IBM OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2021 Snapshot
Financial Results Summary - Three Months Ended
Yr. to Yr.
Percent/
(Dollars and shares in millions except per share
amounts) Margin
For the three months ended June 30: 2021 2020
Change
Revenue $ 18,745 $ 18,123 3.4 %*
Gross profit margin 48.0 % 48.0 % 0.0 pts.
Total expense and other (income) $ 7,451 $ 7,129 4.5 %
Income from continuing operations before income
taxes $ 1,552 $ 1,571 (1.2) %
Provision for income taxes from continuing
operations $ 227 $ 209 8.8 %
Income from continuing operations $ 1,325 $ 1,362 (2.7) %
Income from continuing operations margin 7.1 % 7.5 % (0.4) pts.
Net income $ 1,325 $ 1,361 (2.7) %
Earnings per share from continuing operations -
assuming dilution $ 1.47 $ 1.52 (3.3) %
Weighted-average shares outstanding - assuming
dilution 904.2 894.9 1.0 %
* (0.6) percent adjusted for currency; (0.5) percent excluding divested businesses and adjusted for currency.
OnOctober 8, 2020 , we announced our plan to separate our managed infrastructure services unit of ourGlobal Technology Services (GTS) segment into a new public company. The managed infrastructure services unit is comprised of outsourcing and other infrastructure modernization and management services, and the name of the new company will be Kyndryl. The separation is expected to be achieved through aU.S. federal tax-free spin-off toIBM 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 Kyndryl as discontinued operations after separation.
Currency:
The references to "adjusted for currency" or "at constant currency" in the Management Discussion do not include operational impacts that could result from fluctuations in foreign currency rates. When we refer to growth rates at constant currency or adjust such growth rates for currency, it is done so that certain financial results can be viewed without the impact of fluctuations in foreign currency exchange rates, thereby facilitating period-to-period comparisons of business performance. Financial results adjusted for currency are calculated by translating current period activity in local currency using the comparable prior-year period's currency conversion rate. This approach is used for countries where the functional currency is the local currency. Generally, when the dollar either strengthens or weakens against other currencies, the growth at constant currency rates or adjusting for currency will be higher or lower than growth reported at actual exchange rates. Refer to "Currency Rate Fluctuations" for additional information.
Revenue Adjusted for Divested Businesses and Constant Currency:
To provide better transparency on the recurring performance of the ongoing business, the company provides total revenue, geographic revenue and cloud revenue growth rates excluding divested businesses and at constant currency. These divested businesses are included in the category "Other-divested businesses."
48
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Management Discussion - (continued)
Operating (non-GAAP) Earnings:
In an effort to provide better transparency into the operational results of the business, supplementally, management separates business results into operating and non-operating categories. Operating earnings from continuing operations is a non-GAAP measure that excludes the effects of certain acquisition-related charges, intangible asset amortization, expense resulting from basis differences on equity method investments, retirement-related costs, discontinued operations and certain Kyndryl separation-related charges and their related tax impacts. Due to the unique, non-recurring nature of the enactment of theU.S. Tax Cuts and Jobs Act (U.S. tax reform), management characterizes the one-time provisional charge recorded in the fourth quarter of 2017 and adjustments to that charge as non-operating. Adjustments include true-ups, accounting elections and any changes to regulations, laws, audit adjustments, etc. that affect the recorded one-time charge. Management also characterizes direct and incremental charges incurred to accomplish the Kyndryl separation as non-operating given their unique and non-recurring nature. These charges primarily relate to transaction and third-party support costs, business separation and applicable employee retention fees, pension settlement charges and related tax charges. All other spending for Kyndryl is included in both earnings from continuing operations and in operating (non-GAAP) earnings. For acquisitions, operating (non-GAAP) earnings exclude the amortization of purchased intangible assets and acquisition-related charges such as in-process research and development, transaction costs, applicable retention, restructuring and related expenses, tax charges related to acquisition integration and pre-closing charges, such as financing costs. These charges are excluded as they may be inconsistent in amount and timing from period to period and are significantly impacted by the size, type and frequency of the company's acquisitions. All other spending for acquired companies is included in both earnings from continuing operations and in operating (non-GAAP) earnings. Throughout the Management Discussion, the impact of acquisitions over the prior 12-month period may be a driver of higher expense year to year. For retirement-related costs, management characterizes certain items as operating and others as non-operating, consistent with GAAP. We include defined benefit plan and nonpension postretirement benefit plan service costs, multi-employer plan costs and the cost of defined contribution plans in operating earnings. Non-operating retirement-related costs include defined benefit plan and nonpension postretirement benefit plan amortization of prior service costs, interest cost, expected return on plan assets, amortized actuarial gains/losses, the impacts of any plan curtailments/settlements and pension insolvency costs and other costs. Non-operating retirement-related costs are primarily related to changes in pension plan assets and liabilities which are tied to financial market performance, and the company considers these costs to be outside of the operational performance of the business. Overall, management believes that supplementally providing investors with a view of operating earnings as described above provides increased transparency and clarity into both the operational results of the business and the 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. 49 Table of Contents
Management Discussion - (continued)
The following table provides the company's operating (non-GAAP) earnings for the second quarter of 2021 and 2020.
Yr. to Yr.
(Dollars in millions except per share amounts) Percent
For the three months ended June 30: 2021 2020 Change Net income as reported$ 1,325 $ 1,361 (2.7) % Income/(loss) from discontinued operations, net of tax - (1) (100.0) Income from continuing operations$ 1,325 $ 1,362 (2.7) % Non-operating adjustments (net of tax): Acquisition-related charges$ 373 $ 365 2.0 % Non-operating retirement-related costs/(income) 261
222 17.4 U.S. tax reform impacts 14 - nm Separation-related charges 131 - nm
Operating (non-GAAP) earnings*$ 2,103 $ 1,949 7.9 %
Diluted operating (non-GAAP) earnings per share*
6.9 %
* Refer to page 89 for a more detailed reconciliation of net income to operating earnings and operating earnings per share.
nm - not meaningful Separation of Kyndryl:
IBM is redefining its future as a hybrid cloud platform and AI company. TheOctober 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.IBM will focus on its open hybrid cloud platform and AI capabilities to accelerate clients' digital transformations. Upon separation, Kyndryl 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. BothIBM and Kyndryl 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 continue to make good progress on executing the necessary financial, legal and regulatory milestones to enable the separation and remain on track to complete the separation by the end of 2021. Environmental Dynamics: OnMarch 11, 2020 , theWorld Health Organization (WHO ) declared the novel coronavirus (COVID-19) a global pandemic which resulted in significant governmental measures being initiated around the globe to slow down and control the spread of the virus. The health ofIBM employees, our clients, business partners and community continue to be our primary focus. We are actively engaged to ensure our plans continue to be aligned with recommendations of theWHO , theU.S. Centers for Disease Control and Prevention and governmental regulations. This environment has only reinforced the need for clients to modernize their businesses to succeed in this new normal, with hybrid cloud and AI at the core of their digital transformations. The reliance on technology, particularly hybrid cloud and AI technologies that give clients the scalability and flexibility needed to adjust to the rapid market changes, has become more acute. We are helping to advise, build, move and manage our clients' journey to the cloud, working with our clients to apply AI, automation and other technologies to make their workflows more intelligent and responsive and partnering with clients to help them enhance employee engagement and productivity, reskill the workforce faster and reimagine ways of working. We expect the rate and pace of recovery from the pandemic to differ by geography and industry. However, the spending environment continues to improve and the economy is reopening in many parts of the world, such as theU.S. ,Canada and several countries inWestern Europe . From an industry standpoint, we have seen meaningful improvement in areas most affected by the pandemic such as travel, transportation, automotive and industrial products. 50
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Management Discussion - (continued)
The underlying fundamentals of our business continue to remain sound and provide some level of stability in our revenue, profit and cash as we continue to manage through this macroeconomic uncertainty. As the world recovers from the effects of the pandemic,IBM continues to be well positioned to support our clients
to emerge even stronger.
Financial Performance Summary - Three Months Ended
In the second quarter of 2021, we reported$18.7 billion in revenue,$1.3 billion in income from continuing operations and operating (non-GAAP) earnings of$2.1 billion , resulting in diluted earnings per share from continuing operations of$1.47 as reported and$2.33 on an operating (non-GAAP) basis. We also generated$2.6 billion in cash from operations,$1.0 billion in free cash flow, which includes$0.6 billion of cash impacts from the structural actions initiated in the fourth quarter of 2020 and Kyndryl separation-related charges, and delivered shareholder returns of$1.5 billion through dividends. These results reflect continued progress in our revenue performance, gross profit dollar expansion and our balance sheet and liquidity position remains strong. Total consolidated revenue increased 3.4 percent as reported but was flat excluding divested businesses and adjusted for currency compared to the prior-year period. With the economy reopening in many parts of the world, the overall spend environment continues to improve, including in some industries that had been most impacted by the pandemic. On a segment basis, Cloud &Cognitive Software increased 6.1 percent as reported and 2 percent adjusted for currency with improvement in year-to-year growth compared to the last quarter. This performance was led by growth across both Cloud & Data Platforms and Cognitive Applications, partially offset by a decline in Transaction Processing Platforms. Cloud & Data Platforms grew 11.5 percent as reported (8 percent adjusted for currency) led by hybrid cloud platform andCloud Pak growth. Cognitive Applications increased 11.6 percent (8 percent adjusted for currency) led by growth in Security and AI applications. Global Business Services (GBS) increased 11.6 percent as reported (7 percent adjusted for currency) as clients accelerate the rate and pace of their digital transformations. GBS revenue returned to pre-pandemic levels this quarter with growth across all lines of business. GTS increased 0.4 percent as reported but decreased 4 percent adjusted for currency with a modest improvement in year-to-year performance compared to the first quarter of 2021, driven by improving trends in client-based business volumes and project activity. Systems decreased 7.3 percent as reported (10 percent adjusted for currency) reflecting product cycle dynamics acrossIBM
Z, Power and Storage. Total cloud revenue of$7.0 billion in the second quarter of 2021 grew 13 percent as reported (9 percent adjusted for currency and excluding divested businesses and adjusted for currency). Over the trailing 12 months, total cloud revenue was$27.0 billion , up 15 percent as reported (12 percent adjusted for currency) and 13 percent excluding divested businesses and adjusted for currency. From a geographic perspective,Americas revenue grew 4.4 percent year to year as reported (3 percent adjusted for currency).Europe /Middle East /Africa (EMEA) increased 6.0 percent as reported but decreased 3 percent adjusted for currency.Asia Pacific declined 2.3 percent year to year as reported (5 percent adjusted for currency). Total consolidated gross margin of 48.0 percent was flat year to year, while gross profit dollars increased 3.5 percent compared to the prior-year period. The operating (non-GAAP) gross margin of 49.3 percent increased 0.3 points versus the prior-year period reflecting actions taken to streamline and simplify our operating model. Total expense and other (income) of$7.5 billion increased 4.5 percent in the second quarter of 2021 versus the prior-year period. Our expense dynamics reflect a higher level of investment in innovation, skills and our ecosystem as we execute our hybrid cloud and AI strategy. We are aggressively hiring, scaling our garage footprint, increasing our research spend in areas including quantum, hybrid cloud and AI, and expanding our ecosystem. The year-to-year increase in expense was also driven by the effects of currency, separation-related charges in the current-year period, lower IP income and higher non-operating retirement-related costs, partially offset by a benefit from expected credit loss expense, lower workforce rebalancing charges and lower interest expense in the current-year period. Total operating (non-GAAP) expense and other (income) increased 2.1 percent year to year, driven primarily by the factors above excluding separation-related charges and higher non-operating retirement-related costs. 51 Table of Contents
Management Discussion - (continued)
The pre-tax income from continuing operations of$1.6 billion decreased 1.2 percent year to year, and the pre-tax margin from continuing operations was 8.3 percent, a decrease of 0.4 points. The continuing operations provision for income taxes was$0.2 billion in both the second quarter of 2021 and 2020. Net income from continuing operations of$1.3 billion decreased 2.7 percent, and the net income margin from continuing operations was 7.1 percent, a decrease of
0.4 points year to year. Operating (non-GAAP) pre-tax income from continuing operations of$2.5 billion increased 9.3 percent year to year and the operating (non-GAAP) pre-tax margin from continuing operations increased 0.7 points to 13.5 percent. The operating (non-GAAP) provision for income taxes was$0.4 billion in both the second quarter of 2021 and 2020. Operating (non-GAAP) income from continuing operations of$2.1 billion increased 7.9 percent with an operating (non-GAAP) income margin from continuing operations of 11.2 percent, up 0.5 points year to year. Diluted earnings per share from continuing operations of$1.47 in the second quarter of 2021 decreased 3.3 percent and operating (non-GAAP) diluted earnings per share of$2.33 increased 6.9 percent versus the second quarter of 2020. Diluted earnings per share from continuing operations includes impacts related to the amortization of purchased intangibles assets and other acquisition-related charges, retirement-related charges,U.S. tax reform enactment impacts and Kyndryl separation-related charges. The impact of the Kyndryl separation-related charges for second-quarter 2021 was ($0.15 ) per share. We generated$2.6 billion in cash flow provided by operating activities, a decrease of$1.0 billion compared to the second quarter of 2020, primarily driven by payroll tax and value-added tax payment deferrals and exemptions of$0.6 billion in the prior year due to tax relief programs related to COVID-19 and a decline from accounts receivable of$0.3 billion . Net cash from operating activities includes approximately$0.5 billion of cash impacts from our structural actions initiated in the fourth quarter of 2020 and Kyndryl separation-related charges. In the second quarter of 2021, investing activities were a net use of cash of$2.7 billion , an increase of$1.4 billion compared to the prior-year period, primarily driven by an increase in cash used for acquisitions. Financing activities were a use of cash of$3.1 billion in the second quarter of 2021 compared to$1.6 billion in the second quarter of 2020. The$1.5 billion change was primarily driven by debt transactions, as we continued to deleverage in accordance with our debt maturity schedules. 52 Table of Contents
Management Discussion - (continued)
Financial Results Summary -Six Months Ended
Yr. to Yr.
Percent/
(Dollars and shares in millions except per share
amounts) Margin
For the six months ended June 30: 2021 2020 Change
Revenue $ 36,474 $ 35,694 2.2 %*
Gross profit margin 47.2 % 46.6 % 0.6 pts.
Total expense and other (income) $ 14,751 $ 15,101 (2.3) %
Income from continuing operations before income
taxes $ 2,457 $ 1,522 61.5 %
Provision for/(benefit from) income taxes from
continuing operations $ 177 $ (1,017) nm
Income from continuing operations $ 2,281 $ 2,538 (10.2) %
Income from continuing operations margin 6.3 % 7.1 % (0.9) pts.
Net income $ 2,280 $ 2,536 (10.1) %
Earnings per share from continuing operations -
assuming dilution $ 2.52 $ 2.83 (11.0) %
Weighted-average shares outstanding - assuming
dilution 903.0 895.0 0.9 %
At 6/30/2021 At 12/31/2020
Assets $ 146,814 $ 155,971 (5.9) %
Liabilities $ 124,747 $ 135,244 (7.8) %
Equity $ 22,067 $ 20,727 6.5 %
* (1.5) percent adjusted for currency; (1.4) percent excluding divested businesses and adjusted for currency.
nm - not meaningful
The following table provides the company's operating (non-GAAP) earnings for the first six months of 2021 and 2020.
Yr. to Yr.
(Dollars in millions except per share amounts) Percent
For the six months ended June 30: 2021 2020 Change Net income as reported$ 2,280 $ 2,536 (10.1) % Income/(loss) from discontinued operations, net of tax (1) (2) (67.4) Income from continuing operations$ 2,281 $ 2,538 (10.2) % Non-operating adjustments (net of tax): Acquisition-related charges$ 707 $ 736 (3.9) % Non-operating retirement-related costs/(income) 542
472 14.8 U.S. tax reform impacts (6) (149) (96.3) Separation-related charges 177 - nm Operating (non-GAAP) earnings*$ 3,702 $ 3,598 2.9 %
Diluted operating (non-GAAP) earnings per share*
2.0 %
* Refer to page 90 for a more detailed reconciliation of net income to operating earnings and operating earnings per share.
nm - not meaningful
Financial Performance Summary -Six Months Ended
In the first six months of 2021, we reported$36.5 billion in revenue,$2.3 billion in income from continuing operations and operating (non-GAAP) earnings of$3.7 billion , resulting in diluted earnings per share from continuing operations of$2.52 as reported and$4.10 on an operating (non-GAAP) basis. We generated$7.5 billion in cash from operations,$2.6 billion in free cash flow and delivered shareholder returns of$2.9 billion through dividends.
Total consolidated revenue increased 2.2 percent as reported but declined 1
percent excluding divested businesses and adjusted for currency. Cloud &
53
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Management Discussion - (continued)
currency). Within this segment, Cloud & Data Platforms grew 12.2 percent as reported (9 percent adjusted for currency) with continued solidRed Hat performance led by Red Hat Enterprise Linux (RHEL) and our OpenShift hybrid cloud platform. Cognitive Applications grew 8.1 percent as reported (5 percent adjusted for currency), while Transaction Processing Platforms declined 9.3 percent as reported (13 percent adjusted for currency). GBS increased 6.8 percent as reported (3 percent adjusted for currency) with growth in Consulting and Global Process Services. Application Management increased 0.5 percent as reported, but declined 4 percent adjusted for currency. GTS decreased 0.6 percent as reported (5 percent adjusted for currency) with declines in Infrastructure & Cloud Services andTechnology Support Services . Systems decreased 2.4 percent as reported (5 percent adjusted for currency) and was impacted by product cycle dynamics in the current-year period. Total cloud revenue of$13.5 billion in the first six months of 2021 grew 17 percent as reported (13 percent adjusted for currency and excluding divested businesses and adjusted for currency). From a geographic perspective,Americas revenue grew 2.3 percent year to year as reported (2 percent adjusted for currency). EMEA increased 4.2 percent as reported but decreased 4 percent adjusted for currency.Asia Pacific declined 0.9 percent year to year as reported (4 percent adjusted for currency). Total consolidated gross margin of 47.2 percent increased 0.6 points year to year with margin expansion in Cloud &Cognitive Software , GTS, GBS and Systems. Operating (non-GAAP) gross margin of 48.3 percent increased 0.7 points compared to the prior-year period. Total expense and other (income) decreased 2.3 percent in the first six months of 2021 versus the prior-year period. Our expense reflects the higher level of investment we are making in innovation, skills and our ecosystem, more than offset by lower workforce rebalancing charges, a benefit from expected credit loss expense, lower travel expense and lower interest expense in the current-year period. Expense also reflects an increase from the effects of currency, separation-related charges in the current-year period and higher non-operating retirement-related costs. Total operating (non-GAAP) expense and other (income) decreased 4.9 percent year to year, driven primarily by the factors above excluding the separation-related charges and non-operating retirement-related costs. Pre-tax income from continuing operations of$2.5 billion increased 61.5 percent compared to the first six months of 2020. The pre-tax margin from continuing operations was 6.7 percent, an increase of 2.5 points versus the prior-year period. In the prior-year period, workforce rebalancing charges were$865 million , compared to$241 million in the current year. The continuing operations provision for income taxes in the first six months of 2021 was$0.2 billion compared to a benefit from income taxes of$1.0 billion in the first six months of 2020. The company reported a tax benefit in the first quarter of 2021, which was primarily driven by the resolution of certain tax audit matters. The prior-year benefit was primarily related to the tax impacts of an intra-entity sale of certain of the company's intellectual property. Net income from continuing operations of$2.3 billion decreased 10.2 percent, and the net income margin from continuing operations was 6.3 percent, a decrease of 0.9 points year to year. Operating (non-GAAP) pre-tax income from continuing operations of$4.3 billion increased 43.4 percent year to year and the operating (non-GAAP) pre-tax margin from continuing operations increased 3.4 points to 11.8 percent. These results reflect higher workforce rebalancing charges in 2020 as described above. The operating (non-GAAP) provision for income taxes was$0.6 billion in the first six months of 2021, compared to a benefit from income taxes of$0.6 billion in the first six months of 2020. The prior year operating (non-GAAP) benefit from income taxes was primarily driven by the same factor described above. Operating (non-GAAP) income from continuing operations of$3.7 billion increased 2.9 percent with an operating (non-GAAP) income margin from continuing operations of 10.1 percent. Diluted earnings per share from continuing operations of$2.52 in the first six months of 2021 decreased 11.0 percent and operating (non-GAAP) diluted earnings per share of$4.10 increased 2.0 percent versus the first six months of 2020. Diluted earnings per share from continuing operations includes impacts related to the amortization of purchased intangibles assets and other acquisition-related charges, retirement-related charges,U.S. tax reform enactment impacts 54 Table of Contents
Management Discussion - (continued)
and Kyndryl separation-related charges. The impact of the Kyndryl
separation-related charges for the first six months of 2021 was (
In the second quarter, we continued to take actions to further enhance our balance sheet and liquidity position. AtJune 30, 2021 , the balance sheet remained strong with the flexibility to support and invest in the business. Cash and cash equivalents, restricted cash and marketable securities atJune 30, 2021 were$8.2 billion , a decrease of$6.1 billion fromDecember 31, 2020 , primarily due to debt reduction payments and acquisitions. In line with our overall debt pay down strategy, we have reduced total debt by$6.4 billion fromDecember 31, 2020 and$17.9 billion since the second quarter of 2019 (immediately preceding theRed Hat transaction).
Key drivers in the balance sheet and total cash flows were:
Total assets decreased
• A decrease in cash and cash equivalents, restricted cash and marketable
securities of
A decrease in financing receivables of
balances and sales of receivables; partially offset by
•An increase in goodwill of
Total liabilities decreased
• A decrease in total debt of
primarily driven by debt maturities and early retirements of
A decrease in other accrued expenses and liabilities of
workforce rebalancing actions;
A decrease in taxes payable of
of the resolution of certain tax audit matters;
• A decrease in retirement and nonpension postretirement benefit obligations of
• A decrease in accounts payable of
currency) reflecting declines from seasonally higher year-end balances.
Total equity of
•Net income of
An increase in accumulated other comprehensive income of
translation gains; partially offset by
•Dividends paid of
55
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Management Discussion - (continued)
We generated$7.5 billion in cash flow provided by operating activities, a decrease of$0.5 billion compared to the first six months of 2020. Cash flows from operating activities includes approximately$1.2 billion of cash impacts from our structural actions initiated in the fourth quarter of 2020 and Kyndryl separation-related charges. In the first six months of 2021, investing activities were a net use of cash of$4.7 billion compared to$2.1 billion in the prior-year period. The$2.5 billion increase year to year was driven primarily by an increase in net cash used for acquisitions ($2.8 billion ) and a decrease in cash provided by divestitures ($0.8 billion ), partially offset by a decrease in cash used for net purchases of marketable securities and other investments ($1.0 billion ). Financing activities were a net use of cash of$8.9 billion in the first six months of 2021 compared to$1.7 billion in the prior-year period. The$7.2 billion increase year to year was primarily driven by a decrease in net cash provided by debt transactions with a higher level of net issuances in the prior year. 56 Table of Contents
Management Discussion - (continued)
Second Quarter and First Six Months in Review
Results of Continuing Operations
Segment Details
The following is an analysis of the second quarter and first six months of 2021 versus the second quarter and first six months of 2020 reportable segment external revenue and gross margin results. Segment pre-tax income includes transactions between segments that are intended to reflect an arm's-length transfer price and excludes certain unallocated corporate items.
Yr. to Yr.
Percent
Yr. to Yr. Change
(Dollars in millions) Percent/Margin Adjusted For
For the three months ended June 30: 2021 2020 Change Currency Revenue: Cloud & Cognitive Software$ 6,098 $ 5,748 6.1 % 2.5 % Gross margin 78.1 % 77.1 % 1.0 pts. Global Business Services 4,341 3,890 11.6 % 7.3 % Gross margin 27.9 % 28.4 % (0.6) pts. Global Technology Services 6,342 6,316 0.4 % (4.1) % Gross margin 35.3 % 34.2 % 1.1 pts. Systems 1,717 1,852 (7.3) % (10.2) % Gross margin 55.1 % 57.8 % (2.7) pts. Global Financing 242 265 (8.6) % (11.6) % Gross margin 27.4 % 38.6 % (11.2) pts. Other 5 50 (89.6) % (89.3) % Gross margin nm (338.2) % nm Total consolidated revenue$ 18,745 $ 18,123 3.4 %* (0.6) %
Total consolidated gross profit$ 9,004 $ 8,700 3.5 % Total consolidated gross margin 48.0 % 48.0 % 0.0 pts. Non-operating adjustments: Amortization of acquired intangible assets 180 187 (3.8) % Separation-related charges 58 -
nm
Operating (non-GAAP) gross profit$ 9,242 $ 8,887 4.0 % Operating (non-GAAP) gross margin 49.3 % 49.0 %
0.3 pts.
* (0.5) percent excluding divested businesses and adjusted for currency.
nm - not meaningful
57
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Management Discussion - (continued)
Yr. to Yr.
Percent
Yr. to Yr. Change
(Dollars in millions) Percent/Margin Adjusted For
For the six months ended June 30: 2021 2020 Change Currency
Revenue:
Cloud & Cognitive Software$ 11,534 $ 10,987 5.0 % 1.6 % Gross margin 77.1 % 76.3 % 0.8 pts. Global Business Services 8,575 8,027 6.8 % 2.8 % Gross margin 28.0 % 27.8 % 0.2 pts. Global Technology Services 12,712 12,783
(0.6) % (4.7) %
Gross margin 34.9 % 34.1 % 0.8 pts.
Systems 3,144 3,220 (2.4) % (5.0) %
Gross margin 54.8 % 54.6 % 0.2 pts.
Global Financing 482 564 (14.7) % (17.1) %
Gross margin 29.7 % 39.7 % (10.0) pts.
Other 28 113 (75.3) % (75.6) %
Gross margin nm (291.7) % nmTotal consolidated revenue$ 36,474 $ 35,694 2.2 %* (1.5) % Total consolidated gross profit$ 17,208 $ 16,622 3.5 % Total consolidated gross margin 47.2 % 46.6 % 0.6 pts. Non-operating adjustments: Amortization of acquired intangible assets 355 375 (5.4) % Separation-related charges 61 -
nm
Operating (non-GAAP) gross profit$ 17,624 $ 16,998 3.7 % Operating (non-GAAP) gross margin 48.3 % 47.6 %
0.7 pts.
* (1.4) percent excluding divested businesses and adjusted for currency.
nm - not meaningful Cloud &Cognitive Software Yr. to Yr. Percent Yr. to Yr. Change (Dollars in millions) Percent Adjusted For For the three months ended June 30: 2021 2020 Change Currency Cloud & Cognitive Software external revenue:$ 6,098 $ 5,748
6.1 % 2.5 % Cloud & Data Platforms$ 3,120 $ 2,797 11.5 % 7.9 % Cognitive Applications 1,391 1,246 11.6 8.0
Transaction Processing Platforms 1,587 1,706
(7.0) (10.5)
Yr. to Yr.
Percent
Yr. to Yr. Change
(Dollars in millions) Percent Adjusted ForFor the six months ended June 30: 2021 2020 Change Currency Cloud & Cognitive Software external revenue:$ 11,534 $ 10,987
5.0 % 1.6 % Cloud & Data Platforms$ 5,986 $ 5,333 12.2 % 8.8 % Cognitive Applications 2,624 2,428 8.1 4.9
Transaction Processing Platforms 2,925 3,226
(9.3) (12.5)
Cloud &Cognitive Software revenue of$6,098 million increased 6.1 percent as reported and 2 percent adjusted for currency in the second quarter of 2021 compared to the prior-year period, led by growth in both Cloud & Data Platforms and Cognitive Applications, partially offset by declines in Transaction Processing Platforms. We continued to have strong subscription and support renewal rates this quarter and our software deferred income increased more
than
a billion
58
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Management Discussion - (continued)
dollars year to year. For the first six months of 2021, Cloud &
In the second quarter, Cloud & Data Platforms revenue of$3,120 million increased 11.5 percent as reported and 8 percent adjusted for currency compared to the prior-year period, led by strength in our hybrid cloud platform andCloud Paks . In the quarter, both RHEL and OpenShift continued to deliver strong growth and gained share in their respective markets. We now have more than 3,200 clients using our hybrid cloud platform, which is approximately four times the number of clients since we announced theRed Hat acquisition.Cloud Paks continued to resonate with our clients. In the second quarter, we had strength inCloud Pak for Integration, which delivers rapid and cost-saving solutions for integration development as well asCloud Pak for Business Automation as clients leveraged AI-powered automation to solve operational challenges. The acquisition ofTurbonomic in the second quarter further extends our automation offerings. Cognitive Applications second-quarter revenue of$1,391 million increased 11.6 percent as reported and 8 percent adjusted for currency compared to the prior-year period. This growth was driven by Security software and services,Maximo asset management, our Weather offerings and Sterling supply chain. With the acceleration of cybersecurity attacks, clients are increasingly looking for modernized security platforms to detect and protect against ransomware and other attacks. This quarter, we had strength in our integrated software and services offerings includingCloud Pak for Security, Data Security and X-Force Security Services. In the area of supply chain, the demand for omnichannel solutions accelerated requirements for Sterling Order Management in industries such as retail. Transaction Processing Platforms revenue of$1,587 million decreased 7.0 percent as reported and 11 percent adjusted for currency in the second quarter compared to the prior-year period. We provide flexibility to our clients in how they purchase this mission-critical software and since early last year, we are seeing a continued preference for operating expenses over capital expenditures, which has continued to put pressure on perpetual licenses, in favor of more consumption-like models. Our continued strong software renewals this quarter reflect that clients remain committed to our products. Within Cloud &Cognitive Software , cloud revenue of$2.1 billion grew 29 percent as reported (25 percent adjusted for currency) in the second quarter of 2021 compared to the prior-year period. For the first six months of 2021, cloud revenue of$4.0 billion grew 33 percent as reported (29 percent adjusted for currency) compared to the first six months of the prior year. Yr. to Yr. Percent/ (Dollars in millions) Margin
For the three months ended
$ 4,761 $ 4,432 7.4 % External gross profit margin 78.1 % 77.1 % 1.0 pts. Pre-tax income$ 1,720 $ 1,708 0.7 % Pre-tax margin 25.2 % 26.3 % (1.1) pts. Yr. to Yr. Percent/ (Dollars in millions) Margin
For the six months ended
$ 8,893 $ 8,384 6.1 % External gross profit margin 77.1 % 76.3 % 0.8 pts.
Pre-tax income$ 3,147 $ 2,641 19.2 % Pre-tax margin 24.0 % 21.1 % 3.0 pts. 59 Table of Contents
Management Discussion - (continued)
Cloud &Cognitive Software gross profit margin increased 1.0 points to 78.1 percent in the second quarter of 2021 compared to the prior-year period driven primarily by revenue growth and improvement in services margins, partially offset by the investments we are making in new innovations and our ecosystem. For the first six months of 2021, gross profit margin increased 0.8 points to 77.1 percent, driven primarily by the same factors. In the second quarter, pre-tax income of$1,720 million increased 0.7 percent and pre-tax margin decreased 1.1 points to 25.2 percent compared to the prior year. The pre-tax income improvement reflects the revenue growth and gross profit margin expansion in the current year. The pre-tax margin decline reflects the investments we are making in new innovations and our ecosystem and higher workforce rebalancing charges year to year, partially offset by the gross margin expansion. For the first six months of 2021, pre-tax income of$3,147 million increased 19.2 percent and pre-tax margin of 24.0 percent increased 3.0 points compared to the prior year, primarily driven by the gross margin expansion and lower workforce rebalancing charges in the current year. Global Business Services Yr. to Yr. Percent Yr. to Yr. Change (Dollars in millions) Percent Adjusted For For the three months ended June 30: 2021 2020 Change Currency Global Business Services external revenue:$ 4,341 $ 3,890
11.6 % 7.3 % Consulting$ 2,236 $ 1,936 15.5 % 11.2 % Application Management 1,821 1,734 5.1 0.7 Global Process Services 284 221 28.4 24.7 Yr. to Yr. Percent Yr. to Yr. Change (Dollars in millions) Percent Adjusted For For the six months ended June 30: 2021 2020 Change Currency Global Business Services external revenue:$ 8,575 $ 8,027
6.8 % 2.8 % Consulting$ 4,425 $ 4,007 10.4 % 6.4 % Application Management 3,591 3,573 0.5 (3.5) Global Process Services 559 447 25.0 21.7 Global Business Services revenue of$4,341 million grew 11.6 percent as reported and 7 percent adjusted for currency in the second quarter of 2021 compared to the prior-year period, with growth across all three business units. Our revenue performance reflects the trend that clients are accelerating their rate and pace of digital transformations. OurRed Hat practice had continued strong results with more than 170Red Hat client engagements added this quarter. We continue to invest in GBS by expanding our skills and investing to integrate and scale our recent acquisitions. For the first six months of 2021, GBS revenue of$8,575 million increased 6.8 percent as reported and 3 percent adjusted for currency reflecting strong year-to-year growth in Consulting and Global Process Services. In the second-quarter 2021, Consulting revenue of$2,236 million grew 15.5 percent as reported and 11 percent adjusted for currency which reflects the investments we are making in building skills in third-party cloud providers and in expanding our practices with ecosystem partners. Clients are finding value in our differentiated garage methodology to co-create solutions for the majority of our value propositions across Enterprise Resource Planning implementation, Business Process Outsourcing and Application Modernization.
Application Management revenue of
60
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Management Discussion - (continued)
Global Process Services second-quarter revenue of$284 million grew 28.4 percent as reported and 25 percent adjusted for currency compared to the prior-year period, reflecting strong growth in our intelligent workflow offerings. These end-to-end offerings, which leverage hybrid cloud and AI to transform client processes, connect Consulting with Business Process Outsourcing in areas such as finance, supply chain, customer service and talent transformation. Within GBS, cloud revenue of$1.9 billion grew 35 percent as reported (30 percent adjusted for currency) in the second quarter of 2021 compared to the same prior-year period. For the first six months of 2021, cloud revenue of$3.6 billion grew 34 percent as reported (29 percent adjusted for currency) compared to the same period in 2020. Yr. to Yr. Percent/ (Dollars in millions) Margin
For the three months ended
$ 1,210 $ 1,107 9.3 % External gross profit margin 27.9 % 28.4 % (0.6) pts. Pre-tax income$ 371 $ 362 2.5 % Pre-tax margin 8.4 % 9.2 % (0.7) pts. Yr. to Yr. Percent/ (Dollars in millions) Margin
For the six months ended
$ 2,404 $ 2,231 7.7 % External gross profit margin 28.0 % 27.8 % 0.2 pts.
Pre-tax income$ 761 $ 633 20.3 % Pre-tax margin 8.8 % 7.8 % 1.0 pts.
GBS second-quarter gross profit margin of 27.9 percent decreased 0.6 points on a year-to-year basis, primarily driven by a decline in our Consulting margin, partially offset by increased margins in Application Management and Global Process Services. Our gross margin performance reflects the higher level of investments we are making to expand our skills and practices to continue to capture the market opportunity. We are expanding our delivery resources and adding skilled practitioners in high demand areas. In addition, we are investing to integrate and scale our recently announced acquisitions. Pre-tax income of$371 million increased 2.5 percent and pre-tax margin of 8.4 percent decreased 0.7 points in the second quarter of 2021 compared to the prior-year period. The pre-tax income and margin performance reflects the higher level of investments described above, and in our go-to-market resources. For the first six months of 2021, pre-tax income of$761 million increased 20.3 percent and pre-tax margin of 8.8 percent increased 1.0 points compared to the prior-year period, driven primarily by gross profit margin expansion due to lower costs in the current year as a result of prior workforce rebalancing actions and lower workforce rebalancing charges year to year.Global Technology Services Yr. to Yr. Percent Yr. to Yr. Change (Dollars in millions) Percent Adjusted For For the three months ended June 30: 2021 2020 Change Currency Global Technology Services external revenue:$ 6,342 $ 6,316 0.4 % (4.1) % Infrastructure & Cloud Services$ 4,836 $ 4,813
0.5 % (4.2) %
Technology Support Services 1,506 1,503 0.2 (4.1)
61
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Management Discussion - (continued)
Yr. to Yr.
Percent
Yr. to Yr. Change
(Dollars in millions) Percent Adjusted For
For the six months ended June 30: 2021 2020 Change Currency
Global Technology Services external revenue: $ 12,712 $ 12,783 (0.6) % (4.7) %
Infrastructure & Cloud Services $ 9,689 $ 9,729 (0.4) % (4.8) % Technology Support Services 3,023 3,054 (1.0) (4.4)
Global Technology Services revenue of$6,342 million increased 0.4 percent as reported, but declined 4 percent adjusted for currency in the second quarter of 2021 compared to the same prior-year period. This reflects a modest improvement in year-to-year performance compared to the first-quarter 2021, driven by improving trends in client-based business volumes and project activity. For the first six months of 2021, GTS revenue of$12,712 million decreased 0.6 percent as reported and 5 percent adjusted for currency as compared to the prior-year period, driven by declines in both Infrastructure & Cloud Services andTechnology Support Services . In the second-quarter 2021, Infrastructure & Cloud Services revenue of$4,836 million increased 0.5 percent as reported, but declined 4 percent adjusted for currency compared to the prior-year period. Our current clients continue to value partnering with Kyndryl to modernize and manage their mission-critical workloads and services, as reflected in our strong renewal rate. The renewals this quarter included six deals with a contract value greater than$100 million . While our performance with existing clients remains strong, the sales cycle for new logo clients is elongating, as they await additional information related to Kyndryl.
Within GTS, cloud revenue of$2.4 billion decreased 1 percent as reported and 5 percent adjusted for currency in the second quarter of 2021 compared to the same period in the prior year. For the first six months of 2021, cloud revenue of$4.8 billion grew 2 percent as reported, but declined 2 percent adjusted for currency compared to the first six months of 2020. Yr. to Yr. Percent/ (Dollars in millions) Margin
For the three months ended
$ 2,237 $ 2,158 3.7 % External gross profit margin 35.3 % 34.2 % 1.1 pts. Pre-tax income$ 381 $ 250 52.3 % Pre-tax margin 5.7 % 3.8 % 1.9 pts. Yr. to Yr. Percent/ (Dollars in millions) Margin
For the six months ended
$ 4,437 $ 4,354 1.9 % External gross profit margin 34.9 % 34.1 % 0.8 pts.
Pre-tax income$ 520 $ 72 624.6 % Pre-tax margin 3.9 % 0.5 % 3.4 pts.
62
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Management Discussion - (continued)
reflects the benefits from the productivity actions taken in 2020 to improve the profit and margin profile of the business in advance of the Kyndryl separation.
Pre-tax income of$381 million increased 52.3 percent and pre-tax margin of 5.7 percent increased 1.9 points in the second quarter of 2021 compared to the same period in 2020, driven primarily by the gross profit margin expansion due to lower costs in the current year as a result of workforce rebalancing actions taken in the prior year. For the first six months of 2021, pre-tax income increased$448 million to$520 million and pre-tax margin of 3.9 percent increased 3.4 points compared to the prior-year period, driven primarily by gross profit margin expansion and lower workforce rebalancing charges in the current year.
Services Backlog and Signings
Yr. to Yr.
Percent
Yr. to Yr. Change
At June 30, At June 30, Percent Adjusted For
(Dollars in billions) 2021 2020 Change Currency
Total backlog $ 103.7 $ 107.1 (3.2) % (6.4) %
The estimated total services backlog at
Total services backlog includes Infrastructure & Cloud Services, Security
Services, Consulting, Global Process Services, Application Management and TSS.
Total backlog is intended to be a statement of overall work under contract which
is either non-cancellable, or which historically has very low likelihood of
termination, given the criticality of certain services to the company's clients.
Total backlog does not include as-a-Service arrangements that allow for
termination under contractual commitment terms. Backlog estimates are subject to
change and are affected by several factors, including terminations, changes in
the scope of contracts, periodic revalidations, adjustments for revenue not
materialized and adjustments for currency.
Yr. to Yr.
Percent
Yr. to Yr. Change
(Dollars in millions) Percent Adjusted ForFor the three months ended June 30: 2021 2020 Change
Currency Total signings$ 9,178 $ 8,204 11.9 % 8.1 % Yr. to Yr. Percent Yr. to Yr. Change (Dollars in millions) Percent Adjusted For
For the six months ended June 30: 2021 2020 Change
Currency Total signings$ 15,911 $ 17,132 (7.1) % (10.3) % 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, 63
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Management Discussion - (continued)
where revenues equal renewals. Certain longer-term TSS contracts that have characteristics similar to outsourcing contracts are included in signings.
Contract portfolios purchased in an acquisition are treated as positive backlog
adjustments provided those contracts meet the company's requirements for initial
signings. A new signing will be recognized if a new services agreement is signed
incidental or coincidental to an acquisition or divestiture.
Management believes that the estimated values of services backlog and signings
disclosed herein provide insight into our potential future revenue, which is
used by management as a tool to monitor the performance of the business and
viewed as useful decision-making information for investors. The conversion of
signings and backlog into revenue may vary based on the types of services and
solutions, customer decisions, and as well as other factors, which may include,
but are not limited to, macroeconomic environment or external events.
Systems
Yr. to Yr.
Percent
Yr. to Yr. Change
(Dollars in millions) Percent Adjusted ForFor the three months ended June 30: 2021 2020 Change
Currency Systems external revenue:$ 1,717 $ 1,852 (7.3) % (10.2) % Systems Hardware$ 1,384 $ 1,488 (7.0) % (9.9) % IBM Z (10.6) (13.3) Power Systems (1.6) (4.6) Storage Systems (6.7) (9.7) Operating Systems Software 333 365 (8.7) (11.7) Yr. to Yr. Percent Yr. to Yr. Change (Dollars in millions) Percent Adjusted For
For the six months ended June 30: 2021 2020 Change
Currency Systems external revenue:$ 3,144 $ 3,220 (2.4) % (5.0) % Systems Hardware$ 2,498 $ 2,484 0.5 % (2.0) % IBM Z 10.2 7.8 Power Systems (5.2) (7.9) Storage Systems (8.9) (11.7) Operating Systems Software 646 736 (12.2) (14.8)
Systems revenue of$1,717 million decreased 7.3 percent as reported and 10 percent adjusted for currency in the second quarter of 2021 compared to the prior-year period. Systems Hardware revenue of$1,384 million declined 7.0 percent as reported and 10 percent adjusted for currency reflecting product cycle dynamics across IBM Z, Power Systems and Storage Systems. Operating Systems Software revenue of$333 million decreased 8.7 percent as reported and 12 percent adjusted for currency, driven primarily by a decline in IBM Z operating systems software due to higher transactional revenue in the prior-year second quarter. For the first six months of 2021, Systems revenue of$3,144 million decreased 2.4 percent as reported and 5 percent adjusted for currency compared to the prior-year period. The decline was primarily driven by Storage Systems and Power Systems and a decline inOperating Systems Software , partially offset by growth in IBM Z. IBM Z revenue decreased 10.6 percent as reported and 13 percent adjusted for currency in the second quarter compared to very strong performance in the prior-year period. Financial services continued to drive IBM Z performance due to capacity requirements to address robust market volatility. With focus on security, purchases were also driven by clients seeking capabilities such as pervasive encryption and Hyper Protect to secure mission-critical applications and data, both on premises and in the cloud. During the last eight quarters, the z15 client value proposition has been 64
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Management Discussion - (continued)
apparent. The z15 is secure, scalable and reliable, and the z15 program continues to outpace the strong z14 program providing further proof of IBM Z as an enduring platform.
Power Systems revenue decreased 1.6 percent as reported and 5 percent adjusted for currency in the second quarter of 2021 compared to the prior-year period, reflecting a sequential year-to-year improvement compared to the first-quarter 2021. The decline in revenue in the second quarter reflects the product cycle dynamics and was driven primarily by declines in low-end systems, partially offset by growth in high-end systems.
Storage Systems revenue declined 6.7 percent as reported and 10 percent adjusted for currency in the second-quarter 2021 compared to the prior-year period, driven primarily by a decline in high-end storage systems tied to the IBM Z product cycle.
Within Systems, cloud revenue of$0.7 billion decreased 16 percent as reported (19 percent adjusted for currency) in the second quarter of 2021 compared to the same quarter in 2020. For the first six months of 2021, cloud revenue of$1.2 billion decreased 3 percent as reported (5 percent adjusted for currency) compared to the same prior-year period. Yr. to Yr. Percent/ (Dollars in millions) Margin
For the three months ended June 30: 2021 2020
Change
Systems:
External Systems Hardware gross profit$ 679 $ 772 (12.0) % External Systems Hardware gross profit margin 49.1 % 51.9 % (2.8) pts.External Operating Systems Software gross profit$ 267 $ 299 (10.7) %External Operating Systems Software gross profit margin 80.2 % 82.0 % (1.8) pts. External total gross profit$ 946 $ 1,071 (11.7) % External total gross profit margin 55.1 % 57.8 %
(2.7) pts.
Pre-tax income $ 176 $ 248 (28.8) %
Pre-tax margin 9.0 % 11.8 % (2.8) pts.
Yr. to Yr.
Percent/
(Dollars in millions) MarginFor the six months ended June 30: 2021 2020
Change
Systems:
External Systems Hardware gross profit$ 1,207 $ 1,151 4.8 % External Systems Hardware gross profit margin 48.3 % 46.3 % 2.0 pts.External Operating Systems Software gross profit$ 517 $ 607 (14.8) %External Operating Systems Software gross profit margin 80.0 % 82.5 % (2.4) pts. External total gross profit$ 1,724 $ 1,758 (1.9) % External total gross profit margin 54.8 % 54.6 %
0.2 pts.
Pre-tax income $ 174 $ 31 466.3 %
Pre-tax margin 4.9 % 0.9 % 4.0 pts.
Systems gross profit margin decreased 2.7 points to 55.1 percent in the
second-quarter 2021 compared to the prior-year period. Systems margin
performance was driven by declines in Storage Systems and Operating Systems
Software margins and a revenue mix to Power Systems, partially offset by margin
expansion in Power Systems and IBM Z. For the first six months of 2021, Systems
gross profit margin increased 0.2 points to 54.8 percent compared to the same
period in 2020, primarily driven by a mix to IBM Z and margin expansion in IBM Z
and Power Systems, partially offset by a decline in Storage Systems margin.
In the second quarter of 2021, Systems pre-tax income of $176 million decreased
28.8 percent and pre-tax margin of 9.0 percent decreased 2.8 points compared to
the prior-year period, driven primarily by the portfolio mix and the z15
65
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Management Discussion - (continued)
product cycle, partially offset by lower costs in the current year as a result of prior workforce rebalancing actions. For the first six months of 2021, pre-tax income increased$143 million to$174 million and pre-tax margin of 4.9 percent increased 4.0 points compared to the prior-year period, driven primarily by lower costs in the current year as a result of prior workforce rebalancing actions and lower workforce rebalancing charges in the current year.
Global Financing
See pages 85 through 88 for a discussion of Global Financing's segment results.
Geographic Revenue
In addition to the revenue presentation by reportable segment, we also measure revenue performance on a geographic basis.
Yr. to Yr.
Yr. to Yr. Percent Change
Percent Excluding Divested
Yr. to Yr. Change Businesses And(Dollars in millions) Percent Adjusted For Adjusted For For the three months ended June 30: 2021 2020 Change
Currency Currency
Total Revenue $ 18,745 $ 18,123 3.4 % (0.6) % (0.5) %
Americas $ 8,820 $ 8,450 4.4 % 2.9 % 3.0 %
Europe/Middle East/Africa (EMEA) 6,038 5,695 6.0 (3.0) (2.9)
Asia Pacific 3,887 3,977 (2.3) (4.5) (4.5)
Yr. to Yr.
Yr. to Yr. Percent Change
Percent Excluding Divested
Yr. to Yr. Change Businesses And(Dollars in millions) Percent Adjusted For Adjusted For For the six months ended June 30: 2021 2020 Change
Currency Currency Total Revenue$ 36,474 $ 35,694 2.2 % (1.5) % (1.4) % Americas$ 16,999 $ 16,617 2.3 % 1.6 % 1.7 %
Europe/Middle East/Africa (EMEA) 11,679 11,212 4.2
(4.3) (4.2)
Asia Pacific 7,797 7,865 (0.9) (4.1) (4.1)
Total revenue of$18,745 million increased 3.4 percent as reported and was flat excluding divested businesses and adjusted for currency in the second quarter of 2021 compared to the prior-year period.Americas revenue of$8,820 million increased 4.4 percent as reported and 3 percent adjusted for currency. WithinAmericas , theU.S. increased 1.5 percent compared to the prior year.Canada increased 34.7 percent as reported and 20 percent adjusted for currency.Latin America decreased 1.7 percent as reported and 2 percent adjusted for currency, withBrazil revenue flat as reported, but declining 1 percent adjusted for currency. In EMEA, total revenue of$6,038 million increased 6.0 percent as reported, but decreased 3 percent adjusted for currency. Within EMEA,Germany increased 4.2 percent as reported, but declined 4 percent adjusted for currency. As reported,France , theUK andItaly increased 18.4 percent, 13.9 percent and 11.1 percent, respectively, and grew 9 percent, 2 percent and 2 percent, respectively, adjusted for currency.Asia Pacific revenue of$3,887 million decreased 2.3 percent as reported and 5 percent adjusted for currency. WithinAsia Pacific ,Japan decreased 2.8 percent as reported and 1 percent adjusted for currency. As reported,India ,Australia andChina decreased 5.1 percent, 4.7 percent and 3.3 percent, respectively, and declined 8 percent, 18 percent and 10 percent, respectively, adjusted for currency. 66 Table of Contents
Management Discussion - (continued)
For the first six months of 2021, total revenue of$36,474 million increased 2.2 percent as reported, but declined 1 percent excluding divested businesses and adjusted for currency compared to the prior-year period.Americas revenue of$16,999 million increased 2.3 percent as reported and 2 percent adjusted for currency. WithinAmericas , theU.S. increased 1.1 percent compared to the prior year.Canada increased 20.7 percent as reported and 10 percent adjusted for currency.Latin America decreased 5.6 percent as reported and 2 percent adjusted for currency, withBrazil revenue declining 7.2 percent as reported and 1 percent adjusted for currency. In EMEA, total revenue of$11,679 million increased 4.2 percent as reported, but declined 4 percent adjusted for currency. Within EMEA, theUK increased 10.4 percent as reported and grew slightly adjusted for currency. As reported,France ,Italy andGermany increased 6.9 percent, 6.8 percent and 3.8 percent, respectively, but declined 2 percent, 2 percent and 5 percent, respectively, adjusted for currency.Asia Pacific revenue of$7,797 million decreased 0.9 percent as reported and 4 percent adjusted for currency. WithinAsia Pacific ,Japan decreased 1.4 percent as reported and 2 percent adjusted for currency.India decreased 8.6 percent as reported and 10 percent adjusted for currency andChina decreased 7.0 percent as reported and 12 percent adjusted for currency.Australia grew 4.4 percent as reported, but declined 11 percent adjusted for currency.
Expense
Total Expense and Other (Income)
Yr. to Yr.
(Dollars in millions) PercentFor the three months ended June 30: 2021 2020
Change
Total consolidated expense and other (income)
4.5 % Non-operating adjustments: Amortization of acquired intangible assets$ (281) $ (284) (1.2) % Acquisition-related charges (18) (1)
nm
Non-operating retirement-related (costs)/income (328) (273)
19.8
Separation-related charges (117) -
nm
Operating (non-GAAP) expense and other (income)
2.1 % Total consolidated expense-to-revenue ratio 39.8 % 39.3 % 0.4 pts. Operating (non-GAAP) expense-to-revenue ratio 35.8 % 36.3 %
(0.5) pts.
nm - not meaningful
Yr. to Yr.
(Dollars in millions) PercentFor the six months ended June 30: 2021 2020
Change
Total consolidated expense and other (income)
(2.3) % Non-operating adjustments: Amortization of acquired intangible assets$ (559) $ (569) (1.9) % Acquisition-related charges (34) (2)
nm
Non-operating retirement-related (costs)/income (670) (538)
24.6
Separation-related charges (175) -
nm
Operating (non-GAAP) expense and other (income)
(4.9) % Total consolidated expense-to-revenue ratio 40.4 % 42.3 % (1.9) pts. Operating (non-GAAP) expense-to-revenue ratio 36.5 % 39.2 %
(2.7) pts.
nm - not meaningful
67
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Management Discussion - (continued)
Total expense and other (income) increased 4.5 percent in the second quarter of 2021 versus the prior year. Our expense dynamics reflect a higher level of investment in innovation, skills and our ecosystem as we execute our hybrid cloud and AI strategy. We are aggressively hiring, scaling our garage footprint, increasing our research spend in areas including quantum, hybrid cloud and AI, and expanding our ecosystem. The year-to-year increase in expense was also driven by the effects of currency, separation-related charges in the current-year period, lower IP income and higher non-operating retirement-related costs, partially offset by a benefit from expected credit loss expense, lower workforce rebalancing charges and lower interest expense in the current-year period. Total operating (non-GAAP) expense and other (income) increased 2.1 percent year to year, driven primarily by the factors described above excluding the separation-related charges and 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
Yr. to Yr.
(Dollars in millions) PercentFor the three months ended June 30: 2021 2020
Change
Selling, general and administrative expense: Selling, general and administrative - other$ 4,451 $ 4,239 5.0 % Advertising and promotional expense 399 363
9.9
Workforce rebalancing charges 95 137
(30.6)
Amortization of acquired intangible assets 281 284
(1.2)
Stock-based compensation 152 155
(2.1)
Provision for/(benefit from) expected credit loss expense (43) 70
nm
Total consolidated selling, general and administrative expense$ 5,334 $ 5,248 1.6 % Non-operating adjustments: Amortization of acquired intangible assets$ (281) $ (284)
(1.2) % Acquisition-related charges (18) (1) nm Separation-related charges (116) - nm Operating (non-GAAP) selling, general and administrative expense$ 4,919 $ 4,962 (0.9) % nm - not meaningful Yr. to Yr. (Dollars in millions) Percent
For the six months ended June 30: 2021 2020
Change
Selling, general and administrative expense: Selling, general and administrative - other$ 8,757 $ 8,580 2.1 % Advertising and promotional expense 750 791
(5.1)
Workforce rebalancing charges 241 865
(72.1)
Amortization of acquired intangible assets 558 568
(1.9)
Stock-based compensation 275 272
1.2
Provision for/(benefit from) expected credit loss expense (73) 126
nm
Total consolidated selling, general and administrative expense$ 10,508 $ 11,203 (6.2) % Non-operating adjustments: Amortization of acquired intangible assets$ (558) $ (568)
(1.9) % Acquisition-related charges (34) (2) nm Separation-related charges (175) - nm Operating (non-GAAP) selling, general and administrative expense$ 9,742 $ 10,633 (8.4) % nm - not meaningful 68 Table of Contents
Management Discussion - (continued)
Total selling, general and administrative (SG&A) expense increased 1.6 percent in the second quarter of 2021 versus the prior year driven by the higher level of investments we are making to execute our hybrid cloud and AI strategy, as well as the following factors:
? The effects of currency (3 points); and
? Separation-related charges in the current-year period (2 points); partially
offset by
? A benefit from expected credit loss expense compared to a provision in the
prior-year period (2 points); and
? Lower workforce rebalancing charges (1 point).
Operating (non-GAAP) expense decreased 0.9 percent year to year, primarily driven by the same factors excluding the separation-related charges.
SG&A expense decreased 6.2 percent in the first six months of 2021 versus the prior year driven primarily by the following factors:
? Lower workforce rebalancing charges (6 points);
? A benefit from expected credit loss expense compared to a provision in the
prior-year period (2 points); and
? Lower spending (1 point) including reductions in travel; partially offset by
? The effects of currency (2 points); and
? Separation-related charges in the current-year period (2 points).
Operating (non-GAAP) expense decreased 8.4 percent year to year, primarily driven by the same factors excluding the separation-related charges.
Provisions for expected credit loss expense decreased$199 million year to year in the first six months of 2021, primarily driven by decreases in both specific and general reserves in the current year compared with increases in the prior-year period. In the prior year, the global pandemic resulted in some deterioration in customer credit quality and/or bankruptcies which had an impact to provisions in the first half of 2020. We have started to see improvement in credit quality and some emergence from bankruptcies in the current year as the economy begins to reopen in many parts of the world. The receivables provision coverage was 2.5 percent atJune 30, 2021 , an increase of 10 basis points from bothDecember 31, 2020 andJune 30, 2020 .
Research, Development and Engineering
Yr. to Yr.
(Dollars in millions) PercentFor the three months ended June 30: 2021 2020
Change
Research, development and engineering expense
4.7 % Non-operating adjustment: Separation-related charges$ 0 $ -
nm
Operating (non-GAAP) research, development and engineering expense$ 1,656 $ 1,582 4.7 % nm - not meaningful 69 Table of Contents
Management Discussion - (continued)
Yr. to Yr.
(Dollars in millions) PercentFor the six months ended June 30: 2021 2020
Change
Research, development and engineering expense
2.5 % Non-operating adjustment: Separation-related charges$ 0 $ -
nm
Operating (non-GAAP) research, development and engineering expense$ 3,286 $ 3,207 2.5 % nm - not meaningful Research, development and engineering (RD&E) expense was 8.8 percent and 9.0 percent of revenue in the second quarter and first six months of 2021, respectively, compared to 8.7 percent and 9.0 percent in the prior-year periods, respectively, reflecting our continuing investment in innovation as we increase spending in areas including quantum, hybrid cloud and AI. RD&E expense in the second quarter of 2021 increased 4.7 percent year to year, primarily driven by higher spending (3 points) and the effects of currency (2 points). RD&E expense in the first six months of 2021 increased 2.5 percent year to year, primarily driven by the effects of currency (2 points) and higher spending (1 point).
Intellectual Property and Custom Development Income
Yr. to Yr.
(Dollars in millions) PercentFor the three months ended June 30: 2021 2020
Change
Intellectual Property andCustom Development Income: Licensing of intellectual property including royalty-based fees$ 64 $ 128 (49.9) % Custom development income 67 74
(9.0)
Sales/other transfers of intellectual property 4 1
192.3
Total $ 135 $ 203 (33.5) %
Yr. to Yr.
(Dollars in millions) PercentFor the six months ended June 30: 2021 2020
Change
Intellectual Property andCustom Development Income: Licensing of intellectual property including royalty-based fees$ 136 $ 162 (16.0) % Custom development income 136 149
(9.1)
Sales/other transfers of intellectual property 10 8
28.2
Total $ 282 $ 319 (11.7) %
Total intellectual property and custom development income decreased 33.5 percent
and 11.7 percent year to year in the second quarter and first six months of
2021, respectively. These decreases were primarily driven by licensing of
intellectual property including royalty-based fees. 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.
70
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Management Discussion - (continued)
Other (Income) and Expense
Yr. to Yr.
(Dollars in millions) PercentFor the three months ended June 30: 2021 2020
Change
Other (income) and expense: Foreign currency transaction losses/(gains)$ (14) $ 62
nm
(Gains)/losses on derivative instruments 79 (92)
nm
Interest income (11) (23) (50.6) % Net (gains)/losses from securities and investment assets 0 0
(29.3)
Retirement-related costs/(income) 328 273
19.8
Other (67) (43)
56.0
Total consolidated other (income) and expense
76.1 % Non-operating adjustments: Amortization of acquired intangible assets$ (1) $ (1) - Non-operating retirement-related (costs)/income (328) (273) 19.8 % Operating (non-GAAP) other (income) and expense$ (14) $ (95)
(85.7) %
nm - not meaningful
Yr. to Yr.
(Dollars in millions) PercentFor the six months ended June 30: 2021 2020
Change
Other (income) and expense: Foreign currency transaction losses/(gains)$ (123) $ (64) 92.2 % (Gains)/losses on derivative instruments 239 9
nm
Interest income (25) (74)
(66.4)
Net (gains)/losses from securities and investment assets (6) (5)
10.9
Retirement-related costs/(income) 670 538
24.6
Other (79) (42)
87.0
Total consolidated other (income) and expense
87.3 % Non-operating adjustments: Amortization of acquired intangible assets$ (1) $ (1) - Non-operating retirement-related (costs)/income (670) (538) 24.6 % Operating (non-GAAP) other (income) and expense$ 5 $ (178)
nm nm - not meaningful Total consolidated other (income) and expense was$315 million of expense in the second quarter of 2021 compared to$179 million in the prior-year period. The year-to-year increase was primarily driven by:
Net exchange losses (including derivative instruments) in the current year
? versus net exchange gains (including derivative instruments) in the prior year
(
? Higher non-operating retirement-related costs (
"Retirement-Related Plans" for additional information.
Operating (non-GAAP) other (income) and expense was$14 million of income in the second quarter of 2021 and decreased$82 million compared to the prior-year period. The year-to-year change was driven primarily by the effects of currency described above. 71 Table of Contents
Management Discussion - (continued)
Total consolidated other (income) and expense was
Net exchange losses (including derivative instruments) in the current year
? versus net exchange gains (including derivative instruments) in the prior year
(
? Higher non-operating retirement-related costs (
"Retirement-Related Plans" for additional information; and
? Lower interest income (
the current-year period.
Operating (non-GAAP) other (income) and expense was$5 million of expense in the first six months of 2021 compared to income of$178 million in the prior-year period. The year-to-year change was driven primarily by the effects of currency and lower interest income described above. Interest Expense Yr. to Yr. (Dollars in millions) Percent For the three months ended June 30: 2021 2020 Change Interest expense$ 281 $ 323 (12.9) % Yr. to Yr. (Dollars in millions) Percent
For the six months ended
$ 562 $ 649 (13.4) % Interest expense decreased$42 million and$87 million year to year in the second quarter and first six months of 2021, respectively. Interest expense is presented in cost of financing in the Consolidated Income Statement if the related external borrowings are to support the Global Financing external business. Overall interest expense (excluding capitalized interest) for the second quarter and first six months of 2021 was$386 million and$772 million , respectively, a decrease of$55 million and$113 million versus the comparable prior-year periods. The decrease for the second quarter was primarily driven by a lower average debt balance compared to the prior-year period. The year-to-year decrease for the first six months of 2021 was primarily driven by a lower average debt balance and lower average interest rates in the current-year period. 72 Table of Contents
Management Discussion - (continued)
Retirement-Related Plans
The following table provides the total pre-tax cost for all retirement-related
plans. The operating cost amounts are included in the Consolidated Income
Statement within the caption (e.g., Cost, SG&A, RD&E) relating to the job
function of the plan participants. The non-operating cost amounts are included
in other (income) and expense.
Yr. to Yr.
(Dollars in millions) Percent
For the three months ended June 30: 2021 2020 Change
Retirement-related plans - cost: Service cost$ 98 $ 98 (0.2) % Multi-employer plans 7 7
(1.5)
Cost of defined contribution plans 265 267
(0.6) Total operating costs$ 370 $ 372 (0.5) % Interest cost$ 414 $ 546 (24.2) %
Expected return on plan assets (742) (854)
(13.1)
Recognized actuarial losses 636 559
13.7
Amortization of prior service costs/(credits) 1 0 124.0 Curtailments/settlements 16 13 24.9 Other costs 3 9 (61.5)
Total non-operating costs/(income)$ 328 $ 273 19.8 % Total retirement-related plans - cost$ 698 $ 645
8.1 %
Yr. to Yr.
(Dollars in millions) PercentFor the six months ended June 30: 2021 2020
Change
Retirement-related plans - cost: Service cost$ 193 $ 197 (1.7) % Multi-employer plans 15 14
1.1
Cost of defined contribution plans 536 532
0.8
Total operating costs $ 744 $ 743 0.1 %
Interest cost $ 826 $ 1,086 (23.9) %Expected return on plan assets (1,484) (1,706)
(13.0)
Recognized actuarial losses 1,276 1,122
13.7
Amortization of prior service costs/(credits) 4 1
398.9
Curtailments/settlements 34 21 56.8
Other costs 15 14 0.9Total non-operating costs/(income)$ 670 $ 538 24.6 % Total retirement-related plans - cost$ 1,414 $ 1,281
10.4 % Total pre-tax retirement-related plan cost increased by$52 million compared to the second quarter of 2020, primarily driven by lower expected return on plan assets ($112 million ) and an increase in recognized actuarial losses ($76 million ), partially offset by lower interest costs ($132 million ). Total cost for the first six months of 2021 increased$133 million versus the first six months of 2020, primarily driven by lower expected return on plan assets ($222 million ) and an increase in recognized actuarial losses ($154 million ), partially offset by lower interest costs ($259 million ). As described in the "Operating (non-GAAP) Earnings" section, management characterizes certain retirement-related costs as operating and others as non-operating. Utilizing this characterization, operating retirement-related costs in the second quarter of 2021 were$370 million , a decrease of$2 million compared to the second quarter of 2020. For the first six months of 2021, operating retirement-related costs were$744 million , an increase of$1 million compared to the prior-year period. Non-operating costs of$328 million in the second quarter of 2021 increased$54 million year to year 73
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Management Discussion - (continued)
and for the first six months of 2021 were
Taxes
The provision for income taxes for the second quarter of 2021 was$227 million , compared to$209 million in the second quarter of 2020. The operating (non-GAAP) provision for income taxes for the second quarter of 2021 was$431 million , compared to$369 million in the second quarter of 2020. The provision for income taxes for the first six months of 2021 was$177 million , compared to a benefit from income taxes of$1,017 million for the first six months of 2020. The operating (non-GAAP) provision for income taxes for the first six months of 2021 was$610 million , compared to a benefit from income taxes of$592 million for the first six months of 2020. The benefit from income taxes for the first six months of 2020 was primarily related to the tax impacts of an intra-entity sale of certain of the company's intellectual property. The operating (non-GAAP) benefit from income taxes was primarily driven by the same factor.IBM's full-year tax provision and effective tax rate are impacted by recurring factors including the geographic mix of income before taxes, state and local taxes, the effects of various global income tax strategies and any discrete tax events, such as the settlement of income tax audits and changes in or new interpretations of tax laws. The GAAP tax provision and effective tax rate could also be affected by adjustments to the previously recorded charges forU.S. tax reform attributable to any changes in law, new regulations and guidance, audit adjustments, among others. During the fourth quarter of 2020, theU.S. Internal Revenue Service (IRS) concluded its examination of the company'sU.S. income tax returns for 2013 and 2014, which had a specific focus on certain cross-border transactions that occurred in 2013 and issued a final Revenue Agent's Report. TheIRS' proposed adjustments relative to these cross-border transactions, if sustained, would result in additional taxable income of approximately$4.5 billion . The company strongly disagrees with theIRS on these specific matters and filed itsIRS Appeals protest in the first quarter of 2021. In the third quarter of 2018, theIRS commenced its audit of the company'sU.S. tax returns for 2015 and 2016. The company anticipates that this audit will be completed in 2021. With respect to majorU.S. state and foreign taxing jurisdictions, the company is generally no longer subject to tax examinations for years prior to 2015. The company is no longer subject to income tax examination of itsU.S. federal tax returns for years prior to 2013. The open years contain matters that could be subject to differing interpretations of applicable tax laws and regulations as it relates to the amount and/or timing of income, deductions and tax credits. Although the outcome of tax audits is always uncertain, the company believes that adequate amounts of tax, interest and penalties have been provided for any adjustments that are expected to result for these years. The company is involved in a number of income tax-related matters inIndia challenging tax assessments issued by the India Tax Authorities. As ofJune 30, 2021 , the company had recorded$731 million as prepaid income taxes inIndia . A significant portion of this balance represents cash tax deposits paid over time to protect the company's right to appeal various income tax assessments made by the India Tax Authorities. Although the outcome of tax audits are always uncertain, the company believes that adequate amounts of tax, interest and penalties have been provided for any adjustments that are expected to result for these years. The amount of unrecognized tax benefits atJune 30, 2021 is$8,019 million which can be reduced by$580 million associated with timing adjustments,U.S. tax credits, potential transfer pricing adjustments, and state income taxes. The net amount of$7,439 million , if recognized, would favorably affect the company's effective tax rate. 74 Table of Contents
Management Discussion - (continued)
Earnings Per Share
Basic earnings per share is computed on the basis of the weighted-average number of shares of common stock outstanding during the period. Diluted earnings per share is computed on the basis of the weighted-average number of shares of common stock outstanding plus the effect of dilutive potential common shares outstanding during the period using the treasury stock method. Dilutive potential common shares include outstanding stock options and stock awards.
Yr. to Yr.
PercentFor the three months ended June 30: 2021 2020
Change
Earnings per share of common stock from continuing operations: Assuming dilution$ 1.47 $ 1.52 (3.3) % Basic$ 1.48 $ 1.53 (3.3) % Diluted operating (non-GAAP)$ 2.33 $ 2.18 6.9 % Weighted-average shares outstanding: (in millions) Assuming dilution 904.2 894.9 1.0 % Basic 895.0 889.4 0.6 % Yr. to Yr. Percent
For the six months ended June 30: 2021 2020
Change
Earnings per share of common stock from continuing operations: Assuming dilution$ 2.52 $ 2.83 (11.0) % Basic$ 2.55 $ 2.85 (10.5) % Diluted operating (non-GAAP)$ 4.10 $ 4.02 2.0 % Weighted-average shares outstanding: (in millions) Assuming dilution 903.0 895.0 0.9 % Basic 894.3 888.7 0.6 % Actual shares outstanding atJune 30, 2021 were 896.3 million. The weighted-average number of common shares outstanding assuming dilution during the second quarter and first six months of 2021 were 9.3 million (1.0 percent) and 8.0 million (0.9 percent) shares higher, respectively, than the same periods of 2020. Financial Position Dynamics AtJune 30, 2021 , our balance sheet remained strong with flexibility to support the business. We continue to manage the investment portfolio to meet our capital preservation and liquidity objectives and have continued to take actions to enhance our balance sheet strength and liquidity position. Cash, restricted cash and marketable securities atJune 30, 2021 were$8,165 million , a decrease of$6,110 million fromDecember 31, 2020 , primarily due to debt reduction payments and acquisitions. Financing receivables declined$4,111 million to$13,868 million since the end of 2020 primarily resulting from collections of seasonally higher year-end balances and our strategic actions to re-focus our Global Financing portfolio. Total debt of$55,176 million atJune 30, 2021 decreased$6,362 million fromDecember 31, 2020 , and$17,863 million since the end of the second quarter 2019 (immediately preceding theRed Hat acquisition). We have made good progress in deleveraging while being acquisitive and without sacrificing investments in our business or our solid dividend policy. In the first six months of 2021, we generated$7,539 million in net cash from operations, compared to$8,052 million in the first six months of 2020. We have consistently generated strong cash flow from operations and continue to have access to additional sources of liquidity through the capital markets and our unused credit facilities. 75
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Management Discussion - (continued)
Our pension plans were well funded at the end of 2020, with worldwide qualified plans funded at 102 percent. Overall pension funded status as of the end of June was fairly consistent with year-end 2020, and we currently have no change to expected plan contributions in 2021.
The assets and debt associated with the Global Financing business are a significant part of our financial position. The financial position amounts appearing on pages 5 and 6 are the consolidated amounts including Global Financing. The amounts appearing in the separate Global Financing section, beginning on page 85, are supplementary data presented to facilitate an understanding of the Global Financing business.
IBM Working Capital At June 30, At December 31, (Dollars in millions) 2021 2020 Current assets$ 30,774 $ 39,165 Current liabilities 36,616 39,869 Working capital$ (5,842) $ (705) Current ratio 0.84:1 0.98:1
Working capital decreased
Current assets decreased
? A decrease of
restricted cash and marketable securities; and
A decrease in financing receivables of
? for currency) primarily due to collections of higher year-end balances and
sales of financing receivables; partially offset by
An increase in prepaid expenses and other current assets of
? million adjusted for currency) primarily driven by an increase in derivative
assets.
Current liabilities decreased
A decrease in other accrued expenses and liabilities of
? million adjusted for currency) primarily due to payments of
workforce rebalancing actions;
A decrease in taxes payable of
? currency) primarily driven by tax payments and decline in reserves as a result
of resolution of certain tax audit matters;
A decrease in short-term debt of
? million, including a
partially offset by reclassifications of
reflect upcoming maturities; and
A decrease in accounts payable of
? currency) reflecting declines from seasonally higher year-end balances;
partially offset by
An increase in deferred income of
? currency) driven by annual customer billings and an increase in software
renewal rates.
76
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Management Discussion - (continued)
Receivables and Allowances
Roll Forward of Total IBM Receivables Allowance for Credit Losses
(Dollars in millions) January 1, 2021 Additions / (Releases) * Write-offs **
Other + June 30, 2021 $ 644 $ (67) $ (28)$ 1 $ 550
* Additions/(Releases) for Allowance for Credit Losses are recorded in expense.
**Refer to note A, "Significant Accounting Policies," in our 2020 Annual Report for additional information regarding allowance for credit loss write-offs.
+ Primarily represents translation adjustments
The totalIBM receivables provision coverage was 2.5 percent atJune 30, 2021 , an increase of 10 basis points compared toDecember 31, 2020 . The increase in coverage was primarily driven by the overall decrease in total receivables, partially offset by a decrease in customer specific provisions. In the prior year, the global pandemic resulted in some deterioration in customer credit quality and/or bankruptcies which had an impact to provisions in the first half of 2020. We have started to see improvement in credit quality and some emergence from bankruptcies in the current year as the economy begins to reopen in many parts of the world. The majority of the write-offs during the six months endedJune 30, 2021 related to receivables which had been previously reserved.
Global Financing Receivables and Allowances
The following table presents external Global Financing receivables excluding immaterial miscellaneous receivables.
At June 30, At December 31,
(Dollars in millions) 2021 2020
Amortized cost * $ 14,111 $ 18,264Specific allowance for credit losses 173
184
Unallocated allowance for credit losses 54
79
Total allowance for credit losses 228
263
Net financing receivables$ 13,883 $
18,001
Allowance for credit losses coverage 1.6 %
1.4 %
* Includes deferred initial direct costs which are expensed in
The percentage of Global Financing receivables reserved increased from 1.4
percent at
Roll Forward of Global Financing Receivables Allowance for Credit Losses
(Dollars in millions) January 1, 2021 Additions / (Releases)* Write-offs **
Other + June 30, 2021 $ 263 $ (23) $ (12)$ 0 $ 228
* Additions/(Releases) for Allowance for Credit Losses are recorded in expense.
**Refer to note A, "Significant Accounting Policies," in our 2020 Annual Report for additional information regarding allowance for credit loss write-offs.
+ Primarily represents translation adjustments
Global Financing's expected credit loss expense (including impacts from off-balance sheet commitments which are recorded in other liabilities) was a net release of$12 million and$29 million for the three and six months endedJune 30, 2021 , respectively, compared to an addition of$28 million and$39 million for the three and six months endedJune 30 , 77
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Management Discussion - (continued)
2020, respectively. The decreases in both periods in 2021 were primarily driven
by lower specific and unallocated reserves in
Noncurrent Assets and Liabilities
At June 30, At December 31,
(Dollars in millions) 2021 2020
Noncurrent assets $ 116,039 $ 116,806
Long-term debt $ 48,735 $ 54,355
Noncurrent liabilities (excluding debt)
Noncurrent assets decreased
A decrease in long-term financing receivables of
? adjusted for currency) as a result of reductions from seasonally higher
year-end balances and sales of receivables;
? A decrease in net property, plant and equipment of
adjusted for currency); and
A decrease of
? operating right-of-use assets, deferred taxes and investments and sundry
assets; partially offset by
An increase in goodwill and net intangible assets of
? million adjusted for currency) due to additions from new acquisitions,
partially offset by intangibles amortization; and
? An increase in prepaid pension assets of
for currency).
Long-term debt decreased
? Reclassifications to short-term debt of
maturities; and
? Early redemption of
Noncurrent liabilities (excluding debt) decreased
? A decrease in retirement and nonpension postretirement benefit obligations of
? A decrease in long-term operating lease liabilities of
million adjusted for currency) related primarily to real estate leases.
78
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Management Discussion - (continued)
Debt
Our funding requirements are continually monitored and strategies are executed
to manage the overall asset and liability profile. Additionally, we maintain
sufficient flexibility to access global funding sources as needed.
At June 30, At December 31,
(Dollars in millions) 2021 2020
Total company debt $ 55,176 $ 61,538
Total Global Financing segment debt $ 17,470 $ 21,167
Debt to support external clients 14,234 17,819
Debt to support internal clients 3,236 3,348Non-Global Financing debt$ 37,706 $ 40,371 Total debt of$55,176 million decreased$6,362 million ($5,831 million adjusted for currency) fromDecember 31, 2020 , driven by debt maturities and early retirements of$5,954 million . Total debt has decreased$17,863 million since the end of the second quarter 2019 (immediately preceding theRed Hat acquisition).
Non-Global Financing debt of
Global Financing debt of$17,470 million decreased$3,696 million ($3,500 million adjusted for currency) fromDecember 31, 2020 , primarily due to lower funding requirements associated with financing receivables. In the first quarter of 2021,IBM Credit early redeemed all of its outstanding fixed-rate debt in the aggregate amount of$1.75 billion and deregistered with theU.S Securities and Exchange Commission . Global Financing provides financing predominantly for the company's external client assets, as well as for assets under contract by otherIBM units. These assets, primarily forGlobal Technology Services , generate long-term, stable revenue streams similar to the Global Financing asset portfolio. Based on their attributes, theseGlobal Technology Services assets are leveraged with the balance of the Global Financing asset base. Global Financing's funding of theGlobal Technology Services assets will wind down with the separation of Kyndryl as Global Financing refocuses its portfolio to supportIBM's hybrid cloud platform and AI capabilities. The debt used to fund Global Financing assets is primarily composed of intercompany loans. Total debt changes generally correspond with the level of client and commercial financing receivables, the level of cash and cash equivalents, the change in intercompany and external payables and the change in intercompany investment fromIBM . The terms of the intercompany loans are set by the company to substantially match the term, currency and interest rate variability underlying the financing receivable and are based on arm's-length pricing. The Global Financing debt-to-equity ratio remained at 9.0 to 1 atJune 30, 2021 . We measure Global Financing as a stand-alone entity, and accordingly, interest expense relating to debt supporting Global Financing's external client and internal business is included in the "Global Financing Results of Operations" on page 85 and in note 4, "Segments." In the Consolidated Income Statement, the external debt-related interest expense supporting Global Financing's internal financing to the company is reclassified from cost of financing to interest expense.
Equity
Total equity increased$1,341 million fromDecember 31, 2020 , primarily due to an increase from net income of$2,280 million , an increase in accumulated other comprehensive income of$1,685 million mainly due to retirement-related benefit plans of$991 million and an increase in foreign currency translation gains of$393 million , partially offset by dividends paid of$2,924 million . 79
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Management Discussion - (continued)
Cash Flow
Our cash flows from operating, investing and financing activities, as reflected in the Consolidated Statement of Cash Flows on page 7, are summarized in the following table. These amounts include the cash flows associated with the Global Financing business. (Dollars in millions)
For the six months endedJune 30 : 2021
2020
Net cash provided by/(used in) continuing operations: Operating activities$ 7,539 $ 8,052 Investing activities (4,671) (2,138) Financing activities (8,914) (1,739)
Effect of exchange rate changes on cash, cash equivalents and restricted cash
(65) (301)
Net change in cash, cash equivalents and restricted cash
$ 3,874
Net cash provided by operating activities decreased
A decrease in payroll tax and value-added tax deferrals of approximately
? million primarily driven by prior-year tax relief under the
other non-U.S. government assistance programs related to COVID-19; and
? An increase in workforce rebalancing payments of
by
? Performance-related improvements within net income;
A net decrease in cash payments for income taxes of
? to a withholding tax payment on intercompany dividends in the second quarter of
2020; and
? A decrease in interest payments on debt of approximately
Net cash used in investing activities increased
An increase in cash used for acquisitions of
? hybrid cloud and AI software capabilities and to add skills in strategic GBS
ecosystem partners; and
? A decrease in cash provided by divestitures of
by
? A decrease in cash used for net purchases of marketable securities and other
investments of
? A decrease in cash used for net capital expenditures of
Net cash used in financing activities increased
A decrease in net cash provided by debt transactions of
? primarily driven by a higher level of net additions in the prior year;
partially offset by a lower level of maturities in the current year consistent
with our overall debt pay down strategy.
80
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Management Discussion - (continued)
Looking Forward
Separation of Kyndryl
OnOctober 8, 2020 we announced our plan to separate the managed infrastructure services unit of our GTS segment into a new public company, to be named Kyndryl. The separation is expected to be achieved through aU.S. federal tax-free spin-off toIBM shareholders and be completed by the end of 2021. The separation will create two industry-leading companies, each with strategic focus and flexibility to capitalize on their respective missions and drive client and shareholder value.IBM will accelerate our open hybrid cloud platform growth strategy and AI capabilities to drive clients' digital transformations. Upon separation, Kyndryl 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. BothIBM and Kyndryl 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 have made good progress on executing the necessary financial, legal and regulatory milestones to enable the separation and remain on track to complete the separation by the end of 2021.
Across every industry, enterprises are using technology to redesign business processes, whether through automation in manufacturing, telemedicine in healthcare or omnichannel in retail. These digital transformations are enabled by a hybrid cloud environment. The technology and services we provide to our clients enable their business growth and productivity increases and improve customer experiences. This is why our strategy is focused on hybrid cloud and AI. Hybrid cloud is the reality for our clients today. They have multiple public clouds, private clouds, on-premise workloads and are dealing with stringent regulatory and security requirements. Our hybrid cloud platform gives clients the ability to flexibly deploy and manage data and applications across any environment. With hybrid cloud, clients can derive 2.5 times more value in comparison to other approaches. This is what we have built our platform for and why we have such confidence in our strategy. To execute our strategy, we continue to take decisive steps and make the necessary investments to strengthen our portfolio, both organic and inorganic, in skills, ecosystem and innovation. During the second quarter of 2021, we continued to make progress in the execution of our strategy. We announced a series of products to further differentiate our hybrid cloud and AI capabilities. To complement these organic investments, we completed several acquisitions, adding hybrid cloud and AI software capabilities and skills in strategic GBS ecosystem partners. We are adding delivery capabilities in GBS, technical skills inRed Hat and go-to-market capabilities across the company. We are building a more client-centric culture through our ecosystem of partners and our garage model which provides clients with a more technical and experiential approach, and we are increasing research and development in quantum, hybrid cloud and AI to drive innovation. We have also taken actions to streamline and simplify our operating model and the fundamentals of our business model remain solid. We executed the structural actions initiated in the fourth quarter of 2020 to improve the profit profile of Kyndryl and to create financial flexibility to reinvest in our business. Our balance sheet and liquidity position remain strong. AtJune 30, 2021 , we had$8.2 billion of cash and cash equivalents, restricted cash and marketable securities. We have made good progress in deleveraging, while being acquisitive and without sacrificing investments in our business or our solid dividend policy. We have reduced our debt by$17.9 billion from our peak level atJune 30, 2019 (immediately preceding theRed Hat acquisition). Looking forward, there is tremendous opportunity for us to help our clients become digital businesses. At the same time, the overall spending environment has continued to improve, and with the economy opening up in many parts of the world, many markets and industries are getting back on track. We continue to take prudent actions to improve our operating model and accelerate our strategy. We are managing for the long-term and are confident in the direction and focus of our business. We expect to continue our progress as a leading hybrid cloud and AI company with a focus on revenue growth and cash generation while maintaining our solid and modestly growing dividend policy. 81
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Management Discussion - (continued)
Our pension plans are well funded. Contributions for all retirement-related plans are expected to be approximately$2.3 billion in 2021, an increase of approximately$100 million compared to 2020, of which$0.2 billion generally relates to legally required contributions to non-U.S. defined benefit and multi-employer plans. We expect 2021 pre-tax retirement-related plan cost to be approximately$2.9 billion , an increase of approximately$300 million compared to 2020. This estimate reflects current pension plan assumptions atDecember 31, 2020 . Within total retirement-related plan cost, operating retirement-related plan cost is expected to be approximately$1.5 billion , approximately flat versus 2020. Non-operating retirement-related plan cost is expected to be approximately$1.4 billion , an increase of approximately$300 million compared to 2020, primarily driven by lower income from expected return on assets.
Currency Rate Fluctuations
Changes in the relative values of non-U.S. currencies to theU.S. dollar (USD) affect our financial results and financial position. AtJune 30, 2021 , currency changes resulted in assets and liabilities denominated in local currencies being translated into fewer dollars than at year-end 2020. We use financial hedging instruments to limit specific currency risks related to financing transactions and other foreign currency-based transactions. During periods of sustained movements in currency, the marketplace and competition adjust to the changing rates. For example, when pricing offerings in the marketplace, we may use some of the advantage from a weakeningU.S. dollar to improve our position competitively, and price more aggressively to win the business, essentially passing on a portion of the currency advantage to our customers. Competition will frequently take the same action. Consequently, we believe that some of the currency-based changes in cost impact the prices charged to clients. We also maintain currency hedging programs for cash management purposes which temporarily mitigate, but do not eliminate, the volatility of currency impacts on our financial results. We translate revenue, cost and expense in our non-U.S. operations at current exchange rates in the reported period. References to "adjusted for currency" or "constant currency" reflect adjustments based upon a simple mathematical formula. However, this constant currency methodology that we utilize to disclose this information does not incorporate any operational actions that management could take to mitigate fluctuating currency rates. Currency movements impacted our year-to-year revenue and earnings per share growth in the first six months of 2021. Based on the currency rate movements in the first six months of 2021, total revenue increased 2.2 percent as reported but decreased 1.5 percent at constant currency versus the first six months of 2020. On an income from continuing operations before income tax basis, these translation impacts, mitigated by the net impact of hedging activities, resulted in a theoretical maximum (assuming no pricing or sourcing actions) increase of approximately$170 million in the first six months of 2021 on an as-reported basis and an increase of approximately$210 million on an operating (non-GAAP) basis. The same mathematical exercise resulted in an increase of approximately$160 million in the first six months of 2020 on an as-reported basis and an increase of approximately$150 million on an operating (non-GAAP) basis. We view these amounts as a theoretical maximum impact to our as-reported financial results. Considering the operational responses mentioned above, movements of exchange rates, and the nature and timing of hedging instruments, it is difficult to predict future currency impacts on any particular period, but we believe it could be substantially less than the theoretical maximum given the competitive pressure in the marketplace. For non-U.S. subsidiaries and branches that operate inU.S. dollars or whose economic environment is highly inflationary, translation adjustments are reflected in results of operations. Generally, we manage currency risk in these entities by linking prices and contracts toU.S. dollars.
Liquidity and Capital Resources
In our 2020 Annual Report, on pages 56 to 58, there is a discussion of our liquidity including two tables that present three years of data. The table presented on page 56 includes net cash from operating activities, cash and cash equivalents, restricted cash and short-term marketable securities, and the size of our global credit facilities for each of the past three years. For the six months ended, or at, as applicable,June 30, 2021 , those amounts are$7.5 billion of net cash from operating activities,$8.2 billion of cash and cash equivalents, restricted cash and short-term marketable 82
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Management Discussion - (continued)
securities and$10.0 billion in global credit facilities, respectively. While we have no current plans to draw on these credit facilities, they are available as back-up liquidity. OnJune 22, 2021 , the company entered into a new$2.5 billion Three-Year Credit Agreement and$7.5 billion Five-Year Credit Agreement to replace the existing$2.5 billion Three-Year and$10.25 billion Five-Year Credit Agreements and terminated its$2.5 billion 364-Day Credit Agreement. Refer to note 11, "Borrowings" for additional details on these credit agreements. OnJuly 9, 2019 , we closed the acquisition ofRed Hat for cash consideration of$34.8 billion . The transaction was funded through a combination of cash on hand and proceeds from debt issuances. In order to reduce this debt and return to target leverage ratios within a couple of years, we suspended our share repurchase program at the time of theRed Hat acquisition closing. The major rating agencies' ratings on our debt securities atJune 30, 2021 appear in the following table. InMay 2021 , Standard and Poor's downgraded our long-term debt rating from A to A- and our commercial paper rating from A-1
to
A-2.
STANDARD MOODY'S
AND INVESTORS
IBM RATINGS: POOR'S SERVICESenior long-term debt A- A2 Commercial paper A-2 Prime-1IBM has ample financial flexibility, supported by our strong liquidity position and cash flows, to operate at a single A credit rating. Debt levels have decreased$6.4 billion fromDecember 31, 2020 and$17.9 billion from our peak levels atJune 30, 2019 (immediately preceding theRed Hat acquisition) and we will continue to deleverage throughout 2021 utilizing our debt maturities schedule. We do not have "ratings trigger" provisions in our debt covenants or documentation, which would allow the holders to declare an event of default and seek to accelerate payments thereunder in the event of a change in credit rating. Our debt covenants are well within the required levels. Our contractual agreements governing derivative instruments contain standard market clauses which can trigger the termination of the agreement if our credit rating were to fall below investment grade. AtJune 30, 2021 , the fair value of those instruments that were in a liability position was$142 million , before any applicable netting, and this position is subject to fluctuations in fair value period to period based on the level of our outstanding instruments and market conditions. We have no other contractual arrangements that, in the event of a change in credit rating, would result in a material adverse effect on our financial position or liquidity. InJuly 2017 , theUK's Financial Conduct Authority (FCA), which regulates the London Interbank Offered Rate (LIBOR), announced that it intends to phase out LIBOR by the end of 2021. InMarch 2021 , theFCA announced an extension of the phase out in the case ofU.S. dollar settings for certain tenors until the end ofJune 2023 . Various central bank committees and working groups continue to discuss replacement of benchmark rates, the process for amending existing LIBOR-based contracts, and the potential economic impacts of different alternatives. The Alternative Reference Rates Committee has identified the Secured Overnight Financing Rate (SOFR) as its preferred alternative rate for USD LIBOR. SOFR is a measure of the cost of borrowing cash overnight, collateralized byU.S. Treasury securities, and is based on directly observableU.S. Treasury -backed repurchase transactions. We have evaluated the replacement of the LIBOR benchmark interest rate, including risk management and internal operational readiness and we are monitoring the FASB standard-setting process to address financial reporting issues that might arise in connection with transition from LIBOR to a new benchmark rate. However, it is not expected to have a material impact in the consolidated financial results. We prepare our Consolidated Statement of Cash Flows in accordance with applicable accounting standards for cash flow presentation on page 7 of this Form 10-Q and highlight causes and events underlying sources and uses of cash in that format on page 80. For the purpose of running its business,IBM manages, monitors and analyzes cash flows in a different manner. 83
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Management Discussion - (continued)
Management uses free cash flow as a measure to evaluate its operating results, plan shareholder return levels, strategic investments and assess its ability and need to incur and service debt. The entire free cash flow amount is not necessarily available for discretionary expenditures. We define free cash flow as net cash from operating activities less the change in Global Financing receivables and net capital expenditures, including the investment in software. A key objective of the Global Financing business is to generate strong returns on equity, and our Global Financing receivables are the basis for growth. Accordingly, management considers Global Financing receivables as a profit-generating investment, not as working capital that should be minimized for efficiency. Therefore, management includes presentations of both free cash flow and net cash from operating activities that exclude the effect of Global Financing receivables.
The following is management's view of cash flows for the first six months of 2021 and 2020 prepared in a manner consistent with the description above.
Net cash from operating activities and free cash flow in 2021 include significant cash impacts from the workforce rebalancing actions we initiated in the fourth quarter of 2020 and Kyndryl separation-related charges.
(Dollars in millions) For the six months endedJune 30 : 2021
2020
Net cash from operating activities per GAAP$ 7,539 $ 8,052 Less: change in Global Financing receivables 3,763
2,971
Net cash from operating activities, excluding Global Financing receivables$ 3,776 $ 5,081 Capital expenditures, net (1,217) (1,434) Free cash flow$ 2,559 $ 3,647 Acquisitions (2,866) (19) Divestitures (25) 757
Common stock repurchases for tax withholdings (234)
(211)
Dividends (2,924) (2,890)
Non-Global Financing debt (2,331) 3,958
Other (includes Global Financing net receivables and Global
Financing debt) (288) (1)
Change in cash, cash equivalents, restricted cash and short-term marketable securities
$ (6,110) $ 5,241 In the first six months of 2021, we generated free cash flow of$2.6 billion , a decrease of$1.1 billion versus the prior year. The current-year period includes cash impacts from structural actions we initiated in the fourth quarter of 2020 and separation-related charges in the amount of$1.2 billion . In the first six months of 2021, we also continued to return value to shareholders with$2.9 billion in dividends. Events that could temporarily change the historical cash flow dynamics discussed previously and in our 2020 Annual Report include significant changes in operating results, material changes in geographic sources of cash, unexpected adverse impacts from litigation, future pension funding requirements, periods of severe downturn in the capital markets or the timing of tax payments. Whether any litigation has such an adverse impact will depend on a number of variables, which are more completely described in note 13, "Contingencies," in this Form 10-Q. With respect to pension funding, we expect to make legally mandated pension plan contributions to certain non-U.S. defined benefit plans of approximately$200 million in 2021. Contributions related to all retirement-related plans are expected to be approximately$2.3 billion in 2021. Financial market performance could increase the legally mandated minimum contributions in certain non-U.S. countries that require more frequent remeasurement of the funded status. We are not quantifying any further impact from pension funding because it is not possible to predict future movements in the capital markets or changes in pension plan funding regulations.
In 2021, we are not legally required to make any contributions to the
Our cash flows are sufficient to fund our current operations and obligations,
including investing and financing activities such as acquisitions, dividends and
debt service. When additional requirements arise, we have several liquidity
84
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Management Discussion - (continued)
options available. These options may include the ability to borrow additional funds at reasonable interest rates and utilizing our committed global credit facilities. With our share repurchase program suspended since the close of theRed Hat acquisition, our overall shareholder payout remains at a comfortable level and we remain fully committed to our dividend.
Global Financing
Global Financing is a reportable segment that is measured as a stand-alone entity. Global Financing facilitatesIBM clients' acquisition of information technology systems, software and services by providing financing solutions in the areas where the company has the expertise, while generating solid returns on equity. Results of Operations Yr. to Yr. Percent/ (Dollars in millions) Margin For the three months ended June 30: 2021 2020 Change External revenue$ 242 $ 265 (8.6) % Internal revenue 260 241 7.9 Total revenue$ 502 $ 506 (0.7) % Pre-tax income$ 246 $ 176 39.3 % Yr. to Yr. Percent/ (Dollars in millions) Margin For the six months ended June 30: 2021 2020 Change External revenue$ 482 $ 564 (14.7) % Internal revenue 428 453 (5.4) Total revenue$ 910 $ 1,017 (10.5) % Pre-tax income$ 412 $ 370 11.3 % We have refocused our Global Financing business onIBM's products and services. The wind down of our OEM commercial financing operations is complete. In 2020, we began entering into agreements to sell certain financing receivables to third parties. While these strategic actions continue to impact external revenue and pre-tax income on a year-to-year basis, our repositioning of the Global Financing business has strengthened our liquidity position, improved the quality of our portfolio and lowered our debt needs. Global Financing total revenue decreased 0.7 percent in the second quarter of 2021 compared to the prior year. External revenue decreased 8.6 percent (12 percent adjusted for currency), driven by external financing (down 23.1 percent to$160 million ), partially offset by external used equipment sales (up 43.8 percent to$82 million ). Internal revenue was up 7.9 percent due to increases in internal used equipment sales (up 23.5 percent to$230 million ), partially offset by declines in internal financing (down 45.7 percent to$29 million ). Global Financing total revenue decreased 10.5 percent in the first six months of 2021 compared to the same period in 2020. External revenue decreased 14.7 percent (17 percent adjusted for currency), driven by a decline in external financing (down 22.2 percent to$344 million ), partially offset by an increase in external used equipment sales (up 12.8 percent to$137 million ). Internal revenue decreased 5.4 percent, driven by a decline in internal financing (down 51.6 percent to$66 million ), partially offset by an increase in internal used equipment sales (up 14.6 percent to$362 million ). For both the three and six months endedJune 30, 2021 , the decreases in external financing were due to a lower average asset balance, partially driven by the strategic actions, and the decreases in internal financing were due to lower yields and a lower average asset balance. Internal used equipment sales were up due to increased sales to GTS. 85
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Management Discussion - (continued)
Global Financing pre-tax income increased 39.3 percent to$246 million in the second quarter of 2021 and 11.3 percent to$412 million in the first six months of 2021, compared to the same periods in 2020. The increase in the second quarter was primarily driven by improvements in provisions for credit losses and an increase in gross profit reflecting higher sales of internal used equipment. The increase in pre-tax income for the first six months of 2021 was primarily driven by improvements in provisions for credit losses, partially offset by a decrease in gross profit due to lower revenue as a result of the declining
asset
base.
Return on Equity Calculation
For Three Months Ended For Six Months Ended
June 30, June 30,
(Dollars in millions) 2021 2020 2021 2020
Numerator
Global Financing after-tax income*
$ 714 $ 588 $ 603 $ 677 Denominator Average Global Financing equity (2)**$ 1,986 $ 2,453 $ 2,108 $ 2,551 Global Financing return on equity (1)/(2) 36.0 % 24.0 %
28.6 % 26.5 %
* Calculated based upon an estimated tax rate principally based on Global
Financing's geographic mix of earnings as
** Average of the ending equity for Global Financing for the last two quarters and three quarters, for the three months endedJune 30 and for the six months endedJune 30 , respectively. Global Financing return on equity was 36.0 percent for the three months endedJune 30, 2021 , compared to 24.0 percent for the three months endedJune 30, 2020 . The increase was driven by a lower average equity balance and an increase in net income. Return on equity was 28.6 percent for the six months endedJune 30, 2021 , compared to 26.5 percent for the six months endedJune 30, 2020 . The increase was driven by a lower average equity balance, partially offset by a decrease in net income, which included a discrete tax benefit of$40 million in the first quarter of 2020. 86 Table of Contents
Management Discussion - (continued)
Financial Position
At June 30, At December 31,
(Dollars in millions) 2021 2020
Cash and cash equivalents $ 1,403 $ 1,862
Client financing receivables:
Net investment in sales-type and direct financing leases (1) 3,647 4,092
Client loans 9,225 11,498
Total client financing receivables 12,871 15,590
Commercial financing receivables 1,012 2,411
Other receivables 52 91
Total external receivables (2) 13,936 18,092
Intercompany financing receivables (3) (4) 3,869 3,959
Other assets 1,729 1,162
Total assets $ 20,937 $ 25,075
Intercompany payables (3) $
387 $ 303 Debt (5) 17,470 21,167 Other liabilities 1,139 1,254 Total liabilities 18,996 22,723 Total equity 1,941 2,352 Total liabilities and equity$ 20,937 $ 25,075
(1) Includes deferred initial direct costs which are expensed in
consolidated financial results.
The difference between the year-to-date decrease in total external
receivables of
in the free cash flow presentation on page 84 is primarily attributable to
currency impacts.
(3) This entire amount is eliminated for purposes of
results and therefore does not appear in the Consolidated Balance Sheet.
(4) These assets, along with all other financing assets in this table, are
leveraged at the value in the table using Global Financing debt.
(5) Global Financing debt is primarily composed of intercompany loans.
AtJune 30, 2021 , approximately 64 percent of the total external portfolio was with investment-grade clients with no direct exposure to consumers, an increase of 7 points year to year and relatively flat compared toMarch 31, 2021 . We continue to apply our rigorous credit policies, particularly in industries and countries disrupted by COVID-19, as it relates to the origination of new business. This investment grade percentage is based on the credit ratings of the companies in the portfolio and reflects mitigating credit enhancement actions taken by the client to reduce the risk toIBM . We have a long-standing practice of taking mitigation actions, in certain circumstances, to transfer credit risk to third parties, with enhanced focus due to current macroeconomic uncertainty. These actions may include credit insurance, financial guarantees, nonrecourse borrowings, transfers of receivables recorded as true sales in accordance with accounting guidance or sales of equipment under operating lease. Sale of receivables arrangements are also utilized in the normal course of business as part of our cash and liquidity management. For the six months endedJune 30, 2021 , we sold$2,091 million of client financing receivables to third parties, consisting of loan and lease receivables of$1,359 million and$732 million , respectively. More than half of the receivables sold were classified as current assets at the time of sale. For the six months endedJune 30, 2020 , we sold$711 million of client financing receivables to third parties, consisting of loan and lease receivables of$294 million and$417 million , respectively. In addition, we sold$2,621 million of commercial financing receivables for the six months endedJune 30, 2021 , to a third-party investor. we also classified$467 million and$383 million ofIBM commercial financing receivables as held for sale atJune 30, 2021 andDecember 31, 2020 , respectively, in short-term financing receivables in the Consolidated 87
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Management Discussion - (continued)
Balance Sheet. Payment terms for commercial financing receivables generally
range from 30 to 90 days and sales are made to the investor on a revolving
basis. We did not have any sales of commercial financing receivables for the six
months ended
The transfers of these receivables qualified as true sales and therefore reduced financing receivables. The cash proceeds from the sales are included in cash flows from operating activities, with no impact to free cash flow, and the impacts to the Consolidated Income Statement, including fees and net gain or loss associated with the transfers of these receivables for the six months endedJune 30, 2021 andJune 30, 2020 , were not material. For additional information relating to the sales of financing receivables refer to note 8, "Financing Receivables."
Refer to pages 77 through 79 for additional information related to Global Financing receivables, allowance for credit losses and debt.
Residual Value
Residual value is a risk unique to the financing business, and management of this risk is dependent upon the ability to accurately project future equipment values at lease inception. Global Financing has insight into product plans and cycles forIBM products. Based upon this product information, Global Financing continually monitors projections of future equipment values and compares them with the residual values reflected in the portfolio. Global Financing optimizes the recovery of residual values by selling assets sourced from end of lease, leasing used equipment to new clients, or extending lease arrangements with current clients. The following table presents the recorded amount of unguaranteed residual value for sales-type and direct financing leases, as well as operating leases atJune 30, 2021 andDecember 31, 2020 . In addition, the table presents the run out of when the unguaranteed residual value assigned to equipment on leases atJune 30, 2021 andDecember 31, 2020 , is expected to be returned to the company.
Unguaranteed Residual Value
At At Estimated Run Out of June 30, 2021 Balance
December 31, June 30, 2024 and(Dollars in millions) 2020 2021 2021 2022 2023 Beyond
Sales-type and direct financing leases $ 469
50 $ 113 $ 133 $ 92
Operating leases 48 30 23 4 1 2
Total unguaranteed residual value $ 516
72 $ 117 $ 133 $ 95
88
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Management Discussion - (continued)
GAAP Reconciliation
The tables below provide a reconciliation of our income statement results as
reported under GAAP to our operating earnings presentation which is a non-GAAP
measure. Management's calculation of operating (non-GAAP) earnings, as
presented, may differ from similarly titled measures reported by other
companies. Refer to the "Operating (non-GAAP) Earnings" section for management's
rationale for presenting operating earnings information.
Acquisition- Retirement- U.S. Separation-
(Dollars in millions except per share amounts) Related Related Tax Reform Related Operating
For the three months ended June 30, 2021: GAAP Adjustments Adjustments Impacts Charges (non-GAAP)
Gross profit $ 9,004 $ 180 $ - $ - $ 58 $ 9,242
Gross profit margin 48.0 % 1.0 pts. - pts. - pts. 0.3 pts. 49.3 %
S,G&A $ 5,334 $ (298) $ - $ - $ (116) $ 4,919
R,D&E 1,657 - - - 0 1,656
Other (income) and expense 315 (1) (328) - - (14)Total expense and other (income) 7,451 (299) (328) - (117)
6,708
Pre-tax income from continuing operations 1,552 479 328 - 175
2,534
Pre-tax margin from continuing operations 8.3 % 2.6
pts. 1.7 pts. - pts. 0.9 pts. 13.5 % Provision for income taxes*$ 227 $ 107 $ 67$ (14) $ 44 $ 431 Effective tax rate 14.7 % 1.4 pts. 0.7 pts. (0.5) pts. 0.7 pts. 17.0 %
Income from continuing operations$ 1,325 $ 373
$ 261 $ 14 $ 131
7.1 % 2.0 pts. 1.4 pts. 0.1 pts. 0.7 pts. 11.2 %
Diluted earnings per share from continuing
operations $ 1.47 $ 0.41 $ 0.29 $ 0.01 $ 0.15 $ 2.33
Acquisition- Retirement- U.S. Separation-(Dollars in millions except per share amounts) Related Related Tax Reform Related
Operating
For the three months ended June 30, 2020: GAAP Adjustments
Adjustments Impacts Charges (non-GAAP)
Gross profit $ 8,700 $ 187 $ - $ - $ - $ 8,887
Gross profit margin 48.0 % 1.0 pts. - pts. - pts. - pts. 49.0 %
S,G&A $ 5,248 $ (285) $ - $ - $ - $ 4,962
R,D&E 1,582 - - - - 1,582
Other (income) and expense 179 (1) (273) - - (95)Total expense and other (income) 7,129 (286) (273) - -
6,570
Pre-tax income from continuing operations 1,571 473 273 - -
2,318
Pre-tax margin from continuing operations 8.7 % 2.6
pts. 1.5 pts. - pts. - pts. 12.8 % Provision for income taxes*$ 209 $ 108 $ 52 $ - $ - $ 369 Effective tax rate 13.3 % 1.9 pts. 0.7 pts. - pts. - pts. 15.9 %
Income from continuing operations$ 1,362 $ 365 $ 222 $ - $ - $
1,949
Income margin from continuing operations 7.5 % 2.0 pts. 1.2 pts. - pts. - pts. 10.8 % Diluted earnings per share from continuing operations$ 1.52 $ 0.41 $ 0.25 $ - $ -$ 2.18 * The tax impact on operating (non-GAAP) pre-tax income from continuing operations is calculated under the same accounting principles applied to the GAAP pre-tax income which employs an annual effective tax rate method to the results. 89 Table of Contents
Management Discussion - (continued)
Acquisition- Retirement- U.S. Separation-
(Dollars in millions except per share amounts) Related Related Tax Reform Related Operating
For the six months ended June 30, 2021: GAAP Adjustments
Adjustments Impacts Charges (non-GAAP)
Gross profit $ 17,208 $ 355 $ - $ - $ 61 $ 17,624
Gross profit margin 47.2 % 1.0 pts. - pts. - pts. 0.2 pts. 48.3 %
S,G&A $ 10,508 $ (591) $ - $ - $ (175) $ 9,742
R,D&E 3,286 - - - 0 3,286
Other (income) and expense 676 (1) (670) - - 5
Total expense and other (income) 14,751 (593) (670) - (175) 13,313
Pre-tax income from continuing operations 2,457 948 670 - 236
4,312
Pre-tax margin from continuing operations 6.7 % 2.6 pts. 1.8 pts. - pts. 0.6 pts. 11.8 % Provision for income taxes*$ 177 $ 240 $ 128 $ 6 $ 59 $ 610 Effective tax rate 7.2 % 4.0 pts. 1.9 pts. 0.1 pts. 1.0 pts. 14.1 % Income from continuing operations$ 2,281 $
707 $ 542
3,702
Income margin from continuing operations 6.3 % 1.9 pts. 1.5 pts. 0.0 pts. 0.5 pts. 10.1 % Diluted earnings per share from continuing operations$ 2.52 $ 0.79 $ 0.60 $ (0.01) $ 0.20 $ 4.10 Acquisition- Retirement- U.S. Separation-
(Dollars in millions except per share amounts) Related Related Tax Reform Related
Operating
For the six months ended June 30, 2020: GAAP Adjustments
Adjustments Impacts Charges (non-GAAP)
Gross profit $ 16,622 $ 375 $ - $ - $ - $ 16,998
Gross profit margin 46.6 % 1.1 pts. - pts. - pts. - pts. 47.6 %
S,G&A $ 11,203 $ (570) $ - $ - $ - $ 10,633
R,D&E 3,207 - - - - 3,207
Other (income) and expense 361 (1) (538) - - (178)
Total expense and other (income) 15,101 (571) (538) - - 13,992
Pre-tax income from continuing operations 1,522 946 538 - -
3,006
Pre-tax margin from continuing operations 4.3 % 2.7 pts. 1.5 pts. - pts. - pts. 8.4 % Provision for (benefit from) income taxes*$ (1,017) $ 210 $ 65$ 149 $ -$ (592) Effective tax rate (66.8) % 28.0 pts. 14.1 pts. 5.0 pts. - pts. (19.7) % Income from continuing operations$ 2,538 $ 736 $ 472$ (149) $ - $
3,598
Income margin from continuing operations 7.1 % 2.1 pts. 1.3 pts. (0.4) pts. - pts. 10.1 % Diluted earnings per share from continuing operations$ 2.83 $ 0.83 $ 0.53 $ (0.17) $ -$ 4.02 * The tax impact on operating (non-GAAP) pre-tax income from continuing operations is calculated under the same accounting principles applied to the GAAP pre-tax income which employs an annual effective tax rate method to the results. 90 Table of Contents
Management Discussion - (continued)
Forward-Looking and Cautionary Statements
Except for the historical information and discussions contained herein, statements contained in this Form 10-Q may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based on the company's current assumptions regarding future business and financial performance. These statements involve a number of risks, uncertainties and other factors that could cause actual results to differ materially, including, but not limited to, the following: a downturn in economic environment and client spending budgets; a failure of the company's innovation initiatives; damage to the company's reputation; risks from investing in growth opportunities; failure of the company's intellectual property portfolio to prevent competitive offerings and the failure of the company to obtain necessary licenses; the possibility that the proposed separation of the managed infrastructure services unit of the company'sGlobal Technology Services segment will not be completed within the anticipated time period or at all, the possibility of disruption or unanticipated costs in connection with the proposed separation or the possibility that the separation will not achieve its intended benefits; the company's ability to successfully manage acquisitions, alliances and dispositions, including integration challenges, failure to achieve objectives, the assumption of liabilities, and higher debt levels; fluctuations in financial results; impact of local legal, economic, political, health and other conditions; the company's failure to meet growth and productivity objectives; ineffective internal controls; the company's use of accounting estimates; impairment of the company's goodwill or amortizable intangible assets; the company's ability to attract and retain key employees and its reliance on critical skills; impacts of relationships with critical suppliers; product quality issues; impacts of business with government clients; reliance on third party distribution channels and ecosystems; cybersecurity and data privacy considerations; adverse effects from environmental matters, tax matters; legal proceedings and investigatory risks; the company's pension plans; currency fluctuations and customer financing risks; impact of changes in market liquidity conditions and customer credit risk on receivables; risk factors related toIBM securities; and other risks, uncertainties and factors discussed in the company's Form 10-Qs, Form 10-K and in the company's other filings with theU.S. Securities and Exchange Commission or in materials incorporated therein by reference. Any forward-looking statement in this Form 10-Q speaks only as of the date on which it is made. Except as required by law, the company assumes no obligation to update or revise any forward-looking statements.
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