INTERNATIONAL BUSINESS MACHINES CORP (IBM) FY 2021 MD&A

Management Discussion

International Business Machines Corporation and Subsidiary Companies

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OVERVIEW

The financial section of the International Business Machines Corporation (IBM or the company) 2021 Annual Report includes the Management Discussion, the Consolidated Financial Statements and the Notes to Consolidated Financial Statements. This Overview is designed to provide the reader with some perspective regarding the information contained in the financial section.

Organization of Information

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Operating (non-GAAP) Earnings

In an effort to provide better transparency into the operational results of the business, supplementally, management separates business results into operating and non-operating categories. Operating earnings from continuing operations is a non-GAAP measure that excludes the effects of certain acquisition-related charges, intangible asset amortization, expense resulting from basis differences on equity method investments, retirement-related costs, certain impacts from the Kyndryl separation and related tax effects. Due to the unique, non-recurring nature of the enactment of the U.S. Tax Cuts and Jobs Act (U.S. tax reform), management characterizes the one-time provisional charge recorded in the fourth quarter of 2017 and adjustments to that charge as non-operating. Adjustments include true-ups, accounting elections and any changes to regulations, laws, audit adjustments, etc. that affect the recorded one-time charge. Management also characterizes direct and incremental charges incurred related to the Kyndryl separation as non-operating given their unique and non-recurring nature. These charges include applicable employee awards and tax impacts related to the separation. Given its unique and temporary nature, management has also characterized the unrealized gain on Kyndryl common stock recorded in other (income) and expense in the Consolidated Income Statement as non-operating. The gain reflects fair value changes in the shares that were retained by the company immediately following the separation, with the intent to dispose of such shares within twelve months after the distribution. For acquisitions, operating (non-GAAP) earnings exclude the amortization of purchased intangible assets and acquisition-related charges such as in-process research and development, transaction costs, applicable retention, restructuring and related expenses, tax charges related to acquisition integration and pre-closing charges, such as financing costs. These charges are excluded as they may be inconsistent in amount and timing from period to period and are significantly impacted by the size, type and frequency of the company’s acquisitions. All other spending for acquired companies is included in both earnings from continuing operations and in operating (non-GAAP) earnings. Throughout the Management Discussion, the impact of acquisitions over the prior 12-month period may be a driver of higher expense year to year. For retirement-related costs, management characterizes certain items as operating and others as non-operating, consistent with GAAP. We include defined benefit plan and nonpension postretirement benefit plan service costs, multi-employer plan costs and the cost of defined contribution plans in operating earnings. Non-operating retirement-related costs include defined benefit plan and nonpension postretirement benefit plan amortization of prior service costs, interest cost, expected return on plan assets, amortized actuarial gains/losses, the impacts of any plan curtailments/settlements and pension insolvency costs and other costs. Non-operating retirement-related costs are primarily related to changes in pension plan assets and liabilities which are tied to financial market performance, and the company considers these costs to be outside of the operational performance of the business.

Overall, management believes that supplementally providing investors with a view of operating earnings as described above provides increased transparency and clarity into both the operational results of the business and the performance of the company’s pension plans; improves visibility to management decisions and their impacts on operational performance; enables better comparison to peer companies; and allows the company to provide a long-term strategic view of the business going forward. In addition, these non-GAAP measures provide a perspective consistent with areas of interest we routinely receive from investors and analysts. Our reportable segment financial results reflect pre-tax operating earnings from continuing operations, consistent with our management and measurement system.

FORWARD-LOOKING AND CAUTIONARY STATEMENTS

Certain statements contained in this Annual Report may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Any forward-looking statement in this Annual Report speaks only as of the date on which it is made; IBM assumes no obligation to update or revise any such statements except as required by law. Forward-looking statements are based on IBM’s current assumptions regarding future business and financial performance; these statements, by their nature, address matters that are uncertain to different degrees. Forward-looking statements involve a number of risks, uncertainties and other factors that could cause actual results to be materially different, as discussed more fully elsewhere in this Annual Report and in the company’s filings with the Securities and Exchange Commission (SEC), including IBM’s 2021 Form 10-K filed on February 22, 2022.

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8Management Discussion

International Business Machines Corporation and Subsidiary Companies

MANAGEMENT DISCUSSION SNAPSHOT

NM–Not meaningful

The following table provides the company’s operating (non-GAAP) earnings for 2021 and 2020. See page 29 for additional information.

** Includes a $1.5 billion pre-tax charge for structural actions in the fourth quarter resulting in an impact to diluted operating (non-GAAP) earnings per share of ($1.33).

NM–Not meaningful

Separation of Kyndryl

On November 3, 2021, IBM took an important step in advancing its focus on hybrid cloud and Artificial Intelligence (AI) with the separation of its managed infrastructure services unit into a new public company, Kyndryl. The separation of Kyndryl creates two industry-leading companies, which will continue to have a strong commercial relationship. Both IBM and Kyndryl have increased clarity and ability to focus on their respective operating and financial models, including capital deployment, investment strategies, and investment grade capital structures. The separation enables greater freedom of action to partner and capture new opportunities. The outcome of all of these actions will be increased value for clients and investors.

Global Pandemic

On March 11, 2020, the World Health Organization (WHO) declared the novel coronavirus (COVID-19) a global pandemic which resulted in significant governmental measures being initiated around the globe to slow down and control the spread of the virus. As we managed through the second year of the pandemic, the health of IBM employees, our clients, business partners and community remains our primary focus. We are actively engaged to ensure our plans continue to be aligned with recommendations of the WHO, the U.S. Centers for Disease Control and Prevention and governmental regulations.

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The continued environment of uncertainty has only reinforced the need for clients to modernize their businesses to succeed in this new normal, with hybrid cloud and AI at the core of their digital transformations. Across industries, clients are using technology as a source of competitive advantage. We are enabling clients’ transformations by embedding technology at the core of their businesses. Among other things, for example, we are leveraging our hybrid cloud and AI capabilities to help clients reimagine critical workflows, at scale, and modernize applications to increase agility, drive innovation and create operational efficiencies. We are also applying data analytics and automation to mitigate friction in their supply chains and automate business tasks.

The spending environment continued to improve throughout the year despite additional waves of the pandemic. From an industry standpoint, we have seen meaningful improvement in areas most affected by the pandemic such as travel, transportation, automotive and industrial products as well as retail and consumer packaged goods. IBM continues to be well positioned to support our clients to emerge even stronger.

Financial Performance Summary

In 2021, we reported $57.4 billion in revenue, income from continuing operations of $4.7 billion and operating (non-GAAP) earnings of $7.2 billion. Diluted earnings per share from continuing operations was $5.21 as reported and $7.93 on an operating (non-GAAP) basis. On a consolidated basis, we generated $12.8 billion in cash from operations and $6.5 billion in free cash flow, which includes 10 months of Kyndryl operations, cash impacts from the structural actions initiated in the fourth quarter of 2020 and Kyndryl separation-related charges, and delivered shareholder returns of $5.9 billion in dividends. These results reflect progress in our key growth areas resulting from the strong client demand we see in the marketplace for our technology and consulting. We continue to increase investments in skills, innovation and our ecosystem, and our balance sheet continues to provide us with the flexibility to support our business needs.

Total revenue grew 3.9 percent as reported and 3 percent adjusted for currency compared to the prior year with increases in our key growth areas of software and consulting. Year-to-year performance also included a benefit from incremental revenue from our new commercial relationship with Kyndryl beginning in the fourth quarter of 2021, which represented approximately 1 point of our full-year revenue growth. Software revenue increased 5.3 percent as reported and 4 percent adjusted for currency, including approximately 2 points of growth from fourth-quarter sales to Kyndryl. Hybrid Platform & Solutions grew 8.8 percent as reported (8 percent adjusted for currency), led by strong double-digit growth in Red Hat. Transaction Processing declined 3.3 percent as reported (4 percent adjusted for currency) as clients continued their preference for operating expenses over capital expenditures. Consulting revenue increased 9.8 percent as reported and 8 percent adjusted for currency with growth across all three business areas. Infrastructure revenue decreased 2.4 percent year to year as reported and 3 percent adjusted for currency, with the overall decline in revenue reflecting our product cycle dynamics. This performance also includes approximately 1 point of growth from fourth-quarter sales to Kyndryl. Across the segments, total hybrid cloud revenue of $20.2 billion in 2021 grew 20 percent as reported and 19 percent adjusted for currency.

From a geographic perspective, Americas revenue grew 4.4 percent year to year as reported (4 percent adjusted for currency). Europe/Middle East/Africa (EMEA) increased 4.1 percent (1 percent adjusted for currency). Asia Pacific grew 2.8 percent (3 percent adjusted for currency).

The gross margin of 54.9 percent decreased 1.0 point year to year, however, gross profit dollars increased 2.0 percent compared to the prior year. Overall, gross margin was impacted by the significant investments we are making to drive our hybrid cloud and AI strategy as well as our product cycle dynamics. The operating (non-GAAP) gross margin of 56.2 percent decreased 1.1 points versus the prior year.

Total expense and other (income) decreased 5.8 percent in 2021 versus the prior year primarily driven by a $1.9 billion (7 points) decrease in charges for workforce rebalancing and a benefit from expected credit loss expense in the current year compared to a provision in the prior year, partially offset by higher non-operating retirement-related costs and the effects of currency. Our expense dynamics reflect a higher level of investment in innovation, skills and our ecosystem, both organically and through acquisitions, as we execute our hybrid cloud and AI strategy. We are aggressively hiring and scaling resources to better serve clients, while increasing our research spend to deliver innovation in AI, hybrid cloud and emerging areas such as quantum and we are expanding our ecosystem. Total operating (non-GAAP) expense and other (income) decreased 6.8 percent year to year, driven primarily by the same factors excluding the higher non-operating retirement-related costs.

Pre-tax income from continuing operations of $4.8 billion increased 88.0 percent and the pre-tax margin was 8.4 percent, an increase of 3.8 points versus 2020, primarily due to the higher workforce rebalancing charges in 2020. The continuing operations effective tax rate for 2021 was 2.6 percent compared to (52.9) percent in 2020. The current year effective tax rate was primarily driven by tax benefits related to audit settlements in multiple jurisdictions. The prior-year effective tax rate was primarily driven by a net tax benefit of $0.9 billion related to an intra-entity sale of certain of the company’s intellectual property (IP) in the first quarter of 2020, and a benefit of $0.2 billion related to a foreign tax law change. Net income from continuing operations of $4.7 billion increased 19.8 percent and the net income from continuing operations margin was 8.2 percent, up 1.1 points year to year. Operating (non-GAAP) pre-tax

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10Management Discussion

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income from continuing operations of $7.9 billion increased 43.6 percent year to year and the operating (non-GAAP) pre-tax margin from continuing operations increased 3.8 points to 13.7 percent, reflecting the lower workforce rebalancing charges in the current year. The operating (non-GAAP) effective tax rate for 2021 was 9.0 percent compared to (11.5) percent in 2020. The prior year operating (non-GAAP) benefit from income taxes was primarily driven by the net tax benefit from the intra-entity IP sale. Operating (non-GAAP) income from continuing operations of $7.2 billion increased 17.2 percent and the operating (non-GAAP) income margin from continuing operations of 12.5 percent was up 1.4 points year to year.

Diluted earnings per share from continuing operations of $5.21 in 2021 increased 18.9 percent and operating (non-GAAP) diluted earnings per share of $7.93 increased 16.3 percent versus 2020, with the prior year including a ($1.33) impact from the fourth-quarter structural actions on both an as reported and operating (non-GAAP) basis.

Our balance sheet is presented on a consolidated basis, with the December 31, 2020 balance sheet reclassified to provide line items on a continuing operations basis and separately provide current and noncurrent assets and liabilities for Kyndryl discontinued operations. In order to present a meaningful year-to-year comparison, the amounts presented below exclude assets and liabilities of discontinued operations.

At December 31, 2021, the balance sheet remained strong with the flexibility to support and invest in the business needs. Cash and cash equivalents, restricted cash and marketable securities at year end were $7.6 billion, a decrease of $6.7 billion from December 31, 2020. During 2021, we continued to de-lever our debt, invest in acquisitions and provide a growing dividend to shareholders. We have reduced total debt by $9.6 billion from prior year end and $21.3 billion since the second quarter of 2019 (immediately preceding the Red Hat transaction).

Total assets, excluding discontinued operations, decreased $8.2 billion (decreased $5.1 billion adjusted for currency) from December 31, 2020 primarily driven by:

Total liabilities, excluding discontinued operations, decreased $15.1 billion (decreased $10.9 billion adjusted for currency) from December 31, 2020 primarily driven by:

Total equity of $19.0 billion decreased $1.7 billion from December 31, 2020 as a result of:

Our cash flows from operating, investing and financing activities, as reflected in the Consolidated Statement of Cash Flows, include the cash flows of discontinued operations. For 2021, they included 10 months of Kyndryl operations versus a full year of Kyndryl in 2020.

On a consolidated basis, cash provided by operating activities was $12.8 billion in 2021, a decrease of $5.4 billion compared to 2020, driven primarily by a decrease in cash provided by receivables ($3.9 billion) and a decrease in payroll tax and value-added tax payment

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liabilities ($1.0 billion) due to payments in the current year for tax relief provided under the U.S. CARES Act and other non-U.S. government assistance programs in 2020.

Net cash used in investing activities of $6.0 billion increased $2.9 billion compared to the prior year, primarily driven by an increase in net cash used for acquisitions ($3.0 billion).

Financing activities were a net use of cash of $13.4 billion in 2021 compared to $9.7 billion in 2020. The year-to-year increase of $3.6 billion was driven by a decrease in net cash provided from debt transactions ($4.4 billion), partially offset by an increase in cash provided of $0.9 billion due to the Kyndryl distribution to IBM at separation.

DESCRIPTION OF BUSINESS

Please refer to IBM’s Annual Report on Form 10-K filed with the SEC on February 22, 2022, for Item 1A. entitled “Risk Factors.”

IBM is addressing the hybrid cloud and AI opportunity with a platform-centric approach, focused on providing two primary sources of client value – technology and business expertise. We provide integrated solutions and products that leverage: data, information technology, deep expertise in industries and business processes, with trust and security and a broad ecosystem of partners and alliances. Our hybrid cloud platform and AI technology and services capabilities support clients’ digital transformations and help them engage with their customers and employees in new ways. These solutions draw from an industry-leading portfolio of capabilities in software, consulting services, and a deep incumbency in mission-critical systems, all bolstered by one of the world’s leading research organizations.

IBM Strategy

Our strategy is focused on helping clients leverage the power of hybrid cloud and Artificial Intelligence (AI). In 2021, we took an important step with the spin-off of our managed infrastructure services business, now known as Kyndryl. Our strategy resonates with clients, who must continually innovate and redefine their businesses with technology. Our flexible, secure, and open hybrid cloud platform accelerates clients’ outcomes, differentiates the company, and drives a multiplier effect across our software, consulting, and infrastructure businesses as well as to a broad ecosystem of partners. Our strategy positions IBM for accelerated growth today, while preparing the company for the opportunities of the future.

Accelerating Digital Transformation

A new era of rapid change and disruption is underway. The need for digital transformation has dramatically accelerated due to the pandemic and extends through the core mission-critical business processes of almost all large enterprises. Successful digital transformations face major obstacles: (1) managing increased complexity, as large enterprises use multiple heterogeneous IT environments and clouds, (2) deriving value from an explosion of available data, projected by analysts to grow up to three-fold in the next three years, (3) guaranteeing competitive operations, in the context of disruptive changes and worker shortages, (4) addressing  the increase of malicious security breaches and rising cost of cybercrime, and (5) successfully meeting those challenges together with a cohesive end-to-end sustainable execution.

To address these obstacles, enterprises want technology that provides flexibility with open-source across heterogeneous environments – an approach known as hybrid cloud. We have demonstrated that such an approach creates 2.5 times more value for enterprises than a public cloud-only one. Open-source technologies, such as Linux, containers, and Kubernetes, are essential to hybrid cloud, as they harness the power of millions of developers to accelerate the speed of innovation. 85 percent of organizations expect to use Linux containers by 2025. Additionally, AI continues to expand as a key technology to unlock value, with more than 80 percent of enterprises agreeing that intelligent automation can improve business results. As AI for production scales, enterprises and governments focus on ensuring AI models are unbiased and trustworthy.

A Differentiated Architecture for Business Innovation

The evolution we see in the market confirms the strategic changes executed by IBM to deliver on a hybrid cloud and AI strategy, creating sustained value for our clients. Our differentiation derives from a flexible, secure, open hybrid cloud platform, the comprehensive set of assets it impacts, and our ability to combine them to scale up solutions for enterprise digital transformation and mission-critical systems.

Our value proposition builds on five core capabilities, addressing our clients’ hybrid cloud and AI needs: (1) Build and modernize for the hybrid cloud, to develop and operate with speed, consistency and agility, (2) Create data-driven business insights regardless of where data lives and while maintaining enterprise grade data governance, privacy and trust, (3) Automate the end-to-end enterprise processes, for effectiveness and efficiency with AI driven decision-making, (4) Secure everywhere, with consistent governance and compliance across environments, and (5) Bring it together by transforming our clients’ businesses and processes into sustainable best-in-class industry practices.

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12Management Discussion

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Our full technology stack helps us to meet clients wherever they are in digital transformation, and we offer the consulting expertise to help guide and implement the best solutions for that journey. Our rapidly growing ecosystem of cloud, ISVs, hardware, network, and services partners enhance the client experience and drive the value and innovation that can be derived from IBM open-source technologies.

Our hybrid cloud approach is platform-centric, with Linux, containers, and Kubernetes as the architectural foundation. Platforms provide compelling economics:  every $1 of platform spend on average drives $3 to $5 of software revenue, $6 to $8 of services and $1 to $2 of enterprise infrastructure. The multiplier effect of our technology stack creates more value for IBM and our growing ecosystem of partners. The hybrid cloud market alone represents a $1 trillion market, out of which (1) Red Hat Hybrid cloud platforms and IBM Software address a $450 billion market opportunity, (2) IBM Consulting, a $300 billion market opportunity, and (3) IBM Infrastructure, a $230 billion market opportunity.

To capture this hybrid cloud market opportunity, we are prioritizing our investment in offerings aligned to our stated strategy such as Red Hat OpenShift and RHEL, IBM Cloud Paks, related IBM Consulting practices and IBM Infrastructure. We have purposefully embedded our hybrid cloud open platform with our other offerings, to accelerate innovation and amplify impact in our clients’ environment. We have also fostered our ESG initiatives, as the world continues to move toward a more circular economy, a priority for our stakeholder groups and a growing business opportunity for IBM. In 2021, we targeted 2030 for reaching net zero greenhouse gas emissions, and we launched new AI-enabled solutions such as the IBM Environmental Intelligent Suite, to make our clients more sustainable over time.

In addition to our organic investments in R&D, we have been aggressive in inorganic investments in critical hybrid cloud and sustainability software assets, such as Instana, Turbonomic and Envizi. In Consulting, we have also been aggressive acquiring the expertise our clients demand to support their digital innovation including 7Summits, Taos, BoxBoat Technologies and BlueTab Solutions. We successfully completed 15 acquisitions in 2021.

IBM Software solutions amplify the growth and value of our hybrid cloud platform into the software stack with four critical technology capabilities – (1) “Modernize” from legacy to hybrid cloud architecture, (2) Create “data-driven” business insights from distributed data linked via a hybrid data fabric powered by an automated governance, (3) “Automate” end-to-end processes running across IT and business environments, (4) “Secure” together multiple environments, applications and data. Our capabilities are delivered through Cloud Paks that are pre-integrated, pre-certified, AI-powered containerized software packages and are optimized for Red Hat OpenShift. Of the Fortune 500, 40 percent have purchased IBM Cloud Paks, and two-thirds use IBM Security, while increasingly leveraging our expanding software subscription and as-a-service models. We deeply infuse Artificial Intelligence across our Software portfolio, and we are advancing trustworthy AI with a multidisciplinary approach through the IBM AI Ethics board. In 2021, we added new natural language processing enhancements to Watson Discovery. We are combining and integrating products such as Turbonomic, Instana and Watson AIOps to offer a complete set of AI-powered automation software.

Red Hat, reported in our Software segment, is the leading hybrid cloud software platform, and the only one that is fully integrated and open source, with built-in development, security, and operations features. More than 94 percent of the Fortune 500 use Red Hat products and solutions. Red Hat takes advantage of a broad ecosystem of partners and of millions of developers to accelerate innovation. Leveraging the power of Kubernetes and containers, OpenShift creates the foundation that allows our clients to manage

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siloed, multi-cloud, edge, and legacy infrastructure as a single platform. These capabilities are a clear differentiator, enabling our clients to “write once, deploy anywhere” for their hybrid architecture. We are seeing strong momentum, with more than 3,800 clients using our hybrid cloud platform, adding 1,000 clients in 2021. Red Hat OpenShift is recognized as a leader and clear choice for container platform, with more than 40 percent market share in 2021. We are continually investing in Red Hat OpenShift, RHEL and Ansible to extend our technology leadership, while combining the Red Hat platform with IBM’s incumbency, scale, and reach.

IBM Consulting, with 150,000+ professionals in over 150+ countries, helps clients design their digital transformation, build open hybrid cloud architectures, orchestrate applications across environments, and optimize key workflows and business processes. 100 percent of top ten companies in financial services, telecoms, public sector, automotive and healthcare are clients. IBM Consulting has more Red Hat OpenShift certified experts than any of our competition and drove about 700 Red Hat engagements in 2021. IBM Consulting has re-designed its services practices to foster adoption of our hybrid cloud platform and has built or migrated hybrid cloud applications for more than 500 clients. IBM Consulting works with our hybrid cloud and AI ecosystem partners and developers to create the custom solutions that realize digital transformation for clients worldwide, across industries. IBM Consulting also captures growth by investing in advanced practices with AWS, Azure, and major ISVs, such as Adobe, Oracle, SAP and Salesforce.

IBM Infrastructure is the foundation of our hybrid cloud stack, and closely integrates the Red Hat solutions. Our clients are using a combination of public and private cloud infrastructure to keep their mission-critical data and workloads secure, and we continue to be at the heart of mission-critical enterprise workloads. For example, 90 percent of the top 50 banks run on IBM Z, our Mainframe solution. IBM Z delivers security, privacy, and resiliency at scale in a hybrid cloud environment – including running OpenShift to extend the hybrid cloud value proposition. Power, Storage, and IBM Cloud enhance how clients consume, manage, and operate as they take full advantage of our hybrid cloud capabilities for critical workloads. As a result, 94 percent of the Fortune 50 use IBM Cloud.

IBM Research continues to invest in the most promising future technologies with critical impact on clients’ hybrid cloud and AI transformations with confidential computing, trusted AI, neuro-symbolic AI, and sustainability. IBM Quantum fosters next generation computing by (1) delivering the industry leading as-a-Service and software development platform, Qiskit, (2) enabling quantum workflows in existing software such as Watson Studio and (3) providing consulting and technical services as clients and partners adopt quantum computing. In 2021, we unveiled Eagle, a 127-qubit quantum processor. This is the first quantum chip that breaks the 100-qubit barrier and represents a key milestone on our path towards building a 1,000-qubit processor in 2023. Today, more than 380,000 registered users have run over 1.2 trillion hardware quantum circuits. We are committed to accelerating and scaling quantum computing by partnering with industries and fostering a growing ecosystem. The IBM Quantum Network has grown to more than 175 members, including universities, banks, auto companies, telcos, and a wide array of companies from other industries.

Expanding Client Engagements and Our Ecosystem

During 2021, we increased our focus, agility, and client-centric culture. We evolved the way we go to market with our two sales groups – Technology and Consulting. We are scaling technical engagement with clients through significant expansion of experiential selling, client engineering, customer success managers and technical sales talent to help our clients achieve their goals with hybrid cloud and AI.

In parallel, we have accelerated the expansion of our ecosystem as an essential vehicle of our market footprint and growth. We are proactively partnering with a broad variety of companies including hyperscalers, service providers, global system integrators, Software/SaaS vendors and hardware vendors. These partners embed our hybrid cloud platform in their own offerings, integrate it in their services and/or resell it as a channel. We are investing $1 billion in our ecosystem to ensure that our partners have the resources they need to develop software and build their businesses on our platform. Additionally, we have established a strategic partnership with Kyndryl combining IBM incumbency in applications integration with Kyndryl incumbency in managed infrastructure.

2021 was a milestone year for IBM’s Hybrid Cloud and AI strategy. We have positioned our business to capture growth opportunities and to fulfill IBM’s purpose to be the catalyst that makes the world work better.

Business Segments and Capabilities

IBM operates in more than 175 countries around the world. Our platform-centric hybrid cloud and AI strategy is realized through our operations and consist of four business segments: Software, Consulting, Infrastructure and Financing.

Software

Software brings together our hybrid cloud platform and our software solutions, optimized for that platform, to help clients become more data-driven, and to automate, secure and modernize their environments. It includes all software, except operating system software reported in the Infrastructure segment.

Software comprises two business areas – Hybrid Platform & Solutions and Transaction Processing, which have the following capabilities:

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Hybrid Platform & Solutions: includes software, infused with AI, to help clients operate, manage, and optimize their IT resources and business processes within hybrid, multi-cloud environments. It includes the following:

Red Hat: provides enterprise open-source solutions, for hybrid, multi-cloud environments, which includes Red Hat Enterprise Linux (RHEL), OpenShift, our hybrid cloud platform, as well as Ansible.

Automation: optimizes processes from business workflows to IT operations with AI-powered automation. Automation includes software for business automation, AIOps and management, integration, and application servers.

Data & AI: accelerates data-driven agendas by infusing AI throughout the enterprise, empowering intelligent decision making. The portfolio includes capabilities that simplify self-service data consumption through a data fabric, optimize customer care operations and make better predictions through business analytics. Data & AI capabilities facilitate how businesses collaborate with each other, and enable intelligent management of enterprise assets and supply chains with environmental intelligence and the world’s most accurate weather forecast data to build more resilient, sustainable operations.

Security: creates a risk-aware, secure business by gaining real-time threat insights, orchestrating actions and automating responses across all touchpoints. Security includes software and services for threat, data and identity.

Transaction Processing: the software that supports clients’ mission-critical, on-premise workloads in industries such as banking, airlines and retail. This includes transaction processing software such as Customer Information Control System and storage software, as well as the analytics and integration software running on IBM operating systems such as DB2 and WebSphere running on z/OS.

Consulting

Consulting provides deep industry expertise and market-leading capabilities in business transformation and technology implementation. Consulting designs and builds open, hybrid cloud architectures and optimizes key workflows and business processes with IBM and ecosystem partner technologies. Consulting uses its IBM Garage method to convene experts to co-create business products and solutions together with clients to accelerate their digital transformations.

Consulting comprises three business areas – Business Transformation, Technology Consulting and Application Operations, which have the following capabilities:

Business Transformation: provides services that enable clients to apply technologies at scale to transform key workflows, processes and domains end-to-end, including strategy, business process design and operations, data and analytics, and system integration. These services deploy AI in business processes to exploit the value of data and include a full ecosystem of partners alongside IBM technology, including strategic partnerships with Adobe, Oracle, SAP and Salesforce, among others.

Technology Consulting: helps clients architect and implement cloud platforms and strategies to transform the enterprise experience and enable innovation, including application modernization for hybrid cloud with Red Hat OpenShift.

Application Operations: focuses on application and cloud platform services required to operationalize and run cloud platforms. It facilitates clients’ efforts to manage, optimize, and orchestrate application and data workloads across environments through both custom applications and ISV/ERP packages.

Infrastructure

Infrastructure provides trusted, agile, and secure solutions for hybrid cloud, and is the foundation of the hybrid cloud stack. Infrastructure is optimized for infusing AI into mission-critical transactions and tightly integrated with IBM Software including Red Hat for accelerated hybrid cloud benefits. Infrastructure also includes remanufacturing and remarketing of used equipment with a focus on sustainable recovery services.

Infrastructure comprises two business areas – Hybrid Infrastructure and Infrastructure Support, which have the following capabilities:

Hybrid Infrastructure: provides clients with innovative infrastructure platforms to help meet the new requirements of hybrid multi-cloud and enterprise AI workloads leveraging flexible and as-a-service consumption models. Hybrid Infrastructure includes IBM Z and Distributed Infrastructure.

IBM Z: the premier transaction processing platform with leading security, resilience and scale. It includes IBM Z and LinuxONE, with a range of high-performance systems designed to address computing capacity, security and performance needs of businesses. IBM Z operating system software environments include z/OS, a security-rich, high-performance enterprise operating system, as well as Linux and other platforms that are enabled with enterprise AI and are hybrid cloud ready.

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Distributed Infrastructure: the portfolio is uniquely positioned for hybrid cloud, meeting client demands for scalability, security and capacity. Distributed Infrastructure includes Power, Storage, and IBM Cloud Infrastructure-as-a-Service (IaaS). Power consists of high-performance servers, designed and engineered for big data and AI-enabled workloads and are optimized for hybrid cloud and Linux. The Storage portfolio consists of a broad range of storage hardware and software-defined offerings, including Z-attach and distributed flash, tape solutions, software-defined storage controllers, data protection software and network-attach storage. Both Power and Storage offerings are available via flexible consumption models. IBM Cloud IaaS is built on enterprise-grade hardware with an open architecture and is specifically designed for regulated industries with leading security and compliance capabilities. IBM Cloud IaaS offers flexible computing options across x86, Power, Storage and IBM Z as a service to meet client workload needs.

Infrastructure Support: works across hybrid cloud environments providing a uniquely integrated services experience for clients. Infrastructure Support delivers comprehensive, proactive and AI-enabled services to maintain and improve the availability and value of clients’ IT infrastructure (hardware and software) both on-premises and in the cloud. These offerings include maintenance for IBM products and other technology platforms, as well as open source and cross-vendor software and solution support.

Financing

Financing facilitates IBM clients’ acquisition of information technology systems, software and services through its financing solutions. The financing arrangements are predominantly for products or services that are critical to the end users’ business operations and support IBM’s hybrid cloud platform and AI strategy. Financing conducts a comprehensive credit evaluation of its clients prior to extending financing. As a captive financier, Financing has the benefit of both deep knowledge of its client base and a clear insight into the products and services financed. These factors allow the business to effectively manage two of the major risks associated with financing, credit and residual value, while generating strong returns on equity.

Financing comprises the following two business areas – Client Financing and Commercial Financing:

Client Financing: lease, installment payment plan and loan financing to end-user clients for terms up to seven years, and internal loan financing in support of IBM IaaS service arrangements. Assets financed are primarily new and used IT hardware, software and services where we have expertise.

Commercial Financing: short-term working capital financing to distributors and resellers primarily of IBM products. In 2019, we began the wind down of the Original Equipment Manufacturer (OEM) IT portion of our commercial financing operations which completed in early 2021. In the fourth-quarter 2020, Financing expanded its financial flexibility by entering into an agreement with a third-party investor to sell up to $3 billion of its IBM commercial financing receivables, at any one time, on a revolving basis over the agreement’s three-year term.

Human Capital

Employees and Related Workforce

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As a globally integrated enterprise, IBM operates in more than 175 countries and is continuing to shift our business to the higher value segments of enterprise IT. Our global workforce is highly skilled, reflective of the work we do for our clients’ digital transformations and in support of their mission-critical operations. Our global workforce includes developers, consultants, client delivery and services specialists, research scientists and others. Our employees are among the world’s leading experts in cloud, AI, quantum computing, cybersecurity and industry-specific solutions.

In November 2021, we completed the separation of our managed infrastructure services business to Kyndryl, comprising approximately 90,000 employees. Over our 111-year history, we have consistently made bold moves to transform and develop our talent. Today, IBM employees are clearly focused on our hybrid cloud and AI strategy for growth.

Talent and Culture

IBM attracts, develops, engages and retains talent in a dynamic and competitive environment. IBM offers a compelling employee value proposition: we develop and deliver innovative technologies including hybrid cloud, AI, and quantum, for clients whose businesses the world relies on. IBM is continuously transforming and developing its talent, both through learning and hiring. Voluntary attrition was higher in 2021 than in 2020 consistent with the overall labor market. On a longer horizon, the average voluntary attrition rate of the pandemic years (2020 and 2021) was still lower than the previous two years (2018 and 2019). In 2021, we added skills in consulting

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and key technical areas. We are scaling our investments in garages, client engineering centers and customer success managers. Employees are encouraged and enabled to learn and grow their careers, with employees using our learning platform to complete more than 70 hours of learning on average in 2021. Our digital learning and career platform uses Watson AI to generate personalized recommendations and includes peer-to-peer collaboration and internal social sharing. Over 170,000 employees globally participated in our annual engagement survey, which measures factors such as workplace experience, inclusion, pride and propensity to recommend IBM as an employer. Our industry-leading talent practices enabled more than eight out of ten employees to be highly engaged. Every manager and leader in IBM has access to their team and organization engagement levels along with actionable data-driven insights.

Diversity and Inclusion

IBM has a long, proud history as a pioneer in diversity and inclusion. A diverse and inclusive workplace leads to greater innovation, agility, performance, and engagement, enabling both business growth and societal impact. We ensure employees from diverse backgrounds are engaged, can be their authentic selves, build skills and grow their careers. In April 2021, with the full support of our Board of Directors, we disclosed an overview of our diversity, equity and inclusion efforts and programs, including diversity representation data and remain committed to continued transparency in 2022. We are proud of our inclusive culture, with nine out of ten employees responding that they can be their authentic selves at work. Our focus on creating a diverse and inclusive workplace led to increased levels of inclusion for women, Black and Hispanic employees. Women make up more than one-third of our workforce, and we increased representation of women, Black and Hispanic employees in 2021 compared to the prior year. In addition, executive representation of women globally, and Hispanic and Black executives in the U.S. improved by 1.0 point, 0.4 points and 1.5 points, respectively, in 2021. Further, a diversity modifier was added to the executive compensation program in 2021 to reinforce our continued accountability for progress. Globally, IBM executives are measured on the improvement of diversity and inclusion for women. In the U.S., executives are also measured on improvement of diversity and inclusion for U.S. underrepresented minorities. While we have taken significant actions and made progress, we have ongoing work to do.

IBM believes in pay equity: we have had an equal pay policy since 1935 and a long-standing practice of maintaining pay equity. To this end, we conduct statistical pay equity analysis that includes all countries with IBM employees. We also empower employees to understand their pay by providing comprehensive education and transparent access to pay statements including a comparison to market pay ranges.

Health, Safety and Well-Being

We have a long-standing commitment to the health, safety and well-being of our employees. This remained a focus in 2021 as we continued to face the COVID-19 pandemic. We have a robust case management system to manage COVID-19 exposures and a comprehensive playbook on workplace health and safety measures that allow our offices to reopen when local clinical conditions allow. These measures include limiting travel and in-person meetings and events, required self-screening before accessing workplaces, and imposing strict social distancing and mask wearing. In countries where vaccine access is sufficient or where legally mandated, only employees who are fully vaccinated against COVID-19 can access IBM workplaces.

Additionally, from the outset of the COVID-19 pandemic, IBM has focused on mental health and supporting our employees for the long run with programs shaped by frequent survey polls and employee input sessions. Such programs include: four weeks additional paid time off for working parents and caregivers facing disruption, training for employees on resilience and for managers on how to identify and address mental health issues and financial counseling offerings tailored to pandemic-related matters. Employees are supported with 24/7 access to IBM’s world-class Health and Safety team, education, timely updates and forums to ask questions and raise concerns.

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YEAR IN REVIEW

Results of Continuing Operations

As discussed in the “Organization of Information” section, with the completion of the separation on November 3, 2021 results of Kyndryl are reported as discontinued operations. Prior periods have been reclassified to conform to this presentation in the Management Discussion to allow for a meaningful comparison of continuing operations.

Segment Details

In the fourth quarter of 2021, immediately prior to the separation of Kyndryl, the company made a number of changes to its organizational structure and management system to align the company’s operating model to its platform-centric approach to hybrid cloud and AI. With these changes, the company revised its reportable segments, but did not impact its Consolidated Financial Statements. The table below presents each reportable segment’s revenue and gross margin results, followed by an analysis of the 2021 versus 2020 reportable segment results. Prior-year results have been recast to conform with the changes noted above.

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Software

* Recast to reflect segment changes.

Software revenue of $24,141 million increased 5.3 percent as reported (4 percent adjusted for currency) in 2021 compared to the prior year. In the fourth quarter of 2021, we had incremental sales from our new commercial relationship with Kyndryl, representing approximately 2 points of full-year revenue growth. We had strong double-digit growth in Software hybrid cloud revenue as reported and adjusted for currency. There was strong growth in Hybrid Platform & Solutions, as reported and at constant currency, driven primarily by Red Hat, Security and Automation, as our strategy around hybrid cloud and AI solutions continued to resonate with our clients. Transaction Processing revenue decreased year to year as reported and adjusted for currency. Although a significant portion of the revenue in this area is annuity based, the timing of larger transactions is tied to client buying cycles and their preference for more consumption-like models which impacted sales of perpetual licenses.

Hybrid Platform & Solutions revenue of $17,751 million increased 8.8 percent as reported (8 percent adjusted for currency) in 2021 compared to the prior year. The incremental sales from Kyndryl in the fourth quarter of 2021 in Hybrid Platform & Solutions were not

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material to the full-year revenue growth. Red Hat revenue increased 30.6 percent as reported (30 percent adjusted for currency), with strong growth across infrastructure software and application development and emerging technologies, as RHEL and OpenShift address enterprises’ critical hybrid cloud requirements. We now have 3,800 clients on our hybrid cloud platform as of December 31, 2021, which was an increase of more than 1,000 clients compared to the prior year. Automation revenue increased 6.1 percent as reported (5 percent adjusted for currency), reflecting solid performance in AIOps and Management as we help our clients address resource management and observability. We are building our capabilities both organically and inorganically, and clients are realizing rapid time to value from our recent acquisitions including Instana and Turbonomic. Security revenue increased 6.8 percent as reported (5 percent adjusted for currency) with year-to-year growth across security software and services. Security innovation is an integral part of our strategy, and in the fourth quarter of 2021 we launched a new data security solution, Guardium Insights, and completed the acquisition of ReaQta. Data & AI revenue was flat year to year and declined 1 percent adjusted for currency. Within Data & AI, we had solid year-to-year growth in Data Fabric as well as our Business Analytics and Weather offerings.

Transaction Processing revenue of $6,390 million decreased 3.3 percent as reported (4 percent adjusted for currency) in 2021 compared to the prior year. Incremental sales from Kyndryl in the fourth quarter of 2021 contributed approximately 5 points of full-year revenue growth. In 2021, clients continued their preference for operating expenses over capital expenditures, which continued to put pressure on perpetual licenses, in favor of more consumption-like models. Our subscription and support renewal rate was stronger in 2021 compared to the prior year, reflecting our clients’ commitment to our infrastructure platform and our high-value software offerings.

Within Software, hybrid cloud revenue of $8.7 billion grew 26 percent as reported and 25 percent adjusted for currency year to year, driven by Red Hat as well as our software that has been optimized for our hybrid cloud platform which helps our clients apply AI, automation and security across their environments to transform and improve their business workflows.

* Recast to reflect segment changes.

The Software gross profit margin increased 0.4 points to 78.8 percent in 2021 compared to the prior year. Pre-tax income of $4,722 million increased 41.3 percent compared to the prior year with a pre-tax margin expansion of 5.0 points to 19.6 percent. The increase in pre-tax income and margin reflects the lower workforce rebalancing charges year to year, which resulted in a 3.3 points improvement in the pre-tax margin compared to 2020.

Consulting

* Recast to reflect segment changes.

Consulting revenue of $17,844 million increased 9.8 percent as reported (8 percent adjusted for currency) in 2021 compared to the prior year, with growth across all three business areas. Clients are accelerating their business transformations and are turning to IBM Consulting as their trusted partner to help drive innovation, increase agility and productivity, and capture new growth opportunities, powered by hybrid cloud and AI. We had strong double-digit growth in Consulting hybrid cloud revenue as reported and adjusted for currency. Our total Consulting signings in 2021 grew at a mid-single-digit rate compared to the prior year and our book-to-bill for 2021 was 1.1. Consulting continued to drive hybrid cloud platform adoption by our clients, with approximately 700 Red Hat engagements in 2021. Our strategic acquisitions and expansion of strategic partnerships also contributed to our year-to-year revenue growth in 2021.

Business Transformation revenue of $8,284 million increased 15.2 percent as reported (13 percent adjusted for currency) compared to the prior year. We had strong demand for our Business Transformation solutions, with good performance across all service lines including growth in offerings such as data platform services, Salesforce consulting services, and SAP consulting services and solutions.

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Technology Consulting revenue of $3,466 million increased 10.6 percent as reported (10 percent adjusted for currency) driven primarily by growth in high-value offerings to develop cloud native applications and modernize existing applications for the cloud.

Application Operations revenue of $6,095 million increased 2.8 percent as reported (1 percent adjusted for currency), driven primarily by offerings which provide end-to-end management of custom applications in cloud environments, reflecting our clients’ trust in IBM Consulting to operate and manage their critical applications whether running in the cloud or on-premises environments.

Within Consulting, hybrid cloud revenue of $7.9 billion grew 34 percent as reported and 32 percent adjusted for currency, driven by Red Hat-related signings focused on modernizing clients’ applications and revenue from consulting engagements in the areas of our strategic partnerships, such as Salesforce, SAP, AWS and Azure.

* Recast to reflect segment changes.

The Consulting gross profit margin decreased 1.3 points to 28.0 percent compared to the prior year. Pre-tax income of $1,449 million increased 40.1 percent compared to the prior year and the pre-tax margin increased 1.8 points to 8.1 percent. The decline in gross profit margin reflects our investment in new offerings, integrating and scaling our acquisitions, as well as increased labor costs due to the competitive labor market which were not yet reflected in our pricing. The year-to-year improvement in pre-tax income reflects increased gross profit dollars driven by growth in revenue. The increase in pre-tax margin compared to the prior year was driven primarily by the lower workforce rebalancing charges year to year, which resulted in a 2.9 points improvement in the pre-tax margin, which was partially offset by the decline in gross profit margin.

Consulting Signings and Book-to-Bill

* Recast to conform to 2021 presentation, reflecting the separation of Kyndryl on November 3, 2021.

Signings are management’s initial estimate of the value of a client’s commitment under a services contract within IBM Consulting. There are no third-party standards or requirements governing the calculation of signings. The calculation used by management involves estimates and judgments to gauge the extent of a client’s commitment, including the type and duration of the agreement, and the presence of termination charges or wind-down costs.

Contract extensions and increases in scope are treated as signings only to the extent of the incremental new value. Total signings can vary over time due to a variety of factors including, but not limited to, the timing of signing a small number of larger contracts. Signings associated with an acquisition will be recognized on a prospective basis.

Management believes the estimated values of signings disclosed provide an indication of our forward-looking revenue. Signings are used to monitor the performance of the business and viewed as useful information for management and shareholders. The conversion of signings into revenue may vary based on the types of services and solutions, contract duration, customer decisions, and other factors, which may include, but are not limited to, the macroeconomic environment.

Book-to-bill represents the ratio of IBM Consulting signings to its revenue over the same period. The metric is a useful indicator of the demand of our business over time. This definition should be read in conjunction with the signings definition noted above.

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Infrastructure

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* Recast to reflect segment changes.

Infrastructure revenue of $14,188 million decreased 2.4 percent year to year as reported (3 percent adjusted for currency). In the fourth quarter of 2021, we had incremental sales from Kyndryl, representing approximately 1 point of growth in full-year revenue. The overall decline in revenue reflects our product cycle dynamics. Although impacted by product cycles, our portfolio of products continues to provide critical and lasting value to our clients in support of their hybrid cloud and digital transformation journeys, and we continue to innovate and refresh our product portfolio to deliver enhanced technologies to our clients.

Hybrid Infrastructure revenue of $8,167 million declined 2.9 percent as reported (4 percent adjusted for currency). Revenue in 2021 included incremental sales from Kyndryl in fourth quarter, representing approximately 1 point of growth in full-year revenue. The overall decline in revenue reflects product cycle dynamics in IBM Z and our Distributed Infrastructure platforms. IBM Z revenue decreased 4.9 percent as reported (5 percent adjusted for currency) as we concluded the tenth quarter of z15 availability at the end of 2021. The z15 program continued to outpace the success of the prior program and we shipped more MIPS in the z15 program than any program in our history. Clients continued to leverage IBM Z as an essential part of their hybrid cloud infrastructure and its combination of security, scalability, reliability, cloud native development, and newer flexible consumption offerings demonstrate the value of the IBM Z platform within our hybrid cloud and AI strategy. Distributed Infrastructure revenue declined 1.8 percent as reported (3 percent adjusted for currency), driven primarily by declines in Power and Cloud Platform, partially offset by growth in Storage solutions driven by demand from hyperscalers for our tape products. In the third-quarter 2021, our next generation Power 10 became available within the high-end system which has unique hardware innovations, including a processor specifically optimized for data intensive workloads such as SAP S/4HANA.

Infrastructure Support revenue of $6,021 million declined 1.6 percent as reported (3 percent adjusted for currency) year to year. The fourth-quarter incremental sales from Kyndryl represented approximately 2 points of growth in full-year revenue. The overall decline in revenue in 2021 reflects the hardware product cycles.

Within Infrastructure, hybrid cloud revenue of $3.6 billion declined 10 percent as reported and 11 percent adjusted for currency, driven primarily by product cycle dynamics.

* Recast to reflect segment changes.

The Infrastructure gross profit margin decreased 2.2 points to 55.3 percent in 2021 compared to the prior year, driven primarily by margin declines in Distributed Infrastructure reflecting product cycle dynamics, partially offset by margin improvement in IBM Z. Pre-tax income of $2,025 million increased 22.4 percent and pre-tax margin increased 2.9 points year to year to 14.3 percent, driven primarily by the lower workforce rebalancing charges year to year, which resulted in a 3.6 points improvement in pre-tax margin, partially offset by the decline in gross profit.

Financing

See pages 55 through 57 for a discussion of Financing’s segment results.

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Geographic Revenue

In addition to the revenue presentation by reportable segment, we also measure revenue performance on a geographic basis.

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Total revenue of $57,350 million in 2021 increased 3.9 percent year to year as reported and 3 percent adjusted for currency. Revenue in 2021 includes incremental sales from our new commercial relationship with Kyndryl which began in the fourth quarter of 2021, representing approximately 1 point of revenue growth for the year.

Americas revenue increased 4.4 percent as reported and 4 percent adjusted for currency. In 2021, revenue includes incremental sales from Kyndryl, representing approximately 1 point of revenue growth for the year. Within North America, the U.S. increased 3.0 percent and Canada increased 23.6 percent as reported and 16 percent adjusted for currency. Latin America increased 0.9 percent as reported and 4 percent adjusted for currency. Within Latin America, Brazil revenue was flat as reported, but grew 3 percent adjusted for currency.

EMEA revenue increased 4.1 percent as reported and 1 percent adjusted for currency. Revenue in 2021 includes incremental sales from Kyndryl, representing approximately 1 point of revenue growth for the year. The UK, France and Germany increased 7.4 percent, 6.5 percent and 5.6 percent, respectively, as reported, and increased 1 percent, 4 percent and 4 percent, respectively, adjusted for currency. Italy increased 0.6 percent as reported, but decreased 2 percent adjusted for currency.

Asia Pacific revenue increased 2.8 percent as reported and 3 percent adjusted for currency. In 2021, revenue includes incremental sales from Kyndryl, representing approximately 2 points of revenue growth for the year. Japan revenue decreased 0.6 percent as reported, but grew 3 percent adjusted for currency. India increased 6.8 percent as reported and 7 percent adjusted for currency. Australia increased 7.7 percent as reported and was flat adjusted for currency. China increased 2.0 percent as reported, but declined 2 percent adjusted for currency.

Total Expense and Other (Income)

* Includes a $1.5 billion pre-tax charge for structural actions in the fourth quarter.

NM–Not meaningful

Our expense dynamics reflect a higher level of investment in innovation, skills and our ecosystem, both organically and through acquisitions, as we execute our hybrid cloud and AI strategy. We are aggressively hiring to better serve clients, while increasing our research spend to deliver innovation in AI, hybrid cloud and emerging areas such as quantum, and we are expanding our ecosystem.

Total expense and other (income) decreased 5.8 percent in 2021 versus the prior year primarily driven by a $1.9 billion decrease in charges for workforce rebalancing, including the charges for structural actions in the fourth quarter of 2020, and a benefit from expected credit loss expense in the current year compared to a provision in the prior year, partially offset by higher non-operating retirement-related costs and the effects of currency. Total operating (non-GAAP) expense and other (income) decreased 6.8 percent year to year, driven primarily by the factors above excluding the higher non-operating retirement-related costs.

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For additional information regarding total expense and other (income) for both expense presentations, see the following analyses by category.

Selling, General and Administrative Expense

* Includes a $1.5 billion pre-tax charge for structural actions in the fourth quarter.

NM–Not meaningful

Total selling, general and administrative (SG&A) expense decreased 8.8 percent in 2021 versus 2020, driven primarily by the following factors:

Operating (non-GAAP) SG&A expense decreased 9.6 percent year to year primarily driven by the same factors.

Provisions for expected credit loss expense decreased $154 million in 2021 compared to 2020, primarily driven by decreases in both specific and general reserves in the current year compared to increases in the prior year. In the prior year, the global pandemic resulted in some deterioration in customer credit quality and/or bankruptcies which had an impact to provisions in the first half of 2020. We saw continued improvement in credit quality and some emergence from bankruptcies in the current year as economies have begun to reopen in many parts of the world. The receivables provision coverage was 2.1 percent at December 31, 2021, a decrease of 10 basis points from December 31, 2020.

Research, Development and Engineering Expense

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Research, development and engineering (RD&E) expense increased 3.6 percent in 2021 versus 2020, reflecting our continuing investment in innovation as we increase spending in areas including quantum, hybrid cloud and AI. The year-to-year increase was primarily driven by higher spending (2 points) and the effects of currency (1 point).

Intellectual Property and Custom Development Income

Total Intellectual Property and Custom Development Income decreased 1.4 percent in 2021 compared to 2020. The timing and amount of licensing, sales or other transfers of IP may vary significantly from period to period depending upon the timing of licensing agreements, economic conditions, industry consolidation and the timing of new patents and know-how development.

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Other (Income) and Expense

NM–Not meaningful

Total other (income) and expense was $873 million of expense in 2021 compared to $802 million in 2020. The year-to-year change was primarily driven by:

Operating (non-GAAP) other (income) and expense was $285 million of income in 2021 and increased $13 million compared to the prior-year period and excludes the impacts of non-operating retirement-related costs, the amortization of acquired intangible assets and the unrealized gain on Kyndryl stock described above.

Interest Expense

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Interest expense decreased $133 million compared to 2020. Interest expense is presented in cost of financing in the Consolidated Income Statement only if the related external borrowings are to support the Financing external business. Overall interest expense (excluding capitalized interest) in 2021 was $1,547 million, a decrease of $191 million year to year primarily driven by a lower average debt balance in the current year.

Stock-Based Compensation

Pre-tax stock-based compensation cost of $919 million increased $45 million compared to 2020. This was primarily due to increases related to the conversion of options previously issued by acquired entities ($30 million) and restricted stock units ($25 million), partially offset by a decrease from performance share units ($10 million). Stock-based compensation cost, and the year-to-year change, was reflected in the following categories: Cost: $145 million, up $19 million; SG&A expense: $555 million, up $5 million; and RD&E expense: $218 million, up $21 million.

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Retirement-Related Plans

The following table provides the total pre-tax cost for all retirement-related plans. Total operating costs/(income) are included in the Consolidated Income Statement within the caption (e.g., Cost, SG&A, RD&E) relating to the job function of the plan participants.

Total pre-tax retirement-related plan cost increased by $150 million compared to 2020, primarily driven by lower expected returns on plan assets ($481 million) and an increase in recognized actuarial losses ($239 million), partially offset by lower interest costs ($555 million).

As discussed in the “Operating (non-GAAP) Earnings” section, we characterize certain retirement-related costs as operating and others as non-operating. Utilizing this characterization, operating retirement-related costs in 2021 were $1,320 million, a decrease of $59 million compared to 2020. Non-operating costs of $1,282 million in 2021 increased $209 million year to year, driven primarily by the same factors as above.

Income Taxes

The continuing operations effective tax rate for 2021 was 2.6 percent compared to (52.9) percent in 2020. The current year effective tax rate was primarily driven by tax benefits related to audit settlements in multiple jurisdictions. The prior-year effective tax rate was primarily driven by a net tax benefit of $0.9 billion related to an intra-entity sale of certain of the company’s intellectual property in the first quarter of 2020, and a benefit of $0.2 billion related to a foreign tax law change. The operating (non-GAAP) effective tax rate for 2021 was 9.0 percent compared to (11.5) percent in 2020. The prior year operating (non-GAAP) benefit from income taxes was primarily driven by the net tax benefit from the intra-entity IP sale. For more information, see note H, “Taxes.”

Earnings Per Share

Basic earnings per share is computed on the basis of the weighted-average number of shares of common stock outstanding during the period. Diluted earnings per share is computed on the basis of the weighted-average number of shares of common stock outstanding plus the effect of dilutive potential common shares outstanding during the period using the treasury stock method. Dilutive potential common shares include outstanding stock options and stock awards.

Actual shares outstanding at December 31, 2021 and 2020 were 898.1 million and 892.7 million, respectively. The year-to-year increase was primarily the result of the common stock issued under employee plans. The average number of common shares outstanding assuming dilution was 8.0 million shares higher in 2021 versus 2020.

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Financial Position

Dynamics

Our balance sheet is presented on a consolidated basis, with the December 31, 2020 balance sheet reclassified to provide line items on a continuing operations basis and separately provide current and noncurrent assets and liabilities for Kyndryl discontinued operations. Our post-separation balance sheet at December 31, 2021 continues to provide us with flexibility to support our business needs. We continue to manage the investment portfolio to meet our liquidity objectives.

Cash, restricted cash and marketable securities at December 31, 2021 were $7,556 million, a decrease of $6,695 million compared to prior year end, as we continued to actively de-lever our debt, invested $3,293 million in acquisitions and provided a growing dividend to our shareholders. Financing receivables declined $4,540 million to $13,439 million since the end of 2020 primarily due to the strategic actions taken to re-focus our Financing portfolio. Assets from discontinued operations declined $15,764 million due to the separation of Kyndryl, which occurred on November 3, 2021.

Total debt of $51,703 million decreased $9,629 million from prior year end. We have reduced total debt $21,307 million since the end of the second quarter of 2019 (immediately preceding the Red Hat acquisition). We have made good progress in deleveraging while being acquisitive and without sacrificing investments in our business or our solid dividend policy. Liabilities from discontinued operations declined $7,136 million due to the separation of Kyndryl.

Our cash flow is presented on a consolidated basis and includes 10 months of Kyndryl operations for 2021 versus a full year of Kyndryl operations for 2020. During 2021, we generated $12,796 million in cash from operating activities, a decrease of $5,401 million compared to 2020. Our cash from operating activities for 2021 reflects cash paid in 2021 for separation charges and structural actions initiated in the fourth-quarter 2020. We returned $5,869 million to shareholders through dividends in 2021. Our cash generation permits us to invest and deploy capital to areas with the most attractive long-term opportunities.

Consistent with accounting standards, the company remeasured the funded status of our retirement and postretirement plans at December 31. At December 31, 2021, the overall net underfunded position was $5,450 million, a decrease of $5,033 million from December 31, 2020, driven by higher discount rates partially offset by modest asset returns. At year end, our qualified defined benefit plans were well-funded and the required contributions related to these plans and multi-employer plans are expected to be approximately $200 million 2022. In 2021, the return on the U.S. Personal Pension Plan assets was 2.0 percent and the plan was 112 percent funded at December 31, 2021. Overall, global asset returns were 3.0 percent and the qualified defined benefit plans worldwide were 107 percent funded at December 31, 2021.

IBM Working Capital

* Amounts presented exclude the current assets and current liabilities of discontinued operations of $2,618 million and $3,820 million, respectively.

Working capital decreased $4,577 million from the year-end 2020 position. The key changes are described below:

Current assets decreased $7,008 million ($6,060 million adjusted for currency) due to:

Current liabilities decreased $2,430 million ($1,080 million adjusted for currency) as a result of:

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Receivables and Allowances

Roll Forward of Total IBM Receivables Allowance for Credit Losses

The total IBM receivables provision coverage was 2.1 percent at December 31, 2021, excluding receivables classified as held for sale, a decrease of 10 basis points compared to December 31, 2020. The decrease in coverage and decrease in allowance were driven by the overall decrease in receivables and an improvement in certain customers’ credit quality given the improvement of the macroeconomic environment since the beginning of the pandemic in 2020. The majority of the write-offs during the year related to receivables which had been previously reserved.

Financing Segment Receivables and Allowances

The following table presents external Financing segment receivables excluding receivables classified as held for sale, and immaterial miscellaneous receivables.

* Includes deferred initial direct costs which are expensed in IBM’s consolidated financial results.

The percentage of Financing segment receivables reserved increased from 1.5 percent at December 31, 2020, to 1.6 percent at December 31, 2021, primarily driven by the decline in amortized cost, which reflects the strategic actions described in Financing's "Results of Operations.”

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Roll Forward of Financing Segment Receivables Allowance for Credit Losses (included in Total IBM)

Financing’s expected credit loss expense (including reserves for off-balance sheet commitments which are recorded in other liabilities) was a release of $54 million in 2021, compared to an addition of $34 million in 2020. The decrease was primarily driven by lower reserves in Americas and EMEA, due to the overall improvement in the quality of our portfolio as well as lower future funding commitments reserves related to the separation of Kyndryl.

Noncurrent Assets and Liabilities

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The decrease in noncurrent assets of $1,198 million (an increase of $967 million adjusted for currency) was driven by:

Long-term debt decreased $9,300 million ($8,092 million adjusted for currency) primarily driven by:

Noncurrent liabilities (excluding debt) decreased $3,372 million ($1,680 million adjusted for currency) primarily driven by:

Debt

Our funding requirements are continually monitored and we execute our strategies to manage the overall asset and liability profile. Additionally, we maintain sufficient flexibility to access global funding sources as needed.

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Total debt of $51,703 million decreased $9,629 million ($8,410 million adjusted for currency) from December 31, 2020, primarily driven by early retirements and debt maturities of $8,557 million. Total debt decreased $21,307 million since the end of the second quarter 2019 (immediately preceding the Red Hat acquisition).

Non-Financing debt of $37,775 million decreased $2,460 million ($1,640 million adjusting for currency) from December 31, 2020 due to scheduled debt maturities during 2021.

Financing segment debt of $13,929 million decreased $7,170 million ($6,770 million adjusting for currency) from December 31, 2020, primarily due to lower external funding requirements associated with financing receivables, as well as lower internal funding requirements after the separation of Kyndryl. In the first quarter of 2021, IBM Credit early redeemed all of its outstanding fixed-rate debt in the aggregate amount of $1.75 billion and deregistered with the U.S. Securities and Exchange Commission.

Financing provides financing solutions predominantly for IBM’s external client assets, and the debt used to fund Financing assets is primarily composed of intercompany loans. Total debt changes generally correspond with the level of client and commercial financing receivables, the level of cash and cash equivalents, the change in intercompany and external payables and the change in intercompany investment from IBM. The terms of the intercompany loans are set by the company to substantially match the term, currency and interest rate variability underlying the financing receivable and are based on arm’s-length pricing. The Financing debt-to-equity ratio remained at 9.0 to 1 at December 31, 2021.

We measure Financing as a stand-alone entity, and accordingly, interest expense relating to debt supporting Financing’s external client and internal business is included in the “Financing Results of Operations” and in note E, “Segments.” In the Consolidated Income

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Statement, the external debt-related interest expense supporting Financing’s internal financing to the company is classified as interest expense.

Equity

Total equity decreased $1,731 million from December 31, 2020, primarily due to a decrease of $7,203 million related to the separation of Kyndryl and dividends paid of $5,869 million; partially offset by increases from net income of $5,743 million, a decrease in accumulated other comprehensive losses of $4,839 driven by retirement-related benefit plans ($3,828 million), cash flow hedges ($438 million) and foreign currency translation adjustments ($573 million) and common stock of $762 million.

Cash Flow

Our cash flows from operating, investing and financing activities, as reflected in the Consolidated Statement of Cash Flows on page 65 are summarized in the table below and include the cash flows of discontinued operations. These amounts also include the cash flows associated with the Financing business.

Net cash provided by operating activities decreased $5,401 million in 2021 driven by the following key factors:

Net cash used in investing activities increased $2,947 million driven by:

Net cash used in financing activities increased $3,633 million driven by:

Discontinued Operations

Pre-tax income from discontinued operations of $1,744 million in 2021 decreased 18.6 percent compared to the prior year. As the separation of Kyndryl occurred on November 3, 2021, the current year included 10 months of Kyndryl operations compared with a full year in 2020. The current year also included a higher level of separation-related charges. These dynamics were partially offset by higher charges for structural actions in the prior year. The discontinued operations provision for income taxes in 2021 was $714 million compared with $484 million in 2020. The current year provision included tax charges related to the Kyndryl separation. See note C, “Separation of Kyndryl,” for additional information.

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GAAP Reconciliation

The tables below provide a reconciliation of our income statement results as reported under GAAP to our operating earnings presentation which is a non-GAAP measure. Management’s calculation of operating (non-GAAP) earnings, as presented, may differ from similarly titled measures reported by other companies. Please refer to the “Operating (non-GAAP) Earnings” section for management’s rationale for presenting operating earnings information.

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30Management Discussion

International Business Machines Corporation and Subsidiary Companies

Consolidated Fourth-Quarter Results

NM–Not meaningful

The following table provides operating (non-GAAP) earnings for the fourth quarter of 2021 and 2020. See page 36 for additional information.

*  Includes a $0.6 billion pre-tax charge for structural actions.

** Includes a $1.5 billion pre-tax charge for structural actions resulting in an impact to diluted operating (non-GAAP) earnings per share of ($1.33).

NM–Not meaningful

Snapshot

In the fourth quarter of 2021, we reported $16.7 billion in revenue, income from continuing operations of $2.5 billion and operating (non-GAAP) earnings of $3.0 billion. Diluted earnings per share from continuing operations was $2.72 as reported and $3.35 on an operating (non-GAAP) basis. On a consolidated basis, we generated $2.5 billion in cash from operations, $3.3 billion in free cash flow and delivered shareholder returns of $1.5 billion in dividends. These results reflect the strong demand we see in the marketplace for our technology and consulting. We continue to invest in skills, innovation and our ecosystem to position us for 2022 and the longer term.

Total revenue increased 6.5 percent as reported and 9 percent adjusted for currency compared to the prior year with strong performance in our key growth areas of software and consulting. Fourth-quarter 2021 also includes incremental revenue from our new commercial relationship with Kyndryl, representing approximately 3.5 points of our total revenue growth. Software increased 8.2 percent as reported and 10 percent adjusted for currency, with growth in both Hybrid Platform & Solutions and Transaction Processing. Within this segment, Hybrid Platform & Solutions grew 7.1 percent (9 percent adjusted for currency), with Red Hat delivering strong double-digit growth. Transaction Processing revenue grew from the new commercial relationship with Kyndryl. Consulting increased 13.1 percent as reported and 16 percent adjusted for currency with growth across all business areas. Consulting growth was led by Business Transformation which grew 17.9 percent as reported and 20 percent adjusted for currency reflecting strong demand for solutions to transform critical workflows. Infrastructure decreased 0.2 percent as reported but grew 2 percent adjusted

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for currency including a benefit from the Kyndryl commercial relationship. Across the segments, total IBM hybrid cloud revenue of $6.2 billion in the fourth quarter of 2021 grew 16 percent as reported and 18 percent adjusted for currency.

From a geographic perspective, Americas revenue increased 6.6 percent year to year as reported (7 percent adjusted for currency). EMEA increased 3.6 percent (7 percent adjusted for currency). Asia Pacific increased 10.9 percent year to year as reported (16 percent adjusted for currency).

The gross margin was 56.9 percent and the operating (non-GAAP) gross margin was 58.0 percent, both decreasing  2.0 points year to year. Overall, gross margin was impacted by the significant investments we are making to drive our hybrid cloud and AI strategy and a competitive labor market which has impacted labor costs due to higher acquisition, retention and wage costs.

Total expense and other (income) decreased 19.4 percent in the fourth quarter of 2021 versus the prior-year period primarily driven by a $1.5 billion pre-tax charge in the fourth quarter of 2020 for structural actions to simplify and optimize our operating model and improve our position going forward. This decrease was partially offset by increased spending as we continue to invest to drive growth and scale resources to better serve our clients. We are also increasing our research spend to deliver innovation in AI, hybrid cloud and emerging areas such as quantum and expanding our ecosystem. Total operating (non-GAAP) expense and other (income) decreased 19.8 percent year to year, driven primarily by the same factors.

Pre-tax income from continuing operations of $2.9 billion increased $1.9 billion and the pre-tax margin was 17.2 percent, an increase of 10.7 points versus the prior-year period, primarily due to the prior-year workforce rebalancing charge. The continuing operations effective tax rate for the fourth quarter of 2021 was 14.2 percent compared to an effective tax rate of (17.3) percent in the fourth quarter of 2020. The prior-year tax rate was primarily driven by the geographical mix of pre-tax income, including from structural actions taken in 2020. Net income from continuing operations was $2.5 billion, an increase of 106.9 percent year to year. The net income margin from continuing operations was 14.7 percent, an  increase of 7.2 points from the prior-year period.

Operating (non-GAAP) pre-tax income from continuing operations of $3.5 billion increased 101.9 percent year to year and the operating (non-GAAP) pre-tax margin from continuing operations increased 10.0 points to 21.2 percent, primarily due to the prior-year workforce rebalancing charge. The operating (non-GAAP) effective tax rate from continuing operations in the fourth quarter of 2021 was 14.2 percent versus 3.7 percent in the prior year. The increase was primarily driven by the same factors described above. Operating (non-GAAP) income from continuing operations of $3.0 billion increased 80.0 percent with an operating (non-GAAP) income margin from continuing operations of 18.2 percent, up 7.4 points year to year.

Diluted earnings per share from continuing operations of $2.72 in the fourth quarter of 2021 increased 106.1 percent and operating (non-GAAP) diluted earnings per share of $3.35 increased 78.2 percent versus the fourth quarter of 2020, respectively.

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32Management Discussion

International Business Machines Corporation and Subsidiary Companies

Results of Continuing Operations

As discussed in the “Organization of Information” section, with the completion of the separation on November 3, 2021, results of Kyndryl are reported as discontinued operations. Prior periods have been reclassified to conform to this presentation in the Management Discussion to allow for a meaningful comparison of continuing operations.

Segment Details

The following is an analysis of the fourth quarter of 2021 versus the fourth quarter of 2020 reportable segment revenue and gross margin results. Segment pre-tax income includes certain limited transactions, predominantly between the Financing and Infrastructure segments, that are recorded to other income and excludes certain unallocated corporate items. Prior-year results have been recast to conform with segment changes effective fourth-quarter 2021.

Software

Software revenue of $7,273 million increased 8.2 percent as reported (10 percent adjusted for currency) in the fourth quarter of 2021 compared to the prior-year period. Fourth-quarter 2021 includes incremental revenue from our new commercial relationship with Kyndryl, representing approximately 5 points of revenue growth. We had double-digit growth in total hybrid cloud revenue within the segment as reported and adjusted for currency. We had continued strength in our Hybrid Platform & Solutions portfolio, led by Red Hat, Automation and Data & AI. Transaction Processing revenue grew in the fourth quarter with all the growth coming from the new commercial relationship with Kyndryl.

Hybrid Platform & Solutions revenue of $5,140 million increased 7.1 percent as reported (9 percent adjusted for currency) year to year. This revenue performance reflects the strength across the software growth areas that focus on hybrid cloud and AI, and includes incremental revenue in fourth-quarter 2021 from our new commercial relationship with Kyndryl, representing approximately 1 point of revenue growth. Red Hat revenue grew 18.6 percent as reported (21 percent adjusted for currency) driven primarily by strong  growth in infrastructure and double-digit growth in application development and emerging technologies, as RHEL and OpenShift address enterprises’ critical hybrid cloud requirements. Automation revenue increased 12.8 percent as reported (15 percent adjusted for currency), driven primarily by good performance in AIOps and management that address resource management and observability, as well as continued growth in Cloud Pak for Integration. Data & AI revenue grew 1.4 percent as reported (3 percent adjusted for currency) reflecting the strength in Data Fabric which enables clients to connect siloed data that is distributed across a hybrid cloud landscape. Within Data & AI, we also had strong performance in our business analytics and weather offerings. Within Security, although we had growth in the full-year 2021, revenue in the fourth quarter declined 2.3 points as reported (1 percent adjusted for currency) driven by lower performance in Data Security. Security innovation is an integral part of our strategy and in the fourth quarter, we launched a new data security solution, Guardium Insights, and acquired ReaQta which leverages AI and machine learning to automatically identify and block threats.

Within Hybrid Platform & Solutions, our annual recurring revenue (ARR) increased 8 percent in the fourth quarter of 2021 compared to the prior-year period. ARR is a key performance metric management uses to assess the health and growth trajectory of our Hybrid

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Platform & Solutions business within the Software segment. ARR is calculated by estimating the current quarter’s recurring, committed value for certain types of active contracts as of the period-end date and then multiplying that value by four. This value is based on each arrangement’s contract value and start date, mitigating fluctuations during the contract term, and includes the following consumption models: (1) software subscription agreements, including committed term licenses, (2) as-a-service arrangements such as SaaS and PaaS, (3) maintenance and support contracts, and (4) security managed services contracts. ARR should be viewed independently of revenue as this performance metric and its inputs may not represent the amount of revenue recognized in the period and therefore is not intended to represent current period revenue or revenue that will be recognized in future periods.

Transaction Processing revenue of $2,133 million increased 11.2 percent as reported (14 percent adjusted for currency) year to year. Fourth-quarter 2021 includes incremental revenue from our new commercial relationship with Kyndryl, representing approximately 16 points of revenue growth. In the fourth quarter, we also had some large perpetual license transactions given the expansion in IBM Z capacity driven by the z15 program, as well as strong renewal rates which is proof of our client’s commitment to our infrastructure platform and our high-value software offerings.

Within Software, total hybrid cloud revenue of $2.7 billion grew 22 percent as reported (24 percent adjusted for currency) in the fourth quarter of 2021 compared to the prior-year period reflecting our clients’ demand for our Hybrid Platform & Solutions offerings.

Software gross profit margin of 80.9 percent increased 0.4 points year to year compared to the prior-year period. Pre-tax income of $2,109 million increased 83.2 percent and pre-tax margin increased 11.9 points to 29.0 percent, reflecting the lower workforce rebalancing charges year to year which resulted in 9.7 points of improvement on the pre-tax margin.

Consulting

Consulting revenue of $4,746 million increased 13.1 percent as reported (16 percent adjusted for currency) in the fourth quarter of 2021 compared to the prior-year period. We had strong growth year to year in all three business areas, led by Business Transformation, and our book-to-bill ratio was 1.2. We had double-digit growth in total hybrid cloud revenue in the segment as reported and adjusted for currency. Clients are accelerating their business transformations, powered by hybrid cloud and AI, to drive innovation, increase their agility and productivity, and capture new growth opportunities. Enterprises are turning to IBM Consulting as their trusted partner on their transformation journey and are leveraging our deep client, industry and technical expertise, which helps drive adoption of our hybrid cloud platform.

Business Transformation revenue of $2,213 million increased 17.9 percent as reported (20 percent adjusted for currency). This business area brings together technology and strategic consulting to transform critical workflows at scale. We enable this by leveraging our skills and capabilities in IBM technologies along with our strategic ecosystem partners. Our practices are centered on areas such as finance and supply chain, talent, industry-specific solutions and digital design. This quarter, we had broad-based revenue growth reflecting strong demand for these solutions.

Technology Consulting revenue of $928 million increased 14.4 percent as reported (19 percent adjusted for currency). Technology Consulting architects and implements cloud platforms and strategies, leveraging hybrid cloud with Red Hat OpenShift. In the fourth quarter, we continued to see good performance in application modernization offerings that build cloud native applications as well as modernize existing applications for the cloud.

Application Operations revenue of $1,605 million increased 6.5 percent as reported (8 percent adjusted for currency). This business area focuses on application and cloud platform services required to operationalize and run in both cloud and on-premise environments. The growth in fourth-quarter revenue was driven by offerings which provide end-to-end management of custom applications in cloud environments.

Within Consulting, hybrid cloud revenue of $2.2 billion grew 31 percent as reported (34 percent adjusted for currency) in the fourth quarter of 2021 compared to the prior-year period, reflecting strong double-digit growth across all three business areas. Consulting Red Hat-related signings more than doubled year to year in the fourth quarter, as we added over 150 engagements in the quarter. Our hybrid cloud revenue from our strategic partnerships grew at a solid double-digit rate in the fourth quarter on a year-to-year basis.

Consulting fourth-quarter gross profit margin of 27.0 percent decreased 2.7 points year to year. The gross profit margin decline was across all three business areas. We are in a competitive labor market and continued to have increased pressure on labor costs. We expect to capture this increased resource cost in engagements going forward, however, this will take time to be reflected in our future profit profile. Pre-tax income increased $374 million to $436 million and pre-tax margin increased 7.7 points to 9.2 percent compared to the prior-year period. The increase in pre-tax income and margin reflects the lower workforce rebalancing charges year to year which resulted in 9.4 points of improvement on the pre-tax margin.

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34Management Discussion

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Infrastructure

Infrastructure revenue of $4,414 million decreased 0.2 percent as reported, but increased 2 percent adjusted for currency in the fourth quarter of 2021 compared to the prior-year period. The incremental sales from our new commercial relationship with Kyndryl contributed approximately 5 points of revenue growth in the fourth quarter. By bringing together Hybrid Infrastructure and Infrastructure Support (formerly Technology Support Services), we can now better manage the lifecycle of our hardware platform and provide end-to-end value for our clients.

Hybrid Infrastructure revenue of $2,873 million was flat as reported and grew 2 percent adjusted for currency in the fourth quarter of 2021 compared to the prior-year period. In the fourth quarter, the incremental sales from our new commercial relationship with Kyndryl contributed approximately 4 points of revenue growth. Distributed Infrastructure grew 4.7 percent as reported and 7 percent adjusted for currency, driven primarily by revenue growth across our storage portfolio, partially offset by declines in Power and Cloud IaaS. IBM Z revenue decreased 5.9 percent as reported (4 percent adjusted for currency) reflecting the z15 product cycle. This was the tenth quarter of z15 availability and the program continues to outpace the strong z14 program with more MIPS shipped than any program in our history. With its combination of security, scalability and reliability, the z15 continues to resonate with our clients, who are leveraging IBM Z as an essential part of their hybrid cloud infrastructure.

Infrastructure Support revenue of $1,541 million decreased 0.9 percent as reported, but grew 1 percent adjusted for currency in the fourth quarter of 2021 compared to the prior year. The Infrastructure Support business benefited from our new commercial relationship with Kyndryl, which contributed incremental revenue representing approximately 6 points of revenue growth in the fourth quarter.

Within Infrastructure, hybrid cloud revenue of $1.3 billion decreased 12 percent as reported (11 percent adjusted for currency) in the fourth quarter of 2021 compared to the same period in 2020, primarily driven by the IBM Z and Distributed Infrastructure product cycles.

The Infrastructure gross profit margin decreased 5.3 points to 54.8 percent in the fourth quarter of 2021 compared to the prior-year period. Pre-tax income of $1,036 million increased 64.6 percent and the pre-tax margin increased 9.2 points year to year to 23.5 percent. The decrease in gross profit margin was driven primarily by declines in margins across the Hybrid Infrastructure product portfolio and margin decline in Infrastructure Support. The increase in pre-tax income and margin reflects the lower workforce rebalancing charges year to year, which resulted in 9.4 points of improvement in the pre-tax margin.

Financing

Financing revenue of $172 million decreased 29.4 percent as reported (29 percent adjusted for currency) compared to the prior year, primarily driven by declines in client financing revenue due to a lower average asset balance. Financing's fourth-quarter pre-tax income decreased 27.9 percent to $79 million and the pre-tax margin of 46.0 percent increased 0.9 points year to year. The decrease in pre-tax income was driven by the lower average asset balance noted above which reflects the strategic actions described in Financing’s “Results of Operations.”

Geographic Revenue

Total revenue of $16,695 million increased 6.5 percent as reported and 9 percent adjusted for currency in the fourth quarter compared to the prior-year period. Fourth-quarter 2021 includes incremental revenue from our new commercial relationship with Kyndryl, representing approximately 3.5 points of revenue growth.

Americas revenue of $8,121 million increased 6.6 percent as reported and 7 percent adjusted for currency. Fourth-quarter 2021 includes incremental revenue from Kyndryl, representing approximately 2 points of revenue growth. Within North America, revenue in the U.S. increased 5.0 percent and Canada increased 22.3 percent as reported (19 percent adjusted for currency). Latin America increased 6.1 percent as reported (9 percent adjusted for currency). Within Latin America, Brazil increased 6.3 percent as reported (8 percent adjusted for currency).

EMEA revenue of $5,266 million increased 3.6 percent as reported and 7 percent adjusted for currency. This includes incremental revenue from Kyndryl, representing approximately 4 points of revenue growth. Germany and France increased 7.3 percent and 6.8 percent, respectively, as reported, and increased 13 percent and 12 percent, respectively, adjusted for currency. Italy decreased 3.6 percent as reported, but grew 2 percent adjusted for currency. In the UK, revenue declined 1.1 percent as reported and 3 percent adjusted for currency.

Asia Pacific revenue of $3,307 million increased 10.9 percent as reported and 16 percent adjusted for currency. The fourth quarter incremental revenue from Kyndryl represented approximately 6 points of revenue growth. Japan increased 6.0 percent as reported and 15 percent adjusted for currency. India, China and Australia increased 29.8 percent, 19.1 percent and 16.0 percent, respectively, as reported and increased 32 percent, 17 percent and 18 percent, respectively, adjusted for currency.

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Total Expense and Other (Income)

* Includes a $1.5 billion pre-tax charge for structural actions.

NM–Not meaningful

Total expense and other (income) decreased 19.4 percent in the fourth quarter with an expense-to-revenue ratio of 39.7 percent compared to 52.4 percent in the fourth quarter of 2020. The year-to-year decrease was primarily driven by the fourth-quarter 2020 charge for structural actions (18 points), impact of currency (3 points), non-operating Kyndryl-related benefits (1 point) and shared services expense transferred to Kyndryl at separation (1 point), partially offset by higher spending (3 points) and higher non-operating retirement-related costs (1 point). Our expense dynamics reflect a higher level of investment in innovation, skills and our ecosystem, both organically and through acquisitions, as we execute our hybrid cloud and AI strategy. We are aggressively hiring and scaling resources to better serve clients, while increasing our research spend to deliver innovation in AI, hybrid cloud and emerging areas such as quantum, and we are expanding our ecosystem.

Total operating (non-GAAP) expense and other income decreased 19.8 percent year to year, primarily driven by the same factors described above, excluding the non-operating Kyndryl-related benefits and higher non-operating retirement-related costs.

Cash Flow

On a consolidated basis, we generated $2.5 billion in cash flow from operating activities in the fourth quarter of 2021, a decrease of $3.3 billion compared to the fourth quarter of 2020, primarily driven by a decrease in cash provided by receivables of $2.5 billion which includes one month of Kyndryl’s results. Net cash used in investing activities of $0.7 billion was $0.1 billion higher than the prior year, primarily driven by a decrease in cash provided by net non-operating finance receivables ($0.4 billion), partially offset by a decrease in cash used for capital expenditures ($0.3 billion). Net cash used in financing activities of $2.7 billion decreased $3.6 billion compared to the prior year, primarily due to lower net reductions in debt ($2.8 billion) and net cash proceeds from the Kyndryl distribution to IBM upon separation ($0.9 billion).

Results of Discontinued Operations

Pre-tax income/(loss) from discontinued operations, was a loss of $63 million in the fourth quarter of 2021 compared to income of $354 million in the fourth quarter of 2020. As the separation of Kyndryl occurred on November 3, 2021, the fourth-quarter 2021 included a partial quarter of Kyndryl operations compared with a full quarter in the prior-year period. The current-year period also included a higher level of separation-related charges. These dynamics were partially offset by higher charges for structural actions in the prior-year period. The discontinued operations provision for income taxes in the fourth quarter of 2021 was $66 million compared with $188 million in the prior-year period. The fourth-quarter 2021 provision for income taxes included tax charges related to the Kyndryl separation.

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36Management Discussion

International Business Machines Corporation and Subsidiary Companies

GAAP Reconciliation

The tables below provide a reconciliation of our income statement results as reported under GAAP to our operating earnings presentation which is a non-GAAP measure. Management’s calculation of operating (non-GAAP) earnings, as presented, may differ from similarly titled measures reported by other companies. Refer to the “Operating (non-GAAP) Earnings” section for management’s rationale for presenting operating earnings information.

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PRIOR YEAR IN REVIEW

This section provides a summary of our financial performance in 2020 as compared with 2019. As discussed in the “Organization of Information” section, financial performance has been reclassified to reflect discontinued operations presentation and recast to conform to our segment changes effective fourth-quarter 2021. Refer to “Year in Review” pages 30-45 of the “Management Discussion” section of our 2020 Annual Report for other details of our financial performance in 2020 compared to 2019.

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NM–Not meaningful

The following table provides the company’s operating (non-GAAP) earnings for 2020 and 2019. See page 45 for additional information.

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* Includes a $0.6 billion pre-tax charge for structural actions in the fourth quarter.

** Includes a $1.5 billion pre-tax charge for structural actions in the fourth quarter resulting in an impact to diluted operating (non-GAAP) earnings per share of ($1.33).

NM–Not meaningful

Financial Performance Summary

In 2020, we reported $55.2 billion in revenue and income from continuing operations of $3.9 billion, which included a $1.5 billion pre-tax charge for structural actions (primarily workforce rebalancing) in the fourth quarter to simplify and optimize our operating model. Operating (non-GAAP) earnings in 2020 were $6.1 billion, which also included the charge for workforce rebalancing. Diluted earnings per share from continuing operations was $4.38 as reported and $6.82 on an operating (non-GAAP) basis. On a consolidated basis, we also generated $18.1 billion in cash from operations, $10.8 billion in free cash flow and delivered shareholder returns of $5.8 billion in dividends. With the unprecedented COVID-19 pandemic and macroeconomic uncertainty beginning in March 2020, client priorities shifted to maintaining operational stability, flexibility and preservation of cash. While there was continued demand for offerings that support their digital transformation, clients moved to shorter term duration engagements and prioritized operational expenditures over capital expenditures, which impacted the company’s performance in 2020. However, our results reflected strong performance in hybrid cloud led by Red Hat, gross margin expansion and solid cash generation. We also continued to strengthen our position as a hybrid cloud platform and AI company through strategic organic investments and acquisitions.

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38Management Discussion

International Business Machines Corporation and Subsidiary Companies

Total revenue decreased 4.4 percent as reported and 4.5 percent adjusted for currency compared to the prior year. To provide better transparency on the recurring performance of the ongoing business, total revenue, geographic revenue and hybrid cloud revenue growth rates are provided excluding divested businesses and at constant currency. These divested businesses are included in the category “Other—divested businesses.” Excluding divested businesses and adjusted for currency, revenue decreased 2.9 percent. Software revenue increased 2.3 percent as reported and 2 percent adjusted for currency, with strong performance from Red Hat, offset by declines in transactional performance in other areas of the portfolio. Software revenue performance was impacted by purchase deferrals, clients opting for shorter duration contracts and preference for operating expenses over capital expenditures. Consulting decreased 4.0 percent as reported and 4 percent adjusted for currency with declines due to project delays and less discretionary spending by clients. Infrastructure decreased 7.9 percent year to year as reported and 8 percent adjusted for currency primarily due to product cycle dynamics. Across the segments, total IBM hybrid cloud revenue of $16.8 billion in 2020 grew 22 percent as reported (21 percent adjusted for currency) and 24 percent excluding divested businesses and adjusted for currency.

From a geographic perspective, Americas revenue declined 5.5 percent year to year as reported (3 percent excluding divested businesses and adjusted for currency). EMEA decreased 3.0 percent (3 percent excluding divested businesses and adjusted for currency). Asia Pacific declined 3.7 percent (3 percent excluding divested businesses and adjusted for currency).

The gross margin of 55.9 percent increased 1.3 points year to year, and the operating (non-GAAP) gross margin of 57.3 percent increased 1.7 points versus the prior year, reflecting portfolio mix with strong software contribution and our focus on productivity.

Total expense and other (income) increased 16.3 percent in 2020 compared to the prior year. The year-to-year performance was driven by higher charges for workforce rebalancing, a full year of Red Hat operational spending in 2020 compared to six months in 2019, lower gains from divestitures and higher non-operating retirement-related costs, partially offset by lower spending including reductions in travel and other expenses associated with COVID-19 restrictions. Total operating (non-GAAP) expense and other (income) increased 15.5 percent year to year, driven primarily by the same factors excluding the non-operating retirement-related costs.

Pre-tax income from continuing operations of $2.6 billion decreased 64.3 percent and the pre-tax margin was 4.7 percent, a decrease of 7.8 points versus 2019, primarily due to higher workforce rebalancing charges in 2020, lower gains from divestitures and higher retirement-related costs in the current year. The continuing operations effective tax rate for 2020 was (52.9) percent compared to 0.8 percent in 2019. The benefit from income taxes in 2020 was primarily due to the tax impacts of an intra-entity sale of certain of the company’s intellectual property and related impacts in the first quarter, which resulted in a net tax benefit of $0.9 billion and a benefit of $0.2 billion related to a foreign tax law change. Net income from continuing operations of $3.9 billion decreased 45.0 percent and the net income from continuing operations margin was 7.1 percent, down 5.3 points year to year, primarily due to the fourth-quarter workforce rebalancing charge. Operating (non-GAAP) pre-tax income from continuing operations of $5.5 billion decreased 42.1 percent year to year and the operating (non-GAAP) pre-tax margin from continuing operations decreased 6.5 points to 9.9 percent, reflecting the higher workforce rebalancing charges and lower gains from divestitures in the current year. The operating (non-GAAP) effective tax rate for 2020 was (11.5) percent compared to 4.0 percent in 2019. The current year operating (non-GAAP) benefit from income taxes was primarily driven by the net tax benefit from an intra-entity IP sale in the first quarter. Operating (non-GAAP) income from continuing operations of $6.1 billion decreased 32.7 percent and the operating (non-GAAP) income margin from continuing operations of 11.1 percent was down 4.7 points year to year.

Diluted earnings per share from continuing operations of $4.38 in 2020 decreased 45.3 percent and operating (non-GAAP) diluted earnings per share of $6.82 decreased 33.0 percent versus 2019, both including a ($1.33) impact from the structural actions initiated in the fourth-quarter 2020.

During 2020, we continued to take actions to further enhance our balance sheet and liquidity position. Cash and cash equivalents, restricted cash and marketable securities at year end were $14.3 billion, an increase of $5.3 billion from December 31, 2019. Throughout 2020, we took mitigation actions to preserve liquidity as well as strategic actions to optimize our capital structure, for example, we re-focused our Financing portfolio reducing our external debt needs. We reduced total debt by $1.4 billion from year end 2019 and $11.7 billion since the second quarter of 2019 (immediately preceding the Red Hat transaction).

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Results of Continuing Operations

As discussed in the “Organization of Information” section, with the completion of the separation on November 3, 2021, results of Kyndryl are reported as discontinued operations. Prior periods have been reclassified to conform to this presentation in the Management Discussion to allow for a meaningful comparison of continuing operations.

Segment Details

The following is an analysis of the 2020 versus 2019 reportable segment results. The table below presents each reportable segment’s revenue and gross margin results. Segment pre-tax income includes certain limited transactions, predominantly between the Financing and Infrastructure segments, that are recorded to other income and excludes certain unallocated corporate items. Prior-year results have been recast to conform with segment changes effective fourth-quarter 2021.