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IBM (IBM +3%) is trading higher after reporting a huge EPS beat in Q2, its largest upside since 4Q20. Revenue rose a pretty modest 1.9% yr/yr to $15.77 bln, but that was better than expected. Another positive was IBM raising its FY24 free cash flow guidance to now be above its $12 bln prior guidance. It also reaffirmed FY24 constant currency (CC) revenue growth consistent with its mid-single digit model. IBM posted strong results in Software and Infrastructure while Consulting was a bit soft.

• Software growth accelerated by 8.4% CC to $6.7 bln, with growth across both Hybrid Platform & Solutions (+6% CC) and Transaction Processing (+13% CC) as clients leverage the capabilities of IBM's AI and hybrid cloud platforms. IBM said that this performance reflects investments it has been making, both organically and via acquisitions. Red Hat annual bookings growth accelerated to over 20% in Q2, including OpenShift annual bookings up over 40%.
• Infrastructure also had a strong performance with CC revenue up 2.7% yr/yr to $3.6 bln. IBM is capitalizing on strong and broad-based demand for its hardware platforms, especially IBM Z. The company noted that it's now more than two years into the z16 cycle and the revenue performance continues to outperform prior cycles. Clients are facing increasing demands for workloads and IBM Z addresses these needs.
• Consulting revenue was a bit weak, up just 1.8% CC to $5.2 bln, but down 0.9% in actual dollars. IBM saw a pullback on discretionary projects as clients prioritized spending. Higher rates and inflation impacted timing of decision-making and discretionary spend in Consulting. A silver lining is that IBM's book of business in generative AI inception to date is greater than $2 bln, and about three-quarters of that represents Consulting signings with strong quarter-over-quarter momentum in Q2.
• Speaking of AI, it has been a year since IBM introduced Watsonx and its generative AI strategy to the market. IBM has infused AI across the business, from the tools clients use to manage their hybrid cloud environments to its platform products across .ai, .data, and .gov, to Infrastructure and Consulting. In Software, IBM noted that its automation products like Apptio and watsonx Orchestrate are leveraging AI. IBM expects to do the same with HashiCorp once that acquisition closes. In Infrastructure, IBM Z is equipped with real-time AI inferencing capabilities, and in Consulting, IBM said its experts are helping clients design and implement AI strategies.

After a gap down following its Q1 report in April, IBM bounced back with a huge EPS beat in Q2 and that was despite its Consulting segment being soft. Technology spending remains robust and that was evident with IBM's huge quarter from its Software segment. Unfortunately, higher rates and inflation are causing some clients to rein in some Consulting spend. Nevertheless, we think this report, particularly IBM's take on AI spending, and IBM's raised FCF guidance bode well for other tech names as we get into the heart of earnings season.