INTERNATIONAL BUSINESS MACHINES CORP (IBM) FY 2022 MD&A

Management Discussion

International Business Machines Corporation and Subsidiary Companies

OVERVIEW

The financial section of the International Business Machines Corporation (IBM or the company) 2022 Annual Report includes the Management Discussion, the Consolidated Financial Statements and the Notes to Consolidated Financial Statements. This Overview is designed to provide the reader with some perspective regarding the information contained in the financial section.

Organization of Information

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Operating (non-GAAP) Earnings

In an effort to provide better transparency into the operational results of the business, supplementally, management separates business results into operating and non-operating categories. Operating earnings from continuing operations is a non-GAAP measure that excludes the effects of certain acquisition-related charges, intangible asset amortization, expense resulting from basis differences on equity method investments, retirement-related costs, certain impacts from the Kyndryl separation and 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 primarily include true-ups, accounting elections and any changes to regulations, laws, audit adjustments that affect the recorded one-time charge. Management characterizes direct and incremental charges incurred related to the Kyndryl separation as non-operating given their unique and non-recurring nature. These charges primarily relate to any 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. 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 our 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 the 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 we consider 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 our pension plans; improves visibility to management decisions and their impacts on operational performance; enables better comparison to peer companies; and allows us to provide a long-term strategic view of the business going forward. In addition, these non-GAAP measures provide a perspective consistent with areas of interest we routinely receive from investors and analysts. Our reportable segment financial results reflect pre-tax operating earnings from continuing operations, consistent with our management and measurement system.

FORWARD-LOOKING AND CAUTIONARY STATEMENTS

Certain statements contained in this Annual Report may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Any forward-looking statement in this Annual Report speaks only as of the date on which it is made; IBM assumes no obligation to update or revise any such statements except as required by law. Forward-looking statements are based on IBM’s current assumptions regarding future business and financial performance; these statements, by their nature, address matters that are uncertain to different degrees. Forward-looking statements involve a number of risks, uncertainties and other factors that could cause actual results to be materially different, as discussed more fully elsewhere in this Annual Report and in the company’s filings with the Securities and Exchange Commission (SEC), including IBM’s 2022 Form 10-K filed on February 28, 2023.

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8Management Discussion

International Business Machines Corporation and Subsidiary Companies

MANAGEMENT DISCUSSION SNAPSHOT

NM–Not meaningful

The following table provides the company’s operating (non-GAAP) earnings for 2022 and 2021. See page 29 for additional information.

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

NM–Not meaningful

Macroeconomic Environment

Our business profile positions us well in challenging times. Our diversification across geographies, industries, clients and business mix provides some stability in revenue, profit and cash generation.

Throughout 2022, we experienced escalating labor and component costs and a strong U.S. dollar. While those dynamics have put pressure on our margin profile, we are seeing progress in the actions we have taken to mitigate the impacts of these higher costs. Consulting, which makes up well over half of IBM’s workforce, is most impacted by the labor cost inflation. We have begun to see improved utilization and priced margin improvements year over year, and our acquisitions have become more accretive, all of which will benefit our margin profile going forward. Our Consulting pre-tax margin of 8.8 percent increased 0.7 points in 2022 versus the prior year and improved 3.2 points in the second half of 2022 compared to the first half reflecting the benefit of these actions. 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. This includes price increases in our maintenance and support agreements for our hardware and software portfolios. Additionally, despite the many global supply chain disruptions throughout 2022, our supply chain has demonstrated resiliency and the ability to proactively respond to potential disruptions in order to meet our clients’ needs. The strengthening of the U.S. dollar impacted our reported revenue and gross profit dollars in 2022. 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

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movements, and because we do not hedge all currencies, this did have a currency impact to our overall profit and cash flows in 2022. 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 2022. These charges, together with the year-to-year lost business due to the wind-down, impacted our pre-tax income by approximately $230 million for the year ended December 31, 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. Historically, Russia, Ukraine and Belarus made up less than one percent of the company’s full-year revenue. While the revenue impact is not material to total consolidated IBM revenue, the business in Russia has historically been high margin and therefore, is a more significant headwind to our profit and cash flows.

Financial Performance Summary

In 2022, we reported $60.5 billion in revenue, income from continuing operations of $1.8 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 $8.3 billion, which excludes the impact of the settlement charge. 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 retirement-related plans. Diluted earnings per share from continuing operations was $1.95 as reported, including an impact of $4.84 from the pension settlement charge, and diluted earnings per share was $9.13 on an operating (non-GAAP) basis. On a consolidated basis, we generated $10.4 billion in cash from operations and $9.3 billion in free cash flow and returned $5.9 billion to shareholders in dividends. We are pleased with the fundamentals of our business and the progress we have made in executing our strategy. Our 2022 performance demonstrates that we are now a higher-growth, higher-value company with the ability to generate strong cash from operations and a growing free cash flow.

Total revenue grew 5.5 percent as reported and 12 percent adjusted for currency compared to the prior year, including approximately 4 points from incremental sales to Kyndryl. Over 70 percent of current-year revenue was in our growth areas of Software and Consulting and approximately half of our revenue is recurring. Software revenue increased 6.9 percent as reported and 12 percent adjusted for currency, including approximately 6 points of growth from incremental sales to Kyndryl. There was continued momentum in our recurring revenue stream in both Hybrid Platform & Solutions and Transaction Processing. Hybrid Platform & Solutions grew 4.9 percent as reported and 9 percent adjusted for currency, led by strong double-digit revenue growth in Red Hat. Transaction Processing increased 12.2 percent as reported and 19 percent adjusted for currency, including approximately 19 points of growth from incremental sales to Kyndryl. Consulting revenue increased 7.1 percent as reported and 15 percent adjusted for currency as we help clients with their digital transformations. Infrastructure revenue increased 7.8 percent year to year as reported and 14 percent adjusted for currency, reflecting strong double-digit growth in Hybrid Infrastructure driven by our z16 program, which launched in the second quarter of 2022. The Infrastructure revenue performance also includes approximately 6 points of growth from incremental sales to Kyndryl. Across the segments, total hybrid cloud revenue of $22.4 billion in 2022 grew 11 percent as reported and 17 percent adjusted for currency, and represents 37 percent of IBM’s revenue.

From a geographic perspective, Americas revenue grew 9.7 percent year to year as reported (10 percent adjusted for currency). Europe/Middle East/Africa (EMEA) increased 2.9 percent (14 percent adjusted for currency). Asia Pacific declined 0.7 percent as reported, but grew 11 percent adjusted for currency.

The gross margin of 54.0 percent decreased 0.9 points year to year, however, gross profit dollars increased 3.8 percent compared to the prior year. Overall, gross margin was impacted by the investments we are making to drive our hybrid cloud and artificial intelligence (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. The operating (non-GAAP) gross margin of 55.1 percent decreased 1.0 points versus the prior year.

Total expense and other (income) increased 18.3 percent in 2022 versus the prior year primarily driven by the pension settlement charge of $5.9 billion, higher spending reflecting continued investment in our offerings, technical talent and ecosystem, and year-to-year impacts related to Kyndryl retained shares, partially offset by the effects of currency and benefits from the actions taken to streamline our operations and go-to-market model. Total operating (non-GAAP) expense and other (income) decreased 3.2 percent year to year, driven primarily by the effects of currency and benefits from the actions taken to streamline our operations and go-to-market model, partially offset by higher spending to drive our hybrid cloud and AI strategy.

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10Management Discussion

International Business Machines Corporation and Subsidiary Companies

Pre-tax income from continuing operations of $1.2 billion decreased 76.1 percent and the pre-tax margin was 1.9 percent, a decrease of 6.5 points versus 2021. These declines were primarily driven by the $5.9 billion pension settlement charge. The continuing operations effective tax rate for 2022 was (54.2) percent compared to 2.6 percent in 2021. The current-year effective tax rate was primarily driven by the pension settlement charge. The prior-year effective tax rate was primarily driven by tax benefits related to audit settlements in multiple jurisdictions. Net income from continuing operations of $1.8 billion decreased 62.2 percent and the net income from continuing operations margin was 2.9 percent, down 5.3 points year to year. Operating (non-GAAP) pre-tax income from continuing operations of $9.8 billion increased 24.6 percent year to year and the operating (non-GAAP) pre-tax margin from continuing operations increased 2.5 points to 16.2 percent. These profit dynamics reflect our portfolio shift toward higher value, driven by Software and Consulting. 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) effective tax rate for 2022 was 15.2 percent compared to 9.0 percent in 2021. The lower prior-year operating (non-GAAP) effective tax rate was primarily driven by tax benefits related to audit settlements in multiple jurisdictions. Operating (non-GAAP) income from continuing operations of $8.3 billion increased 16.0 percent and the operating (non-GAAP) income margin from continuing operations of 13.8 percent was up 1.2 points year to year.

Diluted earnings per share from continuing operations of $1.95 in 2022 decreased 62.6 percent, which included an impact of $4.84 from the pension settlement charge. Operating (non-GAAP) diluted earnings per share of $9.13 increased 15.1 percent versus 2021.

At December 31, 2022, the balance sheet remained strong with the flexibility to support and invest in the business. Cash and cash equivalents, restricted cash and marketable securities at year end were $8.8 billion, an increase of $1.3 billion from December 31, 2021. During 2022, we continued to invest in acquisitions and provide a solid and modestly growing dividend to shareholders. Total debt of $50.9 billion at December 31, 2022 decreased $0.8 billion driven by currency impacts, partially offset by net debt issuances.

Total assets decreased $4.8 billion ($1.3 billion adjusted for currency) from December 31, 2021 primarily driven by decreases in prepaid pension assets, intangible assets, deferred taxes, and prepaid expenses and other; partially offset by an increase in cash and restricted cash. Total liabilities decreased $7.8 billion ($4.3 billion adjusted for currency) from December 31, 2021 primarily driven by a decrease in retirement and postretirement benefit obligations. Total equity of $22.0 billion increased $3.0 billion from December 31, 2021 as a result of a decrease in accumulated other comprehensive losses, 2022 net income and common stock issuances, partially offset by dividends paid.

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 $10.4 billion in 2022, a decrease of $2.4 billion compared to 2021, driven by financing receivables. Net cash used in investing activities of $4.2 billion decreased $1.8 billion compared to the prior year and net cash used in financing activities of $5.0 billion decreased $8.4 billion compared to 2021.

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DESCRIPTION OF BUSINESS

Please refer to IBM’s Annual Report on Form 10-K filed with the SEC on February 28, 2023, for Item 1A. entitled “Risk Factors.”

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

IBM Strategy

IBM continues to execute its Hybrid Cloud and AI strategy, the two most transformative technologies for business today. Over the last couple of years, we have driven deep change within the company to deliver this platform-centric strategy. We have continually delivered innovation in our software and infrastructure offerings and scaled and enhanced the capabilities of our consulting practices. We have expanded our partner ecosystem, simplified our go-to-market model, and pursued strategic acquisitions and divestitures.

Our strategy aligns with the needs of our clients

Our clients are accelerating their digital transformations as they face economic uncertainties, skill shortages, supply chain instability, security breaches and heightened sustainability goals. These market realities confirm the following convictions that have shaped our strategy:

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IBM’s differentiated value proposition

Our differentiated value proposition encompasses our integrated competencies across software, consulting and infrastructure, leveraging our open hybrid cloud platform. We draw upon five core capabilities to address our clients’ hybrid cloud and AI needs: (1) build and modernize for the hybrid cloud environments that operate with speed, consistency and agility, (2) create AI-infused, data-driven business insights regardless of where data lives, while maintaining enterprise grade data governance, privacy and trust, (3) automate the end-to-end enterprise processes for efficacy with AI-driven decision-making, (4) secure everywhere, with consistent governance and compliance across environments, and (5) bring it together by transforming our clients’ businesses and processes into sustainable best-in-class industry practices.

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12Management Discussion

International Business Machines Corporation and Subsidiary Companies

Our full technology stack helps us meet clients where they are in their digital transformations, and we offer the consulting expertise to help guide and implement the best solutions for that journey. Our rapidly growing ecosystem of cloud, independent software vendors (ISVs), hardware, network and services partners enhance the client experience and drive the value and innovation derived from IBM technologies. Our focus on hybrid cloud accelerates our open and collaborative approach to partnership.

Our hybrid cloud platform strategy drives sustained growth and financial performance: on average, every $1 of platform spend results in $3 to $5 of software revenue, $6 to $8 of services and $1 to $2 of enterprise infrastructure. The hybrid cloud opportunity represents over a $1 trillion market across software, consulting and infrastructure.

IBM’s integrated value is amplified by ensuring our existing businesses all advance the hybrid cloud value proposition to our clients. We strategically embed the Red Hat platform with our offerings: (1) IBM Software’s growing portfolio runs on Red Hat OpenShift Container Platform (OCP), (2) IBM Infrastructure solutions are optimized hybrid cloud deployments for mission-critical workloads, and (3) IBM Consulting is the leading market system integrator with hybrid cloud and Red Hat expertise to help clients transform their business and technology.

IBM Software extends the value of our hybrid cloud platform with four critical capabilities: (1) “Modernize” for agility and speed from legacy to hybrid cloud architecture, (2) “Data-driven”, predicting outcomes from distributed data and applying AI to empower predictive decision-making, real-time digital intelligence and sustainable operations, (3) “Automate” at scale to make experiences and tasks more productive and impactful, and (4) “Secure” all touchpoints, all the time, employing real-time threat insights, automated detection and orchestrated response. Red Hat, reported in our Software segment, delivers the leading open-source hybrid cloud platform and enables clients to build, secure, operate and manage any application, anywhere, from on-premises environments to multiple clouds and the edge. One hundred percent of commercial banks, telecommunication, media and technology companies in the Fortune Global 500 rely on Red Hat. Red Hat collaborates with a broad ecosystem of partners and communities comprised of millions of developers. These capabilities allow our clients to “write once, deploy anywhere” for cloud native application development and modernization. We embed the Red Hat platform with our offerings, to advance the hybrid cloud value proposition to our clients.

IBM Consulting delivers business transformation for our clients through hybrid cloud and AI technologies. Our 160,000+ professionals together with our open ecosystem of partners help clients advance digital transformation, build open hybrid cloud architectures, orchestrate critical applications across environments, and optimize key workflows and business processes. IBM Consulting drives transformative projects across different industries with its IBM Garage method. IBM Consulting has dedicated talent in practices to support IBM technology and continues to invest in the industry’s largest Red Hat practice to make hybrid cloud a foundation for innovation and business growth, enabling clients to get more value from investments. IBM Consulting has deepened its hybrid cloud consulting offerings and scaled cloud capability to 40,000+ cloud platform certifications, while accelerating the transformation journeys for its clients in 2022. IBM Consulting also captures growth by investing in practices with a wide ecosystem of partners, including AWS, Azure and major ISVs.

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IBM Infrastructure solutions provide unmatched performance, security and resiliency for mission-critical, trusted, or regulated applications running in a hybrid environment. We drive customer adoption and leading DevOps experience for IBM hybrid cloud at scale, deeply integrating with Red Hat and IBM Software offerings. We delivered major breakthroughs in 2022, with next generation z16, Power10 servers and new storage offerings. Forty-five of the world’s top 50 banks are running on IBM zSystems, which excel at transaction processing with integrated AI and unmatched throughput, availability and advanced security for the era of quantum computing. Power, Storage, and IBM Cloud help to accelerate enterprise digital transformation with secure, scalable and resilient solutions built for hybrid cloud agility and application modernization. Infrastructure Support provides lifecycle services and support to optimize and maintain hybrid cloud environments, with visibility and automated diagnosis and remediation.

IBM Research continues to help define the evolution of computing. In 2022, our focused research agenda provided a pipeline of innovations, including automated container-driven environments, AI models, security management, sustainability and many others. Our published Technology Atlas illustrates strategic goals and detailed plans for the next three years of research. We continued to develop technology to harness the potential of the paradigm-shifting inflection point in AI represented by foundation models. We outlined a pioneering vision for quantum-centric supercomputing and announced new breakthrough advancements in quantum software and hardware, including the 433 qubit Osprey processor. We continue to monetize our unparalleled IP and to leverage our world-class skills in semiconductors to innovate in hardware and collaborate with industry-leading partners.

In addition to our organic investments in R&D, our inorganic investments foster our strategy by adding critical competencies to our software and consulting businesses. Our acquisitions of Databand.ai, Randori and Envizi expanded our growing portfolio of AI-driven software, bringing capabilities to help our clients gain better observability into their data, protect against cybersecurity breaches across their various exposure points and manage their environmental performance. We expanded our consulting expertise in data, AI, digital, and cloud through the acquisitions of Sentaca, Neudesic, Dialexa and Octo. These investments also facilitate growth by deepening our industry expertise and consulting capabilities with government and telco clients. In 2022, IBM successfully completed eight acquisitions in total.

Expanding client engagements and our ecosystem

During 2022, we helped clients harness the power of hybrid cloud and AI technologies to address current challenges and opportunities. We invested in experiential selling, client engineering, customer success management, expert lab services and deep technical expertise to show clients the value of technology as a fundamental source of competitive advantage. We engaged clients in digital transformations using automation and security and other solutions to increase growth, productivity, resilience and responsiveness. We introduced a product-led growth initiative under our new global “Let’s create” campaign, illustrating how technology can be brought to life to solve the biggest challenges in business.

When IBM and our partners work together to solve clients’ most complex business challenges, everyone wins. We opened access to software technology on the AWS marketplace to provide flexibility through an open ecosystem. IBM customers can purchase 30 IBM products through the Azure Marketplace and deploy these IBM technologies on Azure. We gave partners access to the same training, and deep technical and product expertise as IBMers to foster a consistent client experience. We deepened our partnership with cloud hyperscalers, large independent software vendors and global system integrators, making it easier for partners and clients to embrace hybrid cloud. Our commitment to the IBM ecosystem gives partners and clients the flexibility and market access they need to run workloads seamlessly in any environment.

In 2022, IBM’s execution and innovation of our hybrid cloud and AI strategy improved the trajectory of our business. We see the core convictions that have shaped our strategy continue to resonate in the market. As we enter 2023, we will continue to advance our R&D innovation, inorganic investment and fast-growing ecosystem, positioning IBM as a leader in a world where hybrid cloud and AI are central to enterprise success.

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14Management Discussion

International Business Machines Corporation and Subsidiary Companies

Business Segments and Capabilities

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

Software

Software provides software solutions that address client needs for a hybrid cloud platform, data and AI, automation, and security on their journey to hybrid cloud. It includes all software, except operating system software reported in the Infrastructure segment.

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

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

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

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

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

Security: creates a risk-aware, secure business by gaining real-time threat insights, orchestrating actions and automating responses across all touchpoints, in line with a zero-trust security strategy. Security includes software and services for threat management, data security, and identity and access management.

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

Consulting

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

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

Business Transformation: provides strategy, process design, system implementation and operations services to improve and transform key business processes. These services deploy AI and automation in business processes to exploit the value of data and include an ecosystem of partners alongside IBM technology, including strategic partnerships with Adobe, Oracle, Salesforce and SAP, among others.

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

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

Infrastructure

Infrastructure provides trusted, agile and secure solutions for hybrid cloud and is the foundation of the hybrid cloud stack. Infrastructure is optimized for infusing AI into mission-critical transactions and tightly integrated with IBM Software including Red Hat for accelerated hybrid cloud benefits.

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

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

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

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

Hybrid Infrastructure also includes remanufacturing and remarketing of used equipment with a focus on sustainable recovery services.

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

Financing

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

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

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

Commercial Financing: short-term working capital financing to distributors and resellers primarily of IBM products. The company has an existing agreement with a third-party investor to sell IBM short-term commercial financing receivables on a revolving basis.

Human Capital

Employees and Related Workforce

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As a globally integrated enterprise, IBM operates in more than 175 countries and is continuing to shift our business to the higher value segments of enterprise IT. Our highly skilled global workforce is reflective of the work we do for clients in support of their digital transformations and mission-critical operations through our focus on hybrid cloud and AI. Our employees are among the world’s leading experts in hybrid cloud, AI, quantum computing, cybersecurity and industry-specific solutions. We believe our success depends on the caliber of our talent and the engagement and inclusion of IBMers in the workplace.

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16Management Discussion

International Business Machines Corporation and Subsidiary Companies

Talent and Culture

We attract, develop, engage and retain talent in a dynamic and competitive environment. IBM provides a compelling employee value proposition, offering professionals competitive compensation and attractive career opportunities in the development and delivery of innovative technologies for clients whose businesses the world relies on. Our value proposition and talent strategy help to retain talent. During 2022, voluntary attrition decreased consistent with the overall labor market.

We are continuously transforming and developing our talent, both through learning and hiring. In 2022, we added skills in consulting and key technical areas and invested in scaling our capacity in strategically important markets. We are expanding our ability to deliver best-in-class customer experiences by investing in talent to facilitate garages, client engineering centers and customer success management. We continue to invest in upskilling and reskilling our workforce. Our digital learning and career platforms are examples of this commitment to provide employees access to the resources needed to build strategic skills and grow their careers. These digital platforms utilize Watson AI to generate personalized recommendations for employees and include peer-to-peer collaboration and internal social sharing functionality. Helping employees learn and apply new skills is important for retention and critical to our ability to transform and evolve.

Employee engagement is an indicator of employee well-being and their dedication to the company’s mission, purpose and values. We conduct an annual engagement survey to assess the health of the company’s culture and employee sentiment. More than 185,000 employees globally participated in the 2022 engagement survey, providing actionable data-driven insights to managers and leaders around factors such as workplace experience, inclusion, pride and propensity to recommend IBM as an employer. More than eight out of ten employees that participated in the survey responded that they felt engaged at work, a testament to our industry-leading talent practices.

Diversity and Inclusion

IBM has a long, proud history as a pioneer in diversity and inclusion. We work to ensure employees from diverse backgrounds are engaged, can be their authentic selves, build skills and grow their careers. Nearly nine out of ten employees feel empowered to be their authentic selves at work. We believe a diverse and inclusive workplace leads to greater innovation, agility, performance and engagement, enabling both business growth and societal impact. Our focus on creating a diverse and inclusive workplace has led to increased levels of inclusion for women, Black and Hispanic employees. Women make up more than one-third of our workforce. In addition, executive representation of women globally, and Hispanic and Black executives in the U.S. improved by 0.3 points, 0.4 points and 0.6 points, respectively, in 2022. Our executive compensation program metrics include a diversity modifier to reinforce our focus and continued accountability for improving the diverse representation of our workforce. Globally, our executives are measured on the improvement of diversity and inclusion for women. In the U.S., executives are also measured on improvement of diversity and inclusion for U.S. underrepresented minorities.

We believe in pay equity whereby employees should be compensated fairly for their work and performance, regardless of their gender, race or other personal characteristics. We have a long-standing practice of maintaining pay equity, which has been part of our global policy since 1935 and we remain firmly committed to equal pay for equal work. To this end, we conduct statistical pay equity assessments across all countries with IBM employees. We also empower employees to understand their pay by providing comprehensive compensation education. Employees can also directly access information about their pay, including a comparison against their market pay range, through the HR system or their direct managers.

Health, Safety and Well-Being

IBM has a long-standing commitment to the health, safety and well-being of our employees. This commitment is embodied in our health and safety policy which is implemented through our externally certified Health and Safety Management System (HSMS). Objectives of our HSMS include providing a safe and healthy workplace, preventing work-related injuries and illnesses, enhancing worker health and productivity and providing resources to fulfill these commitments.

We feel that our employees perform best at work, at home and in the communities where they live and work when their well-being is supported. We believe in not taking a one-size-fits-all approach when it comes to health, safety and well-being. We strive to provide programs that are culturally relevant and inclusive to address the needs of a diverse employee population. We have taken our experience from the pandemic and created an environment to support our employees’ needs on flexibility. Access to well-being services and resources are offered through onsite activities, partnerships with external vendors, amongst other methods of delivery.

We offer a wide range of evidence-based health promotion services and programs, covering all aspects of employee well-being: physical, mental and financial health. In 2022, programs were focused on cardiovascular, musculoskeletal and mental health, addressing some of the medical issues that were exacerbated during the COVID-19 pandemic. All IBMers worldwide have confidential, 24/7 access to critical mental health support through employee assistance programs and supplemental resources. Other programs include additional paid time off for working parents and caregivers experiencing life events, training for employees on resilience, as well as financial counseling offerings. Employees are supported with around-the-clock access to IBM’s world-class Health and Safety team, education, timely updates and forums to ask questions and raise concerns.

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YEAR IN REVIEW

Results of Continuing Operations

As discussed in the “Organization of Information” section, with the completion of the separation on November 3, 2021, the results of Kyndryl are reported as discontinued operations and as such, have been excluded from continuing operations and segment results for all periods presented.

Segment Details

In the first quarter of 2022, we realigned our management structure to reflect the planned divestiture of our healthcare software assets which was completed in the second quarter of 2022. This change impacted our Software segment and Other–divested businesses category, but did not impact our Consolidated Financial Statements. Prior-year results have been recast to reflect this change. The table below presents each reportable segment’s revenue and gross margin results, followed by an analysis of the 2022 versus 2021 reportable segment results.

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Software

* Recast to reflect segment change.

Software revenue of $25,037 million increased 6.9 percent as reported (12 percent adjusted for currency) in 2022 compared to the prior year, driven by growth in both Hybrid Platform & Solutions and Transaction Processing. This includes incremental sales to Kyndryl which contributed approximately 6 points to Software revenue growth. Software concluded 2022 with seasonally strong transactional performance in the fourth quarter and a solid and growing recurring revenue base. Within Software, hybrid cloud revenue of $9,321 million grew 11 percent as reported (16 percent adjusted for currency) year to year. Our platform-based approach to hybrid cloud and AI is resonating with clients. We have modernized and optimized our software capabilities to run on this platform across Automation, Data & AI and Security for the platform.

Hybrid Platform & Solutions revenue of $17,866 million increased 4.9 percent as reported (9 percent adjusted for currency) in 2022 compared to the prior year. Incremental sales to Kyndryl contributed approximately 1 point to revenue growth. Within Hybrid Platform & Solutions, we had revenue growth across all of our business areas. Red Hat revenue increased 12.6 percent as reported (17 percent

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adjusted for currency) led by double-digit growth in OpenShift and Ansible, both of which gained market share in 2022. OpenShift had $1.0 billion in annual recurring revenue exiting 2022. Revenue in RHEL also had strong growth and gained share in 2022 compared to the prior year. Red Hat continues to be a leader in open-source technology and its hybrid cloud offerings continue to transform enterprise IT. Automation revenue increased 2.1 percent as reported (7 percent adjusted for currency), led by Integration and AIOps and Management as clients look to automate business workflows and improve applications. Data & AI revenue increased 1.5 percent as reported (6 percent adjusted for currency), reflecting demand in areas such as Data Management, Data Fabric, Information Exchange, and Asset and Supply Chain Management. In addition, our offerings such as Envizi and Environmental Intelligence Suite are resonating with clients as they continue to prioritize sustainability efforts. Security revenue increased 2.2 percent as reported (7 percent adjusted for currency), led by strength across our offerings such as Threat Management, Data Security and Identity. We continue to help clients detect, prevent and respond to security incidents as they adopt zero-trust security strategies.

Across Hybrid Platform & Solutions, our annual recurring revenue (ARR) was $13.3 billion exiting 2022. 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.

Transaction Processing revenue of $7,171 million increased 12.2 percent as reported (19 percent adjusted for currency) in 2022 compared to the prior year. This includes incremental sales to Kyndryl which contributed approximately 19 points of revenue growth in 2022. Client demand for this mission-critical software has followed increases in zSystems installed capacity over the last two product cycles and consistently strong renewal rates during 2022 are evidence of the importance of this software in a hybrid cloud environment.

* Recast to reflect segment change.

The Software gross profit margin of 79.6 percent in 2022 was flat compared to the prior year. Pre-tax income of $6,162 million increased 27.1 percent compared to the prior year with a pre-tax margin expansion of 3.9 points to 24.6 percent. The improvements year to year in pre-tax income and pre-tax margin were driven primarily by the higher gross profit contribution from our strong revenue growth including the Kyndryl commercial relationship, which reflects the demand for our products, as well as portfolio mix.

Consulting

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Consulting revenue of $19,107 million increased 7.1 percent as reported (15 percent adjusted for currency) in 2022 compared to the prior year, with strong growth across all three business areas. Clients are leveraging IBM’s hybrid cloud leadership and deep industry expertise to navigate the complexity of their digital transformation journeys. Strong demand for our Consulting offerings led to signings growth of 6.9 percent as reported (14 percent adjusted for currency) in 2022. We had our best quarterly book-to-bill for 2022 in the fourth quarter and had a book-to-bill ratio of 1.1 for the year. Book-to-bill represents the ratio of IBM Consulting signings to its revenue over the same period and is a useful indicator of the demand for our business over time. Clients are partnering with IBM Consulting as they decide which applications to modernize and how to migrate these applications across hybrid, multi-cloud environments. Within Consulting, hybrid cloud revenue of $9,019 million grew 15 percent as reported (23 percent adjusted for currency) year to year with both our Red Hat practice and strategic partnerships contributing to the growth.

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Business Transformation revenue of $8,834 million increased 6.6 percent as reported (14 percent adjusted for currency) compared to the prior year. We had strong demand for our Business Transformation solutions, with growth across our service line offerings such as data and client experience transformations, supply chain and finance optimizations. Our partnerships with key ISVs including SAP, Salesforce and Adobe enabled us to help clients transform their critical workloads at scale and improve the way they engage with their customers.

Technology Consulting revenue of $3,765 million increased 8.6 percent as reported (17 percent adjusted for currency), led by our cloud development and cloud modernization practices which architect and implement clients’ cloud platforms and strategies. Our Red Hat engagements as well as strategic hyperscaler partnerships also contributed to the year-to-year revenue growth.

Application Operations revenue of $6,508 million increased 6.8 percent as reported (15 percent adjusted for currency). We help clients optimize their operations and reduce costs by taking over the management of applications in hybrid and multi-cloud environments. Our incumbency and understanding of clients’ applications are key differentiators which helped to contribute to this growth.

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The Consulting gross profit margin decreased 2.5 points to 25.5 percent compared to the prior year. Pre-tax income of $1,677 million increased 15.7 percent compared to the prior year and the pre-tax margin increased 0.7 points to 8.8 percent. The decline in gross profit margin reflects labor cost inflation which put pressure on the margin profile in 2022, however, the gross profit margin improved 2.4 points in the second half of 2022 compared to the first half reflecting the benefit from pricing actions and productivity. The year-to-year improvement in pre-tax income and pre-tax margin reflects the benefits of productivity within our workforce, a more streamlined operating and go-to-market structure as well as our acquisitions which have become more accretive.

Consulting Signings

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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.

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Infrastructure

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Infrastructure revenue of $15,288 million increased 7.8 percent as reported (14 percent adjusted for currency) year to year driven by strong double-digit growth in Hybrid Infrastructure. Incremental sales to Kyndryl contributed approximately 6 points to the Infrastructure revenue growth. Within Infrastructure, hybrid cloud revenue of $3,895 million increased 7 percent as reported (11 percent adjusted for currency) year to year, driven by the product cycle dynamics of z16 and Storage in the current year.

Hybrid Infrastructure revenue of $9,451 million increased 15.7 percent as reported (21 percent adjusted for currency). Incremental sales to Kyndryl contributed approximately 6 points to the revenue growth. Within Hybrid Infrastructure, zSystems revenue grew 30.6 percent as reported (36 percent adjusted for currency) on a year-to-year basis, reflecting strong execution around our new z16 program. The z16 capabilities include cyber-resilient security, embedded AI at scale and cloud-native development for hybrid cloud. Clients are leveraging cyber-resiliency to comply with business regulations and proactively avoid outages in their operations. The new on-chip AI accelerator has been helping mitigate and detect fraud in credit card application processing. The z16 is also the industry’s first quantum-safe system, delivering 25 billion encrypted transactions per day for clients. In the third quarter of 2022, we also 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, now playing an important role in a hybrid cloud environment. Distributed Infrastructure revenue increased 6.6 percent as reported (12 percent adjusted for currency). This performance was led by strength in Power Systems with the extension of our Power10 innovation throughout the Power Systems product lines. The Power10 server platform is designed to deliver flexible and secure infrastructure for hybrid cloud environments. In addition, recent innovation within our Storage product lines included a refresh to our flash storage solutions which contributed to Storage performance in 2022.

Infrastructure Support revenue of $5,837 million decreased 3.1 percent as reported, but grew 3 percent adjusted for currency year to year. This includes incremental sales to Kyndryl which contributed approximately 6 points of revenue growth in 2022. Infrastructure Support performance in 2022 was impacted by client adoption of new hardware with the launch of the z16 program. In the first year of a new hardware cycle, product is under standard warranty which results in a cyclical decline in maintenance revenue.

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The Infrastructure gross profit margin decreased 2.6 points to 52.8 percent in 2022 compared to the prior year driven by Infrastructure Support. The gross profit margin decline in Infrastructure Support was primarily driven by portfolio mix. Hybrid Infrastructure profit margin reflected declines in zSystems and Distributed Infrastructure profit margins in line with product cycle dynamics, offset by product mix primarily toward zSystems. Pre-tax income of $2,262 million increased 11.7 percent, primarily driven by the revenue growth from the z16 product cycle and an increase in IP income year to year from a joint development and licensing agreement signed in the fourth quarter of 2022. The pre-tax margin increased 0.5 points year to year to 14.8 percent, primarily driven by portfolio mix.

Financing

See pages 40 through 42 for a discussion of Financing’s segment results.

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Geographic Revenue

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

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Total revenue of $60,530 million in 2022 increased 5.5 percent year to year as reported and 12 percent adjusted for currency, which includes approximately 4 points of revenue growth from incremental sales to Kyndryl.

Americas revenue increased 9.7 percent as reported and 10 percent adjusted for currency, which includes approximately 3 points of revenue growth from incremental sales to Kyndryl. Within North America, the U.S. increased 9.2 percent and Canada increased 3.3 percent as reported and 7 percent adjusted for currency. Latin America increased 18.4 percent as reported and 19 percent adjusted for currency. Within Latin America, Brazil revenue increased 17.6 percent as reported and 14 percent adjusted for currency.

EMEA revenue increased 2.9 percent as reported and 14 percent adjusted for currency, which includes approximately 5 points of revenue growth from incremental sales to Kyndryl. France, the UK and Italy increased 9.6 percent, 5.3 percent and 3.2 percent, respectively, as reported, and increased 22 percent, 17 percent and 15 percent, respectively, adjusted for currency. Germany decreased 4.7 percent as reported, but grew 6 percent adjusted for currency. The orderly wind-down of our Russian operations in the second quarter of 2022 negatively impacted the revenue growth rate in EMEA by 1.7 points as reported and 2 points adjusted for currency.

Asia Pacific revenue decreased 0.7 percent as reported, but grew 11 percent adjusted for currency, which includes approximately 5 points of revenue growth from incremental sales to Kyndryl. Japan revenue decreased 3.5 percent as reported, but grew 15 percent adjusted for currency. India increased 20.3 percent as reported and 28 percent adjusted for currency. Australia increased 7.3 percent as reported and 16 percent adjusted for currency. China decreased 22.7 percent as reported and 20 percent adjusted for currency, driven primarily by large transactions in the financial sector in the prior year related to our zSystems products.

Total Expense and Other (Income)

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

NM–Not meaningful

Our expense dynamics in 2022 reflect our continued investment in innovation, skills and our ecosystem, both organically and through acquisitions, as we accelerate and execute our hybrid cloud and AI strategy. Our work to digitally transform our operations provides flexibility to continue to invest in innovation and in talent.

Total expense and other (income) increased 18.3 percent in 2022 versus the prior year primarily driven by the one-time, non-cash pension settlement charge of $5.9 billion, higher spending reflecting our continuing focus on our portfolio and investment in our offerings, technical talent and ecosystem, and year-to-year impacts related to Kyndryl retained shares, partially offset by the effects of currency and benefits from the actions taken to streamline operations and our go-to-market model.

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Total operating (non-GAAP) expense and other (income) decreased 3.2 percent year to year, driven primarily by the effects of currency and benefits from the actions taken to streamline operations and our go-to-market model, partially offset by higher spending reflecting our continuing focus on our portfolio and investment in our offerings, technical talent and ecosystem.

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

Selling, General and Administrative Expense

NM–Not meaningful

Total selling, general and administrative (SG&A) expense decreased 0.7 percent in 2022 versus 2021, driven primarily by the following factors:

Operating (non-GAAP) SG&A expense decreased 0.3 percent year to year primarily driven by the same factors.

Provisions for expected credit loss expense was $64 million in 2022 as compared to a benefit of $71 million in 2021. The year-to-year change was 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. The prior-year decreases were primarily driven by improvement in customer credit quality and some emergence from bankruptcies as economies began to reopen after the global pandemic shutdowns. The receivables provision coverage was 2.4 percent at December 31, 2022, an increase of 30 basis points from December 31, 2021 driven by an increase in specific reserves and, to a lesser extent, a decrease in receivables.

Research, Development and Engineering Expense

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Research, development and engineering (RD&E) expense increased 1.2 percent in 2022 versus 2021, reflecting our continuing investment to deliver innovation in AI, hybrid cloud and emerging areas such as quantum. The year-to-year increase was primarily driven by higher spending (3 points), partially offset by the effects of currency (2 points).

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Intellectual Property and Custom Development Income

Total Intellectual Property and Custom Development Income increased 8.4 percent in 2022 compared to 2021. In the fourth quarter of 2022, we signed a three-year joint development and licensing agreement with a Japanese consortium to leverage our intellectual property and expertise on advanced semiconductors which resulted in income of approximately $100 million in 2022.

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

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

NM–Not meaningful

Total other (income) and expense was $5,803 million of expense in 2022 compared to $873 million in 2021. The year-to-year increase

was primarily driven by:

Operating (non-GAAP) other (income) and expense was $1,099 million of income in 2022 and increased $814 million compared to the prior year. The year-to-year increase was driven primarily by the effects of currency, higher gains on divestitures and higher interest income described above.

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Interest Expense

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Interest expense increased $61 million compared to 2021. Interest expense is presented in cost of financing in the Consolidated Income Statement only if the related external borrowings are to support the Financing external business. Overall interest expense (excluding capitalized interest) in 2022 was $1,562 million, an increase of $14 million year to year primarily driven by higher average interest rates, partially offset by a lower average debt balance in the current year.

Stock-Based Compensation

Pre-tax stock-based compensation cost of $987 million increased $68 million compared to 2021. This was primarily due to a current-year change in our Employee Stock Purchase Plan which is considered compensatory beginning second-quarter 2022 ($43 million), an increase from performance share units ($21 million), grants of stock options in the current year ($19 million) and an increase from restricted stock units ($17 million), partially offset by a decrease associated with options previously issued by acquired entities ($31 million). Stock-based compensation cost, and the year-to-year change, was reflected in the following categories: Cost: $164 million, up $18 million; SG&A expense: $566 million, up $10 million; and RD&E expense: $258 million, up $40 million.

Retirement-Related Plans

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

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

NM–Not meaningful

Total pre-tax retirement-related plan cost increased by $5,131 million compared to 2021, primarily due to an increase in curtailment/settlements ($5,875 million) driven by the $5.9 billion third-quarter pension settlement charge, lower expected returns on plan assets ($174 million) and higher interest costs ($105 million), partially offset by a decrease in recognized actuarial losses ($886 million), lower cost of defined contribution plans ($67 million) and lower service cost ($66 million).

As discussed in the “Operating (non-GAAP) Earnings” section, we characterize certain retirement-related costs as operating and others as non-operating. Utilizing this characterization, operating retirement-related costs in 2022 were $1,184 million, a decrease of $136 million compared to 2021. These operating cost decreases were primarily driven by lower cost of defined contribution plans and lower service cost. Non-operating costs of $6,548 million in 2022 increased $5,267 million year to year, driven primarily by the pension settlement charge, lower expected returns on plan assets and higher interest costs, partially offset by a decrease in recognized actuarial losses.

Income Taxes

The continuing operations effective tax rate for 2022 was (54.2) percent compared to 2.6 percent in 2021. The current-year effective tax rate was primarily driven by the transfer of a portion of the Qualified PPP’s defined benefit pension obligations and related plan assets. The prior-year effective tax rate was primarily driven by tax benefits related to audit settlements in multiple jurisdictions.

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The operating (non-GAAP) effective tax rate for 2022 was 15.2 percent compared to 9.0 percent in 2021. The prior-year operating (non-GAAP) effective tax rate was primarily driven by tax benefits related to audit settlements in multiple jurisdictions. For more information, see note H, “Taxes.”

Earnings Per Share

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

Actual shares outstanding at December 31, 2022 and 2021 were 906.1 million and 898.1 million, respectively. The year-to-year increase was primarily the result of the common stock issued under employee plans. The average number of common shares outstanding assuming dilution was 7.6 million shares higher in 2022 versus 2021.

Financial Position

Dynamics

Our balance sheet at December 31, 2022 remained strong and continues to provide us with flexibility to support and invest in the business.

Cash, restricted cash and marketable securities at December 31, 2022 were $8,840 million, an increase of $1,283 million compared to prior year end. Total debt of $50,949 million decreased $755 million from prior year end primarily driven by currency impacts. We continue to manage our debt levels while being acquisitive and without sacrificing investments in our business or our solid and growing dividend.

Our cash flow is presented on a consolidated basis and includes discontinued operations. Refer to note C, “Separation of Kyndryl,” for additional information. During 2022, we generated $10,435 million in cash from operating activities, a decrease of $2,361 million compared to 2021 driven by a decline in financing receivables. Our free cash flow for 2022 was $9,291 million, an increase of $2,784 million versus the prior year. See pages 34 and 35 for additional information on free cash flow. We invested $2,348 million in acquisitions to accelerate our hybrid cloud and AI capabilities, generated $1,272 million from the divestiture of certain businesses, and returned $5,948 million to shareholders through dividends in 2022. There was no cash flow impact from the U.S. pension settlement charge. Our cash generation supports invesment and deployment of capital to areas with the most attractive long-term opportunities.

Consistent with accounting standards, the company remeasured the funded status of our retirement and postretirement plans at December 31. As a result of higher discount rates, partially offset by negative asset returns of 14.3 percent and 15.7 percent on our U.S. and global qualified plans, respectively, the remeasurement resulted in a significant reduction to our pension plan benefit obligations and an improvement in our overall funded status. In addition, as discussed in the Overview section, we transferred $16 billion of our U.S. Qualified PPP obligations and related plan assets to Insurers in 2022 to further reduce the risk profile of our plans. The overall net underfunded position at December 31, 2022 was $2,151 million, a decrease of $3,299 million from the prior year end. At December 31, 2022, the U.S. Qualified PPP was 125 percent funded and the qualified defined benefit plans worldwide were 114 percent funded. The required contributions related to these plans and multi-employer plans are expected to be approximately $200 million in 2023.

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IBM Working Capital

Working capital increased $1,693 million from the year-end 2021 position. Current assets decreased $421 million (increased $589 million adjusted for currency) due to a decline in prepaid expenses and other current assets primarily from the disposition of our investment in Kyndryl of $807 million, and a decrease in accounts receivable driven by currency; partially offset by a net increase in cash and restricted cash. Current liabilities decreased $2,114 million ($1,133 million adjusted for currency) due to a decrease in short-term debt mainly due to maturities; partially offset by reclassifications from long-term debt to reflect upcoming maturities.

Receivables and Allowances

Roll Forward of Total IBM Receivables Allowance for Credit Losses

È Other includes reserve additions/(releases) related to discontinued operations.

Excluding receivables classified as held for sale, the total IBM receivables provision coverage was 2.4 percent at December 31, 2022, an increase of 30 basis points compared to December 31, 2021. The increase in coverage was primarily driven by an increase in specific reserves and, to a lesser extent, a decrease in receivables. The majority of the write-offs during the year related to receivables which had been previously reserved.

Financing Segment Receivables and Allowances

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

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

The percentage of Financing segment receivables reserved decreased from 1.6 percent at December 31, 2021, to 1.3 percent at December 31, 2022, primarily driven by write-offs of previously reserved receivables.

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

Financing’s expected credit loss expense (including reserves for off-balance sheet commitments which are recorded in other liabilities) was a net release of $5 million and $54 million at December 31, 2022 and 2021, respectively. The prior-year net release was primarily driven by lower unallocated reserve requirements in Americas and EMEA due to sales of receivables.

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Noncurrent Assets and Liabilities

The decrease in noncurrent assets of $4,337 million ($1,912 million adjusted for currency) was driven by a decrease in prepaid pension assets and associated deferred taxes mainly driven by plan remeasurements, amortization of intangibles, and derecognition of goodwill and intangible assets related to the divestiture of our healthcare software assets.

Long-term debt increased $1,272 million ($2,329 million adjusted for currency) primarily driven by issuances; partially offset by reclassifications to short-term debt to reflect upcoming maturities and currency impacts.

Noncurrent liabilities (excluding debt) decreased $6,942 million ($5,515 million adjusted for currency) primarily driven by a decrease in retirement and postretirement benefit obligations and deferred taxes driven by plan remeasurements.

Debt

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

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Total debt of $50,949 million decreased $755 million (increased $296 million adjusted for currency) from December 31, 2021, primarily driven by maturities of $6,984 million and currency impacts; partially offset by issuances of $7,971 million.

Non-Financing debt of $38,077 million increased $302 million ($983 million adjusting for currency) from December 31, 2021, primarily due to new debt issuances.

Financing segment debt of $12,872 million decreased $1,057 million ($687 million adjusting 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 the company to substantially match the term, currency and interest rate variability underlying the financing receivable. The Financing debt-to-equity ratio remained at 9.0 to 1 at December 31, 2022.

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

Equity

Total equity increased $3,025 million from December 31, 2021 as a result of:

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Cash Flow

Our cash flows from operating, investing and financing activities, as reflected in the Consolidated Statement of Cash Flows on page 49, are summarized in the table below and include the cash flows of discontinued operations. These amounts also include the cash flows associated with the Financing business.

Net cash provided by operating activities decreased $2,361 million in 2022. This was due to a decrease in cash provided by financing receivables of $4,623 million primarily driven by higher prior-year sales of financing receivables and current-year z16 product cycle dynamics, partially offset by an increase in cash from sales cycle working capital of $2,027 million primarily due to efficiencies in our collections, and a decrease in payments for structural actions and Kyndryl separation-related charges.

Net cash used in investing activities decreased $1,773 million driven by an increase in cash provided by divestitures, and a decrease in cash used in acquisitions.

Net cash used in financing activities decreased $8,397 million. Total debt was a net source of cash of $1,221 million in 2022 as compared to a net use of cash of $8,116 million in 2021. The year-to-year change was driven by higher issuances offsetting maturities in the current year, compared to net higher maturities in the prior year.

Discontinued Operations

Pre-tax loss from discontinued operations was $20 million in 2022 compared to pre-tax income of $1,744 million in the prior year. As the separation of Kyndryl occurred on November 3, 2021, the discontinued operations results for 2021 included ten months of Kyndryl operations. The loss in 2022 primarily reflects the net impact of changes in separation-related estimates, the settlement of assets and liabilities in accordance with the separation and distribution agreement and a gain on sale of a joint venture historically managed by Kyndryl, which transferred to Kyndryl in the first quarter of 2022 upon receiving regulatory approval. The discontinued operations provision for income taxes in 2022 was $124 million compared with $714 million in 2021. The discontinued operations provision for income taxes for the year ended December 31, 2022, primarily reflects the impact of provision to return adjustments on the Kyndryl-related taxes. See note C, “Separation of Kyndryl,” for additional information.

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GAAP Reconciliation

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

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30Management Discussion

International Business Machines Corporation and Subsidiary Companies

PRIOR YEAR IN REVIEW

This section provides a summary of our segment results and year-to-year comparisons between 2021 and 2020. These results have been recast to conform to our segment change effective first-quarter 2022 which impacted the Software segment and the Other—divested businesses category. The recast results are presented below. There was no change to the Consulting, Infrastructure or Financing segments, and there was no change to our consolidated results. Refer to “Year in Review” pages 17 to 29 of the “Management Discussion” section of our 2021 Annual Report for other details of our financial performance in 2021 compared to 2020.

Segment Details

The table below presents each reportable segment’s revenue and gross margin results. Prior-year results have been recast to conform with the segment change effective first-quarter 2022.

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Software

* Recast to reflect segment change.

Software revenue of $23,426 million increased 5.9 percent as reported (5 percent adjusted for currency) in 2021 compared to the prior year. In the fourth quarter of 2021, we had incremental sales to Kyndryl, representing approximately 2 points of full-year revenue growth. We had strong double-digit growth in Software hybrid cloud revenue as reported and adjusted for currency. There was strong growth in Hybrid Platform & Solutions, as reported and at constant currency, driven primarily by Red Hat, Security and Automation, as our strategy around hybrid cloud and AI solutions continued to resonate with our clients. Transaction Processing revenue decreased year to year as reported and adjusted for currency. Although a significant portion of the revenue in this area is annuity based, the timing of larger transactions is tied to client buying cycles and their preference for more consumption-like models which impacted sales of perpetual licenses.

Hybrid Platform & Solutions revenue of $17,036 million increased 9.8 percent as reported (9 percent adjusted for currency) in 2021 compared to the prior year. The incremental sales from Kyndryl in the fourth quarter of 2021 in Hybrid Platform & Solutions were not material to the full-year revenue growth. Red Hat revenue increased 30.6 percent as reported (30 percent adjusted for currency), with strong growth across infrastructure software and application development and emerging technologies, as RHEL and OpenShift address

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enterprises’ critical hybrid cloud requirements. Automation revenue increased 6.1 percent as reported (5 percent adjusted for currency), reflecting solid performance in AIOps and Management as we help our clients address resource management and observability. We are building our capabilities both organically and inorganically, and clients are realizing rapid time to value from our acquisitions including Instana and Turbonomic. Security revenue increased 6.8 percent as reported (5 percent adjusted for currency) with year-to-year growth across security software and services. Security innovation is an integral part of our strategy and, in the fourth quarter of 2021, we launched a new data security solution, Guardium Insights, and completed the acquisition of ReaQta. Data & AI revenue was flat year to year and declined 1 percent adjusted for currency. Within Data & AI, we had solid year-to-year growth in Data Fabric as well as our Business Analytics and Weather offerings.

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

Within Software, hybrid cloud revenue of $8.4 billion grew 29 percent as reported and 27 percent adjusted for currency year to year, driven by Red Hat as well as our software that has been optimized for our hybrid cloud platform which helps our clients apply AI, automation and security across their environments to transform and improve their business workflows.

* Recast to reflect segment change.

The Software gross profit margin increased 0.3 points to 79.6 percent in 2021 compared to the prior year. Pre-tax income of $4,849 million increased 41.7 percent compared to the prior year with a pre-tax margin expansion of 5.2 points to 20.7 percent. The increase in pre-tax income and margin reflects the lower workforce rebalancing charges year to year, which resulted in a 3.3 point improvement in the pre-tax margin compared to 2020.

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32Management Discussion

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OTHER INFORMATION

Looking Forward

As technology remains a fundamental source of competitive advantage, we continue to see strong demand for our hybrid cloud and AI solutions. It is clear that technology is playing a significant role in today’s environment as clients continue to navigate several challenges including inflation and demographic shifts, supply chain issues and heightened sustainability efforts. We are helping our clients seize new business opportunities, overcome today’s challenges and emerge stronger. We are building a stronger, more focused company that is closely aligned to the needs of our clients. We have continued to focus our portfolio in hybrid cloud and AI, invest in our offerings, technical talent and ecosystem and streamline our go-to-market model.

Hybrid Cloud and AI Progress

We believe hybrid cloud and AI are the two most transformational enterprise technologies of our time. These technologies work together to drive business outcomes. Hybrid cloud is where the world is going and containers are the preferred destination for applications. Our platform, built on Red Hat, is the leading container platform. It allows our clients to harness the power of open-source software innovations. Our software and infrastructure technologies have been optimized to run on that platform and include advanced data and AI, automation and the security capabilities our clients need. Our global team of consultants leverage their extensive technical and business expertise to accelerate clients’ digital transformation journeys. Companies are eager to deploy AI and automation capabilities to boost their levels of productivity. We have been co-creating with clients to deploy AI at scale. We are investing in large language or foundation models, that will allow our clients to deploy AI with greater speed and less resources and we have infused these capabilities across our AI portfolio.

Our partner ecosystem is a key 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. In 2023, we are expanding and better enabling our broader ecosystem. In January, we launched PartnerPlus, a new, simplified program that increases our reach and scale through new and existing IBM partners.

We continue to invest, both organically and inorganically, to deliver innovation for our clients and shape the technologies of the future. Throughout 2022, we delivered significant innovations in Infrastructure with our z16 and Power platforms. Quantum is an example of our commitment to shape the future of technology. We unveiled Osprey, a 433-qubit quantum processor that brings us closer to delivering our goal of building a 1,000+ qubit system in 2023. We also formed a collaboration with a Japanese consortium to leverage the depth of our intellectual property on advanced semiconductors. We completed eight acquisitions in 2022 to complement our organic innovation, adding capabilities in areas like hybrid cloud services, security, data observability and sustainability and expanded our footprint in the U.S. Federal market with our acquisition of Octo. Additionally, as sustainability becomes more of a priority, companies need digital technologies to create a baseline, analyze data and improve the way they operate. We have been building a portfolio of solutions to help companies make progress on this journey.

We remain confident in the strategy that we are executing and in the fundamentals of our business. Our balance sheet and liquidity position remain strong. At December 31, 2022 we had $8.8 billion of cash and cash equivalents, restricted cash and marketable securities and we continue to manage our debt levels while being acquisitive and without sacrificing investments in our business or our solid dividend policy. We also took actions in 2022 to further reduce the risk profile of our retirement-related plans.

Our 2022 performance demonstrates that we are now a higher-growth, higher-value company. Our strategy continues to strongly resonate with clients and partners. We enter 2023 as a more capable and nimble company, well-equipped to meet our clients’ needs. 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.

We expect a few dynamics to impact our profit in 2023. Currency was a significant headwind in 2022, impacting our revenue by approximately $3.5 billion. At mid-January spot rates, currency translation would be fairly neutral to revenue in 2023, with a headwind in the first-half changing to a tailwind in the second-half 2023. However, we recognized over $650 million of hedging gains in 2022 which will not repeat in 2023, resulting in an impact to our profit and cash on a year-to-year basis.

With the significant portfolio actions we have taken over the last couple of years, we have some remaining stranded costs in our business. We expect to address these remaining stranded costs early in the year and anticipate a charge of approximately $300 million in the first quarter of 2023. We would expect to generate savings in the second half and pay back by the end of the year.

Lastly, after completion of our annual review of useful lives of our property, plant and equipment assets, due to advances in technology, we have made an accounting change to extend the useful life of our server and network equipment, effective the first of January. Based on our year-end asset base, we expect this change to benefit 2023 pre-tax profit by over $200 million, primarily in our Infrastructure segment. Given this is a change to depreciation expense, there is no benefit to cash.

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Retirement-Related Plans

The combination of higher discount rates and the U.S. pension risk transfer, partially offset by negative asset returns, improved the overall funded status of our plans. In aggregate, our worldwide-tax qualified plans are funded at 114 percent, with the U.S. at 125 percent. Contributions for all retirement-related plans are expected to be approximately $2.1 billion in 2023, an increase of approximately $100 million compared to 2022, of which $0.2 billion generally relates to legally required contributions to non-U.S. defined benefit and multi-employer plans. We expect 2023 pre-tax retirement-related plan cost to be approximately $1.2 billion. This estimate reflects current pension plan assumptions at December 31, 2022. Within total retirement-related plan cost, operating retirement-related plan cost is expected to be approximately $1.2 billion in 2023, approximately flat versus 2022. Non-operating retirement-related plan cost is expected to be approximately $0.1 billion, a decrease of approximately $6.5 billion compared to 2022, primarily driven by the $5.9 billion settlement charge resulting from the U.S. pension risk transfer, lower recognized actuarial losses, partially offset by higher interest cost.

Liquidity and Capital Resources

We have generated solid cash flow from operations allowing us to invest and deploy capital to areas with the most attractive long-term opportunities. We provide for additional liquidity through several sources: maintaining an adequate cash balance, access to global funding sources, committed global credit facilities and other committed and uncommitted lines of credit worldwide. The following table provides a summary of the major sources of liquidity for the years ended December 31, 2020 through 2022.

Cash Flow and Liquidity Trends

*  Includes cash flows of discontinued operations of $1.6 billion and $4.4 billion in 2021 and 2020, respectively.

** Includes 10 months of Kyndryl operations, and reflects cash paid in 2021 for separation charges and structural actions initiated in the fourth-quarter 2020.

È See note P, “Borrowings,” for additional information.

The indenture governing our debt securities and our various credit facilities each contain significant covenants which obligate the company to promptly pay principal and interest, limit the aggregate amount of secured indebtedness and sale and leaseback transactions to 10 percent of IBM’s consolidated net tangible assets, and restrict our ability to merge or consolidate unless certain conditions are met. The credit facilities also include a covenant on our consolidated net interest expense ratio, which cannot be less than 2.20 to 1.0, as well as a cross default provision with respect to other defaulted indebtedness of at least $500 million.

We are in compliance with all of our significant debt covenants and provide periodic certification to our lenders. The failure to comply with debt covenants could constitute an event of default with respect to our debt to which such provisions apply. If certain events of default were to occur, the principal and interest on the debt to which such event of default applied would become immediately due and payable.

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 IBM’s credit rating were to fall below investment grade. At December 31, 2022, the fair value of those instruments that were in a liability position was $1,034 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.

The major ratings agencies’ ratings on our debt securities at December 31, 2022 were as follows and remain unchanged from December 31, 2021.

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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 2022 to further improve our liquidity and plan for our 2023 debt maturities. Debt levels have decreased $0.8 billion from

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December 31, 2021 primarily driven by currency, partially offset by net debt issuances. In the first quarter of 2023, we issued $9.5 billion of debt primarily to plan for our debt maturity obligations in 2024. See note W, “Subsequent Events,” for additional information.

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.

We prepare our Consolidated Statement of Cash Flows in accordance with applicable accounting standards for cash flow presentation on page 49 and highlight causes and events underlying sources and uses of cash in that format on page 28. 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 2022, 2021 and 2020 prepared in a manner consistent with the description above and is presented on a consolidated basis, including cash flows of discontinued operations.

ÈÈ Includes the distribution from Kyndryl of $0.9 billion.

From the perspective of how management views cash flow, in 2022, after investing $1.9 billion in capital investments, we generated free cash flow of $9.3 billion, an increase of $2.8 billion versus the prior year. The year-to-year increase in consolidated free cash flow reflects prior year Kyndryl-related activity including the impact of separation-related charges and capital expenditures, current year working capital improvements driven by efficiencies in collections and mainframe cycle dynamics, higher cash tax payments and payments for structural actions in 2021, partially offset by an increase in capital expenditures in 2022 to drive our strategy. In 2022, we continued to return value to shareholders with $5.9 billion in dividends and invested $2.3 billion in eight acquisitions.

IBM’s Board of Directors considers the dividend payment on a quarterly basis. In the second quarter of 2022, the Board of Directors increased the company’s quarterly common stock dividend from $1.64 to $1.65 per share.

Events that could temporarily change the historical cash flow dynamics discussed previously include significant changes in operating results, material changes in geographic sources of cash, unexpected adverse impacts from litigation, future pension funding requirements during 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 R, “Commitments & Contingencies.” With respect to pension funding, in 2022, we contributed $118 million to our non-U.S. defined benefit plans compared to $103 million in 2021. As highlighted in the Contractual Obligations table, we expect to make legally mandated pension plan contributions to certain non-U.S. plans of approximately $1.1 billion in the next five years. The 2023 contributions are currently expected to be approximately $200 million. Contributions related to all retirement-related plans are expected to be approximately

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$2.1 billion in 2023, an increase of approximately $100 million compared to 2022. Financial market performance could increase the legally mandated minimum contributions in certain non-U.S. countries that require more frequent remeasurement of the funded status. We are not quantifying any further impact from pension funding because it is not possible to predict future movements in the capital markets or pension plan funding regulations.

In 2023, 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.

Contractual Obligations

Certain contractual obligations reported in the previous table exclude the effects of time value and therefore, may not equal the amounts reported in the Consolidated Balance Sheet. Certain noncurrent liabilities are excluded from the previous table as their future cash outflows are uncertain. This includes deferred taxes, derivatives, deferred income, disability benefits and other sundry items. Certain obligations related to our divestitures are included.

Purchase obligations include all commitments to purchase goods or services of either a fixed or minimum quantity that meet any of the following criteria: (1) they are noncancelable, (2) we would incur a penalty if the agreement was canceled, or (3) we must make specified minimum payments even if we do not take delivery of the contracted products or services (take-or-pay). If the obligation to purchase goods or services is noncancelable, the entire value of the contract is included in the previous table. If the obligation is cancelable, but we would incur a penalty if canceled, the dollar amount of the penalty is included as a purchase obligation. Contracted minimum amounts specified in take-or-pay contracts are also included in the table as they represent the portion of each contract that is a firm commitment.

In the ordinary course of business, we enter into contracts that specify that we will purchase all or a portion of our requirements of a specific product, commodity or service from a supplier or vendor. These contracts are generally entered into in order to secure pricing or other negotiated terms. They do not specify fixed or minimum quantities to be purchased and, therefore, we do not consider them to be purchase obligations.

Interest on floating-rate debt obligations is calculated using the effective interest rate at December 31, 2022, plus the interest rate spread associated with that debt, if any.

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Off-Balance Sheet Arrangements

In the normal course of business, we may enter into off-balance sheet arrangements such as client financing commitments and guarantees. At December 31, 2022, we had no off-balance sheet arrangements that have, or are reasonably likely to have, a material current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. See the table above for our contractual obligations, and note R, “Commitments & Contingencies,” for detailed information about our guarantees, financial commitments and indemnification arrangements. We do not have retained interests in assets transferred to unconsolidated entities or other material off-balance sheet interests or instruments.

Critical Accounting Estimates

The application of GAAP requires IBM to make estimates and assumptions about certain items and future events that directly affect its reported financial condition. The accounting estimates and assumptions discussed in this section are those that we consider to be the most critical to our financial statements. An accounting estimate is considered critical if both (a) the nature of the estimate or assumption is material due to the levels of subjectivity and judgment involved, and (b) the impact within a reasonable range of outcomes of the estimate and assumption is material to IBM’s financial condition. Senior management has discussed the development, selection and disclosure of these estimates with the Audit Committee of IBM’s Board of Directors. Our significant accounting policies are described in note A, “Significant Accounting Policies.”

A quantitative sensitivity analysis is provided where that information is reasonably available, can be reliably estimated and provides material information to investors. The amounts used to assess sensitivity (e.g., 1 percent, 10 percent, etc.) are included to allow users of the financial statements to understand a general direction cause and effect of changes in the estimates and do not represent management’s predictions of variability. For all of these estimates, it should be noted that future events rarely develop exactly as forecasted, and estimates require regular review and adjustment.

Pension Assumptions

For our defined benefit pension plans, the measurement of the benefit obligation to plan participants and net periodic pension (income)/cost requires the use of certain assumptions, including, among others, estimates of discount rates and expected return on plan assets.

Changes in the discount rate assumptions would impact the (gain)/loss amortization and interest cost components of the net periodic pension (income)/cost calculation and the projected benefit obligation (PBO). The discount rate assumption for the IBM Personal Pension Plan (PPP), a U.S.-based defined benefit plan, increased by 270 basis points to 5.30 percent on December 31, 2022. This change will decrease pre-tax income recognized in 2023 by an estimated $89 million. A 25 basis point increase or decrease in the discount rate assumption for the PPP would cause a corresponding decrease or increase, respectively, in the pre-tax income recognized in 2023 of an estimated $5 million. Further changes in the discount rate assumptions would impact the PBO which, in turn, may impact our funding decisions if the PBO exceeds plan assets. A 25 basis point increase or decrease in the discount rate would cause a corresponding decrease or increase, respectively, in the PPP’s PBO of an estimated $0.4 billion based upon December 31, 2022 data.

The expected long-term return on plan assets assumption is used in calculating the net periodic pension (income)/cost. Expected returns on plan assets are calculated based on the market-related value of plan assets, which recognizes changes in the fair value of plan assets systematically over a five-year period in the expected return on plan assets line in net periodic pension (income)/cost. The differences between the actual return on plan assets and the expected long-term return on plan assets are recognized over five years in the expected return on plan assets line in net periodic pension (income)/cost and also as a component of actuarial (gains)/losses, which are recognized over the service lives or life expectancy of the participants, depending on the plan, provided such amounts exceed thresholds which are based upon the benefit obligation or the value of plan assets, as provided by accounting standards.

To the extent the outlook for long-term returns changes such that management changes its expected long-term return on plan assets assumption, each 50 basis point change in the expected long-term return on PPP plan assets assumption would have an estimated impact of $139 million on the following year’s pre-tax net periodic pension (income)/cost (based upon the PPP’s plan assets at December 31, 2022 and assuming no contributions are made in 2023).

We may voluntarily make contributions or be required, by law, to make contributions to our pension plans. Actual results that differ from the estimates may result in more or less future IBM funding into the pension plans than is planned by management. Impacts of these types of changes on our pension plans in other countries worldwide would vary depending upon the status of each respective plan.

In addition to the above, we evaluate other pension assumptions involving demographic factors, such as retirement age and mortality, and update these assumptions to reflect experience and expectations for the future. Actual results in any given year can differ from actuarial assumptions because of economic and other factors.

For additional information on our pension plans and the development of these assumptions, see note V, “Retirement-Related Benefits.”

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Revenue Recognition

Application of GAAP related to the measurement and recognition of revenue requires us to make judgments and estimates. Specifically, complex arrangements with nonstandard terms and conditions may require significant contract interpretation to determine the appropriate accounting, including whether promised goods and services specified in an arrangement are distinct performance obligations. Other significant judgments include determining the standalone selling price (SSP), determining whether IBM or a reseller is acting as the principal in a transaction and whether separate contracts should be combined and considered part of one arrangement.

Revenue recognition is also impacted by our ability to determine when a contract is probable of collection and to estimate variable consideration, including, for example, rebates, volume discounts, service-level penalties and performance bonuses. We consider various factors when making these judgments, including a review of specific transactions, historical experience and market and economic conditions. Evaluations are conducted each quarter to assess the adequacy of the estimates. If the estimates were changed by 10 percent in 2022, the impact on net income would have been $65 million.

Costs to Complete Service Contracts

We enter into numerous service contracts through our services businesses. During the contractual period, revenue, cost and profits may be impacted by estimates of the ultimate profitability of each contract, especially contracts for which we use cost-to-cost measures of progress. For those contracts, if at any time these estimates indicate the contract will be unprofitable, the entire estimated loss for the remainder of the contract is recorded immediately in cost. We perform ongoing profitability analyses of these services contracts in order to determine whether the latest estimates require updating. Key factors reviewed to estimate the future costs to complete each contract are future labor costs and product costs and expected productivity efficiencies. Contract loss provisions recorded as a component of other accrued expenses and liabilities were immaterial at December 31, 2022 and 2021.

Income Taxes

We are subject to income taxes in the U.S. and numerous foreign jurisdictions. Significant judgments are required in determining the consolidated provision for income taxes.

During the ordinary course of business, there are many transactions and calculations for which the ultimate tax determination is uncertain. As a result, we recognize tax liabilities based on estimates of whether additional taxes and interest will be due. These tax liabilities are recognized when, despite our belief that our tax return positions are supportable, we believe that certain positions may not be fully sustained upon review by tax authorities. We believe that our accruals for tax liabilities are adequate for all open audit years based on our assessment of many factors, including past experience and interpretations of tax law. This assessment relies on estimates and assumptions and may involve a series of complex judgments about future events. To the extent that new information becomes available which causes us to change our judgment regarding the adequacy of existing tax liabilities, such changes to tax liabilities will impact income tax expense in the period in which such determination is made.

Significant judgment is also required in determining any valuation allowance recorded against deferred tax assets. In assessing the need for a valuation allowance, management considers all available evidence for each jurisdiction including past operating results, estimates of future taxable income and the feasibility of ongoing tax planning strategies/actions. In the event that we change our determination as to the amount of deferred tax assets that can be realized, we will adjust the valuation allowance with a corresponding impact to income tax expense in the period in which such determination is made.

The consolidated provision for income taxes will change period to period based on nonrecurring events, such as the settlement of income tax audits and changes in tax laws, as well as recurring factors including the geographic mix of income before taxes, state and local taxes and the effects of various global income tax strategies.

To the extent that the provision for income taxes increases/decreases by 1 percent of income from continuing operations before income taxes, consolidated net income would have decreased/improved by $12 million in 2022.

Valuation of Assets

The application of business combination and impairment accounting requires the use of significant estimates and assumptions. The acquisition method of accounting for business combinations requires us to estimate the fair value of assets acquired including separately identifiable intangible assets, liabilities assumed, and any noncontrolling interest in the acquiree to properly allocate purchase price consideration. Impairment testing for assets, other than goodwill, requires the allocation of cash flows to those assets or group of assets and if required, an estimate of fair value for the assets or group of assets. Our estimates are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. These valuations require the use of management’s assumptions, which would not reflect unanticipated events and circumstances that may occur.

Valuation of Goodwill

We review goodwill for impairment annually and whenever events or changes in circumstances indicate the carrying value of goodwill may not be recoverable. We first assess qualitative factors in each of our reporting units that carry goodwill including relevant events and circumstances that affect the fair value of the reporting units to determine whether it is more likely than not that the fair value of a

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reporting unit is less than its carrying amount. Judgment in the assessment of qualitative factors of impairment include entity specific factors, industry, market and other macroeconomic conditions, legal and regulatory actions, as well as other individual factors impacting each reporting unit such as loss of key personnel and overall financial performance. If we do not perform a qualitative assessment, or if the qualitative assessment indicates it is more likely than not that the fair value of a reporting unit is less than its carrying amount, we perform a quantitative test.

In the quantitative test, we compare the fair value of each reporting unit to its carrying amount. Estimating the fair value of a reporting unit is judgmental in nature and involves the use of significant estimates and assumptions. We estimate the fair value of our reporting units using the income approach. When circumstances warrant, we may also use a combination of the income approach and certain market approaches. Under the income approach, we estimate the fair value of a reporting unit based on the present value of estimated discounted future cash flows. The discounted cash flow methodology includes the use of projections, which require the use of significant estimates and assumptions specific to the reporting unit as well as those based on general economic conditions. Factors specific to each reporting unit include revenue growth rates, gross margins, discount rates, terminal value growth rates, capital expenditures projections, assumed tax rates and other assumptions deemed reasonable by management.

After performing the annual goodwill impairment qualitative analysis during the fourth quarter of 2022, the company determined it was not necessary to perform the quantitative goodwill impairment test. In 2021, as a result of the separation of Kyndryl and the segment changes that occurred immediately prior to the separation, we performed the quantitative test for all reporting units which resulted in no impairment as the estimated fair value of each reporting unit exceeded its carrying value.

Loss Contingencies

We are currently involved in various claims and legal proceedings. At least quarterly, we review the status of each significant matter and assess our potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount can be reasonably estimated, we accrue a liability for the estimated loss. Significant judgment is required in both the determination of probability and the determination as to whether an exposure is reasonably estimable. Because of uncertainties related to these matters, accruals are based only on the best information available at the time. As additional information becomes available, we reassess the potential liability related to our pending claims and litigation, and may revise our estimates. These revisions in the estimates of the potential liabilities could have a material impact on our results of operations and financial position.

Financing Receivables Allowance for Credit Losses

The Financing business reviews its financing receivables portfolio on a regular basis in order to assess collectibility and records adjustments to the allowance for credit losses at least quarterly. A description of the methods used by management to estimate the amount of uncollectible receivables is included in note A, “Significant Accounting Policies.” Factors that could result in actual receivable losses that are materially different from the estimated reserve include significant changes in the economy, or a sudden change in the economic health of a client that represents a significant concentration in Financing’s receivables portfolio.

To the extent that actual collectibility differs from management’s estimates currently provided for by 10 percent, Financing’s segment pre-tax income and our income from continuing operations before income taxes would be higher or lower by an estimated $17 million depending upon whether the actual collectibility was better or worse, respectively, than the estimates.

Change in Accounting Estimate

In the fourth quarter of 2022, we completed our annual assessment of the useful lives of our property, plant and equipment. Due to advances in technology, we determined we should increase the estimated useful lives of our server and network equipment from five to six years for new assets and from three to four years for used assets. This change in accounting estimate will be effective beginning January 1, 2023 and applied on a prospective basis to the assets on our balance sheet as of December 31, 2022, as well as future asset purchases. Based on the carrying amount of server and network equipment included in property, plant and equipment-net in our Consolidated Balance Sheet as of December 31, 2022, we estimate this change to this existing asset class will increase income from continuing operations before income taxes for 2023 by over $200 million.

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 December 31, 2022, currency changes resulted in assets and liabilities denominated in local currencies being translated into fewer dollars than at year-end 2021. We use financial hedging instruments to limit specific currency risks related to 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, resulted 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

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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 2022. Based on the currency rate movements in 2022, total revenue increased 5.5 percent as reported and 11.6 percent at constant currency versus 2021. On an income from continuing operations before income taxes basis, these translation impacts mitigated by the net impact of hedging activities resulted in a theoretical maximum (assuming no pricing or sourcing actions) decrease of approximately $335 million in 2022 on an as-reported basis and a decrease of approximately $455 million on an operating (non-GAAP) basis. The same mathematical exercise resulted in an increase of approximately $70 million in 2021 on an as-reported basis and an increase of approximately $100 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.

Market Risk

In the normal course of business, our financial position is routinely subject to a variety of risks, including the market risk associated with interest rate and currency movements on outstanding debt and non-U.S. dollar denominated assets and liabilities, and other risks such as collectibility of accounts receivable.

We regularly assess these risks and have established policies and business practices to protect against the adverse effects of these and other potential exposures. As a result, we do not anticipate any material losses from these risks.

Our debt, in support of the Financing business and the geographic breadth of our operations, contains an element of market risk from changes in interest and currency rates. We manage this risk, in part, through the use of a variety of financial instruments including derivatives, as described in note T, “Derivative Financial Instruments.”

To meet disclosure requirements, we perform a sensitivity analysis to determine the effects that market risk exposures may have on the fair values of our debt and other financial instruments.

The financial instruments that are included in the sensitivity analysis are comprised of our cash and cash equivalents, marketable securities, short-term and long-term loans, commercial financing and installment payment receivables, investments, long-term and short-term debt and derivative financial instruments. Our derivative financial instruments generally include interest rate swaps, foreign currency swaps and forward contracts.

To perform the sensitivity analysis, we assess the risk of loss in fair values from the effect of hypothetical changes in interest rates and foreign currency exchange rates on market-sensitive instruments. The market values for interest and foreign currency exchange risk are computed based on the present value of future cash flows as affected by the changes in rates that are attributable to the market risk being measured. The discount rates used for the present value computations were selected based on market interest and foreign currency exchange rates in effect at December 31, 2022 and 2021. The differences in this comparison are the hypothetical losses associated with each type of risk.

Information provided by the sensitivity analysis does not necessarily represent the actual changes in fair value that we would incur under normal market conditions because, due to practical limitations, all variables other than the specific market risk factor are held constant. In addition, the results of the model are constrained by the fact that certain items are specifically excluded from the analysis, while the financial instruments relating to the financing or hedging of those items are included by definition. Excluded items include short-term and long-term receivables from sales-type and direct financing leases, forecasted foreign currency cash flows and the company’s net investment in foreign operations. As a consequence, reported changes in the values of some of the financial instruments impacting the results of the sensitivity analysis are not matched with the offsetting changes in the values of the items that those instruments are designed to finance or hedge.

The results of the sensitivity analysis at December 31, 2022 and 2021, are as follows:

Interest Rate Risk

A hypothetical 10 percent adverse change in the levels of interest rates, with all other variables held constant, would result in a decrease in the fair value of our financial instruments of approximately $0.2 billion and $0.4 billion at December 31, 2022 and 2021, respectively. Changes in the relative sensitivity of the fair value of our financial instrument portfolio for these theoretical changes in the level of interest rates are primarily driven by changes in debt maturities, interest rate profile and amount.

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Foreign Currency Exchange Rate Risk

A hypothetical 10 percent adverse change in the levels of foreign currency exchange rates relative to the U.S. dollar, with all other variables held constant, would result in a decrease in the fair value of our financial instruments of approximately $1.4 billion at December 31, 2022 and 2021. The theoretical changes are primarily driven by changes in foreign currency activities related to long-term debt and derivatives.

Financing Risks

See the “Description of Business” on page 15 for a discussion of the financing risks associated with the Financing business and management’s actions to mitigate such risks.

Cybersecurity

While cybersecurity risk can never be completely eliminated, our approach draws on the depth and breadth of our global capabilities, both in terms of our offerings to clients and our internal approaches to risk management. We offer commercial security solutions that deliver capabilities in areas such as identity and access management, data security, application security, network security and endpoint security. These solutions include pervasive encryption, threat intelligence, analytics, cognitive and artificial intelligence, and forensic capabilities that analyze client security events, yielding insights about attacks, threats, and vulnerabilities facing the client. We also offer professional consulting and technical services solutions for security from assessment and incident response to deployment and resource augmentation. In addition, we offer managed and outsourced security solutions from multiple security operations centers around the world. Finally, security is embedded in a multitude of our products and offerings through secure engineering and operations, and by critical functions (e.g., encryption, access control) in servers, storage, software, services and other solutions.

From an enterprise perspective, we implement a multi-faceted risk-management approach based on the National Institute of Standards and Technology Cybersecurity Framework to identify and address cybersecurity risks. In addition, we have established policies and procedures that provide the foundation upon which IBM’s infrastructure and data are managed. We regularly assess and adjust our technical controls and methods to identify and mitigate emerging cybersecurity risks. We use a layered approach with overlapping controls to defend against cybersecurity attacks and threats on networks, end-user devices, servers, applications, data and cloud solutions. We draw heavily on our own commercial security solutions and services to mitigate cybersecurity risks. We also have threat intelligence and security monitoring programs, as well as a global incident response process to respond to cybersecurity threats and attacks. In addition, we utilize a combination of online training, educational tools, videos and other awareness initiatives to foster a culture of security awareness and responsibility among our workforce.

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

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Our Financing business is focused on IBM’s products and services. Financing revenue decreased 16.6 percent (13 percent adjusted for currency) to $645 million compared to the prior year, 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 22.9 percent to $340 million compared to the prior year and the pre-tax margin of 52.6 percent decreased 4.4 points year to year. The decrease in pre-tax income in 2022 was primarily driven by the strategic actions described above.

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Financial Position

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(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 $0.2 billion (from $13.5 billion in 2021 to $13.7 billion in 2022) and the $0.7 billion change in Financing segment’s receivables disclosed in the free cash flow presentation on page 34 is primarily attributable to currency impacts.

(3) The 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.

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At December 31, 2022, we continue to apply our rigorous credit policies. Approximately 73 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 September 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 secured 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 2022, sales of client financing receivables were largely focused on credit mitigation. 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.

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

For additional information relating to financing receivables refer to note L, “Financing Receivables.” Refer to pages 26 to 27 for additional information related to Financing segment receivables, allowance for credit losses and debt.

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Return on Equity Calculation

Return on equity was 20.1 percent compared to 19.3 percent for the years ended December 31, 2022 and 2021, respectively. The increase was driven by a lower average equity balance, partially offset by a decrease in net income, which reflects the strategic actions taken in the prior year to reposition the Financing business.

Residual Value

The estimated residual value represents the estimated fair value of the equipment under lease at the end of the lease. The company estimates the future fair value of leased equipment by using historical models, analyzing the current market for new and used equipment and obtaining forward-looking product information such as marketing plans and technology innovations.

The company optimizes the recovery of residual values by extending lease arrangements with, or selling leased equipment to existing clients and periodically reassesses the realizable value of its lease residual values.

The following table presents the recorded amount of unguaranteed residual value for sales-type and direct financing leases at December 31, 2022 and 2021. In addition, the table presents the run out of when the unguaranteed residual value assigned to equipment on leases at December 31, 2022, is expected to be returned to the company. The unguaranteed residual value for operating leases at December 31, 2022 and 2021 was not material.

Unguaranteed Residual Value

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Management Responsibility for Financial Information

Responsibility for the integrity and objectivity of the financial information presented in this Annual Report rests with IBM management. The accompanying financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America, applying certain estimates and judgments as required.

IBM maintains an effective internal control structure. It consists, in part, of organizational arrangements with clearly defined lines of responsibility and delegation of authority, and comprehensive systems and control procedures. An important element of the control environment is an ongoing internal audit program. Our system also contains self-monitoring mechanisms, and actions are taken to correct deficiencies as they are identified.

To assure the effective administration of internal controls, we carefully select and train our employees, develop and disseminate written policies and procedures, provide appropriate communication channels and foster an environment conducive to the effective functioning of controls. We believe that it is essential for the company to conduct its business affairs in accordance with the highest ethical standards, as set forth in the IBM Business Conduct Guidelines. These guidelines, translated into numerous languages, are distributed to employees throughout the world, and reemphasized through internal programs to assure that they are understood and followed.

The Audit Committee of the Board of Directors is composed solely of independent, non-management directors, and is responsible for recommending to the Board the independent registered public accounting firm to be retained for the coming year, subject to stockholder ratification. The Audit Committee meets regularly and privately with the independent registered public accounting firm, with the company’s internal auditors, as well as with IBM management, to review accounting, auditing, internal control structure and financial reporting matters.