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    2020 Annual Report


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    Dear IBM Investor: What we have witnessed over the past year is an acceleration of digital transformation. Every company in every industry wants to build a much stronger digital foundation to Today your fundamentally change the way its business works. There is no going back. In the next two to three years, we expect to see digital transformation at a rate that, before 2020, we thought company is would take 5 to 10 years. Perhaps the most profound and exciting change our clients positioned to lead are experiencing is the adoption of new business models based on digital technologies that IBM is building. This is evident whether you look at the use of AI-powered assistants as we enter the era to offset the massive increase of requests flooding call centers, the meteoric rise of telemedicine, or the use of hybrid cloud to build rich, personalized and secure experiences in of hybrid cloud areas like digital banking. and AI. As I write As I will describe to you in this letter, we have made decisive moves to help our clients thrive by tapping into the immense power of hybrid cloud and AI. My confidence in our ability to you, the world is to exit this turbulent period stronger is grounded in the strength of our strategy, the progress of our transformation, and the talent and resilience of IBMers around the world. still experiencing 2020 performance For the year, we generated $73.6 billion of revenue, disruption as a a decline of 4 percent excluding the impact of currency and divestitures. Much of this reflects the broader uncertainty of the macro environment, which also affects our clients. result of the global The urgency for digital transformation continues to fuel momentum for our business. Our cloud-related revenue grew 20 percent to $25.1 billion excluding the impact of currency pandemic. and divestitures, and now represents over one-third of our total revenue. Red Hat was a key driver with normalized revenue growth of 18 percent in 2020 and a backlog topping $5 billion for the first time at year end. Red Hat, together with our modernized Cloud Pak solutions, delivered overall software revenue growth for the year. Global Business Services (GBS) cloud revenue grew at a double-digit rate as we focused on modernizing clients’ applications and reimagining their workflows with AI. Global Technology Services helped clients navigate the unprecedented volatility in their own business volumes, ending the year with strong contract renewals and new client additions. With IBM Systems, as always, performance reflects product cycles. Even with a very successful new product introduction in the second half of 2019, IBM Z revenue grew in 2020, with the z15 now shipping the largest capacity in the platform’s history.


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    2 IBM 2020 Annual Report The fundamentals across our business continue to be Everywhere you look today, businesses have an acute need for strong. Our operating gross profit margin expanded 130 basis speed to market, flexibility and nimbleness, and continuous points to over 49 percent, an indication of the value our innovation. On these, hybrid cloud delivers. In fact, clients clients derive from our offerings. Operating net income was find that choosing a hybrid cloud approach is 2.5 times more $7.8 billion, even after a significant charge for structural valuable than relying on public cloud alone. actions to improve our go-forward position. Gaining momentum In this environment we also took actions to enhance our One of the best indicators of progress is to look at the pace balance sheet and liquidity, resulting in a stronger financial of client consumption. On that front, we are making good position. Free cash flow is the fuel for our growth, and for headway. We now have more than 2,800 clients using our the year we generated a solid $18.2 billion of net cash from hybrid cloud platform, up 40 percent over the past year, operations and free cash flow of $10.8 billion. We focused as they leverage it to accelerate their own digital our captive financing business on our hybrid cloud and transformation journeys. AI strategy, reducing our external financing needs. We continued to return capital to our shareholders in the form Energy industry services, software and equipment leader of $5.8 billion in dividends. We raised the dividend for the Schlumberger is expanding customer access to its AI- 25th consecutive year in an uninterrupted 105 years of powered exploration and production solutions and making paying a dividend, while continuing to invest in technologies, its data platform hybrid cloud-friendly, exclusively through skills, and ecosystems to expand our capabilities and OpenShift. This engagement is also driving business for accelerate future growth. Cloud Paks, IBM Cloud and GBS. Delta Air Lines is using OpenShift, Cloud Paks and GBS expertise to modernize its The right strategy for digital transformation digital customer experience. Hybrid cloud and AI are the two next great shifts in the technology landscape, and IBM is positioning itself to play IBM has built two industry clouds designed to tackle the a key role in this swift and massive transformation. We see specific needs of mission-critical and highly regulated the hybrid cloud opportunity at $1 trillion. Most of it is still industries. Our Cloud for Financial Services added key ahead of us, as less than 25 percent of workloads have moved partners in 2020, such as Adobe, Infosys Finacle, Persistent to public clouds thus far. Meanwhile, the current enterprise Systems and many others. Some of the world’s largest banks deployment rate of AI is only in the single digits. signed on, including Bank of America, BNP Paribas and MUFG Bank. To seize the immense opportunity that this represents, our approach is platform-centric. Linux, Containers and In 2020, we launched our Cloud for Telecommunications. Kubernetes are the foundation of our hybrid cloud platform So far, more than 35 partners have joined. As a strategic with Red Hat OpenShift as our core product, delivering partner, Samsung is working with IBM and Red Hat to develop all of these attributes and more. We have a vast software next-generation 5G and mobile edge device solutions for portfolio modernized to run cloud-native anywhere. Our GBS private networks. Separately, we are helping companies like expertise is a key factor in driving consumption and is Vodafone Idea, Verizon and Bharti Airtel transform their IT currently helping hundreds of major clients on their hybrid and telecom network operations. cloud journeys. All of these capabilities are supported by our systems and cloud infrastructure, which allows us to build Clients are moving to deploy AI at scale. More than 40,000 industry-specific clouds. clients have turned to IBM to unlock value from their data. IBM’s AI platform is differentiated by automation, natural Based on this foundation, we are successfully leveraging language processing and trust. It is the only AI platform that Red Hat as a unique platform to address what our global, can run anywhere—on premise, private cloud and public complex and highly regulated clients need: a hybrid cloud cloud. Clients across industries are using it to infuse AI into platform that is open, flexible and secure. Our hybrid their core business processes, such as hiring, supply chains cloud approach lets clients connect their back office to their and customer service. front office, modernize mission-critical workloads, build cloud-native apps, and securely deploy and manage data Putting Watson Assistant, natural language processing and and applications across various IT environments. enterprise AI search capabilities to work as multilingual virtual agents, IBM helped Children’s Healthcare of Atlanta create the “COVID-19 Pediatric Assessment Tool” for parents.


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    3 Using the OpenPages with Watson platform, we are helping clients to manage risk more effectively and efficiently across their global operations by consolidating audit, risk, and control processes and procedures. Trust is table stakes for the expansion of data and AI in daily business processes. IBM clients’ data is their data, and their insights are their insights. That commitment and our industry-leading encryption technology differentiate our AI in the marketplace. Decisive moves for future growth Over the past year, we have made a series of decisive moves to support our hybrid cloud and AI strategy. We announced the separation of our managed infrastructure services business in October 2020. In a business where scale matters, “NewCo” will be the biggest in its field, with more than 4,600 clients at the start, including 75 percent of the Fortune 100. Our two companies will continue to share a strong bond as NewCo will remain IBM’s preferred partner for infrastructure management. In 2020, we closed seven strategic acquisitions. All are designed to strengthen our hybrid cloud and AI portfolio. They enhance our software, expand our GBS capabilities in implementation and consulting, augment our security offerings, and support our go-to-market to drive hybrid Arvind Krishna Chairman and cloud consumption. Chief Executive Officer To accelerate consumption of our hybrid cloud platform, we have elevated the role of partners and also rapidly expanded our ecosystem by adding hundreds of new partnerships with global system integrators, independent software vendors and major third-party software partners. We are investing $1 billion in our ecosystem so that our partners can play a much bigger role in fulfilling the many needs of our clients. Partners are helping broaden the reach of our software portfolio. For example, we collaborated with Salesforce to build our Digital Health Pass, which incorporates data such as temperature checks, COVID-19 test results and vaccine status to help organizations safely reopen. The Digital Health Pass is Thank you to former Executive Chairman combined with the power of Salesforce’s customer relationship management solutions and IBM’s technologies, such as hybrid Ginni Rometty. Under her leadership cloud, AI and Blockchain. Together we are also building a new we laid the foundation for the hybrid cloud vaccine management platform for Ireland’s Health Service Executive. Our partnership with ServiceNow on Watson AIOps and AI strategy that will drive the engine supports our continued leadership in transformative AI by of our clients’ success. helping clients automate IT operations and reduce risk.


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    4 IBM 2020 Annual Report In addition, we are aligning our go-to-market model with Trust is our license to operate, and for more than a century our hybrid cloud and AI approach, implementing a simplified IBM has earned the trust of our clients and society. We client segmentation, putting IBM Garage at the center of our continue to earn it through projects such as our work with the experiential sales process and working more closely with Vatican to develop principles for ethical AI, and our leadership ecosystem partners so they can deliver more value to clients. role in data privacy reinforced by the IBM Policy Lab. Responsible stewardship Emerging stronger Being a responsible steward of technology is core to I am proud of the work IBMers have done to bring us to this IBM culture and has never been more important than point, and I am grateful to you, our shareholders, for your it was in 2020. support on our journey. We saw how our commitment to Good Tech can make a As I look back, for me as for so many other IBMers, 2020 difference during a global emergency. We organized the has put the spotlight on IBM’s essential role for our clients. High-Performance Computing Consortium to put our fastest IBM is the backbone of some of the most critical systems computers at the disposal of scientists around the world that keep the world running. Our technologies and services working to understand and combat COVID-19. IBM’s Watson help banks process credit card transactions, businesses Assistant for Citizens helped dozens of governments at all run supply chains, telcos connect customers, healthcare levels disseminate information about COVID-19 testing and providers improve patient care, and companies and cities best practices. tackle cyber threats. As protesters took to the streets to condemn systemic IBM’s essential and transformative role in the world is a racism, we sent a letter to Congress explaining our decision reminder that few companies have the trust, talent and to abandon facial recognition software, prompting other tech ingenuity to help clients solve their greatest challenges companies to follow suit. Internally we launched several the way that your company can. IBM is reshaping its future social justice initiatives including Emb(race), a program as a hybrid cloud and AI platform company. I am excited highlighting the experiences of Black IBMers, and a program about our ability to emerge stronger as the world recovers increasing our partnerships with historically Black colleges from the effects of the global public health crisis, and the and universities (HBCUs). We created the position of SVP of possibilities ahead as our clients accelerate their digital Transformation and Culture, strengthening our transparency transformation journeys. around and commitment to fostering the culture of diversity and inclusion that is the foundation of IBM’s success. The climate crisis is one of the most urgent issues of our time. IBM has been a leader in corporate sustainability for half a century. Our first corporate environmental policy Arvind Krishna statement dates back to 1971. Since 1990, we have shared Chairman and Chief Executive Officer our progress in managing waste, conserving energy, using renewable electricity and reducing carbon dioxide emissions. We are taking other steps to advance our environmental leadership. We are setting a new goal to reach net zero greenhouse gas emissions by 2030 to help address the climate crisis. As a founding member of the Climate In an effort to provide additional and useful information regarding the company’s Leadership Council, we also support a carbon tax that fi nancial results and other fi nancial information, as determined by generally accepted will reduce carbon emissions globally through market- accounting principles (GAAP), these materials contain non-GAAP financial measures on a continuing operations basis, including revenue adjusted for divested businesses based incentives. and constant currency, free cash flow, and other “operating” fi nancial measures including operating gross profit margin, operating earnings, operating earnings per share and operating net income. The rationale for management’s use of this non-GAAP information is included on pages 18, 19, and 57 of the company’s 2020 Annual Report, which is Exhibit 13 to the Form 10-K submitted with the SEC on February 23, 2021. For reconciliation of these non-GAAP fi nancial measures to GAAP and other information, please refer to pages 21, 45, and 58 of the company’s 2020 Annual Report. These materials also contain year-to-year change in revenue for Red Hat, normalized for historical comparability. The rationale for management’s use of this non-GAAP fi nancial measure and its reconciliation to GAAP are respectively included as Exhibits 99.2 and 99.1 to the company’s Form 8-K submitted with the SEC on January 21, 2021.


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    5 Hybrid cloud and AI are IBM’s clear path “Over the last decade, IBM has to growth transformed itself to meet the mission-critical needs of our clients. Today, IBM is laser- focused on open hybrid cloud— a $1 trillion market opportunity. At the beginning of 2020, less than 25 percent Our hybrid cloud platform of mission-critical workloads had moved to provides a full stack of capabilities to clients including the cloud. As companies sought to equip their our AI-enabled software employees to work remotely during the pandemic, portfolio, cloud transformation services, systems, security many sped up the pace of their technological and the IBM public cloud.” changes. They’ve realized the sooner they can Jim Whitehurst make the jump to cloud and cloud-enabled AI, President, IBM the better. This trend will continue until the 75 percent of workloads that were left behind migrate to hybrid cloud. IBM is uniquely qualified to deliver what our clients need and want. In Red Hat OpenShift IBM is doubling down on its investment in hybrid we have the leading open source hybrid cloud cloud and AI because we see it as the best way to platform. Add our Cloud Paks, and we can help our customers on this journey. They want the transform complex legacy architecture into a speed, efficiency and innovation that comes with completely secure integrated platform. Our moving to the cloud, without having to reinvent clients benefit from the seamless automation, their entire IT infrastructure. That’s what hybrid data mining and analysis, development of cloud- cloud is all about. native applications and multicloud management our platform provides. Our services team brings the expertise to make migration to the hybrid cloud easy and a custom fit for each client. Our combined offerings are the recipe for our clients’ success and IBM’s growth. Our industry- leading security makes the hybrid cloud safe and compliant for heavily regulated enterprises like banks, telcos and energy companies. Our automation frees up people for business transformation. Our cloud-native AI integrates data from across the IT infrastructure, generating new insights into processes and outcomes that create real business value. IBM’s services team has the industry and technological expertise to help our clients reinvent themselves using our platform and the applications that run on it, from banking to telecoms to retail to energy to just about anything.


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    6 IBM 2020 Annual Report IBM and Red Hat— In the financial services sector, our hybrid cloud platform is helping banks around the world roll out new digital services while providing built-in security that satisfies data protection regulations. leading in hybrid Technology from IBM Cloud and Red Hat is enabling Banco Sabadell’s 100 percent digital model in Mexico. CaixaBank, Spain’s leading financial group in terms of retail and digital banking, is cloud building a hybrid cloud infrastructure using Red Hat OpenShift. As 5G becomes more prevalent, telecommunications providers IBM’s acquisition of Red Hat has been a game changer for need to scale quickly to support growing volumes of data, enterprise computing. Red Hat’s software underpins the most voice and multimedia services. Indian telco Vodafone Idea flexible, secure and cost-effective platform for running mission- is transforming its network into an open hybrid cloud platform critical workloads—the hybrid cloud. using IBM’s Watson AI and Red Hat Ansible Automation Platform to improve the cost and quality of its core network Red Hat OpenShift is the leading enterprise Kubernetes delivery. Bharti Airtel is leveraging IBM and Red Hat to build platform—used across industries as the foundation for cloud- a more efficient, flexible network cloud for core operations native applications. With OpenShift, customers can choose the and new digital services. right environment for workloads and run applications seamlessly across any kind of architecture, whether on-premise, public Red Hat ecosystem partners are helping our clients get more cloud, private cloud or at the edge. out of our platform. In 2020, IBM and Red Hat introduced Red Hat Marketplace, the first enterprise software and service OpenShift is also the platform for IBM Cloud Paks, offering marketplace designed for hybrid cloud computing. Red Hat clients containerized solutions for data, integration, automation, Marketplace has one of the largest curated collections of tools multicloud management and security. Our focus is on helping and services developers need to build cloud-native applications. large enterprises succeed and on removing complexity and risk from their digital journeys. “A hybrid cloud foundation built on open source offers the flexibility, acceleration and innovation that digital transformation requires. For most corporations, hybrid cloud is the only practical way to the cloud.” Paul Cormier President and Chief Executive Officer, Red Hat


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    7 Unlocking the power Navigating the pandemic with Watson Assistant of client data Organizations turned to Watson Assistant, IBM’s AI-powered virtual agent for business, to field COVID-related questions Throughout 2020, IBM helped organizations unlock the power from customers, employees and the general public. Use of of their data to drive measurable results at scale. Clients deployed Watson Assistant surged 64 percent between February and our hybrid cloud software to modernize their IT landscapes, use November 2020. data to predict and shape future outcomes, automate workflows, enhance customer service and secure their organizations Burger King Brazil customized Watson Assistant to connect against cyber threats. 16,000 employees across 800 restaurants to information on HR with speed, reliability and security. Using Watson AI for business requires mastery of automation, natural Assistant and Watson Discovery, GlaxoSmithKline launched language processing and trust. New Watson Natural Language 16 virtual assistants that answered 83,000 questions in a Understanding capabilities from Project Debater will help single three-month span. GM Financial used Watson Assistant businesses analyze linguistic nuances, while new AI FactSheets to manage 50 to 60 percent of live chat requests when the for Watson Studio in Cloud Pak for Data will increase the pandemic hit. transparency and explainability of AI models. Trust is critical to AI adoption. We help our clients understand how AI models IBM trained Watson Assistant to answer COVID-related make decisions, provide transparency into how AI technology questions, and offered it free of charge to hospitals, governments is built, and govern and champion the responsible use of AI. and other organizations for 90 days. The Royal Marsden, a leading London-based cancer center, used its virtual agent Additionally, the introduction of Watson AIOps and the to give employees consistent information about the virus and acquisitions of WDG Automation and Instana expanded our related workplace guidance. The Government of Colombia AI-powered automation capabilities. Partnerships with Box, created a virtual agent that facilitated over 11,000 queries Cloudera, MongoDB and ServiceNow grew our AI ecosystem. per month on travel guidance and virus prevention. And ahead of the November elections, the Idaho Secretary of State We have more than 40,000 Watson client engagements across used Watson Assistant to answer logistical questions from 20 industries, where market leaders are using IBM Watson to its 900,000-plus voters. work smarter. EY is using IBM Watson Discovery to transform M&A due diligence with a custom natural language processing model that delivers insights into competitive deal processes. Deutsche Lufthansa AG is using IBM Watson Studio, IBM Watson Machine Learning and IBM Cloud Pak for Data to achieve operational excellence and enhance customer and employee experiences. And with our business partner EquBot, we helped HSBC develop the AI-powered US equity index AiPEX, a first-of-its-kind tool that analyzes vast amounts of publicly “We want to help clients available data—from company announcements to satellite transform their businesses— leveraging our hybrid cloud and images of store parking lots—to identify potential growth stocks. AI software to modernize their applications, improve customer service and dramatically cut costs. We’ll continue working across our ecosystem to increase adoption of our platform, and help our clients find innovative ways to fuel their digital transformations.” Rob Thomas Senior Vice President, IBM Cloud and Data Platform


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    8 IBM 2020 Annual Report Creating intelligent workflows IBM Global Business Services (GBS) helps organizations reinvent the way they work. With intelligent workflows, businesses can reshape core functions across their organizations—from supply chains to recruitment and bill processing. Running on the hybrid cloud and powered by IBM’s leading AI automation software and analytics, intelligent workflows connect data from disparate systems, streamline processes and generate actionable insights. For example, 12 of Europe’s largest banks worked with IBM consultants to co-create a blockchain-based trade finance platform called we.trade. Small- and medium-sized businesses benefit from being able to collaborate and trade across a transparent and secure environment. Transaction information is authorized and shared only with the appropriate parties across the platform via smart contracts. Along with reduced risk and increased regulatory compliance for all users, we.trade has reported up to 80 percent savings in transaction processing. In just five days, IBM helped TSB Bank in the United Kingdom launch its web-based TSB Smart Agent to allow immediate customer access to applications for repayment deferrals on Mikhel Ruia, Managing Director mortgages and loans during the pandemic. The AI-driven of Glenmuir, a British golf clothing TSB Smart Agent complemented employee actions to respond manufacturer and member of we.trade via its bank, HSBC. to more than 40,000 customer requests during the first several weeks of operation. Rising to strategic needs and multiple challenges caused by brushfires and COVID-19, leading telecommunications company Telstra and IBM co-created a cognitive supply chain control tower, an integrated supply chain platform and agile work protocols to serve its operations reliably. “An open, flexible, hybrid approach “2020 was one of the most to cloud gives businesses the challenging periods in history freedom to choose from multiple for businesses, with 6 out of providers to best meet their 10 organizations accelerating business and IT needs. As we their digital transformations. help clients shift to hybrid cloud, Recognizing that future we see tremendous benefits from disruptions are inevitable and open innovation. Build once, run unpredictable, now is the time anywhere. Innovate anywhere to create intelligent workflows with anyone’s technology. that streamline processes That’s the beauty of a hybrid and help people manage these cloud platform.” tectonic shifts.” John Granger Mark Foster Senior Vice President, Senior Vice President, Hybrid Cloud Services and IBM Services Chief Operating Officer, IBM Global Business Services


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    9 “NewCo”: a trusted partner to Driving innovation the world’s global enterprises To clarify our approach to the $1 trillion market opportunity for and resilience hybrid cloud growth, IBM announced the spin-off of our market- leading managed infrastructure services unit, “NewCo” (to be Maintaining business continuity, enabling remote workforces and named later). strengthening virtual customer engagement were all critical in 2020. In response, IBM Global Technology Services (GTS) rallied The spin-off will create two market-leading companies focused for go-to-market coverage—taking client service to the next level on what they do best. For IBM that means concentrating on its to keep businesses up and running while facilitating their hybrid cloud platform, AI capabilities and consulting services to migrations to hybrid cloud. help clients on their digital transformation journeys. NewCo will pursue a $500 billion market opportunity in managed As GTS focused its service offerings to support hybrid cloud infrastructure services. and AI, industry analysts took notice. NelsonHall gave IBM top marks for addressing both immediate and future client needs. NewCo—with more than 4,600 technology-intensive, highly Everest joined all analysts in naming IBM “a leader in delivery regulated clients in 115 countries, a backlog of $60 billion and automation through intelligent automation.” And Forrester more than twice the scale of its nearest competitor—will have ranked IBM as a leader in disaster recovery as a service.* For greater agility to design, run and modernize the infrastructures example, National Telecom Public Co., Ltd. is using IBM of the world’s most important organizations. open-source software support services to help hotels control virus spread as Thailand reopens its borders. Both companies will be on an improved growth trajectory with greater abilities to partner and capture new opportunities— But outstanding client services is what really defined GTS in creating value for clients and shareholders. Operating 2020. Hybrid cloud technology allows manufacturers, logistics independently, IBM and NewCo will capitalize on their companies, governments, retailers and service providers, to work respective strengths. together across a multitude of different computing environments. As a result, GTS saw significant demand for a hybrid cloud approach to reinventing supply chains in 2020. For example, IBM signed a multi-year agreement with Coca-Cola European Partners, to use the power of the open hybrid cloud, combined with the expertise of IBM Services, to transform its soft drink supply chain. Adopting a hybrid cloud strategy, South Korean credit card issuer Lotte Card turned to GTS to migrate and manage its mission- critical enterprise systems. Using cloud-native technology from IBM and Red Hat OpenShift, Lotte Card accelerated customer workload processing by 300 percent. As the speed of digital “The spin-off of NewCo is an opportunity that presents transformation increases, the flexibility of cloud technologies exciting potential. We are already over traditional IT infrastructures will allow Lotte Card to the number one managed respond with greater agility to rapidly changing market infrastructure services provider in the world. Our unmatched conditions, and to better serve its customers in near real time. talent, the breadth of our services, our ecosystem of partners and our deep global client relationships should position us well for the future.” Martin Schroeter CEO, NewCo * The Forrester Wave™: Disaster Recovery-As-A-Service Providers, Q2 2019 by Naveen Chhabra with Glenn O’Donnell, Amanda Lipson and Bill Nagel. April 2019.


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    10 IBM 2020 Annual Report Enhancing the client As the need for digital transformation accelerated in 2020, it became clear that businesses benefited the most when they were supported by an ecosystem of partners that continually experience through provided the best technologies and industry expertise. That’s why IBM has committed to a $1 billion investment ecosystems in its hybrid cloud ecosystem over the next three years. This investment has already begun supporting a coalition of best- of-breed global system integrators and independent software vendors that are helping clients migrate their mission-critical workloads to IBM’s hybrid cloud platform. More than 85 new partners from a wide range of technology and industry backgrounds joined the ecosystem in 2020— reflecting IBM’s ability to leverage long-standing relationships in the technology community. A key part of this ecosystem, Red Hat “We’re dedicated to fostering a culture of openness and Marketplace provides clients with greater scale, resources collaboration among our and capabilities, reinforcing the value of the OpenShift hybrid ecosystem partners while cloud platform. ensuring that their data is not compromised. By investing in our partners and working together, we will drive success for our clients, for our partners and for IBM.” Bob Lord Senior Vice President, Worldwide Ecosystems and Blockchain Uniting the developer ecosystem to solve global problems Since its inception in 2018, the annual Call for Code competition to create open source technology to help tackle the world’s biggest challenges has scaled to engage more than 400,000 developers and problem solvers across 179 nations. The 2020 challenge focused on managing the effects of climate change and fighting COVID-19. The winning application from Agrolly is built on IBM Cloud Object Storage, IBM Watson Studio and IBM Watson Assistant. It connects small farmers to personalized, real-time data from The Weather Company (an IBM business) to help them cope with climate change. The competition also yielded promising COVID-19 solutions, some of which may be going to market.


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    11 Adobe, a leader in multimedia and creative software, is partnering with Red Hat and IBM to focus on instilling trust through the customer experience for businesses in regulated industries. The IBM iX digital and design consultancy will extend its offerings across Adobe’s core enterprise applications. The global leader in customer relationship management (CRM) platforms, Salesforce is working with IBM to help organizations safely reopen and provide individuals with a verifiable way to manage and share their vaccination and health status. IBM advanced its long-standing partnership with enterprise application software innovator SAP by contributing an industry cloud solution focused on industrial manufacturing. The aim is to help companies rewire their organizations to create efficient, automated business processes that increase productivity and customer satisfaction. A pacesetter in digital workflow software, ServiceNow is collaborating with IBM to use Watson AIOps and ServiceNow’s intelligent workflow capabilities to help companies reduce operational risk and lower costs through automation. Leading systems integrator Wipro expanded its partnership with IBM to help businesses securely migrate and manage mission-critical workloads and cloud-native applications on IBM’s hybrid cloud platform. Driving growth for our clients, our partners and IBM In 2020, IBM adopted a single, consistent client engagement model across hybrid cloud, software, services and systems— giving clients greater access to Red Hat and acting as one team with a singular focus on client success. Clients want to consume our technology more easily, with greater access to our unmatched technical and industry expertise and business value creation “IBM’s streamlined engagement earlier in the process. In response, we have intensified our focus model simplifies the way clients on experiential selling—both digitally and through IBM Garage, interact with us, experience our differentiated technology and where we co-create, co-execute and co-operate with clients to service offerings, leverage our give them clear visibility into our capabilities and their projected unmatched industry expertise, business results. and realize tangible business value. By following these principles, IBM will open new We also increased investment in our ecosystem of system market opportunities as we give integrators and software vendors so they can play a much bigger more clients the confidence to role in client fulfillment in ways that drive mutual success use their data for competitive advantage.” for customers, partners and IBM. We’re giving our partners the access they need to experience our hybrid cloud platform and Bridget van Kralingen Senior Vice President, develop solutions that speak directly to client needs. Global Markets


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    12 IBM 2020 Annual Report The industry standard for cloud and enterprise IT As governments and regulated industries migrate their mission- critical workloads to hybrid cloud, they must be confident in the safety, security and reliability of the IT infrastructures they rely on, and know that their systems are built to adapt to client needs—not vice versa. IBM’s industry-optimized clouds enable clients to focus on their business processes instead of on IT and applications. These are highly focused clouds designed with a deep understanding of particular regulatory environments. Industry- specific features and controls including identity management, access management and configuration management are built in so that any solutions clients develop or deploy on these clouds automatically comply with industry regulations. In 2020, we brought some of the world’s largest banks onto IBM Cloud for Financial Services, including BNP Paribas and MUFG Bank, and expanded our financial services ecosystem. We unveiled the IBM Cloud for Telecommunications and added 35 partners to our telecommunications ecosystem. We also broadened our strategic partnership with Samsung on 5G technology. Using IBM Cloud Satellite, which runs on Red Hat OpenShift, IBM is also collaborating with AT&T to help businesses deploy applications to any environment where their data resides—including the network edge. IBM’s Systems portfolio delivers critical value to our enterprise client base, in support of our hybrid cloud strategy. IBM’s z15 saw record-setting volumes on Linux as clients leveraged Red Hat OpenShift, Ansible and our cloud-native offerings in “With Red Hat OpenShift on “IBM is making digital IBM Z and LinuxONE servers, transformation increasingly response to the pandemic. Our high-value, secure and scalable clients can modernize their accessible by creating industry- platform was more relevant than ever. In financial services, applications for the hybrid cloud specific clouds, which unleash for example, z15 helped our clients scale capacity quickly and and determine their own IT enormous value, especially strategies to optimize the value of for regulated industries like remotely, enabling them to navigate unprecedented market their existing IT infrastructure. banking, government and telco. volatility. 2020 also marked the 20th anniversary of Linux on They can maintain security and By building this capacity, we IBM Z, a milestone of innovation for a platform that is attracting scalability in the public cloud, open our clients to digital and enjoy ‘write once/run transformation that can change a new generation of developers to help our clients anticipate anywhere’ application portability how they serve their customers and overcome future challenges. in an environment that protects and think about their business, sensitive data.” while reducing risk to the financial system as a whole.” Tom Rosamilia Senior Vice President, Howard Boville IBM Systems and Chairman, Senior Vice President, North America IBM Hybrid Cloud


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    13 Applying science and technology to serve client New milestones needs in 2020 for IBM Research For the 28th straight year, IBM led the industry in US patents— In 2020, IBM Research doubled down on transformative the majority of them in AI, cloud and hybrid cloud, quantum innovations. Chief among these is quantum computing, which computing, and security. IBM Research continues to build uses quantum physics principles to solve problems far faster on our natural language processing and encryption innovations than binary computing. Complementing classical computing, to deliver real-world commercial results. quantum could help tackle some of our toughest challenges. An AI model from IBM and Pfizer uses written text samples to IBM leads in quantum computing, with nearly 300,000 registered help predict the eventual onset of Alzheimer’s disease. The users and more than 140 organizations in our network. Among model uses IBM’s hybrid cloud platform, which enables the them, Anthem, Inc. is studying how quantum may further automated collection and analysis of global data. improve diagnostic accuracy for personalized healthcare treatments; Delta Air Lines is exploring quantum’s potential to IBM led the global Urgency of Science (#urgencyofscience) transform customer experiences; at Keio University’s Network campaign, joined by numerous private and public sector Hub (Japan), Mitsubishi Chemical and JSR are researching partners. ways to reduce quantum computation errors to help manufacture more efficient OLED devices; and the University of Tokyo and IBM and AMD entered a Confidential Computing Collaboration Fraunhofer-Gesellschaft (Germany) will operate the first agreement to foster security in hybrid cloud and high- non-US installations of IBM Quantum System One computers. performance computing environments. By 2023, IBM will produce a quantum processor with more IBM released RoboRXN, a free, cloud-disseminated tool that than 1,000 qubits—giving us a potential advantage in solving uses AI, neural translation and machine automation to help problems faster than even today’s fastest supercomputers. We scientists more accurately predict chemical reactions. have also developed quantum-safe security software for hybrid cloud, and have partnered with historically Black colleges and universities (HBCUs) to help prepare quantum’s next generation. “Research is a critical component “With quantum, we’re witnessing of IBM’s commitment to the most exciting development in delighting our clients with the computing in 60 years. It will be solutions and industry expertise a revolution in the way science is they need to compete and grow. practiced, the rate of accelerated We are optimally positioned discovery and a whole new class for growth with our hybrid of intelligent mission-critical cloud, AI and services offerings. applications.” Emerging technologies like Darío Gil quantum—along with our Senior Vice President and ongoing innovations in security Director of IBM Research and energy efficiency—will supercharge the next phase of our clients’ digital transformations as they derive even greater business value from their data.” Jim Whitehurst President, IBM


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    14 IBM 2020 Annual Report Transformation and culture Having the right culture gives meaning to IBM’s mission, fosters growth and innovation, and contributes directly to our delivery of differentiated value to our clients. While dedicating themselves to client service in 2020, IBMers also shared their thoughts—through company-wide conversations, via our annual engagement survey and directly with our CEO—about evolving our culture in four key areas: Growth—obsessing over our clients’ growth; winning in the marketplace to drive growth for IBM; providing development IBM’s commitment to opportunities to help IBMers succeed in their careers purpose and values in 2020 Inclusion—building and developing empathetic In 2020 IBM reaffirmed its commitment to our purpose and relationships; fostering meaningful collaborations; values through a number of key initiatives: embracing flexibility; listening – CEO letter to the US Congress outlining policy proposals Innovation—shedding the status quo to encourage to advance racial equality and announcing that IBM has entrepreneurialism; being creative and adaptable; being curious, sunset its general-purpose facial recognition and analysis bold and nimble; learning from our mistakes software products. Feedback—embracing candor and transparency; creating – Sponsorship of OneTen, a startup that will focus on training avenues for ongoing dialogs; being respectful, but honest Black candidates to fill 1 million professional corporate roles and willing to grow over the next 10 years. Leading with purpose and culture yields powerful and – Call for Code for Racial Justice—an activation of IBM’s sustainable outcomes. It’s what motivates us to do our best ecosystem of partners, advocates and employees to develop work and enables us to bring our whole selves to work. As open source projects focusing on Police & Judicial Reform IBM pursues the disruptive processes of growth and change for and Accountability, Diverse Representation and Policy & our clients and for our company, we also proceed with purpose— Legislation Reform. committed to our values and focused on what matters. – Launch of Open P-TECH—a free digital education platform for workplace and digital skills including AI, cloud computing, cybersecurity and design thinking—and committed to 1,000 paid IBM internships for US P-TECH students. – IBM Quantum Computing education partnership with HBCUs “Companies focused on culture as part of a $100 million investment in developing a diverse as a tenet for growth will thrive in the digital era as it becomes and inclusive quantum workforce. the underlying force driving the inclusion, innovation and – IBM Policy Lab calls for a risk-based approach to AI trust that leads to sustainable solutions to yield powerful regulation, resulting in the Vatican’s nomination of IBM as outcomes and meaningful one of two primary signatories to the Rome Call for AI Ethics societal progress.” advocating a human-centered approach to AI. Obed Louissaint Senior Vice President, Transformation and Culture


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    15 Reinventing the Managing workforce crises in 2020 world of work IBM focused on workforce resilience during 2020. Events of the most difficult year in recent memory tested— In January, we mobilized IBM’s Corporate Crisis Management and then affirmed—IBM’s pioneering commitment to reinventing Team (CCMT) at the earliest signs of a potential pandemic, the world of work. Our tradition of applying intelligence, reason relying on IBM’s established response plans for Ebola and SARS. and science to all challenges for our employees and our clients became more relevant than ever during a period of global In early March, we transitioned 95 percent of IBM’s global pandemic, social unrest and political uncertainty that taxed workforce to remote work in a matter of days, leveraging all of our resolve. To manage these crises, we relied upon the full the IBM hybrid cloud platform to provide key workforce force of IBM values, technologies and humanistic approaches collaboration tools to more than 345,000 employees across to protect, support and inspire our workforce. more than 175 countries. The COVID-19 pandemic laid bare the inadequacies of Throughout 2020 we provided key tools, wellness and mental 19th century industrial work structures, such as: the 9-to-5 health guidance, and management support to help employees workday predicated on a handful of time zones in a world with stay safe and sane, circulating real-time global and local updates more than two dozen; agricultural-era assumptions about on the pandemic, and establishing a 24/7 “Ask Health & Safety” family structure and care obligations; noninclusive definitions team to address questions and concerns. of personal identities; and stigmas surrounding mental health issues. The current crises underscore the need to focus on what As we prepare for a safe post-COVID workplace, we must adjust matters—leadership and efficiency, but also empathy and our people management approach to the new normal. Mastering acceptance—all supported by a foundation of trust. ongoing challenges will require maintaining a growth mindset, adapting to change and learning from our mistakes. IBM will apply design thinking to how employees use hybrid office space in purpose-driven ways. We must keep current with skills retraining and recruiting as accelerated digital transformation drives a tighter tech skills job market. Automation will create new jobs. We will make every effort to address employee demands for empathy, transparency and social responsibility in a new era of activism. IBM Work From Home Pledge “Thanks to our hybrid cloud- enabled digital workplace, IBM I pledge to be Family First. adapted nearly overnight to I pledge to support Flexibility for Personal Needs. 95 percent remote work in 2020. With the right collaboration tools I pledge to support “Not Camera Ready” times. in place, we focused on employee I pledge to Be Kind. health, well-being and resiliency— I pledge to Set Boundaries and Prevent Video Fatigue. offering new benefits and training 30,000 managers in I pledge to Take Care of Myself. empathetic leadership. Employee I pledge to Frequently Check In on people. engagement actually increased in 2020. And we are strongly I pledge to Be Connected. positioned to define the future of work for a post-COVID world.” Nickle LaMoreaux IBM CEO Arvind Krishna endorsed Senior Vice President and the IBM Work From Home Pledge, Chief Human Resources Officer created by IBMers.


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    16 Financial Highlights International Business Machines Corporation and Subsidiary Companies ($ in millions except per share amounts) For the year ended December 31: 2020 2019 Revenue $ 73,620 $ 77,147 Net Income $ 5,590* $ 9,431 Income from continuing operations $ 5,501* $ 9,435 Operating (non-GAAP) earnings** $ 7,774* $ 11,436 Earnings per share of common stock—continuing operations Assuming dilution $ 6.13* $ 10.57 Basic $ 6.18* $ 10.63 Diluted operating (non-GAAP)** $ 8.67* $ 12.81 Net cash provided by operating activities $ 18,197 $ 14,770 Capital expenditures, net $ 3,042 $ 2,370 Share repurchases $ — $ 1,361 Cash dividends paid on common stock $ 5,797 $ 5,707 Per share of common stock $ 6.51 $ 6.43 At December 31: 2020 2019 Cash, cash equivalents, restricted cash and marketable securities $ 14,275 $ 9,009 Total assets $155,971 $152,186 Working capital $ (705) $ 718 Total debt $ 61,538 $ 62,899 Total equity $ 20,727 $ 20,985 Common shares outstanding (in millions) 893 887 Stock price per common share $ 125.88 $ 134.04 * Includes a $2.0 billion pre-tax charge for structural actions in the fourth quarter resulting in an impact of ($1.84) to diluted earnings per share from continuing operations and diluted operating (non-GAAP) earnings per share. The impact to basic earnings per share was ($1.85). ** See page 45 for a reconciliation of net income to operating earnings.


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    Report of Financials 17 International Business Machines Corporation and Subsidiary Companies MANAGEMENT DISCUSSION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Overview 18 Basis & Policies Forward-Looking and Cautionary Statements 19 A Significant Accounting Policies 74 Management Discussion Snapshot 19 B Accounting Changes 87 Description of Business 23 Performance & Operations Year in Review 30 C Revenue Recognition 90 Prior Year in Review 53 D Segments 91 Other Information 55 E Acquisitions & Divestitures 96 Looking Forward 55 F Research, Development & Engineering 100 Liquidity and Capital Resources 56 G Taxes 100 Critical Accounting Estimates 59 H Earnings Per Share 104 Currency Rate Fluctuations 62 Balance Sheet & Liquidity Market Risk 63 I Financial Assets & Liabilities 105 Cybersecurity 64 J Inventory 106 K Financing Receivables 106 Report of Management 65 L Property, Plant & Equipment 110 Report of Independent Registered M Leases 110 Public Accounting Firm 66 N Intangible Assets Including Goodwill 112 O Investments & Sundry Assets 114 CONSOLIDATED FINANCIAL STATEMENTS P Borrowings 114 Income Statement 68 Q Other Liabilities 117 Comprehensive Income 69 R Commitments & Contingencies 118 Balance Sheet 70 S Equity Activity 120 Cash Flows 71 Risk Management, Compensation/Benefits & Other Equity 72 T Derivative Financial Instruments 123 U Stock-Based Compensation 126 V Retirement-Related Benefits 128 W Subsequent Events 140 Performance Graph 141 Stockholder Information 142 Board of Directors and Senior Leadership 143


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    18 Management Discussion International Business Machines Corporation and Subsidiary Companies OVERVIEW The financial section of the International Business Machines Corporation (IBM or the company) 2020 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 The Management Discussion is designed to provide readers with an overview of the business and a narrative on our financial results and certain factors that may affect our future prospects from the perspective of management. The “Management Discussion Snapshot” presents an overview of the key performance drivers in 2020. Beginning with the “Year in Review,” the Management Discussion contains the results of operations for each reportable segment of the business and a discussion of our financial position and cash flows. Other key sections within the Management Discussion include: “Looking Forward” and “Liquidity and Capital Resources,” which includes a description of management’s definition and use of free cash flow. The Consolidated Financial Statements provide an overview of income and cash flow performance and financial position. The Notes follow the Consolidated Financial Statements. Among other items, the Notes contain our accounting policies, revenue information, acquisitions and divestitures, certain commitments and contingencies and retirement-related plans information. On October 8, 2020, we announced our plan to separate the managed infrastructure services unit of our Global Technology Services (GTS) segment into a new public company (currently referred to as NewCo and to be named later). The separation is expected to be achieved through a U.S. federal tax-free spin-off to IBM shareholders and completed by the end of 2021. It will be subject to customary market, regulatory and other closing conditions, including final IBM Board of Directors’ approval. The announcement did not have any classification impact to our Consolidated Financial Statements or segment reporting. We will report the managed infrastructure services unit as discontinued operations after its separation. In the first quarter of 2020, we realigned offerings and the related management system to reflect divestitures completed in the second half of 2019 and tighter integration of certain industry-specific consulting services. These changes impacted Cloud & Cognitive Software and Global Business Services (GBS) but did not impact the Consolidated Financial Statements. Total recast revenue for full-year 2019 and 2018 was approximately $0.3 billion and $0.4 billion, respectively. The periods presented in this Annual Report are reported on a comparable basis. On July 9, 2019, IBM acquired 100 percent of the outstanding shares of Red Hat, Inc. (Red Hat). Red Hat is reported within the Cloud & Cognitive Software segment, in Cloud & Data Platforms. Refer to note E, “Acquisitions & Divestitures,” for additional information. The references to “adjusted for currency” or “at constant currency” in the Management Discussion do not include operational impacts that could result from fluctuations in foreign currency rates. When we refer to growth rates at constant currency or adjust such growth rates for currency, it is done so that certain financial results can be viewed without the impact of fluctuations in foreign currency exchange rates, thereby facilitating period-to-period comparisons of business performance. Financial results adjusted for currency are calculated by translating current period activity in local currency using the comparable prior-year period’s currency conversion rate. This approach is used for countries where the functional currency is the local currency. Generally, when the dollar either strengthens or weakens against other currencies, the growth at constant currency rates or adjusting for currency will be higher or lower than growth reported at actual exchange rates. See “Currency Rate Fluctuations” for additional information. To provide better transparency on the recurring performance of the ongoing business, the company provides total revenue, geographic revenue and cloud revenue growth rates excluding divested businesses and at constant currency. These divested businesses are included in the category “Other—divested businesses.” Within the financial statements and tables in this Annual Report, certain columns and rows may not add due to the use of rounded numbers for disclosure purposes. Percentages reported are calculated from the underlying whole-dollar numbers. Operating (non-GAAP) Earnings In an effort to provide better transparency into the operational results of the business, supplementally, management separates business results into operating and non-operating categories. Operating earnings from continuing operations is a non-GAAP measure that excludes the effects of certain acquisition-related charges, intangible asset amortization, expense resulting from basis differences on equity method investments, retirement-related costs, discontinued operations and certain managed infrastructure services spin- off charges and their related tax impacts. Management characterizes direct and incremental charges incurred to accomplish the managed infrastructure services spin-off as non-operating given their unique and non-recurring nature. These charges primarily relate to transaction and third-party support costs, business separation and applicable employee retention fees, pension settlement charges and related tax charges. All other spending for the managed infrastructure services business operations is included in both earnings from continuing operations and in operating (non-GAAP) earnings. Due to the unique, non-recurring nature of the enactment of the U.S.


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    Management Discussion 19 International Business Machines Corporation and Subsidiary Companies Tax Cuts and Jobs Act (U.S. tax reform), management characterizes the one-time provisional charge recorded in the fourth quarter of 2017 and adjustments to that charge as non-operating. Adjustments include true-ups, accounting elections and any changes to regulations, laws, audit adjustments, etc. that affect the recorded one-time charge. For acquisitions, operating (non-GAAP) earnings exclude the amortization of purchased intangible assets and acquisition-related charges such as in-process research and development, transaction costs, applicable retention, restructuring and related expenses, tax charges related to acquisition integration and pre- closing charges, such as financing costs. These charges are excluded as they may be inconsistent in amount and timing from period to period and are significantly impacted by the size, type and frequency of the company’s acquisitions. All other spending for acquired companies is included in both earnings from continuing operations and in operating (non-GAAP) earnings. Throughout the Management Discussion, the impact of acquisitions over the prior 12-month period may be a driver of higher expense year to year. For retirement- related costs, management characterizes certain items as operating and others as non-operating, consistent with GAAP. We include defined benefit plan and nonpension postretirement benefit plan service costs, multi-employer plan costs and the cost of defined contribution plans in operating earnings. Non-operating retirement-related costs include defined benefit plan and nonpension postretirement benefit plan amortization of prior service costs, interest cost, expected return on plan assets, amortized actuarial gains/losses, the impacts of any plan curtailments/settlements and pension insolvency costs and other costs. Non-operating retirement-related costs are primarily related to changes in pension plan assets and liabilities which are tied to financial market performance, and the company considers these costs to be outside of the operational performance of the business. Overall, management believes that supplementally providing investors with a view of operating earnings as described above provides increased transparency and clarity into both the operational results of the business and the performance of the company’s pension plans; improves visibility to management decisions and their impacts on operational performance; enables better comparison to peer companies; and allows the company to provide a long-term strategic view of the business going forward. Our reportable segment financial results reflect pre-tax operating earnings from continuing operations, consistent with our management and measurement system. In addition, these non-GAAP measures provide a perspective consistent with areas of interest we routinely receive from investors and analysts. 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 2020 Form 10-K filed on February 23, 2021. MANAGEMENT DISCUSSION SNAPSHOT ($ and shares in millions except per share amounts) Yr.-to-Yr. Percent/Margin For year ended December 31: 2020 2019 Change Revenue $ 73,620 $ 77,147 (4.6)%* Gross profit margin 48.3 % 47.3 % 1.0 pts. Total expense and other (income) $ 30,937 ** $ 26,322 17.5 % Income from continuing operations before income taxes $ 4,637 ** $ 10,166 (54.4)% Provision for/(benefit from) income taxes from continuing operations $ (864) $ 731 NM Income from continuing operations $ 5,501 ** $ 9,435 (41.7)% Income from continuing operations margin 7.5 % 12.2 % (4.8)pts. Income/(loss) from discontinued operations, net of tax $ 89  $ (4) NM Net income $ 5,590 ** $ 9,431 (40.7)% Earnings per share from continuing operations–assuming dilution $ 6.13 ** $ 10.57 (42.0)% Weighted-average shares outstanding–assuming dilution 896.6 892.8 0.4 % Assets $155,971 $152,186 2.5 % Liabilities $135,244 $131,202 3.1 % Equity $ 20,727 $ 20,985 (1.2)% * (4.7) percent adjusted for currency; (3.5) percent excluding divested businesses and adjusted for currency. ** Includes a $2.0 billion pre-tax charge for structural actions in the fourth quarter resulting in an impact to diluted earnings per share from continuing operations of ($1.84).  Relates to discontinued operations of Microelectronics, divested in 2015.  At December 31 NM–Not meaningful


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    20 Management Discussion International Business Machines Corporation and Subsidiary Companies The following table provides the company’s operating (non-GAAP) earnings for 2020 and 2019. See page 45 for additional information. ($ in millions except per share amounts) Yr.-to-Yr. For year ended December 31: 2020 2019 Percent Change Net income as reported $5,590 * $ 9,431 (40.7)% Income/(loss) from discontinued operations, net of tax** 89 (4) NM Income from continuing operations $5,501 * $ 9,435 (41.7)% Non-operating adjustments (net of tax) Acquisition-related charges 1,454 1,343 8.3 Non-operating retirement-related costs/(income) 908 512 77.2 U.S. tax reform impacts (110) 146 NM Spin-off-related charges 21 — NM Operating (non-GAAP) earnings $7,774 * $11,436 (32.0)% Diluted operating (non-GAAP) earnings per share $ 8.67 * $ 12.81 (32.3)% * Includes a $2.0 billion pre-tax charge for structural actions in the fourth quarter resulting in an impact to diluted operating (non-GAAP) earnings per share of ($1.84). ** Relates to discontinued operations of Microelectronics, divested in 2015. NM–Not meaningful Strategic Announcement IBM is redefining its future as a hybrid cloud platform and AI company. The October 8, 2020 announcement of our plan to separate the managed infrastructure services unit of our GTS segment into a new public company will create two industry-leading companies, each with strategic focus and flexibility to capitalize on their respective missions and drive client and shareholder value. Client buying needs for application and infrastructure services are diverging, while adoption of our hybrid cloud platform is accelerating. This change in clients’ needs makes it the right time to create two market-leading companies focused on what they do best. IBM will focus on its open hybrid cloud platform and AI capabilities to accelerate clients’ digital transformations. Upon separation, NewCo will immediately be the world's leading managed infrastructure services provider and will have greater agility to design, run and modernize the infrastructure of the world’s most important organizations. Both IBM and NewCo will have greater ability to focus on their operating and financial models, have more freedom to partner with others and both will align their investments and capital structure to their strategic focus areas. We are on track to complete the separation by the end of 2021. Environmental Dynamics On March 11, 2020, the World Health Organization (WHO) declared the novel coronavirus (COVID-19) a global pandemic. This resulted in significant governmental measures being initiated around the globe, including travel bans and border closings, shelter- in-place orders, closures of non-essential businesses and social distancing requirements in efforts to slow down and control the spread of the virus. Throughout 2020, the health of IBM employees, our clients, business partners and community continued to be our primary focus. We are actively engaged to ensure our plans and response activities continue to be aligned with recommendations of the WHO, the U.S. Centers for Disease Control and Prevention, and governmental regulations. IBM continues to be well positioned to support our clients through this crisis. The pandemic has driven companies to accelerate their digital transformations, resulting in the removal of traditional barriers to progress. The reliance on technology, particularly hybrid cloud and AI technologies that give clients the scalability and flexibility needed to adjust to the rapid market changes, has become more acute. We are helping to advise, build, move and manage our clients’ journey to the cloud. We are also working with our clients to apply AI, automation and other technologies to make their workflows more intelligent and responsive. As our clients are intensifying their focus on their most important asset, their people, we are partnering with clients to help them enhance employee engagement and productivity, reskill the workforce faster and reimagine ways of working. The COVID-19 pandemic and broader macroeconomic uncertainty has placed every company in uncharted waters. In this environment, the underlying fundamentals of our business continue to remain sound: Our diversification and mix by industry, geography and client segment provides some stability during these times; IBM has always focused on the enterprise space, and within that our business is more concentrated in large enterprises, which in total have been relatively more stable throughout the pandemic; From an industry perspective, the majority of our revenue comes from clients in financial services, telecom, and the public sector – industries that run the world’s most critical processes; From a geographic perspective, we are continuing to see markets experience different impacts from the pandemic over time. Our global footprint provides some natural hedge;


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    Management Discussion 21 International Business Machines Corporation and Subsidiary Companies Approximately 60 percent of our annual revenue is in recurring revenue streams; Our balance sheet remains strong with ample liquidity and access to capital. All of this provides some level of stability, not only in our revenue, but also in profit and cash, as we continue to manage through these challenging times. However, in this macroeconomic environment, clients balanced near-term needs and opportunities for transformation. Their near-term priorities were focused on operational stability, flexibility and cash preservation, and as such, in 2020, we experienced some disruptions in transactional performance, shorter duration software transactions and delays in some services projects. At the same time, this environment has only reinforced the need for clients to modernize their businesses to succeed in this new normal, with hybrid cloud and AI at the core of their digital transformations. While the current environment poses certain short- term challenges, it also presents long-term opportunities that IBM will seize as our open hybrid platform and AI-driven model delivers greater innovation, higher productivity and more strategic optionality to our clients. Financial Performance Summary In 2020, we reported $73.6 billion in revenue and income from continuing operations of $5.5 billion, which included a $2.0 billion pre-tax charge for structural actions (primarily workforce rebalancing) in the fourth quarter to simplify and optimize our operating model. Operating (non-GAAP) earnings in 2020 were $7.8 billion, which also included the charge for workforce rebalancing. Diluted earnings per share from continuing operations was $6.13 as reported and $8.67 on an operating (non-GAAP) basis. We also generated $18.2 billion in cash from operations, $10.8 billion in free cash flow and delivered shareholder returns of $5.8 billion in dividends. With the unprecedented COVID-19 pandemic and macroeconomic uncertainty beginning in March 2020, client priorities shifted to maintaining operational stability, flexibility and preservation of cash. While there was continued demand for offerings that support their digital transformation, clients moved to shorter term duration engagements and prioritized operational expenditures over capital expenditures, which impacted the company’s performance in 2020. However, our results reflect strong performance in hybrid cloud led by Red Hat, gross margin expansion and solid cash generation. We also continued to strengthen our position as a hybrid cloud platform and AI company through strategic organic investments and acquisitions. Total consolidated revenue decreased 4.6 percent as reported and 4.7 percent adjusted for currency compared to the prior year. Excluding divested businesses and adjusted for currency, revenue decreased 3.5 percent. Cloud & Cognitive Software increased 2.1 percent as reported and 2 percent adjusted for currency, with strong performance from Red Hat, offset by declines in transactional performance in other areas of the portfolio. Within Cloud & Cognitive Software, Cloud & Data Platforms, which includes Red Hat, grew 20.9 percent as reported (20 percent adjusted for currency), while Cognitive Applications decreased 3.0 percent as reported (3 percent adjusted for currency), and Transaction Processing Platforms declined 16.8 percent as reported (17 percent adjusted for currency) reflecting the impacts of the macroeconomic uncertainty, with purchase deferrals and clients opting for shorter duration contracts. Global Business Services decreased 3.8 percent as reported and 4 percent adjusted for currency with declines across all lines of business due to project delays and less discretionary spending by clients. Global Technology Services decreased 5.7 percent as reported and 5 percent adjusted for currency with declines in Infrastructure & Cloud Services and Technology Support Services driven by lower business volumes primarily with clients in industries more impacted by the macroeconomic environment. Systems decreased 8.2 percent year to year as reported and 9 percent adjusted for currency due to product cycle dynamics. Across the segments, total IBM cloud revenue of $25.1 billion in 2020 grew 19 percent as reported (18 percent adjusted for currency) and 20 percent excluding divested businesses and adjusted for currency. From a geographic perspective, Americas revenue declined 6.0 percent year to year as reported (4 percent excluding divested businesses and adjusted for currency). Europe/Middle East/Africa (EMEA) decreased 3.3 percent (4 percent excluding divested businesses and adjusted for currency). Asia Pacific declined 3.5 percent (4 percent excluding divested businesses and adjusted for currency). The consolidated gross margin of 48.3 percent increased 1.0 points year to year, and the operating (non-GAAP) gross margin of 49.3 percent increased 1.3 points versus the prior year, reflecting portfolio mix with strong software contribution and our focus on productivity. Total expense and other (income) increased 17.5 percent in 2020 compared to the prior year. The year-to-year performance was driven by higher charges for workforce rebalancing, a full year of Red Hat operational spending in 2020 compared to six months in 2019, lower gains from divestitures and higher non-operating retirement-related costs, partially offset by lower spending including reductions in travel and other expenses associated with COVID-19 restrictions. Total operating (non-GAAP) expense and other (income) increased 16.8 percent year to year, driven primarily by the same factors excluding the non-operating retirement-related costs. Pre-tax income from continuing operations of $4.6 billion decreased 54.4 percent and the pre-tax margin was 6.3 percent, a decrease of 6.9 points versus 2019, primarily due to higher workforce rebalancing charges in 2020, lower gains from divestitures and higher retirement-related costs in the current year. The continuing operations effective tax rate for 2020 was (18.6) percent compared to 7.2


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    22 Management Discussion International Business Machines Corporation and Subsidiary Companies percent in 2019. The benefit from income taxes in 2020 was primarily due to the tax impacts of an intra-entity sale of certain of the company’s intellectual property and related impacts in the first quarter, which resulted in a net tax benefit of $0.9 billion. Net income from continuing operations of $5.5 billion decreased 41.7 percent and the net income from continuing operations margin was 7.5 percent, down 4.8 points year to year, primarily due to the fourth-quarter workforce rebalancing charge. Operating (non-GAAP) pre- tax income from continuing operations of $7.7 billion decreased 38.7 percent year to year and the operating (non-GAAP) pre-tax margin from continuing operations decreased 5.8 points to 10.4 percent, reflecting the higher workforce rebalancing charges and lower gains from divestitures in the current year. The operating (non-GAAP) effective tax rate for 2020 was (1.5) percent compared to 8.5 percent in 2019. The current year operating (non-GAAP) benefit from income taxes was primarily driven by the net tax benefit from an intra-entity IP sale in the first quarter. Operating (non-GAAP) income from continuing operations of $7.8 billion decreased 32.0 percent and the operating (non-GAAP) income margin from continuing operations of 10.6 percent was down 4.3 points year to year. Diluted earnings per share from continuing operations of $6.13 in 2020 decreased 42.0 percent and operating (non-GAAP) diluted earnings per share of $8.67 decreased 32.3 percent versus 2019, both including a ($1.84) impact from the fourth-quarter 2020 structural actions. During 2020, we continued to take actions to further enhance our balance sheet and liquidity position. At December 31, 2020, the balance sheet remained strong with flexibility to support and invest in the business, with a strong cash position and ample credit available during these uncertain times. Cash and cash equivalents, restricted cash and marketable securities at year end were $14.3 billion, an increase of $5.3 billion from December 31, 2019. Throughout 2020, we took mitigation actions to preserve liquidity as well as strategic actions to optimize our capital structure, for example, we re-focused our Global Financing portfolio reducing our external debt needs. We have reduced total debt by $1.4 billion from prior year end and $11.5 billion since the second quarter of 2019 (immediately preceding the Red Hat transaction). Total assets increased $3.8 billion (increased $0.9 billion adjusted for currency) from December 31, 2019 primarily driven by: An increase of $5.3 billion in cash and cash equivalents, restricted cash and marketable securities; An increase in deferred taxes of $4.1 billion primarily due to the intra-entity sale of IP in the first quarter; and An increase in prepaid pension assets of $0.7 billion driven by higher returns on plan assets and plan remeasurements; partially offset by A decline in receivables of $6.5 billion mainly due to sales of financing receivables, continued focus on collections, including collection of divestiture-related receivables and a decline in revenue. Total liabilities increased $4.0 billion (increased $0.1 billion adjusted for currency) from December 31, 2019 driven by: An increase in other accrued expenses and liabilities of $2.5 billion primarily due to the workforce rebalancing charge in the fourth quarter of 2020; An increase in deferred income of $1.3 billion; and An increase in retirement and nonpension postretirement benefit obligations of $1.1 billion mainly driven by plan remeasurements; partially offset by A decrease in total debt of $1.4 billion. Total equity of $20.7 billion decreased $0.3 billion from December 31, 2019 as a result of: Dividends paid of $5.8 billion; partially offset by Net income of $5.6 billion. Cash provided by operating activities was $18.2 billion in 2020, an increase of $3.4 billion compared to 2019, driven primarily by an increase in cash provided by receivables ($4.8 billion); partially offset by performance-related declines within net income. Net cash used in investing activities of $3.0 billion decreased $23.9 billion compared to the prior year, primarily driven by a decrease in net cash used for acquisitions ($32.3 billion) due to the acquisition of Red Hat in the prior year, partially offset by a decrease in cash provided by net non-operating finance receivables ($6.2 billion), primarily driven by the wind down of the OEM IT commercial financing operations. Financing activities were a net use of cash of $9.7 billion in 2020 compared to a net source of cash of $9.0 billion in 2019. The year- to-year change of $18.8 billion was driven by a decrease in net cash provided from debt transactions ($20.0 billion) primarily driven by a higher level of net additions in the prior year to fund the Red Hat acquisition and a decrease in cash used for gross common stock repurchases ($1.4 billion).


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    Management Discussion 23 International Business Machines Corporation and Subsidiary Companies DESCRIPTION OF BUSINESS Please refer to IBM’s Annual Report on Form 10-K filed with the SEC on February 23, 2021, for Item 1A. entitled “Risk Factors.” We create value for clients by providing 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 consulting and IT implementation services, cloud, digital and cognitive offerings, and enterprise systems and software which are all bolstered by one of the world’s leading research organizations. IBM Strategy As technology has increasingly become a key engine of business success, enterprises around the world are prioritizing digital transformation. The pressing need to adapt to evolving market requirements and adopt new business models that improve customer experience and streamline business performance has accelerated the urgency of this transformation. To date, only 25 percent of enterprise workloads have made it onto a public cloud–mostly limited to greenfield cloud applications or ones that are easy to “lift and shift.” The remaining 75 percent have not moved, as enterprises wrestle with how to handle the mission- critical workloads and data that require heightened security, particularly for highly regulated industries with complex, often cross- border, compliance needs. Hybrid cloud and AI are the only way to deliver the digital transformation businesses are looking for across all their processes, applications and data. Together, they have a multiplier effect on the speed and breadth of transformation. Only a fraction of enterprise data is being leveraged for business insights, in part because it is spread across public clouds, datacenters and increasingly, edge computing. The emergence of edge computing across many industries will only expand the kinds of hybrid environments our clients use. A hybrid cloud approach bridges the silos within this existing enterprise infrastructure, maintaining security for mission-critical workloads while enabling the data collection and analysis that accelerates development and deployment of AI at scale. AI unlocks the value of enterprise data, using it to reinvent processes, predict outcomes and transform businesses. The pressing need to pivot to remote work and reinvent their business models during the pandemic accelerated the urgency of this transformation for many enterprises. Companies are focused more than ever on moving workloads to the cloud. IBM’s Commitment to Hybrid Cloud and AI That makes hybrid cloud and AI an enormous opportunity for IBM. Hybrid cloud alone represents a $1 trillion market. We are targeting this market because we recognize the value it brings to our clients. Through deep engagement with a wide breadth of clients, we know that a hybrid cloud approach on average creates 2.5 times more value for enterprises than a public cloud-alone strategy, and IBM leads in delivering better return on investment (ROI) through hybrid cloud. This higher ROI comes from enhanced business acceleration, developer productivity, infrastructure cost efficiency and regulatory compliance and security. We have built a hybrid cloud platform, based on open technologies, that allows clients to realize their digital and AI transformations across the applications, data and environments in which they operate. Watson is IBM’s industry leading AI for business, a portfolio of enterprise-ready pre-built applications and tools designed to reduce the costs and hurdles of AI adoption through industry-leading natural language processing, automation and trust in our responsible use of AI. Building on our hybrid cloud platform, our software collects and analyzes data from across our clients’ enterprises, training our AI to provide insights into their business processes. These insights enable intelligent workflows, reinventing the way businesses operate and driving improved business outcomes that accelerate our clients’ adoption of AI. Trust is a key differentiator for IBM’s AI, and of paramount importance to our clients. In a recent survey, 76 percent of AI professionals said being able to trust their AI’s output is fair, safe and reliable is “critically” or “very” important to their business. That is why we believe that AI must be transparent and explainable, and that data and insights belong to the creator. In keeping with this belief, we have designed hybrid cloud and AI solutions that give our clients sole control of their encryption keys. Our homomorphic encryption takes data privacy and security one step further, allowing data to be processed without decryption. We have pivoted all of IBM to deliver on this hybrid cloud and AI value for our clients. We believe we have the portfolio that will support IBM’s success as well our clients’ and ecosystem partners’ success. It includes the services capabilities that drive consumption of our technology and enable digital transformation, our software portfolio that can achieve transformational business outcomes through AI and automation, and our systems and infrastructure that can run this platform for mission-critical applications.


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    24 Management Discussion International Business Machines Corporation and Subsidiary Companies IBM’s Technology Stack and Platform Approach IBM offers clients a full technology stack that meets them wherever they are on their journey, from their existing IT infrastructure to our hybrid cloud platform to our cloud-native software to our services professionals who can advise on custom solutions that create the most value for our clients. Our ecosystem partners enhance the client experience and innovation that can be derived from IBM technology. Our hybrid cloud approach is platform-centric, with Linux, containers and Kubernetes as the architectural foundation. Platforms provide compelling economics: every $1 of platform spend on average drives $3 to $5 of software revenue, $6 to $8 of services and $1 to $2 of enterprise infrastructure. The multiplier effect of our technology stack creates more value for IBM and our growing ecosystem of partners. IBM IBM HybridCloud Hybrid Cloudand andAI AISolutions Solutions Business Transformation IBM Services Digital Transformation • System Integrator Business Transformation and Hybrid Cloud Services IBM Services Digital Transformation Application Modernization• • System Integrator Partners and Hybrid Cloud Services ApplicationWorkflows Intelligent Modernization • Partners Intelligent Workflows Hybrid Cloud Software IBM Software Automation • Data and AI • Software and Hybrid Cloud Software IBM Software IBM Cloud Paks Automation • Data and AI • Integration • Networking • Security • Software and IBM Cloud Paks Integration • Networking • Security • SaaS Partners Industry Capabilities SaaS Partners Industry Capabilities Hybrid Hybrid Cloud Cloud Platform Platform RedHat Red Hat Development, Development,Security Securityand andOperational OperationalServices Services HybridCloud Hybrid CloudPlatform Platform Infrastructure Infrastructure IBMCloud IBM Cloud Public Clouds Public Clouds IBM IBMSystems Systems Enterprise Enterprise Edge Edge AWS•Azure•Other AWS•Azure•Other Infrastructure Infrastructure Hybrid cloud platforms and software comprise a $450 billion market opportunity and are the key to any hybrid cloud architecture. Red Hat OpenShift is the leading hybrid cloud software platform, and the only one that is fully integrated and open source, with built- in development, security and operations features. It takes advantage of an ecosystem of millions of developers to accelerate innovation. Leveraging the power of Kubernetes and containers, OpenShift creates the foundation that allows our clients to manage siloed, multi-cloud, edge and legacy infrastructure as a single platform. These capabilities are a clear differentiator, enabling our clients to “write once, deploy anywhere” for their hybrid architecture. We are seeing strong momentum, with more than 2,800 clients using our hybrid cloud platform at the end of 2020. Cloud Paks are IBM’s containerized, modernized software built to extend the value of OpenShift. They are key to realizing value through digital transformation in four important ways. They help our clients to modernize applications to take advantage of the hybrid platform, automate processes for speed and efficiency, use the power of AI for data driven decision-making and prediction, and secure the entire platform from the data center to the edge. Cloud Paks provide a powerful addition to IBM’s traditional middleware. Our traditional middleware is an industry standard that creates tremendous value for our clients through connectivity on all kinds of systems and gives IBM a leadership position in the market. IBM’s software enables solutions that can transform businesses. It is the software that solves industry or business-specific problems such as supply chain or asset management and uses our breakthrough natural language processing and automation capabilities as well as other technologies including analytics, encryption, blockchain and machine learning. IBM Research continues to advance these technologies, for example integrating neural and symbolic techniques to build AI that can perform more complex tasks by understanding and reasoning more like humans. Business transformation and hybrid cloud services provide a $300 billion market opportunity. Key to how our technology is delivered, IBM Global Business Services (GBS) is a leading design, consulting and systems integration organization, with more OpenShift certified experts than any of the competition. They are the leaders in helping enterprises move workloads onto OpenShift – the top hybrid cloud platform – and have built or migrated hybrid cloud applications for more than 500 clients.


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    Management Discussion 25 International Business Machines Corporation and Subsidiary Companies Our consultants have the trust of clients around the world, many having worked in the same industries as the clients they serve. Our services professionals bring that deep knowledge to helping clients develop their hybrid cloud infrastructure, applying the full range of IBM’s and its partners’ capabilities to build intelligent workflows enabled by our technology stack. GBS works with our ecosystem partners and IBM developers to create the custom solutions that realize digital transformation for our clients in any country and any industry. Infrastructure, a $230 billion market, is at the base of our stack, incorporating the public and private cloud technology that integrates with our hybrid cloud approach. Our clients are using a combination of public and private cloud infrastructure to keep their mission-critical data and workloads secure. IBM provides both in a way that can easily be slotted into our hybrid cloud platform and AI. IBM public cloud is the technology behind our clouds for highly regulated industries, such as IBM Cloud for Financial Services and IBM Cloud for Telecommunications, with industry-specific security and compliance features. To help clients integrate their private clouds into a hybrid cloud strategy using IBM IT infrastructure, we have made investments in our IBM Z, LinuxONE, Power and Storage offerings to support our hybrid cloud platform and software. Investing in the Future Investment in future technologies is an important part of our strategy. Hybrid cloud and AI are the technologies of today, but IBM’s investment in quantum computing positions us to win in the next era of computing. We were the first technology company to publish plans to produce a quantum processor with more than 1,000 qubits by 2023 giving us a significant first mover advantage. We already have more than 285,000 registered users in our market-leading quantum network. The 130+ members of the IBM Q Network – including universities, banks, auto companies, telcos and a wide array of companies from other industries – have run over 500 billion quantum circuits. IBM Research continues to develop new technologies and improve on our existing ones, ensuring that IBM stays in the vanguard of technological innovation that helps enterprises achieve their digital transformations. Aligning Structure to Strategy As we focus our strategy on hybrid cloud and AI, IBM is making it easier for our clients to consume our technology and gain better access to our deep technical expertise. We are adjusting our portfolio to align to our strategy. The announced spin-off of our managed infrastructure services business will better align IBM to our hybrid cloud platform and AI strategy and create clearer focus for both companies. With over 4,600 technology- intensive, highly regulated clients in 115 countries and more than twice the scale of its nearest competitor, NewCo will pursue a $500 billion market opportunity in managed infrastructure services. At the same time, we continue to invest organically and inorganically. The acquisitions we announced in 2020 extend our hybrid cloud and AI technology and services capabilities to provide value for our clients. We are changing the way we go to market to simplify our client segmentation and better align IBM’s salesforce with our clients so that we more consistently deliver the value of our platform. We will demonstrate the value of our hybrid cloud and AI approach through technical and experiential selling. IBM Garage, a market-leading immersive experience for co-creating solutions, helps our clients and partners grasp the value of the platform by seeing it in practice. We are expanding our ecosystem by adding hundreds of new global systems integrators, independent software vendors and major third-party software partners. We are investing $1 billion in our ecosystem to ensure that our partners have the resources they need to develop software and build their businesses on our platform expanding IBM’s go-to-market reach. When our partners succeed, our clients succeed, and that translates to success for IBM. Our hybrid cloud and AI strategy is designed for our mutual success. It is the engine to propel growth across our entire business, enhanced by a revised sales strategy, ecosystem priority and go-to-market approach. The focus of 2021 will be to accelerate that engine. Business Segments and Capabilities Our hybrid cloud and AI strategy is realized through our operations and consist of five business segments: Cloud & Cognitive Software, Global Business Services, Global Technology Services, Systems and Global Financing.


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    26 Management Discussion International Business Machines Corporation and Subsidiary Companies Cloud & Cognitive Software Cloud & Cognitive Software brings together IBM’s software platforms and solutions, enabling us to help clients predict, automate, secure and modernize, on a secure hybrid cloud. It includes all software, except operating system software reported in the Systems segment. Cloud & Cognitive Software comprises three business areas–Cognitive Applications, Cloud & Data Platforms and Transaction Processing Platforms, which have the following capabilities: Cognitive Applications: includes software that address vertical and domain-specific solutions, increasingly infused with AI, enabled by IBM’s Watson technology. Application areas such as health, financial services, supply chain, asset management, weather and security software and services are among the offerings. Cloud & Data Platforms: includes the company’s distributed middleware and data platform software, including Red Hat, which enables the operation of clients’ hybrid cloud environments, whether on-premise or in public and private clouds. Included are IBM Cloud Paks, which are pre-integrated enterprise grade solutions built on Red Hat OpenShift and a combination of containerized IBM and Red Hat software and services. It also includes product areas such as WebSphere distributed, analytics platform software such as DB2 distributed, information integration, and enterprise content management, as well as blockchain and AI/Watson platforms. As clients increasingly move more of their mission-critical workloads to the cloud, their multi-cloud environments will be based on a foundation of Linux, with Kubernetes open source software to deploy, manage and scale container-based applications. Red Hat, which provides the leading Linux operating system–Red Hat Enterprise Linux (RHEL)–and the leading hybrid cloud platform–Red Hat OpenShift–is at the center of this transformational shift among clients. Transaction Processing Platforms: the software that supports client 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 (e.g., DB2 and WebSphere running on z/OS). Global Business Services Global Business Services provides clients with consulting, business process and application management services, focused on implementing AI-enabled intelligent workflows and modernizing application suites, optimized for hybrid cloud environments. These professional services deliver value and innovation to clients through solutions which leverage industry, technology and business strategy and process expertise. GBS is the digital reinvention partner for IBM clients, combining industry knowledge, functional expertise, and applications with the power of business design and cognitive and cloud technologies. The full portfolio of GBS services is backed by its globally integrated delivery network and integration with technologies, solutions and services across IBM. GBS assists clients in their digital transformations, helping them build business platform strategies and experiences, transform processes to intelligent workflows using AI and other exponential technologies, and build hybrid, open cloud infrastructures. Global Business Services comprises three business areas–Consulting, Application Management and Global Process Services, which have the following capabilities: Consulting: provides business consulting services focused on bringing to market solutions that help clients shape their digital blueprints and customer experiences, modernize their applications, define their cognitive operating models, unlock the potential in all data to improve decision-making, set their next-generation talent strategies and create new technology architectures in a cloud-centric world. Application Management: delivers system integration, application management, maintenance and support services for packaged software, as well as custom and traditional applications. Value is delivered through advanced capabilities in areas such as security and privacy, application testing and modernization, cloud application migration and automation. Global Process Services (GPS): delivers finance, procurement, talent and engagement, and industry-specific business process outsourcing services. These services deliver improved business results to clients through a consult-to-operate model which includes the strategic change and/or operation of the client’s processes, applications and infrastructure. GBS is redefining process services for both growth and efficiency through the application of the power of cognitive technologies like Watson, as well as the IoT, blockchain and deep analytics. Global Technology Services Global Technology Services provides comprehensive IT infrastructure and platform services that create business value for clients. Clients gain access to leading-edge capabilities and realize high-quality performance, greater flexibility and economic value. GTS delivers these outcomes through insights drawn from IBM’s decades of experience across thousands of engagements, the skills of practitioners, advanced technologies, applied innovation from IBM Research and global scale.


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    Management Discussion 27 International Business Machines Corporation and Subsidiary Companies Global Technology Services comprises two business areas–Infrastructure & Cloud Services and Technology Support Services, which have the following capabilities: Infrastructure & Cloud Services: delivers a portfolio of project, managed, outsourcing and cloud-delivered services focused on clients’ enterprise IT infrastructure environments with improved quality, flexibility and economic value. The portfolio consists of Infrastructure Services and IBM Cloud. Infrastructure Services modernizes and manages IT environments to accelerate clients’ digital transformations. It provides a comprehensive set of services and solutions that include resiliency, security, and network capabilities. These solutions embed unique insights drawn from depth of expertise and scale to enable high performance of mission-critical systems and services. The portfolio is built leveraging platforms, such as the MultiCloud Management Platform and the IBM Services Platform with Watson, which augment human intelligence with cognitive technologies to address complex client environments. This portfolio is delivered by skilled and experienced practitioners to ensure secure, resilient and reliable client environments. On October 8, 2020, IBM announced our plan to separate the managed infrastructure services unit into a new public company. We are on track to complete the separation by the end of 2021. The IBM Cloud infrastructure layer is built on an open architecture and specifically designed for clients to run mission-critical workloads with leading edge security capabilities including confidential computing and keep your own keys to ensure our clients data is their data. It also includes industry-specific public clouds with built-in controls for highly regulated industries such as financial services, telecommunications, government and healthcare. IBM Cloud powered by deep AI capabilities across the hybrid cloud platform helps our clients extract insights from their data from multiple sources, all within a secure and open architecture. Built on enterprise grade hardware, it also provides storage, network functionality, and a full range of compute options such as virtual machines, containers, bare metal, and serverless, as well as virtualization for enterprise deployments. Technology Support Services: delivers comprehensive support services to maintain and improve the availability of clients’ IT infrastructures. These offerings include maintenance for IBM products and other technology platforms, as well as open source and cross-vendor software and solution support, drawing on innovative technologies and leveraging IBM Services Platform with Watson capabilities. Systems Systems provides clients with innovative infrastructure platforms to help meet the new requirements of hybrid multi-cloud and enterprise AI workloads. IBM Systems also designs advanced semiconductor and systems technology in collaboration with IBM Research, primarily for use in our systems. Systems comprises Systems Hardware and Systems Operating Software, which have the following capabilities: Systems Hardware: includes IBM’s servers and Storage Systems. Servers: a range of high-performance systems designed to address computing capacity, security and performance needs of businesses, hyperscale cloud service providers and scientific computing organizations. The portfolio includes IBM Z and LinuxONE, trusted enterprise platforms for integrating data, transactions and insight; and Power Systems, a system designed from the ground up for big data and enterprise AI, optimized for hybrid cloud and Linux. Storage Systems: data storage products and solutions that allow clients to retain and manage rapidly growing, complex volumes of digital information and to fuel data-centric cognitive applications. These solutions address critical client requirements for information retention and archiving, security, compliance and storage optimization, including data deduplication, availability and virtualization. The portfolio consists of a broad range of flash storage, disk and tape storage solutions. Operating Systems Software: IBM Z operating system environments include z/OS, a security-rich, high-performance enterprise operating system, as well as Linux. Power Systems offers a choice of AIX, IBM i or Linux operating systems that leverage POWER architecture to deliver secure, reliable and high performing enterprise-class workloads across a breadth of server offerings. Global Financing Global Financing encompasses two primary businesses: financing, primarily conducted through IBM Credit LLC (IBM Credit), and remanufacturing and remarketing. IBM Credit, a wholly owned subsidiary of IBM, facilitates IBM clients’ acquisition of information technology systems, software and services through its financing solutions. The financing arrangements are predominantly for products or services that are critical to the end users’ business operations and support IBM’s hybrid cloud platform and AI strategy. Global Financing conducts a comprehensive credit evaluation of its clients prior to extending financing. As a captive financier, Global Financing has the benefit of both deep knowledge of its client base and a clear insight into the products and services financed. These factors allow the business to effectively manage two of the major risks associated with financing, credit and residual value, while generating


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    28 Management Discussion International Business Machines Corporation and Subsidiary Companies strong returns on equity. Global Financing also maintains a long-term partnership with IBM’s clients through various stages of the IT asset life cycle–from initial purchase and technology upgrades to asset disposition decisions. Global Financing comprises the following business areas: Client Financing: lease, installment payment plan and loan financing to end users and internal clients for terms up to seven years. Assets financed are primarily new and used IT hardware, software and services where we have expertise. Internal financing is predominantly in support of Global Technology Services’ long-term client service contracts. All internal financing arrangements are at arm’s-length rates and are based upon market conditions. Commercial Financing: short-term working capital financing to suppliers, distributors and resellers primarily of IBM products. In 2019, we wound down the Original Equipment Manufacturer (OEM) IT portion of our commercial financing operations. In the fourth-quarter 2020, Global Financing expanded its financial flexibility by entering into an agreement with a third-party investor to sell up to $3 billion of its IBM commercial financing receivables, at any one time, on a revolving basis over the agreement’s three-year term. Remanufacturing and Remarketing: assets include used equipment returned from lease transactions, or used and surplus equipment acquired internally or externally. These assets may be refurbished or upgraded, and sold or leased to new or existing clients both externally and internally. Externally remarketed equipment revenue represents sales or leases to clients and resellers. Internally remarketed equipment revenue primarily represents used equipment that is sold internally to Global Technology Services. Systems may also sell the equipment that it purchases from Global Financing to external clients. IBM Worldwide Organizations The following worldwide organizations play key roles in IBM’s delivery of value to its clients: Global Markets Research, Development and Intellectual Property Global Markets IBM operates in more than 175 countries with a broad distribution of revenue. To manage this global footprint, Global Markets leads our dedicated country-based IBM operations in order to serve clients, develop markets, and ultimately, ensure IBM is led through a client lens. These teams serve our clients locally, complemented by digital capabilities, global talent and resources, and an extensive partner ecosystem. These country teams have client leaders, IBM consultants, solution specialists, delivery professionals and business partners all working on behalf of clients. Their mission is to provide insights and innovation and co-create with clients to help them address their most pressing business challenges and opportunities. In this way, we serve as a trusted partner to clients, establishing and maintaining relationships that deliver long-term value based on industry expertise, innovative technologies and an ability to deliver mission critical capabilities to an enterprise at scale. Research, Development and Intellectual Property Our research and development (R&D) operations differentiate us from our competitors. In 2020, we invested approximately 9 percent of total revenue for R&D, focusing on high-growth, high-value opportunities. IBM Research works with clients and our business units through global labs on near-and mid-term innovations. It delivers many new technologies to our portfolio every year and helps clients address their most difficult challenges. IBM Research scientists are conducting pioneering work in hybrid cloud, AI, quantum computing, security, systems and more–applying these technologies across industries including financial services, healthcare, automotive, pharmaceuticals and energy. We actively continue to seek IP protection for our innovations. Some of our technological breakthroughs are used exclusively in IBM products, while others are licensed and may be used in IBM products and/or the products of the licensee. As part of our business model, we license certain of our IP assets, which constitute high-value technology, but may be applicable in more mature markets. While our various proprietary IP rights are important to our success, we believe our business as a whole is not materially dependent on any particular patent or license, or any particular group of patents or licenses. In addition, IBM owns or is licensed under a number of third-party patents, which vary in duration, relating to its products.


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    Management Discussion 29 International Business Machines Corporation and Subsidiary Companies Human Capital Employees and Related Workforce (In thousands) For the year ended December 31: 2020 IBM/wholly owned subsidiaries 345.9 Less-than-wholly owned subsidiaries 10.5 Complementary* 18.9 * The complementary workforce is an approximation of equivalent full-time employees hired under temporary, part-time and limited-term employment arrangements to meet specific business needs in a flexible and cost-effective manner. As a globally integrated enterprise, IBM operates in more than 175 countries and is continuing to shift our business to the higher value segments of enterprise IT. Our global workforce is highly skilled, reflective of the work we do for our clients’ digital transformations and in support of their mission-critical operations. Our global workforce includes developers, consultants, client delivery and services specialists, research scientists and others. Our employees are among the world’s leading experts in cloud, AI, quantum computing, cybersecurity and industry-specific solutions. Talent and Culture IBM attracts, develops, engages and retains talent in a dynamic and competitive environment. IBM offers a compelling employee value proposition: we develop and deliver innovative technologies including hybrid cloud, AI, and quantum, for clients whose businesses the world relies on. IBM is continuously transforming and developing its talent, both through learning and hiring. In 2020, more than 30,000 people from 75 countries joined IBM. Employees are encouraged and enabled to learn and grow their careers, with employees completing more than 80 hours of learning on average in 2020. Our digital learning platform, Your Learning, uses Watson AI to generate personalized recommendations and includes peer-to-peer collaboration and internal social sharing. Hundreds of thousands of employees globally participate in our annual engagement survey, which measures elements such as workplace experience, inclusion, pride and propensity to recommend IBM as an employer. Our industry-leading talent practices enabled IBM to improve employee engagement by more than 2 points year to year and retain employees above historical levels. Every manager and leader in IBM has access to their team and organization engagement levels along with actionable data-driven insights. Diversity and Inclusion IBM has a long, proud history as a pioneer in diversity and inclusion. A diverse and inclusive workplace leads to greater innovation, agility, performance and engagement, enabling both business growth and societal impact. We ensure employees from diverse backgrounds are engaged, can be their authentic selves, build skills and achieve their greatest potential. With the full support of our Board of Directors, beginning in April 2021 we will disclose annually an overview of our diversity, pay equity and inclusion efforts and programs, including diversity representation data. We are proud of our inclusive culture, with nine out of ten employees responding that they can be their authentic selves at work. Our focus on creating a diverse and inclusive workplace led to increased engagement levels for women, Black and Hispanic employees. We are also focused on meeting or exceeding the diversity of skilled talent in the labor market, for every underrepresented group, and at every level of our company. Women now make up more than 33 percent of our workforce, and we increased representation of women, Black and Hispanic employees in 2020 compared to the prior year. While we have taken significant actions and made progress, we have ongoing work to do. IBM believes in pay equity: we have had an equal pay policy since 1935 and a long-standing practice of maintaining pay equity. To this end, we conduct statistical pay equity analysis that includes all countries with IBM employees. We also empower employees to understand their pay by providing comprehensive education and transparent access to pay statements including a comparison to market pay ranges. Health, Safety and Well-Being We have a long-standing commitment to the health, safety and well-being of our employees. Never has this been more important than in 2020 as we faced the COVID-19 pandemic. From early in the course of the outbreak, we supported the health, safety and well-being of our employees by restricting travel, cancelling in-person meetings and events and transitioning nearly 95 percent of our workforce to work from home. We have a robust case management system to manage COVID-19 exposures and a comprehensive playbook on workplace health and safety measures that allow our offices to reopen when conditions improve. Employees are supported with 24/7 access to IBM’s world-class Health and Safety team, education, timely updates and forums to ask questions and raise concerns. Additionally, from the outset of the COVID-19 pandemic, IBM has focused on mental health and supporting our employees for the long run with programs shaped by frequent survey polls and employee input sessions. Such programs include: four weeks additional paid time off for working parents and caregivers facing disruption, robust case management through our Employee Assistance Program to manage COVID-19 exposures and develop comprehensive guidance, training for employees on resilience and for managers on how to identify and address mental health issues and financial counseling offerings tailored to pandemic-related matters.


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    30 Management Discussion International Business Machines Corporation and Subsidiary Companies YEAR IN REVIEW Results of Continuing Operations Segment Details The following is an analysis of the 2020 versus 2019 reportable segment results. The table below presents each reportable segment’s external revenue and gross margin results. Segment pre-tax income includes transactions between segments that are intended to reflect an arm’s-length transfer price and excludes certain unallocated corporate items. ($ in millions) Yr.-to-Yr. Yr.-to-Yr. Percent/ Percent Change Margin Adjusted for For the year ended December 31: 2020 2019 Change Currency Revenue Cloud & Cognitive Software $23,376 $22,891 * 2.1 % 1.9 % Gross margin 77.5 % 77.1 %* 0.4 pts. Global Business Services 16,162 16,798 * (3.8)% (4.1)% Gross margin 29.7 % 27.7 %* 2.0 pts. Global Technology Services 25,812 27,361 (5.7)% (5.4)% Gross margin 34.8 % 34.8 % 0.0 pts. Systems 6,978 7,604 (8.2)% (8.7)% Gross margin 55.9 % 53.1 % 2.8 pts. Global Financing 1,123 1,400 (19.8)% (19.2)% Gross margin 37.7 % 35.6 % 2.1 pts. Other 169 1,092 * (84.5)% (84.4)% Gross margin NM 12.5 %* NM Total consolidated revenue $73,620 $77,147 (4.6)%** (4.7)% Total consolidated gross profit $35,575 $36,488 (2.5)% Total consolidated gross margin 48.3 % 47.3 % 1.0 pts. Non-operating adjustments Amortization of acquired intangible assets 732 534 37.1 % Acquisition-related charges — 13 (100.0)% Spin-off-related charges 1 — NM Operating (non-GAAP) gross profit $36,308 $37,035 (2.0)% Operating (non-GAAP) gross margin 49.3 % 48.0 % 1.3 pts. * Recast to reflect segment changes. ** (3.5) percent excluding divested businesses and adjusted for currency. NM–Not meaningful Cloud & Cognitive Software ($ in millions) Yr.-to-Yr. Yr.-to-Yr. Percent Change Percent Adjusted for For the year ended December 31: 2020 2019 Change Currency Cloud & Cognitive Software external revenue $23,376 $22,891 * 2.1 % 1.9 % Cloud & Data Platforms $11,481 ** $ 9,499 20.9 % 20.5 % Cognitive Applications 5,290 5,456 * (3.0) (3.2) Transaction Processing Platforms 6,606 7,936 (16.8) (17.0) * Recast to reflect segment changes. ** Red Hat was acquired on July 9, 2019. Results in 2020 include a full year of Red Hat revenue. Cloud & Cognitive Software revenue of $23,376 million increased 2.1 percent as reported (2 percent adjusted for currency) in 2020 compared to the prior year. There was strong growth in Cloud & Data Platforms, as reported and at constant currency, driven primarily by Red Hat, as our hybrid cloud and AI solutions are resonating with clients. Both Cognitive Applications and Transaction Processing Platforms revenue decreased year to year as reported and adjusted for currency, driven by declines in transactional software performance as clients delayed longer term commitments in the current environment. Cloud & Data Platforms revenue of $11,481 million increased 20.9 percent as reported (20 percent adjusted for currency) compared to the prior year, driven by a full year of Red Hat revenue contribution and Red Hat’s strong performance in infrastructure and application development and emerging technologies. Red Hat OpenShift, the leading open source hybrid cloud platform, helped clients modernize mission-critical workloads, build cloud native applications, and deploy and manage data and applications across various clouds within an environment that is open, flexible and secure. We now have more than 2,800 clients using our hybrid cloud platform, which is an increase of more than 1,000 new enterprise clients since the acquisition of Red Hat in July 2019.


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    Management Discussion 31 International Business Machines Corporation and Subsidiary Companies Cognitive Applications revenue of $5,290 million decreased 3.0 percent as reported (3 percent adjusted for currency) compared to the prior year. We had good client adoption in security solutions such as Cloud Pak for Security and growth in security services as clients focused on their secure digital transformations. This growth was offset by declines in solutions used by some of the more impacted industries in the current macroeconomic environment where clients deferred transformational investments to focus on their core operations. Transaction Processing Platforms revenue of $6,606 million decreased 16.8 percent as reported (17 percent adjusted for currency) in 2020 compared to the prior year. With the macroeconomic environment due to the COVID-19 pandemic, clients focused on near-term priorities resulting in purchase deferrals, which impacted our transactional software performance in 2020. However, our subscription and support revenue grew in 2020 compared to the prior year. Within Cloud & Cognitive Software, cloud revenue of $7.0 billion grew 67 percent as reported and adjusted for currency year to year. ($ in millions) Yr.-to-Yr. Percent/ Margin For the year ended December 31: 2020 2019 * Change Cloud & Cognitive Software External gross profit $18,118 $17,650 2.7 % External gross profit margin 77.5 % 77.1 % 0.4 pts. Pre-tax income $ 6,362 $ 7,811 (18.5)% Pre-tax margin 24.0 % 30.4 % (6.4)pts. * Recast to reflect segment changes. The Cloud & Cognitive Software gross profit margin increased 0.4 points to 77.5 percent in 2020 compared to the prior year. The gross profit margin expansion was driven primarily by the full-year contribution from Red Hat and year-to-year improvement in services margins as we continued to focus on shifting to higher value services, such as Software-as-a-Service and security services, and driving AI-powered automation across the portfolio. Pre-tax income of $6,362 million decreased 18.5 percent compared to the prior year with a pre-tax margin decline of 6.4 points to 24.0 percent. The decline in pre-tax income and margin was driven primarily by the revenue decline in Transaction Processing Platforms, our continued investment in our strategic areas of cloud and AI, and the impact of higher workforce rebalancing charges year to year which had 2.6 points of impact on the pre-tax margin. Global Business Services ($ in millions) Yr.-to-Yr. Yr.-to-Yr. Percent Change Percent Adjusted for For the year ended December 31: 2020 2019 Change Currency Global Business Services external revenue $16,162 $16,798 * (3.8)% (4.1)% Consulting $ 8,083 $ 8,157 * (0.9)% (1.3)% Application Management 7,133 7,646 (6.7) (6.9) Global Process Services 945 995 (5.0) (4.7) * Recast to reflect segment changes. GBS revenue of $16,162 million decreased 3.8 percent as reported (4 percent adjusted for currency) in 2020 compared to the prior year. As the global pandemic intensified through the year, we aligned our offerings to help clients focus on engaging customers virtually, modernizing and migrating applications to the cloud, empowering a remote workforce, and focusing on cybersecurity and IT resiliency. In 2020, GBS accelerated the number of engagements using Red Hat technology and continued to drive client adoption of Red Hat OpenShift and IBM Cloud Paks. Consulting revenue of $8,083 million decreased 0.9 percent as reported (1 percent adjusted for currency) compared to the prior year. Given the macroeconomic environment during 2020, clients shifted priorities, which led to project delays and less demand for more discretionary offerings. As we pivoted our offerings and capabilities to help address clients’ priorities around application modernization, our GBS Consulting total signings grew for the year at a mid-single digit rate compared to 2019. Application Management revenue of $7,133 million decreased 6.7 percent as reported (7 percent adjusted for currency) driven primarily by the decline in our more traditional on-premise application management services, partially offset by growth in higher value offerings to develop, modernize and manage cloud applications. Our incumbency in Application Management creates the opportunity and trust to be the partner of choice for our clients’ digital journeys, and helps drive adoption of our hybrid cloud platform. Global Process Services revenue of $945 million decreased 5.0 percent as reported (5 percent adjusted for currency), reflecting the impact of the ongoing macroeconomic environment on volume-based services. GPS returned to growth in the fourth quarter of 2020,


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    32 Management Discussion International Business Machines Corporation and Subsidiary Companies as we continued to deliver efficiency and flexibility to our clients’ processes by infusing innovative technology and redesigning intelligent workflows. Within GBS, cloud revenue of $5.8 billion grew 11 percent as reported and adjusted for currency. GBS continued to drive the adoption of our hybrid cloud platform to help our clients accelerate their digital reinventions by modernizing their application infrastructures and leveraging business transformation services built on hybrid cloud. ($ in millions) Yr.-to-Yr. Percent/ Margin For the year ended December 31: 2020 2019 * Change Global Business Services External gross profit $4,795 $4,655 3.0 % External gross profit margin 29.7 % 27.7 % 2.0 pts. Pre-tax income $1,351 $1,623 (16.8)% Pre-tax margin 8.3 % 9.5 % (1.2)pts. * Recast to reflect segment changes. The GBS gross profit margin increased 2.0 points to 29.7 percent compared to the prior year, driven by margin improvements across all three areas of the business. The gross margin expansion reflects our shift to higher-value offerings, improved productivity and operational efficiency created by our investments in innovative delivery capabilities and our ability to leverage our variable and global delivery resource model. Pre-tax income of $1,351 million decreased 16.8 percent compared to the prior year and the pre-tax margin declined 1.2 points to 8.3 percent. The year-to-year declines in pre-tax income and margin were driven by the higher workforce rebalancing charges year to year, which had 2.6 points of impact to pre-tax margin, partially offset by the gross margin expansion. Global Technology Services ($ in millions) Yr.-to-Yr. Yr.-to-Yr. Percent Change Percent Adjusted for For the year ended December 31: 2020 2019 Change Currency Global Technology Services external revenue $25,812 $27,361 (5.7)% (5.4)% Infrastructure & Cloud Services $19,669 $20,736 (5.1)% (5.2)% Technology Support Services 6,144 6,625 (7.3) (6.0) GTS revenue of $25,812 million decreased 5.7 percent as reported (5 percent adjusted for currency) in 2020 compared to the prior year. The revenue decline was driven by lower client business volumes primarily with clients in industries more impacted by the macroeconomic environment. However, cloud revenue grew as reported and adjusted for currency in 2020 compared to the prior year. We had strong contract renewals and added a number of new clients in the fourth quarter. Infrastructure & Cloud Services revenue of $19,669 million decreased 5.1 percent as reported (5 percent adjusted for currency) compared to the prior year. Revenue was impacted by lower client-based business volumes year to year in the more economically sensitive industries. Clients took a longer-term view, with a focus on modernizing their core infrastructure to create operational efficiency and move their mission-critical workloads to a hybrid cloud platform. These clients turn to GTS’s managed infrastructure services with its deep expertise in managing clients’ mission-critical infrastructures and next generation service delivery capabilities infused with AI and automation. As we prepare to separate our managed infrastructure services business in 2021, we are deeply engaged with our clients to ensure a smooth transition to NewCo, the world’s leading provider of infrastructure services. Technology Support Services (TSS) revenue of $6,144 million decreased 7.3 percent as reported (6 percent adjusted for currency) in 2020, driven primarily by the Systems hardware product cycles and a shift away from lower value services. Within GTS, cloud revenue of $9.4 billion grew 10 percent as reported and adjusted for currency.


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    Management Discussion 33 International Business Machines Corporation and Subsidiary Companies ($ in millions) Yr.-to-Yr. Percent/ Margin For the year ended December 31: 2020 2019 Change Global Technology Services External total gross profit $8,975 $9,515 (5.7)% External total gross profit margin 34.8 % 34.8 % 0.0 pts. Pre-tax income $ 117 $1,645 (92.9)% Pre-tax margin 0.4 % 5.8 % (5.3)pts. The GTS gross profit margin of 34.8 percent was flat compared to the prior year. We had margin improvement across the portfolio from the benefits of workforce rebalancing actions taken earlier in the year and from the shift to higher-value business, partially offset by revenue declines in TSS. Pre-tax income of $117 million decreased 92.9 percent and pre-tax margin decreased 5.3 points year to year to 0.4 percent, reflecting the higher level of workforce rebalancing charges in the current year, which had 4.2 points of impact on the pre-tax margin. A significant portion of the structural actions in the fourth quarter of 2020 impacted GTS in order to further improve margins and the overall financial profile of the business. Services Backlog and Signings ($ in billions) Yr.-to-Yr. Yr.-to-Yr. Percent Change Percent Adjusted for At December 31: 2020 2019 Change Currency Total backlog $110.8 $112.4 (1.5)% (4.5)% The estimated total services backlog at December 31, 2020 was $111 billion, a decrease of 1.5 percent as reported (4 percent adjusted for currency). Total services backlog includes Infrastructure & Cloud Services, Security Services, Consulting, Global Process Services, Application Management and TSS. Total backlog is intended to be a statement of overall work under contract which is either noncancellable, or which historically has very low likelihood of termination, given the criticality of certain services to the company’s clients. Total backlog does not include as-a-Service arrangements that allow for termination under contractual commitment terms. Backlog estimates are subject to change and are affected by several factors, including terminations, changes in the scope of contracts, periodic revalidations, adjustments for revenue not materialized and adjustments for currency. ($ in millions) Yr.-to-Yr. Yr.-to-Yr. Percent Change Percent Adjusted for For the year ended December 31: 2020 2019 Change Currency Total signings $38,770 $40,741 (4.8)% (5.1)% Services signings are management’s initial estimate of the value of a client’s commitment under a services contract. There are no third- party standards or requirements governing the calculation of signings. The calculation used by management involves estimates and judgments to gauge the extent of a client’s commitment, including the type and duration of the agreement, and the presence of termination charges or wind-down costs. Signings include Infrastructure & Cloud Services, Security Services, Consulting, Global Process Services and Application Management contracts. Contract extensions and increases in scope are treated as signings only to the extent of the incremental new value. Total services signings can vary over time due to a variety of factors including, but not limited to, the timing of signing a small number of larger contracts, such as in Infrastructure & Cloud Services or Global Process Services. TSS is generally not included in signings as the maintenance contracts tend to be more steady state, where revenues equal renewals. Certain longer-term TSS contracts that have characteristics similar to outsourcing contracts are included in signings. Contract portfolios purchased in an acquisition are treated as positive backlog adjustments provided those contracts meet the company’s requirements for initial signings. A new signing will be recognized if a new services agreement is signed incidental or coincidental to an acquisition or divestiture. Management believes that the estimated values of services backlog and signings disclosed herein provide insight into our potential future revenue, which is used by management as a tool to monitor the performance of the business and viewed as useful decision- making information for investors. The conversion of signings and backlog into revenue may vary based on the types of services and


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    34 Management Discussion International Business Machines Corporation and Subsidiary Companies solutions, customer decisions, and as well as other factors, which may include, but are not limited to, macroeconomic environment or external events. Systems ($ in millions) Yr.-to-Yr. Yr.-to-Yr. Percent Change Percent Adjusted for For the year ended December 31: 2020 2019 Change Currency Systems external revenue $6,978 $7,604 (8.2)% (8.7)% Systems Hardware $5,481 $5,918 (7.4)% (8.0)% IBM Z 1.9 1.2 Power Systems (22.4) (22.9) Storage Systems (6.1) (6.7) Operating Systems Software 1,497 1,686 (11.2) (11.2) Systems revenue of $6,978 million decreased 8.2 percent year to year as reported (9 percent adjusted for currency). Our Systems portfolio continues to deliver critical and lasting value to enterprise clients in support of our hybrid cloud strategy. Systems Hardware revenue of $5,481 million declined 7.4 percent as reported (8 percent adjusted for currency), driven primarily by declines in Power Systems and Storage Systems, partially offset by year-to-year growth in IBM Z. Operating Systems Software revenue of $1,497 million declined 11.2 percent as reported (11 percent adjusted for currency) compared to the prior year. Within Systems Hardware, IBM Z revenue increased 1.9 percent as reported (1 percent adjusted for currency) despite an elongated z15 adoption cycle as a result of the challenging environment. The full-year growth in IBM Z reflects the importance of this high-value, secure and scalable platform with cloud native development capabilities. Our installed base of MIPS is more than 3.5 times the level of a decade ago, with 60 percent of our install base in new workload areas such as Linux. Power Systems revenue decreased 22.4 percent as reported (23 percent adjusted for currency) year to year, reflecting the product cycles across the Power Systems portfolio. Storage Systems revenue decreased 6.1 percent as reported (7 percent adjusted for currency) year to year, driven primarily by declines in high-end storage which is a reflection of the IBM Z cycle. Within Systems, cloud revenue of $2.9 billion declined 3 percent as reported and adjusted for currency. ($ in millions) Yr.-to-Yr. Percent/ Margin For the year ended December 31: 2020 2019 Change Systems External Systems Hardware gross profit $2,668 $2,622 1.8 % External Systems Hardware gross profit margin 48.7 % 44.3 % 4.4 pts. External Operating Systems Software gross profit $1,232 $1,412 (12.8)% External Operating Systems Software gross profit margin 82.3 % 83.8 % (1.5)pts. External total gross profit $3,899 $4,034 (3.3)% External total gross profit margin 55.9 % 53.1 % 2.8 pts. Pre-tax income $ 449 $ 701 (36.0)% Pre-tax margin 5.8 % 8.4 % (2.7)pts. The Systems gross profit margin increased 2.8 points to 55.9 percent in 2020 compared to the prior year, driven primarily by margin improvements in IBM Z and Power Systems, and a mix to IBM Z hardware. Pre-tax income of $449 million declined 36.0 percent and pre-tax margin decreased 2.7 points year to year to 5.8 percent, driven primarily by the higher level of workforce rebalancing charges in the current year, which had 2.5 points of impact on the pre-tax margin.


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    Management Discussion 35 International Business Machines Corporation and Subsidiary Companies Global Financing ($ in millions) Yr.-to-Yr. Percent For the year ended December 31: 2020 2019 Change External revenue $1,123 $1,400 (19.8)% Internal revenue 894 1,232 (27.5) Total revenue $2,017 $2,632 (23.4)% Pre-tax income $ 761 $1,055 (27.8)% In 2019, we began the wind down of our OEM Commercial Financing business to refocus our Global Financing business on IBM’s products and services. In 2020, we entered into arrangements to sell certain financing receivables to third parties. While the strategic actions we have taken are the primary driver of the decline in external revenue and pre-tax income on a year-to-year basis, our repositioning of the Global Financing business has strengthened our liquidity position, improved the quality of our portfolio and lowered our debt needs. Global Financing total revenue decreased 23.4 percent compared to the prior year. This was due to a decrease in internal revenue of 27.5 percent, driven by decreases in internal used equipment sales (down 22.3 percent to $670 million) and internal financing (down 39.5 percent to $224 million). The decrease in internal financing was due to lower average asset balances and yields. External revenue declined 19.8 percent due to decreases in external financing (down 25.5 percent to $834 million), reflecting the wind down of the OEM IT commercial financing operations and a decline in client financing revenue. Sales of used equipment represented 47.5 percent and 43.4 percent of Global Financing’s revenue for the years ended December 31, 2020 and 2019, respectively, which reflects lower financing revenue compared to 2019. The gross profit margin on used sales was 50.7 percent and 52.2 percent for the years ended December 31, 2020 and 2019, respectively. Global Financing pre-tax income decreased 27.8 percent year to year primarily driven by a decline in gross profit ($339 million) due to lower revenue, partially offset by a decrease in expense ($46 million), which was in line with the segment’s performance. Geographic Revenue In addition to the revenue presentation by reportable segment, we also measure revenue performance on a geographic basis. ($ in millions) Yr.-to-Yr. Percent Change Yr.-to-Yr. Excluding Divested Yr.-to-Yr. Percent Change Businesses And Percent Adjusted for Adjusted for For the year ended December 31: 2020 2019 Change Currency Currency Total revenue $73,620 $77,147 (4.6)% (4.7)% (3.5)% Americas $34,114 $36,274 (6.0)% (4.8)% (3.5)% Europe/Middle East/Africa 23,644 24,443 (3.3) (4.7) (3.6) Asia Pacific 15,863 16,430 (3.5) (4.3) (3.5) Total revenue of $73,620 million in 2020 decreased 4.6 percent year to year as reported (5 percent adjusted for currency and 4 percent excluding divested businesses and adjusted for currency). Americas revenue decreased 6.0 percent as reported (5 percent adjusted for currency and 4 percent excluding divested businesses and adjusted for currency). Within North America, the U.S. decreased 4.9 percent and Canada decreased 6.0 percent as reported (5 percent adjusted for currency). Latin America declined 12.9 percent as reported (3 percent adjusted for currency). Within Latin America, Brazil declined 17.9 percent as reported (3 percent adjusted for currency). EMEA revenue decreased 3.3 percent as reported (5 percent adjusted for currency and 4 percent excluding divested businesses and adjusted for currency). As reported, the UK, Germany, France and Italy decreased 9.5 percent, 6.3 percent, 3.4 percent and 1.0 percent, respectively, and declined 10 percent, 9 percent, 5 percent and 3 percent, respectively, adjusted for currency. Asia Pacific revenue decreased 3.5 percent as reported (4 percent adjusted for currency and excluding divested businesses and adjusted for currency). Japan was flat as reported and decreased 2 percent adjusted for currency. As reported, China, Australia and India decreased 13.0 percent, 5.8 percent and 6.7 percent, respectively, and declined 13 percent, 5 percent and 2 percent, respectively, adjusted for currency.


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    36 Management Discussion International Business Machines Corporation and Subsidiary Companies Total Expense and Other (Income) ($ in millions) Yr.-to-Yr. Percent/ Margin For the year ended December 31: 2020 2019 Change Total consolidated expense and other (income) $30,937 * $26,322 17.5 % Non-operating adjustments Amortization of acquired intangible assets (1,126) (764) 47.3 Acquisition-related charges (13) (409) (96.8) Non-operating retirement-related (costs)/income (1,123) (615) 82.5 Spin-off-related charges (28) — NM Operating (non-GAAP) expense and other (income) $28,648 * $24,533 16.8 % Total consolidated expense-to-revenue ratio 42.0 % 34.1 % 7.9 pts. Operating (non-GAAP) expense-to-revenue ratio 38.9 % 31.8 % 7.1 pts. * Includes a $2.0 billion pre-tax charge for structural actions in the fourth quarter. NM–Not meaningful Total expense and other (income) year-to-year results for the year ended December 31, 2020 were impacted by the Red Hat acquisition which closed in July 2019. As a result, in the current year, there was a full year of expenses for Red Hat operational spending and amortization of acquired intangible assets associated with the transaction. The current year also included a fourth-quarter $2.0 billion pre-tax charge for structural actions (primarily workforce rebalancing) to simplify and optimize our operating model. Total expense and other (income) increased 17.5 percent in 2020 versus the prior year primarily driven by the fourth-quarter charge for workforce rebalancing, higher Red Hat operational spending, lower gains from divestitures and higher non-operating retirement-related costs, partially offset by lower spending including reductions in travel and other expenses associated with COVID-19 restrictions. Total operating (non-GAAP) expense and other (income) increased 16.8 percent year to year, driven primarily by the factors above excluding the higher non-operating retirement-related costs. For additional information regarding total expense and other (income) for both expense presentations, see the following analyses by category. Selling, General and Administrative Expense ($ in millions) Yr.-to-Yr. Percent For the year ended December 31: 2020 2019 Change Selling, general and administrative expense Selling, general and administrative–other $16,800 $17,099 (1.8)% Advertising and promotional expense 1,542 1,647 (6.3) Workforce rebalancing charges 2,922 * 555 426.3 Amortization of acquired intangible assets 1,123 762 47.5 Stock-based compensation 586 453 29.5 Provision for/(benefit from) expected credit loss expense 109 89 22.4 Total consolidated selling, general and administrative expense $23,082 * $20,604 12.0 % Non-operating adjustments Amortization of acquired intangible assets (1,123) (762) 47.5 Acquisition-related charges (13) (282) (95.3) Spin-off-related charges (28) — NM Operating (non-GAAP) selling, general and administrative expense $21,917 * $19,560 12.1 % * Includes a $2.0 billion pre-tax charge for structural actions in the fourth quarter. NM–Not meaningful Total selling, general and administrative (SG&A) expense increased 12.0 percent in 2020 versus 2019, driven primarily by the following factors: Fourth-quarter workforce rebalancing charge (10 points); Higher spending (2 points) driven by a full year of Red Hat operational expense in 2020 compared to six months in 2019 (5 points), partially offset by spending reductions associated with COVID-19 restrictions; Higher amortization of acquired intangible assets associated with the Red Hat transaction (1 point); partially offset by Lower acquisition-related charges associated with the Red Hat transaction (2 points).


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    Management Discussion 37 International Business Machines Corporation and Subsidiary Companies Operating (non-GAAP) expense increased 12.1 percent year to year primarily driven by the same factors excluding the acquisition-related charges and amortization of acquired intangible assets associated with the Red Hat transaction. Provisions for expected credit loss expense increased $19.8 million in 2020 compared to 2019. The receivables provision coverage was 2.4 percent at December 31, 2020, an increase of 70 basis points from December 31, 2019. The higher coverage rate at December 31, 2020 also reflects the adoption of the new guidance for current expected credit losses. Research, Development and Engineering Expense ($ in millions) Yr.-to-Yr. Percent For the year ended December 31: 2020 2019 Change Total consolidated research, development and engineering $6,333 $5,989 5.7 % Non-operating adjustment Acquisition-related charges — (53) (100.0) Operating (non-GAAP) research, development and engineering $6,333 $5,936 6.7 % Research, development and engineering (RD&E) expense was 8.6 percent of revenue in 2020 and 7.8 percent of revenue in 2019. RD&E expense increased 5.7 percent in 2020 versus 2019 primarily driven by: Higher spending (7 points) driven by a full year of Red Hat spending in 2020 compared to six months in 2019 (8 points); partially offset by Lower acquisition-related charges associated with the Red Hat transaction (1 point). Operating (non-GAAP) expense increased 6.7 percent year to year primarily driven by Red Hat spending. Intellectual Property and Custom Development Income ($ in millions) Yr.-to-Yr. Percent For the year ended December 31: 2020 2019 Change Licensing of intellectual property including royalty-based fees $ 309 $ 367 (15.8)% Custom development income 275 246 11.7 Sales/other transfers of intellectual property 42 34 22.4 Total $ 626 $ 648 (3.3)% Licensing of intellectual property including royalty-based fees decreased 3.3 percent in 2020 compared to 2019. This was primarily due to a decline in licensing of intellectual property including royalty-based fees compared to the prior year. The timing and amount of licensing, sales or other transfers of IP may vary significantly from period to period depending upon the timing of licensing agreements, economic conditions, industry consolidation and the timing of new patents and know-how development. Other (Income) and Expense ($ in millions) Yr.-to-Yr. Percent For the year ended December 31: 2020 2019 Change Other (income) and expense Foreign currency transaction losses/(gains) $ 114 $ (279) NM (Gains)/losses on derivative instruments (101) 15 NM Interest income (105) (349) (70.0)% Net (gains)/losses from securities and investment assets (22) (32) (31.8) Retirement-related costs/(income) 1,123 615 82.5 Other (149) (937) (84.2) Total consolidated other (income) and expense $ 861 $ (968) NM Non-operating adjustments Amortization of acquired intangible assets (2) (2) — Acquisition-related charges — 154 (100.0) Non-operating retirement-related costs/(income) (1,123) (615) 82.5 Operating (non-GAAP) other (income) and expense $ (265) $(1,431) (81.5)% NM–Not meaningful


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    38 Management Discussion International Business Machines Corporation and Subsidiary Companies Total consolidated other (income) and expense was expense of $861 million in 2020 compared to income of $968 million in 2019. The year-to-year change was primarily driven by: Lower gains from divestitures ($733 million) reflected in Other; Higher non-operating retirement-related costs ($508 million). Refer to “Retirement-Related Plans” for additional information. Net exchange losses (including derivative instruments) in the current year versus net exchange gains (including derivative instruments) in the prior year ($277 million); and Lower interest income ($244 million) driven by lower interest rates and a lower average cash balance in the current year. Operating (non-GAAP) other (income) and expense was $265 million of income in 2020 and decreased $1,167 million compared to the prior-year period. The year-to-year change was primarily driven by the lower gains from divestitures, effects of currency and lower interest income described above. Interest Expense ($ in millions) Yr.-to-Yr. Percent For the year ended December 31: 2020 2019 Change Total consolidated interest expense $1,288 $1,344 (4.2)% Non-operating adjustment Acquisition-related charges — (228) (100.0) Operating (non-GAAP) interest expense $1,288 $1,116 15.4 % Interest expense decreased $56 million compared to 2019. Interest expense is presented in cost of financing in the Consolidated Income Statement only if the related external borrowings are to support the Global Financing external business. Overall interest expense (excluding capitalized interest) in 2020 was $1,738 million, a decrease of $214 million year to year primarily driven by lower average interest rates. Operating (non-GAAP) interest expense increased $172 million compared to the prior-year period. The prior year excluded Red Hat pre-closing debt financing costs and the current year included a full year of interest expense associated with the higher level of debt. Stock-Based Compensation Pre-tax stock-based compensation cost of $937 million increased $258 million compared to 2019. This was primarily due to increases related to a full year of compensation expense associated with the issuances and conversions of stock-based compensation for Red Hat ($167 million) compared to six months in 2019, and issuances of restricted stock units ($91 million). Stock-based compensation cost, and the year-to-year change, was reflected in the following categories: Cost: $153 million, up $53 million; SG&A expense: $586 million, up $134 million; and RD&E expense: $198 million, up $72 million. Retirement-Related Plans The following table provides the total pre-tax cost for all retirement-related plans. Total operating costs/(income) are included in the Consolidated Income Statement within the caption (e.g., Cost, SG&A, RD&E) relating to the job function of the plan participants. ($ in millions) Yr.-to-Yr. Percent For the year ended December 31: 2020 2019 Change Retirement-related plans–cost Service cost $ 406 $ 385 5.5 % Multi-employer plans 29 32 (7.9) Cost of defined contribution plans 1,058 1,040 1.8 Total operating costs/(income) $ 1,494 $ 1,457 2.5 % Interest cost $ 2,203 $ 2,929 (24.8)% Expected return on plan assets (3,448) (4,192) (17.8) Recognized actuarial losses 2,285 1,819 25.7 Amortization of prior service costs/(credits) 13 (9) NM Curtailments/settlements 52 41 28.4 Other costs 18 28 (37.9) Total non-operating costs/(income) $ 1,123 $ 615 82.5 % Total retirement-related plans–cost $ 2,617 $ 2,072 26.3 % NM–Not meaningful Total pre-tax retirement-related plan cost increased by $545 million compared to 2019, primarily driven by lower expected returns on plan assets ($744 million) and an increase in recognized actuarial losses ($467 million), partially offset by lower interest costs ($726 million).


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    Management Discussion 39 International Business Machines Corporation and Subsidiary Companies 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 2020 were $1,494 million, an increase of $37 million compared to 2019. Non-operating costs of $1,123 million in 2020 increased $508 million year to year, driven primarily by the same factors as above. Income Taxes The continuing operations effective tax rate for 2020 was (18.6) percent compared to 7.2 percent in 2019. The decrease in the effective tax rate was primarily driven by a net tax benefit of $0.9 billion related to an intra-entity sale of certain of the company’s intellectual property and related impacts in the first quarter of 2020, and a benefit of $0.2 billion related to a foreign tax law change. The operating (non-GAAP) effective tax rate for 2020 was (1.5) percent compared to 8.5 percent in 2019. The current year operating (non-GAAP) benefit from income taxes was primarily driven by the net tax benefit from the intra-entity IP sale. For more information, see note G, “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. Yr.-to-Yr. Percent For the year ended December 31: 2020 2019 Change Earnings per share of common stock from continuing operations Assuming dilution $6.13 * $10.57 (42.0)% Basic $6.18 * $10.63 (41.9)% Diluted operating (non-GAAP) $8.67 * $12.81 (32.3)% Weighted-average shares outstanding (in millions) Assuming dilution 896.6 892.8 0.4 % Basic 890.3 887.2 0.4 % * The $2.0 billion pre-tax charge for structural actions in the fourth quarter resulted in an impact of ($1.84) to diluted earnings per share from continuing operations and diluted operating (non-GAAP) earnings per share. The impact to basic earnings per share was ($1.85). Actual shares outstanding at December 31, 2020 and 2019 were 892.7 million and 887.1 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 3.8 million shares higher in 2020 versus 2019. Financial Position Dynamics At December 31, 2020, our balance sheet remained strong with flexibility to support the business. We continue to manage the investment portfolio to meet our capital preservation and liquidity objectives. In this unprecedented environment as a result of the COVID-19 pandemic, while we are supporting our clients and improving the flexibility and competitive position of our operations, we took actions to enhance our balance sheet strength and liquidity position. Cash, restricted cash and marketable securities at December 31, 2020 were $14,275 million, an increase of $5,265 million compared to prior year end. Through strategic mitigation actions and re-focus of our Global Financing portfolio, financing receivables declined $4,925 million to $17,979 million as of December 31, 2020. Total debt of $61,538 million decreased $1,361 million from prior year- end. During 2020, we completed bond issuances totaling $8,117 million, with terms ranging from 7 to 30 years, and interest rates ranging from 0.325 to 2.95 percent depending on maturity. We have reduced total debt $11,501 million since the end of the second quarter of 2019 (immediately preceding the Red Hat acquisition). We have consistently generated strong cash flow from operations and continue to have access to additional sources of liquidity through the capital markets and our credit facilities. During 2020, we generated $18,197 million in cash from operating activities, an increase of $3,426 million compared to 2019. The year-to-year increase was primarily driven by the reduction of financing receivables due to sales of receivables. Our free cash flow for 2020 was $10,805 million, a decrease of $1,104 million compared to the prior year. See pages 57 and 58 for additional information on free cash flow. We returned $5,797 million to shareholders through dividends in 2020. We suspended our share repurchase program at the time of the Red Hat closing to focus on debt repayment. At 2020 year end, we had $2.0 billion remaining in share repurchase authorization. Our cash generation permits us to invest and deploy capital to areas with the most attractive long-term opportunities. Consistent with accounting standards, the company remeasured the funded status of our retirement and postretirement plans at December 31. At December 31, 2020, the overall net underfunded position was $11,506 million, an increase of $416 million from December 31, 2019, driven by lower discount rates partially offset by strong asset returns. At year end, our qualified defined benefit


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    40 Management Discussion International Business Machines Corporation and Subsidiary Companies plans were well funded and the required contributions related to these plans and multi-employer plans are expected to be approximately $300 million in both 2021 and 2022. In 2020, the return on the U.S. Personal Pension Plan assets was 12.2 percent and the plan was 108 percent funded at December 31, 2020. Overall, global asset returns were 9.6 percent and the qualified defined benefit plans worldwide were 102 percent funded at December 31, 2020. Global Financing Financial Position Key Metrics ($ in millions) At December 31: 2020 2019 Cash and cash equivalents $ 1,862 $ 1,697 Net investment in sales-type and direct financing leases (1) 4,092 6,224 Equipment under operating leases–external clients (2) 104 238 Client loans 11,498 12,884 Total client financing assets 15,694 19,346 Commercial financing receivables 2,411 3,820 Intercompany financing receivables (3) (4) 3,959 3,870 Total assets $25,075 $29,568 Debt 21,167 24,727 Total equity $ 2,352 $ 2,749 (1) Includes deferred initial direct costs which are expensed in IBM’s consolidated results. (2) Includes intercompany mark-up, priced on an arm’s-length basis, on products purchased from the company’s product divisions which is eliminated in IBM’s consolidated results. (3) Entire amount eliminated for purposes of IBM’s consolidated results and therefore does not appear in the Consolidated Balance Sheet. (4) These assets, along with all other financing assets in this table, are leveraged at the value in the table using Global Financing debt. At December 31, 2020, approximately 61 percent of the total external portfolio was with investment-grade clients with no direct exposure to consumers, a decrease of 4 points year to year and an increase of 4 points compared to September 30, 2020. The reduction in investment grade year to year was driven primarily by credit rating changes within the existing portfolio of clients, partially offset by the wind down of OEM IT commercial financing operations. We continue to apply our rigorous credit policies, particularly in industries and countries disrupted by COVID-19, as it relates to the origination of new business. This investment grade percentage is based on the credit ratings of the companies in the portfolio and reflects mitigating credit enhancement actions taken by the client to reduce the risk to IBM. We have a long-standing practice of taking mitigation actions, in certain circumstances, to transfer credit risk to third parties, with enhanced focus in this unprecedented environment of the COVID-19 pandemic. These actions may include credit insurance, financial guarantees, nonrecourse borrowings, transfers of receivables recorded as true sales in accordance with accounting guidance or sales of equipment under operating lease. Sales of receivables arrangements are also utilized in the normal course of business as part of the company’s cash and liquidity management. During the year ended December 31, 2020, the company sold $2,562 million of client financing receivables, consisting of loan and lease receivables of $1,410 million and $1,152 million, respectively. On December 24, 2020, the company entered into an agreement with a third-party investor to sell up to $3,000 million of IBM short- term commercial financing receivables, at any one time, on a revolving basis. The company sold $515 million of commercial financing receivables under the agreement in the fourth quarter of 2020. In addition, the company included $383 million of commercial financing receivables classified as held for sale at December 31, 2020 in short-term financing receivables in the Consolidated Balance Sheet. The reduction of financing receivables due to these sales resulted in a benefit to cash flows from operating activities, however had no impact to free cash flow. The impact to the Consolidated Income Statement, including fees and net gain or loss associated with the transfer of these receivables for the year ended December 31, 2020, was not material. For additional information relating to the sales of financing receivables refer to note K, “Financing Receivables.” IBM Working Capital ($ in millions) At December 31: 2020 2019 Current assets $39,165 $38,420 Current liabilities 39,869 37,701 Working capital $ (705) $ 718 Current ratio 0.98:1 1.02:1


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    Management Discussion 41 International Business Machines Corporation and Subsidiary Companies Working capital decreased $1,423 million from the year-end 2019 position. The key changes are described below: Current assets increased $745 million ($40 million adjusted for currency) due to: An increase of $5,265 million ($5,064 million adjusted for currency) in cash and cash equivalents, restricted cash and marketable securities; and An increase of $536 million ($446 million adjusted for currency) in total inventory, deferred costs and prepaid expenses and other current assets; partially offset by A decline in receivables of $5,057 million ($5,469 million adjusted for currency) mainly due to sales of financing receivables, continued focus on collections, including collection of divestiture-related receivables and a decline in revenue. Current liabilities increased $2,168 million ($1,121 million adjusted for currency) as a result of: An increase in other accrued expenses and liabilities of $2,491 million ($1,922 million adjusted for currency) primarily due to the fourth-quarter workforce rebalancing charge; and An increase in deferred income of $807 million ($488 million adjusted for currency); and An increase in taxes payable of $462 million ($448 million adjusted for currency); partially offset by A decrease in short-term debt of $1,615 million ($1,552 million adjusted for currency) due to maturities of $9,165 million; partially offset by reclassifications of $7,998 million from long-term debt to reflect upcoming maturities. Receivables and Allowances Roll Forward of Total IBM Receivables Allowance for Credit Losses ($ in millions) Additions/ January 1, 2020 * (Releases) ** Write-offs  Other  December 31, 2020 $ 612 $108 $(85) $ 10 $ 644 * Opening balance does not equal the allowance at December 31, 2019 due to the adoption of the guidance on current expected credit losses. Refer to note B, “Accounting Changes,” for additional information. ** Additions/(Releases) for Allowance for Credit Losses are recorded in expense.  Refer to note A, “Significant Accounting Policies,” for additional information regarding Allowance for Credit Losses write-offs.  Primarily represents translation adjustments. The total IBM receivables provision coverage was 2.4 percent at December 31, 2020, an increase of 60 basis points compared to January 1, 2020. The increase was primarily driven by the overall decline in total receivables and an increase in customer specific provisions. The majority of the write-offs during the year related to receivables which had been previously reserved. Global Financing Receivables and Allowances The following table presents external Global Financing receivables excluding immaterial miscellaneous receivables. ($ in millions) At December 31: 2020 2019 Amortized cost/Recorded investment(1)(2) $18,264 $22,446 Specific allowance for credit losses 184 177 Unallocated allowance for credit losses 79 45 Total allowance for credit losses 263 221 Net financing receivables $18,001 $22,224 Allowance for credit losses coverage 1.4 % 1.0 % (1) Prior to the January 1, 2020 adoption of the guidance on current expected credit losses, the presentation was recorded investment, subsequent to adoption the presentation is amortized cost. Both presentations include deferred initial direct costs which are expensed in IBM’s consolidated results. (2) The amortized cost basis of a financial asset represents the original amount of the financing receivable (including residual value) adjusted for unearned income, deferred initial direct costs, cash collected, write-offs and any foreign exchange adjustment. Recorded investment excluded residual value. Upon the adoption of the guidance on current expected credit losses, the percentage of financing receivables reserved increased from 1.0 percent at December 31, 2019, to 1.1 percent January 1, 2020, primarily driven by a 74.2 percent increase in unallocated reserves.


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    42 Management Discussion International Business Machines Corporation and Subsidiary Companies The percentage of financing receivables reserved increased from 1.1 percent at January 1, 2020, to 1.4 percent at December 31, 2020, which reflects essentially flat unallocated and specific reserves and an overall decline in financing receivables. Roll Forward of Global Financing Receivables Allowance for Credit Losses (included in Total IBM) ($ in millions) Additions/ January 1, 2020 * (Releases) ** Write-offs  Other  December 31, 2020 $ 262 $32 $(36) $4 $263 * Opening balance does not equal the allowance at December 31, 2019 due to the adoption of the guidance on current expected credit losses. Refer to note B, “Accounting Changes,” for additional information. ** Additions/(Releases) for Allowance for Credit Losses are recorded in expense.  Refer to note A, “Significant Accounting Policies,” for additional information regarding Allowance for Credit Loss write-offs.  Primarily represents recoveries of amounts previously written off and translation adjustments. Global Financing’s provision for expected credit losses (including impacts from off-balance sheet commitments which are recorded in other liabilities) was an addition of $34 million in 2020, compared to a release of $7 million in 2019. The increase was primarily driven by higher unallocated and specific reserves in Americas. Noncurrent Assets and Liabilities ($ in millions) At December 31: 2020 2019 Noncurrent assets $116,806 $113,767 Long-term debt $ 54,355 $ 54,102 Noncurrent liabilities (excluding debt) $ 41,020 $ 39,398 The increase in noncurrent assets of $3,039 million ($829 million adjusted for currency) was driven by: An increase in deferred taxes of $4,060 million ($3,915 million adjusted for currency) primarily due to the intra-entity sale of IP in the first quarter; and An increase in prepaid pension assets of $745 million ($526 million adjusted for currency) driven by higher returns on plan assets and plan remeasurements; partially offset by A decrease in long-term financing receivables of $1,626 million ($1,811 million adjusted for currency) as a result of sales of receivables and product cycle dynamics; and A decrease in net intangible assets and goodwill of $44 million ($1,283 million adjusted for currency) resulting from intangibles amortization, partially offset by an increase from new acquisitions. Long-term debt increased $253 million (decreased $1,307 million adjusted for currency) primarily driven by: Issuances of $8,727 million; partially offset by Reclassifications to short-term debt of $7,998 million to reflect upcoming maturities; and Redemption of $2,102 million of certain outstanding bonds. Noncurrent liabilities (excluding debt) increased $1,621 million ($251 million adjusted for currency) primarily driven by: An increase in retirement and nonpension postretirement benefit obligations of $1,106 million ($297 million adjusted for currency) mainly driven by plan remeasurements; and An increase in deferred income of $450 million ($364 million adjusted for currency); partially offset by A decrease in operating lease liabilities of $306 million ($424 million adjusted for currency). Debt Our funding requirements are continually monitored and we execute our strategies to manage the overall asset and liability profile. Additionally, we maintain sufficient flexibility to access global funding sources as needed. ($ in millions) At December 31: 2020 2019 Total company debt $61,538 $62,899 Total Global Financing segment debt $21,167 $24,727 Debt to support external clients 17,819 21,487 Debt to support internal clients 3,348 3,239 Non-Global Financing debt $40,371 $38,173


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    Management Discussion 43 International Business Machines Corporation and Subsidiary Companies Total debt of $61,538 million decreased $1,361 million ($2,859 million adjusted for currency) from December 31, 2019, primarily driven by early retirements and debt maturities of $11,267 million; partially offset by issuances of $8,982 million. Total debt decreased $11,501 million since the end of the second quarter 2019 (immediately preceding the Red Hat acquisition). Non-Global Financing debt of $40,371 million increased $2,199 million ($1,046 million adjusting for currency) from December 31, 2019, but has decreased $7,685 million since June 30, 2019. Global Financing debt of $21,167 million decreased $3,560 million from December 31, 2019 ($3,905 million adjusting for currency), primarily due to lower funding requirements as a result of the decline in financing assets, consistent with the company’s portfolio management strategy. Global Financing provides financing predominantly for IBM’s external client assets, as well as for assets under contract by other IBM units. These assets, primarily for GTS, generate long-term, stable revenue streams similar to the Global Financing asset portfolio. Based on their attributes, these GTS assets are leveraged with the balance of the Global Financing asset base. The debt used to fund Global Financing assets is composed of intercompany loans and external debt. Total debt changes generally correspond with the level of client and commercial financing receivables, the level of cash and cash equivalents, the change in intercompany and external payables and the change in intercompany investment from IBM. The terms of the intercompany loans are set by the company to substantially match the term, currency and interest rate variability underlying the financing receivable and are based on arm’s-length pricing. The Global Financing debt-to-equity ratio remained at 9 to 1 at December 31, 2020. We measure Global Financing as a stand-alone entity, and accordingly, interest expense relating to debt supporting Global Financing’s external client and internal business is included in the “Global Financing Results of Operations” and in note D, “Segments.” In the Consolidated Income Statement, the external debt-related interest expense supporting Global Financing’s internal financing to IBM is reclassified from cost of financing to interest expense. Equity Total equity decreased by $258 million from December 31, 2019, primarily due to dividends paid of $5,797 million and a decline in accumulated other comprehensive income of $740 million mainly due to foreign currency translation adjustments; partially offset by increases from net income of $5,590 million and common stock of $661 million. Cash Flow Our cash flows from operating, investing and financing activities, as reflected in the Consolidated Statement of Cash Flows on page 71 are summarized in the table below. These amounts include the cash flows associated with the Global Financing business. ($ in millions) For the year ended December 31: 2020 2019 Net cash provided by/(used in) continuing operations Operating activities $18,197 $ 14,770 Investing activities (3,028) (26,936) Financing activities (9,721) 9,042 Effect of exchange rate changes on cash, cash equivalents and restricted cash (87) (167) Net change in cash, cash equivalents and restricted cash $ 5,361 $ (3,290) Net cash provided by operating activities increased $3,426 million in 2020 driven by the following key factors: An increase of cash provided by receivables of $4,795 million primarily driven by sales of receivables, including sales of financing receivables of $3,076 million; and Payroll tax and value-added tax payment deferrals and exemptions of approximately $600 million due to tax relief provided under the U.S. CARES Act and other non-U.S. government assistance programs related to COVID-19; partially offset by An increase in workforce rebalancing payments of $293 million; A net increase in cash payments for income taxes of $162 million primarily driven by withholding tax on intercompany dividends in the second quarter; and Performance-related declines within net income. Net cash used in investing activities decreased $23,908 million driven by: A decrease in net cash used for acquisitions of $32,294 million due to the Red Hat acquisition in the prior year; partially offset by A decrease of $6,245 million in cash provided by net non-operating finance receivables primarily driven by the wind down of the OEM IT commercial financing operations; An increase in cash used for net purchases of marketable securities and other investments of $896 million;


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    44 Management Discussion International Business Machines Corporation and Subsidiary Companies An increase in cash used for net capital expenditures of $672 million; and A decrease in cash provided from divestitures of $573 million. Financing activities were a net use of cash of $9,721 million in 2020 compared to a net source of cash of $9,042 million in 2019. The year-to-year change of $18,763 million was driven by: A decrease in net cash provided by debt transactions of $19,998 million driven primarily by a higher level of net additions in the prior year to fund the Red Hat acquisition; partially offset by A decrease in cash used for gross common share repurchases of $1,361 million. Global Financing Return on Equity Calculation ($ in millions) At December 31: 2020 2019 Numerator Global Financing after-tax income (1) * $ 635 $ 765 Denominator Average Global Financing equity (2) ** $2,465 $2,968 Global Financing return on equity (1)/(2) 25.8 % 25.8 % * Calculated based upon an estimated tax rate principally based on Global Financing’s geographic mix of earnings as IBM’s provision for income taxes is determined on a consolidated basis. ** Average of the ending equity for Global Financing for the last five quarters.


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    Management Discussion 45 International Business Machines Corporation and Subsidiary Companies GAAP Reconciliation The tables below provide a reconciliation of our income statement results as reported under GAAP to our operating earnings presentation which is a non-GAAP measure. Management’s calculation of operating (non-GAAP) earnings, as presented, may differ from similarly titled measures reported by other companies. Please refer to the “Operating (non-GAAP) Earnings” section for management’s rationale for presenting operating earnings information. ($ in millions except per share amounts) Acquisition- Retirement- U.S. Tax Spin-off- Related Related Reform Related Operating For the year ended December 31, 2020: GAAP Adjustments Adjustments Impacts Charges (non-GAAP) Gross profit $35,575 $ 732 $ — $ — $ 1 $36,308 Gross profit margin 48.3 % 1.0 pts. — pts. — pts. 0.0 pts. 49.3 % SG&A $23,082 * $(1,137) $ — $ — $ (28) $21,917 * RD&E 6,333 — — — — 6,333 Other (income) and expense 861 (2) (1,123) — — (265) Interest expense 1,288 — — — — 1,288 Total expense and other (income) 30,937 * (1,139) (1,123) — (28) 28,648 * Pre-tax income from continuing operations 4,637 * 1,871 1,123 — 28 7,660 * Pre-tax margin from continuing operations 6.3 % 2.5 pts. 1.5 pts. — pts. 0.0 pts. 10.4 % Provision for/(benefit from) income taxes** $ (864) $ 418 $ 215 $ 110 $ 7 $ (114) Effective tax rate (18.6)% 10.0 pts. 5.5 pts. 1.4 pts. 0.2 pts. (1.5)% Income from continuing operations $ 5,501 * $ 1,454 $ 908 $ (110) $ 21 $ 7,774 * Income margin from continuing operations 7.5 % 2.0 pts. 1.2 pts. (0.1)pts. 0.0 pts. 10.6 % Diluted earnings per share from continuing operations $ 6.13 * $ 1.63 $ 1.01 $(0.12) $0.02 $ 8.67 * * Includes a $2.0 billion pre-tax charge for structural actions in the fourth quarter resulting in an impact of ($1.84) to diluted earnings per share from continuing operations and diluted operating (non-GAAP) earnings per share. ** The tax impact on operating (non-GAAP) pre-tax income is calculated under the same accounting principles applied to the GAAP pre-tax income which employs an annual effective tax rate method to the results. ($ in millions except per share amounts) Acquisition- Retirement- U.S. Tax Spin-off- Related Related Reform Related Operating For the year ended December 31, 2019: GAAP Adjustments Adjustments Impacts Charges (non-GAAP) Gross profit $36,488 $ 547 $ — $ — $ — $37,035 Gross profit margin 47.3 % 0.7 pts. — pts. — pts. — pts. 48.0 % SG&A $20,604 $(1,044) $ — $ — $ — $19,560 RD&E 5,989 (53) — — — 5,936 Other (income) and expense (968) 152 (615) — — (1,431) Interest expense 1,344 (228) — — — 1,116 Total expense and other (income) 26,322 (1,173) (615) — — 24,533 Pre-tax income from continuing operations 10,166 1,721 615 — — 12,503 Pre-tax margin from continuing operations 13.2 % 2.2 pts. 0.8 pts. — pts. — pts. 16.2 % Provision for income taxes* $ 731 $ 378 $ 103 $(146) $ — $ 1,067 Effective tax rate 7.2 % 2.0 pts. 0.5 pts. (1.2)pts. — pts. 8.5 % Income from continuing operations $ 9,435 $ 1,343 $ 512 $ 146 $ — $11,436 Income margin from continuing operations 12.2 % 1.7 pts. 0.7 pts. 0.2 pts. — pts. 14.8 % Diluted earnings per share from continuing operations $ 10.57 $ 1.50 $ 0.58 $0.16 $ — $ 12.81 * The tax impact on operating (non-GAAP) pre-tax income is calculated under the same accounting principles applied to the GAAP pre-tax income which employs an annual effective tax rate method to the results.


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    46 Management Discussion International Business Machines Corporation and Subsidiary Companies Consolidated Fourth-Quarter Results ($ and shares in millions except per share amounts) Yr.-to-Yr. Percent/ Margin For the fourth quarter: 2020 2019 Change Revenue $20,367 $21,777 (6.5)%* Gross profit margin 51.7 % 51.0 % 0.7 pts. Total expense and other (income) $ 9,234 ** $ 7,107 29.9 % Income from continuing operations before income taxes $ 1,289 ** $ 3,993 (67.7)% Provision for income taxes from continuing operations $ 25 $ 324 (92.3)% Income from continuing operations $ 1,264 ** $ 3,669 (65.5)% Income from continuing operations margin 6.2 % 16.8 % (10.6)pts.  Income from discontinued operations, net of tax  $ 92 $ 0 NM Net income $ 1,356 ** $ 3,670 (63.0)% Earnings per share from continuing operations–assuming dilution $ 1.41 ** $ 4.11 (65.7)% Weighted-average shares outstanding–assuming dilution 899.0 893.7 0.6 % * (8.6) percent adjusted for currency; (8.4) percent excluding divested businesses and adjusted for currency. ** Includes a $2.0 billion pre-tax charge for structural actions resulting in an impact to diluted earnings per share from continuing operations of ($1.84).  Relates to discontinued operations of Microelectronics, divested in 2015. NM–Not meaningful The following table provides operating (non-GAAP) earnings for the fourth quarter of 2020 and 2019. See page 52 for additional information. ($ in millions except per share amounts) Yr.-to-Yr. Percent For the fourth quarter: 2020 2019 Change Net income as reported $1,356 * $3,670 (63.0)% Income from discontinued operations, net of tax** 92 0 NM Income from continuing operations $1,264 * $3,669 (65.5)% Non-operating adjustments (net of tax) Acquisition-related charges 359 376 (4.4) Non-operating retirement-related costs/(income) 198 175 13.4 U.S. tax reform impacts 18 (14) NM Spin-off-related charges 21 — NM Operating (non-GAAP) earnings $1,861 * $4,206 (55.8)% Diluted operating (non-GAAP) earnings per share $ 2.07 * $ 4.71 (56.1)% * Includes a $2.0 billion pre-tax charge for structural actions resulting in an impact to diluted operating (non-GAAP) earnings per share of ($1.84). ** Relates to discontinued operations of Microelectronics, divested in 2015. NM–Not meaningful Snapshot In the fourth quarter of 2020, we reported $20.4 billion in revenue and income from continuing operations of $1.3 billion, which included a $2.0 billion pre-tax charge for structural actions (primarily workforce rebalancing) to simplify and optimize our operating model. Fourth quarter operating (non-GAAP) earnings were $1.9 billion, which also included the charge for workforce rebalancing. Diluted earnings per share from continuing operations was $1.41 as reported and $2.07 on an operating (non-GAAP) basis. We generated $5.9 billion in cash from operations, $6.1 billion in free cash flow and delivered shareholder returns of $1.5 billion in dividends. While challenges related to macroeconomic uncertainty and product cycle dynamics continued, our fourth-quarter results reflect strong performance in hybrid cloud led by Red Hat, gross margin expansion and solid cash generation. Total consolidated revenue decreased 6.5 percent as reported and 9 percent adjusted for currency compared to the prior year. Excluding divested businesses, revenue was down 6.2 percent as reported and 8 percent adjusted for currency. Cloud & Cognitive Software decreased 4.5 percent as reported and 7 percent adjusted for currency. Within this segment, Cloud & Data Platforms grew 8.8 percent (6 percent adjusted for currency) with Red Hat delivering double-digit growth across infrastructure software and application development and emerging technologies. Cognitive Applications increased 0.2 percent as reported but decreased 2 percent adjusted for currency and Transaction Processing Platforms decreased 23.8 percent (26 percent adjusted for currency). GBS decreased 2.7 percent as reported and 5 percent adjusted for currency but improved sequentially from the third quarter. Cloud revenue within GBS grew at a double-digit rate and GPS revenue returned to growth in the fourth quarter. GTS decreased 5.5 percent as reported and 8 percent adjusted for currency, with declines in Infrastructure & Cloud Services and Technology Support Services. Systems decreased 17.8 percent as reported and 19 percent adjusted for currency primarily driven by product cycle dynamics. Across the


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    Management Discussion 47 International Business Machines Corporation and Subsidiary Companies segments, total IBM cloud revenue of $7.5 billion in the fourth quarter of 2020 grew 10 percent as reported (7 percent adjusted for currency) and 8 percent excluding divested businesses and adjusted for currency. From a geographic perspective, Americas revenue decreased 10.5 percent year to year as reported (10 percent excluding divested businesses and adjusted for currency). EMEA decreased 3.1 percent (8 percent excluding divested businesses and adjusted for currency). Asia Pacific declined 2.0 percent year to year as reported (5 percent excluding divested businesses and adjusted for currency). The consolidated gross margin of 51.7 percent increased 0.7 points year to year and the operating (non-GAAP) gross margin of 52.5 percent increased 0.7 points with margin expansion across software, services and systems. Total expense and other (income) increased 29.9 percent in the fourth quarter of 2020 versus the prior-year period primarily driven by the workforce rebalancing charge, lower gains from divestitures and the impact of currency. These increases were partially offset by lower spending including reduced travel and other expenses associated with COVID-19 restrictions. Total operating (non-GAAP) expense and other (income) increased 30.8 percent year to year, driven primarily by the same factors. Pre-tax income from continuing operations of $1.3 billion decreased 67.7 percent and the pre-tax margin was 6.3 percent, a decrease of 12.0 points versus the prior-year period, primarily due to the workforce rebalancing charge. The continuing operations effective tax rate for the fourth quarter of 2020 was 1.9 percent compared to an effective tax rate of 8.1 percent in the fourth quarter of 2019. Net income from continuing operations was $1.3 billion, a decrease of 65.5 percent year to year. The net income margin from continuing operations was 6.2 percent, a decrease of 10.6 points from the prior-year period. Operating (non-GAAP) pre-tax income from continuing operations of $2.1 billion decreased 55.8 percent year to year and the operating (non-GAAP) pre-tax margin from continuing operations decreased 11.4 points to 10.2 percent, primarily due to the workforce rebalancing charge. The operating (non-GAAP) effective tax rate from continuing operations in the fourth quarter of 2020 was 10.4 percent versus 10.5 percent in the prior year. Operating (non-GAAP) income from continuing operations of $1.9 billion decreased 55.8 percent with an operating (non-GAAP) income margin from continuing operations of 9.1 percent, down 10.2 points year to year. Diluted earnings per share from continuing operations of $1.41 in the fourth quarter of 2020 decreased 65.7 percent and operating (non-GAAP) diluted earnings per share of $2.07 decreased 56.1 percent versus the fourth quarter of 2019.


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    48 Management Discussion International Business Machines Corporation and Subsidiary Companies Segment Details The following is an analysis of the fourth quarter of 2020 versus the fourth quarter of 2019 reportable segment external revenue and gross margin results. Segment pre-tax income includes transactions between the segments that are intended to reflect an arm’s-length transfer price and excludes certain unallocated corporate items. ($ in millions) Yr.-to-Yr. Yr.-to-Yr. Percent/ Percent Change Margin Adjusted for For the fourth quarter: 2020 2019 Change Currency Revenue Cloud & Cognitive Software $ 6,837 $ 7,160 * (4.5)% (6.6)% Gross margin 79.8 % 79.5 %* 0.2 pts. Global Business Services 4,170 4,285 * (2.7)% (5.2)% Gross margin 30.1 % 27.6 %* 2.6 pts. Global Technology Services 6,568 6,949 (5.5)% (7.8)% Gross margin 35.9 % 35.2 % 0.7 pts. Systems 2,501 3,042 (17.8)% (19.4)% Gross margin 59.9 % 56.0 % 3.8 pts. Global Financing 286 301 (4.8)% (6.0)% Gross margin 33.8 % 35.6 % (1.8)pts. Other 6 40 * (84.8)% (84.1)% Gross margin NM (84.2)%* NM Total consolidated revenue $20,367 $21,777 (6.5)%** (8.6)% Total consolidated gross profit $10,523 $11,100 (5.2)% Total consolidated gross margin 51.7 % 51.0 % 0.7 pts. Non-operating adjustments Amortization of acquired intangible assets 177 189 (6.5)% Spin-off-related charges 1 — NM Operating (non-GAAP) gross profit $10,700 $11,289 (5.2)% Operating (non-GAAP) gross margin 52.5 % 51.8 % 0.7 pts. * Recast to reflect segment changes. ** (8.4) percent excluding divested businesses and adjusted for currency. NM–Not meaningful Cloud & Cognitive Software Cloud & Cognitive Software revenue of $6,837 million decreased 4.5 percent as reported (7 percent adjusted for currency) in the fourth quarter of 2020 compared to the prior year. The year-to-year decline in our software performance reflects the continued challenging transactional environment due to the macroeconomic environment in the fourth quarter of 2020. Since the fourth quarter is seasonally our largest transactional quarter, this was more impactful than in other quarters in 2020. Additionally, we had strong software performance in the fourth quarter of 2019, the peak in our enterprise license agreement (ELA) cycle, where clients renew, on average, about every three years. With the uncertainty our clients are facing in the current environment, many clients opted for shorter duration ELAs. This dynamic, in combination with the large seasonal volume of ELAs in the fourth quarter, impacted our software revenue performance. We had strong year-to-year renewal rates for subscription and support in the fourth-quarter 2020, reflecting our clients’ commitment to our critical software solutions. We had solid growth in Cloud & Data Platforms led by Red Hat’s continued strong performance. Cognitive Applications grew slightly as reported, but declined adjusted for currency. Transaction Processing Platforms declined as reported and adjusted for currency. We had double-digit growth in total cloud revenue within the segment as reported and adjusted for currency. In the fourth quarter, Cloud & Data Platforms revenue of $3,373 million increased 8.8 percent as reported (6 percent adjusted for currency) compared to the prior year, reflecting clients’ adoption of our hybrid cloud and AI solutions, including Red Hat and Cloud Paks. Red Hat continued its strong performance with double-digit revenue growth in the fourth quarter, driven by subscription growth. Red Hat’s strong growth was driven by offerings in infrastructure software and application development and emerging technologies. We are expanding our integration offerings, bringing AI-powered automation across the portfolio through key partnerships and new innovation. We continued to enhance Cloud Pak for Automation, which grew at a strong double-digit rate in the fourth quarter of 2020. Cognitive Applications revenue of $1,545 million grew 0.2 percent year to year as reported, but declined 2 percent adjusted for currency, with growth in security. The growth in security reflects clients’ interest in our modernized Cloud Pak for Security and services. We had declining performance in solutions concentrated in industries impacted more severely by the current environment, such as TRIRIGA, which is focused on commercial real estate.


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    Management Discussion 49 International Business Machines Corporation and Subsidiary Companies Transaction Processing Platforms revenue of $1,919 million decreased 23.8 percent as reported (26 percent adjusted for currency) reflecting our clients’ prioritization of operating expenditures over capital expenditures, which was amplified this quarter, given our strong seasonal mix toward transactional revenue and the ELA dynamics in the fourth-quarter 2020 compared to the prior-year period. Within Cloud & Cognitive Software, total cloud revenue of $2.2 billion grew 39 percent as reported (36 percent adjusted for currency), which reflects our clients’ demand for our hybrid cloud and AI solutions. Cloud & Cognitive Software gross profit margin of 79.8 percent increased 0.2 points during the fourth quarter of 2020 compared to the prior year. Pre-tax income of $1,887 million decreased 30.8 percent compared to the prior year and pre-tax margin decreased 9.8 points to 24.9 percent, driven primarily by the workforce rebalancing charge taken in the fourth-quarter 2020, which had 8.2 points of impact on the pre-tax margin. Global Business Services GBS revenue of $4,170 million decreased 2.7 percent as reported (5 percent adjusted for currency) in the fourth quarter of 2020 compared to the prior year, but reflects a sequential year-to-year improvement versus the third-quarter 2020. Total cloud revenue within the segment grew at a double-digit rate year to year, and Global Process Services revenue returned to growth in the fourth- quarter 2020. This growth was offset by declines in Application Management and Consulting. While there remains some market uncertainty, especially in industries more severely impacted by the current environment, our clients are focused on accelerating their digital reinventions by leveraging business transformation services built on hybrid cloud. Our offerings are aligned to this high-value opportunity with a clear focus on reimagining workflows using AI and modernizing the underlying application infrastructures through hybrid cloud. Consulting revenue of $2,110 million decreased 0.4 percent as reported (3 percent adjusted for currency). We had continued growth in Cloud Application Development, DevOps and Cloud services such as SAP S/4HANA implementations, offset by declines in on- premise engagements. Consulting signings grew 11 percent as reported (8 percent adjusted for currency) driven by advisory work for application modernization and enabled by our unique and experiential Garage methodology. Application Management revenue of $1,801 million decreased 6.3 percent as reported (9 percent adjusted for currency), reflecting a continued shift away from traditional on-premise application management services to building and managing our clients’ cloud applications. Our incumbency in Application Management creates an opportunity, and trust, with our clients to be the partner of choice for their digital journey. This incumbency also drives adoption of Red Hat’s hybrid cloud platform. In 2020, our GBS Red Hat engagements accelerated through the year, with 75 new engagements in the fourth quarter. We are continuing this momentum by investing in ecosystems, resources, offerings and skills, and through the acquisitions announced in the fourth-quarter 2020 which will add to our offerings in areas such as cloud development, cloud migration, platform engineering and digital transformation. Global Process Services (GPS) revenue of $258 million increased 6.2 percent as reported (4 percent adjusted for currency). GPS returned to revenue growth in the fourth-quarter 2020, as we delivered efficiency and flexibility to our clients’ processes through innovative technology and redesign of workflows. Within GBS, cloud revenue of $1.7 billion grew 16 percent as reported (14 percent adjusted for currency) year to year. GBS fourth-quarter gross profit margin of 30.1 percent increased 2.6 points year to year. Pre-tax income of $148 million decreased 68.5 percent year to year and the pre-tax margin decreased 7.3 points to 3.5 percent. The gross profit margin expansion was driven primarily by improved delivery quality resulting from our investment in innovative delivery capabilities. The decline in pre-tax income and margin reflects the workforce rebalancing charge taken in the fourth quarter of 2020, which had 8.8 points of impact on the pre- tax margin. Global Technology Services GTS revenue of $6,568 million decreased 5.5 percent as reported (8 percent adjusted for currency). In the fourth quarter, Infrastructure & Cloud Services revenue declined as reported and adjusted for currency. We had strong growth in cloud revenue, which was offset by a decline in client business volumes. Technology Support Services revenue declined as reported and adjusted for currency due to Systems’ product cycle dynamics. Infrastructure & Cloud Services revenue of $5,006 million decreased 5.2 percent as reported (8 percent adjusted for currency). We continued to prioritize high-value opportunities and rescope contracts with our clients to provide long-term value. While these actions impacted our revenue performance this quarter, they contributed to improved gross margin. We had strong contract renewals in the fourth quarter and signed eleven new logo deals. This was one of the strongest new logo signings periods in the last two years and more than doubled the number signed in the fourth quarter of 2019. However, with our announcement in October 2020 of the spin-off of our managed infrastructure services business, some client negotiations were extended, resulting in the delay of some transactions in the fourth quarter. We are working with our clients to ensure a smooth transition to NewCo after the separation and the positive

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