International Business Machines Corporation's (IBM) IBM Investor Briefing 2021 Conference (Transcript)

International Business Machines Corporation (NYSE:IBM) IBM Investor Briefing 2021 Conference October 4, 2021 9:00 AM ET

Company Participants

Patricia Murphy - VP, IR

Arvind Krishna - Chairman and CEO

Paul Cormier - CEO, Red Hat

Tom Rosamilia - SVP, Cloud and Cognitive Software

Mark Foster - SVP, Global Business Services

Kelly Chambliss - SVP, Americas and Strategic Sales, Global Business Services

John Granger - SVP, Hybrid Cloud Services and COO, Global Business Services

Ric Lewis - SVP, Systems

Jim Kavanaugh - SVP and CFO

Conference Call Participants

Patricia Murphy

Good morning. Good afternoon. Good evening. Welcome to IBM's 2021 Investor Briefing. I'm Patricia Murphy, and I'm here live to kick off the event. It's an exciting time at IBM. We've been focused on our hybrid cloud and AI strategy. The management team has been investing and taking actions to position IBM for the future. And just last week, we took an important step towards one action, the separation of our managed infrastructure services business. But we're not here to talk about Kyndryl, and it's too early to talk about our third quarter or full year performance. What we are here to talk about today is IBM on a go-forward basis.

And so, over the next couple of hours, you're going to hear from several of our senior leaders. Given the environment, some of them are here and some are remote. You're going to hear about how we're addressing the opportunities, our platform-centric approach, and how we're leveraging to integrate the capabilities of IBM to provide value to our clients and to our shareholders.

Our agenda today reflects a simplified management and segment structure, which will become effective just before the spin. Arvind is going to talk about that. And then, Jim will expand on it later. And then, you'll also note that just this morning, we posted an article on our Investors site about the structure. So, please take a look at that.

At the end of the prepared remarks, we'll have a Q&A. We'll bring up all of our presenters. And keeping in the spirit of simplification, we're going to make it simple for you to participate. You could submit questions right from the event page, right from the top right corner where it says, ask a question. You can submit a question at any time. I'll moderate, I'll read out the questions, and I'm going to do that without attribution. And we think that that gives an opportunity for more investors to participate in the Q&A.

So, just a couple of other things before we get started. We're going to focus today on the medium-term horizon. Think about that as the next three years. And so, we're going to be making some forward-looking statements. The risk factors associated with those statements and information on IBM's risk factors is contained in our SEC filings and on the IBM website. We also have a number of non-GAAP items, including in our presentations, and those have been reconciled to the appropriate GAAP measures, also available from the SEC and on the IBM website. Finally, a replay of this webcast will be available by this time tomorrow.

We're looking forward to spending the next couple of hours with you. And so, to start off, it is my great pleasure to introduce Arvind Krishna. You know, Arvind. Arvind is IBM's Chairman and Chief Executive Officer. Arvind, come on up.

Arvind Krishna

Thanks, Patricia. Let me add my very warm welcome to all of you. We are delighted to have an opportunity to talk to you about IBM together with my leadership team. It’s been 18 months since I started in my role. And I have to tell you that my management team and I have immense confidence in our strategy, which is based on hybrid cloud and artificial intelligence or AI. The reason we have this confidence is because we know that our strategy is resonating with our clients.

Across every industry, our clients want to take advantage of these two powerful technologies: hybrid cloud and AI to transform their own business. These technologies give them the opportunity to boost productivity, bring their products to market faster, reduce costs and offer their own clients new experiences, otherwise all to call digital. Our clients are on this journey, and so is IBM.

Two years ago, when we closed Red Hat, we stated that the market is going to be hybrid cloud, not just a singular public cloud. This thesis has borne out. As we have brought our hybrid cloud products and offerings to market, we can see that our clients resonate with this platform that is flexible, secure and open.

The next decisive step we made was announcing the spin-out of Kyndryl. You'll hear a bit more about that today. And as Patricia said, we also put a number of statements on that out on our investor website, and we also submitted our Form 10 to the SEC last week. But there are a number of actions we have made, not just the acquisition of Red Hat and not just the spin-out of Kyndryl. We are optimizing our portfolio and we are making a series of investments through acquisitions.

We are also investing in organic innovations. We are also investing in more capabilities and skills in our consulting teams. We are simplifying our go-to-market model. We are expanding our partner ecosystem. We're aligning incentives for all of our teams towards our growth priorities, and we are advancing the client-centric culture with a growth mindset. These efforts are producing concrete results.

As we reported in the second quarter, our revenue trajectory has improved. Our cloud revenue is growing double-digit over the prior 12 months. Red Hat revenue growth has been in the high-teens, and we continue strong free cash flow generation. While we acknowledge that much more remains to be done, we are seeing evidence. The evidence is that our strategy is bearing fruit, and IBM is already beginning to look like a very different company.

There are three key messages about IBM's future that I'd like you to take away. The first, we are optimizing our portfolio to drive mid-single-digit revenue growth. With the spinout of Kyndryl and the acquisition of Red Hat, you are seeing that just under half our portfolio is software, a little under one-third of it is consulting. These are both healthy drivers of growth, within that, Red Hat growing at a very healthy rate. This allows us to have a platform-centric model. Infrastructure remains an important part of our foundation. So, this portfolio, together with the investments we are making, both in acquisitions and organically, and our growing ecosystem will deliver the mid-single-digit revenue growth, starting in 2022.

Second, we are increasing our focus and agility to better serve clients. We are simplifying our go-to-market. We are making decision-making much easier across the Company. Our ecosystem is more central to our strategy than ever before, our client-centric strategy with 4,000 garages as the evidence where we co-create with our clients. As a result, we are seeing early signs of improved productivity in our sales teams.

Third, we are generating strong free cash flow that enables these investments. We expect to generate $35 billion over the next three years. This free cash flow will allow us to both, invest in our future and offer attractive shareholder returns via dividends. Jim Kavanaugh will go into a lot more detail on all three of these today.

Let me now dig deeper into our priorities, starting with hybrid cloud. The case for hybrid cloud is clear. It starts with our clients' needs. Our clients all use multiple public clouds, but that's not all. The economics of where their applications are, security, locality, regulations and laws dictate that many of them use private cloud as well or on-premise infrastructure. This approach delivers the most value to our clients, and hybrid cloud represents the $1 trillion opportunity that we are pursuing. Ever since we started using the term two years ago, the term hybrid cloud has caught on. Why? Because that's what clients want and to briefly paraphrase Sutton's law, that's where the money is.

So, if you look at the capabilities that we have gained with Red Hat, based on open source innovation, this gives clients the ability to straddle public and private. They can develop their applications and deploy to any location without having to rewrite them each time, get the same level of security across clouds and in their own data center and consume innovation from more than one public cloud.

So, as a result, clients are embracing our hybrid cloud strategy. Within that, regulated clients find the need even more to leverage all of those capabilities that we just described. What's the evidence? Over 3,200 clients are now using our hybrid cloud platform. That's four times as much as before we announced -- our announcing of the Red Hat acquisition.

But it comes to life through some examples. Telcos like Verizon are using cloud-based networks based on our hybrid cloud platform in order to very quickly adapt to shifting client workloads, meaning where are all the calls coming from, where is the data coming. Industrial manufacturers like Siemens need to make use of data in real time. Locality is important. So, they leverage our hybrid cloud platform. Banks like NatWest Group are building new digital banking services, but they need to worry about personalization and security. So, they leverage our hybrid cloud platform. So hopefully, I'm making the case for why the hybrid cloud is what clients want.

But now let's move on to AI or artificial intelligence. Five years ago, when people talked about 45 zettabytes of data, people roll their eyes. There couldn't be that much data. A zettabyte for the quants out there is 21 zeros after a 1. So, just for you to know how much data that is. Now, the 45 is old news. IDC, a consultancy, predicts 175 zettabytes by 2025.

The old adage is software is eating the world, but really maybe data is eating the world. But, how do you take advantage of all this data? We know that if you can leverage the data, it gives a business competitive advantage. Artificial intelligence or AI, is the only technology we know that can harvest insight from the data at this scale, especially because you cannot possibly get enough trained and skilled people to go attack all of this data.

So, how do we use AI to automate processes? That becomes the competitive advantage for every one of our clients. What are our unique capabilities that we stand up for? The AI capabilities IBM develops will run anywhere, by the way, taking advantage of our hybrid cloud platform. We make a hard commitment to not monetize any of our clients' data.

We are going to focus on automation. Automation in how we bring AI to be developed, automation in how we enable trust, and by the way, automation in one of the dirty secrets of this world that 80% of the work lies in getting the data ready to be leveraged by AI. Our focus is to infuse AI then into all the core business processes, hiring and talent management, supply chain, customer service, and a bit recursively applying AI to improve how IT itself works.

A few examples, if you look at CVS, CVS uses AI-powered software, intelligent call agents that handles millions of calls, by the way, with even higher client satisfaction than with people alone. EY uses AI-powered software to drastically reduce the time it takes for them to help their clients due diligence on M&A activities. Citibank uses Watson across 2,500 auditors as they handle the transcripts of their customers, talking to agents there. So hopefully, those examples bring to life how AI can infuse every business process.

But, let me quickly touch upon cybersecurity. I had the privilege to be at the White House in August talking about this topic. And what I said there is, it's going to be the issue of this decade. The cost of cybercrime is rising every year. Estimates range from the hundreds of billions to trillions of dollars in terms of the impact, and that is what is driving demand for our solutions. Whether it's around threat intelligence, identity management, data security, incident response, device management, you can go on and on about the capabilities that are in high, high demand.

We manage $150 billion cybersecurity events each day on behalf of our clients, leveraging cloud and AI-based technologies. We do this on behalf of 17,000 clients across both, commercial and government clients across the world. But we are going to keep innovating in these areas of both, hybrid cloud and artificial intelligence.

Now, we know that client needs keep changing. So, it's not going to be enough to stay there. We're also going to innovate in blockchain and Quantum. You're not going to hear me talk about Quantum today. We'll hold another event later in the year to talk about Quantum, and all of you are more than welcome to that.

So, having talked about both, hybrid cloud and artificial intelligence, now let me talk about how we drive value for our clients and growth for IBM. Our approach is platform-centric. The platform itself is based on Linux containers and Kubernetes. You kind of see that as a red layer behind me. Once we go on the platform, our software portfolio has been optimized for this platform. It runs on containers and Red Hat. But that's not enough. We continue to do lots and lots of innovation, including our Cloud Paks.

IBM Consulting brings all the skills needed to help our clients on their journey, whether it's an application modernization and on the journey to hybrid cloud. Hybrid cloud infrastructure is optimized to give clients the capabilities they need, whether it's across security across the stack, or whether it's against all of the regulatory needs.

You're also seeing us simplifying our segment structure. It very much aligns to the picture you're seeing, and Jim Kavanaugh will get into a lot more detail on this near the end. Our management system is going to get aligned to this just before the separation of Kyndryl.

Now, the economics of this platform are designed to drive growth. So, think about that the platform itself contributes. It contributes revenue at a healthy growth rate. But, for every dollar of platform spent, clients spend $3 to $5 in software. So, as we get our share of that that drives growth. Then they spend $6 to $8 in services. These software and services growth numbers benefit IBM and our ecosystem partners.

So, you see that we are providing services and value at every level of the stack. It makes it easier for clients to consume depending on where they'd like to enter the portfolio. Two examples. If I take Anthem, Anthem was leveraging IBM services to help them on their cloud journey. As they went down this journey, they then began to adopt the hybrid cloud platform. So, they started with services and that drove adoption of the platform. If we take Schlumberger, Schlumberger began by relying on our hybrid cloud platform. That gained us the credibility for them to then take services into other parts of the portfolio. So, they came more from the bottom and then consume more from the top.

Our approach also relies much more heavily on our ecosystem. Let's remember, an ecosystem has to be mutually beneficial. And when it is mutually beneficial, you create a flywheel of growth. The more we grow, the more our partners can grow. The more our partners grow, the more we grow. The importance of partnerships in creating value and driving growth is a key lesson that we perhaps relearned from Red Hat.

Red Hat has been extremely good at partnerships, whether it's with services partners, ISVs, infrastructure partners, and this is something we have learned that by being neutral and by leveraging and benefiting partners, you can benefit yourself.

Let's give some quick examples. Let's look at hyperscalers, Microsoft and Amazon. As we have expanded our partnership with them, our pipeline there can now be measured in the billions of dollars, or a business consultancy like EY. As we are pursuing regulated clients together, our pipeline there is growing dramatically. Infrastructure companies, Samsung and Apple are great examples. You've already heard us talk about ISVs like SAP and Oracle in the past, but we are forging brand-new partnerships that are growing dramatically, Salesforce, Palantir, Adobe are examples of large ones, but it doesn't stop there. You have Box, Cloudera, MongoDB and many other new age ISVs with whom we have deep partnerships. So, you can see that we are leveraging our ecosystem to really drive this flywheel of growth.

Now, let me talk more about our investments and actions that drive performance. Let's remember, technology doesn't stand still. So, the success of our strategy depends on our ability to meet clients' changing needs. We are optimizing our portfolio and we are going to invest organically in new capabilities. We have new managed services on OpenShift, technologies like AutoSQL, approaches like CodeNet, Watson Orchestrate and many, many others that bring tremendous value to our clients.

By the way, part of optimizing our portfolio includes the decision to spinoff Kyndryl, which is on track to be completed in the fourth quarter. Since last April, we have made a series of acquisitions, 15 Since April of 2020. The goal is to enhance our offerings in software and in consulting. And when I say software, it's across automation, it's across security, it's across data and AI.

So, if you think about it, our acquisitions are not just standalone, they complement our organic investments. A great example is what we're doing with Turbonomic and Instana, combined with Watson AIOps to really create an industry-leading AI-powered automation suite of software. In consulting, the acquisition of Waeg, 7Summits, Taos, Nordcloud, all allow us to reinforce our cloud consulting expertise, building upon what we are doing organically and then hiring up to go expand all those capabilities.

We are simplifying our go-to-market model. This helps give clients what they've been asking for, a much more technical and experiential approach. And that lets our clients derive value much more quickly from our portfolio. I already talked how we are expanding our ecosystem, but we're also aligning incentives for executives and our teams around our growth priorities. This is coupled with the changes we are making to our culture. We are building a much more client-centric culture and instilling a growth mindset across the Company.

Now, let me close with some key takeaways. Let me remind you of the way you should think about IBM and how we are now at a watershed moment that defines the future IBM. You heard me talk about how we are optimizing our portfolio to drive sustainable mid-single-digit revenue growth. You heard me talk about the increasing focus and agility to better serve clients. You've heard us talk about our strong free cash flow, $35 billion over the next three years, which enables the investments that I just talked about. So, this brings us to that we are at a watershed moment in our journey.

Now, what sets IBM apart? It has been this ability to take different pieces of technology, hardware, software services, not just from us, but including our ecosystem, and bring it all together for our clients. This creates value for them, and it solves their most pressing business problems. Today, those business problems and transformational journeys are on hybrid cloud and AI. Tomorrow, Quantum computing and some other areas where we'll continue to invest will help bring even more business value. So, with this strategy, the actions we are taking, the investments we are making, IBM is well positioned for growth.

Now, for the next hour or so, we're going to go deeper into the business segments. We're going to start with Paul Cormier, CEO of Red Hat. He's going to be followed by Tom Rosamilia, who will talk about software. Mark Foster, Kelly Chambliss and John Granger are going to talk about IBM Consulting; Ric Lewis on infrastructure; and Jim Kavanaugh will bring it all together, both talk about our financial model and all the numerics I'm sure many of you are waiting on. I look forward to answering your questions during our Q&A session.

Now, let me hand over to Paul.

Paul Cormier

Thank you very much, Arvind. Thanks so much. It's really a pleasure to be here.

So, let's start and really talk about hybrid cloud and what it means to Red Hat. The hybrid cloud opportunity has and continues to be an evolution from data center to the cloud, all the way out to the edge for a number of years. We really feel that we at Red Hat are uniquely positioned for hybrid cloud fueled by the mere fact that Linux and open source is and has been from the beginning at the heart of every cloud. Of course, our course of differentiation here as well is just that that we've been in this business for over 20 years now in the enterprise space. But also, we bring as well enterprise-grade offerings. We bring a number of industry partnerships and ecosystem with it, et cetera. Growth in this space for us will be driven by scale, reach, further services, which I'll talk about a bit, all the way up to the edge and edge capabilities and a real focus on clients' success as they go on this journey. Hybrid cloud is not something we're going to do today, and it will be another fed tomorrow. This is something where our clients really are building an architecture, a lasting architecture for years and years to come. So, we'll talk more about that as we get into here. Okay.

Now, if you look from a Red Hat perspective, over the last 20 years in the enterprise, we've built a base where 94% of the Fortune 500 use Red Hat products. We really see that strong base as well as expansion to fuel high-teens revenue growth for us coming for the years to come. IBM operates in 175 countries. We operate in a subset of that, but we leverage IBM for others. We were the first multibillion-dollar open source strictly open source software company. Open source development has been part of our DNA over the past 20 years and beyond that. It's literally just part of the DNA of the Company. It's ingrained in everything to do.

But, one of the things that I point out all the time, we are an enterprise software company with an open source development model. And that means enterprise software company. We build software and solutions for enterprises to run their business on with 100% open source development model.

Let's talk about -- a little bit about this hybrid multi-cloud evolution. If you look at it from between yesterday, today and tomorrow, I mean, yesterday and even in some cases today, it's really been a data-centric IT world. Private data centers are starting to look at moving to public clouds and now multi-cloud. But it really -- up until very, very recently, it's been a data center-centric model. It's moving very fast. And then today and of course beyond, we move into public and hybrid and even multi-cloud model. And that now becomes the new data center for CIOs.

It also -- we're moving into a services-centric solutions model. And by services, I mean two things. First of all, there's a number of software services that have to sit on top of the hybrid platform for application developers to call. Now, when they call those services, that needs to span that hybrid architecture. But, there's also a number of services that we're now providing, we're seeing our customers very interested in is managed services, where as their IT environments now include hybrid and multi-cloud and beyond, it becomes more complex for them. So, we can now manage our platforms out there for them. And all they have to worry about is using and deploying to those platforms. That's becoming a very, very interesting model for our customers and clients because as it becomes more complex, we can take some of that complexity out for them.

Of course, the future, the hybrid multi-cloud will extend all the way to the edge. The edge is really vertical centric. In a telco world, it's on the cell tower in the manufacturing world. It's on the manufacturing floor. But that now becomes part of that new data center that CIOs have to worry about when their applications are sitting there. The developers have to develop to that. The operators have to operate that, but -- the security people have to secure that. So, that's really a very quick movement up to the edge that you may hear about a lot.

Let's look at some of the challenges of moving out there. The average number of clouds for our customers today is around 5. I mean, if you look at it, it's 2.6 Republic; and 2.6 for private clouds, so about 5. We expect that to even grow over time. But now, as they did have 5 clouds to now worry about in their world, they have to worry about some of the same things they had to worry about when it was within their own data centers, but now it's spread all over various footprints. They have to worry about and they want compliance and security. So, they want certified compliant platforms to run on. They want secure platforms to run on. Application modernization and migration is key here. They want platform consistency. They need an ecosystem around the platform. So, as they bring different partners in, they can span that hybrid platform as well. They need management. We provide that with cloud.redhat.com. But they need management across the hybrid world. They need orchestration, which we provide with Ansible. Even telemetry becomes more important. We're now, especially in the places for managed services that we're managing for them. We can understand when they might have a problem before they're going to have a problem.

The developer experience is really, really important. Developers need a set of tools, workflows and experience, but it's too complex for them to have 5 if it's 5 different clouds, or even 10 if it's 10 different clouds. One common workflow experience for the developer is really important.

The skills required become even more important and become different as well. Managed Cloud services, as I talked about, becomes very important. And part of that is because of the skills gap. But the other part of it is because the CIOs want to concentrate on their applications. And of course, you can only get this with platform security. And lastly, one of the things that our CIOs really, really are concerned about is vendor lock-in. They want platform ubiquity, but -- and with that, you lose some of that lock-in, but they also want open source. And that's where our CIOs can really hedge against that lock-in. It's the code is open. And so, I think that's really important. I think that's really something that's starting to hit with our -- hit home with our CIOs as well.

Let's look at how building hybrid, what it means to us and as well as our partners. If you look at the inner circle, it really is Red Hat Enterprise Linux at the core. I mean, we've been at that for 20 years. OpenShift is the platform that builds on top of that, but it's still well at that core, something that we've been at for a long time. On top of OpenShift with that, we now have -- some of the services that I talked about is a number of cloud services where developers can call a set of APIs for various functions. But, it's also some of the other managed services that I talked about.

All of this -- this is now the platform that spans that hybrid cloud. That's managed that needs to be managed commonly through cloud.redhat.com that I spoke about. But also, if you look at some of the darker outer rings as well, partner services are there, partner applications on top of our platform. From a client perspective, they get to run these applications and products from other vendors across this hybrid platform. From a partner perspective, they get the hybrid platform to run their services.

Certainly, we can't provide every single application and functionality that customers need. We want -- partners are really key here. And partners across that platform are important, including the rich ISV ecosystem, they're working here with as well on top of our platform. And this is really where we really work very, very tightly also with IBM.

With Cloud Paks, Cloud Paks ride on top of that OpenShift platform. So Cloud Paks, which you'll hear much more from Tom about next, Cloud Paks brings so much functionality and value in terms of security and management and things like that. But now, they ride across this platform, but customers partner with IBM and for those functionalities. This is where Cloud Paks sits as part of this -- as part of this partnership where they run on our platform. All of IBM software for that matter runs across this platform in this hybrid architecture. Of course, IBM Consulting, we partnered with all he SIs. But IBM Consulting probably has the largest practice around deploying OpenShift in an architectural way for our customers. And so, this is where we really work very closely with IBM on these things.

Let's look at some of these in action. I mean, if you look at just a couple of examples, Schlumberger. Schlumberger obviously is an oil and gas exploration company. They have applications that specialize in that. They run all across the world. Schlumberger has committed using a Red Hat and IBM's open cloud technology to enable deployment of applications and their exploration in production in a cloud-based environment across the world on top of OpenShift, giving that commonality, no matter where the cloud provider is. In many parts of the world, the cloud providers aren't the big 3 or 4 or 5 that you hear about all the time. They may be regional ones. And those are cloud providers we also -- Red Had also has partnerships as well.

Another one is Telefonica. In conjunction with the Altiostar, Red Hat, Gigatera and Kontron, IBM has led the systems integration of end-to-end to fully open RAN PoC for Telefonica open, and we're in the middle of that with Telefonica Argentina as well for that -- for that proof of concept. We also work with many other pieces of Telefonica as the telco world now starts to really move to part of a software-driven architecture for them.

And then, of course, Adobe. Adobe is delivering their certified Adobe Experience Manger 6.5 as part of their Experience Cloud running on Red Hat OpenShift and IBM Cloud for financial services. This really grew from companies that need regulate -- in regulated industries that need to deliver more personalized experience across the entire customer journey.

So, running this on OpenShift as well, as well as the IBM Financial Cloud is something that really hit a sweet spot for this set of customers.

So, how are we going to get there as we look in the next year or so are four objectives to grow our customer, value and scale the enterprise. First of all, it's scale the business. That's what we have to do now. I mean, one of the things coming into IBM has given us that opportunity is to really scale it and even a faster clip than we were in the past. So, we've adjusted our go-to-market to really look at it from a segmentation -- segment perspective. So, if we look at it from enterprise, the largest 2,000s or so, we really moved telco up to the global level. It's a very technical, very, very contained market and working that from a global level across the telcos as we think the best way, and of course, going beyond that from the commercial level. We have hundreds of thousands of other customers, it will work in a commercial organization, which -- and we look at that commercial side as really very, very, very highly partner leveraged.

If we go up to extend Red Hat to cloud services and to talk a little bit about this, cloud services being a set of software services that span the hybrid cloud as well as managed services for our clients that want to take advantage of running OpenShift that way, whether it be for them to concentrate other ways or not -- or us having the expertise and filling in gaps for them. We really look at that as really an opportunity to scale here as we grow.

Evolve the customer success. I mean, we at Red Hat, we've always been maniacal about customers, and customer support, but not customer success. Moving to cloud and multi-cloud – hybrid cloud and multi-cloud, it's not a thing you do overnight. This is an architectural decision that is engineered. And then, as you deploy, this is a decision that's years in only the making and deployment. This is something -- this is a lasting architecture for our customers. And we really feel it's important for us to be on that entire journey for them. It's not about just coming in today and moving to the next one tomorrow. We really need to help our customers move across this architectural journey that's going to be -- it's going to affect their business for years and years to come. And then finally, continue to foster our open and inclusive culture. This is what made the Company, this open culture, just as we do open software, this open culture and continuing to foster that is how we build the first class team that we have and continue to grow that first-class team.

So, I think the key takeaways for you here are a few things. First of all, we feel Red Hat is uniquely positioned to capture the significant hybrid multi-cloud opportunity, extending all the way up to the edge, which is where the industry is moving for today and many, many years to come. We aligned our execution to the opportunity across Red Hat with a maniacal focus on customer successes I talked about. And we'll continue to deliver high-teens revenue growth accelerated by leveraging our partner ecosystem, industry partners and, of course, scale we get with IBM.

So, with that, I'll turn it over to Tom. Take it, Tom.

Tom Rosamilia

Thank you, Paul. Thank you for your partnership. It's been terrific working with Red Hat. I'm Tom Rosamilia. I have the privilege of leading the software team within IBM. And I'm here to talk about our portfolio, some customer examples of how they're using our capabilities and also some numbers I'll give you at the end.

So, let's start with our incumbency. So, digitization, we're seeing things happening in one year that would have taken 10 years to get done. And in fact, Forrester would say, 94% of enterprises will use multiple clouds. Very little amount of the data has been analyzed by analytics. And there are so many hours of mundane tasks that can be automated. We've got an installed base out there, 65% of Fortune 100 rely on WebSphere. We've seen tremendous number of Watson client engagements. 77% of our Gartner Magic Quadrants feature IBM software in leadership positions or challenger positions. And you can see we manage 150 billion security incidents a day. So, this is a ripe environment for us.

So, let me talk about the portfolio. Software is fundamental to the hybrid cloud. Paul took you through this, built on Red Hat, built on OpenShift. OpenShift is fundamental to everything we're doing and everything we're going to talk about today. And I'm going to talk about the Cloud Paks that are built enterprise-ready on top of Red Hat OpenShift. I build them on Red Hat OpenShift, so I can run them anywhere. We can write them where we want. Clients can deploy them on whatever cloud they want or whatever on-prem environment they want. This is a great advantage that OpenShift provides in a multi-cloud environment.

I've sorted our software capabilities into four categories: Predict, Automate, Secure and Modernize. For prediction, it's all about things like Maximo Asset Manager, where I have 2,500 clients out there today that are doing predictive maintenance on their assets. In emerging areas, something called the Environmental Intelligence Suite, the benefits are to measure, monitor and predict outcomes, to simplify reporting, and this reporting or management of crops or reporting a carbon footprint as an example. Companies are using it for that -- for those reasons to do ESG reporting. But the main part of this portfolio is something called Cloud Pak for data, and we're going to spend a fair amount of time on that.

The second area is around automation. And automation is really around a couple of different areas, areas like Cloud Pak for Business Automation, which embodies RPA and BPM. It also has things like Cloud Pak for Watson AIOps, which automates IT. And we've done some major acquisitions in this area, like Instana and Turbonomic, we'll talk about. It also includes things like Cloud Pak for Network Automation. You may have seen a couple of press releases we just did around working with DISH Network and Telefonica to manage their network infrastructure. We can help clients reclaim 50% of the time they spend on mundane tasks.

The third area is around security. There's never been a better time to be in the security business, real-time threat insights. We're moving from perimeter security to zero trust. Part of this portfolio is something called Cloud Pak for Security, which embodies things like QRadar, Guardium and Verify.

And the last one is around Modernize. We are teaming with IBM Consulting, like never before, around helping clients to modernize their IT environments. And all of our Cloud Paks, which are all built on Red Hat OpenShift are really helping us to do that, this right once run anywhere. We're also helping our clients with garages and as I said, partnering with IBM Consulting to co-create with clients.

Okay. Let's look at the growth rates in these innovative areas. And I'm only going to highlight pieces of each one of these. So, in the Predict category, I'd like to focus on something called Intelligent Data Fabric, and I'll go deeper on that. But, you can see the growth rates in this area. This is not just the database or data warehouse market. This is around something called Data Fabric, which we'll go into details on.

Automation, you can see is also a terrific growth area for us, not just around BPM and RPA, but also around AI operations. And security, in a zero trust environment, this is really growing substantially at a 19% growth rate.

Lastly is Modernize, and this is where we reach out to our multiple clients out there, the multiple installed base that's out there in multiple industries across the world and help them to modernize their existing applications.

So, let's dive into Predict. To me, this is significant. Data Fabric is not a brand-new idea, but it's an emerging idea. And what it says is I don't want to have to move the data into a data warehouse or create data lakes, only to find out I need yet another data lake when I'm adding yet another source of information. By using fabric, which lets me virtualize and materialize that data, I don't have to move the data. So, the time to integrate drops 30%, time to deploy drops 30%, ongoing maintenance drops 70%. We've got a great partnership with IBM Research around this area, which gives us the ability to do this privately, securely and compliant. We leave the data where it is. Differentiators, we can do this 8 times faster nearly half the cost. Auto SQL allows us to access, integrate and manage the data. Auto catalog allows us to do data discovery. And auto privacy allows us actually to redact parts of the record that people may not be able to see or shouldn't be able to see. So, it embodies all of those areas, and this is a particular area of excitement for the industry now, something called Data Fabric.

Let's switch gears to automate. Lots of innovations here by IBM Research and some acquisitions. In the last 1.5 years, we've done acquisitions around WDG, myInvenio, Instana and Turbonomic are the two that I just mentioned. And this is instantiated in things called Cloud Pak for Business Automation for the RPA BPM, Cloud Pak for Watson AIOps, and as I mentioned, Cloud Pak for network automation. Instana is application performance management. It's actually the first one built for containers and does observability. Turbonomic actually allows us to take the next step and actually optimize the resource who's working in a hybrid multi-cloud environment, plus network performance management, which really helps us to optimize all kinds of assets. So, it optimizes containers, virtual machines, server, storage, network database. It tells you if you have too much of one, too few of another. It gives us end-to-end AI-driven automation capabilities, and it allows us to do all kinds of savings, and I'll give you an example of that in a few minutes. But to me, this is a very exciting area around automation.

Third area is around security. And as I said, we're moving from perimeter to zero trust. This is embodied in Cloud Pak for Security, things like QRadar, Verify, SIM, identity and access management, EDR and XDR capabilities. The differentiators for me here are around not just the capabilities of the portfolio, but the capabilities of the people. I've got 8,000 people working in this area, 19,000 clients that we serve 10,000 patents out there, all embedded with AI and ML. And the partners that work on this, the practitioners that do services, I've got about 5,000 people out there doing services for clients in the area of security. They will work with multiple providers, not just my software but anybody's software. We’ve hired more than 700 this year, we'll do another 700 next year. These are special skills. And these people not only can help do the work, but they can help train people to be more secure in their everyday lives.

And the last thing is around Cloud Paks. This software has been infused with innovation from research, from development. It's enters prize ready. They've all been made container native. They're pre-integrated. They're open and customizable. And I will tell you over the last six quarters, I've seen about 1,100 clients using multiple Cloud Paks. We see this recurring revenue increasing to over 100% of what we saw last year, as Jim shared with you in the last quarterly update. And we're really focused on deployment, getting these customers deployed. So, they're getting great value. I should also mention that we did come out this year with a new version of WebSphere called Hybrid Edition, and it just and it just became available this year. I've got over 150 clients on it already.

So, I promised to talk about clients. Let me start with Citi around Predict. Citi was focused on audits, and they've added artificial intelligence and natural language processing to their audit processes. They built AI into their workflows. We did a design workshop with them in January of 2020, 5 IBMers, 25 people from Citi. We combined our consulting services with Promontory and help them to develop the best audit they could do. Over 1,000 audits a year are now done infused by AI, using Cloud Pak for data, using open pages for the unstructured data. Now, they're looking to use Watson Assistant to help them with calls.

Second one is Carhartt. Carhartt is a retailer here in the U.S. They've gone from over -- from $100 million of revenue to almost $1 billion in revenue in sales, and they've had record holiday sales. They were using AppDynamics for their APM. So it's a competitor to Instana but Turbonomic works with many of the APM providers, all the major ones, including Instana. They were getting value from the AppDynamics, but they needed to add Turbo to really get them the kind of optimization and the kind of performance for their clients that they were looking for. We not only were able to tune their system to have much better performance results, but we also save them money. So, they have 24/7 performance assurance. It actually not only does the network and the servers and the storage, but it also does their VM placements and even Java VM heap sizes. This is running on the Azure cloud. They saw a 45% improvement in efficiency on the Azure cloud.

Third one is OTTO, it's a retailer over in Germany. By the way, a data breach costs on average $4.2 million per incident. OTTO is the largest online retailer of home furnishings in Germany. They're using QRadar to do their incident management. They're using our IBM Consulting to help not only do the work but also to train the people. They've taken event analysis from hours to minutes. And what you really want to do in this area because there are so many things being thrown at you is get out of the noise and get to the signal. So, they've seen a 300% reduction in false positives, which is great.

The last one is Modernize and Etihad airlines, the national airline of UAE. They're using Cloud Pak for integration or the API Connect to modernize their back-end systems. They participated in IBM Garage. They did the design thinking with us. This is a key point because we do co-creation with our clients. They have modernized their web check-in and their boarding pass generation. It's all built on Kubernetes, and they've moved to microservices.

Let me just focus on one area. You can see a lot of areas on this slide that I'm investing in. I want to focus on the one on the right, Client Success Managers. Because selling the software is important, but getting it deployed and getting our clients to get the value from the software is even more important to me. So, we have dramatically ramped up the number of CSMs or Client Success Managers this year, and we will continue to do so. So, when a client buys a Cloud Pak, they get a CSM to help them get value as quickly as possible.

And now to the numbers. And you can see we're providing additional transparency in the pie chart on the left. Now, Paul mentioned Red Hat in the high-teens. That becomes a larger percentage of IBM, and it contributes about 4 points to my software segment. I mentioned security, software and services as a high-growth area. It's about a 9% to 10% growth area, plus I get the benefit of full year acquisitions next year and that equals about 2 points of growth. Recurring revenue is improving each year and those renewals also help drive revenue growth. I should note that about 80% of our software falls into the category of recurring revenue. Now, I offset that by a modest headwind in high-value transaction processing sub-segment, which is absolutely mission-critical to our clients and mission-critical to us as well. All that yields a midterm model of mid-single-digit revenue growth.

In summary, our software is absolutely key to our clients' digital transformation. We are all in on Red Hat, not just RHEL but OpenShift. We've built our Cloud Paks on that base to be able to be deployed on anybody's cloud, whether it's on Azure, whether it's on AWS, whether it's on-prem or it's on the IBM Cloud. We are maximizing the value with IBM software innovations.

I will tell you, I've been here 38 years, I have never been more excited to be a part of IBM. Thank you for your time. Over to you, Mark.

Mark Foster

Thank you very much, Tom. Well, Kelly, John and I are really delighted to be talking about the critical role that IBM Consulting plays in the overall IBM strategy. We're also particularly delighted to be having the opportunity to unveil the new name of GBS as IBM Consulting, a name that we think is going to help us to really define the marketplace that we're serving, be clear about the value that we're delivering to our clients, help us to attract and retain talent as well as being clear in terms of the investor value proposition of this part of the business. And this part of the business is a very significant part of IBM.

You can see the global scale that we have as an organization, a footprint of skilled resources, all across the world that straddle right from the areas of strategy, through process reengineering, BPO, systems integration, application management services, hybrid cloud migration and many other areas. And these are skill sets that are recognized by analysts as being in the leading levels in each of their respective areas. And of course, we have a fantastic footprint of global clients that we serve. Most importantly though, IBM Consulting is completely aligned with the hybrid cloud and AI strategy that Arvind has spoke about earlier. And we fit into the overall IBM storyline in a very, very powerful way.

First of all, we are a growth vector in our own right. Going forward, IBM Consulting will be 30% of IBM with an opportunity for profitable growth in its own right. We're also though going to be able to be acting as a multiplier, pulling through the rest of IBM and helping to amplify the impact of our hybrid cloud platform. We have an opportunity to recognize that as clients are approaching their transformational journeys. Many of them will actually approach it Business Transformation first, just as many will approach their transformation technology first. We therefore have the unique opportunity to help our clients on their transformational journeys from whichever starting point that they have.

We have a specific role in IBM Consulting to make sure that we're helping to build the C-suite relationships, the relationships out and around the CIO for the lines of business that in many cases now are making the critical decisions that our clients are making around their transformational journeys, the scale of change -- the scope of change they're driving. And as we do this, we also have a recognition and a very clear role that as with the rest of IBM, we now have an open strategy. We are very clearly playing with a series of the major ecosystem partners in the world, the major ISVs, the major cloud service providers that are going to be the destinations of the backbone solutions that underpin the client transformations that we're a part of.

So together with that and together with our ability to therefore pull through the rest of IBM technology in a very, very powerful way that we've proven already in terms of the pull-through for Red Hat, the pull-through for Cloud Paks, just two examples. We have a real opportunity to act as a multiplier for the total story of IBM moving forward, as well as the power that we have to apply a fantastic innovation and research. And we do see IBM Consulting as a growth vector simply because we see a very, very large marketplace opportunity in front of us. The client imperatives that range from how to drive growth, how to drive more productivity, how to cut cost, how to be more agile, how to be more sustainable, all of these are conversations that I'm having -- that we're having every day with our clients.

And as they're thinking about the scale of change they're now facing, it's a very, very substantial scale. Their digital journeys that have been accelerated through this COVID period are now becoming even more deep and even more pervasive as they now step up to the long-term arc of change in front of them over the next 5 to 10 years. And indeed, I've coined the phrase that we are facing, if you like, a golden decade for consulting, because there is so much scale of change that clients are looking to go on and actually, the resources to do that are very lean within their own organizations. So, they're looking for an execution partner. They're looking for execution of vehicles with the transformational programs to help them go from A to B. And we, therefore, have an opportunity to really help them as they go on that journey.

We should recognize that the consulting that we're talking about is not the consulting of the past. This is not about outsourcing the activity to somebody else to do the work for you. This is very much a co-creational view of consulting where we're working with our clients, providing our skill sets alongside theirs, helping them to co-execute the visions that they're defining and then helping them to run them in the future, often acting to transfer skills back to them, so they're able to be self-sufficient in the future.

So, this is now a really substantial opportunity that we can see in front of us and one that we can obviously use to not only drive growth in our own right, but as I said before, to pull through the assets and solutions from the rest of IBM as well.

And as we think about, therefore, what are going to be the core segments and components of IBM Consulting moving forward, there really are these three main areas. The first is Business Transformation. And that's our ability to help our clients transform their intelligent workflows by bringing technology to bear to transform critical processes, for example, their customer service process or their supply chain or core payments for a bank or insurance claims for insurance organization. And by bringing together the power of our strategic consulting, our process reengineering, our BPO, our data, our AI in a seamless capability that also draws upon the power of these backbone ISVs is a truly unique combination that we're bringing to bear.

And we do see the fact that we are building strategic relationships with each of the critical and fast-growing ISVs out there, whether it's SAP, Salesforce, Adobe. The power that we have to actually work with those organizations to create the underpinning of these intelligent workflows is a critical area of strength and growth for us, as is the deep alliance we can create with the rest of IBM software around assets such as Maximo, TRIRIGA and of course, the whole Watson AI suite. So, a huge amount of power and differentiation in our Business Transformation segment.

The other major marketplace that we're trying to drive towards, of course, is the hybrid cloud marketplace. The marketplace, the transformation as clients move their application to support these new workflows into new infrastructures and new solutions, many of which are going to be in a multi-cloud hybrid environment. So, our Technology Consulting capability will be the capability to help clients with that migration, that modernization at scale. And we see a huge opportunity for application modernization as clients now look to take their entire suites that support critical functions and move them into these new, more agile and flexible environments. And as such, it's going to be our deep partnerships with the cloud service providers, such as AWS, Azure, et cetera. The destinations for many of these applications will be a source of differentiation for us as we build up our strength and capabilities in these critical areas. And of course, all of this takes place on the backbone architecture of Red Hat OpenShift where we have a very, very strong point of view in IBM Consulting. This is going to be the railway tracks down which the transformation of so many of our clients' application infrastructures is going to take place.

And then, the third segment is our Application Operations segment, a large one for us right now, where we have a huge degree of incumbency in helping to manage many of the applications that our clients are now running.

Our ability to help them move that management task to the new application suites of the future, the new hybrid cloud application suites to help them with the multi-cloud management agenda or indeed to help them with their managing of the data fabrics they have in their organizations is a huge opportunity. And in doing that, we can also strengthen as well and draw upon our alliance with the rest of IBM technology, particularly the AIOps world and our mainframe modernization opportunities as well.

And I talked about the strength of our incumbency in this space. It not only helps us drive work in Application Operations moving forward, but is acting also as a strong source for getting us the work and the introductions to work in Technology Consulting and Business Transformation. So, these are the major components that we're excited about in terms of the power of IBM Consulting moving forward.

I'd now like to ask my colleague, Kelly, who runs the Americas for us in IBM Consulting, to talk about how we bring this to life in a client situation. Over to you, Kelly.

Kelly Chambliss

Thank you, Mark. It's my pleasure to talk about how we provide differentiated value to our clients, including through the use of IBM Garage. Clients provide the motivation, the meaning and the purpose behind all that we do. As a marathon runner, an analogy that comes to mind often is that we approach building long-term trusted relationships with our clients, like a marathon or a path full of focus and commitment, not a series of disconnected sprints or transactions.

Key to building long-term trusted relationships with our clients is world-class delivery. And this is one of our greatest strengths. It is often leading to both, repeat and add-on business. We see this clearly with over 70% of our managed services clients also choosing us for business transformation work. Many of our client programs include both, business transformation work and managed services, as we bring the capabilities that Mark spoke about together to form offerings and solutions, that align with our clients' priorities and their areas of investment, specifically around engaging their customers and citizens in providing tremendous client experiences, modernizing and managing core business operations or think of that as AI and automation-driven business process outsourcing, to transform talent and the future of work, and also, of course, to modernize and manage multi-cloud operations. All of this is done with an overarching focus on accelerating business transformations and helping clients on their hybrid cloud journeys. And it is underpinned by our innovative use of both data and AI across all of our offerings. Our offerings are strengthened by our close relationships and collaboration with IBM Technology and Red Hat and also our strategic partnerships, which John will talk about shortly.

One of our greatest differentiators is our ways of working or how we deliver solutions to our clients. We often deliver those solutions using a creative, agile, iterative and innovative approach that we call IBM Garage. And IBM Garage is further supported by our dynamic delivery method, which enables us to form teams quickly of highly skilled professionals from around the world at scale to deliver both, a consistent quality in our solutions, but also a consistent client experience.

Our pervasive use of IBM Garage not only provides a consistent client experience but also an experience that is very engaging and outcome-focused as we co-create, co-execute and co-operate side-by-side with our clients.

So, what is IBM Garage? IBM Garage is a methodology, it's a set of tools, and it's a portfolio of reusable assets that together combined enable us to deliver solutions at the scale expected of the largest, most complex organizations in the world, but at the speed of a startup.

We are increasingly applying IBM Garage across all of our offerings. And you see this evidenced in our 400 new clients that have started Garages with us in the first half of 2021 alone. This brings our active number of garages to over 4,000. Clients are embracing this approach, and this approach is really resonating with our clients. This is evident in an 82 Net Promoter Score for clients with active Garages with anything over 80 considered world-class. IBM Garage not only has a really positive impact on our clients and their speed to value, but it also has a big impact on our ability to attract, retain and engage employees and that is as important as ever. They find the work very fulfilling, very energizing, collaborating closely with our clients, with our strategic partners, with our colleagues from across IBM to deliver scale solutions at speed.

In summary, our offerings are aligned to our client priorities and their investment areas. Secondly, we are increasingly being selected for Digital Transformation and Business Transformation programs. as a result of our unique and innovative ways of working, like IBM Garage and Dynamic Delivery. And last but not least, we are seeing our strategy come to life for and with our clients through significant repeat and add-on business and strong Net Promoter Scores. Thank you.

And I'd like to hand it over to John Granger, who is our Chief Operating Officer for IBM Consulting and also leads all of our cloud work in IBM Consulting. John, over to you.

John Granger

Thank you, Kelly. I'm going to cover three things: Firstly, the investments that we are making in order to grow in order to capture the market opportunity and digital transformation; Secondly, I'm going to deep dive on to perhaps the most important of these investments into strategic partnerships; and then, thirdly, I'm going to show how we bring it all together in order to win clients.

So, starting with investments and most importantly, our investments in our talent pool. We've made a big step change in our hiring. We've been investing ahead of demand in order to ensure that we can meet our clients' needs. And this year, across our entire global network we've increased our headcount by significant double digits. But, it's not just the quantum of our skills that is important, it's also the quality. So, we've been investing in future skilling, particularly in the spaces of hybrid cloud and AI. We have over 55,000 people now cloud trained and over 70% of our team now have expertise in the industry of their choice.

We've also invested in acquisitions. Of the eight that we've made this year, three Nordcloud, Taos and BoxBoat are in the space of building up our differentiated hybrid cloud capability, and they brought us skills in cloud-native applications, in hyperscale expertise and in platform engineering.

We've made two acquisitions, Waeg and 7Summits in the sales force space in order to build our capability there. And we also made acquisitions in data and AI and in building out our industry expertise, particularly in financial services and payments. But the importance of these acquisitions is not just in the points of growth that they bring and the way that they build out our portfolio but they also bring an injection of new leadership talent, and they also enable us to fast track our relationships with our partners, because they bring competencies and assets that help us build those relationships out.

And so, these investments in hiring and in acquisitions in turn enable us to accelerate the building out of offerings -- new offerings and new practices. Take the building out of our differentiated hybrid cloud capability, for example. Our hyperscaler friends and partners tell us that we are setting new records this year in the speed at which we are building out the skills in each of their domains, much faster than our competitors.

In the Red Hat space, in the space of just 18 months, we have built out a practice that's twice as big as our nearest competition and is now generating revenues of over $1 billion. And next up in this space in the hybrid cloud space will be multi-cloud management, where we're building out a practice in Application Operations in AIOps that leverages the investments that IBM has made in the acquisition of Instana and Turbonomic.

Software assets and platforms. Now, these are a growing differentiator in our market that enable you to bring disruptive offerings to the market but also to influence the choice of service providers. So, we have built an IBM Consulting Essentials platform, which is the platform that we use to engage, sell and deliver to our clients at scale through a collaborative experience. So, this platform brings together assets, methods and tools from IBM Consulting, from IBM Research and from our ecosystem partners in order to deliver a differentiated experience on a single platform.

And then, finally, on this page, we're using the opportunity of the Kyndryl spin-off in order to invest in our brand. We are reintroducing GBS to the market. We are repositioning GBS with the market as IBM Consulting. And that's not just to reposition and reintroduce ourselves to our clients, but it's also to ensure we are attracting the widest talent pool because we're then -- we're now being clear about what we do, who we are and the opportunities that we offer.

So, the last and most important of our investments is on the next page and is really in strategic partnerships. And we see these as an absolutely critical vector for growth. Every one of these partnerships on this page is or will be a $1 billion business for us. Because clients are making important technology choices, and they require a world-class implementation partner and we need to ensure that we can ride that way with proficiency in their applications and their products. And it's not just about these individual partnerships. It's also about the breadth of these partnerships, the combination of these partnerships because many of our clients' workflows combine and use multiple of these partners’ products and applications. So, the ability to work, for example, with SAP and hyperscaler partners to transform our clients' ERP capability is really, really important.

Now, as you can see from the chart, there are three dimensions to these partnerships. That's being publicly recognized as a top partner through the award of a precious metal status. There's the extent to which we're building up skills and capabilities in these partnerships, usually measured by certifications. And then, of course, there's building unique solutions. And these are not just industry solutions, but these are often ways in which we can pull through IBM's hybrid cloud platform and AI technology. So for example, you'll see that we are the preferred supplier for Azure Red Hat OpenShift, and we are in a similar position with AWS on Red Hat OpenShift for AWS. And you can see that we are strong or strengthening right across the breadth of these partnerships. And of course, the latest to be added here is Kyndryl where we share a heritage where we share a common client base of over 1,000 clients and, of course, a deep and close understanding of how we work together.

So, let me finish off then by showing on the next page how we bring these investments together in service of our clients in order to win. So, Delta Airlines are looking to transform the efficiency of their flight operations and to make a step change in customer experience. And for reasons of data gravity, for reasons of security, the reasons of complexity and cost of their legacy applications, they chose a hybrid cloud architecture as a solution with Red Hat OpenShift at the center, and AWS is their major public cloud partner. So the winning formula for us then was to take the application modernization capability that Mark talked about, to then combine that with the market-leading Red Hat practice that I referenced earlier to bolster it with the close relationship that we have invested in and built out with our friends at AWS, and then to top it off, by putting the Garage approach that Kelly talked about right at the center of the delivery of our services and our work with the clients. And the last piece of the jigsaw was provided by one of our acquisitions, Taos in the form of platform engineering made sure that we had the full range of technical capabilities that we needed to provide the transformation for our clients that you can see on this page. So, these investments, these acquisitions, the hiring, all of these things are accelerating our ability to grow.

So, with that, let me hand back to Mark in order to close out our part of the meeting.

Mark Foster

Thank you, John. And Delta is just one of the examples of our client work around the world, which gives us so much confidence that the strategy we have for IBM Consulting is going to drive a huge amount of growth for us moving forward. We're confident that we can drive this business at a high single-digit revenue growth level durably into the future as we seize the opportunity of growth riding the waves of growth that are coming through the transformation we see our clients undertaking at this time.

We've been able to see it in the momentum we built up in our signings over this recent period, the growth rates we've seen in hybrid cloud, the pull-through we've had of Red Hat and Cloud Paks, among many others. As we look at the growth going forward, the majority of that growth is going to come from our organic activity, but it will be topped up by our M&A activity, which we're seeing as a massive growth enabler to us, as John has described.

So, in summary, IBM Consulting is going to have an opportunity to really partner with -- around the global industry transformations that we see our clients undertaking around the planet. We see the opportunity to bring the skills and the offerings that Kelly referenced to bear to really focus on those growth markets of hybrid cloud and intelligent workflows, both fast-growing areas.

We see the opportunity for us to be a major pull-through of IBM technology and to enable the adoption of the hybrid cloud platform at scale across many industries, across many clients. And in doing all of this, we're going to be working very, very closely with a deep ecosystem of partners.

I'm excited about the new identity of IBM Consulting, and the ability that, that creates for us to be really clear to the marketplace about our differentiation, but also about the critical role that we play in the growth strategy of IBM overall. So I trust that that's been a very clear picture of the opportunity we see for IBM Consulting, I want to thank John and Kelly for their support.

And now, I'd like to hand over to Ric Lewis to talk about IBM infrastructure.

Ric Lewis

Thanks Mark. My name is Ric Lewis, and I'm the newest member of the IBM leadership team, and I run IBM Systems. And I came to IBM specifically because I believe there's potential for innovation and growth, both in systems and in IBM overall.

Today, the action in the market is around hybrid cloud and AI and that's where we're focused. And I see opportunities in IBM with our hardware, our software, Red Hat consulting, cloud, all of those things tied together creates fantastic solutions for our customer. But the base of it is this infrastructure, and that's what I'm going to speak about today. And the good news is we're starting from a position of strength.

45 of the world's top 50 banks run on IBM Z today. And on a typical Z system in a day, we can run 19 billion transactions. It's not only Z, we've got power as well. 20,000 clients are running on IBM Power, not just Z Power, we've got also storage, 200,000 storage all-flash array systems are deployed worldwide at this point, and we just refreshed that product line, and it's fantastic.

But those are the things that I kind of knew before coming to IBM. There are a couple of things I didn't really know. And that is, first, 94% of the Fortune 50 companies use the IBM Cloud. That's really impressive and it's particularly in something I'm going to talk about today around regulatory clouds, specifically financial services cloud.

And 77,000 infrastructure support clients exist around the world. Those are people taking infrastructure support from our 15,000 professionals that are distributed globally. All of those things come together to build a very strong infrastructure lineup, and it serves as the foundation for the hybrid cloud and AI strategy for IBM.

Here's the picture you've seen in prior presentations. And where we fit in the stack is right there at the bottom, at the foundation, as I just said. And what all does it include? It includes Z, power, storage, infrastructure support and our regulatory clouds. All of those are in the blue box that you can see highlighted below.

So why does this stuff matter? I mean what specifically is it about infrastructure that is still relevant today? There's a whole lot of cloud action going on, et cetera. Well, if you look at the data, 75% of global workloads are still on premises today. And that's a lot, right? And we will talk about that a little bit later. But where the action is, when I talk about that 16% of hybrid cloud infrastructure growth rate?

Now that's growing really fast. In fact, some people believe that's growing faster than public clouds specifically. So that's hybrid cloud, what about AI, well 55% of enterprise are planning to have some sort of hardware-assisted AI in their shops by the end of 2024. So I've mentioned that's where the action is, it really is.

What do we do to win? I just fundamentally believe we innovate. We provide trusted, agile secure solutions for hybrid cloud. We leverage our Z incumbency with those customers to make sure that we understand their needs in that we're delivering like no one else can. We innovate around things like AI that I'm going to talk about today, and we continue to make these platforms modern and capable of cloud-native deployment of Linux deployment, all of those capabilities.

And then finally, we tightly couple with the rest of the stack to deliver deeper, richer value propositions to our customers around security, around AI, around as-a-service delivery and you'll hear more about that in the rest of the presentation. So it's a very big market. It's a dynamic market, and this is a very big business. But I'm going to boil it down to three key areas of strength that I want to talk about.

The first is infrastructure in hybrid cloud. I have a dedicated side on Z that I'll get to next. But other elements of that distributed infrastructure include power, where we just introduced Power10 with industry-leading performance on SAP HANA. We've also got storage where we've recently introduced a new midrange distributed storage platform that has industry-leading price performance capabilities as well as a whole lot of storage software, which is really strong and capable and continuing to grow.

In that category, though, also, I would include our infrastructure support and that recently was moved into my group as part of the Kyndryl spin-off. We kept the technology support group. And it really is around infrastructure support and there are growth opportunities there to tighten the integration with our platforms as well as add AI capabilities and move up the stack in terms of support for open source software and other software things.

With that artificial intelligence is going on in infrastructure support, we add to it work that we're doing in hardware. And that artificial intelligence is right, specifically in the sweet-spot of the value add that we're delivering to our customers and I have a chart that details a little bit more about that.

And finally, regulatory cloud, we've got specific traction in the financial services space. And I want to give you a little description of how are we doing that, why does it resonate with customers? So IBM Z is really essential to the hybrid cloud infrastructure in the digital economy. Now why is that? Z is relevant. Z is a healthy franchise.

Well, I'm going to tell you there's a whole lot of conversation going on out there about, well, can you migrate these workloads, should they live in a public cloud? Really, the fact is, there's no traction on migrating these workloads in the industry today. And the reason is, there's no need to move. We've modernized these workloads.

We have cloud native development inside the platform capable of modernizing all the ways you develop and support those platforms. We're also application-stacking on our LinuxONE platform, other applications that can live and reside on the Z platform. So it makes it relevant and strong and moving to the future, but that's not the only innovation we're doing.

We've got hyper protect security software that allows customers to have their own keys, no matter where either on-prem or in the cloud where they have the only key, we don't even have it, and that's something that's unique in the industry. We're also doing flexible consumption models as a service delivery with our tailor-fit pricing structure. We've got cyber resiliency at the core, which is something that's always been the case for Z platforms; and AI acceleration, which I'm going to talk about in a second around the Telum processor.

So what does all this mean to Z? I said it's a healthy franchise. The last several programs, z15 has had more revenue than z14. z14 had more revenue than z13, and we plan to continue that trend. Not only is there healthy revenue, we've been continuing to expand the MIPS that we've shipped, strong MIPS results in that platform is really the hallmark of advancing. Customers need to consume more MIPS as they do more transactions on that.

And if you look over the last 10 years, where are those MIPS? Well, from 2010 to 2020, the dark blue chunk at the top of that chart is really around the new kind of MIPS, the stuff running on Linux 1, the application stacking. The stuff that's not kicks IMS, DB2. It's the new transactions.

And that tells you, hey, this isn't about just the legacy workloads that have been running on Z. It actually is modernized for the future. And the best part for IBM is for every dollar that we sell of Z, we get $3 to $4 of additional software storage and infrastructure support. It is a powerful franchise, it's healthy and it's modernized for the world's most important mission-critical clients.

It's not just Z, AI. We're innovating in this area. And the unique thing that we're doing here is you hear a lot of industry talk about facial recognition and self-driving cars and those kind of applications for AI. But we're delivering real business value to the most business-critical workloads in the industry.

And the way we're doing that is we're doing it with real-time AI at the point of data creation at speed. The speed of the workload, and that's extremely powerful, and we got that directly through our design process with customers. They said, if you could allow me to do fraud detection at speed in line. That would be a killer feature.

And so we've got a lot of industry accolades about this tremendous innovation in the IBM Telum processor that we introduced August at hot chips and we'll be shipping in the first half of next year.

IBM Power Telum processor, we just refreshed it, and it just started shipping here this last month, and we see a lot of momentum with customers. It's specifically focused at the scale up kind of retail and SAP HANA kind of space, that's where we're seeing the most growth in it. And it's got AI processing in it really optimized for data-intensive workloads such as SAP HANA. So you can see Power10 is modernized as well.

And if that AI isn't enough, we've also got our spectrum scale storage that allows you to move AI data back and forth easily in your hybrid cloud environment for processing. So I talked about Z and I talked about AI and innovation. But this financial services cloud that I mentioned earlier is a real area of action for us.

So I also said 75% of those workloads are still on-prem. That means 25%, as you see in the chart are off-prem at this point. But that's probably not what most people would guess. But what they really don't know is that only 15% of the financial services market workloads have moved off-prem at this point. And it's been about 1% per year for the last five years. So you can tell the slope is very slow.

Why is that? Well, I think there's a couple of reasons. The obvious one, it's difficult to move those workloads. I think the less obvious one is the whole issue around compliance. And as customers take their systems of record and enhance with new mobile experiences and do digital transformation, what they find is that, hey, all of this stuff fits well and all of that, but I need to add some ISVs, I need some new capabilities.

And when you do that, that whole solution has to be compliant and has to be checked out. And what customers find is that's really difficult to not only set up but also to maintain over time. So they've come to us for our hybrid cloud solutions in that financial services cloud space and we have momentum in the space. That's the coolest thing.

We've got 115 ISVs already on our Financial Services Cloud and that covers about 80% of all financial services software consumption that are served by these ISVs. That's a big, huge chunk of that financial services market and we've just taken out the complexity. What's this led to? We have over 450 clients that are buying our solution in that space already and they're super happy. And why are they happy because we do the hard part.

We maintain compliance and make sure those solutions are flexible and agile and always ready to go. We also accelerate their innovation because it's really hard to set this up and get everything compliant to begin with. They can operate with agility because it reduces their OpEx. There's estimates that as much as 15% of OpEx in these environments really was going to just dealing with the compliance issues.

And it all comes with our same great hyper protect kind of confidential computing secure capability that we've been shipping in our Z platform. So it's just a powerful solution and it has fantastic momentum. So when you take some of our distributed infrastructure like Z and storage and then you combine it with the financial services cloud, you get kind of this hybrid solution that no one else can provide.

And customers like Coca-Cola and UPS and Fidelity, those customers are making use of this solution today. And one that I put on here specifically because I really love this solution is BNP Paribas. And what they have is 33 million end customers with 850,000 companies that interoperate with them and they needed to provide new transformative experiences, mobile and web front end, but have that be close to their system of record data.

So what they did is they took system of record data and they put it on the Z platform. And then they added our financial services cloud to give those new experiences and have the breadth of solution options that you get with a cloud offering. And then underpinning it all is our unified data fabric or our storage -- scale storage that I talked about earlier. It's an extremely powerful solution.

And quite frankly, there's one more piece to it, TSS, the infrastructure support that makes it even better because we take care of everything. We provide maintenance. We provide compliance. Everything is taken care of soup to nuts for the customers, and they're really thrilled with that. So I guess the beauty of this for me is only IBM can provide this kind of capability in that kind of environment to transform the environment, make it more agile and allow the customer to deliver these kind of experiences. So I'm just super happy to see customers like that.

So what does this mean going forward? This is a big, stable business that is very profitable for IBM, and we intend to keep it that way. And how do we plan to do that? We're going to invest. We're going to invest and innovate in the space. We're going to continue to invest in IBM Z with things like AI and Z as a service that we recently introduced and all of those capabilities, but we're also going to invest in our storage portfolio around distributed flash, where we have great momentum and great price performance advantage.

And we're also going to invest in the software around our storage platforms. We're also going to continue to invest in infrastructure support. So all other things like AI integration into the products and integrating more of the infrastructure support into those products and offering it as a service and adding multi more multi-vendor than we already have in that business today. And we'll continue to enhance our financial services cloud and expand into more regulatory clouds.

Hybrid cloud and AI is where the action's at, as I said at the beginning of the presentation. And in IBM with our hardware, our software, our consulting, our cloud and even our research that kind of feeds the innovation that we're doing in all these places. We have the intellectual property and skills to help clients like no other competitor.

Thank you for your time today, and I look forward to speaking to you again.

Jim Kavanaugh

Thanks, Ric, and thanks to all of you for joining us here today in our 2021 Investor Briefing. I know it's been a pretty impactful day already and we're going to bring this to closure here now before we start the Q&A. As you can tell from each of the presenters here today, we are extremely excited about today being a landmark day for our company. And as Arvind said, redefining the future of the IBM company.

So when you take a look at it, over the last several years, we've been executing a transformation that started with the acquisition of Red Hat and its strong adoption, which has now positioned IBM for success to capitalize on a hybrid cloud and AI attractive market opportunity.

My colleagues here with me today just shared with you: one, how we've laid the foundation to further capitalize and accelerate and bolster; our, leadership hybrid cloud and AI position; two, how each of the components of their segments fit to the synergistic capability of an integrated hybrid cloud platform-centric thesis; and three, how we are going to win with our differentiated competitive value propositions around specific growth plays.

Now I'm going to bring all this together. And as you could see, Arvind started today with this chart; and now you could tell over the last 1.5 hours, how IBM is leveraging the integrated capabilities in a platform-centric model. It all starts with IBM Software. And underneath that, Red Hat, the industry-leading hybrid multi-cloud platform built on open source.

With our IBM software modernized and optimized on top of that hybrid cloud platform with AI to predict, automate and secure environments, then supported by IBM Consulting, who acts as a trusted business partner in our clients' digital reinvention and journeys to cloud.

As Mark articulated, they are business transformation-led technology powered. What does that mean? It drives scale and adoption to our hybrid cloud platform and it also pulls through IBM technology. And all of this, as Ric just concluded, is underpinned by IBM infrastructure, optimize for the most critical transactional and regulated workloads.

Not on this chart, but a very essential part of IBM's business model equation and our key investment organically is around IBM Research. That plays across each of these layers here today to fuel innovation and create new emerging market opportunities like Quantum that Arvind talked about earlier that hopefully all of you can participate in November when we have our client event.

So when you look at this integrated platform-centric model, it plays to a very attractive market opportunity, a $1 trillion TAM, and it also has a very compelling economic multiplier effect, not only for the IBM stack to create value, but also very importantly, in any platform is for our expanded ecosystem partners. And that really delivers for every dollar of platform, $3 to $5 of software, $6 to $8 of services and $1 to $2 of IBM infrastructure.

Now to capitalize on that attractive market opportunity and also around that economic multiplier, we have aligned IBM's business model. And when you think about it, our strategy, our portfolio and the moves we've been making, our operating model and our capital allocation policy, all centered around creating value through focus for our clients, for our partners, for our shareholders and our employees.

I'm going to share with you here today IBM's financial model and our investment thesis, which is centered around prioritizing capital allocation to investments for growth, around aligning an operating model to a platform-centric business model with increased capability to execute and all leading to an improved financial profile for growth, both revenue and free cash flow generation driven by our leading hybrid cloud and AI capabilities.

But before I dive into the financials, let me clarify that we will be aligning IBM's management system to the platform-centric model that Arvind talked about once the Kyndryl separation goes effective right before that. And consequently, we are going to redefine IBM's new and simplified segment reporting structure with increased granularity around performance contribution to our hybrid cloud and AI thesis.

You see on this chart the four new segments that we are going to be reporting post separation, and that is centered around IBM Consulting, IBM software, IBM Infrastructure and Financing. All of it optimized for our business model in terms of offerings, innovation, investments, and financial return.

Now I'm not going to dive deep into the segment reporting around the granularity. Each of my colleagues here today cover that and we actually sent out an IBM investor article this morning in much more detail explaining that. But when you look at the new segment reporting structure, it is put in place to enable investors to have increased transparency, visibility and sustainability into our growth vectors and our value vectors to capitalize on that $1 trillion hybrid cloud market opportunity overall.

Those four new segments really define the new IBM, a very different company, not only in terms of portfolio with what we've been doing, but more importantly, in terms of business mix, growth profile, operating margin leverage and free cash flow generation as you look here. This chart depicts the new focused hybrid cloud and AI company in terms of our 2020 performance, in terms of revenue and free cash flow.

So let me take a minute and explain it. Starting with revenue, IBM delivered $55 billion of revenue from continued operations in 2020. That is basically IBM's pre-separation revenue of roughly $74 billion, less the external sales that Kyndryl generated, which will go with them as part of the separation. However, Kyndryl now becomes a very valued client with a strong strategic partnership between IBM and Kyndryl going forward.

So we have, for your benefit and transparency, we've modeled out what the impact is of the external sales that would have been in 2020 with a full 12 months. And you could see on the chart that, that was about $2.5 billion incrementally and that's additive to the $55 billion of results from continued operations. As I'll get into a little bit later, we intend to be very clear both in 2021, depending on when the separation goes effective and more importantly, in 2022 about the transparency of the external sales to Kyndryl and the impact to our revenue growth profile.

Now turning to free cash flow. Free cash flow, when you look at it for given a full 12 months' worth of sales, we modeled in 2020 that the baseline is about $10 billion worth of free cash flow. That is the baseline we're going to start with to look to build and grow as I get into the IBM midterm horizon financial model shortly. When you look at our confidence in our ability to grow both revenue and free cash flow, it stems based on our improving business mix that you see on this chart.

On the left-hand side of the chart, our revenue mix composition is now shifted and skewed more towards higher-growth market segments. Post separation, software and consulting will now be over 70% of our IBM revenue composition. And on the right-hand side of the chart with regards to recurring revenue, while we'll still have a very strong recurring revenue base across IBM, greater than 50% composition is a very different quality and a much higher value composition post separation.

As you could see, software is now 65% of that mixed composition of our recurring revenue. What does that mean? Higher improving growth profile, better margins, higher free cash flow generation. So if you take everything that I put together so far and talked about and really bring the whole day together, number one, we're aligning our business being very focused as a company around hybrid cloud and AI with a very compelling platform-centric business model.

We have an improving business mix profile skewed more towards higher growth markets. We have a much higher value recurring revenue profile and you combine that with a chance to reset and redefine our client relationships for incremental wallet share and it lends itself to an attractive financial model an investment thesis over the midterm horizon that you see on this chart, '22 to '24.

Our IBM financial model, mid-single-digit revenue growth, top line and you combine that mid-single-digit growth top line with an improving mix profile and it naturally lends itself to operating margin leverage. That operating margin leverage then translates into high single-digit free cash flow, $750 million of free cash flow growth generation per year.

You now couple that with the baseline of $10 billion of free cash flow, you compound that free cash flow at high single digits and that delivers $35 billion of cumulative free cash flow over the midterm horizon. So from an investment thesis, the new IBM, improving revenue growth profile, higher operating margin, a free cash flow yield that's very strong, lower capital intensity business and a higher return on invested capital overall.

Now let me take a couple of minutes taking that financial model I just talked about in unpacking it, and I'm going to start with revenue growth. IBM's sustainable mid-digit revenue growth is enabled by the key actions to accelerate change that Arvind talked about upfront, specifically aligning the Company in a much more simplistic platform-centric business model, nice economic multiplier that goes along with that, redesigning our go-to-market incentive systems and investing for growth, both organically and inorganically around innovations, ecosystems and a whole new set of skills and capabilities.

And when you take a look at it, you bring all that together, it lends itself to mid-single-digit revenue growth that I talked about earlier. So now let me take that and now unpack it as to the contributors of IBM's mid-single-digit revenue growth. And let me start with IBM Consulting.

As Mark talked about upfront, now a much bigger portion of IBM's revenue mix composition approaching 30%. High single-digit revenue growth that will contribute two points of the mid-single-digit revenue profile of the IBM company. As we capitalize on a significant hybrid cloud market opportunity, as we've shifted in our composition of our business in IBM Consulting now represents over 40% of our portfolio and that's been growing nicely.

Trailing 12 months 20-plus percent revenue growth as we prove that platform economic multiplier overall. We're also investing significantly, as John talked about, building out ecosystems, enabling new skills and talent, ramping those ecosystems with tremendous velocity and also investing inorganically in M&A to build our capability around our business transformation services and around our hybrid cloud transformation services and technology consulting. M&A will deliver two to three points of that IBM Consulting revenue growth profile overall.

Next is our software portfolio with Red Hat. Red Hat delivering high single-digit revenue growth, that will contribute another two points to IBM's mid-single-digit revenue growth profile. That's pretty consistent with what we've been driving inception to date, which talks to the tremendous value in synergistic capability we're getting of bringing IBM and Red Hat together leveraging our large enterprise incumbency and our global reach and scale overall.

So you bring those two pieces together, that leads one point of revenue growth to deliver IBM's mid-single-digit revenue growth. And that will come out of our hybrid cloud and AI software portfolio. As we continue to leverage the components on the right-hand side of the chart about driving innovation organically, around building ecosystems, around driving productivity and value out of a redesigned go-to-market and incentive structure and also around M&A, which M&A should drive about one point of revenue growth to the IBM software mid-single-digit profile overall.

But underneath our IBM software, a couple of key components and statistics that will lend itself to that incremental one point of IBM. One, as Tom talked about, 80% of our software is in high-value recurring revenue streams, which we've been driving strong renewals and growth out of. Two, it's addressing a very significant and growing hybrid cloud market opportunity and we've been growing nicely there in mid- to high teens around our software portfolio over the last trailing 12 months.

And three, the investments we've made to capitalize on our hybrid cloud platform centric thesis around modernizing and optimizing our Cloud Paks on Red Hat OpenShift. We're in the very early innings of this. We're seeing nice acceleration from a net retention rate, and we have much headroom to go as we head into our ELA cycles in the future.

And then IBM infrastructure. As I said upfront, IBM infrastructure is targeted to be flat over the midterm horizon as growth always follows innovation cycles. But in any given year, it could be a contributor or a detractor to growth about a plus or minus one point overall.

So when you look at those segments, we're also going to be providing increased transparency around the key measures of progress to our financial model, starting with IBM Consulting. IBM Consulting, we're going to enhance our disclosures around our hybrid cloud revenue and our platform engagement numbers that we've been providing over the last couple of years with incremental disclosure around signings, book-to-bill, our service line and practice growth contributors and around insights around human capital metrics.

We're also, from a software perspective, going to be supplementing our hybrid cloud revenue and numbers of platform clients with annual recurring revenue and net retention rate that we just started the last couple of quarters. And around IBM infrastructure, we'll continue to provide color and insight around our product cycle dynamics in our portfolio. In addition to that, as I said earlier, we're going to be very clear and transparent on the impact of the external sales to Kyndryl as we move forward.

And given 2021, depending on the effective date of the separation, we're only going to have one or two months of these external sales. But when you look at a full 2022 of 12 months of sales, as you could see on the chart, we've modeled that out to be roughly about $2 billion of revenue contribution to IBM in 2022 only, and that delivers about three points of growth. But I want to be very clear that this is all incremental to the mid-single-digit revenue growth model that I talked about earlier.

As this will be a phenomenon in 2022 only, and then it will be part of our baseline as we go into '23 and '24. And as you could see on the chart, that this external sales to Kyndryl will play out largely concentrated in our IBM Software segment, which will contribute about six points of growth above the mid-single-digit model for IBM Software in 2022. And to a lesser extent, IBM infrastructure, it will contribute about two points of growth to their model overall.

So now let me transition to our second key pillar of measure of performance. We talked about revenue growth. I did some detail about unpacking that, now let me talk about free cash flow generation overall. And as I said earlier, mid-single-digit top line revenue growth profile. You couple that with our improved business mix, it lends itself to high single-digit free cash flow growth, about $750 million of annualized free cash flow generation year-over-year. And now unpacking that as to what are the contributors of that high single-digit free cash flow.

As you could see on the chart, about 25% of that free cash flow is going to be driven by IBM Consulting, resulting from high single-digit revenue growth, with that revenue growth, we get operating leverage and our pretax profit margins approaching low teens. The remaining 75% of our free cash flow growth contribution will be delivered by IBM Software, with growth of mid-single digit in this segment and very strong operating margins around 30% overall.

While IBM infrastructure, as I said, is not targeted to grow revenue over the midterm and not necessarily contribute to free cash flow growth annually. This value vector with its strong incumbency base is a material cash generator that we use to then fuel investment into our two growth vectors overall to capitalize on that $1 trillion hybrid cloud market opportunity overall.

So when you look at it, the strength of our financial model centers around our ability to drive strong, growing free cash flow generation. Cumulatively, $35 billion of free cash flow over the midterm horizon 2022 to 2024. And with that growing free cash flow, it will provide incremental debt capacity, which we are very comfortable operating at a single A credit rating. Overall, $40 billion of financial flexibility to invest in our business for growth and also to deliver attractive shareholder returns, considerable firepower for our growth ambitions to really drive the leadership in hybrid cloud and AI.

Now we've always maintained a very disciplined capital allocation process here in the IBM company. And when you look at our capital allocation policy going forward, it's going to be about reinvesting for growth and about sustaining attractive shareholder returns overall, while preserving a very strong balance sheet and our liquidity position. We intend to reinvest much of our cash flow annual growth back into our business to extend our hybrid cloud and AI leadership to continue developing and innovating new technologies and around building out our ecosystem, all while prioritizing attractive shareholder returns.

And I'll reiterate, as Arvind and I have been on record many times, that we fully expect the initial combined dividend of IBM and Kyndryl to be no less than IBM's dividend today. And finally, we are very comfortable at the capital structure we have today operating at a single A credit rating. The high-value recurring business mix that we have within our company, you couple that with substantial liquidity pools and that strength of that balance sheet I talked about, we're right where we need to be in terms of leverage and capital structure.

So we have a lot to be excited about here today. You take a look at the new company and it is a chance for us to redefine a very attractive financial model, all centered around growth, mid-single-digit revenue growth, top line, with that, improving business mix, strong operating leverage and high single-digit free cash flow generation, $35 billion cumulative free cash flow over the midterm, all delivered through a very focused company that is platform-centric to capitalize on the $1 trillion hybrid cloud and AI market as we move forward. I thank you all for your time here today.

And now, I'm going to turn it back over to Patricia and we'll now assemble up here for the Q&A session. Thank you very much.

Question-and-Answer Session

A - Patricia Murphy

So thank you, Jim. I'm going to invite our presenters up to participate in the Q&A. Many of our presentations were live today, a couple were prerecorded, but all are here in person or on the web to participate live in the Q&A. I want to also mention before we get started, we're very observant of COVID protocols. We're all vaccinated and everyone here has just been tested. We already have a number of questions, so thank you to those who have already submitted a question. But again, for those who haven't to submit a question, go to the top right tab, ask a question, and that will make its way to me.

I just want to remind you also we're going to focus today on a go-forward basis. We're not here to discuss Kyndryl and we're not here to talk about our 2021 performance. We will cover that in our earnings call, which is currently scheduled for October 20. And finally, for the questions we don't get to because I don't think we'll get to everything today, we'll follow-up with you in the coming days or after earnings depending on the question.

So with that, everybody is in place. Let me go to the first question. This one was directed to Arvind. Arvind, you have been focused on partnerships a lot more than prior IBM management. Can you give us some examples of deep technology integration with partners at a product level where IBM and the partner collaborate and how that is helping customers?

Arvind Krishna

Sure, Pat. And thanks for the question because it is one that is close to my heart. Look, we talked about a couple that were up on the -- in our prepared remarks. We talked about Schlumberger. We talked about Siemens. I consider them to be partners, not just clients because we actually go to market together.

Schlumberger's Petrotechnical Suite is going to be running on Red Hat OpenShift, and that's a very deep integration. There's going to be about 18 months of work as we get it to market. Ditto with Siemens as we think about MindSphere and we think about some of their factory automation software, that's going to be optimized, leveraging portions of both our AI suite, Maximo, Red Hat OpenShift, et cetera.

But we can go on as we think about Palantir, as we talked about the Adobe Experience Suite that Paul mentioned. These are all examples where we do deep integration. But I don't want you to think only about deep integration. There is additional opportunity for sideways integration. As IBM Consulting takes clients on a journey whether with Salesforce, whether with SAP, there are opportunities then for them to bring in our software where there is no overlap.

So we're not creating any conflict in cases where there is no overlap, there is opportunities for that, for example, with Maximo and with other parts of the portfolio. So it is something that really becomes a flywheel of growth that I talked about, sometimes with deep integration where it's one inside the other, sometimes by the way, white labeled and sometimes sideways where there is opportunity at a client to bring both pairs of capabilities in.

Patricia Murphy

Very good. Let me go to the next question. Can you talk about the revenue synergies attained from Red Hat and how does that compare to plan?

Arvind Krishna

Sure. I'm going to start, and then I'm going to ask Jim to comment as well. So I would tell you that we are really pleased with where we are so far. If I compare it to where we had anticipated from July of 2019, why did I say that? That is when we closed the acquisition, October of -- July of 2019. October of 2018, we announced the acquisition. We are pretty much straight on.

Are there some puts and takes within where we expected the revenue to come, of course, but if I look at our Cloud Paks and how those have succeeded in creating a new recurring revenue stream for us. If I look at the expansion of Red Hat itself from, I'll call it, the low teens to the high teens, that's an added piece.

You heard John Granger mentioned the $1 billion in GBS revenues that are associated with Red Hat. And by the way, I think about some of these partnerships we have gotten that is maybe an added benefit because some of these partnerships would not have happened without Red Hat, those are added revenue streams.

So all in, I will tell you that we are exactly where we want to be and we expect that this trajectory will carry on for the next few years.

Patricia Murphy

How do you see the evolution of IBM Software ex-Red Hat? What's the risk that the current software assets will continue to lose relevance overtime? I'm just guessing they are. I'm not sure that's true. What areas of software will you emphasize and deemphasize?

Paul Cormier

It's a great question. Thank you for that. So, to me, having rebuilt all of our software on top of OpenShift was absolutely key, and we needed to own Red Hat in order to do that. So that gets us a good bit of growth because the Cloud Paks continue to grow, and sometimes you all ask the question is that lift or shift? The answer is it's a bit of both.

But in many cases, they're trading up from our existing portfolio to buy into Cloud Paks. And these are packaged up, as we said, cloud native containerized software that give them enhanced functions. They pay more money when they do that. So, they're not going to do it because I asked them to. They're going to do it because they see the value in the Cloud Paks.

As I look at the opportunity out there, as I mentioned before, it's about 1,100 clients out there that have bought multiple Cloud Paks, and we're pleased with the rate of deployment with our CSM, Client Success Managers, and doing that deployment. On the places, I'm going to invest. I mentioned them in my remarks that, I'm very excited about Fabric. I'm very excited about Watson Assistant and the value that it can provide call centers. Lots of good examples, lots of good client examples are people benefiting from that.

I'm very excited about automation and whether it's task automation like BPM and RPA or it’s AI ops, IT automation, if you will, and the acquisitions that we did around Instana and Turbo. The security is a great opportunity for us as the world is facing the greatest threats we've ever seen before. And so, those three areas to me represent a great place for us to invest, spend our money. And then on the, I've mentioned earlier, Environmental Intelligence Suite and Maximo, that Arvind just referenced are great opportunities for us in the asset management and in ESG reporting.

Patricia Murphy

Very good. You've mentioned early signs of improved productivity in sales teams. It's difficult for the market to separate a better IT spending environment from internal education metrics like sales productivity. So, can you share some insights into the go-to-market changes you made and share - potentially share some metrics that underscore the productivity improvements you've mentioned?

Arvind Krishna

Let me start with that and then see if anybody else wants to add on. So, as I spoke at the very beginning, you heard a number of people talk about this. So, Paul called me, I talked about investing more in customer success, which means that the makeup of the Salesforce is changing with more people oriented around technical, helping of the clients, deployment post-sales with customer success than only on sales itself. You heard Tom Rosamilia talk about customer success. There, he's investing in thousands of people around client engineering and on post-sales deployment.

Note, in all of these cases, these people are not paid on the initial sales. They are paid on success of the clients. We then go on to some of the metrics that John Granger and Kelly talked about where the 4,000 garages and the success they're in with the clients. When you pull all of this back, it says that we've been keeping our sales headcount in some sense flat while we've been investing in these other areas.

So the revenue growth you've been seeing, as we talked about the second quarter and we are projecting forward, you're going to be maintaining constant sales headcount while we are investing in these other areas. That means if you do the math, you're getting sales productivity in the sales team itself and that's an early sign of what we're doing.

Then we've looked at the consulting growth that is driven through the garage is, that's another early sign of the productivity that we're seeing through these investments that we're making in these experiential and technical oriented teams. Those are sort of early signs of what we're seeing that.

Patricia Murphy

Very good. Okay, this is one a question that came in at the end of the consulting discussion. At what rate is revenue growing through your large partners like SAP, Adobe, Salesforce, Microsoft, et cetera? So another question around partnerships.

Mark Foster

Great question. And of course, across that portfolio of partners, we have varying growth rates across that portfolio of partners. I will say that all of them are growing at or above the growth rates we're talking about for the overall IBM Consulting segment. Some of them are more mature franchises such as SAP and Oracle we're building upon a long history of relationships, but there are also some very fast-growing ones in areas like Adobe, very fast growth in our Microsoft Azure and AWS practices. So, it's a varying storyline, but all of them are growth stories, and we're looking to obviously ride the wider growth that those franchises are seeing themselves in the marketplace.

Patricia Murphy

Thanks, Mark. Here is another one that's going to come your way. How will consultant grow high single digits when app management, application operations now continues to decline?

Mark Foster

Well, we see application operations as a very important part of our overall story. It's a very important part of our incumbency that the fact that we understand the applications that are in that space is a very important part of this de-risking the journeys that the clients are going on there. And our ability to also expand of that footprint into new areas like multi-cloud management, data fabric management, is very much there as well.

So I think that we see the application operations area as an important source of incumbency, and going forward an opportunity for growth. It's also important to see it as part of a lifecycle that relates to technology consulting and the rest of our business as well. As we touched on in the presentation, there're some 70% of our clients in application management services have also employed us for business consulting going forward.

And as a big driver of our growth in Red Hat, OpenShift and in the Cloud Paks as well as come from our incumbency in the application operations space. But may be John, you'd like to talk a bit more about how the lifecycle moves between that technology consulting and then into the application operations space moving forward?

John Granger

Yes, I mean, we see very clearly that we have, as Mark said, a very strong incumbency in application management at our clients, which gives us a great understanding of their processes. The fact that we're there for a long time means that we built those relationships, which gives them a huge amount of confidence then if we want to help them move to the cloud.

We have a lot of knowledge about their applications. We understand the change management issues within those clients. We can never take that application operations base, if you like. We can then move that to the cloud as part of technology consulting, and then use those strategic partnerships that we talked about in order to help our clients move to a hybrid multi-cloud, and we can obviously push forward our Red Hat technology there as well.

But then once we've made that translation to the cloud through technology consulting, then as Mark said, we want to move our clients then into this new growing market space of the next generation of hybrid cloud management. And really there, as I said, we're building out this application operations practice to take advantage as Tom was talking about Turbonomic and Instana investments as IBM. So there's a real life cycle here, which means that we can feel the growth in technology consulting from the incumbency and opportunity that we have in application operations like we've had.

Patricia Murphy

Very good. Here's a question that may go to Paul or others here. How does the Edge provide opportunity for IBM? What parts of the IBM portfolio are best positioned to realize the revenue opportunity across the Edge infrastructure? And where do you see IBM needing to bolster this expertise to take advantage of the Edge grow?

Paul Cormier

I can start, if you like from a Red Hat perspective. As I said in my comments, the Edge is very vertically aligned, as I said the toughest cases on the cell tower manufacturing space. From the factory floor and retail spaces, it's in the stores. But we're trying to get compute closer to where the data is. And that's all part of now. Cloud is the, hybrid cloud with the CIO has to worry about.

And so there has to be secured, there has to be developed first of all. Applications have to develop out to the Edge, has to be operated by this by the IT organization, it has to be secured under that hybrid umbrella. So all the same things apply with applications that are running in the Edge as they do with running in private or public clouds.

So from a Red Hat perspective, we'll extend our OpenShift platform and the services that go -- software services that go on top of that all the way up to the edge and be managed under that one umbrella as well.

Arvind Krishna

And to add to what Paul just said, you begin from the perspective that Paul laid out, there are all these use cases, and you mentioned them, whether it's in Telecom, whether it's in retail, but you can keep going there could be healthcare. What drives it? It's latency because you got to do the compute very close to where the data generated is really important. But it's also resilient. People want a lot more resilient infrastructure, where things can keep going, even when there are some outages, somewhere else in the overall environment.

So if you just begin to unpack that, then it's in all of the Red Hat portfolio. But you can begin to add to it all of the network automation that Tom referenced briefly, you can add to it some of the management and Watson for AI Ops that got mentioned. You can also then say, how do you begin to do this? Have you heard people mentioned, it's quote unquote, as a managed service, meaning that it's technology managing it.

And so, there is an opportunity for a regulated cloud also to come in, in terms of managing all these endpoints. So, as you begin to do all of these pieces, there's a massive opportunity across our software and our infrastructure portfolio. By the way, I wouldn't lose sight of consulting them. As clients begin to appreciate, how I do perhaps have less loss in stores? How do I perhaps automate warehouse operations?

All of those have become examples that our supply chain as well as our retail experts are coming from consulting to help our clients. So, this is really a market that is unfolding in front of us. Opportunities are within the overall TAM. But is it tens or is it hundreds, times going to tell. I tend to think it's on the higher side, not the lower side, but this is still all yet in front of us.

Patricia Murphy

Very good. I'm going to combine a couple of questions here. And Jim, you answered part of this in your prepared remarks. How can we expect the $35 billion in free cash flow generated over the next few years to be deployed in terms of acquisitions, dividends buybacks, and the pace of M&A in 2021 has accelerated? Jim, when you talk about M&A as a potential driver of revenue growth in the medium-term plan, is that incremental M&A or largely recently completed acquisitions?

Jim Kavanaugh

Okay. So, I'm surprised that five questions to get to our capital allocation policy, but with that said, very good discussion here today. As we talked about in the prepared remarks, $40 billion of financial flexibility over this mid-term horizon, let me break that down a little bit more detail. If you look at the combined dividend of IBM and Kyndryl, I obviously cannot speak on behalf of Kyndryl's Board as to post-separation what they do.

But Arvind and I have committed that it would be no less than IBM today. So, take that $40 billion, take $6 billion a year for three years, you're at $18 billion, that's $22 billion left. When you look at what I said about the capital allocation policy, I was very clear in that we are comfortable operating at a single A credit rating, which basically means, we don't have much de-levering to go, outside of post-separation the proceeds will get from that we will use to deliver and improve our financial flexibility going forward.

So out of that $22 billion, Arvind has been on record a couple of times. And by the way, we've spent so far year-to-date in 2021 about $3 billion. Think of $3 billion to $4 billion is our natural going rate. So, that's 22 billion, you take off $10 billion, $9 billion or $12 billion, we've got some incremental firepower to capitalize where we see opportunities to extend our hybrid cloud thesis or to have optionality on incremental return to shareholders overall.

So, now the second part of your question, that incremental M&A, that $3 billion to $4 billion, you've seen what we've done is pretty much aligned to our business strategy around GBS and building out cloud transformational skills and around expanding ecosystems, and what Mark likes to talk about intelligent workflows. That model we spent $1 billion give or take at their multiples, that's how I said two to three points of revenue growth to GBS.

The remainders has been put into play with regards to our hybrid cloud platform software thesis, both Red Hat with containerized security in '21 and also with Instana and Turbonomic in a few others to name, as we move forward. And that software, you all know the multiples. I mean, pick your multiple. We're not going to get astronomical, but 10 to 20 multiple, depending on what area you're in, that should deliver about a point of revenue growth to the IBM software model. You bring all that together and it's about a point and a half to IBM.

Patricia Murphy

Very good. Another IBM Consulting question. Where is the opportunity for new customer engagements? Is it to shift towards mid-sized enterprises? Or is it to focus more and more deeply partner with Fortune 500?

Mark Foster

I'll stop and then I am going to hand over to Kelly to pick it up and what we're seeing here in the Americas particularly. When first of all, we are we do believe that you're doubling down on the largest enterprises in the world and the complexity of the challenges they face as they go on their digital journeys, is going to be our sweet spot. So that's where we are making sure that we're building deep client relationships across the C-suite, and really becoming that trusted partner, as they go on that journey. And to do that, you do have to pick the organizations you're going to work with.

Having said that, as we look at our portfolio clients, we're actually looking at the next generation of winners, the next generation of organizations that are coming up the midsize players that have got an opportunity to become the next generation of Global 500, Global 1000 players. So we do see ourselves making sure as we look at our portfolio, it continues to be one that focuses both on doubling down on deep skills, deep knowledge and relationships. But also just keeping an eye out to what's happening around the marketplace, and making sure that we are able to cover those clients will bring transformation to them, as well.

Kelly Chambliss

Yes, Mark, I agree with that in terms of looking at the next generation of Fortune 500 companies, combined with expanding our footprint and really increasing our impact at our existing clients. A lot of our client base today, we're doing work in one or two areas like supply chain and talent and HR, but there's still opportunities to expand deeper into technology deeper into data and analytics. So when you look across the portfolio, it's really a combination of both paths that we see opportunity for growth.

Patricia Murphy

Very good. So here's the question. What within IBM is different now that will allow the Company to achieve material step up in his historical run race versus prior performance?

Arvind Krishna

So let's start. So if you look at the portfolio, we begin with optimizing the portfolio. And you saw Jim layout the segments in the end. This is a much simpler IBM than we have had for many years. But you have a much simpler company, it allows you to focus both your investments, it allows you to focus your talent, it allows you to simplify decision making, it allows you to align your influences and how you pay people for the performance that you want.

So, the portfolio actually enables all of the second set of actions. Then three, when you say that growth, both revenue growth and free cash flow growth are the priorities, then you optimize your capital allocation against those priorities. This is all very different than we have had for the past decade or two. And I think that that is really what makes a fundamental difference. You're clear on the priority and then you enable an optimized the entire organization to change those priorities.

Now, let's not forget the fundamental foundation. There are use cases and there are technologies that are in high demand. You've heard Mark talk about, and you've heard Paul talk about it and you've heard Tom talk about, and you heard Ric talk about, there is a huge insatiable demand for how people get on their cloud journeys and how people leverage artificial intelligence to change their own businesses. So we tap into that demand and that is what we're focused on. And being able to focus is what is going to drive the step change.

Patricia Murphy

Very good. Here's a question on our NRR. You've talked about net revenue retention surpassing 100% within Cloud Paks last quarter. What are the biggest levers for incremental growth once customers make the transition at Cloud Paks? And how much is core IBM software versus Red Hat?

Paul Cormier

I think the key here is, when I talked about people having multiple Cloud Paks. So we've got clients as at around 1,100 at multiple Cloud Paks. So, the ease of using doing deployment of a second Cloud Pak is much less than -- much simpler than the first one.

So, we get the marginal value of being able to have a complete suite of Cloud Paks installed with some of our clients. And so, they can take advantage of Cloud Paks for data, Cloud Paks for security, Cloud Paks for business automation and they've got a similar look and feel. They're all built on a bedrock of technology and all built on OpenShift.

So, the value to me is that there you've got one Cloud Paks, take a look at another one, take a look at another one. And so the adjacent sales for us is really a key driver for this, all built on a common installed base of OpenShift. So, I think that's the part that I'm most excited about with transition to Cloud Paks for a good part of our software portfolio.

Patricia Murphy

Very good. Switching gears a little bit. Arvind, can you share more about IBM's client centric culture with a growth mindset? How is this culture different than how IBM has operated in the past?

Arvind Krishna

So, this technology, we've always been client centric. So it's not that being client centric is a brand new phenomenon. However, obsessing about clients success post the transaction, obsessing about delighting the client to deploy the software, and doing that as something that we do, not just the client or fundamental changes. If you think about what our consulting teams are doing with the garages that Kelly talked about and John talked about, and that they all talked about the new delivery models on dynamic delivery, they can bring the best skills from all around the globe. And to answer a client's issues, these are all examples of where we are changing.

Now as you talk about a growth mindset. Growth mindset is all about telling people on what they can do quickly, not to get stuck and what they cannot do. So, the fact that the teams get together, when they go offer an opportunity, when they bring the skills in, they don't need to come ask for permission. That is a decision making gets easier also, as they go down.

So what does that do? It increases the velocity of what you can do for a client and we are seeing that in terms of pipelines. We are seeing that in terms of our book-to-bill ratios and consulting. We are seeing it in terms of the deployment that we just talked about NRR. NRR is driven by, as Tom mentioned, that adjacent sales, but there are also expansion of use cases as people get enlightened technology because we have them deployed more quickly.

Patricia Murphy

Very good. We have a bit of a model question here. What it assumes free cash flow in 2022, which were of course not ready to provide yet? And is the $35 billion of free cash flow generation inclusive of any restructuring or transaction costs?

Arvind Krishna

So, you've answered the first part of that question already. But in all seriousness, we are aggressively going after trying to complete this impactful separation. And it's been a long year, a long year to get ready both on the IBM side. And on the Kyndryl side, we made great progress. As Arvind said, the Form 10 is now out publicly. So we expect hopefully to complete the SEC process, what our formal Board approval here in the coming weeks. So that we can make the separation effective as we move forward.

So as we get into IBM's third quarter earnings, which I think is October 20th, if I remember. I am looking forward to this week as we go through our earnings cycle, and then we will have more information available at that point in time more specifically, probably talked about cover around the fourth quarter. And we'll talk about that on a go forward basis, as we move forward. And then when we get to January, we'll talk about how we lay out 2022 overall. The $35 billion overall, remind me, you ask about restructuring?

Patricia Murphy

Yes.

Arvind Krishna

Restructuring, if you think about restructuring, historically, majority of our restructuring was always centered around our managed infrastructure services business. So I don't see any major structural actions in that mid-term model. We, obviously, always continuously reinvest and revitalize our human capital workforce to where the market's going, where client value is going and where profit pools are going. But I don't see any major restructuring in that number.

Unidentified Analyst

Okay. Very good. Here's a question about the fact that there is a war for talent going on. And what is your confidence in your hiring outlook to support your financial targets?

Arvind Krishna

Let me start and then Mark or John can add. Look, when we looked at our overall pipeline of applicants applying to us, I remember right, I think we have about 3 million applicants in our database. We hire multiple tens of thousands each year. Let me acknowledge with all that said, so that tells me that I have confidence that we have an engine. We have a process. We have a value proposition for people who are trying to bring in, that is attractive to them.

All that said, there is a wall for talent. You said it in the question itself. So, we always have to be -- we have to pay attention to it. We have to keep upping our value proposition. We have to keep making sure that the way we work is attractive to the people we bring in. We have to make sure that we can also retrain and rescale our people in all of the skills that are approximate to the marketplace. And that's the nature of the technology world.

In my entire career now, if I include graduate school of almost 35 years in this business, this has been continuous. This is not brand new. And I expect it will continue this way.

Patricia Murphy

Okay. I think we have time for just one more question. So, the question is, what are the portfolio and investment actions do you need to take to achieve your mid single-digit revenue growth? What else do you need to do?

Arvind Krishna

I think, look, the actions that we laid out today, including what we are doing around our company locations, leveraging our fin flags to drive growth. What you're doing organically that we believe that this is sufficient, if I look at the collection of actions that the whole team laid out is enough to drive the mid single-digit growth.

Within that, obviously execution is key. We have to keep executing on what we laid out including the up-skilling of our delivery teams, the up-skilling of our teams that are in front of clients every day. We got to bring value to clients. We've got to work with them.

As so many of, my colleagues here today said, you got to work with the plots. You've got to be focused on their success. And that is the execution we have to go do. With that, I am a hundred percent confident that the strategy laid out today will achieve the mid single-digit revenue growth.

Patricia Murphy

Very good. So let me turn it back to you Arvind, to make some concluding comments.

Arvind Krishna

Thank you. Thanks Pat. Look Jim, I just would like to tell you, let me remind you of the three takeaways that I have started with and that the Jim was closing on. One, we have spent all our two and a half years now optimizing our portfolio. This optimized portfolio will drive the mid single-digit revenue growth.

The execution on the Red is all of the actions and investments whether its ecosystem, whether it's simplifying our go-to-market, and that is the focus on agility to better serve our clients. All of that is fueled by the strong free cash flow, which enables the investments.

And you've heard Jim just answered that in one of the questions, you bring that all together, and that's why we have such confidence in our strategy, both on the revenue growth and on the free cash flow.

Thank you all.

Comments

[RLLH]

Interesting to me (having been one for years) that IBM is shifting back to the days of assigning people to assist a specific customer. We called them Systems Engineers before Lou Gerstner eliminated them in the 1990's as a cost savings measure. To me that seemed the start of IBM's long descent. Glad to see them coming back.

[User 1051056]

I don't care about the blah, blah blah any more. Ginni talked good blah blah blah too, but never delivered. So I will wait for results. I did not see any projected numbers to hold management too.

[donjamar]

This is preaching to the converted.
I believed in the inherent strentgh of IBM for a long time.
IBM is about 25% of my portfolio
MSFT about 55%; (all under $ 35. cost.)
Have patience and have patience, again
Keep studying the companies as if you own them.

[User 50124969]

People thought Apple was dead. People thought Microsoft was dead. People think IBM is dead. Apple and Microsoft are doing very very well. Big Blue shall also rise again. The turn-around has begun.