Welcome, and thank you for standing by. At this time, all participants are in a listen-only mode. Today's conference is being recorded. If you have any objections, you may disconnect at this time. Now, I will turn the meeting over to Ms. Patricia Murphy with IBM. Ma'am, you may begin.

Thank you. This is Patricia Murphy and I'd like to welcome you to IBM's Fourth Quarter 2022 Earnings Presentation. I'm here today with Arvind Krishna, IBM's Chairman and Chief Executive Officer, and Jim Kavanaugh, IBM's Senior Vice President and Chief Financial Officer. We'll post today's prepared remarks on the IBM investor website within a couple of hours, and a replay will be available by this time tomorrow. Provided additional information to our investors, our presentation includes certain non-GAAP measures. For example, all of our references to revenue growth are at constant currency. We have provided reconciliation charts for other non-GAAP 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. So, with that, I'll turn the call over to Arvind.

Thank you for joining us. Our fourth quarter and full year results demonstrate the execution of our hybrid cloud and AI strategy. We delivered strong revenue growth in our business. The growth was broad-based across our software, consulting, and infrastructure segments, as well as across geographies. Our clients recognize that technology continues to be a fundamental source of competitive advantage. Over the last several quarters, it has become clear that technology is playing a significant role in boosting productivity in the face of inflation, demographic shifts, supply chain challenges, and sustainability requirements. We entered 2022 as a more focused company and took steps to reinforce our position. We strengthened our consulting expertise and expanded strategic partnerships. To bolster our software portfolio, we invested in hybrid cloud and AI capabilities. We also delivered significant innovations in infrastructure with our z16 and Power platforms. All of this was brought to market with a more technical and experiential sales approach. Looking back on the year, we are pleased with the progress we made. We delivered revenue growth above our mid-single-digit model and we delivered solid free cash flow. But I'll acknowledge there is more to do. This year, we'll unlock more productivity, expand our strategic partnerships, and invest more in specific growth markets. For 2023, we see revenue growth in line with our mid-single-digit model range and about $10.5 billion of free cash flow. This keeps us on a path of sustainable growth. I will now provide some color on the progress we are making in the execution of our strategy. Our perspective is clear. Hybrid cloud and AI are the two most transformative technologies for business today. These technologies work together to drive business outcomes. Hybrid cloud is where the world is going. Containers are the preferred destination for applications. Hybrid cloud offers more value than relying on a singular public cloud. It enables organizations to drive business value across multiple clouds, on-premise, or at the edge. This includes scale, security, ease of use, flexibility of deployment, seamless experiences, and faster innovation cycles. Our platform, built on Red Hat, is the leading container platform, allowing clients to harness the power of open-source software innovations. IBM software and infrastructure technologies have been optimized for this platform. Our consultants and others leverage their extensive technical and business expertise to accelerate clients' digital transformation journeys. Clients are realizing real value from working with IBM's hybrid cloud platform approach. For example, we worked with the Canadian Imperial Bank of Commerce, CIBC, to adopt a hybrid cloud approach. Using Red Hat technology, CIBC manages and scales its infrastructure with greater speed and flexibility. They can now develop applications in a private cloud and quickly deploy them to a public cloud. They deliver hundreds of new applications and reduced provisioning time by 95% and deployment time by 50%. We are helping Delta Airlines leverage hybrid cloud to modernize operations, automate operations, and integrate security. IBM Consulting deployed Red Hat on Amazon Web Services and IBM Cloud Packs to provide a consistent platform. Delta now has more levers they can use to boost developer productivity, reduce time to market, and improve employee satisfaction. CIBC and Delta are both great examples of the value hybrid cloud can provide. Let's now talk about artificial intelligence, or AI. AI is projected to contribute $16 trillion to the global economy by 2030, including a massive boost in productivity by infusing AI into every enterprise process. We have been co-creating with many clients to deploy AI at scale. We automated the drive-through experience for quick-serve restaurants. We accelerated the rollout of COVID-19 vaccines by automating the processes that assist millions of customers with inquiries and appointments. By applying AI and automation, we have helped security analysts to cut response times from hours or days to mere minutes. Recently, the U.S. Patent and Trademark Office partnered with IBM to leverage a host of AI capabilities that make it easier for people to glean insights from their vast database of patents. The BBC is now using our AIOps software to automate the management of its IT infrastructure. For businesses, deploying AI can be challenging because it takes time to train each model. But by using large language models, companies can now create multiple models using the same data set. This means businesses can deploy AI with a fraction of the time and resources. That is why we are investing in large language models, our foundation for our clients and have infused these capabilities across our AI portfolio. Our partner ecosystem plays a critical role in the execution of our strategy. In the fourth quarter, we made a series of new IBM software offerings available as a Service in the AWS marketplace. Likewise, Red Hat continued the expansion of its offerings in hyperscaler marketplaces, making Ansible Automation Platform available on both Azure and AWS. Adobe and Salesforce are also leveraging open-source innovation based on Red Hat technologies in their offerings. Business with our strategic partners continues to grow, with SAP, Microsoft, and AWS, all over $1 billion in revenue for the year. We've had great success with our strategic partners, and as we enter the New Year, we are expanding and better enabling our broader ecosystem. Recently launched Partner Plus, a new simplified program that increases our reach and scale through new and existing IBM partners. We remain focused on delivering new innovations that matter to our clients. In the fourth quarter, we introduced Red Hat Device Edge, a lightweight solution to flexibly deploy traditional or containerized workloads on small devices such as robots, IoT gateways, point-of-sale, and public transport. We also formed a collaboration with the Japanese consortium, Rapidus, to leverage the depth of our intellectual property on advanced semiconductors. We unveiled Osprey, a 433-qubit quantum processor, that brings us closer to delivering our goal of building a 1,000-qubit system later this year. At the same time, we continue to acquire companies to complement our organic innovation. In the fourth quarter, we acquired Octo, which improves our footprint in the U.S. federal market. This caps the year with eight acquisitions across software and consulting. As sustainability becomes more of a priority, companies need digital technologies to analyze data, creating a baseline and improving the way they operate. Our software has helped IBM reduce its own carbon footprint. Across IBM's global real estate presence, we were able to reduce carbon emissions by over 61% when compared to 2010. Using IBM sustainability software, we have simplified and automated our sustainability reporting processes and reduced reporting costs by 30%. Let me wrap by saying I'm pleased with the progress we have made with our portfolio, our go-to-market, and our ecosystem. I'm confident in our ability to leverage hybrid cloud and AI to help clients turn business challenges into opportunities. Our strategy continues to strongly resonate with clients and partners, and this gives us a solid foundation to build upon in this year. While there is more to be done, we enter the New Year as a more capable and nimble company, well-equipped to meet our clients' needs. I will now turn it over to Jim who will give you more detailed information on our performance and expectations.

Thanks, Arvind. I'll start with the financial highlights of the fourth quarter. We delivered $16.7 billion in revenue, $3.8 billion of operating pre-tax income, and operating earnings per share of $3.60. In our seasonally strongest quarter, we generated $5.2 billion of free cash flow. Our revenue for the quarter was up over 6% at constant currency. While the dollar weakened a bit from 90 days ago, it still impacted our reported revenue by over $1 billion and 6.3 points of growth. As always, I'll focus my comments on constant currency. And I'll remind you that we wrapped on the separation of Kyndryl at the beginning of November. The one-month contribution to our fourth quarter revenue growth was offset by the impact of our divested health business. Revenue growth this quarter was again broad-based. Software revenue was up 8% and consulting up 9%. These are our growth vectors and represent over 70% of our revenue. Infrastructure was up 7%. Within each of these segments, our growth was pervasive. We also had good growth across our geographies, with mid-single-digit growth or better in Americas, EMEA, and Asia Pacific. For the year, we gained share overall. We had strong transactional growth in software and hardware to close the year. At the same time, our recurring revenue, which provides a solid base of revenue and profit, also grew, led by software. I'll remind you that on an annual basis, about half of our revenue is recurring. Over the last year, we've seen the results of a more focused hybrid cloud and AI strategy. Our approach to hybrid cloud is platform-centric. As we land a platform, we get a multiplier effect across software, consulting, and infrastructure. For the year, our hybrid cloud revenue was over $22 billion, up 17% from 2021. Looking at our profit metrics for the quarter, we expanded operating pre-tax margin by 170 basis points. This reflects a strong portfolio mix and improving software and consulting margins. These same dynamics drove a 60 basis point increase in operating gross margin. Our expense was down year-to-year, driven by currency dynamics. Within our base expense, the work we're doing to digitally transform our operations provides flexibility to continue to invest in innovation and in talent. Our operating tax rate was 14%, which is flat versus last year. And our operating earnings per share of $3.60 was up over 7%. Turning to free cash flow. We generated $5.2 billion in the quarter and $9.3 billion for the year. Our full year free cash flow is up $2.8 billion from 2021. As we talked about all year, we have a few drivers of our free cash flow growth. First, I'll remind you, 2021's cash flow results included Kyndryl-related activity, including the impact of spin charges and CapEx; second, we had working capital improvements driven by efficiencies in our collections and mainframe cycle dynamics. Despite strong collections, the combination of revenue performance above our model and the timing of the transactions in the quarter led to higher-than-expected working capital at the end of the year. This impacted our free cash flow performance versus expectations. Our year-to-year free cash flow growth also includes a modest tailwind from cash tax payments and lower payments for structural actions, partially offset by increased CapEx investment for today's IBM. In terms of cash uses for the year, we invested $2.3 billion to acquire eight companies across software and consulting, mitigated by over $1 billion in proceeds from divested businesses, and we returned nearly $6 billion to shareholders in the form of dividends. From a balance sheet perspective, we ended the year in a strong liquidity position with cash of $8.8 billion, this is up over $1 billion year-to-year and our debt balance is down nearly $1 billion. Our balance sheet remains strong, and I say the same for our retirement-related plans. At year-end, our worldwide tax-qualified plans are funded at 114%, with the U.S. at 125%. Both are up year-to-year. You'll recall, back in September, we took another step to reduce the risk profile of our plans. We transferred a portion of our U.S. qualified defined benefit plan obligations to insurers, without changing the benefits payable to plan participants. This resulted in a significant non-cash charge in our GAAP results in the third quarter, and we'll see a benefit in our non-operating charges going forward. You can see the benefit of this and other pension assumptions to the 2023 retirement-related costs in our supplemental charts. Turning to the segments. Software revenue grew 8%, fueled by growth in both hybrid platform and solutions and transaction processing. We concluded the year with seasonally strong transactional performance as well as a solid and growing recurring revenue base in software. In hybrid platform and solutions, revenue was up 10%, with pervasive growth across our business areas: Red Hat, automation, data and AI, and security. Our platform-based approach to hybrid cloud and AI is resonating with clients. As a proof point, OpenShift, our industry-leading hybrid cloud platform, now has $1 billion in annual recurring revenue, and we modernize and optimize our software capabilities, including through cloud packs across automation, data, AI, and security for that platform. Red Hat revenue grew 15% in the quarter, led by strength in OpenShift and Ansible, both growing double digits and gaining market share. Automation revenue was up 9%, led by business automation, application servers, and integration as clients look to automate business workflows and improve applications. Data and AI revenue grew 8%, reflecting enterprise needs to organize, store, and manage their data. This performance reflects demand in areas including data management, data fabric, and asset and supply chain management. Security delivered 10% revenue growth. We're helping clients detect, prevent, and respond to security incidents, which led to strength across threat management, data security, and identity. Across these businesses, the annual recurring revenue or ARR for hybrid platform and solutions is $13.3 billion. And for all of software, hybrid cloud revenue is now more than $9.3 billion over the last year, up 16%. In transaction processing, revenue was up 3%. Demand for this mission-critical software has followed increases in Z Systems' installed base capacity over the last couple of product cycles, and strong renewal rates continued this quarter. Both are evidence of the importance of this platform in a hybrid cloud environment. Moving to software profit. Our pre-tax margin was up 2 points this quarter, contributing to a full year margin of nearly 25%. Consulting revenue grew 9%. Clients are leveraging IBM's hybrid cloud leadership and deep industry expertise to navigate the complexity of their digital transformation journeys. Revenue growth was broad-based across all business lines and geographies. Remind you that this is on top of the 16% growth consulting delivered in the fourth quarter of 2021. Strong demand for our offerings led to signings growth of 17%. With this, the fourth quarter had the best quarterly book-to-bill of the year, and we sequentially improved our trailing 12-month book-to-bill ratio to 1.1. Clients are partnering with IBM Consulting as they decide what applications to modernize and how to migrate those applications across hybrid, multi-cloud environments. Over the last 12 months, consulting delivered $9 billion in hybrid cloud revenue, which is up 23%. This quarter, our Red Hat practice was again a meaningful contributor to this growth. Revenue from strategic partnerships also grew at a strong double-digit rate. We continue to see momentum in this space. In aggregate, our strategic partnership bookings were up over 50% with Azure and AWS more than doubling. Turning to our lines of business. Business transformation revenue grew 7%. Growth in business transformation was again driven by data and client experience transformation, along with supply chain and finance optimization. Our partnerships with key ISV partners like SAP, Salesforce, and Adobe enable IBM Consulting to transform critical workloads at scale. In technology consulting, where we architect and implement clients' cloud platforms and strategies, revenue was up 10%. Growth was led by cloud application development practices. Red Hat engagements along with our strategic hyperscaler partnerships contributed to the growth. Application operations revenue grew 12%. We help clients to optimize their operations and reduce costs by taking over the management of applications in hybrid and multi-cloud environments. Our incumbency and understanding of clients' applications are key differentiators. Moving to consulting profit. Our pre-tax margin was 11% for the quarter and nearly 9% for the year. The fourth quarter margin is up nearly 2 points year-to-year and over 1 point sequentially. We are starting to see the benefit from pricing actions and productivity, and our acquisitions have become more accretive. Turning to the Infrastructure segment. Revenue grew 7%, driven by hybrid infrastructure, which was up 11%. Within hybrid infrastructure, Z systems revenue grew 21% this quarter. Among the new z16 capabilities, clients are leveraging cyber resiliency to comply with business regulations and proactively avoid outages in their operation, while the new on-chip AI accelerator, for example, has been helping mitigate risk and detect fraud in credit card application processes. Our distributed infrastructure revenue was up 5%. This performance was fueled by strength in power following the extension of Power 10 innovation throughout the product line. Infrastructure support performance was flat, including the impact from client adoption of new hardware with the latest z16 product cycle. Moving to infrastructure profit. Pre-tax margin was down less than 1 point in the quarter. And for the full year, our pre-tax margin was nearly 15%. Now let me bring it back up to the IBM level to wrap up. At our investor briefing 15 months ago, we laid out our hybrid cloud and AI strategy and our priorities of revenue growth and free cash flow generation. Since then, we've been focused on our portfolio, our go-to-market model, our ecosystem, and our capital allocation to execute that strategy and create value through focus. We now just completed the first year as today's IBM. Our 2022 revenue was up nearly 12%, including nearly 4 points of incremental Kyndryl contribution that's above our model of mid-single-digit growth. Over 70% of our revenue was in our growth vectors of software and consulting, and about half of our revenue is recurring. With this high-value mix and contribution from the incremental Kyndryl revenue, we expanded our full year operating pre-tax margin by 2.5 points. Our free cash flow was $9.3 billion, up $2.8 billion from the prior year. We invested organically and inorganically and returned significant value to shareholders through dividends. Now there were some external factors that we faced this past year that impacted our profit and cash. We exited a profitable business in Russia. We are dealing with a much stronger dollar, and we are operating in a highly inflationary environment, which put pressure on our margins, especially in consulting. Putting it all together, we are pleased with the fundamentals of our business and the progress we have made in executing our strategy. Our 2022 performance demonstrates that we now have a higher growth, higher value company with higher return on invested capital and a strong and growing free cash flow. For 2023, we again expect solid growth in our two most important measures of success; revenue and free cash flow. Arvind talked about the important role technology plays in this environment and how our solutions are closely aligned to the needs of our clients. With this, we expect constant currency revenue growth for the year to be in line with our mid-single-digit model. As we enter this year, I think it's prudent to expect the low end of the mid-single-digit model. For free cash flow, we'd expect to generate about $10.5 billion in 2023, which is up over $1 billion year-to-year. Let me spend a minute on our expectations for constant currency revenue and pre-tax profit performance by segment. In software, with continued momentum in our recurring revenue stream in both hybrid platform and solutions and transaction processing, we expect revenue growth in line with software's mid-single-digit model. This revenue growth generates operating leverage, and we'd expect software pre-tax margin to expand by about 2 points year-to-year. Consulting's model is to deliver high single-digit revenue. We're coming off a strong year with revenue growth of 15% as we help clients with their digital transformations. This momentum and strong book-to-bill ratio support consulting revenue growth at the high end of its model despite the tough comparison. We expect to expand consulting pre-tax margin by at least 1 point as we continue to realize more of the price increases and improved utilization. Infrastructure revenue is roughly flat over the mid-term model horizon, with performance in any year reflecting product cycle dynamics. We're entering the year three quarters into the z16 cycle and will also ramp on Power 10. As a result, we expect 2023 infrastructure revenue below its model and pre-tax margin in the low-teens. For perspective, infrastructure should impact IBM's overall revenue growth by over 1 point. With these segment dynamics, we would expect IBM's operating pre-tax margin to expand by about 0.5 points. That's in line with our model and our tax rate should be in the mid- to high-teens range. Let me comment on a few items within our expectations. First, as I said, currency was a significant headwind in 2022, impacting revenue by $3.5 billion. With the movement of spot rates over the last 90 days, currency translation would be fairly neutral to revenue in 2023 with a headwind in the first half, flipping to a tailwind in the second. But I'll remind you that we had over $650 million of hedging gains in 2022, which will not repeat in 2023, resulting in an impact to our profit and cash on a year-to-year basis. Second, as you know, we've taken a number of significant portfolio actions over the last couple of years, which has resulted in some stranded costs in our business. We expect to address these remaining stranded costs early in the year and anticipate a charge of about $300 million in the first quarter. We would start to see benefits in the second half and pay back by the end of the year. And then third, we regularly review the useful lives of our assets. Due to advances in technology, we are making an accounting change to extend the useful life of our server and networking equipment effective the 1st of January. Based on our year-end asset base, we expect this change to benefit 2023 pre-tax profit by over $200 million, primarily in our Infrastructure segment. Given this is a change to the depreciation, there's no benefit to cash. Looking at the first quarter, our constant currency revenue growth should be fairly consistent with the full year. Reported growth will also include about a three-point currency headwind at current spot rates. With operating leverage, we'd expect operating pre-tax margin to expand 50 to 100 basis points in the first quarter. And that's before the charge I just mentioned for the remaining stranded costs. Given the timing of currency and stranded cost dynamics, we'd expect about one-third of our net income in the first half and about two-thirds in the second half. To sum it all up, we have made a lot of progress this past year. While there's always more work to do, we're confident in the fundamentals of our business and how we're positioned as we enter the New Year. Patricia, let's go to the Q&A.

Thank you, Jim. Before we begin the Q&A, I'd like to mention a couple of items. First, supplemental information for the quarter and the year is provided at the end of the presentation. And then second, as always, I'd ask you to refrain from multi-part questions. Operator, let's please open it up for questions.

Thank you. We will now start the question-and-answer session of the conference. Our first question will come from Amit Daryanani with Evercore. Your line is open.

Thanks a lot for taking my question. I guess my question is around the free cash flow numbers. And perhaps you could spend a little bit of time on, you touched on kind of the 22 levers a fair bit and how you got there. But as you think about calendar 2023 free cash flow of $10.5 billion, upwards of $1.2 billion. What are the puts and takes? What are the bridge that gets you there? And then maybe related to that, as I think about what you did in 2022 and 2023, it does imply to get to the $35 billion number over the three years, 2024 would have to be $14 billion plus. So perhaps you can level set that because I do think from, when you provided the $35 million number, a fair bit has changed. So maybe a bridge for 2023 and just an update on how you think about the $35 billion number over three years as well? Thank you.

Thanks, Amit. This is Jim. I appreciate the question. So let's start there. We saw solid free cash flow generation in 2022, up $2.8 billion year-over-year. Now, as you remember, we entered 2022. We talked about a very strong free cash flow generation engine. And we put in place guidance for 2022 well in excess of our model of $750 million year-to-year. First, as we were very transparent, we were going to get at least about half of that out of the Kyndryl related spin dynamics. That's the charges and CapEx. And we were going to get a little bit more than half of that out of our base operations overall. And I think when you look at 2022, what happened we got impacted by two external factors. Number one, the unfortunate humanitarian crisis with the war in Russia and Ukraine, and we exited that business, the right decision. Second is unprecedented U.S. dollar appreciation. I think last time I looked, the rate, breadth, the magnitude of the change is the most we've seen in multiple decades. We got hit with that. But we're able to overcome some of that with the fundamental underpinnings of our business overall and still delivered almost $3 billion of free cash flow year-over-year. By the way, the Russian currency by itself is over $600 million of profit and cash we had to absorb. So now to your question about 2023, we guided, as you heard in the prepared remarks, a $10.5 billion, that's up $1.2 billion year-over-year, and again, above our $750 million year-to-year. The underpinnings of that, though, are going to be very different in 2023. Given the improving business fundamentals of our now sustainable revenue growth with a high-value mix contribution, we see then continued operating leverage. So our cash PTI is going to deliver a substantial amount of that free cash flow generation year-over-year. We're still going to get working capital efficiency. So our realization will definitely be up over 100%. But that's really given the volume dynamics of what happened in the fourth quarter with a very strong and accelerated growth profile as we went through the fourth quarter, and we finished extremely strong on our transactional business in the month of December. So that now creates an opportunity for free cash flow generation in 2023 and that's in our guidance. And then there are some other puts and takes. Yes, we'll get modest structural actions tailwind, but they're going to be offset by a cash tax headwind for the year. So that kind of plays out 2022 and 2023 now. How does that relate to a mid-term model? First of all, we're one year into that mid-term model. And as I talked about, the dynamics in dealing with the decision to exit our Russia business and the significant U.S. dollar appreciation, I quantified it for you over a $600 million impact on profit and cash. But as you all know quite well, that's not a one-time impact; that will continue over a multi-period, and it definitely puts pressure on our mid-term model to the tune cumulatively of over $2.5 billion. So, we are entirely focused on how we execute this company on a sustainable revenue growth profile and generating that $10.5 billion of free cash flow. So it enables us, with the right ample financial flexibility, to continue to invest in our business and return value to our shareholders overall.

Thank you, Amit. Sheila, let’s go to the next question.

Our next question comes from Wamsi Mohan with Bank of America. Your line is open.

Hi, yes. Thank you. Arvind, nice to see the revenue guide here. I was wondering if you could share some thoughts around what's happening in software, in particular, you've had a really strong performance in transaction processing over the past year. How are you thinking about the trajectory of that? I know historically, we've kind of thought about this as mid-single-digit or higher decliner, and clearly, we're tracking very differently here. If you could share some thoughts around the trajectory of that in 2023 and beyond, that would be very helpful. Thank you.

Yeah. Thanks Wamsi, for the question. So, I'll address your transaction processing question first and then all of software right after that. So some of you have heard me talk about that transaction processing would be a mid-single-digit decliner in the past. And that's effectively, Wamsi, is what you asked, what's going to be different. As we look at our business there and we look both at the underlying MIPS growth, as well as the criticality of that software, as well as our ability to have some very modest pricing uplift, we would now look at that business as being a slight increaser as opposed to a modest decliner. So, I think, if you are looking at that one, Wamsi, low single-digit increases for transaction processing is what we think is appropriate for the short to medium-term model looking forward. Now, that does help in overall software. So first, let's look at software and decompose it. Software, as Jim mentioned in his prepared remarks, is almost 80% recurring revenue. We see that recurring revenue increasing consistent with our model of the mid-single digits, based on both the consumption, the usage, as well as what we have seen through '22 in people renewing that base of software business. Then, I will acknowledge to you that '22 was a great ELA year, and '23 will not be as good as '22. But with the transactional piece of the business being less than 20%, that has a much smaller impact on the overall growth rate. As you put all that together, we see the mid-single digits as being appropriate for the software business.

Excellent. Thank you, Wamsi. Let’s go to the next question.

Our next question comes from Toni Sacconaghi with Bernstein. Your line is open.

Thank you. I would like to ask about operating profit in general. At the start of the year, your goal was to improve operating profit by 400 basis points, but it ended up at 270. For the fourth quarter, you aimed for a 250 basis point increase in operating margin, but it only reached 170. This has resulted in free cash flow being lower than expected this year and possibly next year, compared to your $35 billion target. You have two main objectives, Arvind: to grow in the mid-single digits and to generate strong cash flow, which has been affected by margins. The margin performance this year was not what you anticipated, so could you elaborate on what deviated from your expectations? What challenges did you face in making that forecast, and how should investors view free cash flow realization moving forward?

Yes, Toni, thank you. You are correct that these numbers are slightly below our expectations from the beginning of the year. I will ask Jim to provide more details on this. However, I want to emphasize that while we have a dual focus on revenue growth and free cash flow growth, revenue growth is key. This growth is reflected in client satisfaction, improved NPS from our clients, and increased usage of both our software and consulting services, which encourages clients to engage more over time. It is important to achieve free cash flow growth as well. Jim mentioned earlier that we did not anticipate the shutdown of our business in Russia, which had some impact. Additionally, we did not foresee the currency challenges being as significant as they turned out to be, and I recognize that inflation, particularly wage inflation, affected our consulting margins more than we expected. One way to address this could have been to halt hiring and limit salary increases, but that would have led to lower capacity by the end of this year, undermining our confidence in growth for both consulting and software, which we are now committed to for 2023. Therefore, we made a business decision to continue increasing our capacity, resulting in healthier revenue and ultimately improved margins, but those benefits will be realized in 2023 rather than all in 2022. This is how we approach balancing our investments in the business with quarterly results. Now, I'll turn it over to Jim for further specifics on your questions.

Yes. Just to put some numbers around this, Toni, you're exactly right. We entered the year. We talked about a business profile, higher revenue growth company, higher operating margins, strong free cash flow yield. And we had guided at mid single-digit revenue growth, and we guided that four points of operating margin improvement. The two points of external that both Arvind and I have talked about, Russia and currency. By the way, that was about 0.5 point because currency member, as we've talked about many times throughout these calls, not only the rate breadth and velocity and change in magnitude that we haven't seen in about two to three decades, but it impacts human capital-based consulting business very differently than a product technology-based business. As we talk about human capital it's all pretty much a natural hedge because your cost is basically matched with your revenue outside of global delivery. But in a product-based business, our costs like the industry are predominantly U.S. dollar source, and that's why you've seen pressure on the gross profit margin line and the pre-tax profit margin line around our technology base of business. Now underlying that though, I think you're seeing a fundamental improvement in our margins as we go forward. So about 50 basis points of currency. The remaining 100 basis points was consulting. And we talked about that. That's been a rate and pace discussion. You dial back 15, 18 months ago, we called a very accelerated demand environment of our clients shifting to digital transformation and journey to cloud. And starting in the second half of 2021, we made the bet to make investments around skill capability ecosystems, and we opened up the aperture to build extended capabilities inorganically. We knew as we went through 2022 that we were then operating in a highly inflationary environment. And then it became a rate and pace discussion on how quick can you get price margins and optimization and realize through your backlog. And I think we've acknowledged that we were pretty slow throughout the year. Now with that said, we finished the year about nine points of margin in consulting. We had nice improvement. We exited the fourth quarter at 11-point PTI model that was up almost 200 basis points year-over-year, our first half to second half, we saw an acceleration of three points of margin from about a seven-point operating PTI model to well over 10 points of an operating PTI model. Most importantly, the green shoots are starting to play out in the fourth quarter. Our utilization of effective capacity, one of the three levers we talked about all year, is up three points in the fourth quarter. Our price margins, third consecutive quarter are up year-to-year, and you're seeing that play out in that operating profit performance. Finally, acquisitions. Now, we're on a steady state and our acquisitions are back to accretion. So, we see nice green shoots that lead to our guidance in 2023 at the high end of our high single-digit model in consulting on revenue coming off of a very strong 15% growth in 2022 and guiding another one point plus in operating margins going forward.

Thanks for the question, Toni. Let's go to the next question.

Our next question will come from Shannon Cross with Credit Suisse. Your line is open.

Hi, can you hear me?

Yes, we can hear you now. You may go ahead.

Okay. Interesting. Arvind, can you discuss AI and its role in your business? There's a lot of conversation right now about OpenAI and Microsoft's investments. I'm trying to understand how IBM plans to monetize and capitalize on it, and how you view your competitive position compared to others. If you have any examples of how you are utilizing it, that would be helpful. As AI becomes a more prominent topic in 2023 and considering your long history with it, I'm curious about your current status and future plans. Thank you.

Thanks, Shannon. So, first, let me acknowledge AI has become a big topic of conversation this year. I was in Davos last week, and it probably came up at almost every single discussion around technology, what's happening with AI as well as what's happening with OpenAI. If I think about it over the last decade, I think there were three moments you can talk about, and then I'll begin to translate those into a business impact. One, when IBM won Jeopardy! with Watson, I think it was a big moment, and AI came onto everyone's roadmap. Second, when DeepMind from Google or Alphabet started winning competitions around, for example, GO, and that became another big moment along with the protein folding that they did and now with OpenAI and ChatGPT. But if I step back just a moment, all of this latest version is based on what is called large language models as the underlying science. Universities do it, Google does it, IBM does it, as does OpenAI. To just get to why it's so exciting. For example, for us, it allows us to do 13 language models when we are looking at understanding different natural languages in the same cost as originally one. That is what is so exciting about these technologies because if you can get an order of magnitude improvement in cost and speed and the resource consumed, both in terms of hardware and people, that is incredibly exciting. Now, let me translate this into how do we monetize this. So, our monetization of AI is very much focused on that $16 trillion of productivity that I've talked about that we're going to get over the decade. The vast majority of that comes from enterprise automation, and when I say enterprise, I include governments into it. Some examples, if you can automate the drive-through and order-taking for quick-serve restaurants, that's an example of what can happen. If we can get deflection rates of 40%, 50%, 60% at everyone's call centers, that's a massive operational efficiency for all of our clients. If we can help retirees get their pensions through interacting with a Watson-powered AI chatbot, that is an enterprise use case where all of these technologies come into play. By the way, all my three examples are real clients where we are resulting in anywhere from hundreds to thousands of people, efficiency for each of these clients. So that's how we get it. If I look inside IBM, how we do promotions, how we do people movement, how we begin to improve our code to cash, how we improve our customer service and people ask complicated questions around triage of IT systems going down are all very real examples where we are improving client service and saving money all at the same time.

Shannon, thank you very much. Sheila, can we go to the next question.

Our next question comes from Erik Woodring with Morgan Stanley. Your line is open.

Hey, guys. Good afternoon. Thanks for taking the question. I wanted to just touch on the consulting business. Signings were very strong in the December quarter, up 17%. Your quarterly book-to-bill was an improvement from the September quarter. Can you maybe just, again, just step back and elaborate on the environment, what we're in, what you saw in 4Q that potentially stood out to you where strength in signings is coming from changes to contract duration? Maybe just double-clicking on the consulting business. Just to help us understand what gives you confidence to be kind of at the high end of your midterm model for 2023? Thanks.

Thanks, Erik, for the question. I'll take this. When we entered the fourth quarter, we had a pretty solid pipeline. And we talked about reaffirmed mid-teens growth for consulting for the year, which as you know, is well above our model. But again, as I talked about on the previous question, we had made the investments in bringing in skill capability, expanding ecosystem, strategic partnerships, and acquisitions. But we saw that pipeline entering the quarter we saw a very solid and pretty disciplined sales closure rate as we moved through the year. Now, how did the year end that positions us for 2023? Let me just put some stats to really bring it home. Number one, ecosystem velocity, we saw continue to increase throughout the year of our strategic partnerships. I think we said in the prepared remarks, strategic partnerships grew revenue 25% in 2022 and was about 40% of our consulting base of business. That is up about 50% year-over-year. We have seen extensive acceleration. And by the way, in the fourth quarter, our signings growth which delivered a 1.3 book-to-bill, our hyperscaler partnerships with Azure and with AWS, our signings were 2x. Our ISV portfolio with the likes of SAP, Salesforce, Adobe, we were up over 50% in signings. So our book of business and the partnerships we have tremendous strength that's fueling our backlog, point number one. Point number two, Red Hat. We continue to see acceleration of consulting being the tip of the spear that's really driving the scale and adoption of our hybrid cloud platform. Oh, by the way, is also dragging IBM technology and software. Since inception, a little over three years, we signed $7.4 billion of business in Red Hat, tremendous strength and that, again, fuels our backlog for 2023. And then you look at full year, we grew both large transformational deals, and we grew small deals double digit, both sides. So it's pervasive across the board. So when we look at our backlog, we look at all of our indicators of our business on the realization of that model. We look at the acquisition portfolio and how it's scaling. We feel pretty confident about the high end of our high single-digit model in 2023. Oh, by the way, to Toni's question, at operating margins being accretive.

Erik, thanks for the question. Let’s go to the next one please.

Our next question comes from Lisa Ellis with SVB MoffettNathanson. Your line is open.

Hi, good afternoon. Thanks for taking my question. Maybe following on that, I had a broader question, Arvind, on the overall demand environment you're seeing. I think with earnings coming in from various enterprise tech players so far, we're seeing a pretty wide range of signals about how the demand environment is shaping up for 2023. Can you just comment a bit on what you're seeing from your large clients, say, relative to this past year? Thank you.

Yeah. Thanks, Lisa, for the question. Look, if I think about our overall client base, we were first really pleased that there wasn't much of a difference by geography. As I go through it, Japan, India, Australia, the Middle East, Western Europe, the UK, North America were really pretty strong in demand across. So I think Lisa, if I break it down into the two portions around technology and consulting, what we are seeing is that most of our clients do believe, but even if there are some I call the minor or different headwinds in 2023, they are going to emerge stronger. As they want to emerge stronger, that means they're all deploying technology to help offset wage inflation, cyber issues, supply chain challenges, and all the demographic shifts, meaning there's just fewer skilled people to hire. Consequently, we're seeing them double down, and that is why we have focused on certain areas and certain partners, both for consulting and in technology. So they all want to deploy automated ways to get from the front to the back maybe Salesforce and Adobe play a very strong role in that. They all want to leverage cloud technologies that they can scale technology up to better handle client demand. Our partnerships with the hyperscalers play into that. They all want to leverage far more technology than they have before to counteract the wage inflation and other inflationary aspects and what we do with Red Hat plays into that. So I kind of see, Lisa, that all of our clients play into that. Now you've mentioned a wide spectrum from the people you're seeing recently, I think the reason that we are remaining in this optimistic frame of mind, we have no consumer business. I agree that our clients may have a consumer business, but we don't have that directly. And so I think consequently, we might be seeing a little bit different subset of the economy than those who might have a large direct exposure to a consumer business.

Thanks, Lisa. Let’s go to the next question, please.

Our next question comes from David Grossman with Stifel. Your line is open.

Thank you. You experienced strong transactional momentum in the software business during the fourth quarter, and your prepared remarks offered valuable insights into the overall business and how the widespread growth may reflect the changes you've been discussing regarding your go-to-market strategy and sales adjustments. With that said, Arvind, could you provide details on any specific product changes in software that might be contributing to this momentum and indicate if your competitive positioning is evolving in any of the three non-Red Hat segments? Additionally, I apologize for the two-part question, but I wanted to confirm with Jim that the working capital challenges you mentioned in the fourth quarter will reverse in 2023. Thank you.

Yes. Thanks, David. Let me talk a little bit about the product capabilities. And as you said outside Red Hat, let’s focus on automation, data AI, and cyber. If I look at those, let's take automation. I'm really pleased with the progress we have made around an area I’ll call AIOps. But if you think about, we made a couple of small acquisitions Instana and Turbonomics, we built our own AIOps portfolio. We're seeing tremendous pick-up from that as our clients want to take out labor complexity but also want to optimize their overall IT infrastructure, hardware, and software. They also want to have uptime that is now the talk about not just 2 9s and 3 9s, but up to 5 9s. They also want to worry about how to make sure some go to always on. I think our AIOps portfolio there really advantages us, and I believe we're in a unique position because we help our clients in an environment across multiple public clouds and on-premise, and with their private clouds in that space. If I think about data and AI, our focus on data fabric and allowing our clients to leverage the data wherever it is, not always moving it, but allowing them to catalog it, leveraging AI, and deep inside our products is another example of where we have a unique capability. And third, if I look at cyber, we focus a lot on threat management. And if we think about how we can leverage the inputs from all kinds of sources in these days, and people are really worried about all of the threats coming, whether from nation-states or just from bad actors, then it allows them to leverage that portfolio better. Consequently, we're going to remain pretty focused on these areas. You should expect both organic and inorganic investment. And David, I can't help but say, we are giving our clients the ability to deploy these capabilities on multiple public clouds as well as on-premise, and I believe that does advantage them because it gives them a lot more flexibility and freedom than they might have from some other vendors.

Yes. I would just build on that, Arvind. I mean, Software's book of business today, it's an integral part of our hybrid cloud platform thesis. It is the foundation. We eclipsed $25 billion for the first time ever here in 2022. So over 40% of IBM's revenue and two-thirds of our EBITDA. So when you look at it, we are a hybrid cloud AI platform-centric company overall and software is right at that core. So why that recurring revenue stream and the improvements we've been seeing throughout 2022, and as Arvind answered earlier, getting that back to a growing contribution not only helps the competitiveness and market share of our top line, but I think all of you understand the marginal dollar of that book of business is in the 90-plus percent range, as we move forward. So David, I think you also asked a question about clarification. Free cash flow growth, $10.5 billion about, up $1.2 billion year-to-year, above our model of $7.5 billion. That will be driven based on the fundamental improvements of our underlying revenue growth and operating leverage and cash PTI, but there will also be, yes, a working capital efficiency contribution to our cash generation next year, really just the volume dynamics of what played out in the fourth quarter. We'll get that back.

Thanks, David. We are past the top of the hour, but let's take one more question.

Our last question will come from Kyle McNealy with Jefferies. Your line is open.

Thanks very much for squeezing it in. This one is macro related as well, but just pretty quick. It seems like some of the long macros implied in your 2023 guidance, but I don't think you talked specifically about whether you're seeing anything specifically slowing. It sounded generally positive for you guys, even though there's a bit of a slowdown implied in the guidance. Microsoft and F5 talked about a divergence between new business and new applications, seeing some growth versus renewal business, capacity expansions, cross-selling, and things like that. Are you seeing a similar thing in terms of new applications slowing a bit and some of the kind of recurring and cross-selling capacity expansion is holding up? How much of either of those is driving your lower end of mid-single-digit growth guidance for 2023 and kind of break it down, if you can? Thanks.

Okay. Look, I think that first and I'll address your point of new application versus existing pretty directly. The point about the lower end of the mid-single digit is largely from the fact that the Infrastructure segment will be a headwind going into 2023, whereas it was a tailwind in 2022. I wouldn't read anything more than that into our low end as opposed to the middle of the range. Now, for us, I don't really see that. I see that our clients do want to do new development. Now, from our perspective, if somebody is doing an expanded salesforce deployment, I call that a new application. If somebody is doing a new application on Azure or if they are moving, well, they never really directly move. They always talk about refactoring, putting in new functions, integrating with other applications they might have in their shop, or that they buy as SaaS properties, we consider all that new development. And so, for us, our consulting teams are largely doing that new development for our clients. In that process, they tend to use OpenShift from Red Hat, it tends to use Red Hat Linux, they tend to use our AI automation. Our AI automation then surrounds all those things to make them much more resilient, much more robust, much more secure, and those are the capabilities we bring. So we are not really seeing that divergence, I will tell you straightforwardly, but there is likely a focus that in that new application, is it helping automate things more? Is it helping make things I call it straight through as opposed to with a lot of manual intervention? That is probably a bigger focus. Maybe we don't see it because we kind of called that play in late 2021, because we kind of saw those things coming and becoming more important. And we decided to invest in them, both in technology and in consulting. Patricia, with that being the last question, let me now make a couple of very quick comments to wrap up the call. 2022 was an important year for us. As Jim said, it was the first full year of the new IBM. The results we delivered reinforce our confidence in our strategy and our model. While there is always more to do, we are pleased with our position as we enter 2023, and I look forward to continuing this dialogue as you roll through the year.

Thank you, Arvind. Sheila, let me turn it back to you to close out the call.

Thank you. Thank you for participating on today's call. The conference has now ended. You may disconnect at this time.