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 MONTHS ENDED MARCH 31, 2022

Snapshot

Financial Results Summary — Three Months Ended March 31:


							Yr. to Yr.
							Percent/
(Dollars and shares in millions except per share amounts)							Margin
For the three months ended March 31:	2022			2021			Change
Revenue	$	14,197		$	13,187		7.7	%*
Gross profit margin		51.7	%		53.3	%	(1.6)	pts.
Total expense and other (income)	$	6,712		$	6,784		(1.1)	%
Income from continuing operations before income taxes	$	623		$	244		156.0	%
Provision for/(benefit from) income taxes from continuing operations	$	(39)		$	(160)		(75.5)	%
Income from continuing operations	$	662		$	403		64.3	%
Income from continuing operations margin		4.7	%		3.1	%	1.6	pts.
Income from discontinued operations, net of tax	$	71		$	552		(87.2)	%
Net income	$	733		$	955		(23.3)	%
Earnings per share from continuing operations - assuming dilution	$	0.73		$	0.45		62.2	%
Consolidated earnings per share - assuming dilution	$	0.81		$	1.06		(23.6)	%
Weighted-average shares outstanding - assuming dilution		909.2			901.7		0.8	%

	At 3/31/2022			At 12/31/2021
Assets	$	133,275		$	132,001		1.0	%
Liabilities	$	114,162		$	113,005		1.0	%
Equity	$	19,112		$	18,996		0.6	%

10.9 percent adjusted for currency.

Organization of Information:

On November 3, 2021, the company completed the separation of its managed infrastructure services unit into a new public company with the distribution of 80.1 percent of the outstanding common stock of Kyndryl Holdings, Inc. (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. The company 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. The company accounts for the retained Kyndryl common stock as a fair value investment included within prepaid expenses and other current assets in the Consolidated Balance Sheet with subsequent fair value changes included in other (income) and expense in the Consolidated Income Statement.

The accounting requirements for reporting the separation of Kyndryl as a discontinued operation were met when the separation was completed. Accordingly, the historical results of Kyndryl are presented as discontinued operations and, as such, have been excluded from continuing operations and segment results for all periods presented. Consolidated diluted earnings per share includes the results of discontinued operations. Refer to note 3, “Separation of Kyndryl,” for additional information.

In the first quarter of 2022, the company realigned its management structure to reflect the planned divestiture of its healthcare data and analytics assets. This change impacted the company’s Software segment and Other–divested businesses category. In the fourth quarter of 2021, immediately prior to the separation of Kyndryl, the company made a

Management Discussion – (continued)

number of changes to its organizational structure and management system. These changes impacted the company’s reportable segments but did not impact the Consolidated Financial Statements. Refer to note 5, “Segments,” for additional information on the company’s reportable segments. The segments are reported on a comparable basis for all periods.

To provide useful decision-making information for management and shareholders, the company defines and measures hybrid cloud revenue as end-to-end cloud capabilities within hybrid cloud environments, which includes technology (software and hardware), services and solutions to enable clients to implement cloud solutions across public, private and multi-clouds. The definition of hybrid cloud revenue is consistent with the prior methodology for cloud revenue historically presented. This spans across IBM’s Consulting, Software and Infrastructure segments. Examples include (but are not limited to) Red Hat Enterprise Linux (RHEL), Red Hat OpenShift, Cloud Paks, as-a-service offerings, service engagements related to cloud deployment of technology and applications, and infrastructure used in cloud deployments.

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 of its 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.

Operating (non-GAAP) Earnings:

In an effort to provide better transparency into the operational results of the business, supplementally, management separates business results into operating and non-operating categories. Operating earnings from continuing operations is a non-GAAP measure that excludes the effects of certain acquisition-related charges, intangible asset amortization, expense resulting from basis differences on equity method investments, retirement-related costs, certain impacts from the Kyndryl separation and 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 related to the Kyndryl separation as non-operating given their unique and non-recurring nature. These charges primarily relate to any unrealized gains or losses on Kyndryl common stock which are recorded in other (income) and expense in the Consolidated Income Statement. The unrealized gains or losses reflect fair value changes in the shares that were retained by the company immediately following the separation, with the intent to dispose of such shares within twelve months after the distribution. For acquisitions, operating (non-GAAP) earnings exclude the amortization of purchased intangible assets and acquisition-related charges such as in-process research and development, transaction costs, applicable retention, restructuring and related expenses, tax charges related to acquisition integration and pre-closing charges, such as financing costs. These charges are excluded as they may be inconsistent in amount and timing from period to period and are significantly impacted by the size, type and frequency of the company’s acquisitions. All other spending for acquired companies is included in both earnings from continuing operations and in operating (non-GAAP) earnings. Throughout the Management Discussion, the impact of acquisitions over the prior 12 month period may be a driver of higher expense year to year. For retirement-related costs, management characterizes certain items as operating and others as non-operating, consistent with GAAP. We include defined benefit plan and nonpension postretirement benefit plan service costs, multi-employer plan costs and the cost of defined contribution plans in operating earnings. Non-operating retirement-related costs include defined benefit plan and nonpension postretirement benefit plan amortization of prior

Management Discussion – (continued)

service costs, interest cost, expected return on plan assets, amortized actuarial gains/losses, the impacts of any plan curtailments/settlements and pension insolvency costs and other costs. Non-operating retirement-related costs are primarily related to changes in pension plan assets and liabilities which are tied to financial market performance, and the company considers these costs to be outside of the operational performance of the business.

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

The following table provides the company’s operating (non-GAAP) earnings for the first quarter of 2022 and 2021.


					Yr. to Yr.
(Dollars in millions except per share amounts)					Percent
For the three months ended March 31:	2022		2021		Change
Net income as reported	$	733	$	955	(23.3)	%
Income from discontinued operations, net of tax		71		552	(87.2)
Income from continuing operations	$	662	$	403	64.3	%
Non-operating adjustments (net of tax):
Acquisition-related charges	$	359	$	330	8.5	%
Non-operating retirement-related costs/(income)		144		299	(51.8)
U.S. tax reform impacts		(116)		(19)	nm
Kyndryl-related impacts		222		—	nm
Operating (non-GAAP) earnings*	$	1,271	$	1,013	25.5	%
Diluted operating (non-GAAP) earnings per share*	$	1.40	$	1.12	25.0	%

Refer to page 74 for a more detailed reconciliation of net income to operating earnings.

nm - not meaningful

Macroeconomic Environment:

The geopolitical situation in Eastern Europe intensified in February 2022, with Russia’s invasion of Ukraine. The safety and security of our employees and their families in the impacted regions remains our primary focus. Since February 2022, we have been providing our employees with relocation assistance, financial support and other forms of direct engagement. IBM employees from around the world have mobilized and are participating in multiple volunteer initiatives, showcasing the best of IBM values and culture.

The Russian war in Ukraine resulted in the U.S., UK, and the European Union member governments, among others, placing economic sanctions on numerous Russian entities, specific Russian-controlled entities, as well as Belarus. On March 7, 2022, IBM announced the suspension of business activities in Russia. For the period ended March 31, 2022, we assessed certain accounting-related matters that generally require consideration of current information reasonably available to us and forecasted financial data in the context of unknown future impacts to IBM as a result of the suspension of this business. These assessments did not result in any material impacts to our consolidated financial results as of and for the quarter ended March 31, 2022. We will continue to assess these matters in future periods. The long-term impacts of the Russian war in Ukraine remain uncertain; however, we do not expect a significant impact on the company’s future results of operations or financial position. For full year 2021, Russia, Ukraine and Belarus made up less than one percent of the company’s full year revenue. While the revenue impact is not expected to be material to total consolidated IBM revenue for the full year 2022, the business in Russia has historically been high margin and therefore, would result in a headwind to our profit and cash flows.

Management Discussion – (continued)

In the third year of the COVID-19 pandemic, our priority continues to be the health of IBM employees, our clients, business partners and community. The pandemic has 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 spending environment continues to improve, and we remain focused on providing the technology and consulting services that our clients need to accelerate their digital organizations and emerge from the pandemic even stronger.

Financial Performance Summary — Three Months Ended March 31:

In the first quarter of 2022, we reported $14.2 billion in revenue, income from continuing operations of $0.7 billion and operating (non-GAAP) earnings of $1.3 billion. Diluted earnings per share from continuing operations was $0.73 as reported and $1.40 on an operating (non-GAAP) basis. On a consolidated basis, we generated $3.2 billion in cash from operations and $1.2 billion in free cash flow and delivered shareholder returns of $1.5 billion in dividends. These results reflect progress in our key growth areas as we continue to see a strong demand environment for both our technology and consulting. We continued to increase investments in innovation, our ecosystem and talent and our balance sheet provides us with the flexibility to support our business needs.

Total revenue grew 7.7 percent as reported and 11 percent adjusted for currency compared to the prior-year period. This includes incremental sales to Kyndryl which contributed over 5 points to the revenue growth. Software delivered strong revenue growth of 12.3 percent as reported and 15 percent adjusted for currency, including over 8 points of growth from incremental sales to Kyndryl. Hybrid Platform & Solutions increased 7.4 percent as reported and 10 percent adjusted for currency, with incremental sales to Kyndryl contributing approximately 1.5 points of this growth. Revenue growth was led by strong double-digit growth in Red Hat. Transaction Processing grew 26.5 percent as reported and 31 percent adjusted for currency, including approximately 28 points of growth from incremental Kyndryl sales. Consulting revenue increased 13.3 percent as reported and 17 percent adjusted for currency, with a strong demand profile and growth across all three business areas. Infrastructure revenue decreased 2.3 percent year to year as reported and was flat adjusted for currency, with the overall decline in revenue reflecting our product cycle dynamics. This performance also includes over 8 points of growth from incremental sales to Kyndryl. Across the segments, total hybrid cloud revenue of $5.0 billion in the first quarter of 2022 grew 14 percent as reported and 17 percent adjusted for currency.

From a geographic perspective, Americas revenue grew 8.9 percent year to year as reported (9 percent adjusted for currency). Europe/Middle East/Africa (EMEA) increased 7.7 percent (14 percent adjusted for currency). Asia Pacific grew 4.6 percent (11 percent adjusted for currency).

Gross margin of 51.7 percent decreased 1.6 points year to year, however, gross profit dollars grew compared to the prior-year period. Overall, gross margin was impacted by the significant investments we are making to drive our hybrid cloud and AI strategy and due to mix from our Infrastructure product cycles. These impacts were partially offset by improvement in the Software gross margin. Operating (non-GAAP) gross margin of 52.9 percent decreased 1.7 points versus the prior year for similar reasons.

Total expense and other (income) decreased 1.1 percent in the first quarter of 2022 versus the prior-year period primarily driven by the effects of currency, lower non-operating retirement-related costs and lower workforce rebalancing charges, partially offset by an unrealized loss on Kyndryl retained shares and higher spending reflecting our continuing investment in innovation, our ecosystem and talent, both organically and through acquisitions. We are aggressively hiring to better serve clients, while increasing our research spend to deliver innovation in AI, hybrid cloud and emerging areas such as quantum. Total operating (non-GAAP) expense and other (income) decreased 2.6 percent year to year, driven primarily by the factors described above excluding the lower non-operating retirement-related costs and the unrealized loss on Kyndryl shares.

Pre-tax income from continuing operations of $0.6 billion increased 156.0 percent and pre-tax margin was 4.4 percent, an increase of 2.5 points versus the first quarter of 2021. The continuing operations benefit from income taxes in the first quarter of 2022 was $39 million compared to a $160 million benefit in the first quarter of 2021. The current-year benefit was driven by many factors including the impacts of recently published foreign tax credit regulations,

Management Discussion – (continued)

geographical mix of income, incentives and changes in unrecognized tax benefits. The prior-year benefit was primarily related to the tax impacts from the resolution of certain tax audits. Net income from continuing operations of $0.7 billion increased 64.3 percent and the net income from continuing operations margin was 4.7 percent, up 1.6 points year to year.

Operating (non-GAAP) pre-tax income from continuing operations of $1.5 billion increased 45.9 percent and the operating (non-GAAP) pre-tax margin from continuing operations increased 2.8 points to 10.7 percent. The operating (non-GAAP) income tax provision for the first quarter of 2022 was $244 million, compared to a provision for income taxes of $25 million in the first quarter of 2021. The increase in the operating (non-GAAP) income tax provision in the first quarter of 2022, compared to the prior year was primarily driven by tax impacts from the resolution of certain tax audits in the first quarter of 2021. Operating (non-GAAP) income from continuing operations of $1.3 billion increased 25.5 percent and the operating (non-GAAP) income margin from continuing operations of 9.0 percent was up 1.3 points year to year.

Diluted earnings per share from continuing operations of $0.73 in the first quarter of 2022 increased 62.2 percent and operating (non-GAAP) diluted earnings per share of $1.40 increased 25.0 percent versus the prior-year period.

Consolidated diluted earnings per share in the first quarter of 2022 was $0.81 compared to $1.06 in the prior-year period. This includes a year-to-year reduction of $0.53 from discontinued operations due to the separation of Kyndryl.

Our balance sheet at March 31, 2022 continues to provide us with the flexibility to support the business. Cash and cash equivalents, restricted cash and marketable securities at March 31, 2022 were $10.8 billion, an increase of $3.2 billion from December 31, 2021. Total debt of $54.2 billion at March 31, 2022 increased $2.5 billion primarily due to new debt issuances.

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

Total assets increased $1.3 billion ($1.8 billion adjusted for currency) from December 31, 2021 driven by:

	●	An increase in cash and cash equivalents, restricted cash and marketable securities of $3.2 billion ($3.3 billion adjusted for currency); and

	●	An increase in goodwill and net intangible assets of $0.3 billion ($0.5 billion adjusted for currency) due to additions from new acquisitions; partially offset by intangibles amortization and currency impacts; partially offset by

	●	A decrease in receivables of $2.5 billion ($2.4 billion adjusted for currency) primarily due to collections of higher year-end balances.

Total liabilities increased $1.2 billion ($2.1 billion adjusted for currency) from December 31, 2021 driven by:

	●	An increase in total debt of $2.5 billion ($2.9 billion adjusted for currency) primarily due to issuances of $4.1 billion, partially offset by maturities of $1.1 billion; and

	●	An increase in deferred income of $0.9 billion ($1.0 billion adjusted for currency) primarily driven by annual customer billings and continued growth in software renewal rates; partially offset by

	●	A decrease in accounts payable of $0.5 billion primarily due to declines from seasonally higher year-end balances;

	●	A decrease in retirement and nonpension postretirement benefit obligations of $0.5 billion ($0.3 billion adjusted for currency); and

Management Discussion – (continued)

	●	A decrease in taxes payable of $0.5 billion primarily due to indirect tax payments.

Total equity of $19.1 billion increased $0.1 billion from December 31, 2021 as a result of:

	●	Net income of $0.7 billion;

	●	A decrease in accumulated other comprehensive losses of $0.7 billion driven by retirement-related benefit plans and foreign currency translation adjustments; and

	●	Common stock of $0.2 billion; partially offset by

	●	Dividends paid of $1.5 billion.

Our cash flows from operating, investing and financing activities, as reflected in the Consolidated Statement of Cash Flows, include the cash flows of discontinued operations.

On a consolidated basis, cash provided by operating activities was $3.2 billion in the first three months of 2022, a decrease of $1.7 billion compared to the first three months of 2021. Net cash used in investing activities of $1.4 billion decreased $0.6 billion compared to the prior-year period. Financing activities were a net source of cash of $1.4 billion in the first three months of 2022 compared to a net use of cash of $5.8 billion in the first three months of 2021.

Management Discussion – (continued)

First Quarter in Review

Results of Continuing Operations

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

Segment Details

The table below presents each reportable segment’s revenue and gross margin results, followed by an analysis of the first quarter of 2022 versus the first quarter of 2021 reportable segments results. Prior-year results have been recast to conform with the changes as described in the “Organization of Information” section.


									Yr. to Yr.
									Percent
							Yr. to Yr.		Change
(Dollars in millions)							Percent/Margin		Adjusted For
For the three months ended March 31:	2022			2021*			Change		Currency
Revenue:
Software	$	5,772		$	5,138		12.3	%	15.4	%
Gross margin		78.8	%		77.8	%	1.1	pts.
Consulting		4,829			4,262		13.3	%	17.4	%
Gross margin		24.3	%		27.8	%	(3.5)	pts.
Infrastructure		3,219			3,293		(2.3)	%	0.3	%
Gross margin		50.5	%		56.3	%	(5.9)	pts.
Financing		154			208		(26.2)	%	(24.5)	%
Gross margin		37.7	%		35.5	%	2.2	pts.
Other		224			284		(21.3)	%	(18.9)	%
Gross margin		(32.9)	%		(29.6)	%	(3.3)	pts.
Total revenue	$	14,197		$	13,187		7.7	%	10.9	%
Total gross profit	$	7,335		$	7,027		4.4	%
Total gross margin		51.7	%		53.3	%	(1.6)	pts.
Non-operating adjustments:
Amortization of acquired intangible assets		181			174		4.0	%
Operating (non-GAAP) gross profit	$	7,516		$	7,201		4.4	%
Operating (non-GAAP) gross margin		52.9	%		54.6	%	(1.7)	pts.

*	Recast to reflect segment changes.

Management Discussion – (continued)

Software


							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For
For the three months ended March 31:	2022		2021*		Change		Currency
Software revenue:	$	5,772	$	5,138	12.3	%	15.4	%
Hybrid Platform & Solutions	$	4,080	$	3,800	7.4	%	10.0	%
Red Hat					18.0		21.1
Automation					3.0		5.4
Data & AI					2.1		4.4
Security					5.4		8.2
Transaction Processing		1,692		1,338	26.5		30.6

Recast to reflect segment changes.

Software revenue of $5,772 million increased 12.3 percent as reported (15 percent adjusted for currency) in the first quarter of 2022 compared to the prior-year period. This includes incremental sales to Kyndryl which contributed over 8 points to the revenue growth. Both Hybrid Platform & Solutions and Transaction Processing grew, with Transaction Processing benefitting significantly from sales to Kyndryl. Within Software, hybrid cloud revenue of $2.1 billion grew 22 percent as reported (25 percent adjusted for currency) driven by strong growth in Hybrid Platform & Solutions. In addition, we had continued year-to-year growth this quarter in our software subscription and support renewal rates.

Hybrid Platform & Solutions revenue of $4,080 million increased 7.4 percent as reported (10 percent adjusted for currency) in the first quarter of 2022 compared to the prior-year period. Incremental sales to Kyndryl contributed approximately 1.5 points to the revenue growth. We continue to drive focus around the strategic hybrid cloud and AI needs of our clients, including Red Hat, Data & AI, Automation and Security. Red Hat revenue grew 18.0 percent as reported (21 percent adjusted for currency) in the first quarter of 2022, driven by strong performance across the Red Hat portfolio. Our foundational hybrid cloud offerings, RHEL and OpenShift, each gained market share this quarter. Red Hat’s hybrid cloud offerings continue to transform enterprise IT, and we continue to deliver new innovations. Automation revenue grew 3.0 percent as reported (5 percent adjusted for currency), led by AIOps and Management and Integration. We have invested in an AI-powered approach to Automation and our solutions are resonating with clients as they address growing complexity, digital shifts, and skill shortages across their businesses. Data & AI revenue increased 2.1 percent as reported (4 percent adjusted for currency), driven by good performance across the portfolio, including continued adoption of Data Fabric, expansion of our Data Management footprint, a focus on sustainable operations with Asset & Supply Chain Management and the need for reliable data sharing with Information Exchange. Security revenue grew 5.4 percent as reported (8 percent adjusted for currency) compared to strong performance in the prior-year first quarter. We had growth in the first quarter of 2022 in Threat Management and Data Security due to the evolving cybersecurity environment. We also continue to have good client demand for Cloud Pak for Security and continue to invest in security innovation including our ReaQta acquisition in 2021.

For the first quarter of 2022, Hybrid Platform & Solutions grew annual recurring revenue (ARR) by 9 percent compared to the prior-year period. ARR is a key performance metric management uses to assess the health and growth trajectory of our Hybrid Platform & Solutions business within the Software segment. ARR is calculated by estimating the current quarter’s recurring, committed value for certain types of active contracts as of the period-end date and then multiplying that value by four. This value is based on each arrangement’s contract value and start date, mitigating fluctuations during the contract term, and includes the following consumption models: (1) software subscription agreements, including committed term licenses, (2) as-a-service arrangements such as SaaS and PaaS, (3) maintenance and support contracts, and (4) security managed services contracts. ARR should be viewed independently of revenue as this performance metric and its inputs may not represent the amount of revenue recognized in the period and therefore is not intended to represent current period revenue or revenue that will be recognized in future periods. ARR is calculated at estimated constant currency.

Management Discussion – (continued)

Transaction Processing revenue of $1,692 million grew 26.5 percent as reported (31 percent adjusted for currency) in the first quarter compared to the prior-year period. Incremental sales to Kyndryl contributed approximately 28 points to the revenue growth. We also continued to have strong renewals of these critical software offerings which build on the expanded zSystems capacity and traction throughout the strong z15 program.


							Yr. to Yr.
							Percent/
(Dollars in millions)							Margin
For the three months ended March 31:	2022			2021*			Change
Software:
Gross profit	$	4,550		$	3,995		13.9	%
Gross profit margin		78.8	%		77.8	%	1.1	pts.
Pre-tax income	$	1,134		$	658		72.3	%
Pre-tax margin		19.7	%		12.8	%	6.8	pts.

Recast to reflect segment changes.

Software gross profit margin increased 1.1 points to 78.8 percent in the first quarter of 2022 compared to the prior-year period, reflecting the broad-based revenue performance in the quarter. Pre-tax income of $1,134 million increased 72.3 percent year to year and pre-tax margin increased 6.8 points to 19.7 percent in the first quarter of 2022 compared to the prior year. The pre-tax margin improvement was driven primarily by higher gross profit contribution.

Consulting


							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For
For the three months ended March 31:	2022		2021*		Change		Currency
Consulting revenue:	$	4,829	$	4,262	13.3	%	17.4	%
Business Transformation	$	2,255	$	1,953	15.5	%	19.3	%
Technology Consulting		955		835	14.4		18.9
Application Operations		1,619		1,474	9.8		14.2

Recast to reflect segment change.

Consulting revenue of $4,829 million increased 13.3 percent as reported and 17 percent adjusted for currency in the first quarter of 2022 compared to the prior-year period, with strong growth in revenue and signings across all three business areas. Our book-to-bill remains solid at 1.1 for the first quarter of 2022 as clients continue to trust IBM to execute their complex business transformations by leveraging our skills, deep industry expertise and our ecosystem. Within Consulting, hybrid cloud revenue of $2.1 billion grew 24 percent as reported (29 percent adjusted for currency), with continued strong demand and momentum in our Red Hat practice which added over 130 new clients this quarter. In the first quarter of 2022, Red Hat related signings nearly doubled year to year. Our strategic partnerships also contributed to our performance with solid double-digit revenue growth in the quarter from these partnerships, led by Salesforce, SAP, AWS and Azure.

Business Transformation revenue of $2,255 million increased 15.5 percent as reported and 19 percent adjusted for currency on a year-to-year basis. We had broad-based growth with strength in our practices centered on customer experience, talent and data transformations as well as supply chain and finance application deployments. We continued to bring together technology and strategic consulting to transform critical workflows at scale.

Technology Consulting revenue of $955 million increased 14.4 percent as reported and 19 percent adjusted for currency in the first quarter of 2022 compared to the prior-year period, led by growth in our engagements around developing and modernizing applications for cloud deployments.

Management Discussion – (continued)

Application Operations revenue of $1,619 million increased 9.8 percent as reported and 14 percent adjusted for currency compared to the first quarter of 2021, led by growth in cloud application management. We had growth in areas that focus on the management of applications and cloud platform services required to run hybrid cloud environments.


							Yr. to Yr.
							Percent/
(Dollars in millions)							Margin
For the three months ended March 31:	2022			2021*			Change
Consulting:
Gross profit	$	1,176		$	1,187		(0.9)	%
Gross profit margin		24.3	%		27.8	%	(3.5)	pts.
Pre-tax income	$	348		$	277		25.8	%
Pre-tax margin		7.2	%		6.5	%	0.7	pts.

Recast to reflect segment change.

Consulting first-quarter gross profit margin of 24.3 percent decreased 3.5 points on a year-to-year basis, reflecting the significant investments we have made to enable revenue growth. We continued to invest in our partner ecosystem to expand our reach and continue to scale our recent acquisitions. We are also investing in talent across our workforce, by further developing skills in existing resources, adding certifications and bringing in technical skills in areas of hybrid cloud and AI. Consulting continues to be impacted by the competitive and inflationary labor market which exerts pressure on the profitability of our existing contracts. We expect to capture this increased resource cost through price in our engagements and recognize this will take a few quarters to be reflected in our margin profile. Pre-tax income increased 25.8 percent to $348 million compared to the prior year. Pre-tax margin increased 0.7 points to 7.2 percent in the first-quarter 2022 compared to the prior year. We have taken actions to streamline our operations and go-to-market structure which have contributed to the pre-tax margin expansion.

Consulting Signings and Book-to-Bill


							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For
For the three months ended March 31:	2022		2021		Change		Currency
Total Consulting signings	$	5,136	$	3,796	35.3	%	40.9	%

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

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

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

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

Management Discussion – (continued)

Infrastructure


							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For
For the three months ended March 31:	2022		2021*		Change		Currency
Infrastructure revenue:	$	3,219	$	3,293	(2.3)	%	0.3	%
Hybrid Infrastructure	$	1,700	$	1,782	(4.6)	%	(2.5)	%
zSystems					(19.0)		(17.6)
Distributed Infrastructure					5.2		7.8
Infrastructure Support		1,519		1,512	0.4		3.7

Recast to reflect segment change.

Infrastructure revenue of $3,219 million decreased 2.3 percent as reported and was flat adjusted for currency in the first quarter of 2022 compared to the prior-year period. This includes incremental sales to Kyndryl which contributed over 8 points to the revenue growth. Within Infrastructure, hybrid cloud revenue of $0.7 billion decreased 20 percent as reported (18 percent adjusted for currency), driven by product cycle dynamics.

Hybrid Infrastructure revenue of $1,700 million decreased 4.6 percent as reported (2 percent adjusted for currency) compared to first quarter of 2021. Incremental sales to Kyndryl contributed over 8 points to the revenue growth. Within Hybrid Infrastructure, zSystems revenue declined 19.0 percent as reported (18 percent adjusted for currency) year to year. This was the eleventh quarter of availability of the z15 program, which has been a very strong program in both revenue performance and capacity, with more z15 MIPs shipped than in any other previous program. In April 2022, we announced the newest solution, IBM z16, which provides differentiated capabilities including embedded AI at scale, cyber-resilient security and cloud-native development for hybrid cloud. Distributed Infrastructure revenue grew 5.2 percent as reported and 8 percent adjusted for currency. Revenue growth in Power reflects clients’ demand for SAP S/4HANA data intensive workloads on our newest Power10 high-end system.

Infrastructure Support revenue of $1,519 million increased 0.4 percent as reported and 4 percent adjusted for currency compared to the prior-year period. This includes incremental sales to Kyndryl which contributed over 8 points of revenue growth for the quarter.


							Yr. to Yr.
							Percent/
(Dollars in millions)							Margin
For the three months ended March 31:	2022			2021*			Change
Infrastructure:
Gross profit	$	1,625		$	1,856		(12.4)	%
Gross profit margin		50.5	%		56.3	%	(5.9)	pts.
Pre-tax income	$	199		$	292		(31.7)	%
Pre-tax margin		6.2	%		8.9	%	(2.7)	pts.

Recast to reflect segment change.

Infrastructure gross profit margin decreased 5.9 points to 50.5 percent in the first quarter of 2022 compared to the prior year, driven primarily by mix due to product cycle dynamics. Pre-tax income decreased 31.7 percent to $199 million in the first quarter of 2022 compared to the prior-year period. Pre-tax margin decreased 2.7 points to 6.2 points compared to the prior-year first quarter, reflecting the zSystems product cycle.

Financing

See pages 70 through 73 for a discussion of Financing’s segment results.

Management Discussion – (continued)

Geographic Revenue

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



							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For
For the three months ended March 31:	2022		2021		Change		Currency
Total Revenue	$	14,197	$	13,187	7.7	%	10.9	%
Americas	$	7,056	$	6,477	8.9	%	8.9	%
Europe/Middle East/Africa (EMEA)		4,231		3,928	7.7		13.9
Asia Pacific		2,910		2,781	4.6		11.3

Total revenue of $14,197 million increased 7.7 percent as reported (11 percent adjusted for currency) in the first quarter of 2022 compared to the prior year, which includes approximately 5 points of revenue growth from incremental sales to Kyndryl.

Americas revenue of $7,056 million increased 8.9 percent as reported (9 percent adjusted for currency), which includes approximately 4 points of revenue growth from incremental sales to Kyndryl. Within North America, the U.S. increased 7.0 percent compared to the prior year and Canada increased 8.2 percent as reported (8 percent adjusted for currency). Latin America increased 25.5 percent as reported (25 percent adjusted for currency), with Brazil increasing 24.8 percent as reported (20 percent adjusted for currency).

In EMEA, total revenue of $4,231 million increased 7.7 percent as reported (14 percent adjusted for currency), which includes approximately 7 points of revenue growth from incremental sales to Kyndryl. The UK, France and Germany increased 14.4 percent, 12.6 percent and 8.5 percent, respectively, as reported, and increased 18 percent, 20 percent and 16 percent, respectively, adjusted for currency. Italy decreased 3.7 percent as reported, but increased 3 percent adjusted for currency.

Asia Pacific revenue of $2,910 million increased 4.6 percent as reported (11 percent adjusted for currency), which includes approximately 6 points of revenue growth from incremental sales to Kyndryl. Japan increased 4.0 percent as reported (14 percent adjusted for currency). India and Australia increased 25.9 percent and 11.4 percent, respectively, as reported and 30 percent and 19 percent, respectively, adjusted for currency. China decreased 11.2 percent as reported (13 percent adjusted for currency).

Management Discussion – (continued)

Expense

Total Expense and Other (Income)


							Yr. to Yr.
(Dollars in millions)							Percent
For the three months ended March 31:	2022			2021			Change
Total expense and other (income)	$	6,712		$	6,784		(1.1)	%
Non-operating adjustments:
Amortization of acquired intangible assets	$	(280)		$	(273)		2.5	%
Acquisition-related charges		(7)			(16)		(57.4)
Non-operating retirement-related (costs)/income		(202)			(332)		(39.2)
Kyndryl-related impacts		(222)			—		nm
Operating (non-GAAP) expense and other (income)	$	6,001		$	6,162		(2.6)	%
Total expense-to-revenue ratio		47.3	%		51.4	%	(4.2)	pts.
Operating (non-GAAP) expense-to-revenue ratio		42.3	%		46.7	%	(4.5)	pts.

nm — not meaningful

Total expense and other (income) decreased 1.1 percent in the first quarter of 2022 versus the prior-year period

primarily driven by the effects of currency, lower non-operating retirement-related costs, lower workforce rebalancing charges and lower spending for shared services transferred to Kyndryl, partially offset by an unrealized loss from Kyndryl retained shares and higher spending reflecting our continuing investment in innovation, our ecosystem and talent, both organically and through acquisitions. We are aggressively hiring to better serve clients, while increasing our research spend to deliver innovation in AI, hybrid cloud and emerging areas such as quantum. Total operating (non-GAAP) expense and other (income) decreased 2.6 percent year to year, driven primarily by the factors described above excluding the lower non-operating retirement-related costs and the unrealized loss on Kyndryl stock.

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 March 31:	2022		2021		Change
Selling, general and administrative expense:
Selling, general and administrative — other	$	3,824	$	3,890	(1.7)	%
Advertising and promotional expense		336		345	(2.4)
Workforce rebalancing charges		5		94	(94.4)
Amortization of acquired intangible assets		279		272	2.6
Stock-based compensation		136		115	18.6
Provision for/(benefit from) expected credit loss expense		16		(28)	nm
Total selling, general and administrative expense	$	4,597	$	4,688	(1.9)	%
Non-operating adjustments:
Amortization of acquired intangible assets	$	(279)	$	(272)	2.6	%
Acquisition-related charges		(7)		(16)	(57.4)
Kyndryl-related impacts		0		—	nm
Operating (non-GAAP) selling, general and administrative expense	$	4,311	$	4,399	(2.0)	%

nm — not meaningful

Total selling, general and administrative (SG&A) expense decreased 1.9 percent in the first quarter of 2022 versus the prior-year period driven primarily by the following factors:

Management Discussion – (continued)

	●	Lower workforce rebalancing charges (2 points); and

	●	The effects of currency (2 points); partially offset by

	●	A provision for expected credit loss expense compared to a benefit in the prior-year period (1 point); and

	●	Higher spending (1 point) reflecting our continuing investment in innovation, our ecosystem and talent, partially offset by lower spending for shared services transferred to Kyndryl.

Operating (non-GAAP) expense decreased 2.0 percent year to year primarily driven by the same factors.

The provision for expected credit loss expense increased $44 million year to year in the first three months of 2022 primarily driven by higher expense for specific reserves in the current-year period and a decrease in general reserves in the prior-year period. The receivables provision coverage was 2.3 percent at March 31, 2022, excluding receivables classified as held for sale, an increase of 20 basis points compared to December 31, 2021. The increase was primarily driven by the overall decline in total receivables.

Research, Development and Engineering


					Yr. to Yr.
(Dollars in millions)					Percent
For the three months ended March 31:	2022		2021		Change
Research, development and engineering expense	$	1,679	$	1,616	3.9	%

Research, development and engineering (RD&E) expense in the first quarter of 2022 increased 3.9 percent year to year reflecting our continuing investment to deliver innovation in AI, hybrid cloud and emerging areas such as quantum. Higher spending (5 points) in the current-year period was partially offset by the effects of currency (1 point).

Intellectual Property and Custom Development Income


					Yr. to Yr.
(Dollars in millions)					Percent
For the three months ended March 31:	2022		2021		Change
Intellectual Property and Custom Development Income:
Licensing of intellectual property including royalty-based fees	$	71	$	74	(4.0)	%
Custom development income		48		65	(26.2)
Sales/other transfers of intellectual property		2		6	(73.3)
Total	$	121	$	146	(16.9)	%

Total intellectual property and custom development income in the first quarter of 2022 decreased 16.9 percent year to year. 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.

Management Discussion – (continued)

Other (Income) and Expense


					Yr. to Yr.
(Dollars in millions)					Percent
For the three months ended March 31:	2022		2021		Change
Other (income) and expense:
Foreign currency transaction losses/(gains)	$	(176)	$	(109)	61.0	%
(Gains)/losses on derivative instruments		102		160	(36.1)
Interest income		(17)		(14)	27.5
Net (gains)/losses from securities and investment assets		218		(6)	nm
Retirement-related costs/(income)		202		332	(39.2)
Other		(83)		(18)	356.9
Total other (income) and expense	$	246	$	346	(28.8)	%
Non-operating adjustments:
Amortization of acquired intangible assets	$	(1)	$	(1)	—
Non-operating retirement-related (costs)/income		(202)		(332)	(39.2)	%
Kyndryl-related impacts		(222)		—	nm
Operating (non-GAAP) other (income) and expense	$	(179)	$	13	nm

nm - not meaningful

Total other (income) and expense was expense of $246 million in the first quarter of 2022 compared to expense of $346 million in the prior-year period. The year-to-year change was primarily driven by:

	●	Lower non-operating retirement-related costs ($130 million). Refer to “Retirement-Related Plans” for additional information; and

	●	Net exchange gains (including derivative instruments) in the current-year period versus net exchange losses in the prior-year period ($124 million); partially offset by

	●	An unrealized loss on the Kyndryl retained shares ($222 million).

Operating (non-GAAP) other (income) and expense was income of $179 million in the first quarter of 2022 compared to expense of $13 million in the prior-year period. The year-to-year change was driven primarily by the foreign exchange dynamics described above.

Interest Expense


					Yr. to Yr.
(Dollars in millions)					Percent
For the three months ended March 31:	2022		2021		Change
Interest expense	$	311	$	280	10.9	%

Interest expense increased $31 million in the first quarter of 2022 compared to the prior-year period. Interest expense is presented in cost of financing in the Consolidated Income Statement if the related external borrowings are to support the Financing external business. Overall interest expense (excluding capitalized interest) for the first quarter of 2022 was $393 million, an increase of $7 million versus the prior-year period, primarily driven by higher average interest rates, partially offset by a lower average debt balance in the current year.

Management Discussion – (continued)

Retirement-Related Plans

The following table provides 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 March 31:	2022		2021		Change
Retirement-related plans — cost:
Service cost	$	66	$	68	(3.8)	%
Multi-employer plans		4		6	(32.9)
Cost of defined contribution plans		239		256	(6.8)
Total operating costs	$	309	$	330	(6.6)	%
Interest cost	$	467	$	410	14.1	%
Expected return on plan assets		(749)		(731)	2.5
Recognized actuarial losses		460		622	(26.0)
Amortization of prior service costs/(credits)		7		3	106.8
Curtailments/settlements		8		17	(55.0)
Other costs		9		11	(15.4)
Total non-operating costs/(income)	$	202	$	332	(39.2)	%
Total retirement-related plans — cost	$	510	$	663	(23.0)	%

Total pre-tax retirement-related plan cost decreased by $152 million compared to the first quarter of 2021, primarily driven by a decrease in recognized actuarial losses ($162 million), higher expected return on plan assets ($18 million), and lower cost of defined contribution plans ($17 million), partially offset by higher interest costs ($58 million).

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 first quarter of 2022 were $309 million, a decrease of $22 million compared to the first quarter of 2021, primarily driven by lower cost of defined contribution plans ($17 million). Non-operating costs of $202 million in the first quarter of 2022 decreased $130 million year to year, driven by a decrease in recognized actuarial losses ($162 million), and higher expected return on plan assets ($18 million), partially offset by higher interest costs ($58 million).

Taxes

The continuing operations benefit from income taxes for the first quarter of 2022 was $39 million, compared to a benefit from income taxes of $160 million in the first quarter of 2021. The operating (non-GAAP) income tax provision for the first quarter of 2022 was $244 million, compared to a provision for income taxes of $25 million in the first quarter of 2021.

The continuing operations benefit from income taxes in the first quarter of 2022 was driven by many factors including the impacts of recently published foreign tax credit regulations, geographical mix of income, incentives and changes in unrecognized tax benefits. The continuing operations benefit from income taxes in the first quarter of 2021 was primarily related to the tax impacts from the resolution of certain tax audits. The increase in the operating (non-GAAP) income tax provision in the first quarter of 2022, compared to the prior year was primarily driven by tax impacts from the resolution of certain tax audits in the first quarter of 2021.

IBM’s full-year tax provision and effective tax rate are impacted by recurring factors including the geographic mix of income before taxes, incentives, changes in unrecognized tax benefits 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

Management Discussion – (continued)

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, and 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 2022. In the fourth quarter of 2021, the IRS commenced its audit of the company’s U.S. tax returns for 2017 and 2018. 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 for having challenged tax assessments issued by the India Tax Authorities. At March 31, 2022, the company had recorded $709 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.

The amount of unrecognized tax benefits at March 31, 2022 is $8,699 million which can be reduced by $548 million associated with timing adjustments, U.S. tax credits, potential transfer pricing adjustments, and state income taxes. The net amount of $8,151 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 March 31:	2022		2021		Change
Earnings per share of common stock from continuing operations:
Assuming dilution	$	0.73	$	0.45	62.2	%
Basic	$	0.74	$	0.45	64.4	%
Diluted operating (non-GAAP)	$	1.40	$	1.12	25.0	%
Weighted-average shares outstanding: (in millions)
Assuming dilution		909.2		901.7	0.8	%
Basic		899.3		893.6	0.6	%

Actual shares outstanding at March 31, 2022 were 899.4 million. The weighted-average number of common shares outstanding assuming dilution during the first quarter of 2022 was 7.5 million shares (0.8 percent) higher than the same period of 2021.

Management Discussion – (continued)

Financial Position

Dynamics

Our balance sheet at March 31, 2022 continues to provide us with flexibility to support the business.

Cash, restricted cash and marketable securities at March 31, 2022 were $10,769 million, an increase of $3,213 million from December 31, 2021. Total debt of $54,234 million at March 31, 2022 increased $2,531 million from December 31, 2021 primarily due to new debt issuances. We issued $4,080 million of debt in February 2022 which will support maturities later in the year. We continue to manage our debt levels while being acquisitive and without sacrificing investments in our business or our solid dividend policy.

Our cash flow is presented on a consolidated basis and includes discontinued operations. Refer to note 3, “Separation of Kyndryl,” for additional information. In the first three months of 2022, we generated $3,248 million in cash from operating activities, compared to $4,914 million in the first three months of 2021. We invested $698 million in acquisitions and returned $1,475 million to shareholders through dividends in the first quarter of 2022. Our cash generation permits us to invest and deploy capital to areas with the most attractive long-term opportunities.

Our pension plans were well funded at the end of 2021, with worldwide qualified plans funded at 107 percent. Overall pension funded status as of the end of March 2022 was fairly consistent with year-end 2021, and we currently have no change to expected plan contributions in 2022.

IBM Working Capital


	At March 31,		At December 31,
(Dollars in millions)	2022		2021
Current assets	$	31,330	$	29,539
Current liabilities		34,056		33,619
Working capital	$	(2,726)	$	(4,080)
Current ratio		0.92:1		0.88:1

Working capital increased $1,354 million from the year-end 2021 position. The key changes are described below:

Current assets increased $1,791 million ($1,926 million adjusted for currency) due to:

	●	An increase of $3,213 million ($3,261 million adjusted for currency) in cash and cash equivalents, restricted cash, and marketable securities; partially offset by

	●	A decline in receivables of $1,635 million ($1,547 million adjusted for currency) mainly due to collections of higher year-end balances.

Current liabilities increased $437 million ($767 million adjusted for currency) as a result of:

	●	An increase in deferred income of $1,008 million ($1,086 million adjusted for currency) primarily driven by annual customer billings and continued growth in software renewal rates; and

	●	An increase in short-term debt of $903 million ($883 million adjusted for currency) primarily due to reclassifications of $2,014 million from long-term debt to reflect upcoming maturities; partially offset by maturities of $1,087 million; partially offset by

	●	A decrease in accounts payable of $502 million ($474 million adjusted for currency) primarily due to declines from seasonally higher year-end balances;

Management Discussion – (continued)

	●	A decrease in taxes payable of $492 million ($476 million adjusted for currency) primarily due to indirect tax payments; and

	●	A decrease of $461 million ($243 million adjusted for currency) in compensation and benefits and other accrued expenses and liabilities.

Receivables and Allowances

Roll Forward of Total IBM Receivables Allowance for Credit Losses


(Dollars in millions)
January 1, 2022		Additions / (Releases) *		Write-offs **		Foreign currency and other		March 31, 2022
$	443	$	17	$	(24)	$	(5)	$	432

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

**Refer to note A, “Significant Accounting Policies,” in our 2021 Annual Report for additional information regarding allowance for credit loss write-offs.

Excluding receivables classified as held for sale, the total IBM receivables provision coverage was 2.3 percent at March 31**,** 2022, an increase of 20 basis points compared to December 31, 2021. The increase was primarily driven by the overall decline in total receivables. The majority of the write-offs during the three months ended March 31, 2022 related to receivables which had been previously reserved.

Financing Segment Receivables and Allowances

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


	At March 31,			At December 31,
(Dollars in millions)	2022			2021
Amortized cost *	$	11,563		$	12,859
Specific allowance for credit losses		141			159
Unallocated allowance for credit losses		37			42
Total allowance for credit losses		179			201
Net financing receivables	$	11,385		$	12,658
Allowance for credit losses coverage		1.5	%		1.6	%

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

The percentage of Financing segment receivables reserved decreased from 1.6 percent at December 31, 2021, to 1.5 percent at March 31, 2022, primarily driven by write-offs of previously reserved receivables, partially offset by the decline in amortized cost.

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


(Dollars in millions)
January 1, 2022		Additions / (Releases)*		Write-offs **		Foreign currency and other		March 31, 2022
$	201	$	(8)	$	(17)	$	3	$	179

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

**	Refer to note A, “Significant Accounting Policies,” in our 2021 Annual Report for additional information regarding allowance for credit loss write-offs.

Financing’s expected credit loss expense (including reserves for off-balance sheet commitments which are recorded in other liabilities) was a net release of $10 million for the three months ended March 31, 2022, compared to a net

Management Discussion – (continued)

release of $18 million for the same period in 2021. The decrease in net releases was primarily driven by lower unallocated reserve requirements in the prior year in Americas due to sales of receivables, partially offset by specific reserve releases in the current year in Americas and EMEA.

Noncurrent Assets and Liabilities


	At March 31,		At December 31,
(Dollars in millions)	2022		2021
Noncurrent assets	$	101,945	$	102,462
Long-term debt	$	46,545	$	44,917
Noncurrent liabilities (excluding debt)	$	33,562	$	34,469

The decrease in noncurrent assets of $517 million ($146 million adjusted for currency) was driven by:

	●	A decrease in long-term financing receivables of $815 million ($793 million adjusted for currency) due to reclasses to short-term receivables and declines from seasonally higher year-end balances; partially offset by

	●	An increase in goodwill and net intangible assets of $265 million ($460 million adjusted for currency) due to additions from new acquisitions; partially offset by intangibles amortization and currency impacts.

Long-term debt increased $1,628 million ($1,972 million adjusted for currency) primarily driven by:

	●	Issuances of $4,063 million; partially offset by

	●	Reclassifications to short-term debt of $2,014 million to reflect upcoming maturities.

Noncurrent liabilities (excluding debt) decreased $907 million ($616 million adjusted for currency) primarily driven by:

	●	A decrease in retirement and postretirement benefit obligations of $498 million ($324 million adjusted for currency); and

	●	A decrease of $410 million ($292 million adjusted for currency) in deferred income, operating lease liabilities and other liabilities.

Debt

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


	At March 31,		At December 31,
(Dollars in millions)	2022		2021
Total company debt	$	54,234	$	51,703
Financing segment debt*	$	12,168	$	13,929
Non-Financing debt	$	42,067	$	37,775

Financing segment debt includes debt of $1,183 million at March 31, 2022 and $1,345 million at December 31, 2021 to support intercompany financing receivables and other intercompany assets. Refer to Financing’s “Financial Position” on page 71 for additional details.

Total debt of $54,234 million increased $2,531 million ($2,855 million adjusted for currency) from December 31, 2021, primarily driven by issuances of $4,080 million, partially offset by maturities of $1,111 million.

Management Discussion – (continued)

Non-Financing debt of $42,067 million increased $4,292 million ($4,582 million adjusted for currency) from December 31, 2021 primarily due to new debt issuances.

Financing segment debt of $12,168 million decreased $1,761 million ($1,727 million adjusted for currency) from December 31, 2021 primarily due to lower funding requirements associated with financing receivables.

Financing provides financing solutions predominantly for IBM’s external client assets, and the debt used to fund Financing assets is primarily composed of intercompany loans. Total debt changes generally correspond with the level of client and commercial financing receivables, the level of cash and cash equivalents, the change in intercompany and external payables and the change in intercompany investment from IBM. The terms of the intercompany loans are set by the company to substantially match the term, currency and interest rate variability underlying the financing receivable and are based on arm’s-length pricing. The Financing debt-to-equity ratio remained at 9.0 to 1 at March 31, 2022.

We measure Financing as a stand-alone entity, and accordingly, interest expense relating to debt supporting Financing’s external client and internal business is included in the “Financing Results of Operations” and in note 5, “Segments.” In the Consolidated Income Statement, the external debt-related interest expense supporting Financing’s internal financing to IBM is classified as interest expense.

Equity

Total equity increased $116 million from December 31, 2021, primarily due to an increase from net income of $733 million, a decrease in accumulated other comprehensive losses of $703 million driven by retirement-related benefit plans of ($352 million) and foreign currency translation adjustments ($306 million), and common stock of $221 million; partially offset by dividends paid of $1,475 million.

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 table below and include the cash flows of discontinued operations. These amounts also include the cash flows associated with the Financing business.


(Dollars in millions)
For the three months ended March 31:	2022		2021
Net cash provided by/(used in):
Operating activities	$	3,248	$	4,914
Investing activities		(1,358)		(2,000)
Financing activities		1,377		(5,783)
Effect of exchange rate changes on cash, cash equivalents and restricted cash		(5)		(134)
Net change in cash, cash equivalents and restricted cash	$	3,263	$	(3,002)

Net cash provided by operating activities decreased $1,666 million as compared to the first three months of 2021 driven primarily by:

	●	A decrease of cash provided by financing receivables of $1,232 million primarily driven by higher prior year sales of financing receivables;

	●	A decrease in deferred income of $605 million due to strong performance in the prior-year period; and

	●	An increase in inventory to mitigate supply chain disruption and in anticipation of the z16 cycle; partially offset by

	●	A decrease in workforce rebalancing payments of $401 million.

Management Discussion – (continued)

Net cash used in investing activities decreased $642 million driven by:

	●	A decrease in cash used for acquisitions of $422 million; and

	●	A decrease in cash used for net capital expenditures of $152 million.

Financing activities were a net source of cash of $1,377 million in the first three months of 2022 compared to a net use of cash of $5,783 million in the first three months of 2021. The year-to-year change of $7,160 million was driven by:

	●	An increase in net cash provided by debt transactions of $7,247 million primarily driven by a higher level of maturities in the prior year, and current year net additions.

Results of Discontinued Operations

Income from discontinued operations, net of tax was $71 million in the first quarter of 2022 compared to $552 million in the prior-year period. As the separation of Kyndryl occurred on November 3, 2021, the first quarter of 2021 included a full quarter of Kyndryl operations. The current-year income primarily relates to a joint venture historically managed by Kyndryl, which did not transfer at separation due to the transfer being subject to regulatory approval. Upon receiving regulatory approval in the first quarter of 2022, the company sold its majority shares in the joint venture to Kyndryl. See note 3, “Separation of Kyndryl,” for additional information.

Management Discussion – (continued)

Looking Forward

Our first quarter results reflect the changes we have made to position our company for the future. This solid start to 2022 reinforces the confidence we have in our strategy. Harnessing the power of technologies such as hybrid cloud and AI remains essential as our clients face several strategic challenges and opportunities including competition for talent, supply chain issues, inflation, cybersecurity and geopolitical instability. We continue to see a strong demand environment for both technology and consulting as we help our clients respond to these challenges and opportunities. Over the last two years, we have taken a series of significant steps to capture this demand, and our investments and actions are paying off.

Hybrid Cloud and AI Progress

The hybrid cloud platform we have built is open, secure and flexible and at its core is based on Red Hat, which gives clients powerful software capabilities based on open-source innovation. Our software has been optimized for the platform and helps our clients apply AI, automation and security to make their businesses work better. Our global team of consultants offers deep business expertise by co-creating with clients and finding ways to harness the power of technology to accelerate their digital transformation journeys. Our infrastructure allows clients to take full advantage of an extended hybrid cloud environment.

This platform-centric strategy is producing solid results. We have more than 4,000 hybrid cloud platform clients, including 200 added in the first quarter of 2022. This provides two avenues for growth - from the incremental number of clients, but more importantly it allows us to expand our software, consulting and infrastructure footprint as we help our clients digitally transform and build new and differentiated experiences and services.

We have taken actions to streamline our operations and simplify our go-to-market model, consistent with our more focused, platform-centric business. We are making significant changes to the way we work to build a client-centric culture based on technical experience. Our new client engagement model, based on experiential selling, client engineering, and co-creation, is strongly resonating with our clients. We are accelerating our strategy with continued investment in innovation, our ecosystem and talent.

Innovation – we continue to meet the needs of our clients today while shaping the technologies of tomorrow through increased investments in R&D to deliver innovation in AI, hybrid cloud and emerging areas like quantum. In the first quarter of 2022, we announced a new AIOps solution in collaboration with Flexera that is designed to automate software license compliance, and in April 2022, we announced the IBM z16 platform which is designed for cloud-native development and cybersecurity resilience. We continue to invest in quantum and we are the only company to have an operational computer that is available on our cloud. We made three acquisitions in first quarter 2022 to further strengthen our portfolio and add value to our clients.

Ecosystem – we continue to invest in our ecosystem, both organically and inorganically, and gain momentum with our partner ecosystem. Consulting signings with our ecosystem partners were up more than 50 percent to approximately $2 billion in the first quarter of 2022. We are also investing through acquisition, for example Neudesic, which was acquired in the first quarter of 2022, adds key hyperscaler capabilities to address hybrid multi-cloud demand.

Talent – we are investing in talent across our workforce. We are upskilling existing resources, adding capabilities and skills to support our garages and client engineering centers, adding client success managers to help clients get the most of their IBM solutions and expanding our technical talent across the business.

The fundamentals of our business model remain solid. Our balance sheet and liquidity position remain strong. At March 31, 2022, we had $10.8 billion of cash and cash equivalents, restricted cash and marketable securities and we continue to manage our debt levels while being acquisitive and without sacrificing investments in our business or our solid dividend policy.

Management Discussion – (continued)

IBM is now a very different company. We have, in effect, changed our company’s trajectory. Our business reflects a higher growth, higher value mix with a significant recurring base, led by software. 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 our solid and modestly growing dividend policy. Our expectations for 2022 continue to be aligned with our mid-term financial model which was previously communicated at our investor briefing on October 4, 2021.

Retirement-Related Plans

Our pension plans are well funded. Contributions for all retirement-related plans are expected to be approximately $2.1 billion in 2022, approximately flat compared to 2021, of which $0.2 billion generally relates to legally required contributions to non-U.S. defined benefit and multi-employer plans. We expect 2022 pre-tax retirement-related plan cost to be approximately $2.1 billion, a decrease of approximately $500 million compared to 2021. This estimate reflects current pension plan assumptions at December 31, 2021. Within total retirement-related plan cost, operating retirement-related plan cost is expected to be approximately $1.2 billion, a decrease of approximately $100 million versus 2021. Non-operating retirement-related plan cost is expected to be approximately $0.9 billion, a decrease of approximately $400 million compared to 2021, primarily driven by lower recognized actuarial losses and higher 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 March 31, 2022, currency changes resulted in assets and liabilities denominated in local currencies being translated into fewer dollars than at year-end 2021. 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 three months of 2022. Based on the currency rate movements in the first three months of 2022, total revenue increased 7.7 percent as reported and 10.9 percent at constant currency versus the first three months of 2021. On an income from continuing operations before income taxes basis, these translation impacts, mitigated by the net impact of hedging activities, resulted in a theoretical maximum (assuming no pricing or sourcing actions) decrease of approximately $30 million in the first three months of 2022 on an as-reported basis and a decrease of approximately $50 million on an operating (non-GAAP) basis. The same mathematical exercise resulted in an increase of approximately $50 million in the first three months of 2021 on an as-reported basis and an increase of approximately $70 million on an 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.

Management Discussion – (continued)

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.

Liquidity and Capital Resources

In our 2021 Annual Report, on pages 47 to 49, there is a discussion of our liquidity including two tables that present three years of data. The table presented on page 47 includes consolidated 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 three months ended, or at, as applicable, March 31, 2022, those amounts are $3.2 billion of consolidated net cash from operating activities, $10.8 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.

The major rating agencies’ ratings on our debt securities at March 31, 2022 appear in the following table and remain unchanged from December 31, 2021.


	STANDARD	MOODY’S
	AND	INVESTORS
IBM RATINGS:	POOR’S	SERVICE
Senior long-term debt	A-	A3
Commercial paper	A-2	Prime-2

IBM has ample financial flexibility, supported by our strong liquidity position and cash flows, to operate at a single A credit rating. While debt levels have increased $2.5 billion from December 31, 2021 primarily due to new debt issuances in the first quarter of 2022, debt levels have decreased $18.8 billion from our peak levels at June 30, 2019 (immediately preceding the Red Hat acquisition).

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 March 31, 2022, the fair value of those instruments that were in a liability position was $231 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), had announced its intent to phase out LIBOR by the end of 2021 and the Alternative Reference Rates Committee identified the Secured Overnight Financing Rate (SOFR) as its preferred alternative rate for USD LIBOR. In March 2021, the FCA extended the phase out in the case of U.S. dollar settings for certain tenors until the end of June 2023. Effective December 31, 2021, the use of LIBOR was substantially eliminated for purposes of any new financial contract executions. Any legacy USD LIBOR based financial contracts are expected to be addressed using the LIBOR rates published through the June 2023 extension period. The replacement of the LIBOR benchmark within the company’s risk management activities did not 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 that format on pages 64 and 65. 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

Management Discussion – (continued)

necessarily available for discretionary expenditures. We define free cash flow as net cash from operating activities less the change in Financing receivables and net capital expenditures, including the investment in software. A key objective of the Financing business is to generate strong returns on equity, and our Financing receivables are the basis for that growth. Accordingly, management considers 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 Financing receivables.

The following is management’s view of cash flows for the first three months of 2022 and 2021 prepared in a manner consistent with the description above and is presented on a consolidated basis, including cash flows of discontinued operations.


(Dollars in millions)
For the three months ended March 31:	2022		2021
Net cash from operating activities per GAAP*	$	3,248	$	4,914
Less: change in Financing receivables		1,631		2,863
Net cash from operating activities, excluding Financing receivables	$	1,618	$	2,052
Capital expenditures, net		(378)		(529)
Free cash flow	$	1,240	$	1,522
Acquisitions		(698)		(1,120)
Divestitures		61		(15)
Common stock repurchases for tax withholdings		(80)		(41)
Dividends		(1,475)		(1,457)
Non-Financing debt		4,675		(1,725)
Other (includes Financing net receivables and Financing debt)		(510)		(166)
Change in cash, cash equivalents, restricted cash and short-term marketable securities	$	3,213	$	(3,002)

Includes cash flows of discontinued operations. See note 3, “Separation of Kyndryl,” for additional information.

In the first three months of 2022, we generated free cash flow of $1.2 billion, a decrease of $0.3 billion versus the prior-year period. In the first quarter of 2022, we also continued to return value to shareholders with $1.5 billion in dividends and invested $0.7 billion in acquisitions.

Events that could temporarily change the historical cash flow dynamics discussed previously and in our 2021 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 14, “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 2022. Contributions related to all retirement-related plans are expected to be approximately $2.1 billion in 2022. 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 pension plan funding regulations.

In 2022, we are not legally required to make any contributions to the U.S. defined benefit pension plans.

Our cash flows are sufficient to fund our current operations and obligations, including investing and financing activities such as 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 long-standing dividend policy.

Management Discussion – (continued)

Financing

Financing is a reportable segment that is measured as a stand-alone entity. 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.
(Dollars in millions)					Percent/
For the three months ended March 31:	2022		2021*		Change
Revenue	$	154	$	208	(26.2)	%
Pre-tax income	$	84	$	98	(14.3)	%

Recast to reflect 2021 segment changes.

Our Financing business remains focused on IBM’s products and services. For the three months ended March 31, 2022, financing revenue decreased 26.2 percent (24 percent adjusted for currency) compared to the prior year, driven by client financing down $53 million to $152 million. The decrease in client financing revenue was due to a lower average asset balance, primarily driven by the strategic actions taken in the prior year including selling certain client financing receivables to third parties. While these strategic actions impact revenue and pre-tax income on a year-to-year basis, our repositioning of the Financing business has strengthened our liquidity position, improved the quality of our portfolio, and lowered our debt needs.

Financing pre-tax income decreased 14.3 percent to $84 million compared to the prior year and the pre-tax margin of 54.6 percent increased 7.6 points year to year. The decrease in pre-tax income was driven by a decrease in gross profit, partially offset by a decrease in total expense, primarily as a result of the strategic actions described above.

Management Discussion – (continued)

Financial Position


	At March 31,		At December 31,
(Dollars in millions)	2022		2021
Cash and cash equivalents	$	825	$	1,359
Client financing receivables:
Net investment in sales-type and direct financing leases (1)		3,285		3,396
Client loans		7,908		8,818
Total client financing receivables	$	11,193	$	12,215
Commercial financing receivables
Held for investment		192		444
Held for sale		410		793
Other receivables		49		61
Total external receivables (2)	$	11,843	$	13,512
Intercompany financing receivables (3) (4)		727		778
Other assets (5)		1,076		1,231
Total assets	$	14,471	$	16,880

Intercompany payables (3)	$	163	$	467
Debt (6)		12,168		13,929
Other liabilities		788		937
Total liabilities	$	13,119	$	15,333
Total equity	$	1,352	$	1,547
Total liabilities and equity	$	14,471	$	16,880

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

(2)	The difference between the decrease in total external receivables of $1.7 billion (from $13.5 billion in December 2021 to $11.8 billion in March 2022) and the $1.6 billion change in Financing segment’s receivables disclosed in the free cash flow presentation on page 69 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 Financing segment debt.

(5)	Includes $0.6 billion of other intercompany assets in March 2022 and $0.7 billion in December 2021.

(6)	Financing segment debt is primarily composed of intercompany loans.

Total external receivables decreased $1,669 million primarily due to collections of higher year-end balances, with corresponding reductions in debt funding.

At March 31, 2022, we continue to apply our rigorous credit policies. Approximately 68 percent of the total external portfolio was with investment-grade clients with no direct exposure to consumers, an increase of 4 points year to year and an increase of 1 point compared to December 31, 2021. This investment grade percentage is based on the credit ratings of the companies in the portfolio and reflects certain mitigating actions taken 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. 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.

Throughout 2021, sales of client financing receivables were utilized as part of the company’s cash and liquidity management as well as for credit mitigation. In the first quarter of 2022, sales of client financing receivables were largely focused on credit mitigation. In addition, the company has an existing agreement with a third-party investor to sell IBM short-term commercial financing receivables on a revolving basis. The company has expanded this agreement to other countries and geographies since commencement in the U.S. and Canada in 2020.

Management Discussion – (continued)

The following table presents the total amount of client and commercial financing receivables transferred:


(Dollars in millions)
For the three months ended March 31:	2022		2021
Client financing receivables
Lease receivables	$	15	$	342
Loan receivables		2		653
Total client financing receivables transferred	$	17	$	995
Commercial financing receivables
Receivables transferred during the period	$	1,989	$	1,167
Receivables uncollected at end of period*		724		724

*	Of the total amount of commercial financing receivables sold and derecognized from the Consolidated Balance Sheet, the amounts presented remained uncollected from the business partners as of March 31, 2022 and 2021.

For additional information relating to financing receivables refer to note 9, “Financing Receivables.” Refer to pages 22 through 26 for additional information related to Financing segment receivables, allowance for credit losses and debt.

Return on Equity Calculation


(Dollars in millions)
For the three months ended March 31:	2022			2021*
Numerator
Financing after-tax income**	$	69		$	73
Annualized after-tax income (1)	$	275		$	290
Denominator
Average Financing equity (2)È	$	1,450		$	2,184
Financing return on equity (1)/(2)		19.0	%		13.3	%

*	Recast to reflect 2021 segment changes.

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

È	Average of the ending equity for Financing for the last two quarters.

Return on equity was 19.0 percent compared to 13.3 percent for the three months ended March 31, 2022 and 2021, respectively. The increase was primarily driven by a lower average equity balance, which reflects the strategic actions taken in the prior year to reposition the Financing business.

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. Financing has insight into product plans and cycles for IBM products. Based upon this product information, Financing continually monitors projections of future equipment values and compares them with the residual values reflected in the portfolio.

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 March 31, 2022 and December 31, 2021. In addition, the table presents the run out of when the unguaranteed residual value assigned to equipment on leases at March 31, 2022 is expected to be returned to the company.

Management Discussion – (continued)

Unguaranteed Residual Value


	At		At		Estimated Run Out of March 31, 2022 Balance
	December 31,		March 31,								2025 and
(Dollars in millions)	2021		2022		2022		2023		2024		Beyond
Sales-type and direct financing leases	$	335	$	325	$	72	$	128	$	65	$	60
Operating leases		13		10		6		2		0		2
Total unguaranteed residual value	$	348	$	335	$	78	$	130	$	65	$	62

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. Please refer to the “Operating (non-GAAP) Earnings” section for management’s rationale for presenting operating earnings information.


				Acquisition-			Retirement-			U.S.			Kyndryl-
(Dollars in millions except per share amounts)				Related			Related			Tax Reform			Related			Operating
For the three months ended March 31, 2022:	GAAP			Adjustments			Adjustments			Impacts			Impacts			(non-GAAP)
Gross profit	$	7,335		$	181		$	—		$	—		$	—		$	7,516
Gross profit margin		51.7	%		1.3	pts.		—	pts.		—	pts.		—	pts.		52.9	%
S,G&A	$	4,597		$	(286)		$	—		$	—		$	0		$	4,311
Other (income) and expense		246			(1)			(202)			—			(222)			(179)
Total expense and other (income)		6,712			(287)			(202)			—			(222)			6,001
Pre-tax income from continuing operations		623			468			202			—			222			1,515
Pre-tax margin from continuing operations		4.4	%		3.3	pts.		1.4	pts.		—	pts.		1.6	pts.		10.7	%
Provision for (benefit from) income taxes*	$	(39)		$	109		$	58		$	116		$	—		$	244
Effective tax rate		(6.3)	%		9.1	pts.		4.6	pts.		7.7	pts.		0.9	pts.		16.1	%
Income from continuing operations	$	662		$	359		$	144		$	(116)		$	222		$	1,271
Income margin from continuing operations		4.7	%		2.5	pts.		1.0	pts.		(0.8)	pts.		1.6	pts.		9.0	%
Diluted earnings per share from continuing operations	$	0.73		$	0.39		$	0.16		$	(0.13)		$	0.24		$	1.40


				Acquisition-			Retirement-			U.S.			Kyndryl-
(Dollars in millions except per share amounts)				Related			Related			Tax Reform			Related			Operating
For the three months ended March 31, 2021:	GAAP			Adjustments			Adjustments			Impacts			Impacts			(non-GAAP)
Gross profit	$	7,027		$	174		$	—		$	—		$	—		$	7,201
Gross profit margin		53.3	%		1.3	pts.		—	pts.		—	pts.		—	pts.		54.6	%
S,G&A	$	4,688		$	(288)		$	—		$	—		$	—		$	4,399
Other (income) and expense		346			(1)			(332)			—			—			13
Total expense and other (income)		6,784			(289)			(332)			—			—			6,162
Pre-tax income from continuing operations		244			463			332			—			—			1,039
Pre-tax margin from continuing operations		1.8	%		3.5	pts.		2.5	pts.		—	pts.		—	pts.		7.9	%
Provision for (benefit from) income taxes*	$	(160)		$	132		$	33		$	19		$	—		$	25
Effective tax rate		(65.5)	%		41.9	pts.		24.2	pts.		1.8	pts.		—	pts.		2.4	%
Income from continuing operations	$	403		$	330		$	299		$	(19)		$	—		$	1,013
Income margin from continuing operations		3.1	%		2.5	pts.		2.3	pts.		(0.1)	pts.		—	pts.		7.7	%
Diluted earnings per share from continuing operations	$	0.45		$	0.37		$	0.33		$	(0.02)		$	—		$	1.12

The tax impact on operating (non-GAAP) pre-tax income/(loss) from continuing operations is calculated under the same accounting principles applied to the GAAP pre-tax income/(loss) 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 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 related to climate change and 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; potential failure of the separation of Kyndryl to qualify for tax-free treatment; 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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