International Business Machines Corporation (IBM) Earnings Call Transcript & Summary

Good morning. I'm Katy Huberty, and I'm really pleased to welcome Jim Kavanaugh, CFO of IBM. Jim took over in early 2018 as CFO. Before that, he was SVP of Transformation and Operations.

It's true.

And before that, holding several roles across finance, strategy, operations and sales. So we're really excited to have you today.

Thank you very much, Katy. Thanks for having me.

Before we begin, let me just mention that Morgan Stanley disclosures can be found on our website or at the registration desk outside.

So we're going to jump right into questions. Jim, I want to start just talking big picture because several years ago, IBM started on a transformation journey, shifted the capital allocation strategy and really focused on big bets around cloud and cognitive. Give us your thoughts on where those investments have been executed well and where you think there's more work to do.

Sure. It's probably a great place to start as we've done a tremendous amount of work to reposition our company and reposition our portfolio. At the core of that was around portfolio optimization and capital allocation, to your point. But if you take a look at IBM, our capital allocation model follows our business strategy, which is centered around cloud and cognitive as we believe strongly that the next evolution of cloud is going to be centered around a tighter integration of data and AI and hybrid cloud. And we've been investing significantly around core capabilities around hybrid cloud, around data AI, around security and around digital. And we're repositioning ourselves to enable our clients in that journey to cloud around modernizing and migrating their workloads and also infusing AI into workloads and workflows and how they run companies. So when you take a look at this, we talk about this hybrid cloud opportunity. It's $1.2 trillion over the next couple of years. It's a massive opportunity that's fundamentally going to change the evolution of where the IT industry is going. And we've been investing significantly, to your point, reallocating capital. Over the last 3 years, just to put some numbers to it, Katy, we've invested over $60 billion of RD&E, of capital and of acquisitions to build out capability and reposition our company. Around RD&E, almost $20 billion over the last 3 years. What have we done with that? We modernized and transformed our software portfolio, containerizing it and making it cloud native. We brought new innovation to market, like you've seen with our mainframe, the new z15, which we just announced late in 2019. We've invested in building out new services capabilities while continuously focusing on the future trends of IT in areas like quantum, blockchain and other. Capital, we invested almost $10 billion over the last 3 years to build out our IBM cloud architecture. Right now, we have over 60 availability zones covering 140 countries. And finally, Red Hat and $36 billion overall in the last 3 years in acquisitions to continue to build out a differentiated value proposition on how we're going to go attack and deliver value in this hybrid cloud world. So when you take a look at that investment, significant reallocation and increase in investment overall, and I would tell you, it's paying off. When you look at our cloud-based business, we exited the fourth quarter over $21 billion of cloud; 27% of IBM, up from about 12% just 3 years ago; and Red Hat is off to a great start. But to your question about areas where we need to continue to make progress, I would tell you, AI fits into one of those. AI, we've been investing in building differentiated capabilities. But the reality is AI is still in its early innings. It's moving from experimental phases into scaling phases. And we're going to continue to invest in bringing innovation and also go-to-market skill capabilities overall.

That's great. A few weeks ago, IBM announced CEO transition. Ginni will remain executive Chairman through the end of this year. But in April, Arvind Krishna, who's currently the head of the cloud and cognitive software business and I think was one of the executives really pushing the Red Hat acquisition, he will be taking over in April. And of course, we'll let him talk about his strategy when the time is right. But from your perspective, what are Arvind's strengths that make him the right person to lead IBM through this next phase of the transformation?

Sure. Great question. And obviously, a very exciting time for the IBM company. We've been in existence for 109 years. This is our tenth CEO that's announced, with Arvind Krishna taking over. But I would tell you, Katy, it goes back to the core of who we are, of IBM. We're a high-value, innovative solution company. And Arvind, at its core, is a technologist and a visionary. And you know quite well, this industry that we operate is moving at a rate and pace of lightning speed on technology and innovation. And I believe right now, and the Board believes, that it's the right time today to have a technologist come over and lead the IBM company. Now I would tell you, Arvind has an innate ability, I've worked with him for multiple decades, of really bringing technology and vision and combine it with business models and drive the operational execution, which he has a proven track record. He has done a phenomenal job in accelerating our cloud and cognitive software business. He has a vast array of experiences running systems-based businesses and platforms to software-based businesses across the board to most recently, research. He was actually instrumental in setting up the agenda for IBM about emerging technologies like hybrid cloud, like AI and most recently, quantum and blockchain. And he was the principal architect behind the strategic bull bet of Red Hat, the $34 billion acquisition to position us as a leader in the hybrid cloud-based market. He's a great colleague of mine. I couldn't be more excited overall. I would tell you, Arvind, first, he's a systemic thinker. And second, he is a leader with a growth mindset. He is focused on growth, value, profit pools and how you differentiate and win in the marketplace to make us relevant in front of our clients. And I couldn't be more excited about what he's going to do for IBM and also for our clients leading into that next era of cloud and cognitive.

That's great to hear. We're excited to hear his plan when he becomes CEO in April. You mentioned Red Hat, $34 billion bet on hybrid cloud closed in July. It's an investment that is expected to accelerate IBM's growth rate by 200 basis points over the next 5 years. It's obviously still early days, but can you talk about -- because this is a revenue synergy deal, not a cost synergy deal, talk about how it's performing versus your expectations. And what are some of the revenue synergy opportunities that you're most excited about in the near term?

Great. Excellent question overall. We're obviously very pleased and excited about the potential of bringing IBM and Red Hat together. One, to accelerate our position as a leader in this hybrid cloud $1.2 trillion market opportunity. What you just saw in the fourth quarter, 5 months into this acquisition, we've been able to accelerate Red Hat's growth overall from pre-announcement time of low teens to now we exited fourth quarter at 24% revenue growth overall on a normalized basis. And when you look underneath it, it's pervasive acceleration of growth across all facets of Red Hat from their infrastructure business, which is predominantly well, growing and accelerating into double digits to their application development and emerging technology, which is where OpenShift, Ansible and other emerging technologies set are growing in excess of 50% overall. Red Hat, exiting fourth quarter, achieved a milestone. First time in the history of the company, achieved over $1 billion of revenue in a quarter. So it's a great testament, I think, and instantiation of the power of bringing our 2 great companies together overall. But you asked about performance metrics underneath. One, our billings growth, our backlog is up 20% overall. And most importantly, the instantiation of the value now of Red Hat underneath the IBM umbrella, we are seeing very strong customer adoption and renewal rates. And within the first 5 months, we've actually replenished over $1.1 billion of deferred revenue impairment impact in a 5-month period, which is well in excess of the plan that we had put in place. So we feel pretty good about the first 5 months. But as you said, much more work to do overall. We're going to continue to invest and build skills. But to the heart of your question, we talked about at Investor Day about the revenue synergistic capabilities of bringing the 2 together and why we believed it was better to have IBM and Red Hat together, and we talked about 2 primary areas. One being sell more Red Hat, and that was all predicated on leveraging IBM's global scale and our larger enterprise presence and incumbency. And I would tell you, underneath it, when we went through the due diligence process at Red Hat, we were actually positively surprised. The top 1,000 clients in IBM's large enterprise, only 5% of those clients actually had Red Hat at scale. So we had tremendous opportunity of leveraging IBM's leadership enterprise presence to go drag and pull more Red Hat. And if you look at the fourth quarter, as one key KPI, Red Hat actually doubled the number of large transactions greater than $10 million year-over-year, and over 50% of those were sitting in IBM enterprise-based clients. So all in all, from a sell more Red Hat perspective, doing well in leveraging our presence. But to your question, I would tell you, we're investing significantly because the other play we have is scaling it across IBM's 170-plus country presence around the world. Red Hat only participated in about 90 to 100 countries around the world. We're investing significantly, and we'll see that play out as we go into -- throughout 2020 and 2021. The second piece, though, was sell more IBM. And that was predicated on leveraging our technology architecture of Red Hat OpenShift and modernizing our software and building Cloud Paks on that, which we're off to a good start here in the fourth quarter. We brought 6 new Cloud Paks to market, broad-based adoption across 20 industries. And now we have over 2,000 clients in 5 months that are leveraging Red Hat OpenShift and IBM Cloud Paks. And finally, just to wrap up, this $1.2 trillion market opportunity, half of that market opportunity in hybrid cloud is services. So a big component of this revenue synergistic play is our services capability as we build out new offerings and practices around cloud advisory, at modernization and cloud management. And in the first 5 months, we've signed over 250 services engagements. So off to a great start there, too.

That's all great news. Cloud Paks, this is something that the company started jointly working on as soon as the deal was announced. Tell us a little bit, what are Cloud Paks? What's the customer problem that they're addressing?

Yes. So Cloud Paks, overall, I think at the heart of your question, you're really getting at the technology architecture strategy between IBM and Red Hat, right? So when you think about it, we believe, with Red Hat now, we have a differentiated value proposition to address this hybrid cloud market. And that is based on an architecture strategy that starts with a foundation of Linux as its base, Red Hat being the dominant share provider in the Linux market. And I think you know that Linux over the last 2 years has surpassed Windows as the #1 operating system overall. So that foundation is very important in our technology architecture. On top of that, our containers, Kubernetes and Red Hat OpenShift as our hybrid cloud chosen platform that provides that horizontal orchestration layer of leveraging and managing workloads in any environment overall. We have -- since the time we closed the announcement, we have transformed our software portfolio and built Cloud Paks that are optimized on top of that OpenShift platform. So what are Cloud Paks? Cloud Paks are containerized solutions that are pre-integrated for cloud-based use cases. So we modernized our software from primarily legacy-based middleware to native on the cloud that is optimized on OpenShift, and it enables clients now to build applications and run anywhere. So it leverages the best of IBM's core middleware, our AI, our security, our management with Red Hat's OpenShift hybrid cloud platform to deliver value. And as you said, I think we've brought to market 6 new Cloud Paks since the time of closure. That's around data. That's around security. It's around applications, automation, integration and hybrid cloud management. So use cases, you asked about, I'll bring up a couple. Cloud Pak for Data. This enables organizations to integrate analytics with their applications in a real-time, anywhere environment. And what it does for clients, it allows them to capture speed of innovation with a cloud-based environment at lower cost overall. And clients in the use cases that we've seen so far across the board have been able to access data over 4x faster than traditional-based environments. One other one I'll bring up because it's something that is exploding right now, and that is Cloud Pak for Hybrid Multicloud Management. That's across any cloud platform. This enables clients to have consistent visibility, automation and governance of all of their applications from an on-prem world, all the way to the edge of the network. And this provides clients with the operational efficiency, dynamically managing workloads in any environment with the trust, security and compliance that's required in today's world. And the use cases that we've seen so far, we've seen up to close to 75% IT operational efficiency overall. So we're pretty pleased with the Cloud Pak performance in a very short period of time. And like I said, the broad-based adoption, 20 industries, 2,000 clients overall. So we feel pretty good about that lineup.

As we discussed, Red Hat was a big bet on hybrid cloud. What's your appetite for further M&A to build out this either hybrid cloud or cognitive portfolio?

Well, M&A has always been a very instrumental part of IBM's business model and investment thesis overall. If there's one thing that I've learned, Katy, in this industry, this industry is characterized by a relentless cycle of innovation and commoditization. And portfolio optimization and effective capital allocation are essential to continue to deliver high value to our clients and to our shareholders. And I would tell you, you've seen over the last 18 months to 2 years, we've been taking numerous actions around our portfolio to really simplify and govern our investment prioritization on where we think growth in profit pools are at to drive and extend our strategy of hybrid cloud and around cognitive. That is centered around the Red Hat acquisition to give us a leadership position in hybrid cloud, but it's also about divesting parts of our portfolio that didn't either meet our strategic fit or our financial requirements. So it gets our organization focused on the priorities at hand and how we're going to convert and drive sustainable growth. In terms of acquisitions, I would tell you, our strategy hasn't changed. It's an instrumental part. We're going to constantly look at opportunities to acquire capabilities to extend leadership in our hybrid cloud or cognitive area or bring us into new sets of capabilities overall, and that is consistent with today. And if you look today, one, we have a strong balance sheet. We still have a strong investment-grade rating. We deliver substantial free cash flow on an annual basis. So we have enough investment to continue to drive into our business while also returning value to our shareholders in the form of continued dividends growth over time. But that influx that we have, we're going to continue to be opportunistic and invest in our business because we want to ensure that we're going to deliver that long-term relevancy moving forward.

You mentioned the acceleration in Red Hat from low teens before the deal was announced to 24% this last quarter. During that time, or at least since the Red Hat acquisition closed, IBM's core software ex Red Hat growth slowed. How should we think about growth in that legacy business as you bring Red Hat into the fold?

Okay. I'm glad you asked this question because we get this all the time, not only from the sell side but from our investment community. And some of the meetings I had upstairs was centered around this type of discussion. First, let me start at the macro level. We believe we got a very strong portfolio lineup in our cloud and cognitive software portfolio overall. We just exited fourth quarter accelerating our growth in total to 9% at constant currency. And that was driven by Red Hat, to your point, but also about strong organic growth underneath. Now let me talk to that point because is I think at the core, everyone's focused on what is happening to the core software organic growth overall. The way we manage the business, based on what I said earlier between bringing IBM and Red Hat together, is we look to see how we're going to drive the synergistic value of the technology architecture decisions, i.e., Red Hat OpenShift as that horizontal integration layer and Cloud Paks on top, and also leverage IBM's global presence, incumbency and scale. So when you look at it, the way we manage this business overall for cloud and cognitive software is we look at it internally and drive the operating model on an all-in historical normalized basis. What do I mean by that? It basically is the year-over-year demand for our software, including Red Hat, normalized for the deferred revenue impairment impact this year because it's short term in nature and will diminish and it normalizes out the purchase accounting revenue of Red Hat's revenue from last year. That, we believe, is the best representation of looking at the long-term sustainable performance of our software business. And on that basis, we were up over 3% and a slight acceleration from 2Q to 3Q. But back to its core, this was a synergistic play and a strategic bull bet between the 2. And the way we're going to go drive this is we have to generate some more Red Hat, some more IBM overall. And when we look at it, we are seeing growth in that core fundamental legacy software, and we are seeing an accelerating growth in Red Hat and our global distribution, and large enterprise presence is delivering value to that over time.

The heavy investment that we've talked about in cloud and cognitive, combined with the near-term impact from the Red Hat deferred revenue write-down, has put some margin pressure in the software business. How do you see the opportunity to expand margins going forward?

Yes. Well, this segment, as you know quite well, we invest in this segment for high-value growth, a software-based business model. We're operating even with the purchase accounting-related impacts in the low 30% operating margins overall. But when you take a look at it, the segment has high PTI margins to begin with, and it commands investment prioritization. So we are going to continue to invest in this area to drive high-value growth overall. And that's going to be centered around the consistent theme here that I've been talking about, hybrid cloud, data AI, security, in digital and other AI-led solutions overall. But to your point, when you look at our fourth quarter, our margins were down. Our margins were down 6 points year-over-year. Because we are getting impacted by the Red Hat purchase accounting. Now a couple of points I'll make. One, those impacts are predominantly noncash. And two, they are short term and will diminish over time as we start fueling the replenishment of that deferred revenue and we start wrapping on the significant deferred revenue impairments we've had historically. So we will start seeing, as we move through 2020, margin accretion to our cloud and cognitive software business, which is very representative of the high value-based business model that Red Hat had overall. One last point I'll make, and that is you know this quite well. This operating segment of software plays an instrumental role in IBM's overall margin profile because the revenue growth delivers mix contribution that's accretive to IBM overall as we move forward. But we'll get through this purchase accounting as we're educating many of our investors on.

Yes. As you've gone through this portfolio transformation over the last several years and as you talked about Red Hat, on a pro forma basis, it's certainly helping. But IBM hasn't yet proven to investors sustainable revenue growth. What is the path to that sustainable revenue growth that investors are demanding?

Yes. Definitely, the question of the day. I'm not sick. So let's talk about the sustainable revenue growth profile overall. So I would tell you, first of all, fourth quarter was a very important quarter for us. Not only were we right in the beginning of our mainframe cycle, but it was a very important point about the forward-looking projection of where our business was going. Now we're into our second quarter of Red Hat overall, which we accelerated. But when you take a look at the fourth quarter, we delivered $21.8 billion revenue, if I remember, overall. And on all facets, no matter how you want to look at it, we grew revenue. We grew revenue at actual rates. We grew revenue at constant currency. And we grew revenue at constant currency ex divestiture as we've been taking these portfolio actions that improve the long-term sustainability of our business. By the way, we believe, in the short term, that's the best way to look at the sustainable growth of the business. And on that basis, we grew at 3%. Now within that, we have a very diverse portfolio that provides integrated value overall. We are in a mainframe cycle, right? And typically, in that cycle, as with all of our product-based hardware businesses, they follow innovation cycles, right? We know that. That's why we invest in it, and that's why we bring new innovation to market every 8 to 10 quarters overall. But even excluding mainframe, at constant currency ex divestiture, we grew revenue in the fourth quarter. So it was one and first instantiation point of that. Now let's talk about what gives us confidence on sustainable revenue growth, as we talked about in our January earnings call. There's a couple of factors that I'll just lay out for you. First, and we touched on this earlier, we are going to start seeing some diminishing impacts of 2 major headwinds that we've had. One is significant deferred revenue impairment that impacted the first 5 months of our performance. We have strong renewal rates and client adoption. We replenished $1.1 billion of that deferred revenue. That will diminish over time and start adding more and more growth to IBM. The second is the tough actions we've been doing around portfolio to improve the long-term profile, we'll start wrapping on that as we get through the first half. That has been about a 2-point impact to IBM's revenue growth per quarter in 3Q and 4Q. But then when you look at the core parts of our business: one, our software base of business, we feel very confident, including Red Hat now, in the differentiated value proposition and what we've done to modernize our software. We actually see that accelerating in 2020 as we continue to scale our Red Hat business across our large enterprise and around the world. And second, GBS. GBS, we've done a lot of tough work to reposition that business over the last 2 years. We actually exited the fourth quarter, for the first time in years, where we have our GBS backlog growing now. And that backlog growth now is projecting to an acceleration of revenue as we move through 2020. Now we have more work to do, specifically on GTS. And we talked a lot in our January call about the work we have to do to address the secular shifts that are happening within that marketplace today. That's centered around investing in joint offerings and go-to-market with our GBS business and taking significant structural actions to reposition the competitiveness of that business. So that will improve the trajectory -- not get back to growth, but an improving trajectory as we move throughout 2020. And then in our hardware base of business, we're in the midst of the product cycle. We just refreshed our entire storage portfolio, returned that business back to growth in the fourth quarter. And now we'll come out with a whole new managed distributed midrange storage portfolio here in the first quarter that should provide tremendous leverage in 2020 overall. So at least through the first 3 quarters in a mainframe cycle and with storage, we feel pretty good about growth. So we got work to do in GTS, feel confident in software and GBS and hardware will follow the product cycle. And we'll wrap on those 2 big headwinds.

That's great. Let's -- and it's a good segue into the services business, which is very important to IBM. And as you as you highlighted, 2 very different stories between GBS and GTS. So let's start with the good news, which is GBS has put up really strong growth numbers and margin expansion. The company is really benefiting from advisory and consulting business around digital transformation and cloud, offset by some weakness in the application management business. And so when you take GBS as a whole, how do you see revenue growth and profitability going forward, particularly as you're starting to get into more difficult compares?

Yes. So thanks for starting with the good news first. The team, in all seriousness, has done a fabulous job in repositioning that business. Mark Foster came in from the outside, has really put the operational discipline in that business, transformed our practices, our skills, our service line, and you're starting to see it play out. 2 consecutive years of growth overall. Margin expansion, we actually drove 90 basis points of margin expansion in 2019. We grew signings for the year. We returned our backlog back to growth, and we're well positioned for accelerated growth as we go into 2020. But what Mark has done at its core is really reposition to address where the growth factors are in the industry. And you touched on them around cloud advisory services, et cetera. He's positioned in around 3 platforms of digital, of cloud and of cognitive. And we've lined the entire GBS service line and practice models around those 3 growth platforms and are investing significantly overall. So when you look at GBS in 2020, you take that revenue and backlog position. And let me give you some of the dynamics underneath it. One, we've been seeing very good strength in our consulting-based business that not only is driven off of this evolution of cloud and hybrid moving forward as we're getting great execution on a cloud advisory services. We're also starting to see some of the application modernization and build activity overall in conjunction with next-generation applications like S/4HANA, Salesforce, Workday. We've been building and investing in practices. I think we're the #1 Workday and #1 Salesforce systems integrator in the world today, and we're generating significant growth off of that. But application management, you've talked about that. Application management has went through a big transition from core legacy application build type to now move into application modernization, refactoring workloads and applications to move to the cloud. And as I stated, we actually executed some very strong signings in the second half of 2019. We actually returned signings back to growth in application management, and we're starting to see the early innings of that application modernization to the cloud play out and feel pretty good about that. The third piece of that -- our business there, as you know, is our Global Process Services. And that has also went through a secular shift from what I'll call traditional BPO-based businesses, or labor-based business, to more of a BPaaS business built around how we drive AI into workflows around the world. And we're seeing some great progress in there with substantial signings in '19, and we feel pretty good about what the backlog runout says for that. So around all 3 pieces of our business, we actually do see acceleration as we go through 2020. It was first led by consulting, and I think you'll start seeing the pull of the others. And then in terms of margin, the operating discipline that they've been able to drive around mix shift to higher value, all the productivity actions, the quality of our delivery, that markets changed, will continue as we move forward. Now remember, the model is 50 basis points of improvement year-over-year. We delivered 90 basis points last year. We think we're well in position to go do that again this year.

Shifting to GTS. The good news is, on the last earnings call, you talked about an $8.5 billion book of business within GTS despite the challenges that is growing. But when you look at the overall business, it's declining 4%, and there's concerns as to whether there's a path to return to growth and to expand margins. So talk about your outlook on that business.

Yes. As we spent time on our January earnings call, I tried to give a perspective for our investors about what we're seeing in the marketplace. And more importantly, how that then informs our decisions and the actions that we're actually taking. So you talked about, yes, our revenue was down 4%. Pretty much consistent with what we guided, but it's not the model. It's not what we're looking for. So we do have more work to do here. But what is happening in the marketplace? One, clients -- and we've been doing a tremendous amount of work from the client end by offering, by service line, by practice, as you can quite imagine. But what we're seeing, our clients are in this early innings of chapter 2 of making architectural decisions around their business profile of environments of private, dedicated, public, what stays on-prem. And what we're finding is that, that is being led by application-led transformations, first, from a workload perspective. And you're seeing that play out, to my previous answer on GBS, where we're seeing great momentum in the practices that we built around cloud advisory, cloud migration, cloud app modernization. All of that plays out to real strong project-based services at the front end of that cloud migration journey that GBS is starting to capitalize on. But natural evolution of our industry is how the services model moves. It starts first in GBS, consulting and application. And then as it matures and scales, it moves into more of a GTS-like managed services portfolio. Now with that, we have acknowledged that upfront. We are taking actions to invest and bring to market. One, we historically went to market and built offerings separate between GBS and GTS. We have now -- based on that information, we are creating and investing in an integrated joint offering portfolio lineup that moves a client's journey everywhere from advisory services all the way through to managed services that then leverages the integrated value of our GTS and GBS business together. And some of the services that we're actually seeing some pretty good uptick that we're investing in is things around cybersecurity management. It is exploding out there. Trust and compliance management. We talked walking down here to the room, data management services is exploding. Every client is trying to deal with workloads and data overall. And I would tell you also Red Hat, and we're off to a pretty good start there. So investing in joint go-to-market and joint offering development, changing our operating model, aligning our incentive structure. So we dragged the integrated value between these 2, how we're going to go after the offensive side of GTS to continue to reposition the trajectory of this business. But with that said, in parallel, we've got to get our structural competitiveness fixed. Our margins are well below the industry today. I see that as a ton of headroom opportunity. We talked in January about some structural actions we're going to go address here to really shift our GTS model to adapt to where the market is moving. And that is less labor-intensive and more asset-intensive cloud base that leverages AI and automation that creates a more flexible competitive cost structure for us to win in the marketplace overall.

So the mainframe is a critical component of IBM and pulls along a lot of other revenue streams and recurring revenue streams. So it's clearly a great business. The z14 cycle was certainly better than anybody externally expected. And so talk about the new workloads that you're seeing on the mainframe platform. And what's your expectation for the z15 cycle, which just launched last fall?

Yes. Well, we're very pleased with the new innovation we continue to bring to market. And as we talked about late last fall, we actually brought the z15 to market after 8 quarters, which is typically on the front end of that innovation curve. So it talks about what we've been doing internally to continue to accelerate the speed of innovation in the marketplace. But let me take a step back, because you know quite well, mainframe is the ultimate instantiation of a high-value platform within our business, and we manage it as a platform as a stack. The hardware placements are one aspect of that. But we manage it for the wrap-around synergistic effect of our software middleware that runs on top of that, our other hardware attached like high-end storage, our services business that's attached to it, our financing business that's attached to it. And if you look at that, over the last 3 to 5 years, our profit and cash flow stack has been pretty consistent over that period. So doing quite well. In fact, if you look at the last decade, we've been able to drive 3.5x MIP expansion in the marketplace on mainframe. And within that, if you look at the fourth quarter -- and you asked about comparison to the z14. In the fourth quarter, we had our highest MIP shipment quarter ever. And that was up close to 200% year-over-year. And within that, strong adoption in what we call specialty MIPS, which is really an instantiation of new workloads that are coming on to the mainframe. And we've got numerous cases and use cases around complex fraud detection models, around digital banking. Clients are moving their data onto to the mainframe overall. And why are they doing that? Well, when you look at our differentiated value proposition, one z14, the real aha of innovation in z14 was encryption, pervasive encryption. When you look at z15, we have built on that and now have made for encryption everywhere. So it allows a client to take advantage of our leading industry data privacy and security across any environment of running your workloads on mainframe. The second thing, normal instant recovery, leveraging mainframe's resiliency, availability, performance and data privacy overall. But the final thing, getting to your question, is we have now made the mainframe cloud native. So we just announced, what, 3 weeks ago Red Hat Openshift, first time ever, certified on mainframe. We also announced our Cloud Pak for Application available on mainframe, and we'll soon have all of our Cloud Paks available on mainframe. So what has it done? Now it's opened up a whole new potential ecosystem to enable developers to build applications in a consistent way, and then deploy them across any environment, leveraging our industry-leading resiliency, security, privacy and performance of mainframe overall. So we're bringing mainframe into the new age around cloud-based development.

That's great. We've spent a lot of time so far on the big bets in cloud and cognitive and really the payoff for those bets across the business. When you look into the future, what are the bets that come after cloud and cognitive that can keep the progression of this transformation and return to sustainable growth?

Yes. So to the core of your question, returning to sustainable growth relevancy in the future, everything, it's at the core of IBM. High-value, innovative provider. We have invested consistently high teens from a research development perspective against our product base of businesses over time. We carry that as core commanding investment prioritization to differentiate ourselves overall. And we also have IBM Research, which to me is a treasure. It's a treasure because it allows us to stay on the future leading edge of where technology is going to transform industries, clients and the world overall. And you'll get a little bit of perspective at our Think event here coming up in May around what we call our global technology outlook. Each year, we go through an IBM with our research-led laboratories, what they believe the 5 and 5 is, the 5 biggest trends in the next 5 years that are going to be at scale. Not just released to the market as new innovation, but be at scale. And I'm not going to give all the answers. So I'll tease a few, but you can imagine they're going to be centered around 5G telco networks. There's a tremendous opportunity around open software architectures and around what Red Hat and IBM can do to take a leadership position there. I'm sure there'll be something around AI, augmented AI, RPA and AI. And we'll obviously talk about quantum, which is becoming each day more and more real, and we are investing significantly to continue taking a leadership position. We got 15 quantum computers already in production on the IBM cloud. We have an IBM Qiskit software development network that has over 200,000 developers that have already written 2 billion plus lines of code. And we also have IBM Q Network that has many leading large enterprise customers that are collaborating with us along with academia. So it's a little bit of a teaser and taste on what we'll see at Think here this year.

Great. We have about a minute left, so let me wrap up and just ask you, what do you think is most underappreciated about the IBM story across the investors you meet with?

Well, to me, it's simple and it goes to the heart of our entire discussion here today, and that is we have a very strong belief about what the next evolution of cloud is going to be in the market, and that's hybrid. And that is chapter 2. That is 80-plus percent of the workloads that still have to move to the cloud, and clients are going to need a provider that is going to enable them to modernize, migrate, build and manage those services over time. Now while many others are talking hybrid in the world today and talking containerized-based strategies, there's something very powerful, we believe, in participating across the entire stack. And when you look at this market opportunity of $1.2 trillion, that stack, everything on what I talked to from the foundation of Linux to containers, the Kubernetes to OpenShift, the Cloud Paks to services, both GBS and GTS, we believe we are well positioned to help our clients in driving that next evolution, which will lead to sustainable revenue growth and a true growth factor in IBM going forward.

That's a perfect place to end. Thank you so much for your time.

Excellent. Thank you very much, Katy. Appreciate it.