Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS

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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION

FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2021

Snapshot

Financial Results Summary — Three Months Ended September 30:


							Yr. to Yr.
							Percent/
(Dollars and shares in millions except per share amounts)							Margin
For the three months ended September 30:	2021			2020			Change
Revenue	$	17,618		$	17,560		0.3	%* **
Gross profit margin		46.4	%		48.0	%	(1.6)	pts.
Total expense and other (income)	$	6,852		$	6,603		3.8	%
Income from continuing operations before income taxes	$	1,319		$	1,827		(27.8)	%
Provision for income taxes from continuing operations	$	188		$	128		47.0	%
Income from continuing operations	$	1,130	+	$	1,698		(33.5)	%
Income from continuing operations margin		6.4	%		9.7	%	(3.3)	pts.
Net income	$	1,130	+	$	1,698		(33.4)	%
Earnings per share from continuing operations - assuming dilution	$	1.25	+	$	1.89		(33.9)	%
Weighted-average shares outstanding - assuming dilution		906.0			897.3		1.0	%

(0.3) percent adjusted for currency; (0.2) percent excluding divested businesses and adjusted for currency.

** 2.5 percent normalized to exclude Kyndryl, 1.8 percent excluding Kyndryl and adjusted for currency, 1.9 percent excluding Kyndryl and divested businesses and adjusted for currency.

+ Includes $0.5 billion of Kyndryl separation-related charges resulting in an impact to diluted earnings per share from continuing operations of ($0.56).

Organization of Information:

On November 3, 2021, we completed the previously announced separation of our managed infrastructure services unit into a new public company with the distribution of 80.1 percent of the outstanding common stock of Kyndryl to IBM stockholders on a pro rata basis. To effect the separation, IBM stockholders received one share of Kyndryl common stock for every five shares of IBM common stock held at the close of business on October 25, 2021, the record date for the distribution. IBM retained 19.9 percent of the shares of Kyndryl common stock immediately following the separation with the intent to dispose of such shares within twelve months after the distribution. Our financial results for the third quarter and the nine months ended September 30, 2021 include Kyndryl. With the completion of the separation, the historical results of Kyndryl will be presented as discontinued operations in our Consolidated Financial Statements beginning in the fourth quarter of 2021.

Effective immediately prior to the separation of Kyndryl, we made a number of changes to our organizational structure and management system. These changes will impact our reportable segments beginning in the fourth quarter of 2021 but will not impact our Consolidated Financial Statements. Since these organizational changes did not occur until the fourth quarter of 2021, the periods presented in this Form 10-Q are reported under the historical segments. See note 4, "Segments" for additional information.

Currency:

The references to “adjusted for currency” or “at constant currency” in the Management Discussion do not include operational impacts that could result from fluctuations in foreign currency rates. When we refer to growth rates at constant currency or adjust such growth rates for currency, it is done so that certain financial results can be viewed without the impact of fluctuations in foreign currency exchange rates, thereby facilitating period-to-period comparisons

Management Discussion – (continued)

of business performance. Financial results adjusted for currency are calculated by translating current period activity in local currency using the comparable prior-year period’s currency conversion rate. This approach is used for countries where the functional currency is the local currency. Generally, when the dollar either strengthens or weakens against other currencies, the growth at constant currency rates or adjusting for currency will be higher or lower than growth reported at actual exchange rates. Refer to “Currency Rate Fluctuations” for additional information.

Revenue Adjusted for Divested Businesses and Constant Currency:

To provide better transparency on the recurring performance of the ongoing business, the company provides total revenue, geographic revenue and cloud revenue growth rates excluding certain divested businesses and at constant currency. These divested businesses are included in the category “Other–divested businesses.”

Revenue Adjusted for Kyndryl:

To provide investors with insight on the recurring performance and trends of the ongoing business, the company provides total revenue growth rates excluding an estimate of Kyndryl, which separated on November 3, 2021. The historical results of Kyndryl will be presented as discontinued operations in our Consolidated Financial Statements after separation, beginning in the fourth quarter of 2021.

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, discontinued operations and certain Kyndryl separation-related charges and their related tax impacts. 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 to accomplish the Kyndryl separation as non-operating given their unique and non-recurring nature. These charges primarily relate to transaction and third-party support costs, business separation and applicable employee retention fees, pension settlement charges and related tax separation charges. All other spending for Kyndryl is included in both earnings from continuing operations and in operating (non-GAAP) earnings. 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

Management Discussion – (continued)

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. Our reportable segment financial results reflect pre-tax operating earnings from continuing operations, consistent with our management and measurement system. In addition, these non-GAAP measures provide a perspective consistent with areas of interest we routinely receive from investors and analysts.

The following table provides the company’s operating (non-GAAP) earnings for the third quarter of 2021 and 2020.


					Yr. to Yr.
(Dollars in millions except per share amounts)					Percent
For the three months ended September 30:	2021		2020		Change
Net income as reported	$	1,130	$	1,698	(33.4)	%
Income/(loss) from discontinued operations, net of tax		—		(1)	(100.0)
Income from continuing operations	$	1,130	$	1,698	(33.5)	%
Non-operating adjustments (net of tax):
Acquisition-related charges	$	375	$	358	4.6	%
Non-operating retirement-related costs/(income)		271		237	14.4
U.S. tax reform impacts		—		21	(100.0)
Separation-related charges		510		—	nm
Operating (non-GAAP) earnings*	$	2,286	$	2,315	(1.2)	%
Diluted operating (non-GAAP) earnings per share*	$	2.52	$	2.58	(2.3)	%

Refer to page 92 for a more detailed reconciliation of net income to operating earnings and operating earnings per share.

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Environmental Dynamics:

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. The health of IBM employees, our clients, business partners and community continue to be 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.

This environment 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. The reliance on technology, particularly hybrid cloud and AI technologies that give clients the scalability and flexibility needed to adjust to the rapid market changes, has become more acute. We are helping to advise, build, move and manage our clients’ journey to the cloud, working with our clients to apply AI, automation and other technologies to make their workflows more intelligent and responsive and partnering with clients to help them enhance employee engagement and productivity, reskill the workforce faster and reimagine ways of working.

The spending environment continues to improve and the economy is reopening in many parts of the world. From an industry standpoint, we have seen meaningful improvement in areas most affected by the pandemic such as travel, transportation, automotive and industrial products. The underlying fundamentals of our business continue to remain sound and provide some level of stability in our revenue, profit and cash as we continue to manage through this macroeconomic uncertainty. As the world recovers from the effects of the pandemic, IBM continues to be well positioned to support our clients to emerge even stronger.

Separation of Kyndryl

On November 3, 2021, IBM took an important step in advancing its focus on hybrid cloud and AI with the previously announced 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

Management Discussion – (continued)

relationship. Both IBM and Kyndryl will 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 will also enable 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.

Financial Performance Summary — Three Months Ended September 30:

In the third quarter of 2021, we reported $17.6 billion in revenue, $1.1 billion in income from continuing operations and diluted earnings per share from continuing operations were $1.25 as reported. Income and diluted earnings per share from continuing operations for the third quarter of 2021 include an impact from Kyndryl separation-related charges of $0.5 billion and ($0.56) per share, respectively. Operating (non-GAAP) earnings were $2.3 billion, resulting in diluted earnings per share from continuing operations of $2.52 on an operating (non-GAAP) basis. We also generated $2.7 billion in cash from operations, $0.6 billion in free cash flow, which includes $0.6 billion of cash impacts from the structural actions initiated in the fourth quarter of 2020 and Kyndryl separation-related charges, and delivered shareholder returns of $1.5 billion through dividends. These results reflect progress in our key growth areas driven by strong demand for technology products and services that help our clients advance in their digital transformation journeys. We continue to increase our investments in skills, innovation and our ecosystem, and our balance sheet and liquidity position remain strong.

Total consolidated revenue increased 0.3 percent as reported and was essentially flat excluding divested businesses and adjusted for currency compared to the prior-year period with strong performance in our key growth areas of Global Business Services (GBS) and software, offset by declines in other areas of the business. On a segment basis, Cloud & Cognitive Software increased 2.5 percent as reported and 2 percent adjusted for currency led by growth from Red Hat and our automation and security offerings. Cloud & Data Platforms grew 9.8 percent as reported (9 percent adjusted for currency), while Cognitive Applications decreased 0.2 percent (1 percent adjusted for currency) and Transaction Processing Platforms declined 8.8 percent (9 percent adjusted for currency). GBS grew 11.6 percent as reported (11 percent adjusted for currency) with growth across all lines of business. Within GBS, Consulting increased 16.6 percent (16 percent adjusted for currency) with solid demand as we leverage our skills and ecosystem partners to transform business processes and modernize applications based on OpenShift. GTS decreased 4.8 percent as reported (5 percent adjusted for currency) as clients paused on new project activity in advance of the separation of Kyndryl in the fourth quarter of 2021. Systems decreased 11.9 percent as reported (12 percent adjusted for currency) reflecting product cycle dynamics in IBM Z and Power Systems, partially offset by growth in Storage Systems.

Total cloud revenue of $6.7 billion in the third quarter of 2021 grew 12 percent as reported (12 percent adjusted for currency and excluding divested businesses and adjusted for currency). Over the trailing 12 months, total cloud revenue was $27.8 billion, up 14 percent as reported (11 percent adjusted for currency and excluding divested businesses and adjusted for currency).

From a geographic perspective, Americas revenue grew 1.0 percent year to year as reported, but was flat adjusted for currency. Europe/Middle East/Africa (EMEA) increased 0.5 percent as reported but decreased 1 percent adjusted for currency. Asia Pacific declined 1.3 percent year to year as reported, but was flat year to year adjusted for currency.

Total consolidated gross margin of 46.4 percent decreased 1.6 points year to year and the operating (non-GAAP) gross margin of 48.0 percent decreased 1.0 point versus the prior-year period. 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. However, there was improvement in the GTS gross margin reflecting the benefits from the productivity actions taken in 2020 to improve the margin and profit profile of the business in advance of the Kyndryl separation.

Total expense and other (income) of $6.9 billion increased 3.8 percent in the third quarter of 2021 versus the prior-year period. 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 scaling our garage footprint, increasing our research spend in areas including quantum, hybrid cloud and AI, and expanding our ecosystem.

Management Discussion – (continued)

The year-to-year increase in expense was also driven by $0.2 billion of Kyndryl separation-related charges in the current-year period. Total operating (non-GAAP) expense and other (income) increased 0.5 percent year to year, driven primarily by the factors above excluding the separation-related charges.

The pre-tax income from continuing operations of $1.3 billion decreased 27.8 percent year to year, and the pre-tax margin from continuing operations was 7.5 percent, a decrease of 2.9 points. Kyndryl separation-related charges impacted pre-tax income by $0.3 billion and pre-tax margin by 1.6 points. The continuing operations provision for income taxes was $0.2 billion in the third quarter of 2021, compared to $0.1 billion in the third quarter of 2020. Net income from continuing operations of $1.1 billion decreased 33.4 percent, and the net income margin from continuing operations was 6.4 percent, a decrease of 3.3 points year to year.

Operating (non-GAAP) pre-tax income from continuing operations of $2.4 billion decreased 6.8 percent year to year and the operating (non-GAAP) pre-tax margin from continuing operations decreased 1.0 point to 13.6 percent. The operating (non-GAAP) provision for income taxes was $0.1 billion in the third quarter of 2021, compared to $0.3 billion in the third quarter of 2020. Operating (non-GAAP) income from continuing operations of $2.3 billion decreased 1.2 percent with an operating (non-GAAP) income margin from continuing operations of 13.0 percent, down 0.2 points year to year.

Diluted earnings per share from continuing operations of $1.25 in the third quarter of 2021 decreased 33.9 percent and operating (non-GAAP) diluted earnings per share of $2.52 decreased 2.3 percent versus the third quarter of 2020. Diluted earnings per share from continuing operations includes impacts related to the amortization of purchased intangibles assets and other acquisition-related charges, retirement-related charges, U.S. tax reform enactment impacts and Kyndryl separation-related charges. The impact of the Kyndryl separation-related charges for third-quarter 2021 was ($0.56) per share.

For the three months ended September 30, 2021, we generated $2.7 billion in cash flow provided by operating activities, a decrease of $1.6 billion compared to the third quarter of 2020, primarily driven by a decrease in cash provided by receivables of $1.4 billion. Net cash from operating activities also included approximately $0.5 billion of cash impacts from our structural actions initiated in the fourth quarter of 2020 and Kyndryl separation-related charges. In the third quarter of 2021, investing activities were a net use of cash of $0.6 billion, an increase of $0.3 billion compared to the prior-year period, primarily driven by a decrease in cash provided by net proceeds from marketable securities. Financing activities were a net use of cash of $1.7 billion in the third quarter of 2021, essentially flat compared to the prior-year period.

Management Discussion – (continued)

Financial Results Summary —Nine Months Ended September 30:


							Yr. to Yr.
							Percent/
(Dollars and shares in millions except per share amounts)							Margin
For the nine months ended September 30:	2021			2020			Change
Revenue	$	54,093		$	53,253		1.6	%*
Gross profit margin		46.9	%		47.0	%	(0.1)	pts.
Total expense and other (income)	$	21,603		$	21,704		(0.5)	%
Income from continuing operations before income taxes	$	3,776		$	3,348		12.8	%
Provision for/(benefit from) income taxes from continuing operations	$	365		$	(888)		nm
Income from continuing operations	$	3,411	**	$	4,237		(19.5)	%
Income from continuing operations margin		6.3	%		8.0	%	(1.6)	pts.
Net income	$	3,410	**	$	4,234		(19.5)	%
Earnings per share from continuing operations - assuming dilution	$	3.77	**	$	4.72		(20.1)	%
Weighted-average shares outstanding - assuming dilution		904.0			895.8		0.9	%

	At 9/30/2021			At 12/31/2020
Assets	$	144,214		$	155,971		(7.5)	%
Liabilities	$	121,858		$	135,244		(9.9)	%
Equity	$	22,357		$	20,727		7.9	%

(1.1) percent adjusted for currency; (1.0) percent excluding divested businesses and adjusted for currency.

** Includes $0.7 billion of Kyndryl separation-related charges resulting in an impact to diluted earnings per share from continuing operations of ($0.76).

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The following table provides the company’s operating (non-GAAP) earnings for the first nine months of 2021 and 2020.


					Yr. to Yr.
(Dollars in millions except per share amounts)					Percent
For the nine months ended September 30:	2021		2020		Change
Net income as reported	$	3,410	$	4,234	(19.5)	%
Income/(loss) from discontinued operations, net of tax		(1)		(2)	(76.1)
Income from continuing operations	$	3,411	$	4,237	(19.5)	%
Non-operating adjustments (net of tax):
Acquisition-related charges	$	1,082	$	1,095	(1.1)	%
Non-operating retirement-related costs/(income)		813		710	14.6
U.S. tax reform impacts		(6)		(128)	(95.7)
Separation-related charges		687		—	nm
Operating (non-GAAP) earnings*	$	5,988	$	5,913	1.3	%
Diluted operating (non-GAAP) earnings per share*	$	6.62	$	6.60	0.3	%

Refer to page 93 for a more detailed reconciliation of net income to operating earnings and operating earnings per share.

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Financial Performance Summary —Nine Months Ended September 30:

In the first nine months of 2021, we reported $54.1 billion in revenue, $3.4 billion in income from continuing operations and diluted earnings per share from continuing operations were $3.77 as reported. Income and diluted earnings per share from continuing operations for the third quarter of 2021 include an impact from Kyndryl separation-related charges of $0.7 billion and ($0.76) per share, respectively. Operating (non-GAAP) earnings were $6.0 billion, resulting in diluted earnings per share from continuing operations of $6.62 on an operating (non-GAAP) basis. We generated $10.3 billion in cash from operations, $3.2 billion in free cash flow, which included $1.8 billion of cash

Management Discussion – (continued)

impacts from the structural actions initiated in the fourth quarter of 2020 and Kyndryl separation-related charges, and delivered shareholder returns of $4.4 billion through dividends.

Total consolidated revenue increased 1.6 percent as reported but declined 1 percent excluding divested businesses and adjusted for currency. Cloud & Cognitive Software increased 4.2 percent as reported (2 percent adjusted for currency). Within this segment, Cloud & Data Platforms grew 11.4 percent as reported (9 percent adjusted for currency) with continued solid Red Hat performance led by Red Hat Enterprise Linux (RHEL) and our OpenShift hybrid cloud platform. Cognitive Applications grew 5.1 percent as reported (3 percent adjusted for currency), while Transaction Processing Platforms declined 9.2 percent as reported (12 percent adjusted for currency). GBS increased 8.4 percent as reported (6 percent adjusted for currency) with strong growth in Consulting and Global Process Services. Application Management increased 2.0 percent as reported, but declined 1 percent adjusted for currency. GTS decreased 2.0 percent as reported (5 percent adjusted for currency) with declines in Infrastructure & Cloud Services and Technology Support Services. Systems decreased 5.1 percent as reported (7 percent adjusted for currency) and was impacted by product cycle dynamics in the current-year period.

Total cloud revenue of $20.3 billion in the first nine months of 2021 grew 15 percent as reported (12 percent adjusted for currency and excluding divested businesses and adjusted for currency).

From a geographic perspective, Americas revenue grew 1.9 percent year to year as reported (1 percent adjusted for currency). EMEA increased 3.0 percent as reported but decreased 3 percent adjusted for currency. Asia Pacific declined 1.0 percent year to year as reported (3 percent adjusted for currency).

Total consolidated gross margin of 46.9 percent decreased 0.1 point year to year with declines in GBS and Systems reflecting investment and product cycle dynamics, offset by margin improvements in Cloud & Cognitive Software and GTS. The improvement in GTS reflects the benefits from the productivity actions taken in 2020 in advance of the Kyndryl separation. Operating (non-GAAP) gross margin of 48.2 percent increased 0.1 point compared to the prior-year period.

Total expense and other (income) decreased 0.5 percent in the first nine months of 2021 versus the prior-year period. Our expense reflects the higher level of investment we are making in innovation, skills and our ecosystem, both organically and through acquisitions, more than offset by lower workforce rebalancing charges, a benefit from expected credit loss expense, and lower interest expense in the current-year period. Expense also reflects an increase from the effects of currency, Kyndryl separation-related charges in the current-year period and higher non-operating retirement-related costs. Total operating (non-GAAP) expense and other (income) decreased 3.2 percent year to year, driven primarily by the factors above excluding the separation-related charges and non-operating retirement-related costs.

Pre-tax income from continuing operations of $3.8 billion increased 12.8 percent compared to the first nine months of 2020. The pre-tax margin from continuing operations was 7.0 percent, an increase of 0.7 points versus the prior-year period. In the prior-year period, workforce rebalancing charges were $0.9 billion, compared to $0.2 billion in the current year. The current-year period also includes $0.5 billion of Kyndryl separation-related charges. The continuing operations provision for income taxes in the first nine months of 2021 was $0.4 billion compared to a benefit from income taxes of $0.9 billion in the first nine months of 2020. The prior year tax benefit was primarily related to the tax impacts of an intra-entity sale of certain of the company’s intellectual property. Net income from continuing operations of $3.4 billion decreased 19.5 percent, and the net income margin from continuing operations was 6.3 percent, a decrease of 1.6 points year to year.

Operating (non-GAAP) pre-tax income from continuing operations of $6.7 billion increased 20.2 percent year to year and the operating (non-GAAP) pre-tax margin from continuing operations increased 1.9 points to 12.4 percent. These results reflect higher workforce rebalancing charges in 2020 as described above. The operating (non-GAAP) provision for income taxes was $0.7 billion in the first nine months of 2021, compared to a benefit from income taxes of $0.3 billion in the first nine months of 2020. The prior year operating (non-GAAP) benefit from income taxes was

Management Discussion – (continued)

primarily driven by the same factor described above. Operating (non-GAAP) income from continuing operations of $6.0 billion increased 1.3 percent with an operating (non-GAAP) income margin from continuing operations of 11.1 percent.

Diluted earnings per share from continuing operations of $3.77 in the first nine months of 2021 decreased 20.1 percent and operating (non-GAAP) diluted earnings per share of $6.62 increased 0.3 percent versus the first nine months of 2020. Diluted earnings per share from continuing operations includes impacts related to the amortization of purchased intangibles assets and other acquisition-related charges, retirement-related charges, U.S. tax reform enactment impacts and Kyndryl separation-related charges. The impact of the Kyndryl separation-related charges for the first nine months of 2021 was ($0.76) per share.

In the third quarter, we continued to take actions to further enhance our balance sheet and liquidity position. At September 30, 2021, the balance sheet remained strong with the flexibility to support and invest in the business. Cash and cash equivalents, restricted cash and marketable securities at September 30, 2021 were $8.4 billion, a decrease of $5.9 billion from December 31, 2020, primarily due to debt reduction payments and acquisitions. In line with our overall debt pay down strategy, we have reduced total debt by $7.0 billion from December 31, 2020 and $18.5 billion since the second quarter of 2019 (immediately preceding the Red Hat transaction).

Key drivers in the balance sheet and total cash flows were:

Total assets decreased $11.8 billion ($9.2 billion adjusted for currency) from December 31, 2020 driven by:

•	A decrease in cash and cash equivalents, restricted cash and marketable securities of $5.9 billion ($5.7 billion adjusted for currency); and

•	A decrease in financing receivables of $5.8 billion ($5.3 billion adjusted for currency) primarily as a result of collections of seasonally higher year-end balances and sales of receivables; partially offset by

•	An increase in goodwill of $1.8 billion ($2.3 billion adjusted for currency) from new acquisitions.

Total liabilities decreased $13.4 billion ($10.2 billion adjusted for currency) from December 31, 2020 driven by:

•	A decrease in total debt of $7.0 billion ($6.1 billion adjusted for currency) primarily driven by debt maturities and early retirements of $7.3 billion;

•	A decrease in other accrued expenses and liabilities of $2.3 billion ($1.9 billion adjusted for currency) primarily due to payments of $1.4 billion for workforce rebalancing actions and a decrease of $0.5 billion in derivative liabilities;

•	A decrease in retirement and nonpension postretirement benefit obligations of $1.5 billion ($0.8 billion adjusted for currency);

•	A decrease in taxes payable of $1.1 billion ($1.0 billion adjusted for currency) primarily driven by tax payments and a decline in reserves as a result of the resolution of certain tax audit matters; and

•	A decrease in accounts payable of $0.7 billion ($0.6 billion adjusted for currency) reflecting declines from seasonally higher year-end balances.

Total equity of $22.4 billion increased $1.6 billion from December 31, 2020 as a result of:

•	Net income of $3.4 billion; and

Management Discussion – (continued)

•	An increase in accumulated other comprehensive income of $2.0 billion primarily due to retirement-related benefit plans and cash flow hedge derivatives; partially offset by

•	Dividends paid of $4.4 billion.

We generated $10.3 billion in cash flow provided by operating activities, a decrease of $2.1 billion compared to the first nine months of 2020. Cash flows from operating activities includes approximately $1.7 billion of cash impacts from our structural actions initiated in the fourth quarter of 2020 and Kyndryl separation-related charges. In the first nine months of 2021, investing activities were a net use of cash of $5.3 billion compared to $2.5 billion in the prior-year period. The $2.8 billion increase year to year was driven primarily by an increase in net cash used for acquisitions ($3.0 billion) and a decrease in cash provided by divestitures ($0.5 billion), partially offset by a decrease in cash used for capital expenditures ($0.4 billion). Financing activities were a net use of cash of $10.7 billion in the first nine months of 2021 compared to $3.4 billion in the prior-year period. The $7.2 billion increase year to year was primarily driven by a decrease in net cash provided by debt transactions consistent with our overall debt pay down strategy.

Management Discussion – (continued)

Third Quarter and First Nine Months in Review

Results of Continuing Operations

Segment Details

The following is an analysis of the third quarter and first nine months of 2021 versus the third quarter and first nine months of 2020 reportable segment external revenue and gross margin results. Segment pre-tax income includes transactions between segments that are intended to reflect an arm’s-length transfer price and excludes certain unallocated corporate items.


									Yr. to Yr.
									Percent
							Yr. to Yr.		Change
(Dollars in millions)							Percent/Margin		Adjusted For
For the three months ended September 30:	2021			2020			Change		Currency
Revenue:
Cloud & Cognitive Software	$	5,692		$	5,553		2.5	%	1.9	%
Gross margin		77.0	%		77.1	%	(0.1)	pts.
Global Business Services		4,427			3,965		11.6	%	11.0	%
Gross margin		29.8	%		32.9	%	(3.1)	pts.
Global Technology Services		6,154			6,462		(4.8)	%	(5.4)	%
Gross margin		36.2	%		35.0	%	1.2	pts.
Systems		1,107			1,257		(11.9)	%	(12.4)	%
Gross margin		41.3	%		51.2	%	(9.9)	pts.
Global Financing		220			273		(19.2)	%	(19.8)	%
Gross margin		25.6	%		37.5	%	(11.9)	pts.
Other		18			50		(64.9)	%	(64.9)	%
Gross margin		nm			(336.2)	%	nm
Total consolidated revenue	$	17,618		$	17,560		0.3	%*	(0.3)	%
Total consolidated gross profit	$	8,171		$	8,430		(3.1)	%
Total consolidated gross margin		46.4	%		48.0	%	(1.6)	pts.
Non-operating adjustments:
Amortization of acquired intangible assets		184			180		2.2	%
Acquisition-related charges		—			—		nm
Separation-related charges		108			—		nm
Operating (non-GAAP) gross profit	$	8,463		$	8,610		(1.7)	%
Operating (non-GAAP) gross margin		48.0	%		49.0	%	(1.0)	pts.

(0.2) percent excluding divested businesses and adjusted for currency.

nm - not meaningful

Management Discussion – (continued)


									Yr. to Yr.
									Percent
							Yr. to Yr.		Change
(Dollars in millions)							Percent/Margin		Adjusted For
For the nine months ended September 30:	2021			2020			Change		Currency
Revenue:
Cloud & Cognitive Software	$	17,227		$	16,540		4.2	%	1.7	%
Gross margin		77.1	%		76.6	%	0.5	pts.
Global Business Services		13,002			11,992		8.4	%	5.5	%
Gross margin		28.6	%		29.5	%	(0.9)	pts.
Global Technology Services		18,866			19,245		(2.0)	%	(4.9)	%
Gross margin		35.3	%		34.4	%	1.0	pts.
Systems		4,251			4,477		(5.1)	%	(7.0)	%
Gross margin		51.3	%		53.7	%	(2.3)	pts.
Global Financing		702			837		(16.2)	%	(18.0)	%
Gross margin		28.4	%		39.0	%	(10.6)	pts.
Other		45			163		(72.1)	%	(72.3)	%
Gross margin		nm			(305.4)	%	nm
Total consolidated revenue	$	54,093		$	53,253		1.6	%*	(1.1)	%
Total consolidated gross profit	$	25,379		$	25,052		1.3	%
Total consolidated gross margin		46.9	%		47.0	%	(0.1)	pts.
Non-operating adjustments:
Amortization of acquired intangible assets		540			556		(2.9)	%
Acquisition-related charges		—			—		nm
Separation-related charges		168			—		nm
Operating (non-GAAP) gross profit	$	26,087		$	25,608		1.9	%
Operating (non-GAAP) gross margin		48.2	%		48.1	%	0.1	pts.

(1.0) percent excluding divested businesses and adjusted for currency.

nm - not meaningful

Cloud & Cognitive Software


							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For
For the three months ended September 30:	2021		2020		Change		Currency
Cloud & Cognitive Software external revenue:	$	5,692	$	5,553	2.5	%	1.9	%
Cloud & Data Platforms	$	3,046	$	2,775	9.8	%	9.2	%
Cognitive Applications		1,314		1,317	(0.2)		(1.0)
Transaction Processing Platforms		1,332		1,461	(8.8)		(9.5)


							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For
For the nine months ended September 30:	2021		2020		Change		Currency
Cloud & Cognitive Software external revenue:	$	17,227	$	16,540	4.2	%	1.7	%
Cloud & Data Platforms	$	9,032	$	8,108	11.4	%	8.9	%
Cognitive Applications		3,938		3,745	5.1		2.8
Transaction Processing Platforms		4,257		4,687	(9.2)		(11.6)

Cloud & Cognitive Software revenue of $5,692 million increased 2.5 percent as reported and 2 percent adjusted for currency in the third quarter of 2021 compared to the prior-year period, led by Red Hat, security, automation and Cloud Paks across our software. We had strong growth in Cloud & Data Platforms, partially offset by declines in Transaction

Management Discussion – (continued)

Processing Platforms and Cognitive Applications was flat. We have a strong recurring revenue base in software and our renewal rates for subscription and support increased again this quarter. For the first nine months of 2021, Cloud & Cognitive Software revenue of $17,227 million increased 4.2 percent as reported and 2 percent adjusted for currency driven by growth in Cloud & Data Platforms and Cognitive Applications, partially offset by a decrease in Transaction Processing Platforms.

In the third quarter, Cloud & Data Platforms revenue of $3,046 million increased 9.8 percent as reported and 9 percent adjusted for currency compared to the prior-year period, led by continued growth in Red Hat driven by double-digit growth in both Infrastructure and Application Development and emerging technologies. We also had over 40 percent growth in OpenShift recurring revenue as well as growth in automation led by key solutions such as Cloud Pak for Integration and Cloud Pak for Business Automation, and a strong start to our recent Instana and Turbonomic acquisitions. Our Data and AI revenue was down modestly, driven by declines in the on-premises DataOps portfolio and supply chain as compared to a strong third quarter in the prior year.

Cognitive Applications third-quarter revenue of $1,314 million was flat as reported and decreased 1 percent adjusted for currency compared to the prior-year period. We had continued growth in Security revenue in the third quarter, led by threat management software and services as clients respond to the evolving cybersecurity environment. Security remains a key strategic focus area as we help clients adopt a Zero Trust architecture with Cloud Pak for Security and XForce services.

Transaction Processing Platforms revenue of $1,332 million decreased 8.8 percent as reported and 9 percent adjusted for currency in the third quarter compared to the prior-year period. We provide flexibility to our clients in how they purchase this mission-critical software. In the quarter, 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. However, our continued strong software renewals in the quarter reflect that clients recognize the long-term value in our offerings.

Within Cloud & Cognitive Software, cloud revenue of $2.1 billion grew 21 percent as reported (20 percent adjusted for currency) in the third quarter of 2021 compared to the prior-year period. For the first nine months of 2021, cloud revenue of $6.1 billion grew 28 percent as reported (26 percent adjusted for currency) compared to the first nine months of the prior year. Over the last 12 months, Software cloud revenue of $8.3 billion grew 31 percent as reported and 28 percent adjusted for currency.


							Yr. to Yr.
							Percent/
(Dollars in millions)							Margin
For the three months ended September 30:	2021			2020			Change
Cloud & Cognitive Software:
External gross profit	$	4,385		$	4,281		2.4	%
External gross profit margin		77.0	%		77.1	%	(0.1)	pts.
Pre-tax income	$	1,675		$	1,834		(8.7)	%
Pre-tax margin		25.9	%		28.5	%	(2.6)	pts.


							Yr. to Yr.
							Percent/
(Dollars in millions)							Margin
For the nine months ended September 30:	2021			2020			Change
Cloud & Cognitive Software:
External gross profit	$	13,278		$	12,665		4.8	%
External gross profit margin		77.1	%		76.6	%	0.5	pts.
Pre-tax income	$	4,822		$	4,475		7.8	%
Pre-tax margin		24.7	%		23.6	%	1.1	pts.

Management Discussion – (continued)

Cloud & Cognitive Software gross profit margin decreased 0.1 points to 77.0 percent in the third quarter of 2021 compared to the prior-year period. We had margin decline in services which was partially offset by margin expansion in software. For the first nine months of 2021, gross profit margin increased 0.5 points to 77.1 percent, with margin expansion in software and services.

In the third quarter, pre-tax income of $1,675 million decreased 8.7 percent and pre-tax margin decreased 2.6 points to 25.9 percent compared to the prior year. We expanded our pre-tax margin sequentially compared to the second-quarter 2021, while we continued to invest in new innovation and our ecosystem. For the first nine months of 2021, pre-tax income of $4,822 million increased 7.8 percent and pre-tax margin of 24.7 percent increased 1.1 points compared to the prior year, primarily driven by the gross margin expansion and lower workforce rebalancing charges in the current year.

Global Business Services


							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For
For the three months ended September 30:	2021		2020		Change		Currency
Global Business Services external revenue:	$	4,427	$	3,965	11.6	%	11.0	%
Consulting	$	2,292	$	1,966	16.6	%	15.8	%
Application Management		1,847		1,758	5.1		4.5
Global Process Services		287		240	19.5		19.3


							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For
For the nine months ended September 30:	2021		2020		Change		Currency
Global Business Services external revenue:	$	13,002	$	11,992	8.4	%	5.5	%
Consulting	$	6,717	$	5,973	12.5	%	9.5	%
Application Management		5,439		5,332	2.0		(0.9)
Global Process Services		846		687	23.1		20.9

Global Business Services revenue of $4,427 million grew 11.6 percent as reported and 11 percent adjusted for currency in the third quarter of 2021 compared to the prior-year period. We had growth across all three business areas and our Consulting business accelerated revenue growth to a double-digit rate. We are helping our clients capture new growth opportunities and increase operational flexibility and productivity with hybrid cloud and AI. Our Red Hat practice continued to drive client adoption of our hybrid cloud platform, with more than 180 new Red Hat engagements in the third quarter. In addition, our teams work alongside our clients to co-create business products and solutions, and, as of September 30, 2021, we have done more than 4,000 IBM Garage engagements. For the first nine months of 2021, GBS revenue of $13,002 million increased 8.4 percent as reported and 6 percent adjusted for currency reflecting strong year-to-year growth in Consulting and Global Process Services (GPS). We continue to expand the opportunities to connect Consulting and Business Process Outsourcing within GPS to transform client workflows using hybrid cloud and AI.

In the third-quarter 2021, Consulting revenue of $2,292 million grew 16.6 percent as reported and 16 percent adjusted for currency. We are leveraging our skills and ecosystem partners to transform business processes and modernize applications based on OpenShift.

Application Management revenue of $1,847 million increased 5.1 percent as reported and 5 percent adjusted for currency in the third quarter of 2021 reflecting the impacts of the pandemic in the prior-year period. Our growth this quarter was driven by management of applications in a multi-cloud environment.

Management Discussion – (continued)

GPS third-quarter revenue of $287 million grew 19.5 percent as reported and 19 percent adjusted for currency compared to the prior-year period. Our offerings in finance, procurement, and talent and transformation grew at double-digit rates.

Within GBS, cloud revenue of $2.0 billion grew 38 percent as reported (37 percent adjusted for currency) in the third quarter of 2021 compared to the prior-year period. For the first nine months of 2021, cloud revenue of $5.6 billion grew 35 percent as reported (32 percent adjusted for currency) compared to the same period in 2020. Over the last 12 months, GBS cloud revenue of $7.3 billion grew 30 percent as reported and 27 percent adjusted for currency.


							Yr. to Yr.
							Percent/
(Dollars in millions)							Margin
For the three months ended September 30:	2021			2020			Change
Global Business Services:
External gross profit	$	1,321		$	1,306		1.1	%
External gross profit margin		29.8	%		32.9	%	(3.1)	pts.
Pre-tax income	$	587		$	570		3.0	%
Pre-tax margin		13.1	%		14.2	%	(1.1)	pts.


							Yr. to Yr.
							Percent/
(Dollars in millions)							Margin
For the nine months ended September 30:	2021			2020			Change
Global Business Services:
External gross profit	$	3,724		$	3,538		5.3	%
External gross profit margin		28.6	%		29.5	%	(0.9)	pts.
Pre-tax income	$	1,349		$	1,203		12.1	%
Pre-tax margin		10.2	%		9.9	%	0.3	pts.

GBS third-quarter gross profit margin of 29.8 percent decreased 3.1 points on a year-to-year basis, but improved sequentially compared to the second-quarter 2021. Our gross margin performance reflects our investment in strategic partnerships, new offerings and practices, and integrating and scaling our acquisitions. We are investing to increase our go-to-market resources as well as to scale our practices built around our ecosystem partners and Red Hat.

Pre-tax income of $587 million increased 3.0 percent and pre-tax margin of 13.1 percent decreased 1.1 points in the third quarter of 2021 compared to the prior-year period. The pre-tax income and margin performance reflects our solid growth in revenue and increased gross profit dollars, offset by higher level of investments described above. For the first nine months of 2021, pre-tax income of $1,349 million increased 12.1 percent and pre-tax margin of 10.2 percent increased 0.3 points compared to the prior-year period, driven primarily by revenue growth, lower costs due to prior workforce rebalancing actions and lower workforce rebalancing charges year to year.

Global Technology Services


							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For
For the three months ended September 30:	2021		2020		Change		Currency
Global Technology Services external revenue:	$	6,154	$	6,462	(4.8)	%	(5.4)	%
Infrastructure & Cloud Services	$	4,681	$	4,933	(5.1)	%	(5.6)	%
Technology Support Services		1,473		1,528	(3.7)		(4.6)

Management Discussion – (continued)


							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For
For the nine months ended September 30:	2021		2020		Change		Currency
Global Technology Services external revenue:	$	18,866	$	19,245	(2.0)	%	(4.9)	%
Infrastructure & Cloud Services	$	14,370	$	14,663	(2.0)	%	(5.1)	%
Technology Support Services		4,496		4,582	(1.9)		(4.5)

Global Technology Services revenue of $6,154 million decreased 4.8 percent as reported and 5 percent adjusted for currency in the third quarter of 2021 compared to the prior-year period. For the first nine months of 2021, GTS revenue of $18,866 million decreased 2.0 percent as reported and 5 percent adjusted for currency as compared to the prior-year period.

In the third-quarter 2021, Infrastructure & Cloud Services revenue of $4,681 million decreased 5.1 percent as reported and 6 percent adjusted for currency compared to the prior-year period. In the first half of 2021, we had modest improvements in client-based business volumes and project activity which contributed to in-period revenue. However, this quarter, clients paused on new project activity in advance of the separation of Kyndryl in the fourth-quarter 2021.

Technology Support Services (TSS) third-quarter revenue of $1,473 million decreased 3.7 percent as reported and 5 percent adjusted for currency in the third-quarter 2021 compared to the prior-year period, reflecting the Systems hardware product cycles.

Within GTS, cloud revenue of $2.4 billion increased 1 percent as reported and was flat adjusted for currency in the third quarter of 2021 compared to the same period in the prior year. For the first nine months of 2021, cloud revenue of $7.1 billion grew 2 percent as reported, but declined 1 percent adjusted for currency compared to the first nine months of 2020. Over the last 12 months, GTS cloud revenue of $9.6 billion grew 2 percent as reported, but declined 1 percent adjusted for currency.


							Yr. to Yr.
							Percent/
(Dollars in millions)							Margin
For the three months ended September 30:	2021			2020			Change
Global Technology Services:
External gross profit	$	2,230		$	2,264		(1.5)	%
External gross profit margin		36.2	%		35.0	%	1.2	pts.
Pre-tax income	$	383		$	399		(4.1)	%
Pre-tax margin		5.9	%		5.9	%	0.0	pts.


							Yr. to Yr.
							Percent/
(Dollars in millions)							Margin
For the nine months ended September 30:	2021			2020			Change
Global Technology Services:
External gross profit	$	6,667		$	6,618		0.7	%
External gross profit margin		35.3	%		34.4	%	1.0	pts.
Pre-tax income	$	903		$	471		91.9	%
Pre-tax margin		4.6	%		2.3	%	2.2	pts.

Global Technology Services gross profit margin increased 1.2 points to 36.2 percent in the third quarter of 2021 as compared to the prior-year period, driven primarily by margin improvement in Infrastructure & Cloud Services which reflects the benefits from the structural actions taken in 2020 to improve the margin and profit profile of the business in advance of the Kyndryl separation in the fourth-quarter 2021.

Management Discussion – (continued)

Pre-tax income of $383 million decreased 4.1 percent and pre-tax margin of 5.9 percent was flat in the third quarter of 2021 compared to the same period in 2020, driven primarily by the gross profit margin expansion. For the first nine months of 2021, pre-tax income of $903 million increased 91.9 percent and pre-tax margin of 4.6 percent increased 2.2 points compared to the prior-year period, driven primarily by gross profit margin expansion and lower workforce rebalancing charges in the current year.

Services Backlog and Signings


							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
	At September 30,		At September 30,		Percent		Adjusted For
(Dollars in billions)	2021		2020		Change		Currency
Total backlog	$	99.8	$	108.0	(7.5)	%	(7.1)	%

The estimated total services backlog at September 30, 2021 was $99.8 billion, a decrease of 7.5 percent as reported (7 percent adjusted for currency) on a year-to-year basis. The year-to-year decline was driven primarily by GTS as clients paused on new project activity in advance of the Kyndryl separation. GBS backlog grew year to year driven by Consulting, Security and GPS.

Total services backlog includes Infrastructure & Cloud Services, Security Services, Consulting, Global Process Services, Application Management and TSS. Total backlog is intended to be a statement of overall work under contract which is either non-cancellable, or which historically has very low likelihood of termination, given the criticality of certain services to the company’s clients. Total backlog does not include as-a-Service arrangements that allow for termination under contractual commitment terms. Backlog estimates are subject to change and are affected by several factors, including terminations, changes in the scope of contracts, periodic revalidations, adjustments for revenue not materialized and adjustments for currency.

Services signings are management’s initial estimate of the value of a client’s commitment under a services contract. 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.

Signings include Infrastructure & Cloud Services, Security Services, Consulting, Global Process Services and Application Management contracts. Contract extensions and increases in scope are treated as signings only to the extent of the incremental new value. Total services 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, such as in Infrastructure & Cloud Services or Global Process Services. TSS is generally not included in signings as the maintenance contracts tend to be more steady state, where revenues equal renewals. Certain longer-term TSS contracts that have characteristics similar to outsourcing contracts are included in signings.

Contract portfolios purchased in an acquisition are treated as positive backlog adjustments provided those contracts meet the company’s requirements for initial signings. A new signing will be recognized if a new services agreement is signed incidental or coincidental to an acquisition or divestiture.

Management believes that the estimated values of services backlog and signings disclosed herein provide insight into our potential future revenue, which is used by management as a tool to monitor the performance of the business and viewed as useful decision-making information for investors. The conversion of signings and backlog into revenue may vary based on the types of services and solutions, customer decisions, and as well as other factors, which may include, but are not limited to, macroeconomic environment or external events.

Management Discussion – (continued)


							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For
For the three months ended September 30:	2021		2020		Change		Currency
Total signings	$	8,419	$	9,529	(11.7)	%	(11.7)	%


							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For
For the nine months ended September 30:	2021		2020		Change		Currency
Total signings	$	24,330	$	26,663	(8.8)	%	(10.8)	%

In the third quarter, the GTS renewal rate with existing clients improved 5 points year to year, however, clients paused signing new project activity in advance of the Kyndryl separation. GBS signings grew compared to the prior-year period, with strength in our practices with ecosystem partners and in application modernization offerings built on Red Hat.

Systems


							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For
For the three months ended September 30:	2021		2020		Change		Currency
Systems external revenue:	$	1,107	$	1,257	(11.9)	%	(12.4)	%
Systems Hardware	$	796	$	919	(13.4)	%	(13.9)	%
IBM Z					(33.0)		(33.5)
Power Systems					(24.4)		(24.8)
Storage Systems					11.4		10.9
Operating Systems Software		312		338	(7.8)		(8.4)


							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For
For the nine months ended September 30:	2021		2020		Change		Currency
Systems external revenue:	$	4,251	$	4,477	(5.1)	%	(7.0)	%
Systems Hardware	$	3,294	$	3,404	(3.2)	%	(5.2)	%
IBM Z					0.6		(1.4)
Power Systems					(11.4)		(13.3)
Storage Systems					(3.2)		(5.3)
Operating Systems Software		957		1,074	(10.8)		(12.8)

Systems revenue of $1,107 million decreased 11.9 percent as reported and 12 percent adjusted for currency in the third quarter of 2021 compared to the prior-year period. Systems Hardware revenue of $796 million declined 13.4 percent as reported and 14 percent adjusted for currency, driven by product cycles in IBM Z and Power Systems, partially offset by growth in Storage Systems. Operating Systems Software revenue of $312 million decreased 7.8 percent as reported and 8 percent adjusted for currency, driven primarily by declines in IBM Z and Power Systems operating systems software. For the first nine months of 2021, Systems revenue of $4,251 million decreased 5.1 percent as reported and 7 percent adjusted for currency compared to the prior-year period. The decline was primarily driven by Power Systems and Storage Systems and a decline in Operating Systems Software.

IBM Z revenue decreased 33.0 percent as reported and 33 percent adjusted for currency in the third quarter compared to the prior-year period. While the z15 program continues to outpace the strong z14 program, the magnitude

Management Discussion – (continued)

of that overachievement declined slightly in the third quarter as we near the end of the cycle. This is the ninth quarter of z15 availability, and IBM Z continues to be an enduring platform given market needs for scalability, reliability, security and, more recently, cloud native development. These characteristics, together with our newer, flexible consumption offerings, further demonstrate the value of the IBM Z platform within our hybrid cloud and AI strategy.

Power Systems revenue decreased 24.4 percent as reported and 25 percent adjusted for currency in the third quarter of 2021 compared to the prior-year period. Late in the quarter, we started the rollout of our next generation Power 10, starting with the high-end system which has unique hardware innovations including a processor specifically optimized for data intensive workloads such as SAP S/4 HANA. The mid-range and low-end Power 10 systems will be available during 2022.

Storage Systems revenue increased 11.4 percent as reported and 11 percent adjusted for currency in the third-quarter 2021 compared to the prior-year period driven by demand from hyperscalers for our tape products and growth in entry-level all-flash storage following our product refresh earlier this year.

Within Systems, cloud revenue of $0.3 billion decreased 42 percent as reported (43 percent adjusted for currency) in the third quarter of 2021 compared to the same quarter in 2020. For the first nine months of 2021, cloud revenue of $1.5 billion decreased 13 percent as reported (15 percent adjusted for currency) compared to the same prior-year period. Over the last 12 months, Systems cloud revenue of $2.6 billion declined 15 percent as reported and 17 percent adjusted for currency due to product cycle dynamics.


							Yr. to Yr.
							Percent/
(Dollars in millions)							Margin
For the three months ended September 30:	2021			2020			Change
Systems:
External Systems Hardware gross profit	$	211		$	371		(43.0)	%
External Systems Hardware gross profit margin		26.6	%		40.4	%	(13.8)	pts.
External Operating Systems Software gross profit	$	246		$	273		(9.9)	%
External Operating Systems Software gross profit margin		79.0	%		80.9	%	(1.8)	pts.
External total gross profit	$	458		$	644		(29.0)	%
External total gross profit margin		41.3	%		51.2	%	(9.9)	pts.
Pre-tax income/(loss)	$	(207)		$	(37)		nm
Pre-tax margin		(16.1)	%		(2.5)	%	(13.6)	pts.

nm - not meaningful


							Yr. to Yr.
							Percent/
(Dollars in millions)							Margin
For the nine months ended September 30:	2021			2020			Change
Systems:
External Systems Hardware gross profit	$	1,419		$	1,522		(6.8)	%
External Systems Hardware gross profit margin		43.1	%		44.7	%	(1.7)	pts.
External Operating Systems Software gross profit	$	763		$	880		(13.3)	%
External Operating Systems Software gross profit margin		79.7	%		82.0	%	(2.3)	pts.
External total gross profit	$	2,182		$	2,402		(9.2)	%
External total gross profit margin		51.3	%		53.7	%	(2.3)	pts.
Pre-tax income/(loss)	$	(33)		$	(7)		nm
Pre-tax margin		(0.7)	%		(0.1)	%	(0.5)	pts.

nm - not meaningful

Systems gross profit margin decreased 9.9 points to 41.3 percent in the third-quarter 2021 compared to the prior-year period, driven primarily by declines in Power Systems and Storage Systems margins and a revenue mix to Storage

Management Discussion – (continued)

Systems. For the first nine months of 2021, Systems gross profit margin decreased 2.3 points to 51.3 percent compared to the same period in 2020, driven primarily by a decline in Storage Systems margin, partially offset by margin expansion in IBM Z.

In the third quarter of 2021, Systems pre-tax loss increased $170 million to ($207) million and pre-tax margin decreased 13.6 points to (16.1) percent compared to the prior-year period, driven primarily by the IBM Z and Power Systems product cycles, partially offset by lower costs in the current year as a result of prior workforce rebalancing actions. For the first nine months of 2021, Systems pre-tax loss increased $26 million to ($33) million and pre-tax margin decreased 0.5 points to (0.7) percent compared to the prior-year period, driven primarily by the decline in Storage Systems gross profit margin and product cycle dynamics, partially offset by lower costs due to prior workforce rebalancing actions and lower workforce rebalancing charges in the current year.

Global Financing

See pages 88 through 91 for a discussion of Global Financing’s segment results.

Geographic Revenue

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


									Yr. to Yr.
							Yr. to Yr.		Percent Change
							Percent		Excluding Divested
					Yr. to Yr.		Change		Businesses And
(Dollars in millions)					Percent		Adjusted For		Adjusted For
For the three months ended September 30:	2021		2020		Change		Currency		Currency
Total Revenue	$	17,618	$	17,560	0.3	%	(0.3)	%	(0.2)	%
Americas	$	8,217	$	8,139	1.0	%	0.4	%	0.4	%
Europe/Middle East/Africa (EMEA)		5,593		5,564	0.5		(1.3)		(1.2)
Asia Pacific		3,808		3,857	(1.3)		(0.2)		(0.2)


									Yr. to Yr.
							Yr. to Yr.		Percent Change
							Percent		Excluding Divested
					Yr. to Yr.		Change		Businesses And
(Dollars in millions)					Percent		Adjusted For		Adjusted For
For the nine months ended September 30:	2021		2020		Change		Currency		Currency
Total Revenue	$	54,093	$	53,253	1.6	%	(1.1)	%	(1.0)	%
Americas	$	25,216	$	24,755	1.9	%	1.2	%	1.3	%
Europe/Middle East/Africa (EMEA)		17,272		16,775	3.0		(3.3)		(3.2)
Asia Pacific		11,605		11,723	(1.0)		(2.8)		(2.8)

Total revenue of $17,618 million increased 0.3 percent as reported and was down modestly excluding divested businesses and adjusted for currency in the third quarter of 2021 compared to the prior-year period.

Americas revenue of $8,217 million increased 1.0 percent as reported and was flat adjusted for currency. Within Americas, the U.S. was flat compared to the prior year. Canada increased 9.6 percent as reported and 4 percent adjusted for currency. Latin America increased 1.2 percent as reported and 1 percent adjusted for currency, with Brazil revenue increasing 5.3 percent as reported and 3 percent adjusted for currency.

In EMEA, total revenue of $5,593 million increased 0.5 percent as reported, but decreased 1 percent adjusted for currency. Within EMEA, Germany grew 4.0 percent as reported and 3 percent adjusted for currency while the UK grew 4.4 percent as reported, but declined 2 percent adjusted for currency. Italy and France decreased 6.7 percent and 0.5 percent, respectively, as reported and 7 percent and 1 percent, respectively, adjusted for currency.

Management Discussion – (continued)

Asia Pacific revenue of $3,808 million decreased 1.3 percent as reported and was flat adjusted for currency. Within Asia Pacific, Japan decreased 5.0 percent as reported and 1 percent adjusted for currency. China and Australia increased 2.8 percent and 0.8 percent, respectively, as reported, but each declined 2 percent adjusted for currency. India grew 8.1 percent as reported and 8 percent adjusted for currency.

For the first nine months of 2021, total revenue of $54,093 million increased 1.6 percent as reported, but declined 1 percent excluding divested businesses and adjusted for currency compared to the prior-year period.

Americas revenue of $25,216 million increased 1.9 percent as reported and 1 percent adjusted for currency. Within Americas, the U.S. increased 0.8 percent compared to the prior year. Canada increased 16.9 percent as reported and 8 percent adjusted for currency. Latin America decreased 3.5 percent as reported and 1 percent adjusted for currency, with Brazil revenue declining 3.5 percent as reported and flat adjusted for currency.

In EMEA, total revenue of $17,272 million increased 3.0 percent as reported, but declined 3 percent adjusted for currency. Within EMEA, the UK increased 8.3 percent as reported and was flat adjusted for currency. France, Germany and Italy increased 4.6 percent, 3.8 percent and 2.2 percent, respectively, as reported, but declined 2 percent, 2 percent and 4 percent, respectively, adjusted for currency.

Asia Pacific revenue of $11,605 million decreased 1.0 percent as reported and 3 percent adjusted for currency. Within Asia Pacific, Japan decreased 2.6 percent as reported and 2 percent adjusted for currency. China decreased 3.9 percent as reported and 9 percent adjusted for currency and India decreased 3.2 percent as reported and 4 percent adjusted for currency. Australia grew 3.2 percent as reported, but declined 8 percent adjusted for currency.

Expense

Total Expense and Other (Income)


							Yr. to Yr.
(Dollars in millions)							Percent
For the three months ended September 30:	2021			2020			Change
Total consolidated expense and other (income)	$	6,852		$	6,603		3.8	%
Non-operating adjustments:
Amortization of acquired intangible assets	$	(290)		$	(279)		4.1	%
Acquisition-related charges		(4)			(1)		154.7
Non-operating retirement-related (costs)/income		(328)			(291)		12.9
Separation-related charges		(169)			—		nm
Operating (non-GAAP) expense and other (income)	$	6,061		$	6,032		0.5	%
Total consolidated expense-to-revenue ratio		38.9	%		37.6	%	1.3	pts.
Operating (non-GAAP) expense-to-revenue ratio		34.4	%		34.4	%	0.0	pts.

nm - not meaningful

Management Discussion – (continued)


							Yr. to Yr.
(Dollars in millions)							Percent
For the nine months ended September 30:	2021			2020			Change
Total consolidated expense and other (income)	$	21,603		$	21,704		(0.5)	%
Non-operating adjustments:
Amortization of acquired intangible assets	$	(849)		$	(848)		0.1	%
Acquisition-related charges		(37)			(3)		nm
Non-operating retirement-related (costs)/income		(998)			(829)		20.5
Separation-related charges		(344)			—		nm
Operating (non-GAAP) expense and other (income)	$	19,374		$	20,024		(3.2)	%
Total consolidated expense-to-revenue ratio		39.9	%		40.8	%	(0.8)	pts.
Operating (non-GAAP) expense-to-revenue ratio		35.8	%		37.6	%	(1.8)	pts.

nm - not meaningful

Total expense and other (income) increased 3.8 percent in the third quarter of 2021 versus the prior year period. 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, scaling our garage footprint, increasing our research spend in areas including quantum, hybrid cloud and AI, and expanding our ecosystem. The year-to-year increase in expense was also driven by separation-related charges in the current-year period and includes higher expense from acquired businesses. Total operating (non-GAAP) expense and other (income) increased 0.5 percent year to year, driven primarily by the factors described above excluding the separation-related charges.

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

Selling, General and Administrative Expense


					Yr. to Yr.
(Dollars in millions)					Percent
For the three months ended September 30:	2021		2020		Change
Selling, general and administrative expense:
Selling, general and administrative — other	$	4,087	$	3,864	5.8	%
Advertising and promotional expense		349		361	(3.3)
Workforce rebalancing charges		0		18	nm
Amortization of acquired intangible assets		289		278	4.1
Stock-based compensation		156		129	20.6
Provision for/(benefit from) expected credit loss expense		(21)		(4)	nm
Total consolidated selling, general and administrative expense	$	4,860	$	4,647	4.6	%
Non-operating adjustments:
Amortization of acquired intangible assets	$	(289)	$	(278)	4.1	%
Acquisition-related charges		(4)		(1)	154.7
Separation-related charges		(169)		—	nm
Operating (non-GAAP) selling, general and administrative expense	$	4,398	$	4,367	0.7	%

nm - not meaningful

Management Discussion – (continued)


					Yr. to Yr.
(Dollars in millions)					Percent
For the nine months ended September 30:	2021		2020		Change
Selling, general and administrative expense:
Selling, general and administrative — other	$	12,844	$	12,444	3.2	%
Advertising and promotional expense		1,099		1,152	(4.6)
Workforce rebalancing charges		241		883	(72.7)
Amortization of acquired intangible assets		847		846	0.1
Stock-based compensation		431		401	7.5
Provision for/(benefit from) expected credit loss expense		(94)		122	nm
Total consolidated selling, general and administrative expense	$	15,368	$	15,849	(3.0)	%
Non-operating adjustments:
Amortization of acquired intangible assets	$	(847)	$	(846)	0.1	%
Acquisition-related charges		(37)		(3)	nm
Separation-related charges		(343)		—	nm
Operating (non-GAAP) selling, general and administrative expense	$	14,141	$	15,000	(5.7)	%

nm - not meaningful

Total selling, general and administrative (SG&A) expense increased 4.6 percent in the third quarter of 2021 versus the prior year reflecting the higher level of investments we are making, both organically and through acquisitions, to execute our hybrid cloud and AI strategy. The year-to-year increase was primarily driven by:

	●	Kyndryl separation-related charges in the current-year period (4 points); and

	●	Higher spending (1point) including expenses of acquired businesses.

Operating (non-GAAP) expense increased 0.7 percent year to year and excluded the separation-related charges.

SG&A expense decreased 3.0 percent in the first nine months of 2021 versus the prior year driven primarily by the following factors:

	●	Lower workforce rebalancing charges (4 points);

	●	A benefit from expected credit loss expense compared to a provision in the prior-year period (1 point); partially offset by

	●	Kyndryl separation-related charges in the current-year period (2 points); and

	●	The effects of currency (1 point).

Operating (non-GAAP) expense decreased 5.7 percent year to year, primarily driven by the same factors excluding the separation-related charges.

Provisions for expected credit loss expense decreased $216 million in the first nine months of 2021 compared to the prior-year period, primarily driven by decreases in both specific and general reserves in the current year compared to increases in the prior-year period. 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 have started to see 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 2.5 percent at September 30, 2021, an increase of 10 basis points from December 31, 2020, due to the decline in total receivables balance, and a decrease of 10 basis points from September 30, 2020.

Management Discussion – (continued)

Research, Development and Engineering


					Yr. to Yr.
(Dollars in millions)					Percent
For the three months ended September 30:	2021		2020		Change
Research, development and engineering expense	$	1,621	$	1,515	7.0	%
Non-operating adjustment:
Separation-related charges	$	(1)	$	—	nm
Operating (non-GAAP) research, development and engineering expense	$	1,620	$	1,515	6.9	%

nm - not meaningful


					Yr. to Yr.
(Dollars in millions)					Percent
For the nine months ended September 30:	2021		2020		Change
Research, development and engineering expense	$	4,907	$	4,722	3.9	%
Non-operating adjustment:
Separation-related charges	$	(1)	$	—	nm
Operating (non-GAAP) research, development and engineering expense	$	4,906	$	4,722	3.9	%

nm - not meaningful

Research, development and engineering (RD&E) expense was 9.2 percent and 9.1 percent of revenue in the third quarter and first nine months of 2021, respectively, compared to 8.6 percent and 8.9 percent in the prior-year periods, respectively, reflecting our continuing investment in innovation as we increase spending in areas including quantum, hybrid cloud and AI.

RD&E expense in the third quarter of 2021 increased 7.0 percent year to year, primarily driven by higher spending (6 points) and the effects of currency (1 point).

RD&E expense in the first nine months of 2021 increased 3.9 percent year to year, primarily driven by higher spending (2 points) and the effects of currency (2 points).

Intellectual Property and Custom Development Income


					Yr. to Yr.
(Dollars in millions)					Percent
For the three months ended September 30:	2021		2020		Change
Intellectual Property and Custom Development Income:
Licensing of intellectual property including royalty-based fees	$	69	$	60	14.7	%
Custom development income		74		62	18.9
Sales/other transfers of intellectual property		10		11	(10.9)
Total	$	153	$	134	14.5	%


					Yr. to Yr.
(Dollars in millions)					Percent
For the nine months ended September 30:	2021		2020		Change
Intellectual Property and Custom Development Income:
Licensing of intellectual property including royalty-based fees	$	205	$	222	(7.7)	%
Custom development income		210		212	(0.8)
Sales/other transfers of intellectual property		20		19	5.0
Total	$	435	$	453	(3.9)	%

Management Discussion – (continued)

Total intellectual property and custom development income increased 14.5 percent year to year in the third quarter, but decreased 3.9 percent in the first nine months of 2021 compared to the prior-year period. 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.

Other (Income) and Expense


					Yr. to Yr.
(Dollars in millions)					Percent
For the three months ended September 30:	2021		2020		Change
Other (income) and expense:
Foreign currency transaction losses/(gains)	$	(21)	$	109	nm
(Gains)/losses on derivative instruments		7		(101)	nm
Interest income		(14)		(15)	(10.6)	%
Net (gains)/losses from securities and investment assets		3		(6)	nm
Retirement-related costs/(income)		328		291	12.9
Other		(69)		(25)	179.3
Total consolidated other (income) and expense	$	234	$	253	(7.3)	%
Non-operating adjustments:
Amortization of acquired intangible assets	$	(1)	$	(1)	—
Non-operating retirement-related (costs)/income		(328)		(291)	12.9	%
Operating (non-GAAP) other (income) and expense	$	(94)	$	(39)	144.2	%

nm - not meaningful


					Yr. to Yr.
(Dollars in millions)					Percent
For the nine months ended September 30:	2021		2020		Change
Other (income) and expense:
Foreign currency transaction losses/(gains)	$	(145)	$	45	nm
(Gains)/losses on derivative instruments		246		(92)	nm
Interest income		(39)		(90)	(56.8)	%
Net (gains)/losses from securities and investment assets		(3)		(11)	(74.9)
Retirement-related costs/(income)		998		829	20.5
Other		(148)		(67)	120.9
Total consolidated other (income) and expense	$	911	$	614	48.4	%
Non-operating adjustments:
Amortization of acquired intangible assets	$	(2)	$	(2)	—
Non-operating retirement-related (costs)/income		(998)		(829)	20.5	%
Operating (non-GAAP) other (income) and expense	$	(90)	$	(217)	(58.6)	%

nm - not meaningful

Total consolidated other (income) and expense was $234 million of expense in the third quarter of 2021 compared to $253 million in the prior-year period. The year-to-year decrease was primarily driven by:

	●	Net exchange gains (including derivative instruments) in the current year versus net exchange losses (including derivative instruments) in the prior year ($22 million); and

	●	Gains on land/building dispositions and divestitures ($44 million) included in “Other”; partially offset by

Management Discussion – (continued)

	●	Higher non-operating retirement-related costs ($37 million). Refer to “Retirement-Related Plans” for additional information.

Operating (non-GAAP) other (income) and expense was $94 million of income in the third quarter of 2021 and increased $56 million compared to the prior-year period. The year-to-year change was driven primarily by the factors described above, excluding the higher non-operating retirement-related costs.

Total consolidated other (income) and expense was $911 million of expense in the first nine months of 2021 compared to $614 million in the prior year. The year-to-year increase was primarily driven by:

	●	Higher non-operating retirement-related costs ($170 million). Refer to “Retirement-Related Plans” for additional information;

	●	Net exchange losses (including derivative instruments) in the current year versus net exchange gains (including derivative instruments) in the prior year ($149 million); and

	●	Lower interest income ($51 million) primarily due to lower interest rates in the current-year period.

Operating (non-GAAP) other (income) and expense was $90 million of income in the first nine months of 2021 and decreased $127 million compared to the prior-year period. The year-to-year change was driven primarily by the effects of currency and lower interest income described above.

Interest Expense


					Yr. to Yr.
(Dollars in millions)					Percent
For the three months ended September 30:	2021		2020		Change
Interest expense	$	291	$	323	(10.0)	%


					Yr. to Yr.
(Dollars in millions)					Percent
For the nine months ended September 30:	2021		2020		Change
Interest expense	$	852	$	971	(12.3)	%

Interest expense decreased $32 million and $119 million year to year in the third quarter and first nine months of 2021, respectively. Interest expense is presented in cost of financing in the Consolidated Income Statement if the related external borrowings are to support the Global Financing external business. Overall interest expense (excluding capitalized interest) for the third quarter and first nine months of 2021 was $392 million and $1,164 million, respectively, a decrease of $40 million and $154 million versus the comparable prior-year periods. The decrease for the third quarter was primarily driven by a lower average debt balance, partially offset by higher average interest rates compared to the prior-year period. The year-to-year decrease for the first nine months of 2021 was primarily driven by a lower average debt balance in the current-year period.

Management Discussion – (continued)

Retirement-Related Plans

The following tables provide the total pre-tax cost for all retirement-related plans. The operating cost amounts 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. The non-operating cost amounts are included in other (income) and expense.


					Yr. to Yr.
(Dollars in millions)					Percent
For the three months ended September 30:	2021		2020		Change
Retirement-related plans — cost:
Service cost	$	97	$	103	(5.8)	%
Multi-employer plans		3		7	(62.3)
Cost of defined contribution plans		264		259	1.9
Total operating costs	$	364	$	369	(1.5)	%
Interest cost	$	411	$	551	(25.4)	%
Expected return on plan assets		(737)		(867)	(14.9)
Recognized actuarial losses		631		579	8.9
Amortization of prior service costs/(credits)		3		0	nm
Curtailments/settlements		13		21	(38.5)
Other costs		7		6	19.7
Total non-operating costs/(income)	$	328	$	291	12.9	%
Total retirement-related plans — cost	$	692	$	660	4.8	%

nm - not meaningful


					Yr. to Yr.
(Dollars in millions)					Percent
For the nine months ended September 30:	2021		2020		Change
Retirement-related plans — cost:
Service cost	$	290	$	300	(3.1)	%
Multi-employer plans		17		22	(20.5)
Cost of defined contribution plans		800		791	1.1
Total operating costs	$	1,107	$	1,112	(0.4)	%
Interest cost	$	1,237	$	1,637	(24.4)	%
Expected return on plan assets		(2,221)		(2,573)	(13.7)
Recognized actuarial losses		1,907		1,701	12.1
Amortization of prior service costs/(credits)		8		1	nm
Curtailments/settlements		46		42	9.9
Other costs		21		20	6.3
Total non-operating costs/(income)	$	998	$	829	20.5	%
Total retirement-related plans — cost	$	2,106	$	1,941	8.5	%

nm - not meaningful

Total pre-tax retirement-related plan cost increased by $32 million compared to the third quarter of 2020 primarily driven by lower expected return on plan assets ($130 million) and an increase in recognized actuarial losses ($52 million), partially offset by lower interest costs ($140 million). Total cost for the first nine months of 2021 increased $165 million versus the first nine months of 2020, primarily driven by lower expected return on plan assets ($352 million) and an increase in recognized actuarial losses ($206 million), partially offset by lower interest costs ($400 million).

Management Discussion – (continued)

As described in the “Operating (non-GAAP) Earnings” section, management characterizes certain retirement-related costs as operating and others as non-operating. Utilizing this characterization, operating retirement-related costs in the third quarter of 2021 were $364 million, a decrease of $6 million compared to the third quarter of 2020. For the first nine months of 2021, operating retirement-related costs were $1,107 million, a decrease of $5 million compared to the prior-year period. Non-operating costs of $328 million in the third quarter of 2021 increased $37 million year to year and for the first nine months of 2021 were $998 million, an increase of $170 million compared to the prior-year period. These non-operating cost increases were driven primarily by the same factors as described above.

Taxes

The continuing operations provision for income taxes for the third quarter of 2021 was $188 million, compared to $128 million in the third quarter of 2020. The increase primarily relates to higher discrete tax benefits in the prior year. The provision for income taxes for the third quarter of 2021 includes discrete tax charges related to the Kyndryl separation, partially offset by tax benefits associated with third quarter events that resulted in the expected utilization of U.S. foreign tax credits. The operating (non-GAAP) provision for income taxes for the third quarter of 2021 was $115 million, compared to $263 million in the third quarter of 2020. The decrease in the operating (non-GAAP) provision for income taxes was primarily due the tax benefits described above.

The continuing operations provision for income taxes for the first nine months of 2021 was $365 million, compared to a benefit from income taxes of $888 million for the first nine months of 2020. The operating (non-GAAP) provision for income taxes for the first nine months of 2021 was $725 million, compared to a benefit from income taxes of $329 million for the first nine months of 2020. The benefit from income taxes for the first nine months of 2020 was primarily related to the tax impacts of an intra-entity sale of certain of the company’s intellectual property. The operating (non-GAAP) benefit from income taxes was primarily driven by the same factor.

IBM’s full-year tax provision and effective tax rate are impacted by recurring factors including the geographic mix of income before taxes, state and local taxes, the effects of various global income tax strategies and any discrete tax events, such as the settlement of income tax audits and changes in or new interpretations of tax laws. The GAAP tax provision and effective tax rate could also be affected by adjustments to the previously recorded charges for U.S. tax reform attributable to any changes in law, new regulations and guidance, audit adjustments, among others.

During the fourth quarter of 2020, the U.S. Internal Revenue Service (IRS) concluded its examination of the company’s U.S. income tax returns for 2013 and 2014, which had a specific focus on certain cross-border transactions that occurred in 2013 and issued a final Revenue Agent’s Report (RAR). The IRS’ proposed adjustments relative to these cross-border transactions, if sustained, would result in additional taxable income of approximately $4.5 billion. The company strongly disagrees with the IRS on these specific matters and filed its IRS Appeals protest in the first quarter of 2021. In the third quarter of 2018, the IRS commenced its audit of the company’s U.S. tax returns for 2015 and 2016. The company anticipates that this audit will be completed in the fourth quarter of 2021. With respect to major U.S. state and foreign taxing jurisdictions, the company is generally no longer subject to tax examinations for years prior to 2015. The company is no longer subject to income tax examination of its U.S. federal tax return for years prior to 2013. The open years contain matters that could be subject to differing interpretations of applicable tax laws and regulations as it relates to the amount and/or timing of income, deductions and tax credits. Although the outcome of tax audits is always uncertain, the company believes that adequate amounts of tax, interest and penalties have been provided for any adjustments that are expected to result for these years.

The company is involved in a number of income tax-related matters in India challenging tax assessments issued by the India Tax Authorities. As of September 30, 2021, the company had recorded $735 million as prepaid income taxes in India. A significant portion of this balance represents cash tax deposits paid over time to protect the company’s right to appeal various income tax assessments made by the India Tax Authorities. Although the outcome of tax audits are always uncertain, the company believes that adequate amounts of tax, interest and penalties have been provided for any adjustments that are expected to result for these years.

Management Discussion – (continued)

The amount of unrecognized tax benefits at September 30, 2021 is $8,633 million which can be reduced by $917 million associated with timing adjustments, U.S. tax credits, potential transfer pricing adjustments, and state income taxes. The net amount of $7,716 million, if recognized, would favorably affect the company’s effective tax rate.

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.


					Yr. to Yr.
					Percent
For the three months ended September 30:	2021		2020		Change
Earnings per share of common stock from continuing operations:
Assuming dilution	$	1.25	$	1.89	(33.9)	%
Basic	$	1.26	$	1.90	(33.7)	%
Diluted operating (non-GAAP)	$	2.52	$	2.58	(2.3)	%
Weighted-average shares outstanding: (in millions)
Assuming dilution		906.0		897.3	1.0	%
Basic		897.1		891.4	0.6	%


					Yr. to Yr.
					Percent
For the nine months ended September 30:	2021		2020		Change
Earnings per share of common stock from continuing operations:
Assuming dilution	$	3.77	$	4.72	(20.1)	%
Basic	$	3.81	$	4.76	(20.0)	%
Diluted operating (non-GAAP)	$	6.62	$	6.60	0.3	%
Weighted-average shares outstanding: (in millions)
Assuming dilution		904.0		895.8	0.9	%
Basic		895.3		889.6	0.6	%

Actual shares outstanding at September 30, 2021 were 896.8 million. The weighted-average number of common shares outstanding assuming dilution during the third quarter and first nine months of 2021 were 8.7 million (1.0 percent) and 8.2 million (0.9 percent) shares higher, respectively, than the same periods of 2020.

Financial Position

Dynamics

At September 30, 2021, our balance sheet remained strong with flexibility to support the business. We continue to manage the investment portfolio to meet our capital preservation and liquidity objectives and have continued to take actions to enhance our balance sheet strength and liquidity position.

Cash, restricted cash and marketable securities at September 30, 2021 were $8,406 million, a decrease of $5,868 million from December 31, 2020, primarily due to debt reduction payments and acquisitions. Financing receivables declined $5,772 million to $12,207 million since the end of 2020 primarily resulting from collections of seasonally higher year-end balances and our strategic actions to re-focus our Global Financing portfolio. Total debt of $54,501 million at September 30, 2021 decreased $7,037 million from December 31, 2020, and $18,538 million since the end of the second quarter 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. In the first nine months of 2021, we generated $10,252 million in net cash from operations, compared to $12,337 million in the first nine

Management Discussion – (continued)

months of 2020. Our cash from operations in the first nine months of 2021 includes $1.7 billion of cash impacts from the structural actions we initiated in the fourth quarter of 2020 and Kyndryl separation-related charges. We have consistently generated strong cash flow from operations and continue to have access to additional sources of liquidity through the capital markets and our unused credit facilities.

Our pension plans were well funded at the end of 2020, with worldwide qualified plans funded at 102 percent. Overall pension funded status as of the end of September was fairly consistent with year-end 2020, and we currently have no change to expected plan contributions in 2021.

The assets and debt associated with the Global Financing business are a significant part of our financial position. The financial position amounts appearing on pages 5 and 6 are the consolidated amounts including Global Financing. The amounts appearing in the separate “Global Financing” section, beginning on page 88, are supplementary data presented to facilitate an understanding of the Global Financing business.

IBM Working Capital


	At September 30,		At December 31,
(Dollars in millions)	2021		2020
Current assets	$	29,967	$	39,165
Current liabilities		35,832		39,869
Working capital	$	(5,865)	$	(705)
Current ratio		0.84:1		0.98:1

Working capital decreased $5,160 million from the year-end 2020 position. The key changes are described below:

Current assets decreased $9,198 million ($8,405 million adjusted for currency) due to:

	●	A decrease of $5,868 million ($5,666 million adjusted for currency) in cash, restricted cash and marketable securities; and

	●	A decrease in financing receivables of $3,732 million ($3,485 million adjusted for currency) primarily due to collections of higher year-end balances and sales of financing receivables; partially offset by

	●	An increase in prepaid expenses and other current assets of $749 million ($820 million adjusted for currency) primarily driven by an increase in derivative assets.

Current liabilities decreased $4,038 million ($2,909 million adjusted for currency) as a result of:

	●	A decrease in other accrued expenses and liabilities of $2,328 million ($1,893 million adjusted for currency) primarily due to payments of $1,440 million for workforce rebalancing actions and a decrease of $518 million in derivative liabilities;

	●	A decrease in taxes payable of $1,142 million ($1,023 million adjusted for currency) primarily driven by tax payments and a decline in reserves as a result of the resolution of certain tax audit matters;

	●	A decrease in accounts payable of $659 million ($565 million adjusted for currency) reflecting declines from seasonally higher year-end balances; and

	●	A decrease in deferred income of $570 million ($248 million adjusted for currency); partially offset by

Management Discussion – (continued)

	●	An increase in short-term debt of $392 million ($403 million adjusted for currency) due to reclassifications from long-term debt to reflect upcoming maturities and a net increase in commercial paper; partially offset by maturities.

Receivables and Allowances

Roll Forward of Total IBM Receivables Allowance for Credit Losses


(Dollars in millions)
January 1, 2021		Additions / (Releases) *		Write-offs **		Other +		September 30, 2021
$	644	$	(85)	$	(45)	$	(5)	$	510

Additions/(Releases) for Allowance for Credit Losses are recorded in expense.

**Refer to note A, “Significant Accounting Policies,” in our 2020 Annual Report for additional information regarding allowance for credit loss write-offs.

+ Primarily represents translation adjustments.

The total IBM receivables provision coverage was 2.5 percent at September 30, 2021, an increase of 10 basis points compared to December 31, 2020. The increase in coverage and decrease in allowance were primarily driven by the overall decrease in total receivables. 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 nine months of 2020. We have started to see 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 majority of the write-offs during the nine months ended September 30, 2021 related to receivables which had been previously reserved.

Global Financing Receivables and Allowances

The following table presents external Global Financing receivables excluding immaterial miscellaneous receivables.


	At September 30,			At December 31,
(Dollars in millions)	2021			2020
Amortized cost *	$	12,426		$	18,264
Specific allowance for credit losses		167			184
Unallocated allowance for credit losses		40			79
Total allowance for credit losses		207			263
Net financing receivables	$	12,219		$	18,001
Allowance for credit losses coverage		1.7	%		1.4	%

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

The percentage of Global Financing receivables reserved increased from 1.4 percent at December 31, 2020, to 1.7 percent at September 30, 2021, primarily driven by the decline in amortized cost.

Roll Forward of Global Financing Receivables Allowance for Credit Losses


(Dollars in millions)
January 1, 2021		Additions / (Releases)*		Write-offs **		Other +		September 30, 2021
$	263	$	(38)	$	(14)	$	(4)	$	207

Additions/(Releases) for Allowance for Credit Losses are recorded in expense.

**Refer to note A, “Significant Accounting Policies,” in our 2020 Annual Report for additional information regarding allowance for credit loss write-offs.

+ Primarily represents translation adjustments.

Management Discussion – (continued)

Global Financing’s expected credit loss expense (including impacts from off-balance sheet commitments which are recorded in other liabilities) was a release of $18 million and $47 million for the three and nine months ended September 30, 2021, respectively, compared to an addition of $5 million and $44 million for the three and nine months ended September 30, 2020, respectively. The decreases in both periods in 2021 were primarily driven by lower unallocated reserves in Americas and EMEA.

Noncurrent Assets and Liabilities


	At September 30,		At December 31,
(Dollars in millions)	2021		2020
Noncurrent assets	$	114,248	$	116,806
Long-term debt	$	46,926	$	54,355
Noncurrent liabilities (excluding debt)	$	39,100	$	41,020

Noncurrent assets decreased $2,558 million ($815 million adjusted for currency) due to:

	●	A decrease in long-term financing receivables of $2,040 million ($1,848 million adjusted for currency) as a result of reductions from seasonally higher year-end balances and sales of receivables;

	●	A decrease in net property, plant and equipment of $901 million ($674 million adjusted for currency); and

	●	A decrease of $992 million ($579 million adjusted for currency) in total operating right-of-use assets, deferred taxes and investments and sundry assets; partially offset by

	●	An increase in goodwill and net intangible assets of $990 million ($1,744 million adjusted for currency) due to additions from new acquisitions, partially offset by intangibles amortization; and

	●	An increase in prepaid pension assets of $588 million ($689 million adjusted for currency).

Long-term debt decreased $7,429 million ($6,528 million adjusted for currency) due to:

	●	Reclassifications to short-term debt of $5,434 million to reflect upcoming maturities; and

	●	Early redemption of IBM Credit debt of $1,250 million.

Noncurrent liabilities (excluding debt) decreased $1,919 million ($794 million adjusted for currency) due to:

	●	A decrease in retirement and nonpension postretirement benefit obligations of $1,483 million ($831 million adjusted for currency); and

	●	A decrease in long-term operating lease liabilities of $382 million ($277 million adjusted for currency) related primarily to real estate leases; partially offset by

	●	An increase in other liabilities of $282 million ($535 million adjusted for currency) related primarily to income tax reserves related to the separation of Kyndryl.

Management Discussion – (continued)

Debt

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


	At September 30,		At December 31,
(Dollars in millions)	2021		2020
Total company debt	$	54,501	$	61,538
Total Global Financing segment debt	$	15,868	$	21,167
Debt to support external clients		12,677		17,819
Debt to support internal clients		3,191		3,348
Non-Global Financing debt	$	38,633	$	40,371

Total debt of $54,501 million decreased $7,037 million ($6,125 million adjusted for currency) from December 31, 2020, driven by debt maturities and early retirements of $7,301 million. Total debt has decreased $18,538 million since the end of the second quarter 2019 (immediately preceding the Red Hat acquisition).

Non-Global Financing debt of $38,633 million decreased $1,739 million ($1,151 million adjusted for currency) from December 31, 2020 due to scheduled debt maturities in the first nine months of 2021.

Global Financing debt of $15,868 million decreased $5,298 million ($4,974 million adjusted for currency) from December 31, 2020, primarily due to lower funding requirements associated with financing receivables. 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.

Global Financing provides financing predominantly for the company’s external client assets, as well as for assets under contract by other IBM units. These assets, primarily for Global Technology Services, generate long-term, stable revenue streams similar to the Global Financing asset portfolio. Based on their attributes, these Global Technology Services assets are leveraged with the balance of the Global Financing asset base. Global Financing's funding of the Global Technology Services assets supporting the managed infrastructure services unit will wind down with the separation of Kyndryl as Global Financing refocuses its portfolio to support IBM's hybrid cloud platform and AI capabilities.

The debt used to fund Global 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 Global Financing debt-to-equity ratio remained at 9.0 to 1 at September 30, 2021.

We measure Global Financing as a stand-alone entity, and accordingly, interest expense relating to debt supporting Global Financing’s external client and internal business is included in the “Global Financing Results of Operations” on pages 88 to 89 and in note 4, “Segments.” In the Consolidated Income Statement, the external debt-related interest expense supporting Global Financing’s internal financing to the company is reclassified from cost of financing to interest expense.

Equity

Total equity increased $1,630 million from December 31, 2020, primarily due to an increase from net income of $3,410 million, an increase in accumulated other comprehensive income of $2,035 million mainly due to retirement-related benefit plans of $1,469 million and cash flow hedge derivatives of $407 million, partially offset by dividends paid of $4,395 million.

Management Discussion – (continued)

Cash Flow

Our cash flows from operating, investing and financing activities, as reflected in the Consolidated Statement of Cash Flows on page 7, are summarized in the following table. These amounts include the cash flows associated with the Global Financing business.


(Dollars in millions)
For the nine months ended September 30:	2021		2020
Net cash provided by/(used in) continuing operations:
Operating activities	$	10,252	$	12,337
Investing activities		(5,300)		(2,470)
Financing activities		(10,662)		(3,428)
Effect of exchange rate changes on cash, cash equivalents and restricted cash		(159)		(200)
Net change in cash, cash equivalents and restricted cash	$	(5,868)	$	6,239

Net cash provided by operating activities decreased $2,085 million as compared to the first nine months of 2020 driven primarily by:

	●	A decrease in cash provided by receivables of $1,463 million primarily driven by business volume;

	●	An increase in workforce rebalancing payments of $802 million; and

	●	A decrease in payroll tax and value-added tax deferrals of approximately $660 million primarily driven by prior-year tax relief under the U.S. CARES Act and other non-U.S. government assistance programs related to COVID-19; partially offset by

	●	Performance-related improvements within net income;

	●	A net decrease in cash payments for income taxes of $296 million primarily due to a withholding tax payment on intercompany dividends in the second quarter of 2020; and

	●	A decrease in interest payments on debt of approximately $260 million.

Net cash used in investing activities increased $2,830 million as compared to the first nine months of 2020 driven by:

	●	An increase in cash used for acquisitions of $2,981 million to enhance our hybrid cloud and AI software capabilities and to add skills in strategic GBS ecosystem partners; and

	●	A decrease in cash provided by divestitures of $483 million; partially offset by

	●	A decrease in cash used for net capital expenditures of $407 million.

Net cash used in financing activities increased $7,234 million driven primarily by:

	●	A decrease in net cash provided by debt transactions of $7,153 million primarily driven by a higher level of net additions in the prior year; partially offset by a lower level of maturities in the current year.

Management Discussion – (continued)

Looking Forward

Hybrid Cloud and AI Progress

On November 3, 2021, IBM took an important step in advancing its focus on hybrid cloud and AI with the separation of Kyndryl. The separation of Kyndryl creates two industry-leading companies, which will continue to have a strong commercial relationship. Both IBM and Kyndryl will 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 will also enable 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. The separation of Kyndryl is just one of many actions we are taking to focus our business on hybrid cloud and AI and to improve our financial profile.

IBM is addressing the hybrid cloud and AI opportunity with a platform-centric approach. Effective immediately prior to the separation of Kyndryl, the company made a number of changes to its organizational structure and management system. Our new management structure will reflect four reportable segments: Software, Consulting, Infrastructure and Financing. These segment changes align our operating model to our platform-centric approach, reflect a simpler and more streamlined business and will provide greater transparency into segment trends. These changes will impact our reportable segments beginning in the fourth quarter of 2021 but will not impact our Consolidated Financial Statements.

Across every industry, enterprises are using technology to redesign business processes. These digital transformations are enabled by a hybrid cloud environment. Our platform-centric approach is designed to meet clients wherever they are in their journey. The platform we have built is open, secure, and flexible and continues to gain traction in the marketplace. More clients are leveraging our platform capability and our expertise to unlock business value. As of the end of the third quarter, we have more than 3,500 clients using our hybrid cloud platform. This not only fuels our Red Hat revenue performance, but also provides a solid base for the multiplier effect across our software and services. GBS (IBM Consulting post segment change) is helping to drive this platform adoption, and had over 180 new Red Hat engagements in the third quarter. We work alongside our clients to co-create business products and solutions, and have done more than 4,000 Garage engagements as of the third quarter 2021. There is tremendous opportunity for us to help our clients become digital businesses. This is what we have built our platform for and why we have such confidence in our strategy.

To accelerate our strategy, we are taking decisive steps and making the necessary investments to strengthen our portfolio. We continue to leverage our ecosystem to bring joint solutions to market, and to accelerate client transformations. We are investing organically and inorganically to deliver innovation. During the third quarter of 2021, we announced new products in Software and Systems to further differentiate our hybrid cloud and AI capabilities. We are increasing investments in R&D to deliver innovations in our hybrid cloud platform, AI and emerging technologies like quantum. To complement these organic investments, we completed three acquisitions in the third quarter, enhancing our hybrid cloud consulting capabilities. We continue to aggressively hire, bringing in technical talent in Red Hat and highly skilled expertise in consulting. We are scaling resources in our garages to provide a more experiential consulting and sales approach and adding client success managers to help clients get the most value out of their IBM solutions.

With the actions we have taken to simplify our operating model, the fundamentals of our business model remain solid. Our balance sheet and liquidity position remain strong. At September 30, 2021, we had $8.4 billion of cash and cash equivalents, restricted cash and marketable securities. We have made good progress in deleveraging, while being acquisitive and without sacrificing investments in our business or our solid dividend policy. We have reduced our debt by $7.0 billion since the end of 2020 and $18.5 billion from our peak level at June 30, 2019 (immediately preceding the Red Hat acquisition).

The fourth quarter of 2021 is a major milestone as we transition to the future IBM. We continue to take prudent actions to improve our operating model and accelerate our strategy. We are optimizing our portfolio, increasing our focus and agility to better serve clients and we are generating strong free cash flow to enable our investments while

Management Discussion – (continued)

providing shareholder returns. We are managing for the long-term and are confident in the direction and focus of our business. We expect to continue our progress as a leading hybrid cloud and AI company with a focus on revenue growth and cash generation while maintaining a strong dividend policy.

Retirement-Related Plans

Our pension plans are well funded. Contributions for all retirement-related plans are expected to be approximately $2.3 billion in 2021, an increase of approximately $100 million compared to 2020, of which $0.2 billion generally relates to legally required contributions to non-U.S. defined benefit and multi-employer plans. We expect 2021 pre-tax retirement-related plan cost to be approximately $2.9 billion, an increase of approximately $300 million compared to 2020. This estimate reflects current pension plan assumptions at December 31, 2020. Within total retirement-related plan cost, operating retirement-related plan cost is expected to be approximately $1.5 billion, approximately flat versus 2020. Non-operating retirement-related plan cost is expected to be approximately $1.4 billion, an increase of approximately $300 million compared to 2020, primarily driven by lower income from expected return on assets.

Currency Rate Fluctuations

Changes in the relative values of non-U.S. currencies to the U.S. dollar (USD) affect our financial results and financial position. At September 30, 2021, currency changes resulted in assets and liabilities denominated in local currencies being translated into fewer dollars than at year-end 2020. We use financial hedging instruments to limit specific currency risks related to financing transactions and other foreign currency-based transactions.

During periods of sustained movements in currency, the marketplace and competition adjust to the changing rates. For example, when pricing offerings in the marketplace, we may use some of the advantage from a weakening U.S. dollar to improve our position competitively, and price more aggressively to win the business, essentially passing on a portion of the currency advantage to our customers. Competition will frequently take the same action. Consequently, we believe that some of the currency-based changes in cost impact the prices charged to clients. We also maintain currency hedging programs for cash management purposes which temporarily mitigate, but do not eliminate, the volatility of currency impacts on our financial results.

We translate revenue, cost and expense in our non-U.S. operations at current exchange rates in the reported period. References to “adjusted for currency” or “constant currency” reflect adjustments based upon a simple mathematical formula. However, this constant currency methodology that we utilize to disclose this information does not incorporate any operational actions that management could take to mitigate fluctuating currency rates. Currency movements impacted our year-to-year revenue and earnings per share growth in the first nine months of 2021. Based on the currency rate movements in the first nine months of 2021, total revenue increased 1.6 percent as reported but decreased 1.1 percent at constant currency versus the first nine months of 2020. On an income from continuing operations before income tax basis, these translation impacts, mitigated by the net impact of hedging activities, resulted in a theoretical maximum (assuming no pricing or sourcing actions) increase of approximately $200 million in the first nine months of 2021 on an as-reported basis and an increase of approximately $240 million on an operating (non-GAAP) basis. The same mathematical exercise resulted in an increase of approximately $270 million in the first nine months of 2020 on both an as-reported basis and operating (non-GAAP) basis. We view these amounts as a theoretical maximum impact to our as-reported financial results. Considering the operational responses mentioned above, movements of exchange rates, and the nature and timing of hedging instruments, it is difficult to predict future currency impacts on any particular period, but we believe it could be substantially less than the theoretical maximum given the competitive pressure in the marketplace.

For non-U.S. subsidiaries and branches that operate in U.S. dollars or whose economic environment is highly inflationary, translation adjustments are reflected in results of operations. Generally, we manage currency risk in these entities by linking prices and contracts to U.S. dollars.

Management Discussion – (continued)

Liquidity and Capital Resources

In our 2020 Annual Report, on pages 56 to 58, there is a discussion of our liquidity including two tables that present three years of data. The table presented on page 56 includes net cash from operating activities, cash and cash equivalents, restricted cash and short-term marketable securities, and the size of our global credit facilities for each of the past three years. For the nine months ended, or at, as applicable, September 30, 2021, those amounts are $10.3 billion of net cash from operating activities, $8.4 billion of cash and cash equivalents, restricted cash and short-term marketable securities and $10.0 billion in global credit facilities, respectively. While we have no current plans to draw on these credit facilities, they are available as back-up liquidity.

On July 9, 2019, we closed the acquisition of Red Hat for cash consideration of $34.8 billion. The transaction was funded through a combination of cash on hand and proceeds from debt issuances. In order to reduce this debt and return to target leverage ratios within a couple of years, we suspended our share repurchase program at the time of the Red Hat acquisition closing.

The major rating agencies' ratings on our debt securities at September 30, 2021 appear in the following table.


	STANDARD	MOODY’S
	AND	INVESTORS
IBM RATINGS:	POOR’S	SERVICE
Senior long-term debt	A-	A2
Commercial paper	A-2	Prime-1

In October 2021, Moody's downgraded our long-term debt rating from A2 to A3 and our commercial paper rating from Prime-1 to Prime-2. IBM has ample financial flexibility, supported by our strong liquidity position and cash flows, to operate at a single A credit rating. Debt levels have decreased $7.0 billion from December 31, 2020 and $18.5 billion from our peak levels at June 30, 2019 (immediately preceding the Red Hat acquisition) and we will continue to deleverage throughout 2021 utilizing our debt maturities schedule.

We do not have “ratings trigger” provisions in our debt covenants or documentation, which would allow the holders to declare an event of default and seek to accelerate payments thereunder in the event of a change in credit rating. Our debt covenants are well within the required levels. Our contractual agreements governing derivative instruments contain standard market clauses which can trigger the termination of the agreement if our credit rating were to fall below investment grade. At September 30, 2021, the fair value of those instruments that were in a liability position was $149 million, before any applicable netting, and this position is subject to fluctuations in fair value period to period based on the level of our outstanding instruments and market conditions. We have no other contractual arrangements that, in the event of a change in credit rating, would result in a material adverse effect on our financial position or liquidity.

In July 2017, the UK's Financial Conduct Authority (FCA), which regulates the London Interbank Offered Rate (LIBOR), announced that it intends to phase out LIBOR by the end of 2021. In March 2021, the FCA announced an extension of the phase out in the case of U.S. dollar settings for certain tenors until the end of June 2023. Various central bank committees and working groups continue to discuss replacement of benchmark rates, the process for amending existing LIBOR-based contracts, and the potential economic impacts of different alternatives. The Alternative Reference Rates Committee has identified the Secured Overnight Financing Rate (SOFR) as its preferred alternative rate for USD LIBOR. SOFR is a measure of the cost of borrowing cash overnight, collateralized by U.S. Treasury securities, and is based on directly observable U.S. Treasury-backed repurchase transactions. We have evaluated the replacement of the LIBOR benchmark interest rate, including risk management and internal operational readiness and we are monitoring the FASB standard-setting process to address financial reporting issues that might arise in connection with transition from LIBOR to a new benchmark rate. However, it is not expected to have a material impact in the consolidated financial results.

We prepare our Consolidated Statement of Cash Flows in accordance with applicable accounting standards for cash flow presentation on page 7 of this Form 10-Q and highlight causes and events underlying sources and uses of cash in

Management Discussion – (continued)

that format on page 83. For the purpose of running its business, IBM manages, monitors and analyzes cash flows in a different manner.

Management uses free cash flow as a measure to evaluate its operating results, plan shareholder return levels, strategic investments and assess its ability and need to incur and service debt. The entire free cash flow amount is not necessarily available for discretionary expenditures. We define free cash flow as net cash from operating activities less the change in Global Financing receivables and net capital expenditures, including the investment in software. A key objective of the Global Financing business is to generate strong returns on equity, and our Global Financing receivables are the basis for growth. Accordingly, management considers Global Financing receivables as a profit-generating investment, not as working capital that should be minimized for efficiency. Therefore, management includes presentations of both free cash flow and net cash from operating activities that exclude the effect of Global Financing receivables.

The following is management’s view of cash flows for the first nine months of 2021 and 2020 prepared in a manner consistent with the description above.

Net cash from operating activities and free cash flow in 2021 include significant cash impacts from the workforce rebalancing actions we initiated in the fourth quarter of 2020 and Kyndryl separation-related charges.


(Dollars in millions)
For the nine months ended September 30:	2021		2020
Net cash from operating activities per GAAP	$	10,252	$	12,337
Less: change in Global Financing receivables		5,235		5,324
Net cash from operating activities, excluding Global Financing receivables	$	5,018	$	7,014
Capital expenditures, net		(1,855)		(2,262)
Free cash flow	$	3,162	$	4,751
Acquisitions		(3,018)		(37)
Divestitures		26		510
Common stock repurchases for tax withholdings		(252)		(225)
Dividends		(4,395)		(4,343)
Non-Global Financing debt		(1,143)		4,977
Other (includes Global Financing net receivables and Global Financing debt)		(249)		1,111
Change in cash, cash equivalents, restricted cash and short-term marketable securities	$	(5,868)	$	6,744

In the first nine months of 2021, we generated free cash flow of $3.2 billion, a decrease of $1.6 billion versus the prior year. The current-year period includes cash impacts from structural actions we initiated in the fourth quarter of 2020 and separation-related charges in the amount of $1.8 billion. In the first nine months of 2021, we also continued to return value to shareholders with $4.4 billion in dividends.

Events that could temporarily change the historical cash flow dynamics discussed previously and in our 2020 Annual Report include significant changes in operating results, material changes in geographic sources of cash, unexpected adverse impacts from litigation, future pension funding requirements, periods of severe downturn in the capital markets or the timing of tax payments. Whether any litigation has such an adverse impact will depend on a number of variables, which are more completely described in note 13, “Contingencies,” in this Form 10-Q. With respect to pension funding, we expect to make legally mandated pension plan contributions to certain non-U.S. defined benefit plans of approximately $200 million in 2021. Contributions related to all retirement-related plans are expected to be approximately $2.3 billion in 2021. Financial market performance could increase the legally mandated minimum contributions in certain non-U.S. countries that require more frequent remeasurement of the funded status. We are not quantifying any further impact from pension funding because it is not possible to predict future movements in the capital markets or changes in pension plan funding regulations.

In 2021, we are not legally required to make any contributions to the U.S. defined benefit pension plans.

Management Discussion – (continued)

Our cash flows are sufficient to fund our current operations and obligations, including investing and financing activities such as acquisitions, dividends and debt service. When additional requirements arise, we have several liquidity options available. These options may include the ability to borrow additional funds at reasonable interest rates and utilizing our committed global credit facilities. With our share repurchase program suspended since the close of the Red Hat acquisition, our overall shareholder payout remains at a comfortable level and we remain fully committed to our dividend.

Global Financing

Global Financing is a reportable segment that is measured as a stand-alone entity. Global Financing facilitates IBM clients’ acquisition of information technology systems, software and services by providing financing solutions in the areas where the company has the expertise, while generating solid returns on equity.

Results of Operations


					Yr. to Yr.
					Percent/
(Dollars in millions)					Margin
For the three months ended September 30:	2021		2020		Change
External revenue	$	220	$	273	(19.2)	%
Internal revenue		153		208	(26.3)
Total revenue	$	373	$	480	(22.3)	%
Pre-tax income	$	206	$	196	5.1	%


					Yr. to Yr.
					Percent/
(Dollars in millions)					Margin
For the nine months ended September 30:	2021		2020		Change
External revenue	$	702	$	837	(16.2)	%
Internal revenue		581		660	(12.0)
Total revenue	$	1,283	$	1,497	(14.3)	%
Pre-tax income	$	618	$	566	9.1	%

We have refocused our Global Financing business on IBM’s products and services. The wind down of our OEM commercial financing operations is complete. In 2020, we began entering into agreements to sell certain financing receivables to third parties. While these strategic actions continue to impact external revenue and pre-tax income on a year-to-year basis, our repositioning of the Global Financing business has strengthened our liquidity position, improved the quality of our portfolio and lowered our debt needs.

Global Financing total revenue decreased 22.3 percent in the third quarter of 2021 compared to the prior year. External revenue decreased 19.2 percent (20 percent adjusted for currency), driven by external financing (down 25.2 percent to $151 million). Internal revenue was down 26.3 percent primarily due to a decrease in internal used equipment sales (down 22.1 percent to $126 million) which reflects a decrease in sales to GTS.

Global Financing total revenue decreased 14.3 percent in the first nine months of 2021 compared to the same period in 2020. External revenue decreased 16.2 percent (18 percent adjusted for currency), primarily driven by a decline in external financing (down 23.2 percent to $496 million). Internal revenue decreased 12.0 percent primarily driven by a decline in internal financing (down 49.0 percent to $93 million).

For both the three and nine months ended September 30, 2021, the decreases in external financing were due to a lower average asset balance, partially driven by the strategic actions, and the decreases in internal financing were primarily due to a lower average asset balance.

Management Discussion – (continued)

Global Financing pre-tax income increased 5.1 percent to $206 million in the third quarter of 2021 and 9.1 percent to $618 million in the first nine months of 2021, compared to the same periods in 2020. The increase in both periods was primarily driven by improvements in provisions for credit losses, partially offset by a decrease in gross profit which reflects the strategic actions described above.

Return on Equity Calculation


	For Three Months Ended						For Nine Months Ended
	September 30,						September 30,
(Dollars in millions)	2021			2020			2021			2020
Numerator
Global Financing after-tax income*	$	152		$	150		$	454		$	489
Annualized after-tax income (1)	$	610		$	600		$	605		$	651
Denominator
Average Global Financing equity (2)**	$	1,852		$	2,376		$	2,022		$	2,493
Global Financing return on equity (1)/(2)		32.9	%		25.2	%		30.0	%		26.1	%

Calculated based upon an estimated tax rate principally based on Global Financing’s geographic mix of earnings as IBM’s provision for income taxes is determined on a consolidated basis.

** Average of the ending equity for Global Financing for the last two quarters and four quarters, for the three months ended September 30 and for the nine months ended September 30, respectively.

Global Financing return on equity was 32.9 percent for the three months ended September 30, 2021, compared to 25.2 percent for the three months ended September 30, 2020. The increase was driven by a lower average equity balance. Return on equity was 30.0 percent for the nine months ended September 30, 2021, compared to 26.1 percent for the nine months ended September 30, 2020. The increase was driven by a lower average equity balance, partially offset by a decrease in net income, which included a discrete tax benefit of $40 million in the first quarter of 2020.

Management Discussion – (continued)

Financial Position


	At September 30,		At December 31,
(Dollars in millions)	2021		2020
Cash and cash equivalents	$	1,298	$	1,862
Client financing receivables:
Net investment in sales-type and direct financing leases (1)		3,280		4,092
Client loans		8,218		11,498
Total client financing receivables		11,498		15,590
Commercial financing receivables		721		2,411
Other receivables		61		91
Total external receivables (2)		12,280		18,092
Intercompany financing receivables (3) (4)		3,876		3,959
Other assets		1,871		1,162
Total assets	$	19,326	$	25,075

Intercompany payables (3)	$	424	$	303
Debt (5)		15,868		21,167
Other liabilities		1,271		1,254
Total liabilities		17,563		22,723
Total equity		1,763		2,352
Total liabilities and equity	$	19,326	$	25,075

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

(2)	The difference between the year-to-date decrease in total external receivables of $5.8 billion (from $18.1 billion in 2020 to $12.3 billion in 2021) and the $5.2 billion change in Global Financing receivables disclosed in the free cash flow presentation on page 87 is primarily attributable to currency impacts.

(3)	This entire amount is eliminated for purposes of IBM’s consolidated financial results and therefore does not appear in the Consolidated Balance Sheet.

(4)	These assets, along with all other financing assets in this table, are leveraged at the value in the table using Global Financing debt.

(5)	Global Financing debt is primarily composed of intercompany loans.

At September 30, 2021, approximately 66 percent of the total external portfolio was with investment-grade clients with no direct exposure to consumers, an increase of 9 points year to year and an increase of 2 points compared to June 30, 2021. We continue to apply our rigorous credit policies, particularly in industries and countries disrupted by COVID-19, as it relates to the origination of new business. This investment grade percentage is based on the credit ratings of the companies in the portfolio and reflects mitigating credit enhancement actions taken by the client to reduce the risk to IBM.

We have a long-standing practice of taking mitigation actions, in certain circumstances, to transfer credit risk to third parties, with enhanced focus due to current macroeconomic uncertainty. These actions may include credit insurance, financial guarantees, nonrecourse borrowings, transfers of receivables recorded as true sales in accordance with accounting guidance or sales of equipment under operating lease. Sale of receivables arrangements are also utilized in the normal course of business as part of our cash and liquidity management.

For the nine months ended September 30, 2021, we sold $2,970 million of client financing receivables to third parties, consisting of loan and lease receivables of $2,189 million and $781 million, respectively. More than half of the receivables sold were classified as current assets at the time of sale. For the nine months ended September 30, 2020, we sold $1,610 million of client financing receivables to third parties, consisting of loan and lease receivables of $758 million and $852 million, respectively.

In addition, we sold $4,465 million of commercial financing receivables for the nine months ended September 30, 2021, to a third-party investor. We also classified $400 million and $383 million of IBM commercial financing receivables as held for sale at September 30, 2021 and December 31, 2020, respectively, in short-term financing

Management Discussion – (continued)

receivables in the Consolidated Balance Sheet. Payment terms for commercial financing receivables generally range from 30 to 90 days and sales are made to the investor on a revolving basis. We did not have any sales of commercial financing receivables for the nine months ended September 30, 2020.

The transfers of these receivables qualified as true sales and therefore reduced financing receivables. The cash proceeds from the sales are included in cash flows from operating activities, with no impact to free cash flow, and the impacts to the Consolidated Income Statement, including fees and net gain or loss associated with the transfers of these receivables for the nine months ended September 30, 2021 and September 30, 2020, were not material. For additional information relating to the sales of financing receivables refer to note 8, “Financing Receivables.”

Refer to pages 80 through 82 for additional information related to Global Financing receivables, allowance for credit losses and debt.

Residual Value

Residual value is a risk unique to the financing business, and management of this risk is dependent upon the ability to accurately project future equipment values at lease inception. Global Financing has insight into product plans and cycles for IBM products. Based upon this product information, Global Financing continually monitors projections of future equipment values and compares them with the residual values reflected in the portfolio.

Global Financing optimizes the recovery of residual values by selling assets sourced from end of lease, leasing used equipment to new clients, or extending lease arrangements with current clients.

The following table presents the recorded amount of unguaranteed residual value for sales-type and direct financing leases, as well as operating leases at September 30, 2021 and December 31, 2020. In addition, the table presents the run out of when the unguaranteed residual value assigned to equipment on leases at September 30, 2021 and December 31, 2020, is expected to be returned to the company.

Unguaranteed Residual Value


	At		At		Estimated Run Out of September 30, 2021 Balance
	December 31,		September 30,								2024 and
(Dollars in millions)	2020		2021		2021		2022		2023		Beyond
Sales-type and direct financing leases	$	469	$	342	$	31	$	96	$	126	$	90
Operating leases		48		20		12		4		1		2
Total unguaranteed residual value	$	516	$	362	$	43	$	100	$	126	$	92

Management Discussion – (continued)

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.


				Acquisition-			Retirement-			U.S.			Separation-
(Dollars in millions except per share amounts)				Related			Related			Tax Reform			Related			Operating
For the three months ended September 30, 2021:	GAAP			Adjustments			Adjustments			Impacts			Charges			(non-GAAP)
Gross profit	$	8,171		$	184		$	—		$	—		$	108		$	8,463
Gross profit margin		46.4	%		1.0	pts.		—	pts.		—	pts.		0.6	pts.		48.0	%
S,G&A	$	4,860		$	(293)		$	—		$	—		$	(169)		$	4,398
R,D&E		1,621			—			—			—			(1)			1,620
Other (income) and expense		234			(1)			(328)			—			—			(94)
Total expense and other (income)		6,852			(294)			(328)			—			(169)			6,061
Pre-tax income from continuing operations		1,319			478			328			—			277			2,402
Pre-tax margin from continuing operations		7.5	%		2.7	pts.		1.9	pts.		—	pts.		1.6	pts.		13.6	%
Provision for income taxes*	$	188		$	103		$	57		$	—		$	(233)		$	115
Effective tax rate		14.3	%		1.5	pts.		0.4	pts.		—	pts.		(11.4)	pts.		4.8	%
Income from continuing operations	$	1,130		$	375		$	271		$	—		$	510		$	2,286
Income margin from continuing operations		6.4	%		2.1	pts.		1.5	pts.		—	pts.		2.9	pts.		13.0	%
Diluted earnings per share from continuing operations	$	1.25		$	0.41		$	0.30		$	—		$	0.56		$	2.52


				Acquisition-			Retirement-			U.S.			Separation-
(Dollars in millions except per share amounts)				Related			Related			Tax Reform			Related			Operating
For the three months ended September 30, 2020:	GAAP			Adjustments			Adjustments			Impacts			Charges			(non-GAAP)
Gross profit	$	8,430		$	180		$	—		$	—		$	—		$	8,610
Gross profit margin		48.0	%		1.0	pts.		—	pts.		—	pts.		—	pts.		49.0	%
S,G&A	$	4,647		$	(279)		$	—		$	—		$	—		$	4,367
R,D&E		1,515			—			—			—			—			1,515
Other (income) and expense		253			(1)			(291)			—			—			(39)
Total expense and other (income)		6,603			(280)			(291)			—			—			6,032
Pre-tax income from continuing operations		1,827			460			291			—			—			2,578
Pre-tax margin from continuing operations		10.4	%		2.6	pts.		1.7	pts.		—	pts.		—	pts.		14.7	%
Provision for income taxes*	$	128		$	102		$	54		$	(21)		$	—		$	263
Effective tax rate		7.0	%		2.7	pts.		1.3	pts.		(0.8)	pts.		—	pts.		10.2	%
Income from continuing operations	$	1,698		$	358		$	237		$	21		$	—		$	2,315
Income margin from continuing operations		9.7	%		2.0	pts.		1.4	pts.		0.1	pts.		—	pts.		13.2	%
Diluted earnings per share from continuing operations	$	1.89		$	0.40		$	0.26		$	0.03		$	—		$	2.58

The tax impact on operating (non-GAAP) pre-tax income from continuing operations is calculated under the same accounting principles applied to the GAAP pre-tax income which employs an annual effective tax rate method to the results.

Management Discussion – (continued)


				Acquisition-			Retirement-			U.S.			Separation-
(Dollars in millions except per share amounts)				Related			Related			Tax Reform			Related			Operating
For the nine months ended September 30, 2021:	GAAP			Adjustments			Adjustments			Impacts			Charges			(non-GAAP)
Gross profit	$	25,379		$	540		$	—		$	—		$	168		$	26,087
Gross profit margin		46.9	%		1.0	pts.		—	pts.		—	pts.		0.3	pts.		48.2	%
S,G&A	$	15,368		$	(884)		$	—		$	—		$	(343)		$	14,141
R,D&E		4,907			—			—			—			(1)			4,906
Other (income) and expense		911			(2)			(998)			—			—			(90)
Total expense and other (income)		21,603			(886)			(998)			—			(344)			19,374
Pre-tax income from continuing operations		3,776			1,426			998			—			513			6,713
Pre-tax margin from continuing operations		7.0	%		2.6	pts.		1.8	pts.		—	pts.		0.9	pts.		12.4	%
Provision for income taxes*	$	365		$	344		$	185		$	6		$	(174)		$	725
Effective tax rate		9.7	%		3.1	pts.		1.3	pts.		0.1	pts.		(3.3)	pts.		10.8	%
Income from continuing operations	$	3,411		$	1,082		$	813		$	(6)		$	687		$	5,988
Income margin from continuing operations		6.3	%		2.0	pts.		1.5	pts.		0.0	pts.		1.3	pts.		11.1	%
Diluted earnings per share from continuing operations	$	3.77		$	1.20		$	0.90		$	(0.01)		$	0.76		$	6.62


				Acquisition-			Retirement-			U.S.			Separation-
(Dollars in millions except per share amounts)				Related			Related			Tax Reform			Related			Operating
For the nine months ended September 30, 2020:	GAAP			Adjustments			Adjustments			Impacts			Charges			(non-GAAP)
Gross profit	$	25,052		$	556		$	—		$	—		$	—		$	25,608
Gross profit margin		47.0	%		1.0	pts.		—	pts.		—	pts.		—	pts.		48.1	%
S,G&A	$	15,849		$	(849)		$	—		$	—		$	—		$	15,000
R,D&E		4,722			—			—			—			—			4,722
Other (income) and expense		614			(2)			(829)			—			—			(217)
Total expense and other (income)		21,704			(851)			(829)			—			—			20,024
Pre-tax income from continuing operations		3,348			1,407			829			—			—			5,584
Pre-tax margin from continuing operations		6.3	%		2.6	pts.		1.6	pts.		—	pts.		—	pts.		10.5	%
Provision for (benefit from) income taxes*	$	(888)		$	312		$	119		$	128		$	—		$	(329)
Effective tax rate		(26.5)	%		12.3	pts.		6.1	pts.		2.3	pts.		—	pts.		(5.9)	%
Income from continuing operations	$	4,237		$	1,095		$	710		$	(128)		$	—		$	5,913
Income margin from continuing operations		8.0	%		2.1	pts.		1.3	pts.		(0.2)	pts.		—	pts.		11.1	%
Diluted earnings per share from continuing operations	$	4.72		$	1.23		$	0.79		$	(0.14)		$	—		$	6.60

The tax impact on operating (non-GAAP) pre-tax income from continuing operations is calculated under the same accounting principles applied to the GAAP pre-tax income which employs an annual effective tax rate method to the results.

Management Discussion – (continued)

Forward-Looking and Cautionary Statements

Except for the historical information and discussions contained herein, statements contained in this Form 10-Q may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based on the company’s current assumptions regarding future business and financial performance. These statements involve a number of risks, uncertainties and other factors that could cause actual results to differ materially, including, but not limited to, the following: a downturn in economic environment and client spending budgets; a failure of the company’s innovation initiatives; damage to the company’s reputation; risks from investing in growth opportunities; failure of the company’s intellectual property portfolio to prevent competitive offerings and the failure of the company to obtain necessary licenses; the possibility of disruption or unanticipated costs in connection with the separation of Kyndryl or the possibility that the separation will not achieve its intended benefits; the company’s ability to successfully manage acquisitions, alliances and dispositions, including integration challenges, failure to achieve objectives, the assumption of liabilities, and higher debt levels; fluctuations in financial results; impact of local legal, economic, political, health and other conditions; the company’s failure to meet growth and productivity objectives; ineffective internal controls; the company’s use of accounting estimates; impairment of the company’s goodwill or amortizable intangible assets; the company’s ability to attract and retain key employees and its reliance on critical skills; impacts of relationships with critical suppliers; product quality issues; impacts of business with government clients; reliance on third party distribution channels and ecosystems; cybersecurity and data privacy considerations; adverse effects from environmental matters, tax matters; legal proceedings and investigatory risks; the company’s pension plans; currency fluctuations and customer financing risks; impact of changes in market liquidity conditions and customer credit risk on receivables; risk factors related to IBM securities; and other risks, uncertainties and factors discussed in the company’s Form 10-Qs, Form 10-K and in the company’s other filings with the U.S. Securities and Exchange Commission or in materials incorporated therein by reference. Any forward-looking statement in this Form 10-Q speaks only as of the date on which it is made. Except as required by law, the company assumes no obligation to update or revise any forward-looking statements.

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