International Business Machines Corp at Morgan Stanley Technology, Media & Telecom Conference Summary

The following is excerpted from the question-and-answer section of the transcript.

Question: Erik Woodring - Morgan Stanley - Analyst : <_ALACRA_META_ABSTRACT>So I think maybe to start, it's important to look back, and that is you just capped three years since divesting Kyndryl, wrapping your first midterm model. A lot has changed for IBM in the last three years. So maybe for all of us, can you just walk through one of the most important changes you, Arvind, and the team have kind of implemented over this three-year period. Where you think you've outperformed and then maybe some areas where you fell short that you need to, I don't know, refocus or double down and we'll go from there. James Kavanaugh - International Business Machines Corp - Chief Financial Officer, Senior Vice President - Finance and Operations Great place to start. Good afternoon. Really appreciate you having us here today. Today's IBM, as you position it, we are a fundamentally, radically different company than what we were just a handful of years ago. Really focused on the two most transformative technological shifts we believe that are occurring in the marketplace today. One being Hybrid Cloud. And the second being Gen AI. And Arvind, since he's come on board, has really led a bold, strategic pivot of our company. And that is around aligning a portfolio, around a platform centric model playing to our hardware, software, and services with a very attractive economic multiplier overall. REFINITIV STREETEVENTS | www.refinitiv.com | Contact Us consent of Refinitiv. 'Refinitiv' and the Refinitiv logo are registered trademarks of Refinitiv and its affiliated companies. MARCH 03, 2025 / 11:20PM, IBM.N - International Business Machines Corp at Morgan Stanley Technology, Media & Telecom Conference And that's been a great strategic pivot that's played extremely well over the last five years. But to your point, aligning that strategy, we had to do a lot of fundamental work around the business and operating model within our company. And let me just highlight a few of them to the heart of your question. Number one, it started with portfolio optimization. Shifting our portfolio to higher-end growth markets, shifting our portfolio to a software-led platform centric business. We've taken software from mid-20s Pre-Red Hat acquisition to now exiting around 45% of our composition, so a fundamentally different company. Second, we've reinvigorated investments in our organic innovation. And that has ignited organic revenue growth into our company. We've also been building out capabilities around opening up IBM to strategic partnerships. We've been investing in M&A around a set of growth plays that have been bringing significant synergies, and we've been driving a very reinvigorated culture change across IBM, around speed, around risk tolerance, and around talent acquisition and productivity mindset. This has played significant value in return to IBM over the last three years to your question. If you take a look at it, let me put it in perspective. Prior to our midterm model, we had a business profile that was dilutive on revenue growth, incrementally dilutive on profit margin annually, and a stagnant free cash flow. Over the last three years we have strategically repositioned this business that now over the three years we have exceeded or met all of our midterm financial measures around revenue growth, profitability, and free cash flow. We are now a durable, sustainable grower. We've improved our operating pre-tax margins by 800 basis points over three years, and we've basically doubled our free cash flow generation exiting 2024 with the highest free cash flow margin in the history of IBM. So I think this financial performance, the strategically repositioning the company around a focused platform centric strategy, has unlocked significant shareholder value as we have consistently outperformed both the S&P 500 and the S&P Tech over the last three years, and it plays to our investment thesis higher revenue growth company, higher operating margin company, strong free cash flow, and an attractive return to shareholder program.

Question: Erik Woodring - Morgan Stanley - Analyst : Okay. You touched on the $5 billion book of business, cumulative book of business, you've gotten in Gen AI so far, split between Software and Consulting. Can you maybe just go into a little more detail for all of us, one, the strategy, the differentiation that you're talking about, and then two, really where within that ecosystem you are seeing traction with clients. James Kavanaugh - International Business Machines Corp - Chief Financial Officer, Senior Vice President - Finance and Operations Excellent. Gen AI, we have a very differentiated, integrated, open-innovation Gen AI portfolio that's been resonating well, albeit very early in the cycle right now. Erik. We exited 2024 with about over a $5 billion book of business. About 25% of that is Software, north of a billion dollars dollar book of business, and about 75% of that is Consulting, north of $4 billion book of business overall. And we spent time in Investor Day talking about our enterprise client pain points around what the inhibitors around scale and adoption. And the reason I start there is because it infuses the strategy around how we're developing our Gen AI technology strategy overall. REFINITIV STREETEVENTS | www.refinitiv.com | Contact Us consent of Refinitiv. 'Refinitiv' and the Refinitiv logo are registered trademarks of Refinitiv and its affiliated companies. MARCH 03, 2025 / 11:20PM, IBM.N - International Business Machines Corp at Morgan Stanley Technology, Media & Telecom Conference But we talked about three areas of pain points. One, cost. Higher technical and operational cost as enterprise clients are looking for a more efficient way of driving Gen AI solutions in their business. Two, complexity, and it's beyond models. It's now into data and applications and how they're running in a Hybrid Cloud environment with a priority around security. And three, expertise. How did they infuse Gen AI technology application and workloads into their business work streams: HR, finance, procurement, supply chain, how you run a company. And that requires deep domain expertise and knowledge and technical expertise overall. That is infused intelligence and how we've created our strategy, and we said our strategy was focused on a set of competitive advantages. Four areas. Number one, we are an open innovation technology provider. Why? Because we believe in the power of a developer community that drives rapid innovation value. Two, cost efficiency. We have always believed in smaller fit for purpose models that today our granite LLM models are 90% more cost efficient today with better performance running on the most economic AI platform overall. Three, hybrid. To the heart of being a Hybrid Cloud and AI company, IBM is the only company that can build, deploy and manage software in a Hybrid Cloud and AI world. And then finally four, domain expertise as I talked about. We are the only company that brings that Gen AI tech stack along with a consulting business at scale. And we've developed a portfolio of full-staff offerings. Everything from the AI platform, which is built on an Open Innovation rel AI, Open AI, or Red Hat Open AI strategy to our AI data services, to our AI middleware, to our AI assistant and solutions, to embedded strategic partners like Salesforce, Red Hat, excuse me, SAP, Adobe, EY to name many. And we have a consulting business at scale. So the reason I talk about that full stack is we have many ways to monetize the value of that. We monetize value across platforms, across middleware, across agents and solutions, and across consulting. And we talked about Investor Day early in the cycle. For every $1 we land on our watsonx platform of Gen AI, we are getting a multiplier of $5 to $6 across our software and our consulting business overall. In our model going forward over the next medium and long term, we expect out of that 5% growth we'll get a few points out of Gen AI. So we feel pretty good about it.

Question: Erik Woodring - Morgan Stanley - Analyst : Great, very compelling. Let's turn to Consulting. The outlook for the Consulting market is more mixed. You're kind of low-single digits in 2025. You do expect to grow in excess of the market, but there is still some uncertainty about how the services market might grow over the next three years. So maybe one, why is there more uncertainty there and maybe just digging into maybe cyclical versus secular facts. And what are you doing to make sure that you're growing in excess of that market? James Kavanaugh - International Business Machines Corp - Chief Financial Officer, Senior Vice President - Finance and Operations Yeah, great area to talk about right now from Consulting. First of all, Consulting integral part of our Hybrid Cloud AI platform centric model, right? One, capitalizes on an attractive economic multiplier. Every dollar we land on a platform. We get $6 to $8 of an economic multiplier on services overall. That's Hybrid Cloud, that's AI, that's our mainframe platform overall. Two, it provides a tip of the spear that drives scale and adoption, so very essential strategic component of having consulting within our model overall. And three, it pulls our IBM technology and the synergies overall. Now, to the heart of your question. From a market perspective overall, we've been obviously operating in a very dynamic macroeconomic environment and we've been talking over the last three or four quarters about clients that are dynamically reprioritizing their spending focused on cost and productivity and why are they doing that, Erik? REFINITIV STREETEVENTS | www.refinitiv.com | Contact Us consent of Refinitiv. 'Refinitiv' and the Refinitiv logo are registered trademarks of Refinitiv and its affiliated companies. MARCH 03, 2025 / 11:20PM, IBM.N - International Business Machines Corp at Morgan Stanley Technology, Media & Telecom Conference They're doing that because they're trying to create investment flexibility. To reposition their businesses for sustainable competitive advantage around how do they exploit digital transformation, Hybrid Cloud services, generate AI to reposition their business models. And that doesn't surprise us overall. The IT services market, when you look at human capital services over a long period of time, it always experiences cyclicality with new technological innovations over time. But over the long period of time, the IT services market has been growing 4% to 7% over a long period of time. And most importantly, what we're excited about is the differentiation and growth on high growth factors that being Hybrid Cloud services, AI services that we see growing double digits over the next three to five years. So to your question, what differentiates us? What's our growth engine around IBM consulting and our competitive advantage. Well, one, we've done a lot of hard work as Arvind has come on over the last four or five years to reposition our operating model and our portfolio composition around Consulting. Today, 85% of our Consulting book of business centers around Hybrid Cloud, AI, application modernization, and around automation overall. High growth factors, very little composition around discretionary-based businesses overall, which positions as well moving forward. Two, we talked a lot about Investor Day, how we have been aggressively moving forward to leverage human capital and digital labor together, bringing a first-of-a-kind AI-based platform with our IBM Consulting advantage to market with our clients. We're getting great receptivity. It enables us to differentiate our value proposition but also leverage technology arbitrage. So we talk about how we're going to convert services as software now to an AI standardized platform which is getting great receptivity in the market. So that's another key competitive advantage. Third, we're able to drive strategic partnerships. A few years ago we sat on stage here talking about how IBM, and Arvind in particular, has opened up IBM, being a platform-centric company. At that point in time we had one strategic partner that had a book of business north than a billion dollars. Over the last two to three years, we now have three: SAP, Microsoft, AWS, and we're well on our way to building out more capability. And then four, I would tell you is we've been opening up with a very disciplined strategy around our M&A growth and synergistic play. And that is around IBM platforms, around hyperscalers, around TI's fees. So overall we feel pretty good and then I'll wrap it up on Gen AI. A lot of discussion in this conference around Gen AI. Around disruption or disrupter around Consulting. We feel pretty good in the long-term secular growth opportunity around Gen AI for Consulting. And what I've been talking about is when you look at what did cloud do? Cloud enabled digital transformation a decade ago with consulting. People were worried about the disruption. It ended up being a bigger TAM and a higher-growth factor for consulting. We think Gen AI is now going to ignite digital transformation 2.0. We got an early leadership position as a strategic provider of choice, Norton $4 billion book of business, and we're looking forward to capitalize on that as we move forward, so we feel pretty good about it.

Question: Erik Woodring - Morgan Stanley - Analyst : Very cool, given the time, I want to make sure we talk about something that came to light in your Analyst Day that maybe wasn't as well understood, and that is a bit of the juxtaposition of SG&A spend versus R&D. So you alluded to 100 basis points of PTI margin expansion each year underlying that you're really leaning into R&D spending. But actually the model kind of calls for SG&A efficiency and kind of being able to cut back there despite growing your top line. So and M&A, can you just walk us through one where you're investing, what your R&D priorities are, and then, two, just provide us some examples of how you are able to drive those efficiencies in SG&A over multiple years as you're growing, as you're acquiring companies. James Kavanaugh - International Business Machines Corp - Chief Financial Officer, Senior Vice President - Finance and Operations Great question, overall. But you know what, let me start with the second part of that question first, because I think it'll provide context in the first part as to where we're investing overall. When we talked about upfront, Arvind has brought so much to our company to reinvigorate not only the portfolio, the innovation, the growth mindset. He has brought a cultural transformation back around a productivity mindset in the company. How do you generate speed, velocity, efficiency, value? Oh, by the way, we spent time talking about enabling IBM as what we call client zero. How do we take our technology and deploy it inside to reinvent how we run our company? All of that is contributing significant productivity value overall. But if you look at it, operating leverage has always been an instrumental element of our business operating and financial model of IBM overall. Within our management system, we generate operating leverage which we talked about the model is 1 point per year for the sustainable future. If you look at it, we generate it three ways. One, portfolio mix, read that software, high-growth, high-margin content, high-recurring revenue, strong scale efficiency and marginal profit. Two, productivity. Getting ROI out of our innovation investment, our go-to-market investment, our delivery of services, our ecosystem, and three, around scale efficiencies, that's driving our G&A to competitive benchmarks overall. We believe we started out the last midterm model. We said we had a pretty audacious target of generating $2 billion of productivity exit run rate by the end of '24. We just finished '24 over our last midterm model, generating $3.5 billion of productivity. You saw that play out in our margin explosion of 2024. Our margins were up 130 basis points in gross, 120 basis points in pre-tax margins overall. But we believe we got still a lot of headroom to go with multiple levers. How are we going to do that? One, leverage technology and digitization to drive scale. Two, embed AI workflow into our workflows. We're only about 60% penetrated in AI overall. Three, streamline our supply chain, drive procurement value creation, drive structure, talent utilization. We got many different levers and we talked about it's important in our financial model because why? One-third of that is for profit enablement, two-thirds of that is for a flywheel to reinvest back in our business. So the first part of your question, where is that investment going to go? It's going to go back into R&D innovation around Hybrid Cloud with our software portfolio, around AI with our open innovation portfolio, around critical infrastructure, so we bring out that next generation of infrastructure innovation. And four, which we spent time on in investor day emerging technology, that being around quantum computing that we have an early leadership position overall. So those are both important from that flywheel effect overall. REFINITIV STREETEVENTS | www.refinitiv.com | Contact Us consent of Refinitiv. 'Refinitiv' and the Refinitiv logo are registered trademarks of Refinitiv and its affiliated companies. MARCH 03, 2025 / 11:20PM, IBM.N - International Business Machines Corp at Morgan Stanley Technology, Media & Telecom Conference