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

Welcome to the IBM 2021 Annual Meeting of Stockholders. I would now like to turn the conference over to Arvind Krishna. Please go ahead.

Good morning, and welcome to all of you to the 2021 IBM Annual Stockholders' Meeting. I ask for the meeting, please come to order. Thank you all for joining today. I hope you and your families are staying healthy and safe, as we continue to experience the challenges of the global COVID-19 pandemic. My name is Arvind Krishna, Chairman of the Board, and I will act as Chairman of the meeting. Joining me on this webcast today from IBM are Jim Kavanaugh, Senior Vice President and Chief Financial Officer; Michelle Browdy, Senior Vice President and General Counsel; and Frank Sedlarcik, Vice President and Secretary. We are also joined by the members of IBM's Board of Directors. IBM has an exceptional board whose members bring a diversity of background, talents and perspectives from the public and private sectors and from a variety of industries and businesses with operations around the world. I would like to introduce each member of the Board on the line today. In addition to myself, we are joined by Thomas Buberl, Chief Executive Officer of AXA; Mike Eskew, retired Chairman and Chief Executive Officer of United Postal Service; David Farr, Chairman of Emerson Electric Company; Alex Gorsky, Chairman and Chief Executive Officer of Johnson & Johnson; Michelle Harvard, Retired Admiral, United States Navy; Andrew Liveris, retired Executive Chairman and Chief Executive Officer, The Dow Chemical Company; Bill McNabb, retired Chairman and Chief Executive Officer of The Vanguard Group; Martha Pollack, President of Cornell University; Joe Swedish, retired Chairman, President and Chief Executive Officer of Anthem; Peter Voser, retired Chief Executive Officer of Royal Dutch Shell and Chairman of ABB; Rick Waddell, retired Chairman and Chief Executive Officer of the Northern Trust Corporation. All stockholders of record on February 26, 2021, for given notice of this meeting by mail. Copies were also sent to the financial press. [ Michael Barbara ], [ Henry Warnecke ] and [ Doug Zonike ], of First Course Results have been appointed by the Board to serve as the inspector of election for this meeting in accordance with our company's bylaws. The inspector of election sent me a report, which shows that more than 76% of the outstanding stock entitled to word is represented by proxy. Under our by-laws, [Audio Gap] Item 1 [Audio Gap] as the company's independent registered public accounting firm. IBM's proposal is set forth in the proxy statement on Page 74. Item 3, advisory vote on executive compensation. IBM's proposal is set forth on Page 75 of the proxy statement. Note that there are 3 stockholder proposals reflected as Items 4, 5 and 6. Other proposals will not be considered at today's meeting. Our Board recommends a vote against the first 2 stockholder proposals; and for the third stockholder proposal. There is no need to read the proposal or the supporting statement as all of that information is set forth in the proxy statement. Our respect for stockholders, the rules of conduct published in advance of the meeting required that each of the speakers representing stockholder proposals to please limit their comments to a period of 3 minutes per proposal, and to limit their comments to the subject of the proposal. In addition, please note, this is not the time to air personal grievances or to discuss matters that are otherwise not suitable for the conduct of this meeting. The first stockholder proposal is Item 4 on Page 76 in the proxy statement from Kenneth Steiner regarding having an independent board Chairman. Our statement in opposition is on Page 77. I'll now ask the operator to open the line for James McRitchie to present the proposal.

Thank you. This shareholder proposal number 4, request an independent Board Chair, evidence that the current structure is not working is that our stock has fallen from $210 in 2013 to less than $142 this morning. Plus our current Lead Director, may not have the proper orientation to be an effective Lead Director. Mr. Skew is a former CEO, which could tend to make him a champion of CEO right at the expense of shareholders. And he's apparently not had a regular day job since 2007. This proposal topic won an impressive 40% support at the 2019 IBM Annual Meeting, even though IBM management put its hand on the scale and spennt our money on advertisers to oppose this proposal in 2019 and again, today in 2021. Support for proposals to appoint an independent chair received 17% higher support at U.S. companies in 2020. Since management performance setbacks often result in greater support for this proposed topic, the mere submission of this proposal may have been an incentive for our CEO to perform better, leading up to this 2021 Annual Meeting. Giving the chairmanship job to the CEO can simply be an ego trip for the CEO. The CEO can then think that the CEO's vision for the company is invincible, and this could blind the CEO to emerging problems. The role of the CEO and management is to run the company, the role of the Board of Directors is to provide independent oversight and management of the CEO. Thus, there's a conflict of interest for a CEO to have both roles. Shareholders are best served by an independent Board Chair, who can provide a balance of power between the CEO and Board as CEO serving as Chair, can result in excessive management influence on the Board and weaker oversight. Numerous institutional investors recommend independence for those 2 roles. Please vote yes, independent Board Chair, proposal number 4. Thank you very much. [Voting]

Let's move on to the next proposal. The second stockholder proposal is Item 5 on Page 78 in the proxy statement from John Cheveden on the right to act by written consent. Our statement of opposition is on Page 79. I will now ask the operator to open the line for James McRitchie to present the proposal.

IBM now requires more than 30% of shares that cast valid at the Annual Meeting to call a special shareholder meeting. It would be futile to try to get IBM shareholders who did not even vote to go through the bureaucratic process to call a special meeting. So our more than 30% of shares that cast ballots at the annual meeting to call a special meeting is more -- one more reason that we should have the right to act by written consent. Plus our high, more than 30% threshold has bureaucratic pitfalls that trigger minor shareholder errors that could mean that 50% of shares would need to be asked. For a special meeting in order to be sure of obtaining the threshold of more than 30% of requests without [indiscernible]. Dozens of Fortune 500 companies provide for both shareholder rights to act by written consent and to call a special meeting. This proposal topic won 42% at our 2020 Annual Meeting in spite of misleading management opposition to it. The 2020 Annual Meeting was not exactly a fair election because the misleading IBM management statement next to the 2020 proposal. The IBM management said written consent could enable shareholders to initiate written consent without giving notice to all shareholders. To the contrary, written consent can easily be adopted with the safeguard that all shareholders are to be given notice, that provision could have easily been included. In 2020, IBM management said it preferred a special shareholder meeting to written consent. With the widespread use of online shareholder meetings at 2020, no long -- shareholders no longer have the right to discuss concerns with other shareholders and with directors at a special shareholder meeting, which could now be [ stilted ] formalities online meeting. Shareholders are also severely restricted in making their views known at an online special meeting because all the questions and comments can be arbitrarily screened out. For instance, Goodyear management became a leader in this shareholder disenfranchisement by handing a mute button right in the middle of a formal shareholder presentation at the 2020 online shareholder meeting. This proposal is especially important to consider after our Lead Director, Michael Skew, received the highest negative votes of any director in 2019 and 2020, $92 million negative votes. Both with long tenure of 15 years, it can hardly be considered independent. Shirley Jackson, who received the second highest negative votes in 2019 is no longer on the Board. IBM stock has fallen from 2010 or from $210 since 2013. Remember that as you vote. Please vote yes, right to act by written consent, proposal number 5. Thank you. [Voting]

All right. Let's move on to the next proposal. The third stockholder proposal is Item 6 on Page 80 in the proxy statement from Nia Impact Capital, requesting the company published annually a report assessing its diversity, equity and inclusion efforts. Our statement, in support, is on Page 81. I'll now ask for the proposal to be presented by Kristin Hull.

Hello. I am Dr. Kristin Hull Founder and CEO of Nia Impact Capital. At Nia, we seek to generate a competitive rate of return while creating a positive impact for investors, our planet and our communities. That end, we engaged with our portfolio holdings, encouraging improvements on material, social and environmental topics in order to strengthen long-term performance. I formally move Item 6, which request that IBM published a report assessing its diversity, equity and inclusion efforts. We want to thank IBM Board for its support of this resolution and its agreement to report on its process for assessing the effectiveness of IBM's diversity, equity and inclusion programs and its assessment of program effectiveness as reflected in goals, metrics and trends related to the recruitment, retention and promotion rates of employees. IBM's support of this request provides us as investors with comfort that IBM not only understands the business imperative to address diversity, equity and inclusion. It is also taking seriously the building of its own internal programs, oversight systems and accountability mechanisms. This month, IBM released its 2020 Diversity and Inclusion Report. In it, they described some of the innovative and inspired actions they are taking to support diverse communities, including efforts to build ethics into AI at its earliest stages, offering neurodiversity training to employees and actively pushing for criminal justice reform. The report is a clear step forward in providing meaningful data and workplace equity transparency to investors. Not only will IBM be releasing its EEO 1 Form after the spinout of Kyndryl, it has shared its hiring percentages by gender, race and ethnicity and its female promotion rate. What IBM has published is a good start. And as IBM recognizes, there is still more to do. We are calling on IBM to lead when it comes to workplace transparency. Promotion and retention data for all groups is still needed. A company with strong and equitable workplace practices will have no hesitation in sharing its retention data. Over the next year, we will work with IBM on benchmarking its progress. And to encourage its release of what is missing from this report. Today, we celebrate IBM's commitment to improving its reporting. Transparency, even in the face of imperfection, shows the company's true commitment to change as well as its commitment to its employees, its community and its investors, in its effort to build the positive and inclusive company culture needed for today. Thank you.

At this time, the polls are now closed. I will now proceed with a report on your company and our progress in 2020. Our remarks will cover 4 critical aspects of our work. Our financial performance in 2020, our hybrid cloud and AI strategy, our progress and the decisive moves we have made for future growth and the importance of responsible stewardship. Let me start by discussing our financial performance in 2020, year of profound disruption for our clients and for the world at large. For the full year, we delivered $73.6 billion of revenue. Part of this reflects broader uncertainty of the macro environment, which also affects our clients. That said, the urgency of digital transformation continues to fuel momentum for our business. Our cloud-related revenue grew 20% to $25.1 billion and now represents over 1/3 of our total revenue. Red Hat was a key driver with normalized revenue growth of 18% in 2020 and the backlog that topped $5 billion for the first time at year-end. Global Business Services Cloud revenue grew at a double-digit rate as we focus on modernizing client applications and reimagining their workflows with AI. Mobil Technology Services ended the year with strong contract renewals and new clients. IBM z revenue grew in 2020 with the z15 now shipping the largest capacity in the platform's history. The fundamentals across our business continue to be strong. Our operating gross profit margin expanded 130 basis points to over 49%. This indicates the value our clients find in our offerings. Operating net income was $7.8 billion, even after a significant charge for structural actions that will improve our go-forward position. We also took actions to strengthen our balance sheet and liquidity. As a result, we are in a stronger financial position. Free cash flow is the fuel for our growth. And for the year, we generated a solid $18.2 billion of net cash from operations and free cash flow of $10.8 billion. All of this allowed us to return capital to you, our shareholders. And today, I'm pleased to share with you that the Board has approved an increase in our per share dividend to $1.64 per quarter. We are extremely proud to have raised the dividend for 26 consecutive years. Let me now walk you through our strategy that focuses on hybrid cloud and AI. Hybrid cloud allows companies to securely deploy and manage data and applications across public and private clouds. We see this opportunity at $1 trillion. Most of the opportunities still ahead of us as less than 25% of workloads have moved to public cloud thus far. Meanwhile, the current enterprise department rate of AI is in the single digits. To seize this opportunity, our approach is platform-centric. Red Hat, Linux and OpenShift are the foundation of our hybrid cloud platform. We have a vast software portfolio that has been modernized to run cloud-native anywhere. Our GBS expertise is a key factor in driving consumption. Based on this foundation, we have successfully leveraging Red Hat as a unique platform to address what our global, complex and highly regulated clients' needs, a hybrid cloud platform that is open, flexible and secure. For our clients, the benefits of hybrid cloud are clear. Clients find that choosing a hybrid cloud approach is 2.5x more valuable than relying on a single public cloud. We also have built industry clouds that are designed to tackle the specific needs of mission-critical and highly regulated industries. Our cloud for financial services added key partners in 2020, such as Adobe, Infosys, Finacle, Assistance Systems and many others. Some of the world's largest banks signed on that include Bank of America, BNP Paribas and MUFG Bank. In 2020, we have held clients across industries accelerate their digital transformation. Ended 2020 with more than 2,800 clients that were using our hybrid cloud platform, up 40% over the past year. We helped Schlumberger, the world's largest oil field services provider, allowing its customers to deploy applications across any infrastructure. At a moment when connectivity has become so vital, we are helping telcos such as Bharti Airtel, AT&T, Telefónica, Telecom Egypt or Vodafone Portugal to transform their networks. And major global companies across every industry are turning to us to emerge stronger from the pandemic. For instance, Delta Airlines is using OpenShift, Cloud Paks and GBS expertise, to modernize its digital customer experience. At the same time, we are helping clients deploy AI at scale. More than 40,000 clients have turned to IBM to unlock value from their data. IBM's AI platform is differentiated by automation, natural language processing and trust. We have the only AI platform that can run anywhere, on-premise, private cloud and public cloud. We are helping clients across industries, field AI to their core business process, such as hiring, supply chains and customer service. I have immense confidence in our hyper cloud and AI strategy. To support and accelerate our strategy, we have made a series of decisive moves over the past year. Starting with the biggest decision. We announced the separation of our managed infrastructure services business in October. Once the spin-off is completed, our 2 companies will continue to share a strong bond. In 2020 alone, we closed 7 strategic acquisitions. All are designed to bolster our Hybrid Cloud and AI portfolio. The accelerated consumption of our Hybrid Cloud platform, gives elevated role of partners, and we are rapidly expanding our ecosystem by adding hundreds of new partners and also investing $1 billion in our ecosystem, so our partners can play a much bigger role in fulfilling the many needs of our clients. We have also drastically simplified our go-to-market strategy. This includes a simplified and consistent client segmentation and putting what we call free-sales garages, which allow us to co-create with our clients as a center of our sales process. To give you just one example, out of many of the important work we are doing with our partners, we collaborated with Salesforce to build our digital health pass. This digital health pass incorporates data such as temperature checks, COVID-19 test results and vaccine status to help organizations safely reopen. All of these decisive and strategic moves provide a solid foundation for us to unlock future growth. The era of Hybrid Cloud and AI will offer vast new opportunities for business and society. Crises of 2020 has set in motion an acceleration of digital transformation. This means we have a unique opportunity to infuse greater intelligence into the systems that underpin business, society and commerce. But to bring the promise to bare, it takes trust and positive social impact. In 2020, continue to use our scale, cope and trust, making impact on important societal issues. The global public health crisis began. We organized the high-performance computing consortia to put our fastest computers at the disposal of scientists around the world that were working to understand and combat COVID-19. IBM's Watson assistant for citizens helps dozens of governments at all levels, disseminate information of our COVID-19 testing and best practices. As protesters took to the street to condemn systemic racism, sent a letter to Congress, explaining our decision to abandon facial recognition software. This has prompted other companies to follow suit. We take other steps to advance our environmental leadership to help cycle the climate prices, we set a new goal to reach net 0 greenhouse gas emissions by 2030, without the use of carbon offset. The events of the past year have reaffirmed our long-standing commitment to address social injustices, accessibility gaps and growing socioeconomic differences. Within IBM, we continue to foster our culture of conscious inclusion where people of all backgrounds can try. Despite the challenges of a global dynamic, in our November 2020 Annual IBM Engagement Survey, IBM achieved best-in-class inclusion scores with an 88% inclusion score index and essentially, the same percentage of all IBMers are saying that they can be their authentic selves at work. 2020, we made a commitment to be more transparent in how we report diversity and inclusion. And just this month, we released our 2020 Diversity and Inclusion Report. In it, you will see the progress we have made. Specifically, we've increased our diversity representation over the past 3 years of women worldwide and underrepresented minorities in the United States. We have also increased the hiring and advancement opportunities of women and underrepresented minorities in the U.S. in 2020. As I look back for me as for so many other IBMers, 2020 has put the spotlight on IBM's essential role for our clients. IBM is the backbone of some of the most critical systems that keep the world running. Our technology and services help banks process credit card transactions, businesses around supply chains, telco connect customers, health care providers improve patient care and city [indiscernible]. Today, IBM is reshaping its future as a hybrid cloud and AI platform company. My confidence in our ability to exit the turbulent period stronger is grounded in the strength of our strategy, the progress of our transformation and the talented resilience of IBMers around the world. Let me end by thanking you, our shareholders, for your continued confidence in IBM. I'm grateful for your support as we embark on the next chapter of our journey together.

The inspector of election sent me a report this morning on his preliminary count of the world's cast based upon the proxies and ballots, which have been processed. On the basis of that report, I declare each of the 12 nominees listed in the proxy statement, standing for election as directors, received a majority of the votes cast. A majority of words cast voted for the ratification of Pricewaterhousecoopers as the company's independent registered public accounting firm. The stockholder proposal to have an independent Board Chairman did not receive a majority of the word cast. The stockholder proposal on the right to act by written consent did not receive a majority of the votes cast. Stockholder proposal requesting the company published annually, a report addressing its diversity, equity and inclusion efforts, received a majority of the words cast. The proposal concerning the advisory vote on executive compensation is currently at 49%. The votes are still being countered given how close this is. We are now going to move into the question period of the meeting. As we have done for many years, we posted an invitation on the Investor Relations website in March, which gave stockholders the opportunity to submit questions in advance of today's meeting. For stockholders who signed in today with a control number, you can also submit questions through the portal during the meeting.

I will now go through some of those questions that we have received. I will also comment that some of these questions have been answered in the report we gave on the company. We received several questions from shareholders regarding Kyndryl, which is the name of the spin-out of the new company. I would like to share my view on what this means to IBM and what we expect going forward. Since becoming CEO, I prioritized delivering growth. With a specific focus on hybrid cloud and AI. We have built a foundation to capitalize on the trillion-dollar opportunity given by hybrid cloud. Our approach is platform-centric, and the acquisition of Red Heart has established us as the leading hybrid cloud platform provider. With the acceleration of our clients' transformation, their needs are changing. They purchase and consume infrastructure and application services in changing ways, driven by separate buying cycles. As a result, we announced the separation of our managed infrastructure services business via a tax-free spin-off. The name of this new public company is Kyndryl, which will have a separate management team, led by their new CEO, Martin Schroeter, and Kyndryl will be entirely focused on managing and modernizing client-owned infrastructures. As separate businesses, each, meaning IBM and Kyndryl, can capitalize on their respective missions. Both companies will have increased clarity and agility and allows them to focus on their operating and financial models and greater freedom to partner with other providers. Each can better align their investments and capital allocations. Ultimately, this will create immense value for clients and you, as our investors with an improved growth profile of both companies. More information on the separation, including the distribution of Kyndryl's shares to IBM stockholders will be available in the Form 10 later this year. We are making good progress, and we are well on track to executing this spin out. Looking at the portal. We also received several questions from shareholders who asked about our involvement in politics. I'd like to share my view on that topic. For decades, IBM has worked with elected officials at the United States Federal state and local levels as well as government leaders at similar levels around the globe. IBM is engaged with United States administrations from both parties on public policy matters since President Wilson. Our century of doing business teaches us that engaging and having authentic dialogue is the best path to good outcomes. However, we do not, as far as a partisan or political point of view, we do not engage in grassroots lobbying, and we disclose all lobbying as required by law. We also have a long-standing policy not to make contributions of any kind, money, employee time, goods or services directly or indirectly to political parties or candidates, including through intermediary organizations such as packs, campaign funds or trade and industry associations. This policy applies equally in all countries and across all levels of government even when such contributions are permitted by law. I hope that makes our stand on political contributions clear. We also received a number of questions around innovation and IBM's role in AI or artificial intelligence. For more than 100 years, IBM has strived for responsible innovation that is capable of bringing benefits to everyone, not just a few. You heard us talk about it in the report, and you also heard one of our shareholder proposals address that topic. This philosophy of responsible innovation is also applied to artificial intelligence. We aim to create and offer reliable technology that augments, not replaces human decision-making. IBM recognized that clearly articulating principles around the ethical deployment of AI is critical, backed by a strong commitment to but our words into practice. Our trust and transparency principles and several recent developments are going to be described now. We signed the Vatican's Rome Call for AI Ethics. He created the Notre Dame IBM Technology Ethics lab. We have published our points of view on facial recognition as well as the precision regulation of AI. We donated our AI explainability 360 toolkit as an open source resource, and we have contributed to the EU high level expert group's guidelines across for the AI. New technology, including AI, must be transparent and explainable. Technology companies must be clear about who trains their AI systems, what data was used in the training and what went into the recommendations made by AI systems. While we will continue to collaborate with governments, companies and other organizations, we have also embraced the need for an internal governance framework that evaluates opportunities based on well-defined guidance around privacy and security. We have an internal AI Ethics Board that works with experts through our business. We make advancements in technologies like AI and cloud that are changing the world for good. Social impact is built into our business. We want to apply our technology and talent to make an impact through our operations, in our practices and by taking clear stance on these topics. Tech for good, as we call it, is not only making technology responsibly, which means free of bias and with sustainable practices, but also technology that positively impacts individuals, communities and the world. Looking at the questions, there are a number of questions about Red Hat. And to better phrase from one, "Tell us what's happened in the business since the acquisition of Red Hat? What benefits have you seen for our company and technology?" Great question. Since this acquisition closed in 2019, we have leveraged Red Hat as a unique platform to address what our global complex and highly regulated clients need, which is a hybrid cloud platform. This platform now includes 3,000 clients. In terms of Red Hat performance, in 2020, Red Hat generated more than $4.5 billion, normalized for historic compatibility. Full year revenue growth of 18%, both as reported and adjusting for currency. It also operates as a highly profitable business with gross profit margin in excess of 80%. In the first quarter of 2021, Red Hat continued its strong growth, up 17% as reported. In addition to the strong revenue performance, Red Hat, Linux and OpenShift are also the foundations for our hybrid cloud platform. These sit at the heart of our software, middleware and systems. Red Hat isn't just the engine that runs our capabilities. It's what makes it possible for our clients to run workloads in any environment. Looking back at our original intent, get great technology, get a foundation for our platform, allow Red Hat to grow even faster and provide a basis for IBM to realign our core strategy. I think this acquisition has yielded benefits across all these dimensions. One example, we can see the benefit of Red Hat in the synergy between Red Hat and IBM Global Business Services, or GBS. GBS is continuing to leverage and expand the number of clients that work on Red Hat. These span a number of industries and help their clients' journeys to cloud. Since 2019, our GBS Red Hat practice has generated over $2 billion of signings with hundreds of client engagements. 29% of GBS' cloud revenue growth in this first quarter came from a Red Hat practice. Red Hat is now more than 10% of all GBS cloud revenue. I think that speaks to the benefits we get. So you can see how Red Hat today is a core component in our overall hybrid cloud strategy and in accelerating our relationships with other cloud vendors, ecosystem, clients and partners to 3 recently announced deals speak to that, Siemens, Schlumberger and Palantir. So we can see the positive effect of Red Hat across our business. I can also see a lot of questions on sustainability. "what is our position on environmental sustainability?" Few companies can actually have a real impact in the combat or climate change, but IBM is in a unique position to make a real difference through its technology. Is IBM going to invest in more capabilities in this area going forward? So let me give you a little bit of perspective. IBM's energy and climate programs, date back 50 years to where we issued our first corporate environmental policy in 1971. We established our first greenhouse gas emissions reduction goal more than 20 years ago in the year 2000. We are now working on our fifth generation emission reduction goal, having updated our goals earlier this year. Here are our new goals. We gave up 75% of the electricity we consume worldwide from renewable sources by 2025 and 90% by 2030. Reduced our greenhouse gas emission 65% by 2025 against base year 2010, achieved net 0 greenhouse gas emissions by 2030, using feasible technologies such as carbon capture to remove emissions in an amount which equals or exceeds the level of our residual emissions. While we continue to work aggressively to reduce our own emissions, we recognize that our greatest contribution will come through the application of our products, solutions and technologies. And we are going to continue to grow our capabilities in this area. Example, we work with Yara to develop a digital farming platform that brings more data to farmers and helps them increase production. We use weather data from our global high-resolution atmospheric forecasting, or a grass system that helps airlines and transport companies route around turbulence and reduced fuel consumption. We work with utilities and energy retailers to use data and AI to more effectively integrate renewable energy. The possibility to apply big data and digital technologies are endless, and we will be at the forefront of developing and enabling those solutions. I'm also deeply excited by all of our quantum computing efforts, which we believe will also come to bear heavily on helping solve the climate crisis. I think this begins to address many of the questions that we see on the portal. I would like to thank you for joining us today for our 2021 Stockholders' Meeting and for your support of IBM. I now adjourn the meeting.

The conference has now concluded. Thank you for attending today's presentation, and you may now disconnect.