and super intelligence is leading to better business performance. This quarter's results reinforce the strategic choices we have made over the last several years to advance IBM as a software-led hybrid cloud and AI platform company.

In software, Red Hat again grew 11% with bookings growth accelerating back to the high teens. OpenShift ARR growth accelerated to over 30% as organizations scale super intelligence applications and agents into production, reinforcing our conviction that we remain in the early stages of a long-term application modernization cycle. Transaction processing grew 10%, underscoring the strategic importance of the mainframe and validating our view that the softness we saw in the second quarter reflected timing rather than underlying demand. Data grew 20%, supported by continued strength in Confluent. Infrastructure was up 5%, driven by continued momentum in distributed infrastructure, growing 32% this quarter. AI continues to increase demand for storage, and we are gaining share through differentiated offerings across FlashSystem, Storage Fusion, Tape, and IBM Z storage, including AI-enabled capabilities that help clients scale and manage data for AI.

Consulting revenue grew 2% as clients modernized to deploy AI securely and at scale. The durability of our portfolio remains a defining feature of IBM today. z17 continued the strongest innovation cycle in the platform's history, generating more than $1 billion of incremental revenue over six quarters, compared with prior programs. This reflects the security, reliability, scalability, and compelling economics of the platform. As infrastructure costs rise, IBM Z delivers a 2 to 15 times total cost of ownership advantage versus off-platform alternatives, positioning us to capture additional value as AI workloads grow. Building on that advantage, we introduced new single-frame and rack-mount IBM Z systems in July that help clients address data center space, cost, and deployment constraints without compromising performance or security. Client response has been strong, contributing to the highest mid-range revenue launch in IBM Z this quarter in nearly two decades.

Last quarter, we told you Lightwell represents a multibillion-dollar opportunity for IBM and Red Hat to help clients secure their open-source software. Since then, some of the world's largest enterprises have signed up as clients, and we have built a pipeline approaching $700 million in a short period of time. We have released more than 40,000 remediated packages to the Lightwell network, demonstrating the rapid scale-up of our remediation capabilities. Now turning to our AI strategy. Enterprise AI is entering its next phase. Deploying more models or building more agents will not be enough. The advantage will belong to a company that can operate AI securely, efficiently, and sustainably across the enterprise.

Organizations are recognizing that AI is only as effective as the system around it, the data that provides context, the workflows that orchestrate action, the infrastructure that secures and optimizes operations, and the hybrid cloud foundation that provides flexibility without lock-in. IBM has assembled these capabilities across four platforms. Confluent provides continuous business context through a real-time data foundation. watsonx, including IBM Bob and watsonx Orchestrate, support AI-driven software development and agent orchestration. HashiCorp and Apptio automate identity, access, and policy while optimizing cost and performance. Red Hat provides the open hybrid architecture spanning public cloud, on-premises, sovereign environments, and the edge. Together, these platforms help clients move from isolated deployments to AI operating at enterprise scale. Data sits at the center of the AI operating model. 72% of organizations report insufficient real-time data infrastructure, which holds back AI at scale. Agents need the current state of the business.

That is why we are excited about Streamhouse, a capability from Confluent that continuously captures, transforms, and queries real-time data. It complements warehouses and lake houses. A Streamhouse makes real-time governed data continuously available to applications, analytics, and AI, unifying operational and analytical data into a single architecture. We believe Confluent is uniquely positioned with a complete open and hybrid approach that helps clients avoid lock-in while deploying wherever the data resides. As AI scales, clients ask two questions: what will it cost and who controls it? We are innovating on both. Apptio now connects AI spend to business results, providing visibility into AI usage, token consumption, and the cost of running it across the enterprise.

llm-d, an open-source project developed with Red Hat and Google, reuses previously processed context, helping clients run large AI models at 5 to 10 times lower cost by making more efficient use of existing GPU infrastructure. IBM Bob now runs on-prem, so clients in regulated and sovereign environments can keep code and models on their own infrastructure. Governance matters as much as intelligence. As agents multiply, enterprises need to know who each agent is, what authority it has, and what it can access. HashiCorp Vault allows clients to register, authorize, audit, and revoke agents and secure their credentials. IBM Agent Identity and HashiCorp Vault are partnering with NVIDIA Open Agent Safety Platform to strengthen agent security. We believe Agent Identity will become as foundational to enterprise AI as identity has become to the internet. Finally, quantum remains a strategic area of differentiation for IBM and a significant long-term opportunity.

In July, three independent demonstrations of quantum advantage were achieved on IBM hardware with the University of Chicago, Algorithmiq, and Qedma, providing further evidence that quantum computing is moving from scientific promise towards practical value. Our Nighthawk r2 processor has achieved important roadmap milestones across speed, scale, and quality, delivering 7,500 gates, executing 100,000 circuits per second, and enabling performance improvements of up to 19 times over prior generation systems. That performance changes both time to solution and the economics of quantum computation. Workloads costing approximately $100 to run on IBM could cost up to $10 million on slower competitive modalities. Recently, IBM was selected for Stage C, the third phase of the Quantum Benchmarking Initiative led by DARPA, the U.S. Defense Advanced Research Projects Agency, another validation of the strength of IBM's path to building a fault-tolerant quantum computer. Commercial momentum is also growing.

This year, IBM Quantum has signed 16 enterprise engagements across industries including automotive, aerospace, telecommunications, financial services, and manufacturing. This includes AT&T and General Motors, amongst many others, who are now all part of the IBM Quantum Network, the world's largest network of quantum innovators. We are also advancing the technology and infrastructure required for industrial-scale fault-tolerant computing, including the successful connection of our first modular cryogenic systems and continued progress on our 300,000 sq ft Poughkeepsie manufacturing facility. This, along with the closing of the $1 billion award from the Department of Commerce in Anderon for manufacturing quantum wafers, gives us confidence that after the Starling demonstration, we are ready to scale. We look forward to talking more about our progress at our Quantum Day on December 10.

In closing, our third quarter performance reflects the strength of our portfolio and the progress we are making against our strategic priorities of delivering both sustainable revenue growth and higher profitability. Our results reinforce our confidence in delivering revenue growth for 2026 in a range of 4%-5% and enable us to raise our year-over-year free cash flow growth expectation to more than $1 billion. With that, let me hand it over to Jim.

Thanks, Arvind. In the third quarter, we delivered solid results with 6% revenue growth, 70 basis points of operating pre-tax margin expansion, and 11% diluted operating earnings per share growth. Through the first nine months, we generated about $8 billion of free cash flow, up 8% year-over-year. These results reflect strength across our portfolio and solid execution against our priorities. Let me walk through the performance in each of our segments. Software revenue growth accelerated four points sequentially to 9% this quarter, including over four points of organic growth. This performance was driven by our high-value annual recurring revenue base, which grew 8% to $24.9 billion. Three of our four software sub-segments grew revenue double digits, led by the combination of strong new business performance and pipeline closure rates, including the successful closure of around two-thirds of the large deals that slipped from the second quarter.