Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS

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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION

FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2022

Snapshot

Financial Results Summary — Three Months Ended September 30:


							Yr. to Yr.
							Percent/
(Dollars and shares in millions except per share amounts)							Margin
For the three months ended September 30:	2022*			2021			Change
Revenue	$	14,107		$	13,251		6.5	%**
Gross profit margin		52.7	%		53.6	%	(1.0)	pts.
Total expense and other (income)	$	11,931		$	6,293		89.6	%
Income/(loss) from continuing operations before income taxes	$	(4,501)		$	813		nm
Provision for/(benefit from) income taxes from continuing operations	$	(1,287)		$	(224)		nm
Income/(loss) from continuing operations	$	(3,214)		$	1,037		nm
Income/(loss) from continuing operations margin		(22.8)	%		7.8	%	(30.6)	pts.
Income from discontinued operations, net of tax	$	18		$	93		(81.1)	%
Net income/(loss)	$	(3,196)		$	1,130		nm
Earnings/(loss) per share from continuing operations - assuming dilution	$	(3.55)		$	1.14		nm
Consolidated earnings/(loss) per share - assuming dilution	$	(3.54)		$	1.25		nm
Weighted-average shares outstanding - assuming dilution		904.1			906.0		(0.2)	%

Includes a one-time, non-cash, pre-tax pension settlement charge of $5.9 billion ($4.4 billion net of tax) resulting in an impact of ($4.86) to diluted earnings/(loss) per share from continuing operations and an impact of ($4.87) to consolidated diluted earnings/(loss) per share. See note 18, “Retirement-Related Benefits,” for additional information.

** 14.6 percent adjusted for currency.

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Organization of Information:

On November 3, 2021, we completed the separation of our managed infrastructure services unit into a new public company with the distribution of 80.1 percent of the outstanding common stock of Kyndryl Holdings, Inc. (Kyndryl) to IBM stockholders on a pro rata basis. To affect the separation, IBM stockholders received one share of Kyndryl common stock for every five shares of IBM common stock held at the close of business on October 25, 2021, the record date for the distribution. IBM retained 19.9 percent of the shares of Kyndryl common stock immediately following the separation with the intent to dispose of such shares within twelve months after the distribution. 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. As of September 30, 2022, we transferred all 19.9 percent retained interest in Kyndryl common stock pursuant to exchange agreements with a third-party financial institution. Refer to note 8, “Financial Assets & Liabilities,” for additional information.

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 earnings/(loss) 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 software assets which was completed in the second quarter of 2022. This change impacted the company’s Software segment and Other–divested businesses category. In the fourth quarter of 2021, immediately prior to the

Management Discussion – (continued)

separation of Kyndryl, the company made a 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.

In September 2022, the IBM Qualified Personal Pension Plan (Qualified PPP) purchased two separate nonparticipating single premium group annuity contracts from The Prudential Insurance Company of America and Metropolitan Life Insurance Company (collectively, the Insurers) and irrevocably transferred to the Insurers approximately $16 billion of the Qualified PPP’s defined benefit pension obligations and related plan assets, thereby reducing our pension obligations and assets by the same amount. The group annuity contracts were purchased using assets of the Qualified PPP and no additional funding contribution was required from the company. As a result of this transaction, we recognized a one-time, non-cash, pre-tax pension settlement charge of $5.9 billion ($4.4 billion net of tax) in the third quarter of 2022, primarily related to the accelerated recognition of accumulated actuarial losses of the Qualified PPP. The company was also required to remeasure the benefit obligation and plan assets of the Qualified PPP. Refer to note 18, “Retirement-Related Benefits,” for additional information.

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.

Within the tables presented, certain columns and rows may not add due to the use of rounded numbers for disclosure purposes. Percentages presented are calculated from the underlying whole-dollar amounts. Certain prior-period amounts have been reclassified to conform to the current-period presentation. This is annotated where applicable.

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 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-

Management Discussion – (continued)

operating given their unique and non-recurring nature. These charges primarily relate to any net gains or losses on the Kyndryl common stock and the related cash-settled swap with a third-party financial institution, which are recorded in other (income) and expense in the Consolidated Income Statement. The Kyndryl shares 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. For retirement-related costs, management characterizes certain items as operating and others as non-operating, consistent with GAAP. We include defined benefit plan and nonpension postretirement benefit plan service costs, multi-employer plan costs and the cost of defined contribution plans in operating earnings. Non-operating retirement-related costs include defined benefit plan and nonpension postretirement benefit plan amortization of prior service costs, interest cost, expected return on plan assets, amortized actuarial gains/losses, the impacts of any plan curtailments/settlements including a one-time, non-cash, pre-tax settlement charge of $5.9 billion ($4.4 billion, net of tax) in the third quarter of 2022 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 third quarter of 2022 and 2021.


						Yr. to Yr.
(Dollars in millions except per share amounts)						Percent
For the three months ended September 30:	2022			2021		Change
Net income/(loss) as reported	$	(3,196)	*	$	1,130	nm
Income from discontinued operations, net of tax		18			93	(81.1)	%
Income/(loss) from continuing operations	$	(3,214)	*	$	1,037	nm
Non-operating adjustments (net of tax):
Acquisition-related charges	$	315		$	370	(15.0)	%
Non-operating retirement-related costs/(income)		4,566	*		262	nm
Kyndryl-related impacts		(14)			—	nm
Operating (non-GAAP) earnings**	$	1,653		$	1,670	(1.0)	%
Diluted operating (non-GAAP) earnings per share**	$	1.81		$	1.84	(1.6)	%

Includes a one-time, non-cash pension settlement charge of $4.4 billion net of tax.

** Refer to page 95 for a more detailed reconciliation of net loss to operating earnings and operating earnings per share.

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Management Discussion – (continued)

Macroeconomic Environment:

Throughout 2022, we have seen escalating labor and component costs and a strengthening of the U.S. dollar. Consulting, which makes up well over half of IBM’s workforce, is most impacted by the labor cost inflation. While those dynamics continue to put pressure on our margin profile, we are seeing progress in the actions we have taken to mitigate the impacts of these higher costs. We have begun to see improved utilization, acquisitions progressing toward margin accretion and priced margin improvements year over year that will benefit our margin profile going forward. Additionally, across all of our product-based businesses, we have executed price increases above our historical level of increases to be more reflective of the labor and component costs we are incurring due to the inflationary environment and to mitigate the impacts of currency. This includes price increases in our support and maintenance agreements for our hardware and software portfolios. The strengthening of the U.S. dollar impacted our reported revenue and gross profit dollars. We execute hedging programs which defer but do not eliminate the impact of currency. The gains from these hedging programs are reflected primarily in other income and expense. With the rate and magnitude of movements, and because we do not hedge all currencies, we do have a currency impact to our overall profit and cash flows. See “Currency Rate Fluctuations,” for additional information.

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 has been our primary focus. The sanctions placed on numerous Russian entities, specific Russian-controlled entities, as well as Belarus and other measures that have been and continue to be imposed as a result of the war have increased the level of economic and political uncertainty. In the second quarter of 2022, we made the decision to carry out an orderly wind-down of our Russian operations. As such, 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 that resulted in certain immaterial asset and restructuring charges in the second quarter of 2022. These charges, together with the year-to-year lost business due to the wind-down, impacted our pre-tax income by approximately $180 million for the nine months ended September 30, 2022. 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, will continue to be a headwind to our profit and cash flows.

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. Our objective in returning to the workplace is to allow IBM locations to safely accommodate in-person working during pandemic conditions that are constantly changing. Our approach has enabled hundreds of locations to safely reopen, adhering to IBM protocols and adjusting capacity levels through periods where conditions may be improving or worsening over time. 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 be strong, 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.

Management Discussion – (continued)

Financial Performance Summary — Three Months Ended September 30:

In the third quarter of 2022, we reported $14.1 billion in revenue, a loss from continuing operations of $3.2 billion, which includes the impact of a one-time, non-cash, pre-tax pension settlement charge of $5.9 billion ($4.4 billion net of tax). The pension settlement charge was the result of the transfer to Insurers of a portion of our U.S. benefit pension obligations, an action we took to further reduce the risk profile of our worldwide retirement-related plans. Our operating (non-GAAP) earnings for the three months ended September 30, 2022 were $1.7 billion, which excludes the impact of the pension settlement charge, among other items. Diluted loss per share from continuing operations was $3.55 as reported, including an impact of $4.86 from the pension settlement charge, and diluted earnings per share was $1.81 on an operating (non-GAAP) basis. On a consolidated basis, we generated $1.9 billion in cash from operations and $0.8 billion in free cash flow. We delivered shareholder returns of $1.5 billion in dividends and our balance sheet continues to provide us with the flexibility to support our business needs. These results reflect our continued focus on the execution of our strategy and the solid demand for our hybrid cloud and AI solutions.

Total revenue grew 6.5 percent as reported and 15 percent adjusted for currency compared to the prior-year period. This includes incremental sales to Kyndryl which contributed approximately 5 points to the revenue growth. Software delivered revenue growth of 7.5 percent as reported and 14 percent adjusted for currency, including approximately 8 points of growth from incremental sales to Kyndryl. Within Software, Hybrid Platform & Solutions increased 2.4 percent as reported and 8 percent adjusted for currency, with incremental sales to Kyndryl contributing approximately 1.5 points of this growth. Performance was led by continued strong double-digit growth in Red Hat. Transaction Processing grew 23.1 percent as reported and 33 percent adjusted for currency, including approximately 26 points of growth from incremental Kyndryl sales. Consulting revenue increased 5.4 percent as reported and 16 percent adjusted for currency, with growth across all three business lines. Infrastructure revenue increased 14.8 percent year to year as reported and 23 percent adjusted for currency, reflecting strong double-digit growth in Hybrid Infrastructure driven primarily by our z16 program. The Infrastructure revenue performance also includes approximately 9 points of growth from incremental sales to Kyndryl. Across the segments, total hybrid cloud revenue of $5.2 billion in the third quarter of 2022 grew 11 percent as reported and 19 percent adjusted for currency. Over the trailing 12 months, total hybrid cloud revenue was $22.2 billion, up 15 percent as reported (20 percent adjusted for currency) year to year.

From a geographic perspective, Americas revenue grew 12.7 percent year to year as reported (13 percent adjusted for currency). Europe/Middle East/Africa (EMEA) increased 0.5 percent (16 percent adjusted for currency). Asia Pacific was flat year to year but grew 16 percent adjusted for currency.

Gross margin of 52.7 percent decreased 1.0 points year to year, however, gross profit dollars grew 4.6 percent compared to the prior-year period driven by strong revenue performance in our high-value businesses. Overall gross margin was impacted by the investments we are making to drive our hybrid cloud and AI strategy, higher labor and component costs and the impacts of currency, while the mitigating hedging benefits and operational productivity and efficiency we have realized are primarily reflected in expense. Operating (non-GAAP) gross margin of 53.8 percent decreased 1.2 points compared to the prior-year period for similar reasons.

Total expense and other (income) increased 89.6 percent in the third quarter of 2022 versus the prior-year period primarily driven by the pension settlement charge of $5.9 billion and higher spending reflecting our continuing focus on our portfolio and investment in our offerings, technical talent and ecosystem, partially offset by the effects of currency and benefits from the actions taken to streamline operations and our go-to-market model. Total operating (non-GAAP) expense and other (income) decreased 1.0 percent year to year, driven primarily by the factors described above, excluding the pension settlement charge.

Pre-tax loss from continuing operations was $4.5 billion in the third quarter of 2022 compared with pre-tax income of $0.8 billion in the prior-year period with the year-to-year decline driven by the $5.9 billion pension settlement charge. Pre-tax margin was down 38.0 points year to year to (31.9) percent reflecting the impact of the charge. The continuing operations benefit from income taxes in the third quarter of 2022 was $1.3 billion compared to a benefit of $0.2 billion in the third quarter of 2021. The current-year tax benefit is primarily due to the pension settlement charge. The prior-year

Management Discussion – (continued)

tax benefit was primarily driven by events that resulted in additional anticipated utilization of U.S. foreign tax credits. Net loss from continuing operations was $3.2 billion compared with net income of $1.0 billion in the prior-year period and the net income/(loss) from continuing operations margin of (22.8) percent was down 30.6 points year to year.

Operating (non-GAAP) pre-tax income from continuing operations of $2.0 billion increased 22.6 percent compared to the prior-year period and the operating (non-GAAP) pre-tax margin from continuing operations increased 1.8 points to 13.9 percent. These profit dynamics reflect our portfolio shift toward higher value, led by software. Our pre-tax profit includes the contribution from incremental sales to Kyndryl and the negative impacts of currency primarily due to the strengthening of the U.S. dollar. The operating (non-GAAP) income tax provision for the third quarter of 2022 was $312 million, compared to a benefit from income taxes of $67 million in the third quarter of 2021. The current-year tax provision was driven by many factors including the impacts of the geographical mix of income, incentives and changes in unrecognized tax benefits and tax laws. The prior-year tax benefit was primarily driven by events that resulted in additional anticipated utilization of U.S. foreign tax credits. Operating (non-GAAP) income from continuing operations of $1.7 billion decreased 1.0 percent and the operating (non-GAAP) income margin from continuing operations of 11.7 percent was down 0.9 points year to year.

Diluted loss per share from continuing operations was $3.55 in the third quarter of 2022, including an impact of $4.86 from the pension settlement charge, compared to diluted earnings per share of $1.14 in the prior-year period. Operating (non-GAAP) diluted earnings per share of $1.81 decreased 1.6 percent versus the prior-year period.

Consolidated diluted loss per share in the third quarter of 2022 was $3.54 compared to diluted earnings per share of $1.25 in the prior-year period. This includes the impact from the pension settlement charge and a year-to-year reduction of $0.08 from discontinued operations due to the separation of Kyndryl.

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, in the third quarter of 2022, we generated $1.9 billion in cash flow provided by operating activities, a decrease of $0.8 billion compared to the third quarter of 2021, primarily driven by a decrease in cash provided by financing receivables. Net cash used in investing activities of $1.7 billion increased $1.1 billion compared to the prior-year period, primarily driven by an increase in cash used in net marketable securities and other investments of $1.3 billion. Financing activities were a net source of cash of $0.7 billion in the third quarter of 2022, compared to a net use of cash of $1.7 billion in the prior-year period primarily due to higher net issuances of debt in the current year.

Management Discussion – (continued)

Financial Results Summary —Nine Months Ended September 30:


							Yr. to Yr.
							Percent/
(Dollars and shares in millions except per share amounts)							Margin
For the nine months ended September 30:	2022*			2021			Change
Revenue	$	43,840		$	40,656		7.8	%**
Gross profit margin		52.6	%		54.1	%	(1.5)	pts.
Total expense and other (income)	$	25,212		$	20,017		25.9	%
Income/(loss) from continuing operations before income taxes	$	(2,156)		$	1,968		nm
Provision for/(benefit from) income taxes from continuing operations	$	(1,070)		$	(282)		nm
Income/(loss) from continuing operations	$	(1,087)		$	2,250		nm
Income/(loss) from continuing operations margin		(2.5)	%		5.5	%	(8.0)	pts.
Income from discontinued operations, net of tax	$	16		$	1,160		(98.7)	%
Net income/(loss)	$	(1,071)		$	3,410		nm
Earnings/(loss) per share from continuing operations - assuming dilution	$	(1.21)		$	2.49		nm
Consolidated earnings/(loss) per share - assuming dilution	$	(1.19)		$	3.77		nm
Weighted-average shares outstanding - assuming dilution		901.6			904.0		(0.3)	%

	At 9/30/2022			At 12/31/2021
Assets	$	125,850		$	132,001		(4.7)	%
Liabilities	$	105,703		$	113,005		(6.5)	%
Equity	$	20,147		$	18,996		6.1	%

Includes a one-time, non-cash, pre-tax pension settlement charge of $5.9 billion ($4.4 billion net of tax) resulting in an impact of ($4.86) to diluted earnings/(loss) per share from continuing operations and consolidated diluted earnings/(loss) per share. See note 18, “Retirement-Related Benefits,” for additional information.

** 13.8 percent adjusted for currency.

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


						Yr. to Yr.
(Dollars in millions except per share amounts)						Percent
For the nine months ended September 30:	2022			2021		Change
Net income/(loss) as reported	$	(1,071)	*	$	3,410	nm
Income from discontinued operations, net of tax		16			1,160	(98.7)	%
Income/(loss) from continuing operations	$	(1,087)	*	$	2,250	nm
Non-operating adjustments (net of tax):
Acquisition-related charges	$	1,019		$	1,069	(4.7)	%
Non-operating retirement-related costs/(income)		4,856	*		825	nm
U.S. tax reform impacts		(112)			(6)	nm
Kyndryl-related impacts		353			—	nm
Operating (non-GAAP) earnings**	$	5,029		$	4,139	21.5	%
Diluted operating (non-GAAP) earnings per share**	$	5.52		$	4.58	20.5	%

Includes a one-time, non-cash pension settlement charge of $4.4 billion net of tax.

** Refer to page 96 for a more detailed reconciliation of net loss to operating earnings and operating earnings per share.

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Management Discussion – (continued)

Financial Performance Summary —Nine Months Ended September 30:

In the first nine months of 2022, we reported $43.8 billion in revenue, a loss from continuing operations of $1.1 billion, including a one-time, non-cash, pre-tax pension settlement charge of $5.9 billion ($4.4 billion net of tax), and operating (non-GAAP) earnings of $5.0 billion, which excludes the impact of the settlement charge. Diluted loss per share from continuing operations was $1.21 as reported, including an impact of $4.86 from the pension settlement charge, and diluted earnings per share was $5.52 on an operating (non-GAAP) basis. On a consolidated basis, we generated $6.5 billion in cash from operations and $4.1 billion in free cash flow. We delivered shareholder returns of $4.5 billion in dividends.

Total revenue grew 7.8 percent as reported and 14 percent adjusted for currency compared to the prior-year period. This includes incremental sales to Kyndryl which contributed 5 points to the revenue growth. Software delivered revenue growth of 8.6 percent as reported and 14 percent adjusted for currency, with growth in both Hybrid Platform & Solutions and Transaction Processing. The Software revenue performance includes approximately 8 points of growth from incremental sales to Kyndryl. Consulting revenue increased 9.5 percent as reported and 17 percent adjusted for currency, with growth across all three business areas. Infrastructure revenue increased 10.6 percent year to year as reported and 16 percent adjusted for currency, with approximately 8 points of growth from incremental sales to Kyndryl. As the separation of Kyndryl occurred in early November 2021, the impact of these incremental sales to growth was largely in the first three quarters of this year.

From a geographic perspective, Americas revenue grew 12.1 percent year to year as reported (12 percent adjusted for currency). EMEA increased 4.4 percent (16 percent adjusted for currency). Asia Pacific grew 2.6 percent (14 percent adjusted for currency).

Gross margin of 52.6 percent decreased 1.5 points year to year, however, gross profit dollars grew 4.9 percent compared to the prior-year period. Overall gross margin was impacted by the investments we are making to drive our hybrid cloud and AI strategy, higher labor and component costs and the impacts of currency, while the mitigating hedging benefits and operational productivity and efficiency we have realized are primarily reflected in expense. Operating (non-GAAP) gross margin of 53.8 percent decreased 1.6 points versus the prior year for similar reasons.

Total expense and other (income) increased 25.9 percent in the first nine months of 2022 versus the prior-year period primarily driven by the pension settlement charge of $5.9 billion, impacts of $0.4 billion related to the Kyndryl retained shares and higher spending reflecting continuing investment in our hybrid cloud and AI strategy, partially offset by the effects of currency, a gain from the divestiture of our healthcare software assets, lower workforce rebalancing charges and benefits from the actions taken to streamline operations and our go-to-market model. Total operating (non-GAAP) expense and other (income) decreased 3.3 percent year to year, driven primarily by the factors described above excluding the pension settlement charge and the impacts related to the Kyndryl retained shares.

Pre-tax loss from continuing operations was $2.2 billion in the first nine months of 2022 compared with pre-tax income of $2.0 billion in the prior-year period with the year-to-year decline driven by the $5.9 billion pension settlement charge. Pre-tax margin was down 9.8 points year to year to (4.9) percent reflecting the impact of the charge. The continuing operations benefit from income taxes in the first nine months of 2022 was $1.1 billion, compared to a benefit of $0.3 billion in the first nine months of 2021. The increase compared to the prior year was primarily due to the pension settlement charge in the third quarter of 2022. Net loss from continuing operations was $1.1 billion compared with net income of $2.3 billion in the prior-year period and the net income/(loss) from continuing operations margin of (2.5) percent was down 8.0 points year to year.

Operating (non-GAAP) pre-tax income from continuing operations of $6.0 billion increased 38.1 percent compared to the prior-year period and the operating (non-GAAP) pre-tax margin from continuing operations increased 3.0 points to 13.7 percent. These profit dynamics reflect our portfolio shift toward higher value, led by software. Our pre-tax profit includes the contribution from incremental sales to Kyndryl and the negative impacts of currency primarily due to the strengthening of the U.S. dollar. The operating (non-GAAP) provision for income taxes was $969 million in the first

Management Discussion – (continued)

nine months of 2022, compared to $204 million in the first nine months of 2021. The increase compared to the prior year was primarily driven by the resolution of certain tax audits in the first quarter of 2021 as well as third-quarter 2021 events that resulted in additional anticipated utilization of U.S. foreign tax credits. Operating (non-GAAP) income from continuing operations of $5.0 billion increased 21.5 percent and the operating (non-GAAP) income margin from continuing operations of 11.5 percent was up 1.3 points year to year.

Diluted loss per share from continuing operations was $1.21 in the first nine months of 2022, including an impact of $4.86 from the pension settlement charge, compared to diluted earnings per share of $2.49 in the prior-year period. Operating (non-GAAP) diluted earnings per share of $5.52 increased 20.5 percent versus the prior-year period.

Consolidated diluted loss per share in the first nine months of 2022 was $1.19 compared to diluted earnings per share of $3.77 in the prior-year period. This includes the impact from the pension settlement charge and a year-to-year reduction of $1.26 from discontinued operations due to the separation of Kyndryl.

Our balance sheet at September 30, 2022 continues to provide us with the flexibility to support the business. Cash and cash equivalents, restricted cash and marketable securities at September 30, 2022 were $9.7 billion, an increase of $2.2 billion from December 31, 2021. Total debt of $50.9 billion at September 30, 2022 decreased $0.8 billion driven by currency impacts, partially offset by net debt issuances.

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

Total assets decreased $6.2 billion (flat adjusted for currency) from December 31, 2021 driven by:

	●	A decrease in receivables of $3.3 billion ($1.9 billion adjusted for currency) primarily due to collections of higher year-end balances, partially offset by current-year business volumes;

	●	A decrease in goodwill and net intangible assets of $3.0 billion ($0.9 billion adjusted for currency) primarily driven by currency impacts, intangibles amortization and derecognition of goodwill and intangible assets of $0.6 billion related to the divestiture of our healthcare software assets, partially offset by additions from new acquisitions; and

	●	A decrease in net property, plant and equipment and operating right-of-use assets of $1.0 billion ($0.5 billion adjusted for currency); partially offset by

	●	An increase in cash and cash equivalents, restricted cash and marketable securities of $2.2 billion ($2.7 billion adjusted for currency).

Total liabilities decreased $7.3 billion ($0.9 billion adjusted for currency) from December 31, 2021 driven by:

	●	A decrease in retirement and nonpension postretirement benefit obligations of $2.7 billion ($1.4 billion adjusted for currency) of which $0.6 billion is due to the amendment and remeasurement impact of the U.S. Nonpension Postretirement Plan;

	●	A decrease in deferred income of $1.9 billion ($0.8 billion adjusted for currency) reflecting seasonal reductions from higher year-end balances;

	●	A decrease in total debt of $0.8 billion (an increase of $1.4 billion adjusted for currency) primarily driven by maturities of $5.4 billion and currency impacts, partially offset by issuances of $7.9 billion; and

	●	A decrease in taxes payable of $0.6 billion ($0.4 billion adjusted for currency) primarily due to indirect tax payments.

Management Discussion – (continued)

Total equity of $20.1 billion increased $1.2 billion from December 31, 2021 as a result of:

	●	A decrease in accumulated other comprehensive loss of $6.1 billion driven by retirement-related benefit plans primarily due to the pension settlement charge of $4.4 billion net of tax; and

	●	Common stock issuances of $0.7 billion; partially offset by

	●	Dividends paid of $4.5 billion; and

	●	Net loss of $1.1 billion primarily due to the pension settlement charge.

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 $6.5 billion in the first nine months of 2022, a decrease of $3.8 billion compared to the first nine months of 2021, primarily due to a decrease in cash provided by financing receivables driven by higher prior-year sales of receivables. Net cash used in investing activities of $2.9 billion decreased $2.4 billion compared to the prior-year period. Financing activities were a net use of cash of $2.1 billion in the first nine months of 2022 compared to $10.7 billion in the first nine months of 2021.

Management Discussion – (continued)

Third Quarter and First Nine Months 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 following tables present each reportable segment’s revenue and gross margin results, followed by an analysis of the third quarter and first nine months of 2022 versus the third quarter and first nine months 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 September 30:	2022			2021*			Change		Currency
Revenue:
Software	$	5,811		$	5,406		7.5	%	14.2	%
Gross margin		79.0	%		78.6	%	0.4	pts.
Consulting		4,700			4,457		5.4	%	15.6	%
Gross margin		26.0	%		29.5	%	(3.5)	pts.
Infrastructure		3,352			2,921		14.8	%	23.1	%
Gross margin		50.8	%		52.8	%	(2.0)	pts.
Financing		174			184		(5.7)	%	(0.6)	%
Gross margin		32.8	%		28.7	%	4.1	pts.
Other		70			282		(75.1)	%	(70.5)	%
Gross margin		(197.7)	%		(18.5)	%	(179.2)	pts.
Total revenue	$	14,107		$	13,251		6.5	%	14.6	%
Total gross profit	$	7,430		$	7,106		4.6	%
Total gross margin		52.7	%		53.6	%	(1.0)	pts.
Non-operating adjustments:
Amortization of acquired intangible assets		165			183		(10.1)	%
Operating (non-GAAP) gross profit	$	7,595		$	7,290		4.2	%
Operating (non-GAAP) gross margin		53.8	%		55.0	%	(1.2)	pts.

Recast to reflect segment changes.

Management Discussion – (continued)


									Yr. to Yr.
									Percent
							Yr. to Yr.		Change
(Dollars in millions)							Percent/Margin		Adjusted For
For the nine months ended September 30:	2022			2021*			Change		Currency
Revenue:
Software	$	17,749		$	16,339		8.6	%	13.7	%
Gross margin		79.0	%		78.7	%	0.3	pts.
Consulting		14,337			13,098		9.5	%	16.9	%
Gross margin		24.8	%		28.3	%	(3.5)	pts.
Infrastructure		10,805			9,774		10.6	%	16.3	%
Gross margin		51.9	%		55.6	%	(3.7)	pts.
Financing		474			601		(21.2)	%	(17.9)	%
Gross margin		35.1	%		31.5	%	3.7	pts.
Other		475			844		(43.8)	%	(40.2)	%
Gross margin		(63.6)	%		(24.4)	%	(39.1)	pts.
Total revenue	$	43,840		$	40,656		7.8	%	13.8	%
Total gross profit	$	23,055		$	21,985		4.9	%
Total gross margin		52.6	%		54.1	%	(1.5)	pts.
Non-operating adjustments:
Amortization of acquired intangible assets		526			537		(2.0)	%
Operating (non-GAAP) gross profit	$	23,582		$	22,522		4.7	%
Operating (non-GAAP) gross margin		53.8	%		55.4	%	(1.6)	pts.

Recast to reflect segment changes.

Software


							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For
For the three months ended September 30:	2022		2021*		Change		Currency
Software revenue:	$	5,811	$	5,406	7.5	%	14.2	%
Hybrid Platform & Solutions	$	4,172	$	4,074	2.4	%	8.1	%
Red Hat					11.7		18.0
Automation					(2.4)		3.0
Data & AI					(1.0)		4.0
Security					(0.9)		5.8
Transaction Processing		1,640		1,332	23.1		32.8

Recast to reflect segment changes.

Management Discussion – (continued)


							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For
For the nine months ended September 30:	2022		2021*		Change		Currency
Software revenue:	$	17,749	$	16,339	8.6	%	13.7	%
Hybrid Platform & Solutions	$	12,641	$	12,082	4.6	%	9.0	%
Red Hat					13.7		18.6
Automation					1.4		5.6
Data & AI					0.4		4.3
Security					1.4		6.3
Transaction Processing		5,107		4,257	20.0		26.8

Recast to reflect segment changes.

Software revenue of $5,811 million increased 7.5 percent as reported (14 percent adjusted for currency) in the third quarter of 2022 compared to the prior-year period, driven by revenue growth in both Hybrid Platform & Solutions and Transaction Processing. This includes incremental sales to Kyndryl which contributed approximately 8 points to the revenue growth. This revenue performance reflects our strong and growing recurring revenue base, which is approximately 80 percent of our annual software revenue. Within Software, over the trailing 12 months, hybrid cloud revenue of $9,192 million grew 16 percent as reported (20 percent adjusted for currency) year to year, driven by growth in our hybrid cloud and AI capabilities.

Hybrid Platform & Solutions revenue of $4,172 million increased 2.4 percent as reported (8 percent adjusted for currency) in the third quarter of 2022 compared to the prior-year period, led by continued strong double-digit growth in Red Hat. Incremental sales to Kyndryl contributed approximately 1.5 points to the revenue growth. Red Hat revenue grew 11.7 percent as reported (18 percent adjusted for currency) in the third quarter. As a leader in open-source technologies for enterprises, Red Hat performance in the third quarter continued to be driven by market share gains across RHEL, OpenShift and Ansible. Automation revenue decreased 2.4 percent as reported, but grew 3 percent adjusted for currency, reflecting continued adoption in areas such as AI Ops and Management and Integration, and compared to strong acquisition-related contribution in the prior year. We also brought innovation to our clients this quarter such as new Instana observability capabilities for zSystems in a hybrid cloud environment. Data & AI revenue decreased 1.0 percent as reported, but increased 4 percent adjusted for currency, reflecting growth in areas such as Data Management, Data Fabric and Information Exchange. In addition, our offerings like Envizi and Environmental Intelligence Suite are resonating with clients as they prioritize sustainability efforts. Security revenue decreased 0.9 percent as reported, but grew 6 percent adjusted for currency, reflecting growth in Data Security and Threat Management. Within Data Security, growth was driven by client adoption of Guardium Insights as we continue to deliver new product innovation. Within Threat Management, growth was led by CloudPak for Security, which helps clients prevent and respond to modern threats across disparate security feeds.

Across Hybrid Platform & Solutions, our annual recurring revenue (ARR) was $13 billion, up 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 $1,640 million increased 23.1 percent as reported (33 percent adjusted for currency) in the third quarter of 2022 compared to the prior-year period, driven by incremental sales to Kyndryl that contributed approximately 26 points to the revenue growth. The increase in zSystems installed capacity over the last couple of product cycles and continued strong renewal rates are recognition of the importance of this platform in a hybrid cloud environment. As a result, the Transaction Processing annuity base grew this quarter.

For the first nine months of 2022, Software revenue of $17,749 million increased 8.6 percent as reported (14 percent adjusted for currency) compared to the same period in 2021. Incremental sales to Kyndryl contributed approximately 8 points to the revenue growth. We had broad-based growth across Hybrid Platform & Solutions for the first nine months of 2022. Transaction Processing had double-digit growth, driven by incremental sales to Kyndryl that contributed approximately 25 points to the revenue growth.


							Yr. to Yr.
							Percent/
(Dollars in millions)							Margin
For the three months ended September 30:	2022			2021*			Change
Software:
Gross profit	$	4,591		$	4,250		8.0	%
Gross profit margin		79.0	%		78.6	%	0.4	pts.
Pre-tax income	$	1,306		$	990		31.9	%
Pre-tax margin		22.5	%		18.3	%	4.2	pts.

Recast to reflect segment changes.


							Yr. to Yr.
							Percent/
(Dollars in millions)							Margin
For the nine months ended September 30:	2022			2021*			Change
Software:
Gross profit	$	14,025		$	12,862		9.0	%
Gross profit margin		79.0	%		78.7	%	0.3	pts.
Pre-tax income	$	3,816		$	2,707		41.0	%
Pre-tax margin		21.5	%		16.6	%	4.9	pts.

Recast to reflect segment changes.

Software gross profit margin increased 0.4 points to 79.0 percent in the third quarter of 2022 compared to the prior-year period, driven primarily by a mix between products and services, partially offset by a margin decline in services. For the first nine months of 2022, gross profit margin increased 0.3 points to 79.0 percent, driven primarily by the same factors.

In the third quarter, pre-tax income of $1,306 million increased 31.9 percent and pre-tax margin of 22.5 percent increased 4.2 points compared to the prior year. We continued to expand our pre-tax margin given the solid revenue growth including the Kyndryl commercial relationship. For the first nine months of 2022, pre-tax income of $3,816 million increased 41.0 percent and pre-tax margin of 21.5 percent increased 4.9 points compared to the prior-year period, driven by the increase in gross profit contribution year to year which reflects our solid revenue growth.

Management Discussion – (continued)

Consulting


							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For
For the three months ended September 30:	2022		2021*		Change		Currency
Consulting revenue:	$	4,700	$	4,457	5.4	%	15.6	%
Business Transformation	$	2,165	$	2,068	4.7	%	14.3	%
Technology Consulting		943		889	6.1		16.6
Application Operations		1,593		1,501	6.2		16.8

Recast to reflect segment change.


							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For
For the nine months ended September 30:	2022		2021*		Change		Currency
Consulting revenue:	$	14,337	$	13,098	9.5	%	16.9	%
Business Transformation	$	6,646	$	6,070	9.5	%	16.5	%
Technology Consulting		2,826		2,538	11.4		19.3
Application Operations		4,865		4,489	8.4		16.1

Recast to reflect segment change.

Consulting revenue of $4,700 million increased 5.4 percent as reported (16 percent adjusted for currency) in the third quarter of 2022 compared to the prior-year period, with growth across all business areas. Over the trailing 12 months, our book-to-bill ratio was 1.05, reflecting clients’ trust in our deep industry expertise and co-creation approach throughout their hybrid cloud and digital transformation journeys. Within Consulting, over the trailing 12 months, hybrid cloud revenue of $8,889 million grew 21 percent as reported (28 percent adjusted for currency) year to year, as we help clients design and enable enterprise hybrid cloud strategies. Our Red Hat consulting practice continued to be a meaningful contributor to revenue with strong double-digit growth as we continued to add new engagements. Since acquiring Red Hat just over three years ago, Consulting has led nearly 1,400 Red Had engagements with more than $6.5 billion in aggregate bookings. Our strategic partnerships also contributed to our performance in the third quarter, with continued revenue growth at a double-digit rate from these partnerships.

In the third quarter of 2022, Business Transformation revenue of $2,165 million increased 4.7 percent as reported (14 percent adjusted for currency) on a year-to-year basis, as clients looked to IBM to help them transform critical workflows at scale. This growth was pervasive, driven by supply chain, finance, data and client experience transformations. Working with our partners such as SAP, Salesforce and Adobe, we help our clients optimize their operations and improve the way they engage with their customers.

Technology Consulting revenue of $943 million increased 6.1 percent as reported (17 percent adjusted for currency) in the third quarter of 2022 compared to the prior-year period, led by our cloud application development and cloud modernization offerings, including our Red Hat consulting practice.

Application Operations revenue of $1,593 million increased 6.2 percent as reported (17 percent adjusted for currency) compared to the third quarter of 2021. We helped clients optimize their operations and reduce cost by taking over the management of clients’ applications in hybrid and multi-cloud environments. We leverage AI to help predict problems before they happen and monitor our clients’ different environments with dashboards, enabling action to be taken quickly.

For the first nine months of 2022, Consulting revenue of $14,337 million increased 9.5 percent as reported (17 percent adjusted for currency) reflecting strong year-to-year growth as reported and adjusted for currency across all three business areas. Within Business Transformation, year-to-year revenue grew as we brought technology and strategic

Management Discussion – (continued)

consulting together to help clients transform critical workflows at scale. In our Technology Consulting business, we led client engagements around cloud modernization and cloud development. Through our Application Operations offerings, we continued to provide cloud platform and application management services to help our clients run their hybrid cloud environments.


							Yr. to Yr.
							Percent/
(Dollars in millions)							Margin
For the three months ended September 30:	2022			2021*			Change
Consulting:
Gross profit	$	1,220		$	1,315		(7.2)	%
Gross profit margin		26.0	%		29.5	%	(3.5)	pts.
Pre-tax income	$	462		$	466		(0.8)	%
Pre-tax margin		9.8	%		10.5	%	(0.6)	pts.

Recast to reflect segment change.


							Yr. to Yr.
							Percent/
(Dollars in millions)							Margin
For the nine months ended September 30:	2022			2021*			Change
Consulting:
Gross profit	$	3,559		$	3,711		(4.1)	%
Gross profit margin		24.8	%		28.3	%	(3.5)	pts.
Pre-tax income	$	1,154		$	1,013		13.9	%
Pre-tax margin		8.0	%		7.7	%	0.3	pts.

Recast to reflect segment change.

Consulting gross profit margin of 26.0 percent decreased 3.5 points in the third quarter of 2022 compared to the same period in 2021, reflecting the pressure on the margin profile from continued labor costs inflation, however, the Consulting gross profit margin improved 1.8 points compared to the second quarter of 2022. We had two consecutive quarters of priced margin improvement year over year, that will contribute to improved margin performance going forward. Additionally, our utilization rates are improving as we exit the third quarter, and our acquisitions are scaling toward margin accretion. For the first nine months of 2022, Consulting gross profit margin of 24.8 percent decreased 3.5 points compared to the prior-year period, reflecting the same dynamics described above. We continue to invest in our partner ecosystem, expanding our reach and are investing in talent across our workforce, developing and adding technical skills in the areas of hybrid cloud and AI.

Pre-tax income of $462 million decreased 0.8 percent and pre-tax margin of 9.8 percent decreased 0.6 points in the third quarter of 2022 compared to the prior-year period, with almost 3 points of sequential improvement in the pre-tax margin compared to the second quarter of 2022. For the first nine months of 2022, pre-tax income of $1,154 million increased 13.9 percent and pre-tax margin of 8.0 percent increased 0.3 points compared to the prior-year period, as we start to recognize the benefits of priced margin improvements, increased productivity within our workforce, and a more streamlined operating and go-to-market structure.

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 September 30:	2022		2021		Change		Currency
Total Consulting signings	$	4,509	$	5,046	(10.6)	%	(1.9)	%

Management Discussion – (continued)


							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For
For the nine months ended September 30:	2022		2021		Change		Currency
Total Consulting signings	$	14,300	$	13,497	5.9	%	13.3	%

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.

Infrastructure


							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For
For the three months ended September 30:	2022		2021*		Change		Currency
Infrastructure revenue:	$	3,352	$	2,921	14.8	%	23.1	%
Hybrid Infrastructure	$	1,931	$	1,453	32.9	%	41.0	%
zSystems					88.0		97.9
Distributed Infrastructure					13.5		20.9
Infrastructure Support		1,421		1,468	(3.2)		5.3

Recast to reflect segment change.


							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For
For the nine months ended September 30:	2022		2021*		Change		Currency
Infrastructure revenue:	$	10,805	$	9,774	10.6	%	16.3	%
Hybrid Infrastructure	$	6,392	$	5,294	20.7	%	26.2	%
zSystems					39.6		45.4
Distributed Infrastructure					10.1		15.5
Infrastructure Support		4,413		4,480	(1.5)		4.5

Recast to reflect segment change.

Infrastructure revenue of $3,352 million increased 14.8 percent as reported (23 percent adjusted for currency) in the third quarter of 2022 compared to the prior-year period. This includes incremental sales to Kyndryl which contributed

Management Discussion – (continued)

approximately 9 points to the revenue growth. This performance reflects continued strong double-digit growth in Hybrid Infrastructure as reported and adjusted for currency, driven primarily by the z16 product cycle. Within Infrastructure, over the trailing 12 months, hybrid cloud revenue of $3,930 million increased 3 percent as reported (6 percent adjusted for currency) year to year, driven primarily by product cycle dynamics.

Hybrid Infrastructure revenue of $1,931 million increased 32.9 percent as reported (41 percent adjusted for currency) in the third quarter of 2022 compared to the prior-year period. Incremental sales to Kyndryl contributed approximately 11 points to the revenue growth. Within Hybrid Infrastructure, zSystems revenue grew 88.0 percent as reported (98 percent adjusted for currency) on a year-to-year basis, driven by continued adoption of our new z16 program. This latest program combines embedded AI at scale, cloud-native development for hybrid cloud and cyber-resilient security. The z16 is also the industry’s first quantum-safe system, delivering 25 billion encrypted transactions per day for clients. In the third quarter, we introduced our newest LinuxONE server, a highly scalable Linux and Kubernetes-based platform with capabilities to reduce clients’ energy consumption. IBM zSystems remains an enduring platform, playing an important role in a hybrid cloud environment. Distributed Infrastructure revenue grew 13.5 percent as reported (21 percent adjusted for currency). Recent innovation across the portfolio enabled broad-based growth in our Storage and Power platforms, including refreshes to our flash storage solutions and the expansion of our Power10 server family.

Infrastructure Support revenue of $1,421 million decreased 3.2 percent as reported, but grew 5 percent adjusted for currency in the third quarter of 2022 compared to the prior-year period. This includes incremental sales to Kyndryl which contributed approximately 7 points of revenue growth for the quarter.

For the first nine months of 2022, Infrastructure revenue of $10,805 million increased 10.6 percent as reported (16 percent adjusted for currency) compared to the prior-year period. Incremental sales to Kyndryl contributed approximately 8 points of revenue growth. Infrastructure revenue performance was driven by double-digit growth in Hybrid Infrastructure, with zSystems revenue growth driven by the new z16, and growth in Distributed Infrastructure driven by strong performance in high-end disk and flash storage solutions as well as high-end Power10 systems.


							Yr. to Yr.
							Percent/
(Dollars in millions)							Margin
For the three months ended September 30:	2022			2021*			Change
Infrastructure:
Gross profit	$	1,702		$	1,541		10.4	%
Gross profit margin		50.8	%		52.8	%	(2.0)	pts.
Pre-tax income	$	280		$	209		34.1	%
Pre-tax margin		8.3	%		7.1	%	1.2	pts.

Recast to reflect segment change.


							Yr. to Yr.
							Percent/
(Dollars in millions)							Margin
For the nine months ended September 30:	2022			2021*			Change
Infrastructure:
Gross profit	$	5,607		$	5,430		3.3	%
Gross profit margin		51.9	%		55.6	%	(3.7)	pts.
Pre-tax income	$	1,236		$	989		25.0	%
Pre-tax margin		11.4	%		10.1	%	1.3	pts.

Recast to reflect segment change.

Infrastructure gross profit margin of 50.8 percent decreased 2.0 points in the third quarter of 2022 compared to the prior-year period, driven primarily by profit margin decline in Infrastructure Support, partially offset by margin

Management Discussion – (continued)

expansion in Hybrid Infrastructure driven primarily by a product mix benefit from the revenue growth in zSystems. For the first nine months of 2022, gross profit margin of 51.9 percent decreased 3.7 points compared to the prior-year period, driven primarily by profit margin declines in Distributed Infrastructure, which reflects increased component costs and supplier premiums, as well as margin declines in Infrastructure Support, driven by portfolio mix. These declines are partially offset by a product mix benefit from the revenue growth in zSystems.

In the third quarter of 2022, Infrastructure pre-tax income of $280 million increased 34.1 percent and pre-tax margin of 8.3 percent increased 1.2 points compared to the prior-year period, reflecting product mix benefits from the revenue growth in zSystems. For the first nine months of 2022, Infrastructure pre-tax income of $1,236 million increased 25.0 percent and pre-tax margin of 11.4 percent increased 1.3 points compared to the prior-year period, driven primarily by the same factor described above.

Financing

See pages 91 through 94 for a discussion of Financing’s segment results.

Geographic Revenue

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


							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For
For the three months ended September 30:	2022		2021		Change		Currency
Total Revenue	$	14,107	$	13,251	6.5	%	14.6	%
Americas	$	7,416	$	6,579	12.7	%	13.4	%
Europe/Middle East/Africa (EMEA)		3,959		3,939	0.5		15.9
Asia Pacific		2,732		2,734	(0.1)		15.7


							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For
For the nine months ended September 30:	2022		2021		Change		Currency
Total Revenue	$	43,840	$	40,656	7.8	%	13.8	%
Americas	$	22,614	$	20,178	12.1	%	12.4	%
Europe/Middle East/Africa (EMEA)		12,716		12,181	4.4		15.8
Asia Pacific		8,509		8,297	2.6		14.0

Total revenue of $14,107 million increased 6.5 percent as reported (15 percent adjusted for currency) in the third quarter of 2022 compared to the prior-year period, which includes approximately 5 points of revenue growth from incremental sales to Kyndryl.

Americas revenue of $7,416 million increased 12.7 percent as reported (13 percent adjusted for currency), which includes approximately 4 points of revenue growth from incremental sales to Kyndryl. Within North America, the U.S. increased 11.5 percent and Canada increased 3.8 percent as reported (7 percent adjusted for currency). Latin America increased 28.0 percent as reported (32 percent adjusted for currency), with Brazil increasing 30.3 percent as reported (31 percent adjusted for currency).

In EMEA, total revenue of $3,959 million increased 0.5 percent as reported (16 percent adjusted for currency), which includes approximately 6 points of revenue growth from incremental sales to Kyndryl. France and the UK increased 4.5 percent and 3.3 percent, respectively, as reported, and increased 21 percent and 20 percent, respectively,

Management Discussion – (continued)

adjusted for currency. Germany and Italy decreased 8.1 percent and 1.3 percent, respectively, as reported, but increased 7 percent and 15 percent, respectively, adjusted for currency. The suspension and orderly wind-down of our Russian operations in the second quarter impacted the revenue growth rate in EMEA by 1.7 points as reported (2 points adjusted for currency).

Asia Pacific revenue of $2,732 million was flat as reported, but increased 16 percent adjusted for currency, which includes approximately 5 points of revenue growth from incremental sales to Kyndryl. Japan decreased 3.4 percent as reported, but increased 22 percent adjusted for currency. India and Australia increased 6.7 percent and 2.6 percent, respectively, as reported, and increased 15 percent and 10 percent, respectively, adjusted for currency. China decreased 15.3 percent as reported (12 percent adjusted for currency).

For the first nine months of 2022, total revenue of $43,840 million increased 7.8 percent as reported (14 percent adjusted for currency) compared to the prior-year period, which includes approximately 5 points of revenue growth from incremental sales to Kyndryl.

Americas revenue of $22,614 million increased 12.1 percent as reported (12 percent adjusted for currency), which includes approximately 4 points of revenue growth from incremental sales to Kyndryl. Within North America, the U.S. increased 10.8 percent and Canada increased 5.3 percent as reported (8 percent adjusted for currency). Latin America increased 29.1 percent as reported (30 percent adjusted for currency), with Brazil increasing 33.6 percent as reported (30 percent adjusted for currency).

In EMEA, total revenue of $12,716 million increased 4.4 percent as reported (16 percent adjusted for currency), which includes approximately 7 points of revenue growth from incremental sales to Kyndryl. The UK, France and Germany increased 8.0 percent, 5.3 percent and 2.2 percent, respectively, as reported, and increased 19 percent, 18 percent and 14 percent, respectively, adjusted for currency. Italy decreased 1.1 percent as reported, but increased 11 percent adjusted for currency. The suspension and orderly wind-down of our Russian operations in the second quarter impacted the revenue growth rate in EMEA by 1.7 points as reported (2 points adjusted for currency).

Asia Pacific revenue of $8,509 million increased 2.6 percent as reported (14 percent adjusted for currency), which includes approximately 6 points of revenue growth from incremental sales to Kyndryl. Japan was flat as reported and increased 18 percent adjusted for currency. India and Australia increased 20.5 percent and 7.8 percent, respectively, as reported, and increased 27 percent and 16 percent, respectively, adjusted for currency. China decreased 13.1 percent as reported and 12 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 September 30:	2022			2021			Change
Total expense and other (income)	$	11,931	*	$	6,293		89.6	%
Non-operating adjustments:
Amortization of acquired intangible assets	$	(253)		$	(285)		(11.5)	%
Acquisition-related charges		(1)			(4)		(76.9)
Non-operating retirement-related (costs)/income		(6,062)	*		(318)		nm
Kyndryl-related impacts		14			—		nm
Operating (non-GAAP) expense and other (income)	$	5,630		$	5,687		(1.0)	%
Total expense-to-revenue ratio		84.6	%		47.5	%	37.1	pts.
Operating (non-GAAP) expense-to-revenue ratio		39.9	%		42.9	%	(3.0)	pts.

Includes a one-time, non-cash pension settlement charge of $5.9 billion. See note 18, “Retirement-Related Benefits,” for additional information.

nm - not meaningful


							Yr. to Yr.
(Dollars in millions)							Percent
For the nine months ended September 30:	2022			2021			Change
Total expense and other (income)	$	25,212	*	$	20,017		25.9	%
Non-operating adjustments:
Amortization of acquired intangible assets	$	(810)		$	(835)		(2.9)	%
Acquisition-related charges		(9)			(37)		(75.0)
Non-operating retirement-related (costs)/income		(6,455)	*		(967)		nm
Kyndryl-related impacts		(353)			—		nm
Operating (non-GAAP) expense and other (income)	$	17,584		$	18,179		(3.3)	%
Total expense-to-revenue ratio		57.5	%		49.2	%	8.3	pts.
Operating (non-GAAP) expense-to-revenue ratio		40.1	%		44.7	%	(4.6)	pts.

Includes a one-time, non-cash pension settlement charge of $5.9 billion. See note 18, “Retirement-Related Benefits,” for additional information.

nm - not meaningful

Total expense and other (income) increased 89.6 percent in the third quarter of 2022 versus the prior-year period primarily driven by the one-time, non-cash pension settlement charge of $5.9 billion and higher spending reflecting our continuing focus on our portfolio and investment in our offerings, technical talent and ecosystem, partially offset by the effects of currency and benefits from the actions taken to streamline operations and our go-to-market model. Total operating (non-GAAP) expense and other (income) decreased 1.0 percent year to year, driven primarily by the factors described above excluding the pension settlement charge.

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

Management Discussion – (continued)

Selling, General and Administrative Expense


					Yr. to Yr.
(Dollars in millions)					Percent
For the three months ended September 30:	2022		2021		Change
Selling, general and administrative expense:
Selling, general and administrative — other	$	3,681	$	3,553	3.6	%
Advertising and promotional expense		297		342	(13.2)
Workforce rebalancing charges		13		0	nm
Amortization of acquired intangible assets		252		285	(11.5)
Stock-based compensation		138		144	(3.7)
Provision for/(benefit from) expected credit loss expense		11		(17)	nm
Total selling, general and administrative expense	$	4,391	$	4,306	2.0	%
Non-operating adjustments:
Amortization of acquired intangible assets	$	(252)	$	(285)	(11.5)	%
Acquisition-related charges		(1)		(4)	(76.9)
Kyndryl-related impacts		0		—	nm
Operating (non-GAAP) selling, general and administrative expense	$	4,138	$	4,018	3.0	%

nm - not meaningful


					Yr. to Yr.
(Dollars in millions)					Percent
For the nine months ended September 30:	2022		2021		Change
Selling, general and administrative expense:
Selling, general and administrative — other	$	11,501	$	11,397	0.9	%
Advertising and promotional expense		1,028		1,079	(4.7)
Workforce rebalancing charges		46		201	(77.3)
Amortization of acquired intangible assets		808		833	(2.9)
Stock-based compensation		427		399	6.9
Provision for/(benefit from) expected credit loss expense		33		(67)	nm
Total selling, general and administrative expense	$	13,843	$	13,842	0.0	%
Non-operating adjustments:
Amortization of acquired intangible assets	$	(808)	$	(833)	(2.9)	%
Acquisition-related charges		(9)		(37)	(75.0)
Kyndryl-related impacts		0		—	nm
Operating (non-GAAP) selling, general and administrative expense	$	13,025	$	12,972	0.4	%

nm - not meaningful

Total selling, general and administrative (SG&A) expense increased 2.0 percent in the third quarter of 2022 versus the prior-year period driven primarily by the following factors:

	●	Higher spending (6 points) reflecting our continuing investment to drive our hybrid cloud and AI strategy, expenses of acquired businesses and higher travel and commission expense, partially offset by benefits from the actions taken to streamline operations and our go-to-market model and lower spending for shared services transferred to Kyndryl; and

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

	●	The effects of currency (5 points).

Management Discussion – (continued)

Operating (non-GAAP) expense increased 3.0 percent year to year, primarily driven by the same factors.

SG&A expense was flat in the first nine months of 2022 versus the prior-year period driven primarily by the following factors:

	●	Higher spending (4 points) driven primarily by the same factors described above; and

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

	●	The effects of currency (3 points); and

	●	Lower workforce rebalancing charges (1 point).

Operating (non-GAAP) expense increased 0.4 percent year to year, primarily driven by the same factors.

Provisions for expected credit loss expense increased $99 million in the first nine months of 2022 compared to the prior-year period, primarily driven by an increase in specific reserves in the current year compared to decreases in both general and specific reserves in the prior-year period. The receivables provision coverage was 2.3 percent at September 30, 2022, an increase of 20 basis points from December 31, 2021, due to the decline in total receivables balance, and a decrease of 20 basis points from September 30, 2021.

Research, Development and Engineering


					Yr. to Yr.
(Dollars in millions)					Percent
For the three months ended September 30:	2022		2021		Change
Research, development and engineering expense	$	1,611	$	1,606	0.3	%


					Yr. to Yr.
(Dollars in millions)					Percent
For the nine months ended September 30:	2022		2021		Change
Research, development and engineering expense	$	4,963	$	4,863	2.0	%

Research, development and engineering (RD&E) expense in the third quarter of 2022 increased 0.3 percent year to year reflecting our continuing investment to deliver innovation in AI, hybrid cloud and emerging areas such as quantum. Higher spending (3 points) in the current-year period was partially offset by the effects of currency (2 points).

RD&E expense in the first nine months of 2022 increased 2.0 percent year to year, primarily driven by higher spending (4 points) partially offset by the effects of currency (2 points).

Intellectual Property and Custom Development Income


					Yr. to Yr.
(Dollars in millions)					Percent
For the three months ended September 30:	2022		2021		Change
Intellectual property and custom development income:
Licensing of intellectual property including royalty-based fees	$	62	$	75	(17.6)	%
Custom development income		59		68	(12.8)
Sales/other transfers of intellectual property		1		10	(94.5)
Total	$	121	$	153	(20.5)	%

Management Discussion – (continued)


					Yr. to Yr.
(Dollars in millions)					Percent
For the nine months ended September 30:	2022		2021		Change
Intellectual property and custom development income:
Licensing of intellectual property including royalty-based fees	$	246	$	215	14.5	%
Custom development income		164		197	(16.7)
Sales/other transfers of intellectual property		8		20	(58.0)
Total	$	418	$	431	(3.0)	%

Total intellectual property and custom development income decreased 20.5 percent year to year in the third quarter, and 3.0 percent in the first nine months of 2022 compared to the prior-year period. The timing and amount of licensing, sales or other transfers of IP may vary significantly from period to period depending upon the timing of licensing agreements, economic conditions, industry consolidation and the timing of new patents and know-how development.

Other (Income) and Expense


						Yr. to Yr.
(Dollars in millions)						Percent
For the three months ended September 30:	2022			2021		Change
Other (income) and expense:
Foreign currency transaction losses/(gains)	$	(352)		$	(21)	nm
(Gains)/losses on derivative instruments		189			7	nm
Interest income		(53)			(14)	287.1	%
Net (gains)/losses from securities and investment assets		(11)			3	nm
Retirement-related costs/(income)		6,062	*		318	nm
Other		(80)			(48)	65.1
Total other (income) and expense	$	5,755	*	$	244	nm
Non-operating adjustments:
Amortization of acquired intangible assets	$	(1)		$	(1)	—
Non-operating retirement-related (costs)/income		(6,062)	*		(318)	nm
Kyndryl-related impacts		14			—	nm
Operating (non-GAAP) other (income) and expense	$	(293)		$	(74)	294.3	%

Includes a one-time, non-cash pension settlement charge of $5.9 billion.

nm - not meaningful


						Yr. to Yr.
(Dollars in millions)						Percent
For the nine months ended September 30:	2022			2021		Change
Other (income) and expense:
Foreign currency transaction losses/(gains)	$	(1,021)		$	(145)	nm
(Gains)/losses on derivative instruments		730			246	196.5	%
Interest income		(98)			(39)	154.9
Net (gains)/losses from securities and investment assets		262			(3)	nm
Retirement-related costs/(income)		6,455	*		967	nm
Other		(407)			(135)	200.9
Total other (income) and expense	$	5,921	*	$	891	nm
Non-operating adjustments:
Amortization of acquired intangible assets	$	(2)		$	(2)	—
Non-operating retirement-related (costs)/income		(6,455)	*		(967)	nm
Kyndryl-related impacts		(353)			—	nm
Operating (non-GAAP) other (income) and expense	$	(889)		$	(77)	nm

Includes a one-time, non-cash pension settlement charge of $5.9 billion.

nm - not meaningful

Management Discussion – (continued)

Total other (income) and expense was expense of $5,755 million in the third quarter of 2022 compared to $244 million in the prior-year period. The year-to-year change was primarily driven by:

	●	Higher non-operating retirement-related costs ($5,744 million) driven by the pension settlement charge. Refer to note 18, “Retirement-Related Benefits,” for additional information; partially offset by

	●	Higher net exchange gains (including derivative instruments) in the current year ($145 million); and

	●	Higher interest income ($39 million) driven by higher average interest rates in the current year.

Operating (non-GAAP) other (income) and expense was $293 million of income in the third quarter of 2022 and increased $219 million compared to the prior-year period. The year-to-year change was driven primarily by the higher net exchange gains and higher interest income.

Total other (income) and expense was $5,921 million of expense in the first nine months of 2022 compared to $891 million in the prior-year period. The year-to-year decrease was primarily driven by:

	●	Higher non-operating retirement-related costs ($5,489 million) driven by the pension settlement charge. Refer to note 18, “Retirement-Related Benefits,” for additional information; and

	●	Net losses related to Kyndryl retained shares ($267 million); partially offset by

	●	Net exchange gains (including foreign exchange derivative instruments) in the current year versus net exchange losses in the prior year ($477 million). The current-year (gains)/losses on derivative instruments also includes a loss on the cash-settled swap related to the Kyndryl retained shares ($85 million);

	●	Higher gains on divestitures ($283 million) primarily driven by the divestiture of our healthcare software assets (included in “Other”); and

	●	Higher interest income ($60 million) driven by higher average interest rates in the current year.

Operating (non-GAAP) other (income) and expense was $889 million of income in the first nine months of 2022 and increased $812 million compared to the prior-year period. The year-to-year increase was driven primarily by the effects of currency, higher gains on divestitures and higher interest income described above.

Interest Expense


					Yr. to Yr.
(Dollars in millions)					Percent
For the three months ended September 30:	2022		2021		Change
Interest expense	$	295	$	290	1.7	%


					Yr. to Yr.
(Dollars in millions)					Percent
For the nine months ended September 30:	2022		2021		Change
Interest expense	$	903	$	852	6.0	%

Interest expense increased $5 million and $51 million year to year in the third quarter and first nine months of 2022, respectively. 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 third quarter and first nine months of 2022 was $394 million and $1,166 million, respectively, an increase of $2 million and $3 million, respectively, compared to the prior-year periods. The year-to-year dynamics for

Management Discussion – (continued)

both the third quarter and first nine months of 2022 were primarily driven by higher average interest rates, offset by a lower average debt balance.

Retirement-Related Plans

The following tables provide the total pre-tax cost for all retirement-related plans. The operating cost amounts are included in the Consolidated Income Statement within the caption (e.g., Cost, SG&A, RD&E) relating to the job function of the plan participants. The non-operating cost amounts are included in other (income) and expense.


						Yr. to Yr.
(Dollars in millions)						Percent
For the three months ended September 30:	2022			2021		Change
Retirement-related plans — cost:
Service cost	$	59		$	70	(15.6)	%
Multi-employer plans		4			2	76.8
Cost of defined contribution plans		225			252	(10.7)
Total operating costs	$	288		$	324	(11.2)	%
Interest cost	$	436		$	408	6.9	%
Expected return on plan assets		(679)			(726)	(6.5)
Recognized actuarial losses		381			613	(37.9)
Amortization of prior service costs/(credits)		3			3	(11.4)
Curtailments/settlements		5,913	*		13	nm
Other costs		8			7	18.5
Total non-operating costs/(income)	$	6,062	*	$	318	nm
Total retirement-related plans — cost	$	6,350	*	$	642	nm

Includes a one-time, non-cash pension settlement charge of $5.9 billion. See note 18, “Retirement-Related Benefits,” for additional information.

nm - not meaningful


						Yr. to Yr.
(Dollars in millions)						Percent
For the nine months ended September 30:	2022			2021		Change
Retirement-related plans — cost:
Service cost	$	186		$	209	(11.0)	%
Multi-employer plans		11			13	(12.0)
Cost of defined contribution plans		697			760	(8.3)
Total operating costs	$	894		$	982	(8.9)	%
Interest cost	$	1,363		$	1,227	11.1	%
Expected return on plan assets		(2,162)			(2,187)	(1.2)
Recognized actuarial losses		1,283			1,852	(30.7)
Amortization of prior service costs/(credits)		16			7	131.9
Curtailments/settlements		5,931	*		46	nm
Other costs		24			21	9.8
Total non-operating costs/(income)	$	6,455	*	$	967	nm
Total retirement-related plans — cost	$	7,350	*	$	1,949	277.1	%

Includes a one-time, non-cash pension settlement charge of $5.9 billion. See note 18, “Retirement-Related Benefits,” for additional information.

nm - not meaningful

Total pre-tax retirement-related plan cost increased by $5,708 million compared to the third quarter of 2021 primarily due to an increase in curtailments/settlements ($5,900 million) driven by a one-time, non-cash pension settlement charge, lower expected return on plan assets ($47 million) and higher interest costs ($28 million), partially offset by a decrease in recognized actuarial losses ($232 million) and lower cost of defined contribution plans ($27

Management Discussion – (continued)

million). Total cost for the first nine months of 2022 increased $5,401 million compared to the first nine months of 2021, primarily due to an increase in curtailments/settlements ($5,885 million) driven by the pension settlement charge, higher interest costs ($136 million), partially offset by a decrease in recognized actuarial losses ($569 million), and lower cost of defined contribution plans ($63 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 third quarter of 2022 were $288 million, a decrease of $36 million compared to the third quarter of 2021. For the first nine months of 2022, operating retirement-related costs were $894 million, a decrease of $88 million compared to the prior-year period. These operating cost decreases were primarily driven by lower cost of defined contribution plans. Non-operating costs of $6,062 million in the third quarter of 2022 increased $5,744 million year to year and for the first nine months of 2022 were $6,455 million, an increase of $5,488 million compared to the prior-year period. These non-operating cost increases were driven primarily by the $5.9 billion pension settlement charge, higher interest costs and lower expected return on plan assets, partially offset by a decrease in recognized actuarial losses.

Taxes

The continuing operations benefit from income taxes for the third quarter of 2022 was $1,287 million, compared to a benefit of $224 million in the third quarter of 2021. The current-year tax benefit was primarily due to the transfer of a portion of the Qualified PPP’s defined benefit pension obligations and related plan assets. The prior-year tax benefit was primarily driven by events that resulted in additional anticipated utilization of U.S. foreign tax credits. The operating (non-GAAP) income tax provision for the third quarter of 2022 was $312 million, compared to a benefit from income taxes of $67 million in the third quarter of 2021. The current-year tax provision was driven by many factors including the impacts of the geographical mix of income, incentives and changes in unrecognized tax benefits and tax laws. The prior-year tax benefit was primarily driven by events that resulted in additional anticipated utilization of U.S. foreign tax credits.

The continuing operations benefit from income taxes for the first nine months of 2022 was $1,070 million, compared to a benefit of $282 million for the first nine months of 2021. The increase compared to the prior year was primarily driven by the transfer of a portion of the Qualified PPP’s defined benefit pension obligations and related plan assets in the third quarter of 2022. The operating (non-GAAP) provision for income taxes for the first nine months of 2022 was $969 million, compared to $204 million for the first nine months of 2021. The increase in the operating (non-GAAP) income tax provision compared to the prior year was primarily driven by the resolution of certain tax audits in the first quarter of 2021 as well as third-quarter events in 2021 that resulted in additional anticipated utilization of U.S. foreign tax credits.

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 discrete tax events, such as the settlement of income tax audits and changes in or new interpretations of tax laws. The GAAP tax provision and effective tax rate could also be affected by adjustments to the previously recorded charges for U.S. tax reform attributable to any changes in law, new regulations and guidance, 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. federal 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. federal income tax returns for 2015 and 2016. The company anticipates that this audit will be completed in 2022 or early 2023. In the fourth quarter of 2021, the IRS commenced its audit of the company’s U.S. federal income 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

Management Discussion – (continued)

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 as a result of tax assessments issued by the India tax authorities. At September 30, 2022, the company had recorded $704 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 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 amount of unrecognized tax benefits at September 30, 2022 is $8,531 million which can be reduced by $538 million associated with timing adjustments, U.S. tax credits, potential transfer pricing adjustments, and state income taxes. The net amount of $7,993 million, if recognized, would favorably affect the company’s effective tax rate.

Earnings/(Loss) 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.

For the three and nine months ended September 30, 2022, the one-time, non-cash, pre-tax pension settlement charge of $5.9 billion ($4.4 billion net of tax) resulted in net losses as reported. Therefore, otherwise dilutive potential shares of common stock have been excluded from the computation of diluted earnings/(loss) per share as the effect would be antidilutive. See note 7, “Earnings Per Share of Common Stock,” for additional information.

Operating (non-GAAP) earnings per share for the three and nine months ended September 30, 2022 included all potential dilutive securities.


						Yr. to Yr.
						Percent
For the three months ended September 30:	2022			2021		Change
Earnings/(loss) per share of common stock from continuing operations:
Assuming dilution	$	(3.55)	*	$	1.14	nm
Basic	$	(3.55)	*	$	1.16	nm
Diluted operating (non-GAAP)	$	1.81		$	1.84	(1.6)	%
Weighted-average shares outstanding: (in millions)
Assuming dilution		904.1			906.0	(0.2)	%
Basic		904.1			897.1	0.8	%
Assuming dilution (non-GAAP)		912.8			906.0	0.8	%

The $5.9 billion one-time, non-cash, pre-tax pension settlement charge resulted in an impact of ($4.86) to diluted earnings/(loss) per share from continuing operations and an impact of ($4.88) to basic earnings/(loss) per share.

nm - not meaningful

Management Discussion – (continued)


						Yr. to Yr.
						Percent
For the nine months ended September 30:	2022			2021		Change
Earnings/(loss) per share of common stock from continuing operations:
Assuming dilution	$	(1.21)	*	$	2.49	nm
Basic	$	(1.21)	*	$	2.51	nm
Diluted operating (non-GAAP)	$	5.52		$	4.58	20.5	%
Weighted-average shares outstanding: (in millions)
Assuming dilution		901.6			904.0	(0.3)	%
Basic		901.6			895.3	0.7	%
Assuming dilution (non-GAAP)		911.1			904.0	0.8	%

The $5.9 billion one-time, non-cash, pre-tax pension settlement charge resulted in an impact of ($4.86) to diluted earnings/(loss) per share from continuing operations and an impact of ($4.90) to basic earnings/(loss) per share.

nm - not meaningful

Actual shares outstanding at September 30, 2022 were 904.1 million. The weighted-average number of common shares outstanding assuming dilution during the third quarter and first nine months of 2022 were 1.9 million (0.2 percent) and 2.4 million (0.3 percent) shares lower, respectively, than the same periods of 2021, driven by the exclusion of dilutive potential common shares in the current-year computation. The weighted-average number of common shares outstanding assuming dilution used in the non-GAAP diluted earnings per share calculation for the third quarter and first nine months of 2022 were 6.9 million (0.8 percent) and 7.1 million (0.8 percent) shares higher, respectively, than the same periods of 2021.

Financial Position

Dynamics

Our balance sheet at September 30, 2022 continues to provide us with flexibility to support the business.

Cash, restricted cash and marketable securities at September 30, 2022 were $9,728 million, an increase of $2,171 million from December 31, 2021. Total debt of $50,880 million at September 30, 2022 decreased $824 million from December 31, 2021 driven by currency impacts. 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 nine months of 2022, we generated $6,470 million in cash from operating activities, compared to $10,252 million in the first nine months of 2021, primarily due to financing receivables. There was no cash flow impact from the U.S. pension settlement charge. We invested $1,020 million in acquisitions, generated $1,271 million from divested businesses and returned $4,454 million to shareholders through dividends in the first nine months 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 September 2022 has increased from year-end 2021, primarily due to higher interest rates and the settlement of approximately $16 billion of the U.S. Qualified PPP’s defined benefit pension obligations. After the settlement and remeasurement, the U.S. Qualified PPP remained in an overfunded position at September 30, 2022. Refer to note 18, “Retirement-Related Benefits,” for additional information. We currently have no change to expected plan contributions in 2022.

Management Discussion – (continued)

IBM Working Capital


	At September 30,		At December 31,
(Dollars in millions)	2022		2021
Current assets	$	28,999	$	29,539
Current liabilities		30,466		33,619
Working capital	$	(1,467)	$	(4,080)
Current ratio		0.95:1		0.88:1

Working capital increased $2,613 million from the year-end 2021 position. The key changes are described below:

Current assets decreased $540 million (an increase of $1,329 million adjusted for currency) due to:

	●	A decline in receivables of $2,666 million ($1,593 million adjusted for currency) mainly due to collections of higher year-end balances; partially offset by

	●	An increase of $2,171 million ($2,718 million adjusted for currency) in cash, restricted cash and marketable securities.

Current liabilities decreased $3,153 million ($1,401 million adjusted for currency) as a result of:

	●	A decrease in deferred income of $1,378 million ($512 million adjusted for currency) reflecting seasonal reductions from higher year-end balances;

	●	A decrease in short-term debt of $849 million ($850 million adjusted for currency) due to maturities of $5,338 million; partially offset by reclassifications of $4,757 million from long-term debt to reflect upcoming maturities; and

	●	A decrease in taxes payable of $622 million ($423 million adjusted for currency) primarily due to indirect tax payments.

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		September 30, 2022
$	443	$	53	$	(51)	$	(24)	$	421

This roll forward includes any reserves related to discontinued operations.

**	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 September 30, 2022, an increase of 20 basis points compared to December 31, 2021. The increase was primarily driven by the decline in total receivables. The majority of the write-offs during the nine months ended September 30, 2022 related to receivables which had been previously reserved.

Management Discussion – (continued)

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 September 30,			At December 31,
(Dollars in millions)	2022			2021
Amortized cost *	$	11,234		$	12,859
Specific allowance for credit losses		126			159
Unallocated allowance for credit losses		34			42
Total allowance for credit losses		159			201
Net financing receivables	$	11,075		$	12,658
Allowance for credit losses coverage		1.4	%		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 1.4 percent at September 30, 2022, primarily driven by write-offs of previously reserved receivables.

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		September 30, 2022
$	201	$	(13)	$	(23)	$	(5)	$	159

*	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 $3 million and $15 million for the three and nine months ended September 30, 2022, respectively, compared to a net release of $18 million and $47 million for the three and nine months ended September 30, 2021, respectively. The declines in net releases in both periods of 2022 were primarily driven by lower unallocated reserve requirements in the prior year in Americas and EMEA due to sales of receivables.

Noncurrent Assets and Liabilities


	At September 30,		At December 31,
(Dollars in millions)	2022		2021
Noncurrent assets	$	96,851	$	102,462
Long-term debt	$	44,942	$	44,917
Noncurrent liabilities (excluding debt)	$	30,294	$	34,469

Noncurrent assets decreased $5,611 million ($1,355 million adjusted for currency) driven by:

	●	A decrease in goodwill and net intangible assets of $2,970 million ($916 million adjusted for currency) primarily driven by currency impacts, intangibles amortization and derecognition of goodwill and intangible assets of $648 million related to the divestiture of our healthcare software assets, partially offset by additions from new acquisitions;

	●	A decrease of $1,025 million ($528 million adjusted for currency) in net property, plant and equipment and operating right-of-use assets; and

Management Discussion – (continued)

	●	A decrease in long-term financing receivables of $644 million ($265 million adjusted for currency) due to collections from seasonally higher year-end balances, partially offset by current-year business volumes.

Long-term debt increased $26 million ($2,216 million adjusted for currency) due to:

	●	Issuances of $7,532 million; partially offset by

	●	Reclassifications to short-term debt of $4,757 million to reflect upcoming maturities; and

	●	A decrease of $2,191 million due to currency impacts.

Noncurrent liabilities (excluding debt) decreased $4,175 million ($1,761 million adjusted for currency) due to:

	●	A decrease in retirement and postretirement benefit obligations of $2,675 million ($1,392 million adjusted for currency) of which $624 million is due to the amendment and remeasurement impact of the U.S. Nonpension Postretirement Plan;

	●	A decrease of $559 million ($294 million adjusted for currency) in deferred income reflecting seasonal reductions from higher year-end balances; and

	●	A decrease of $359 million ($184 million adjusted for currency) in long-term operating lease liabilities related primarily to real estate leases.

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 September 30,		At December 31,
(Dollars in millions)	2022		2021
Total company debt	$	50,880	$	51,703
Financing segment debt*	$	11,198	$	13,929
Non-Financing debt	$	39,682	$	37,775

Financing segment debt includes debt of $1,166 million at September 30, 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 92 for additional details.

Total debt of $50,880 million decreased $824 million (increased $1,366 million adjusted for currency) from December 31, 2021, primarily driven by maturities of $5,415 million and currency impacts, partially offset by issuances of $7,871 million.

Non-Financing debt of $39,682 million increased $1,907 million ($3,480 million adjusted for currency) from December 31, 2021 primarily due to new debt issuances.

Financing segment debt of $11,198 million decreased $2,730 million ($2,114 million adjusted for currency) from December 31, 2021 primarily due to lower funding requirements associated with financing assets.

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

Management Discussion – (continued)

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 September 30, 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 of $20,147 million increased $1,151 million from December 31, 2021 as a result of:

	●	A decrease in accumulated other comprehensive loss of $6,096 million driven by retirement-related benefit plans, primarily due to the pension settlement charge of $4,411 million net of tax; and

	●	Common stock issuances of $736 million; partially offset by

	●	Dividends paid of $4,454 million; and

	●	Net loss of $1,071 million, primarily due to the pension settlement charge.

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 nine months ended September 30:	2022		2021
Net cash provided by/(used in):
Operating activities	$	6,470	$	10,252
Investing activities		(2,883)		(5,300)
Financing activities		(2,106)		(10,662)
Effect of exchange rate changes on cash, cash equivalents and restricted cash		(463)		(159)
Net change in cash, cash equivalents and restricted cash	$	1,018	$	(5,868)

Net cash provided by operating activities decreased $3,782 million as compared to the first nine months of 2021 driven primarily by:

	●	A decrease in cash provided by financing receivables of $4,164 million primarily driven by higher prior-year sales of receivables; partially offset by

	●	A decrease in payments for structural actions and Kyndryl separation-related charges; and

	●	An increase in cash from sales cycle working capital of $578 million.

Net cash used in investing activities decreased $2,417 million driven primarily by:

	●	A decrease in cash used in acquisitions of $1,999 million;

	●	An increase in cash provided by divestitures of $1,245 million; and

Management Discussion – (continued)

	●	A decrease in cash used in net capital expenditures of $539 million; partially offset by

	●	An increase in cash used in net marketable securities and other investments of $1,365 million.

Net cash used in financing activities decreased $8,556 million driven primarily by:

	●	Total debt was a net source of cash of $2,572 million in the first nine months of 2022 as compared to a net use of cash of $6,086 million in the first nine months of 2021. The year-to-year change of $8,658 million was driven by higher issuances in the current year and higher maturities in the prior year.

Results of Discontinued Operations

Income from discontinued operations, net of tax was $18 million in the third quarter of 2022 compared to $93 million in the prior-year period. For the first nine months of 2022, income from discontinued operations, net of tax was $16 million compared to income of $1,160 million in the prior-year period. As the separation of Kyndryl occurred on November 3, 2021, the year-to-date discontinued operations results as of September 30, 2021 included a full nine months of Kyndryl operations. The income in the third quarter of 2022 primarily reflects the net impact of changes in separation-related estimates and the settlement of assets and liabilities in accordance with the separation and distribution agreement. The income in the first nine months of 2022 reflects the same drivers as above and also includes 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.

Looking Forward

As technology remains a fundamental source of competitive advantage, we continue to see solid demand for our hybrid cloud and AI solutions. It is clear that there is a real opportunity to help businesses leverage technology in today’s environment. Clients continue to navigate several challenges and opportunities from inflation to demographic shifts, to supply chain issues to sustainability efforts. We are helping our clients seize new business opportunities, overcome today’s challenges and emerge stronger. We too are building a stronger company that is closely aligned to the needs of our clients. We have continued to focus our portfolio, invest in our offerings, technical talent, and ecosystem and streamline our go-to-market model. We remain confident in our strategy and execution, and feel we are well-positioned to address the needs of our clients.

Hybrid Cloud and AI Progress

We believe Hybrid cloud and AI are the two most transformational enterprise technologies of our time. Our platform, based on Red Hat, allows our clients to consume software driven by open-source innovation. Our software has been optimized to run on that platform and includes advanced data and AI, automation and the security capabilities our clients need. Our global team of consultants offer deep business expertise and co-create with clients to accelerate their digital transformation journeys. And our infrastructure allows clients to take full advantage of a hybrid cloud environment.

Clients are choosing our hybrid cloud capabilities to unlock more business value and meet their rapidly changing demands. We see more clients consuming across our portfolio of software, consulting and infrastructure capabilities to drive business value. Companies are also eager to deploy AI and automation capabilities to boost their levels of productivity and we are working to bring these capabilities to clients across all industries.

Our partner ecosystem is a crucial element of our strategy. We continue to expand and extend the work we do with partners to serve our joint clients through strategic collaboration agreements. Revenue from these partnerships grew double digits again in the third quarter.

Management Discussion – (continued)

We continue to invest, both organically and inorganically, to deliver innovation for our clients and shape the technologies of the future. Most recently, we unveiled the next generation of our LinuxONE server, a Linux and Kubernetes-based platform designed to support thousands of workloads with the footprint of a single system. Quantum is an example of our commitment to shape the future of technology. We remain on track toward our goal of building a 1,000+ qubit system by 2023. Complementing our organic innovation, we acquired Dialexa in October 2022. This brings our total number of acquisitions in 2022 to seven, adding capabilities in areas like hybrid cloud services, security, data observability and sustainability. And as the world takes on the challenge of sustainability and of building a more circular economy, we have been building a portfolio of solutions to help companies make progress on this journey.

We are confident in the strategy that we are executing and in the fundamentals of our business. Our balance sheet and liquidity position remain strong. At September 30, 2022 we had $9.7 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. As we enter the fourth quarter, we look forward to closing out our first calendar year of “today’s IBM”. Since the separation of Kyndryl, IBM is a more focused, faster-growing and higher-value company. 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.

Retirement-Related Plans

Our pension plans are well funded. Contributions for all retirement-related plans are expected to be approximately $2.0 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 $7.8 billion, an increase of approximately $5.2 billion compared to 2021. The increase is primarily driven by a $5.9 billion settlement charge in the third quarter of 2022 resulting from the transfer of a portion of the U.S. Qualified PPP to insurance companies. This estimate reflects current pension plan assumptions at December 31, 2021 and for the U.S. Qualified PPP and U.S. Nonpension Postretirement Plan, at August 31, 2022 and July 31, 2022, respectively. 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 $6.6 billion, an increase of approximately $5.4 billion compared to 2021, primarily driven by the third-quarter 2022 settlement charge, partially offset by lower recognized actuarial losses and higher income from expected return on assets.

Currency Rate Fluctuations

Throughout 2022, there has been significant strengthening of the U.S. dollar (USD) as compared to most other currencies. Changes in the relative values of non-U.S. currencies to the USD affect our financial results and financial position. At September 30, 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 foreign currency-based transactions.

The combination of the rate, breadth and magnitude of movements in currency, and the fact that we do not hedge 100 percent of our currency exposures, will result in a currency impact to our profit and cash flows in 2022. We execute a hedging program which defers, versus eliminates, the volatility of currency impacts on our financial results. During periods of sustained movements in currency, the marketplace and competition adjust to the changing rates over time.

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, such as updates to pricing and sourcing. Currency movements impacted our year-to-year revenue and earnings per share results in the first nine months of 2022. Based on the currency rate movements in the first nine months of 2022, total revenue increased 7.8 percent as reported and 13.8 percent at constant currency versus the first nine months of 2021. On an income/(loss) from continuing

Management Discussion – (continued)

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) increase in loss of approximately $190 million in the first nine months of 2022 on an as-reported basis and a decrease in income of approximately $280 million on an operating (non-GAAP) basis. The same mathematical exercise resulted in an increase in income of approximately $95 million in the first nine months of 2021 on an as-reported basis and an increase of $130 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.

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 net cash from operating activities, cash and cash equivalents, restricted cash and short-term marketable securities, and the size of our global credit facilities for each of the past three years. For the nine months ended, or at, as applicable, September 30, 2022, those amounts are $6.5 billion of net cash from operating activities, $9.7 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 September 30, 2022 appear in the following table and remain unchanged from June 30, 2022.


	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. We issued debt in July 2022 to further improve our liquidity and plan for our 2023 debt maturities. Debt levels have decreased $0.8 billion from December 31, 2021, primarily driven by currency, partially offset by net debt issuances, and $22.2 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 September 30, 2022, the fair value of those instruments that were in a liability position was $1,079 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.

Effective December 31, 2021, the use of LIBOR was substantially eliminated for purposes of any new financial contract executions. The UK’s Financial Conduct Authority (FCA) extended the phase out of LIBOR in the case of U.S. dollar settings for certain tenors until the end of June 2023. 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.

Management Discussion – (continued)

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 86 and 87. For the purpose of running its business, IBM manages, monitors and analyzes cash flows in a different manner.

Management uses free cash flow as a measure to evaluate its operating results, plan shareholder return levels, strategic investments and assess its ability and need to incur and service debt. The entire free cash flow amount is not necessarily available for discretionary expenditures. We define free cash flow as net cash from operating activities less the change in 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 nine 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 nine months ended September 30:	2022		2021
Net cash from operating activities per GAAP*	$	6,470	$	10,252
Less: change in Financing receivables		1,071		5,235
Net cash from operating activities, excluding Financing receivables	$	5,399	$	5,018
Capital expenditures, net		(1,317)		(1,855)
Free cash flow	$	4,082	$	3,162
Acquisitions		(1,020)		(3,018)
Divestitures		1,271		26
Common stock repurchases for tax withholdings		(329)		(252)
Dividends		(4,454)		(4,395)
Non-Financing debt		4,686		(1,143)
Other (includes Financing net receivables and Financing debt)		(2,066)		(249)
Change in cash, cash equivalents, restricted cash and short-term marketable securities	$	2,171	$	(5,868)

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

In the first nine months of 2022, we generated free cash flow of $4.1 billion, an increase of $0.9 billion versus the prior-year period. Payments for the 2020 structural actions and Kyndryl separation-related charges are down year to year and we are driving working capital improvements. In the first nine months of 2022, we continued to return value to shareholders with $4.5 billion in dividends and invested $1.0 billion in acquisitions, which was more than offset by proceeds from divested businesses.

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 $2.0 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 changes in pension plan funding regulations.

Management Discussion – (continued)

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.

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 September 30:	2022		2021*		Change
Revenue	$	174	$	184	(5.7)	%
Pre-tax income	$	79	$	132	(40.4)	%

Recast to reflect 2021 segment changes.



					Yr. to Yr.
(Dollars in millions)					Percent
For the nine months ended September 30:	2022		2021*		Change
Revenue	$	474	$	601	(21.2)	%
Pre-tax income	$	265	$	362	(26.8)	%

Recast to reflect 2021 segment changes.

Our Financing business is focused on IBM’s products and services. For the three months ended September 30, 2022, financing revenue decreased 5.7 percent as reported (1 percent adjusted for currency) compared to the prior year, driven by client financing down $9 million to $172 million. For the nine months ended September 30, 2022, financing revenue decreased 21.2 percent as reported (18 percent adjusted for currency) compared to the prior year, driven by client financing down $123 million to $469 million. The decreases in client financing revenue in both periods in 2022 were primarily driven by the strategic actions taken in the prior year including selling certain client lease and loan 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 40.4 percent to $79 million in the third quarter of 2022, compared to the prior year and the pre-tax margin of 45.4 percent decreased 26.4 points year to year. For the nine months ended September 30, 2022, Financing pre-tax income decreased 26.8 percent to $265 million compared to the prior year and the pre-tax margin of 55.9 percent decreased 4.3 points year to year. The decreases in pre-tax income in both periods in 2022 were primarily driven by the strategic actions described above.

Management Discussion – (continued)

Financial Position


	At September 30,		At December 31,
(Dollars in millions)	2022		2021
Cash and cash equivalents	$	471	$	1,359
Client financing receivables:
Net investment in sales-type and direct financing leases(1)		3,565		3,396
Client loans		7,346		8,818
Total client financing receivables	$	10,911	$	12,215
Commercial financing receivables:
Held for investment		164		444
Held for sale		395		793
Other receivables		46		61
Total external receivables(2)	$	11,516	$	13,512
Intercompany financing receivables(3) (4)		671		778
Other assets(5)		1,075		1,231
Total assets	$	13,733	$	16,880

Intercompany payables(3)	$	488	$	467
Debt(6)		11,198		13,929
Other liabilities		797		937
Total liabilities	$	12,483	$	15,333
Total equity	$	1,249	$	1,547
Total liabilities and equity	$	13,733	$	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 $2.0 billion (from $13.5 billion in December 2021 to $11.5 billion in September 2022) and the $1.1 billion change in Financing segment’s receivables disclosed in the free cash flow presentation on page 90 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 September 2022 and $0.7 billion in December 2021.

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

Total external receivables decreased $1,996 million primarily driven by collections of higher year-end balances partially offset by current-year business volumes, with corresponding changes in debt funding.

At September 30, 2022, we continue to apply our rigorous credit policies. Approximately 72 percent of the total external portfolio was with investment-grade clients with no direct exposure to consumers, an increase of 6 points year to year and an increase of 1 point compared to June 30, 2022. 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.

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. In addition, the company enters into agreements with third-party financial institutions to sell certain of its client financing receivables, including both loan and lease receivables, for cash proceeds. In the first nine months of 2022, sales of client financing receivables were largely focused on credit mitigation.

Management Discussion – (continued)

During 2021, sales of client financing receivables were utilized as part of the company’s cash and liquidity management as well as for credit mitigation.

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


(Dollars in millions)
For the nine months ended September 30:	2022		2021
Client financing receivables:
Lease receivables	$	15	$	781
Loan receivables		2		2,189
Total client financing receivables transferred	$	17	$	2,970
Commercial financing receivables:
Receivables transferred during the period	$	6,091	$	4,465
Receivables uncollected at end of period*	$	816	$	707

*	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 September 30, 2022 and 2021.

For additional information relating to financing receivables refer to note 9, “Financing Receivables.” Refer to pages 26 through 30 for additional information related to Financing segment receivables, allowance for credit losses and debt.

Return on Equity Calculation


	For Three Months Ended						For Nine Months Ended
	September 30,						September 30,
(Dollars in millions)	2022			2021*			2022			2021*
Numerator
Financing after-tax income**	$	64		$	98		$	217		$	267
Annualized after-tax income (1)	$	257		$	391		$	289		$	356
Denominator
Average Financing equity (2)+	$	1,306		$	1,842		$	1,378		$	2,013
Financing return on equity (1)/(2)		19.7	%		21.2	%		21.0	%		17.7	%

*	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 and four quarters, for the three months ended September 30 and for the nine months ended September 30, respectively.

Return on equity was 19.7 percent and 21.0 percent for the three and nine months ended September 30, 2022, respectively, compared to 21.2 percent and 17.7 percent for the same periods in 2021. The changes in both periods in 2022 were driven by a lower average equity balance, and a decrease in net income, 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.

Management Discussion – (continued)

The following table presents the recorded amount of unguaranteed residual value for sales-type and direct financing leases, as well as operating leases at September 30, 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 September 30, 2022 is expected to be returned to the company.

Unguaranteed Residual Value


	At		At		Estimated Run Out of September 30, 2022 Balance
	December 31,		September 30,								2025 and
(Dollars in millions)	2021		2022		2022		2023		2024		Beyond
Sales-type and direct financing leases	$	335	$	323	$	21	$	72	$	62	$	168
Operating leases		13		10		7		2		0		0
Total unguaranteed residual value	$	348	$	333	$	28	$	74	$	62	$	168

Management Discussion – (continued)

GAAP Reconciliation

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


				Acquisition-			Retirement-			U.S.			Kyndryl-
(Dollars in millions except per share amounts)				Related			Related			Tax Reform			Related			Operating
For the three months ended September 30, 2022:	GAAP			Adjustments			Adjustments		*****	Impacts			Impacts			(non-GAAP)
Gross profit	$	7,430		$	165		$	—		$	—		$	—		$	7,595
Gross profit margin		52.7	%		1.2	pts.		—	pts.		—	pts.		—	pts.		53.8	%
SG&A	$	4,391		$	(253)		$	—		$	—		$	0		$	4,138
Other (income) and expense	$	5,755		$	(1)		$	(6,062)		$	—		$	14		$	(293)
Total expense and other (income)	$	11,931		$	(253)		$	(6,062)		$	—		$	14		$	5,630
Pre-tax income/(loss) from continuing operations	$	(4,501)		$	418		$	6,062		$	—		$	(14)		$	1,965
Pre-tax margin from continuing operations		(31.9)	%		3.0	pts.		43.0	pts.		—	pts.		(0.1)	pts.		13.9	%
Provision for/(benefit from) income taxes**	$	(1,287)		$	103		$	1,495		$	—		$	—		$	312
Effective tax rate		28.6	%		(0.8)	pts.		(12.1)	pts.		—	pts.		0.2	pts.		15.9	%
Income/(loss) from continuing operations	$	(3,214)		$	315		$	4,566		$	—		$	(14)		$	1,653
Income/(loss) from continuing operations margin		(22.8)	%		2.2	pts.		32.4	pts.		—	pts.		(0.1)	pts.		11.7	%
Diluted earnings/(loss) per share from continuing operations +	$	(3.55)		$	0.35		$	5.05		$	—		$	(0.02)		$	1.81

Retirement-Related Adjustments includes a one-time, non-cash, pre-tax pension settlement charge of $5.9 billion ($4.4 billion after tax). See note 18 “Retirement-Related Benefits,” for additional information.

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

+ Operating (non-GAAP) earnings per share was calculated using 912.8 million shares, which includes 8.8 million dilutive potential shares under our stock-based compensation plans and contingently issuable shares. Due to the GAAP net loss for the three months ended September 30, 2022, these dilutive potential shares were excluded from the GAAP loss per share calculation as the effect would have been antidilutive. The difference in share count resulted in an additional ($0.02) reconciling item.


				Acquisition-			Retirement-			U.S.			Kyndryl-
(Dollars in millions except per share amounts)				Related			Related			Tax Reform			Related			Operating
For the three months ended September 30, 2021:	GAAP			Adjustments			Adjustments			Impacts			Impacts			(non-GAAP)
Gross profit	$	7,106		$	183		$	—		$	—		$	—		$	7,290
Gross profit margin		53.6	%		1.4	pts.		—	pts.		—	pts.		—	pts.		55.0	%
SG&A	$	4,306		$	(288)		$	—		$	—		$	—		$	4,018
Other (income) and expense	$	244		$	(1)		$	(318)		$	—		$	—		$	(74)
Total expense and other (income)	$	6,293		$	(289)		$	(318)		$	—		$	—		$	5,687
Pre-tax income from continuing operations	$	813		$	472		$	318		$	—		$	—		$	1,603
Pre-tax margin from continuing operations		6.1	%		3.6	pts.		2.4	pts.		—	pts.		—	pts.		12.1	%
Provision for/(benefit from) income taxes*	$	(224)		$	102		$	55		$	—		$	—		$	(67)
Effective tax rate		(27.6)	%		14.5	pts.		8.9	pts.		—	pts.		—	pts.		(4.2)	%
Income from continuing operations	$	1,037		$	370		$	262		$	—		$	—		$	1,670
Income from continuing operations margin		7.8	%		2.8	pts.		2.0	pts.		—	pts.		—	pts.		12.6	%
Diluted earnings per share from continuing operations	$	1.14		$	0.41		$	0.29		$	—		$	—		$	1.84

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

Management Discussion – (continued)


				Acquisition-			Retirement-			U.S.			Kyndryl-
(Dollars in millions except per share amounts)				Related			Related			Tax Reform			Related			Operating
For the nine months ended September 30, 2022:	GAAP			Adjustments			Adjustments		*	Impacts			Impacts			(non-GAAP)
Gross profit	$	23,055		$	526		$	—		$	—		$	—		$	23,582
Gross profit margin		52.6	%		1.2	pts.		—	pts.		—	pts.		—	pts.		53.8	%
SG&A	$	13,843		$	(818)		$	—		$	—		$	0		$	13,025
Other (income) and expense	$	5,921		$	(2)		$	(6,455)		$	—		$	(353)		$	(889)
Total expense and other (income)	$	25,212		$	(820)		$	(6,455)		$	—		$	(353)		$	17,584
Pre-tax income/(loss) from continuing operations	$	(2,156)		$	1,346		$	6,455		$	—		$	353		$	5,998
Pre-tax margin from continuing operations		(4.9)	%		3.1	pts.		14.7	pts.		—	pts.		0.8	pts.		13.7	%
Provision for/(benefit from) income taxes**	$	(1,070)		$	327		$	1,599		$	112		$	—		$	969
Effective tax rate		49.6	%		(5.7)	pts.		(26.7)	pts.		1.9	pts.		(2.9)	pts.		16.1	%
Income/(loss) from continuing operations	$	(1,087)		$	1,019		$	4,856		$	(112)		$	353		$	5,029
Income/(loss) from continuing operations margin		(2.5)	%		2.3	pts.		11.1	pts.		(0.3)	pts.		0.8	pts.		11.5	%
Diluted earnings/(loss) per share from continuing operations +	$	(1.21)		$	1.13		$	5.39		$	(0.12)		$	0.39		$	5.52

Retirement-Related Adjustments includes a one-time, non-cash, pre-tax pension settlement charge of $5.9 billion ($4.4 billion after tax). See note 18 “Retirement-Related Benefits,” for additional information.

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

+ Operating (non-GAAP) earnings per share was calculated using 911.1 million shares, which includes 9.4 million dilutive potential shares under our stock-based compensation plans and contingently issuable shares. Due to the GAAP net loss for the nine months ended September 30, 2022, these dilutive potential shares were excluded from the GAAP loss per share calculation as the effect would have been antidilutive. The difference in share count resulted in an additional ($0.06) reconciling item.


				Acquisition-			Retirement-			U.S.			Kyndryl-
(Dollars in millions except per share amounts)				Related			Related			Tax Reform			Related			Operating
For the nine months ended September 30, 2021:	GAAP			Adjustments			Adjustments			Impacts			Impacts			(non-GAAP)
Gross profit	$	21,985		$	537		$	—		$	—		$	—		$	22,522
Gross profit margin		54.1	%		1.3	pts.		—	pts.		—	pts.		—	pts.		55.4	%
SG&A	$	13,842		$	(870)		$	—		$	—		$	—		$	12,972
Other (income) and expense	$	891			(2)			(967)			—			—			(77)
Total expense and other (income)	$	20,017			(872)			(967)			—			—			18,179
Pre-tax income from continuing operations	$	1,968			1,409			967			—			—			4,343
Pre-tax margin from continuing operations		4.8	%		3.5	pts.		2.4	pts.		—	pts.		—	pts.		10.7	%
Provision for/(benefit from) income taxes*	$	(282)		$	340		$	141		$	6		$	—		$	204
Effective tax rate		(14.4)	%		12.5	pts.		6.5	pts.		0.1	pts.		—	pts.		4.7	%
Income from continuing operations	$	2,250		$	1,069		$	825		$	(6)		$	—		$	4,139
Income from continuing operations margin		5.5	%		2.6	pts.		2.0	pts.		0.0	pts.		—	pts.		10.2	%
Diluted earnings per share from continuing operations	$	2.49		$	1.18		$	0.91		$	(0.01)		$	—		$	4.58

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

Management Discussion – (continued)

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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