International Business Machines Q2 Earnings Call Highlights

Key Points

• IBM missed Q2 expectations as large software deals slipped late in the quarter, leading the company to lower its full-year 2026 revenue growth outlook to 4%–5% from above 5%. Management said the issue was tied to a shift in client spending toward infrastructure purchases, while free cash flow guidance was left unchanged.
• Software and recurring revenue remain a bright spot, with IBM saying about 80% of software revenue is recurring and annual recurring revenue reaching $24.6 billion, up 8%. The company said the weakness was concentrated in CapEx-sensitive enterprise license deals, while subscription and consumption-based offerings were largely unaffected.
• Other business lines showed mixed performance: consulting signings grew 6% with generative AI representing about 50% of signings, while distributed infrastructure revenue surged 37% and mainframe-related demand remained solid. IBM also reaffirmed major long-term bets in AI, open-source security, and quantum computing.

International Business Machines NYSE: IBM said its second-quarter 2026 results fell short of expectations as some large software transactions slipped late in the period, prompting the company to lower its full-year revenue growth outlook while maintaining its free cash flow target.

Chairman, President and Chief Executive Officer Arvind Krishna said IBM’s “conviction in the strength of our business and our ability to grow and drive shareholder value remains unchanged,” but acknowledged that the company “fell short” on execution in the quarter.

Chief Financial Officer Jim Kavanaugh said IBM delivered 1% revenue growth in the quarter, along with 30 basis points of operating pre-tax margin expansion and 5% diluted operating earnings per share growth. Through the first half of the year, IBM generated $4.8 billion of free cash flow, which Kavanaugh said was flat year over year.

Software Shortfall Tied to Client CapEx Priorities

IBM’s software revenue grew 5% in the quarter, while organic software revenue was flat. Kavanaugh said that in the final weeks of June, IBM saw “a shift in client spending priorities,” with many customers redirecting spending toward servers, storage and memory purchases to secure supply-constrained infrastructure ahead of expected price increases.

As a result, Kavanaugh said “tens of large deals failed to close on the timelines we expected,” accounting for the majority of the shortfall. He said the impact was concentrated in enterprise license agreements tied to mainframe and associated software, which are generally treated by customers as capital investments.

Transaction processing revenue declined 9% in the quarter, while data revenue grew 18% and automation grew 3%. Kavanaugh said transactional software revenue was down high single digits, while IBM’s subscription and consumption-based software was “largely unaffected” by the CapEx dynamics.

IBM said roughly 80% of its annual software revenue is recurring, including subscription and consumption-based offerings such as Red Hat, HashiCorp and Confluent, along with subscription and support revenue. Annual recurring revenue was $24.6 billion, up 8% from a year earlier.

Krishna said the software shortfall was limited to a “CapEx-sensitive area” of the portfolio, while the recurring portion of the business delivered healthy growth. In response to an analyst question, he said about one-third of the large deals that slipped had already closed in the first three weeks of the third quarter, calling that “a good indication” that demand was deferred rather than destroyed.

Guidance Lowered, Free Cash Flow Target Maintained

IBM now expects full-year 2026 revenue growth of 4% to 5%, down from its prior expectation for growth above 5%. The company maintained its expectation to grow free cash flow by about $1 billion this year.

Kavanaugh said the low end of the revenue range reflects the current environment and serves as IBM’s base case. He said the company now expects software revenue growth of 6% to 8% for the full year. The low end assumes recent spending dynamics persist through the second half, while the high end assumes a more typical conversion of IBM’s pipeline.

Kavanaugh said IBM expects infrastructure revenue to grow in the low single digits for 2026, helped by distributed infrastructure and continued program-to-program performance in IBM Z. Consulting revenue is expected to accelerate to low- to mid-single-digit growth for the year.

The company also expects 100 basis points of operating pre-tax margin expansion for the year, with productivity actions more than offsetting revenue-related headwinds. Kavanaugh cited efforts including broader use of AI and automation, reductions in third-party spending, improved sales and marketing efficiency, more efficient software development, supply chain optimization and enhanced services delivery.

Infrastructure Mixed as Distributed Systems Gain

IBM Infrastructure revenue declined 7% in the quarter. Kavanaugh said IBM Z performance was below expectations, but revenue through the first five quarters of z17 availability was nearly 130% of the prior program-to-program cycle.

Krishna said z17 is having “the best refresh cycle in reported history” and that IBM sees “no evidence of clients moving off the mainframe.” He said IBM Z runs more than 70% of the world’s transaction volume by value, with more than 140 million installed MIPS supporting mission-critical transactions.

Kavanaugh said clients continue to invest in IBM Z for resiliency, security and AI-related workloads. He said nearly 50% of z17 customers are investing in AI capabilities with Spyre Accelerator, and that clients deploying watsonx Code Assistant for Z are growing MIPS capacity three times faster than those that are not.

Distributed infrastructure was a brighter spot. Krishna said the business delivered its best quarter of revenue growth on record, rising 37%. Kavanaugh said IBM exited the quarter with about $500 million of backlog, its highest on record, supporting momentum in Power and storage.

Consulting Demand Supported by Generative AI

IBM Consulting signings grew 6%, marking a second consecutive quarter of growth. Revenue rose 1%, driven by demand for application modernization, data transformation and cybersecurity services.

Kavanaugh said generative AI represented about 50% of consulting signings in the quarter and now accounts for more than 30% of backlog. He said clients are moving from pilots to enterprise-wide deployments and are turning to IBM Consulting to re-engineer business processes and unlock productivity through AI, automation and digital labor.

Krishna said clients remain in the early stages of AI adoption and that IBM’s combination of consulting expertise and technology is a differentiator. He said IBM is positioned around hybrid cloud, sovereignty and trust, with watsonx Orchestrate serving as a control plane for building, managing and governing agents across models, clouds and on-premises environments.

IBM Highlights AI, Open Source Security and Quantum Plans

Krishna also discussed IBM’s broader growth initiatives, including AI orchestration, real-time governed data through Confluent and application health and compliance monitoring through Concert.

He highlighted Lightwell, a new IBM and Red Hat capability aimed at helping clients secure open source software. Krishna said clients can subscribe to Lightwell for $1 million per year to access open source packages that have been remediated or validated. He described the addressable opportunity as “multiple billions of dollars” and said IBM had made more than 7,500 package versions available in the first two weeks.

Krishna also said quantum computing is “no longer decades away.” He cited a letter of intent with the U.S. Department of Commerce to build Anderon, described as the world’s first pure-play quantum foundry, supported by $1 billion in chips incentives from the department and a $1 billion cash contribution from IBM. He said IBM plans to invest more than $10 billion in quantum over the next five years, supporting its roadmap to install what it calls the world’s first large-scale, fault-tolerant quantum computer in 2029.

Krishna closed by saying IBM remains confident in its growth opportunities and the actions it is taking to improve execution through the rest of the year.

About International Business Machines (NYSE:IBM)

International Business Machines Corporation (IBM) is a global technology and consulting company headquartered in Armonk, New York. Founded in 1911 as the Computing-Tabulating-Recording Company (CTR) and renamed IBM in 1924, the company has evolved from early electromechanical machines to a diversified technology provider serving enterprises and governments worldwide. IBM is publicly traded on the New York Stock Exchange under the ticker symbol IBM.

IBM's principal businesses encompass cloud computing and software, infrastructure and systems, consulting and technology services, and research and development.

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