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IBM (IBM -6%) is pulling back sharply despite reporting quite healthy upside results for Q1 last night. This was its second largest EPS beat in the last 17 quarters. Revenue inched up 0.5% yr/yr to $14.54 bln, but that was a bit better than expected. Of note, Q1 is IBM's smallest revenue quarter each year, but it's still important for setting the tone for the year. IBM also guided for upside Q2 revs and reaffirmed FY25 guidance with revenue growth of at least 5% CC. It also reaffirmed FCF of about $13.5 bln.

• Its Software segment was the star of the show with revenue up +7% (+9% CC) to $6.3 bln with strength across key categories of Red Hat (+13% CC), Automation (+15% CC), Data (+7% CC) and Transaction Processing (+2% CC). Software is now about 45% of its business with 80% recurring revenue. Red Hat growth was driven by bookings growth in the high teens. Also, OpenShift is now at $1.5 bln ARR, growing about 25%.
• Consulting segment revenue was down -2% (flat CC) to $5.1 bln. IBM said it's seeing clients delay decision-making, especially in discretionary projects which impacted IBM's in-period signings. A silver lining is that IBM had good growth in transformational offerings like Hybrid Cloud and Data. It also continues to build its Consulting generative AI book of business, which is now over $5 bln inception to date.
• Infrastructure segment revenue was down -6% (-4% CC) to $2.9 bln. Hybrid Infrastructure was down -7% CC, comprised of IBM Z being down -14% CC and Distributed Infrastructure -4% CC. However, this segment's results are not all that meaningful. All eyes are on the upcoming launch of its next generation z17 mainframe in mid-2025, which delivers enhanced AI acceleration. IBM says z17 discussions have resonated with clients, given significantly lower power requirements, higher capacity growth and increased performance over z16.
• In terms of its macro view, IBM believes uncertainty may cause clients to pause and take a wait-and-see approach. There are some areas of strength and there are some areas of its business where volatility acts as a catalyst for demand. This played out over the last couple of weeks amongst its financial services clients.
• However, for clients with a more direct impact from current policy, the slowdown may be more pronounced. In particular, Consulting is more susceptible to discretionary pullbacks and DOGE-related initiatives. With that said, IBM has not seen a material change in client buying behavior early in Q2, which likely helped persuade management to reaffirm FY25 guidance.

Overall, IBM's Q1 report was quite strong and even the guidance was encouraging. In fact, we believe this was the first time IBM provided specific revenue guidance, not just its CC outlook, in many quarters which was a nice positive. The problem was the macro commentary on the call, namely that some clients are being cautious in the near term. IBM's Consulting segment seems to be the most vulnerable and it tends to see headwinds before other parts of the business. On a final note, we would have liked a bit more color on the upcoming z17 launch. With the macro uncertainty, the timing of the launch does not seem to be the best.