Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION

FOR THE THREE MONTHS ENDED MARCH 31, 2023

Snapshot

Organization of Information:

In the fourth quarter of 2022, we completed our annual assessment of the useful lives of our property, plant and equipment. Due to advances in technology, we determined we should increase the estimated useful lives of our server and network equipment from five to six years for new assets and from three to four years for used assets. This change in accounting estimate was effective beginning January 1, 2023. Based on the carrying amount of server and network equipment included in property, plant and equipment-net in our Consolidated Balance Sheet as of December 31, 2022, the effect of this change in estimate was an increase in income from continuing operations before income taxes of $74 million or $0.06 per both basic and diluted share for the three months ended March 31, 2023.

In the first quarter of 2023, we initiated a workforce rebalancing action to address remaining stranded costs from portfolio actions over the last couple of years resulting in a charge to pre-tax income from continuing operations of approximately $260 million. In addition, beginning in the first quarter of 2023, we updated our measure of segment pre-tax income to no longer allocate workforce rebalancing actions to our segments, consistent with our management system. Workforce rebalancing charges in the first quarter of 2022 of $5 million were included in the segments.

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

Currency:

The references to “adjusted for currency” or “at constant currency” in the Management Discussion do not include operational impacts that could result from fluctuations in foreign currency rates. When we refer to growth rates at constant currency or adjust such growth rates for currency, it is done so that certain financial results can be viewed without the impact of fluctuations in foreign currency exchange rates, thereby facilitating period-to-period comparisons of its business performance. Financial results adjusted for currency are calculated by translating current period activity in local currency using the comparable prior-year period’s currency conversion rate. This approach is used for countries where the functional currency is the local currency. Generally, when the dollar either strengthens or weakens against other currencies, the growth at constant currency rates or adjusting for currency will be higher or lower than growth reported at actual exchange rates. Refer to “Currency Rate Fluctuations” for additional information.

Operating (non-GAAP) Earnings:

In an effort to provide better transparency into the operational results of the business, supplementally, management separates business results into operating and non-operating categories. Operating earnings from continuing operations is a non-GAAP measure that excludes the effects of certain acquisition-related charges, intangible asset amortization, expense resulting from basis differences on equity method investments, retirement-related costs, certain impacts from the Kyndryl separation and their related tax impacts. Due to the unique, non-recurring nature of the enactment of the U.S. Tax Cuts and Jobs Act (U.S. tax reform), management characterizes the one-time provisional charge recorded in the fourth quarter of 2017 and adjustments to that charge as non-operating. Adjustments primarily include true-ups, accounting elections and any changes to regulations, laws, audit adjustments that affect the recorded one-time charge. Management characterizes direct and incremental charges incurred related to the Kyndryl separation as non-operating given their unique and non-recurring nature. These charges primarily relate to any net gains or losses on the Kyndryl common stock and the related cash-settled swap with a third-party financial institution, which were recorded in other (income) and expense in the Consolidated Income Statement. As of November 2, 2022, the company no longer held an

Management Discussion – (continued)

ownership interest in Kyndryl. For acquisitions, operating (non-GAAP) earnings exclude the amortization of purchased intangible assets and acquisition-related charges such as in-process research and development, transaction costs, applicable retention, restructuring and related expenses, tax charges related to acquisition integration and pre-closing charges, such as financing costs. These charges are excluded as they may be inconsistent in amount and timing from period to period and are significantly impacted by the size, type and frequency of the company’s acquisitions. All other spending for acquired companies is included in both earnings from continuing operations and in operating (non-GAAP) earnings. For retirement-related costs, management characterizes certain items as operating and others as non-operating, consistent with GAAP. We include defined benefit plan and nonpension postretirement benefit plan service costs, multi-employer plan costs and the cost of defined contribution plans in operating earnings. Non-operating retirement-related costs include defined benefit plan and nonpension postretirement benefit plan amortization of prior service costs, interest cost, expected return on plan assets, amortized actuarial gains/losses, the impacts of any plan curtailments/settlements and pension insolvency costs and other costs. Non-operating retirement-related costs are primarily related to changes in pension plan assets and liabilities which are tied to financial market performance, and the company considers these costs to be outside of the operational performance of the business.

​

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

Management Discussion – (continued)

Financial Results Summary — Three Months Ended March 31:

​	​	​	​	​	​	​	​	​	​
​			​			​		Yr. to Yr.
​	​	​	​	​	​	​	​	Percent/
(Dollars and shares in millions except per share amounts)	​	​	​	​	​	​	​	Margin
For the three months ended March 31:	​	2023		​	2022		​	Change
Revenue	​	$	14,252	​	$	14,197		0.4	%*
Gross profit margin	​		52.7	%		51.7	%	1.0	pts.
Total expense and other (income)	​	$	6,451	​	$	6,712		(3.9)	%
Income from continuing operations before income taxes	​	$	1,058	​	$	623		69.8	%
Provision for/(benefit from) income taxes from continuing operations	​	$	124	​	$	(39)		nm	​
Income from continuing operations	​	$	934	​	$	662		41.1	%
Income from continuing operations margin	​		6.6	%		4.7	%	1.9	pts.
Income/(loss) from discontinued operations, net of tax	​	$	(7)	​	$	71	​	nm	​
Net income	​	$	927	​	$	733		26.5	%
Earnings per share from continuing operations - assuming dilution	​	$	1.02	​	$	0.73		39.7	%
Consolidated earnings per share - assuming dilution	​	$	1.01	​	$	0.81	​	24.7	%
Weighted-average shares outstanding - assuming dilution	​		917.8	​		909.2		0.9	%
​	​	​	​	​	​	​	​	​	​
​	​	At 3/31/2023		​	At 12/31/2022		​	​	​
Assets	​	$	133,637	​	$	127,243		5.0	%
Liabilities	​	$	111,964	​	$	105,222		6.4	%
Equity	​	$	21,672	​	$	22,021		(1.6)	%

• 4.4 percent adjusted for currency.

nm - not meaningful

​

The following table provides the company’s operating (non-GAAP) earnings for the first quarter of 2023 and 2022.

​	​	​	​	​	​	​	​	​	​
​			​			​		Yr. to Yr.
(Dollars in millions except per share amounts)	​	​	​	​	​	​	​	Percent
For the three months ended March 31:	​	2023		​	2022		​	Change
Net income as reported	​	$	927	​	$	733		26.5	%
Income/(loss) from discontinued operations, net of tax	​		(7)	​		71		nm	​
Income from continuing operations	​	$	934	​	$	662		41.1	%
Non-operating adjustments (net of tax):	​		​	​					​
Acquisition-related charges	​	$	305	​	$	359		(15.1)	%
Non-operating retirement-related costs/(income)	​	​	5	​	​	144	​	(96.5)	​
U.S. tax reform impacts	​		5	​		(116)		nm	​
Kyndryl-related impacts	​		—	​		222		(100.0)	​
Operating (non-GAAP) earnings*	​	$	1,249	​	$	1,271		(1.8)	%
Diluted operating (non-GAAP) earnings per share*	​	$	1.36	​	$	1.40		(2.9)	%

• Refer to page 67 for a more detailed reconciliation of net income to operating earnings.

nm - not meaningful

Macroeconomic Environment:

​

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

​

We had a good start to 2023 and saw progress from the actions we have taken to mitigate the impacts of escalating labor and component costs and a strong U.S. dollar. Consulting pre-tax margin increased in the first quarter of 2023 as we continue to benefit from pricing and productivity actions. And across our product-based businesses, we announced a

Management Discussion – (continued)

series of price increases reflecting the value we provide to our clients. We expect these actions to continue to contribute to margin improvement throughout 2023. In the current environment, clients are prioritizing digital transformation projects that focus on cost reduction and productivity. While demand for our offerings that support these priorities remains solid, we are seeing some deceleration in Consulting from the previous robust growth levels, especially in the U.S. The strength of the U.S. dollar continued to impact our reported revenue and pre-tax profit. We execute hedging programs which defer but do not eliminate the impact of currency. The (gains)/losses from these hedging programs are reflected primarily in other income and expense. See “Currency Rate Fluctuations,” for additional information.

​

In March 2023, the bank failures of Silicon Valley Bank and Signature Bank created significant market disruption and uncertainty within the U.S. banking sector, in particular with respect to regional banks. We hold minimal cash balances with regional banks in the U.S. We have a robust and disciplined cash management process to protect our cash and maintain financial stability. Further, while we serve many clients in the Financial Services Sector (FSS), less than one percent of our total revenue comes from regional banks. We have not seen any notable changes in the client buying behaviors of our FSS clients in the U.S. We continue to monitor the impacts of this situation but do not anticipate a significant impact on our future results of operations or financial position.

​

Financial Performance Summary — Three Months Ended March 31:

In the first quarter of 2023, we reported $14.3 billion in revenue, income from continuing operations of $0.9 billion and operating (non-GAAP) earnings of $1.2 billion. Diluted earnings per share from continuing operations was $1.02 as reported and $1.36 on an operating (non-GAAP) basis. We generated $3.8 billion in cash from operations and $1.3 billion in free cash flow and delivered shareholder returns of $1.5 billion in dividends. We continued to invest in innovation while transforming our business processes and driving productivity. Our first-quarter results reflect progress in our key growth areas as clients continue to accelerate their digital transformations, modernize their applications, automate their workflows and create flexible and secure hybrid cloud environments.

​

Total revenue grew 0.4 percent as reported and 4 percent adjusted for currency compared to the prior-year period led by our growth areas of Software and Consulting. Software delivered revenue growth of 2.6 percent as reported and 6 percent adjusted for currency, with growth in both Hybrid Platform & Solutions and Transaction Processing. Hybrid Platform & Solutions revenue was up 2.4 percent as reported and 5 percent adjusted for currency. We continue to see client demand for broad capabilities across Red Hat, Automation, Data & AI and Security. Transaction Processing revenue grew 2.9 percent as reported and 7 percent adjusted for currency as this software remains core to our clients’ hybrid cloud strategies. Consulting revenue increased 2.8 percent as reported and 8 percent adjusted for currency, with growth led by data and customer experience transformation projects, in addition to cloud application development and management. Infrastructure revenue decreased 3.7 percent as reported and was flat adjusted for currency, with revenue growth in Hybrid Infrastructure led by zSystems, more than offset by a decline in Infrastructure Support revenue.

​

From a geographic perspective, Americas revenue grew 0.3 percent year to year as reported (1 percent adjusted for currency). Europe/Middle East/Africa (EMEA) increased 2.4 percent (8 percent adjusted for currency). Asia Pacific decreased 2.3 percent but grew 7 percent adjusted for currency.

​

Gross margin of 52.7 percent increased 1.0 point year to year with margin expansion across all reportable segments and a strong portfolio mix overall. Operating (non-GAAP) gross margin of 53.7 percent increased 0.8 points year to year due to the same dynamics.

​

Total expense and other (income) decreased 3.9 percent in the first quarter of 2023 versus the prior-year period primarily driven by an unrealized loss from Kyndryl retained shares in the first-quarter 2022, lower non-operating retirement-related costs, higher interest income, the effects of currency and benefits from productivity and transformation of our business processes. These impacts were partially offset by higher workforce rebalancing charges and higher net spending reflecting our continuing investment in innovation, our ecosystem and talent. Total operating (non-GAAP) expense and other (income) increased 3.5 percent year to year, driven primarily by the factors described

Management Discussion – (continued)

above excluding the prior-year unrealized loss on Kyndryl stock and the lower non-operating retirement-related costs in the current year.

​

Pre-tax income from continuing operations of $1.1 billion increased 69.8 percent and pre-tax margin was 7.4 percent, an increase of 3.0 points versus the first quarter of 2022. Performance this quarter benefitted from the expense dynamics described above, improvements in business mix and ongoing productivity initiatives, partially offset by currency and workforce rebalancing charges. The first-quarter 2023 workforce rebalancing charge of approximately $260 million impacted the pre-tax income from continuing operations year-to-year performance by approximately 40 points and the pre-tax margin by 1.8 points. The continuing operations provision for income taxes in the first quarter of 2023 was $124 million, compared to a benefit of $39 million in the first quarter of 2022. The prior-year benefit was primarily driven by the impact of updates to the foreign tax credit regulations. Net income from continuing operations of $0.9 billion increased 41.1 percent and the net income from continuing operations margin was 6.6 percent, up 1.9 points year to year. The workforce rebalancing charge impacted net income from continuing operations year-to-year performance by approximately 30 points and pre-tax margin by 1.4 points.

​

Operating (non-GAAP) pre-tax income from continuing operations of $1.4 billion decreased 4.4 percent compared to the prior-year period and the operating (non-GAAP) pre-tax margin from continuing operations decreased 0.5 points to 10.2 percent. The workforce rebalancing charge impacted operating (non-GAAP) pre-tax income from continuing operations year-to-year performance by approximately 17 points and operating (non-GAAP) pre-tax margin by 1.8 points. The operating (non-GAAP) income tax provision for the first quarter of 2023 was $200 million, compared to a provision for income taxes of $244 million in the first quarter of 2022. Operating (non-GAAP) income from continuing operations of $1.2 billion decreased 1.8 percent and the operating (non-GAAP) income margin from continuing operations of 8.8 percent was down 0.2 points year to year. The workforce rebalancing charge impacted operating (non-GAAP) income from continuing operations year-to-year performance by approximately 16 points and operating (non-GAAP) pre-tax margin by 1.4 points.

​

Diluted earnings per share from continuing operations of $1.02 in the first quarter of 2023 increased 39.7 percent and operating (non-GAAP) diluted earnings per share of $1.36 decreased 2.9 percent versus the prior-year period. The workforce rebalancing charge resulted in an impact of ($0.22) both to diluted earnings per share from continuing operations and diluted operating (non-GAAP) earnings per share.

​

At March 31, 2023, the balance sheet remained strong with the flexibility to support and invest in the business. Cash and cash equivalents, restricted cash and marketable securities at March 31, 2023 of $17.6 billion increased $8.8 billion from December 31, 2022 and debt of $58.7 billion at March 31, 2023 increased $7.8 billion, both increases driven primarily by net debt issuances.

​

Total assets increased $6.4 billion ($5.9 billion adjusted for currency) from December 31, 2022 primarily driven by the increase in cash and cash equivalents, restricted cash and marketable securities; partially offset by a decrease in receivables. Total liabilities increased $6.7 billion ($6.2 billion adjusted for currency) from December 31, 2022 primarily driven by the increase in debt and an increase in deferred income; partially offset by decreases in compensation and benefits and taxes payable. Total equity of $21.7 billion decreased $0.3 billion from December 31, 2022 as a result of dividends paid, partially offset by first-quarter 2023 net income and common stock issuances.

​

Cash provided by operating activities was $3.8 billion in the first three months of 2023, an increase of $0.5 billion compared to the prior-year period. Net cash used in investing activities of $8.0 billion increased $6.6 billion and net cash provided by financing activities of $5.7 billion increased $4.3 billion compared to the first three months of 2022.

​

Management Discussion – (continued)

First Quarter in Review

​

Results of Continuing Operations

Segment Details

The table below presents each reportable segment’s revenue and gross margin results, followed by an analysis of the first quarter of 2023 versus the first quarter of 2022 reportable segments results.

​	​	​	​	​	​	​	​	​	​	​	​
​			​			​				Yr. to Yr.
​	​	​	​	​	​	​	​	​	​	Percent
​	​	​	​	​	​	​	​	Yr. to Yr.	​	Change
(Dollars in millions)	​		​	​		​	​	Percent/Margin	​	Adjusted For
For the three months ended March 31:	​	2023		​	2022		​	Change	​	Currency
Revenue:		​			​						​
Software	​	$	5,921	​	$	5,772	​	2.6	%	5.6	%
Gross margin	​		79.5	%		78.8	%	0.6	pts.		​
Consulting	​		4,962	​		4,829	​	2.8	%	8.2	%
Gross margin	​		25.2	%		24.3	%	0.9	pts.		​
Infrastructure	​		3,098	​		3,219		(3.7)	%	0.1	%
Gross margin	​		51.7	%		50.5	%	1.2	pts.		​
Financing	​		196	​		154		27.3	%	31.0	%
Gross margin	​		43.9	%		37.7	%	6.2	pts.		​
Other	​		75	​		224	​	(66.6)	%	(65.2)	%
Gross margin	​		(182.3)	%		(32.9)	%	(149.4)	pts.		​
Total revenue	​	$	14,252	​	$	14,197		0.4	%	4.4	%
Total gross profit	​	$	7,509	​	$	7,335		2.4	%		​
Total gross margin	​		52.7	%		51.7	%	1.0	pts.		​
Non-operating adjustments:	​			​							​
Amortization of acquired intangible assets	​	​	148	​		181		(18.0)	%		​
Operating (non-GAAP) gross profit	​	$	7,658	​	$	7,516		1.9	%		​
Operating (non-GAAP) gross margin	​		53.7	%		52.9	%	0.8	pts.		​

​

​

Software

​	​	​	​	​	​	​	​	​	​	​	​
​			​			​				Yr. to Yr.
​	​	​	​	​	​	​	​	​	​	Percent
​	​	​	​	​	​	​	​	Yr. to Yr.	​	Change
(Dollars in millions)	​		​	​		​	​	Percent	​	Adjusted For
For the three months ended March 31:	​	2023		​	2022		​	Change	​	Currency
Software revenue:	​	$	5,921	​	$	5,772		2.6	%	5.6	%
Hybrid Platform & Solutions	​	$	4,179	​	$	4,080		2.4	%	5.2	%
Red Hat	​	​	​	​	​	​	​	8.3	​	10.8	​
Automation	​	​	​	​	​	​	​	(0.9)	​	2.1	​
Data & AI	​	​	​	​	​	​	​	0.8	​	3.4	​
Security	​	​	​	​	​	​	​	(1.2)	​	2.0	​
Transaction Processing	​	​	1,742	​		1,692		2.9		6.5	​

​

Software revenue of $5,921 million increased 2.6 percent as reported (6 percent adjusted for currency) in the first quarter of 2023 compared to the prior-year period with growth in both Hybrid Platform & Solutions and Transaction Processing. This performance reflects the benefits of our growing recurring revenue and continued strong renewal rates. This, together with the growth in transactional software this quarter, demonstrates clients’ commitment to our hybrid cloud and AI platforms.

​

Management Discussion – (continued)

Hybrid Platform & Solutions revenue of $4,179 million increased 2.4 percent as reported (5 percent adjusted for currency) in the first quarter of 2023 compared to the prior-year period reflecting continued client demand for our broad capabilities across all business areas. Red Hat revenue grew 8.3 percent as reported (11 percent adjusted for currency) in the first quarter of 2023 with growth across all major offerings. We had strength in OpenShift, our hybrid cloud platform, and Ansible, our IT automation solution, both of which continued to take market share this quarter. Automation revenue decreased 0.9 percent as reported, but grew 2 percent adjusted for currency driven by growth in offerings such as integration and application servers given client demand for improved IT performance and cost. Data & AI revenue increased 0.8 percent as reported (3 percent adjusted for currency), reflecting growth across Data Management, Business Analytics, and Asset and Supply Chain Management. Many of these offerings, such as DB2, serve as the underpinnings for modern AI and mission-critical workloads. Security revenue decreased 1.2 percent as reported, but grew 2.0 percent adjusted for currency compared to the prior year.

​

Across Hybrid Platform & Solutions, our annual recurring revenue (ARR) was $13.5 billion. ARR is a key performance metric management uses to assess the health and growth trajectory of our Hybrid Platform & Solutions business within the Software segment. ARR is calculated by estimating the current quarter’s recurring, committed value for certain types of active contracts as of the period-end date and then multiplying that value by four. This value is based on each arrangement’s contract value and start date, mitigating fluctuations during the contract term, and includes the following consumption models: (1) software subscription agreements, including committed term licenses, (2) as-a-service arrangements such as SaaS and PaaS, (3) maintenance and support contracts, and (4) security managed services contracts. ARR should be viewed independently of revenue as this performance metric and its inputs may not represent the amount of revenue recognized in the period and therefore is not intended to represent current period revenue or revenue that will be recognized in future periods.

Transaction Processing revenue of $1,742 million increased 2.9 percent as reported (7 percent adjusted for currency) in the first quarter of 2023 compared to the prior-year period. This software remains core to our clients’ hybrid cloud strategies. The strong performance of the last two zSystems cycles drove significant capacity growth. This growth translates to software opportunity and contributed to growth in both recurring and transactional revenue. Together with price increases, this performance contributed to good revenue growth this quarter.

​	​	​	​	​	​	​	​	​	​
​			​			​		Yr. to Yr.
​	​	​	​	​	​	​	​	Percent/
(Dollars in millions)	​		​	​		​	​	Margin
For the three months ended March 31:	​	2023		​	2022		​	Change
Software:		​			​				​
Gross profit	​	$	4,705	​	$	4,550		3.4	%
Gross profit margin	​		79.5	%		78.8	%	0.6	pts.
Pre-tax income	​	$	1,164	​	$	1,134		2.7	%
Pre-tax margin	​		19.7	%		19.7	%	0.0	pts.

​

Software gross profit margin increased 0.6 points to 79.5 percent in the first quarter of 2023 compared to the prior-year period, reflecting the solid revenue performance in the quarter. Pre-tax income of $1,164 million increased 2.7 percent year to year and pre-tax margin of 19.7 percent was flat compared to the prior-year first quarter, reflecting the higher profit contribution from revenue, partially offset by the impact of currency.

Management Discussion – (continued)

Consulting

​	​	​	​	​	​	​	​	​	​	​	​
​			​			​				Yr. to Yr.
​	​	​	​	​	​	​	​	​	​	Percent
​	​	​	​	​	​	​	​	Yr. to Yr.	​	Change
(Dollars in millions)	​		​	​		​	​	Percent	​	Adjusted For
For the three months ended March 31:	​	2023		​	2022		​	Change	​	Currency
Consulting revenue:	​	$	4,962	​	$	4,829	​	2.8	%	8.2	%
Business Transformation	​	$	2,283	​	$	2,255	​	1.3	%	6.5	%
Technology Consulting	​		943	​	​	955	​	(1.3)		4.2	​
Application Operations	​		1,736	​	​	1,619	​	7.3		13.0	​

​

Consulting revenue of $4,962 million increased 2.8 percent as reported and 8 percent adjusted for currency in the first quarter of 2023 compared to strong growth in the first quarter of 2022. Clients continue to leverage IBM’s hybrid cloud leadership and deep expertise to accelerate their digital transformations. More recently, clients are prioritizing digital transformation projects that focus on cost take out and productivity. While total Consulting revenue growth remained solid, we saw some deceleration in revenue growth particularly among U.S. clients with respect to more discretionary projects, impacting backlog realization within the quarter. Our hybrid cloud expertise and the depth and breadth of our strategic partnerships differentiates IBM Consulting in the market. In the first quarter of 2023, we had solid growth in our Red Hat consulting practice and our strategic partnerships continued to make strong contributions to our total Consulting revenue growth.

​

Business Transformation revenue of $2,283 million increased 1.3 percent as reported and 6 percent adjusted for currency in the first quarter of 2023 compared to the prior-year period led by growth in data and customer experience transformation projects.

​

Technology Consulting revenue of $943 million decreased 1.3 percent as reported, but grew 4 percent adjusted for currency on a year-to-year basis led by growth in our engagements around cloud application development.

​

Application Operations revenue of $1,736 million increased 7.3 percent as reported and 13 percent adjusted for currency compared to the first quarter of 2022 led by growth in cloud application management.

​

​	​	​	​	​	​	​	​	​	​
​			​			​		Yr. to Yr.
​	​	​	​	​	​	​	​	Percent/
(Dollars in millions)	​		​	​		​	​	Margin
For the three months ended March 31:	​	2023		​	2022		​	Change
Consulting:		​			​				​
Gross profit	​	$	1,252	​	$	1,176		6.5	%
Gross profit margin	​		25.2	%		24.3	%	0.9	pts.
Pre-tax income	​	$	382	​	$	348		9.6	%
Pre-tax margin	​		7.7	%		7.2	%	0.5	pts.

​

Consulting first-quarter gross profit margin of 25.2 percent increased 0.9 points on a year-to-year basis. Pre-tax income increased 9.6 percent to $382 million in the first quarter of 2023 and pre-tax margin increased 0.5 points to 7.7 percent compared to the prior-year period. Our gross profit margin expansion and pre-tax margin performance continued to benefit from the pricing and productivity actions we have taken during the past year.

Consulting Signings and Book-to-Bill

​	​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	Yr. to Yr.
​	​	​	​	​	​	​	​	​	​	Percent
​	​	​	​	​	​	​	​	Yr. to Yr.	​	Change
(Dollars in millions)	​	​	​	​	​	​	​	Percent	​	Adjusted For
For the three months ended March 31:		2023			2022			Change		Currency
Total Consulting signings	​	$	5,193	​	$	5,136		1.1	%	6.5	%

​

​

Management Discussion – (continued)

Our book-to-bill ratio over the last twelve months was 1.07. In the first quarter of 2023, Consulting signings grew 1.1 percent as reported and 7 percent adjusted for currency. We continued to see broad demand for projects that deliver technology-driven transformations leveraging a hybrid cloud environment. Within the quarter, we saw solid demand for cloud modernization offerings and had one of our largest-ever Red Hat signings quarters. Clients’ focus on driving productivity and cost reductions has contributed to signings growth from digital transformations in areas such as talent, finance and supply chain transformations.

​

Book-to-bill represents the ratio of IBM Consulting signings to its revenue over the same period and is a useful indicator of the demand for our business over time. Signings are management’s initial estimate of the value of a client’s commitment under a services contract within IBM Consulting. There are no third-party standards or requirements governing the calculation of signings. The calculation used by management involves estimates and judgments to gauge the extent of a client’s commitment, including the type and duration of the agreement, and the presence of termination charges or wind-down costs.

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

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

Infrastructure

​	​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	Yr. to Yr.
​	​	​	​	​	​	​	​	​	​	Percent
​	​	​	​	​	​	​	​	Yr. to Yr.	​	Change
(Dollars in millions)	​	​	​	​	​	​	​	Percent	​	Adjusted For
For the three months ended March 31:		2023			2022			Change		Currency
Infrastructure revenue:	​	$	3,098	​	$	3,219		(3.7)	%	0.1	%
Hybrid Infrastructure	​	$	1,709	​	$	1,700		0.5	%	3.8	%
zSystems	​			​		​		7.0		10.7	​
Distributed Infrastructure	​			​				(2.8)		0.3	​
Infrastructure Support	​		1,389	​		1,519		(8.5)		(4.0)	​

​

Infrastructure revenue of $3,098 million decreased 3.7 percent as reported and was flat adjusted for currency in the first quarter of 2023 compared to the prior-year period, reflecting a decrease in Infrastructure Support revenue year to year, partially offset by revenue growth in Hybrid Infrastructure led by zSystems.

Hybrid Infrastructure revenue of $1,709 million increased 0.5 percent as reported (4 percent adjusted for currency) compared to first quarter of 2022. Within Hybrid Infrastructure, zSystems revenue increased 7.0 percent as reported (11 percent adjusted for currency) year to year. This was the fourth quarter of z16 availability and the program’s performance has outpaced that of prior cycles. In addition to its capabilities around embedded AI at scale, cloud native development for hybrid cloud and cyber-resilient security, clients are also leveraging z16 for its energy efficiency. We also had continued strong growth in shipped MIPs for new Linux workloads on z16. Distributed Infrastructure revenue decreased 2.8 percent as reported and was flat adjusted for currency. Revenue growth in Storage was offset by declines in Power reflecting the prior-year strong performance following the launch of Power10 high-end systems in the third quarter of 2021.

Infrastructure Support revenue of $1,389 million decreased 8.5 percent as reported and 4 percent adjusted for currency in the first quarter of 2023 compared to the prior-year period, reflecting product cycle dynamics.

Management Discussion – (continued)

​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	Yr. to Yr.
​	​	​	​	​	​	​	​	Percent/
(Dollars in millions)	​	​	​	​	​	​	​	Margin
For the three months ended March 31:		2023			2022			Change
Infrastructure:		​	​		​	​			​
Gross profit	​	$	1,603	​	$	1,625		(1.4)	%
Gross profit margin	​		51.7	%		50.5	%	1.2	pts.
Pre-tax income	​	$	216	​	$	199		8.5	%
Pre-tax margin	​		7.0	%		6.2	%	0.8	pts.

​

Infrastructure gross profit margin increased 1.2 points to 51.7 percent in the first quarter of 2023 compared to the prior-year period driven by margin expansion in Hybrid Infrastructure, partially offset by a decrease in margin within Infrastructure Support. Pre-tax income increased 8.5 percent to $216 million in the first quarter of 2023 and pre-tax margin increased 0.8 points year to year to 7.0 percent. The pre-tax margin performance reflects the benefits from gross profit margin performance within Hybrid Infrastructure, reflecting product cycle dynamics, as well as the changes in the useful life of servers and network equipment effective January 1, 2023 and an increase in IP income year to year. These benefits were partially offset by product cycle driven revenue declines and mix within Infrastructure Support and the impact of currency.

Financing

​

See pages 64 through 66 for a discussion of Financing’s segment results.

Geographic Revenue

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

​	​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	Yr. to Yr.	​
​	​	​	​	​	​	​	​	​	​	Percent
​	​	​	​	​	​	​	​	Yr. to Yr.	​	Change
(Dollars in millions)	​	​	​	​	​	​	​	Percent	​	Adjusted For
For the three months ended March 31:		2023			2022			Change		Currency
Total Revenue	​	$	14,252	​	$	14,197		0.4	%	4.4	%
Americas	​	$	7,078	​	$	7,056		0.3	%	1.2	%
Europe/Middle East/Africa (EMEA)	​		4,331	​		4,231		2.4		7.9	​
Asia Pacific	​		2,843	​		2,910		(2.3)		7.0	​

​

​

Total revenue of $14,252 million increased 0.4 percent as reported and 4 percent adjusted for currency in the first quarter of 2023 compared to the prior year.

​

Americas revenue of $7,078 million increased 0.3 percent as reported and 1 percent adjusted for currency. The U.S. decreased 0.6 percent compared to the prior year. The decrease in the U.S. was primarily driven by the divestiture of our healthcare software assets in second-quarter 2022 and declines in Infrastructure. Canada increased 2.8 percent as reported and 9 percent adjusted for currency. Latin America increased 7.6 percent as reported and 11 percent adjusted for currency, with Brazil increasing 13.6 percent as reported and 13 percent adjusted for currency.

​

In EMEA, total revenue of $4,331 million increased 2.4 percent as reported and 8 percent adjusted for currency. France and Italy increased 3.6 percent and 2.4 percent, respectively, as reported, and increased 8 percent and 7 percent, respectively, adjusted for currency. The UK and Germany decreased 10.8 percent and 5.4 percent, respectively, as reported, and 2 percent and 1 percent, respectively, adjusted for currency.

​

Asia Pacific revenue of $2,843 million decreased 2.3 percent as reported, but increased 7 percent adjusted for currency. Japan decreased 2.5 percent as reported, but increased 11 percent adjusted for currency. India increased 8.3

Management Discussion – (continued)

percent as reported and 18 percent adjusted for currency. China and Australia decreased 24.3 percent and 16.0 percent, respectively, as reported, and 20 percent and 11 percent, respectively, adjusted for currency.

Expense

Total Expense and Other (Income)

​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	Yr. to Yr.
(Dollars in millions)	​	​	​	​	​	​	​	Percent
For the three months ended March 31:		2023			2022			Change
Total expense and other (income)	​	$	6,451	​	$	6,712		(3.9)	%
Non-operating adjustments:	​			​					​
Amortization of acquired intangible assets	​	$	(244)	​	$	(280)	​	(12.8)	%
Acquisition-related charges	​		(3)	​	​	(7)	​	(50.1)	​
Non-operating retirement-related (costs)/income	​	​	5	​	​	(202)	​	nm	​
Kyndryl-related impacts	​		—	​	​	(222)	​	(100.0)	​
Operating (non-GAAP) expense and other (income)	​	$	6,209	​	$	6,001	​	3.5	%
Total expense-to-revenue ratio	​		45.3	%	​	47.3	%	(2.0)	pts.
Operating (non-GAAP) expense-to-revenue ratio	​		43.6	%	​	42.3	%	1.3	pts.

nm — not meaningful

​

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

​

Selling, General and Administrative Expense

​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	Yr. to Yr.
(Dollars in millions)	​	​	​	​	​	​	​	Percent
For the three months ended March 31:		2023			2022			Change
Selling, general and administrative expense:		​			​				​
Selling, general and administrative — other	​	$	3,886	​	$	3,824		1.6	%
Advertising and promotional expense	​		314	​		336		(6.6)	​
Workforce rebalancing charges	​		259	​		5		nm	​
Amortization of acquired intangible assets	​		243	​		279		(12.9)	​
Stock-based compensation	​		149	​		136		9.4	​
Provision for/(benefit from) expected credit loss expense	​		2	​		16		(88.2)	​
Total selling, general and administrative expense	​	$	4,853	​	$	4,597		5.6	%
Non-operating adjustments:	​			​					​
Amortization of acquired intangible assets	​	$	(243)	​	$	(279)		(12.9)	%
Acquisition-related charges	​	​	(3)	​		(7)		(63.3)	​
Kyndryl-related impacts	​		—	​	​	0	​	(100.0)	​
Operating (non-GAAP) selling, general and administrative expense	​	$	4,607	​	$	4,311		6.9	%

nm — not meaningful

Total selling, general and administrative (SG&A) expense increased 5.6 percent in the first quarter of 2023 versus the prior-year period driven primarily by the following factors:

	●	Higher workforce rebalancing charges (6 points) to address remaining stranded costs from portfolio actions; and

Management Discussion – (continued)

	●	Higher spending (2 points) reflecting our continuing investment to drive our hybrid cloud and AI strategy, partially offset by benefits from productivity and the actions taken to transform our operations; partially offset by

	●	The effects of currency (2 points).

Operating (non-GAAP) expense increased 6.9 percent year to year primarily driven by the same factors.

The provision for expected credit loss expense decreased $14 million year to year, primarily driven by a higher release of general reserves and lower additions to specific reserves in the current-year period. The receivables provision coverage was 2.8 percent at March 31, 2023, excluding receivables classified as held for sale, an increase of 40 basis points compared to December 31, 2022. The increase in coverage was primarily driven by the overall decrease in total receivables and, to a lesser extent, an increase in specific reserves.

Research, Development and Engineering

​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	Yr. to Yr.
(Dollars in millions)	​	​	​	​	​	​	​	Percent
For the three months ended March 31:		2023			2022			Change
Research, development and engineering expense	​	$	1,655	​	$	1,679		(1.4)	%

​

Research, development and engineering (RD&E) expense in the first quarter of 2023 decreased 1.4 percent year to year primarily due to the effects of currency (2 points) which more than offset higher spending in the current-year period. We continue to invest to deliver innovation in AI, hybrid cloud and emerging areas such as quantum computing.

Intellectual Property and Custom Development Income

​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	Yr. to Yr.
(Dollars in millions)	​	​	​	​	​	​	​	Percent
For the three months ended March 31:		2023			2022			Change
Intellectual property and custom development income:		​			​				​
Licensing of intellectual property including royalty-based fees	​	$	61	​	$	71		(14.2)	%
Custom development income	​		115	​		48		139.1	​
Sales/other transfers of intellectual property	​		4	​		2		119.0	​
Total	​	$	180	​	$	121		48.7	%

​

Total intellectual property and custom development income in the first quarter of 2023 increased 48.7 percent year to year. The increase was primarily driven by a three-year joint development and licensing agreement signed in the fourth quarter of 2022 with a Japanese consortium to leverage our intellectual property and expertise on advanced semiconductors.

​

The timing and amount of licensing, sales or other transfers of IP may vary significantly from period to period depending upon the timing of licensing agreements, economic conditions, industry consolidation and the timing of new patents and know-how development.

​

Management Discussion – (continued)

Other (Income) and Expense

​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	Yr. to Yr.
(Dollars in millions)	​	​	​	​	​	​	​	Percent
For the three months ended March 31:		2023			2022			Change
Other (income) and expense:		​			​				​
Foreign currency transaction losses/(gains)	​	$	88	​	$	(176)		nm	​
(Gains)/losses on derivative instruments	​		(142)	​		102		nm	​
Interest income	​		(170)	​		(17)		nm	​
Net (gains)/losses from securities and investment assets	​		5	​		218		(97.6)	%
Retirement-related costs/(income)	​		(5)	​		202		nm	​
Other	​		(22)	​		(83)		(73.9)	​
Total other (income) and expense	​	$	(245)	​	$	246		nm	​
Non-operating adjustments:	​			​					​
Amortization of acquired intangible assets	​	$	(1)	​	$	(1)		—	​
Acquisition-related charges	​		(1)	​		—		nm	​
Non-operating retirement-related (costs)/income	​	​	5	​	​	(202)	​	nm	​
Kyndryl-related impacts	​		—	​		(222)		(100.0)	%
Operating (non-GAAP) other (income) and expense	​	$	(242)	​	$	(179)		35.3	%

nm - not meaningful

Total other (income) and expense was income of $245 million in the first quarter of 2023 compared to expense of $246 million in the prior-year period. The year-to-year change was primarily driven by:

	●	An unrealized loss on the Kyndryl retained shares ($222 million) in the prior-year period;

	●	Non-operating retirement-related income in the first quarter of 2023 compared to cost in the prior-year period ($207 million). Refer to “Retirement-Related Plans” for additional information; and

	●	Higher interest income ($152 million) driven by higher average interest rates and a higher average cash balance in the current year; partially offset by

	●	Lower gains from divestitures and dispositions of land/buildings ($56 million).

Operating (non-GAAP) other (income) and expense was income of $242 million in the first quarter of 2023 compared to income of $179 million in the prior-year period. The year-to-year increase was driven primarily by the higher interest income, partially offset by the lower gains from divestitures and dispositions of land/buildings.

Interest Expense

​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	Yr. to Yr.
(Dollars in millions)	​	​	​	​	​	​	​	Percent
For the three months ended March 31:		2023			2022			Change
Interest expense	​	$	367	​	$	311		18.3	%

​

Interest expense increased $57 million in the first quarter of 2023 compared to the prior-year period. Interest expense is presented in cost of financing in the Consolidated Income Statement if the related external borrowings are to support the Financing external business. Overall interest expense (excluding capitalized interest) for the first quarter of 2023 was $458 million, an increase of $65 million versus the prior-year period, driven by higher average interest rates and a higher average debt balance in the current year.

Management Discussion – (continued)

Retirement-Related Plans

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

​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	Yr. to Yr.
(Dollars in millions)	​	​	​	​	​	​	​	Percent
For the three months ended March 31:		2023			2022			Change
Retirement-related plans — cost:		​			​				​
Service cost	​	$	46	​	$	66		(29.6)	%
Multi-employer plans	​		4	​		4		(6.3)	​
Cost of defined contribution plans	​		269	​		239		12.5	​
Total operating costs	​	$	319	​	$	309		3.3	%
Interest cost	​	$	599	​	$	467		28.2	%
Expected return on plan assets	​		(739)	​		(749)		(1.4)	​
Recognized actuarial losses	​		129	​		460		(71.9)	​
Amortization of prior service costs/(credits)	​		(2)	​		7		nm	​
Curtailments/settlements	​		(1)	​		8		nm	​
Other costs	​		9	​		9		(6.4)	​
Total non-operating costs/(income)	​	$	(5)	​	$	202		(102.5)	%
Total retirement-related plans — cost	​	$	314	​	$	510		(38.5)	%

nm - not meaningful

Total pre-tax retirement-related cost decreased by $197 million compared to the first quarter of 2022, primarily driven by a decrease in recognized actuarial losses ($331 million) and lower service cost ($19 million), partially offset by higher interest costs ($132 million) and higher cost of defined contribution plans ($30 million).

​

As described in the “Operating (non-GAAP) Earnings” section, management characterizes certain retirement-related costs as operating and others as non-operating. Utilizing this characterization, operating retirement-related costs in the first quarter of 2023 were $319 million, an increase of $10 million compared to the first quarter of 2022, primarily driven by higher cost of defined contribution plans ($30 million), partially offset by lower service cost ($19 million). Non-operating costs/(income) was $5 million of income in the first quarter of 2023 compared to cost of $202 million in the prior-year period. The year-to-year change was primarily driven by a decrease in recognized actuarial losses ($331 million), partially offset by higher interest costs ($132 million).

​

The year-to-year decrease in recognized actuarial losses was primarily driven by the December 2022 remeasurement of our retirement and postretirement plans which resulted in a significant reduction to our pension plan benefit obligations and an improvement in our overall funded status primarily due to higher discount rates. In addition, we transferred $16 billion of our U.S. Qualified PPP obligations and related plan assets to third-party insurers in 2022 to further reduce the risk profile of our plans. The transfer resulted in a pre-tax pension settlement charge of $5.9 billion in the third quarter of 2022 primarily related to the accelerated recognition of actuarial losses.

​

​

Management Discussion – (continued)

Taxes

​

The continuing operations provision for income taxes for the first quarter of 2023 was $124 million, compared to a benefit from income taxes of $39 million in the first quarter of 2022. The prior-year benefit was primarily driven by the impact of updates to the foreign tax credit regulations. The operating (non-GAAP) income tax provision for the first quarter of 2023 was $200 million, compared to a provision for income taxes of $244 million in the first quarter of 2022.

IBM’s full-year tax provision and effective tax rate are impacted by recurring factors including the geographical mix of income before taxes, incentives, changes in unrecognized tax benefits and discrete tax events, such as the settlement of income tax audits and changes in or new interpretations of tax laws. The GAAP tax provision and effective tax rate could also be affected by adjustments to the previously recorded charges for U.S. tax reform attributable to any changes in law, new regulations and guidance, and audit adjustments, among others.

During the fourth quarter of 2020, the U.S. Internal Revenue Service (IRS) concluded its examination of the company’s U.S. income tax returns for 2013 and 2014, which had a specific focus on certain cross-border transactions that occurred in 2013 and issued a final Revenue Agent’s Report (RAR). The IRS’ proposed adjustments relative to these cross-border transactions, if sustained, would result in additional taxable income of approximately $4.5 billion. The company strongly disagrees with the IRS on these specific matters and filed its IRS Appeals protest in the first quarter of 2021. In the third quarter of 2018, the IRS commenced its audit of the company’s U.S. tax returns for 2015 and 2016. The company anticipates that this audit will be completed in 2023. In the fourth quarter of 2021, the IRS commenced its audit of the company’s U.S. tax returns for 2017 and 2018. With respect to major U.S. state and foreign taxing jurisdictions, the company is generally no longer subject to tax examinations for years prior to 2015. The company is no longer subject to income tax examination of its U.S. federal tax return for years prior to 2013. The open years contain matters that could be subject to differing interpretations of applicable tax laws and regulations as it relates to the amount and/or timing of income, deductions, and tax credits. Although the outcome of tax audits is always uncertain, the company believes that adequate amounts of tax, interest and penalties have been provided for any adjustments that are expected to result for these years.

The company is involved in a number of income tax-related matters in India challenging tax assessments issued by the India Tax Authorities. As of March 31, 2023, the company had recorded $657 million as prepaid income taxes in India. A significant portion of this balance represents cash tax deposits paid over time to protect the company’s right to appeal various income tax assessments made by the India Tax Authorities. Although the outcome of tax audits are always uncertain, the company believes that adequate amounts of tax, interest and penalties have been provided for any adjustments that are expected to result for these years.

The amount of unrecognized tax benefits at March 31, 2023 is $8,741 million which can be reduced by $539 million associated with timing adjustments, potential transfer pricing adjustments, and state income taxes. The net amount of $8,202 million, if recognized, would favorably affect the company’s effective tax rate.

Earnings Per Share

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

Management Discussion – (continued)

​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	Yr. to Yr.
​	​	​	​	​	​	​	​	Percent
For the three months ended March 31:		2023			2022			Change
Earnings per share of common stock from continuing operations:		​			​				​
Assuming dilution	​	$	1.02	​	$	0.73		39.7	%
Basic	​	$	1.03	​	$	0.74		39.2	%
Diluted operating (non-GAAP)	​	$	1.36	​	$	1.40		(2.9)	%
Weighted-average shares outstanding: (in millions)	​			​					​
Assuming dilution	​		917.8	​		909.2		0.9	%
Basic	​		907.5	​		899.3		0.9	%

​

Actual shares outstanding at March 31, 2023 were 908.0 million. The weighted-average number of common shares outstanding assuming dilution during the first quarter of 2023 was 8.6 million shares (0.9 percent) higher than the same period of 2022.

Financial Position

Dynamics

Our balance sheet at March 31, 2023 continues to provide us with flexibility to support and invest in the business.

Cash and cash equivalents, restricted cash and marketable securities at March 31, 2023 were $17,592 million, an increase of $8,752 million compared to December 31, 2022. Total debt of $58,712 million at March 31, 2023 increased $7,764 million from December 31, 2022 primarily due to new debt issuances. We were opportunistic in accessing the debt market and issued $9,463 million of debt in the first quarter of 2023 to prudently plan for our debt maturity obligations through 2024. We continue to manage our debt levels while being acquisitive and without sacrificing investments in our business or our secure and modestly growing dividend policy.

In the first three months of 2023, we generated $3,774 million in cash from operating activities, an increase of $525 million compared to the first three months of 2022. Our free cash flow at March 31, 2023 was $1,340 million, an increase of $100 million versus the prior year. See pages 62 and 63 for additional information on free cash flow. Our solid cash generation supports investment and deployment of capital to areas with the most attractive long-term opportunities. We completed three acquisitions and returned $1,497 million to shareholders through dividends in the first quarter of 2023.

Our pension plans were well funded at the end of 2022, with worldwide qualified plans funded at 114 percent. Overall pension funded status as of the end of March 2023 was fairly consistent with year-end 2022, and we currently have no change to expected plan contributions in 2023.

IBM Working Capital

​	​	​	​	​	​	​
​	​	At March 31,		​	At December 31,
(Dollars in millions)		2023			2022
Current assets	​	$	35,982	​	$	29,118
Current liabilities	​		30,993	​		31,505
Working capital	​	$	4,989	​	$	(2,387)
Current ratio	​		1.16:1	​		0.92:1

​

Working capital increased $7,376 million from the year-end 2022 position. Current assets increased $6,864 million ($6,730 million adjusted for currency) primarily in cash and cash equivalents, and marketable securities mainly driven by new debt issuances; partially offset by a decrease in receivables mainly from collections of seasonally higher year-end balances. Current liabilities decreased $512 million ($670 million adjusted for currency) primarily in compensation

Management Discussion – (continued)

and benefits driven by payments related to prior year performance-based compensation, and a decrease in taxes payable; partially offset by an increase in deferred income mainly driven by annual customer billings.

Receivables and Allowances

Roll Forward of Total IBM Receivables Allowance for Credit Losses

​	​	​	​	​	​	​	​	​	​	​	​	​	​
(Dollars in millions)		​	​	​	​	​	​	​	​	​	​	​	​
January 1, 2023			**Additions / (Releases) ***			**Write-offs ****			Foreign currency and other+		​	March 31, 2023
$	495	​	$	4	​	$	(8)	​	$	26	​	$	516

• Additions/(Releases) for allowance for credit losses are recorded in expense.

**Refer to note A, “Significant Accounting Policies,” in our 2022 Annual Report for additional information regarding allowance for credit loss write-offs.

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

​

Excluding receivables classified as held for sale, the total IBM receivables provision coverage was 2.8 percent at March 31, 2023, an increase of 40 basis points compared to December 31, 2022. The increase in coverage was primarily driven by the overall decrease in total receivables and, to a lesser extent, an increase in specific reserves. The majority of the write-offs during the three months ended March 31, 2023 related to receivables which had been previously reserved.

Financing Segment Receivables and Allowances

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

​	​	​	​	​	​	​	​
​	​	At March 31,		​	At December 31,
(Dollars in millions)		2023			2022
Amortized cost *	​	$	11,301	​	$	12,843	​
Specific allowance for credit losses	​		126	​		127	​
Unallocated allowance for credit losses	​		38	​		46	​
Total allowance for credit losses	​		164	​		173	​
Net financing receivables	​	$	11,137	​	$	12,670	​
Allowance for credit losses coverage	​		1.5	%		1.3	%

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

​

The percentage of Financing segment receivables reserved increased from 1.3 percent at December 31, 2022, to 1.5 percent at March 31, 2023, primarily driven by the decline in amortized cost.

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

​	​	​	​	​	​	​	​	​	​	​	​	​	​
(Dollars in millions)				​			​			​			​
January 1, 2023		​	Additions / (Releases)*		​	**Write-offs ****		​	Foreign currency and other		​	March 31, 2023
$	173	​	$	(13)	​	$	0	​	$	5	​	$	164

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

**	Refer to note A, “Significant Accounting Policies,” in our 2022 Annual Report for additional information regarding allowance for credit loss write-offs.

Financing’s expected credit loss expense (including reserves for off-balance sheet commitments which are recorded in other liabilities) was a net release of $15 million for the three months ended March 31, 2023, compared to a net release of $10 million for the same period in 2022. The increase in net releases was primarily driven by lower unallocated and specific reserve requirements in the current year in EMEA.

Management Discussion – (continued)

Noncurrent Assets and Liabilities

​	​	​	​	​	​	​
​	​	At March 31,		​	At December 31,
(Dollars in millions)		2023			2022
Noncurrent assets	​	$	97,654	​	$	98,125
Long-term debt	​	$	53,826	​	$	46,189
Noncurrent liabilities (excluding debt)	​	$	27,146	​	$	27,528

​

The decrease in noncurrent assets of $470 million ($790 million adjusted for currency) was primarily due to long-term financing receivables as a result of declines from seasonally higher year-end balances.

Long-term debt increased $7,636 million ($7,424 million adjusted for currency) primarily driven by new debt issuances, partially offset by reclassifications to short-term debt to reflect upcoming maturities.

Noncurrent liabilities (excluding debt) decreased $382 million ($555 million adjusted for currency) primarily driven by a decrease in deferred taxes and operating lease liabilities.

Debt

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

​	​	​	​	​	​	​
​	​	At March 31,		​	At December 31,
(Dollars in millions)		2023			2022
Total debt	​	$	58,712	​	$	50,949
Financing segment debt*	​	$	10,522	​	$	12,872
Non-Financing debt	​	$	48,191	​	$	38,077

• Refer to Financing’s “Financial Position” on page 65 for additional details.

​

Total debt of $58,712 million increased $7,764 million ($7,542 million adjusted for currency) from December 31, 2022, primarily driven by proceeds from issuances of $9,407 million; partially offset by maturities of $2,016 million.

Non-Financing debt of $48,191 million increased $10,114 million ($9,930 million adjusted for currency) from December 31, 2022, primarily driven by our first quarter debt issuances to plan for debt maturities obligations through 2024.

Financing segment debt of $10,522 million decreased $2,350 million ($2,388 million adjusted for currency) from December 31, 2022, primarily due to lower funding requirements associated with financing receivables.

Financing provides financing solutions predominantly for IBM’s external client assets, and the debt used to fund Financing assets is primarily composed of intercompany loans. Total debt changes generally correspond with the level of client and commercial financing receivables, the level of cash and cash equivalents, the change in intercompany and external payables and the change in intercompany investment from IBM. The terms of the intercompany loans are set by the company to substantially match the term, currency and interest rate variability underlying the financing receivable. The Financing debt-to-equity ratio remained at 9.0 to 1 at March 31, 2023.

We measure Financing as a stand-alone entity, and accordingly, interest expense relating to debt supporting Financing’s external client and internal business is included in the “Financing Results of Operations” and in note 4, “Segments.”

Management Discussion – (continued)

Equity

Total equity decreased $349 million from December 31, 2022, primarily driven by dividends paid of $1,497 million, partially offset by an increase from net income of $927 million and common stock of $332 million.

Cash Flow

Our cash flows from operating, investing and financing activities, as reflected in the Consolidated Statement of Cash Flows on page 7, are summarized in the table below. These amounts also include the cash flows associated with the Financing business.

​	​	​	​	​	​	​
(Dollars in millions)	​	​	​	​	​	​
For the three months ended March 31:		2023			2022
Net cash provided by/(used in):		​			​
Operating activities	​	$	3,774	​	$	3,248
Investing activities	​		(7,960)	​		(1,358)
Financing activities	​		5,708	​		1,377
Effect of exchange rate changes on cash, cash equivalents and restricted cash	​		24	​		(5)
Net change in cash, cash equivalents and restricted cash	​	$	1,547	​	$	3,263

​

Net cash provided by operating activities increased $525 million as compared to the first three months of 2022. This was due to an increase in cash provided by financing receivables, a decrease in workforce rebalancing payments, and improvements in sales cycle working capital, partially offset by an increase in performance-based compensation payments given our strong results in 2022.

Net cash used in investing activities increased $6,602 million mainly driven by net purchases of marketable securities and other investments.

Net cash provided by financing activities increased $4,331 million mainly due to an increase in net cash provided by debt transactions of $4,357 million primarily driven by a higher level of net additions in the current year.

Results of Discontinued Operations

Loss from discontinued operations, net of tax, was $7 million in the first quarter of 2023 compared to income of $71 million in the prior-year period. The results for both periods reflect the net impact of changes in separation-related estimates and the settlement of assets and liabilities in accordance with the separation and distribution agreement. The prior-year income also reflects a gain on sale of a joint venture historically managed by Kyndryl, which transferred to Kyndryl in the first quarter of 2022, upon receiving regulatory approval.

​

Management Discussion – (continued)

Looking Forward

As technology remains a fundamental source of competitive advantage, we continue to see strong demand for our hybrid cloud and AI solutions. Clients continue to accelerate their digital transformations, modernize their applications, automate their workflows and create flexible and secure hybrid cloud environments. Technology is helping clients scale and enhance productivity which is especially important in the face of inflation, demographic shifts, cybersecurity, supply chain issues and sustainability goals. We are helping our clients seize new business opportunities, overcome today’s challenges and emerge stronger. We are building a stronger, more focused company that is closely aligned to the needs of our clients. We have continued to focus our portfolio in hybrid cloud and AI, invest in our offerings, technical talent and ecosystem and streamline our go-to-market model.

Hybrid Cloud and AI Strategy

We believe hybrid cloud and AI are the two most transformational enterprise technologies for business. These technologies work together to drive business outcomes and innovation. Hybrid cloud is the most prominent form of IT architecture and our approach is platform centric. Red Hat OpenShift is the leading container platform. It enables our clients to leverage the latest innovations in open-source software. Our software and infrastructure technologies have been tailored for this platform and our global team of consultants leverage their vast technical and business knowledge to accelerate clients’ digital transformation processes. We have been co-creating with clients to unlock business value from a hybrid cloud approach.

The second element of our strategy, AI is projected to add $16 trillion to the global economy by 2030. AI for business is different than AI for consumers given the need for accurate results, trusted data and governance tools. Productivity gains will come from enterprises automating their business workflows. Foundational models, large language models and generative AI will also greatly enhance productivity. We are helping clients turn their workflows into simpler, automated processes with AI and helping them deploy AI into business areas such as IT operations, customer care, cybersecurity and digital labor.

To bring our hybrid cloud and AI strategy to market, our partner ecosystem continues to play a critical role. We continue to expand and extend the work we do with partners to serve our joint clients through strategic collaboration agreements. We also continue to invest, both organically and inorganically, to deliver new innovation that matters for our clients and to shape the technologies of the future. To complement our innovations, we closed three acquisitions in the first quarter of 2023 to extend our capabilities in hybrid cloud and AI. We also continue to engage in projects that have a positive impact on society. Many clients are leveraging our technology and expertise to advance their sustainability agendas.

We are digitally transforming IBM, much in the same way we are helping our clients with their transformations by reimagining and transforming the way we work. This includes optimizing our infrastructure and application environments, as well as redesigning our end-to-end business processes. These productivity initiatives free up spending for reinvestments and contribute to margin expansion.

In the current environment, clients are prioritizing digital transformation projects that focus on cost reduction and productivity. While demand for our offerings that support these priorities remains solid, we saw some deceleration in Consulting from the previous robust growth levels, especially in the U.S.

We remain confident in our strategy and in the fundamentals of our business. Our balance sheet and liquidity position remain strong. At March 31, 2023 we had $17.6 billion of cash and cash equivalents, restricted cash and marketable securities. We issued $9.5 billion of debt in the first quarter of 2023 to prudently plan for our debt maturity obligations through 2024 and we continued to manage our debt levels while being acquisitive and without sacrificing investments in our business or our secure and modestly growing dividend policy. We expect to continue our progress as a leading hybrid cloud and AI company with a focus on revenue growth and cash generation.

Management Discussion – (continued)

Retirement-Related Plans

Our pension plans are well funded. Contributions for all retirement-related plans are expected to be approximately $2.1 billion in 2023, an increase of approximately $100 million compared to 2022, of which $0.2 billion generally relates to legally required contributions to non-U.S. defined benefit and multi-employer plans. We expect 2023 pre-tax retirement-related plan cost to be approximately $1.2 billion, a decrease of approximately $6.5 billion compared to 2022. The decrease is primarily driven by a $5.9 billion settlement charge in the third quarter of 2022 resulting from the transfer of a portion of the U.S. Qualified PPP to insurance companies. This estimate reflects current pension plan assumptions at December 31, 2022. Within total retirement-related plan cost, operating retirement-related plan cost is expected to be approximately $1.2 billion, approximately flat versus 2022. Non-operating retirement-related plan cost is expected to be approximately $0.1 billion, a decrease of approximately $6.5 billion compared to 2022, primarily driven by the third-quarter 2022 settlement charge and lower recognized actuarial losses, partially offset by higher interest cost.

Currency Rate Fluctuations

Changes in the relative values of non-U.S. currencies to the USD affect our financial results and financial position. At March 31, 2023, currency changes resulted in assets and liabilities denominated in local currencies being translated into more dollars than at year-end 2022. We use financial hedging instruments to limit specific currency risks related to foreign currency-based transactions.

Movements in currency, and the fact that we do not hedge 100 percent of our currency exposures, will result in a currency impact to our revenues, profit and cash flows throughout 2023. We execute a hedging program which defers, versus eliminates, the volatility of currency impacts on our financial results. During periods of sustained movements in currency, the marketplace and competition adjust to the changing rates over time.

We translate revenue, cost and expense in our non-U.S. operations at current exchange rates in the reported period. References to “adjusted for currency” or “constant currency” reflect adjustments based upon a simple mathematical formula. However, this constant currency methodology that we utilize to disclose this information does not incorporate any operational actions that management could take to mitigate fluctuating currency rates. Based on the currency rate movements in the first three months of 2023, revenue from continuing operations increased 0.4 percent as reported and 4.4 percent at constant currency versus the first three months of 2022. Currency translation and hedging impacted year-to-year pre-tax profit growth by approximately $150 million and operating (non-GAAP) pre-tax profit growth by approximately $160 million in the first quarter 2023. We view these amounts as a theoretical maximum impact to our as-reported financial results. Considering the operational responses mentioned above, movements of exchange rates, and the nature and timing of hedging instruments, it is difficult to predict future currency impacts on any particular period.

For non-U.S. subsidiaries and branches that operate in U.S. dollars or whose economic environment is highly inflationary, translation adjustments are reflected in results of operations. Generally, we manage currency risk in these entities by linking prices and contracts to U.S. dollars.

Management Discussion – (continued)

Liquidity and Capital Resources

In our 2022 Annual Report, on pages 33 to 35, there is a discussion of our liquidity including two tables that present three years of data. The table presented on page 33 includes consolidated net cash from operating activities, cash and cash equivalents, restricted cash and short-term marketable securities, and the size of our global credit facilities for each of the past three years. For the three months ended, or at, as applicable, March 31, 2023, those amounts are $3.8 billion of net cash from operating activities, $17.6 billion of cash and cash equivalents, restricted cash and short-term marketable securities and $10.0 billion in global credit facilities, respectively. While we have no current plans to draw on these credit facilities, they are available as back-up liquidity.

The major rating agencies’ ratings on our debt securities at March 31, 2023 appear in the following table and remain unchanged from December 31, 2022.

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

​

IBM has ample financial flexibility, supported by our strong liquidity position and cash flows, to operate at a single A credit rating. Debt levels have increased $7.8 billion from December 31, 2022 primarily driven by debt issuances. In the first quarter of 2023, we issued $9.5 billion of debt primarily to plan for our debt maturity obligations through 2024.

​

We do not have “ratings trigger” provisions in our debt covenants or documentation, which would allow the holders to declare an event of default and seek to accelerate payments thereunder in the event of a change in credit rating. Our debt covenants are well within the required levels. Our contractual agreements governing derivative instruments contain standard market clauses which can trigger the termination of the agreement if our credit rating were to fall below investment grade. At March 31, 2023, the fair value of those instruments that were in a liability position was $731 million, before any applicable netting, and this position is subject to fluctuations in fair value period to period based on the level of our outstanding instruments and market conditions. We have no other contractual arrangements that, in the event of a change in credit rating, would result in a material adverse effect on our financial position or liquidity.

​

Effective December 31, 2021, the use of LIBOR was substantially eliminated for purposes of any new financial contract executions. The UK’s Financial Conduct Authority (FCA) extended the phase out of LIBOR in the case of U.S. dollar settings for certain tenors until the end of June 2023. Any legacy USD LIBOR based financial contracts are expected to be addressed using the LIBOR rates published through the June 2023 extension period. The replacement of the LIBOR benchmark within the company’s risk management activities did not have a material impact in the consolidated financial results.

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

Management uses free cash flow as a measure to evaluate its operating results, plan shareholder return levels, strategic investments and assess its ability and need to incur and service debt. The entire free cash flow amount is not necessarily available for discretionary expenditures. We define free cash flow as net cash from operating activities less the change in Financing receivables and net capital expenditures, including the investment in software. A key objective of the Financing business is to generate strong returns on equity, and our Financing receivables are the basis for that growth. Accordingly, management considers Financing receivables as a profit-generating investment, not as working capital that should be minimized for efficiency. Therefore, management includes presentations of both free cash flow and net cash from operating activities that exclude the effect of Financing receivables.

Management Discussion – (continued)

The following is management’s view of cash flows for the first three months of 2023 and 2022 prepared in a manner consistent with the description above.

​	​	​	​	​	​	​	​
(Dollars in millions)	​	​	​	​	​	​
For the three months ended March 31:		2023			2022
Net cash from operating activities per GAAP	​	$	3,774	​	$	3,248	​
Less: change in Financing receivables	​		1,977	​		1,631	​
Net cash from operating activities, excluding Financing receivables	​	$	1,797	​	$	1,618	​
Capital expenditures, net	​		(457)	​		(378)	​
Free cash flow	​	$	1,340	​	$	1,240	​
Acquisitions	​		(22)	​		(698)	​
Divestitures	​		—	​		61	​
Dividends	​		(1,497)	​		(1,475)	​
Non-Financing debt	​		9,692	​		4,675	​
Other (includes Financing receivables and Financing debt)	​		(762)	​		(590)	*
Change in cash, cash equivalents, restricted cash and short-term marketable securities	​	$	8,752	​	$	3,213	​

• Recast to conform to current-year presentation.

​

In the first three months of 2023, we generated free cash flow of $1.3 billion, an increase of $0.1 billion versus the prior-year period. The increase was driven by lower payments for structural actions, working capital efficiencies and our profit performance, partially offset by higher performance-based compensation payments given our strong results in 2022 and an increase in capital expenditures. In the first quarter of 2023, we also continued to return value to shareholders with $1.5 billion in dividends.

Events that could temporarily change the historical cash flow dynamics discussed previously and in our 2022 Annual Report include significant changes in operating results, material changes in geographic sources of cash, unexpected adverse impacts from litigation, future pension funding requirements, periods of severe downturn in the capital markets or the timing of tax payments. Whether any litigation has such an adverse impact will depend on a number of variables, which are more completely described in note 14, “Contingencies,” in this Form 10-Q. With respect to pension funding, we expect to make legally mandated pension plan contributions to certain non-U.S. defined benefit plans of approximately $200 million in 2023. Contributions related to all retirement-related plans are expected to be approximately $2.1 billion in 2023. 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 2023, we are not legally required to make any contributions to the U.S. defined benefit pension plans.

Our cash flows are sufficient to fund our current operations and obligations, including investing and financing activities such as dividends and debt service. When additional requirements arise, we have several liquidity options available. These options may include the ability to borrow additional funds at reasonable interest rates and utilizing our committed global credit facilities. With our share repurchase program suspended since the close of the Red Hat acquisition, our overall shareholder payout remains at a comfortable level and we remain fully committed to our secure and modestly growing dividend policy.

Management Discussion – (continued)

Financing

Financing is a reportable segment that is measured as a stand-alone entity. Financing facilitates IBM clients' acquisition of IBM information technology systems, software and services by providing financing solutions in the areas where the company has the expertise, while generating solid returns on equity.

Results of Operations

​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	Yr. to Yr.	​
(Dollars in millions)	​	​	​	​	​	​	​	Percent	​
For the three months ended March 31:		2023			2022			Change	​
Revenue	​	$	196	​	$	154		27.3	%
Pre-tax income	​	$	100	​	$	84		19.6	%

For the three months ended March 31, 2023, financing revenue increased 27.3 percent (31 percent adjusted for currency) to $196 million compared to the prior year, driven by an increase in Client Financing asset yields.

Financing pre-tax income increased 19.6 percent to $100 million compared to the prior year and the pre-tax margin of 51.3 percent decreased 3.3 points year to year. The increase in pre-tax income was driven by an improvement in expense, partially offset by a lower gross profit. The improvement in expense was primarily driven by settlements on non-accrual assets, lower foreign exchange net losses and a decrease in selling, general and administrative expenses. The lower gross profit was driven by an increase in intercompany interest cost.

Management Discussion – (continued)

Financial Position

​	​	​	​	​	​	​	​
​	​	At March 31,		​	At December 31,
(Dollars in millions)		2023			2022
Cash and cash equivalents	​	$	564	​	$	699	​
Client financing receivables:	​	​	​	​	​	​	​
Net investment in sales-type and direct financing leases(1)	​		3,846	​		4,047	​
Client loans	​		7,047	​		8,329	​
Total client financing receivables	​	$	10,893	​	$	12,376	​
Commercial financing receivables:	​		​	​		​	​
Held for investment	​	​	244	​	​	293	​
Held for sale	​	​	605	​	​	939	​
Other receivables	​	​	38	​	​	66	​
Total external receivables(2)	​	$	11,779	​	$	13,674	​
Intercompany assets(3)	​		325	​		988	(4)​
Other assets	​	​	361	​	​	395	(4)​
Total assets	​	$	13,029	​	$	15,757	​
​	​	​	​	​	​	​	​
Intercompany payables(3)	​	$	424	​	$	637	​
Debt(5)	​	​	10,522	​	​	12,872	​
Other liabilities	​	​	915	​	​	814	​
Total liabilities	​	$	11,861	​	$	14,323	​
Total equity	​	$	1,168	​	$	1,433	​
Total liabilities and equity	​	$	13,029	​	$	15,757	​

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

(2)	The difference between the decrease in total external receivables of $1.9 billion (from $13.7 billion in December 2022 to $11.8 billion in March 2023) and the $2.0 billion change in Financing segment’s receivables disclosed in the free cash flow presentation on page 63 is primarily attributable to currency impacts.

(3)	This entire amount is eliminated for purposes of IBM’s consolidated financial results and therefore does not appear in the Consolidated Balance Sheet.

(4)	Prior period amounts have been recast to conform to 2023 presentation.

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

Total external receivables decreased $1,895 million primarily due to collections of higher year-end balances. Intercompany assets decreased $663 million primarily driven by intercompany financing receivables at December 31, 2022 that settled in the first quarter of 2023. These declines had corresponding reductions in debt funding.

We continue to apply our rigorous credit policies. Approximately 73 percent of the total external portfolio was with investment-grade clients with no direct exposure to consumers at both March 31, 2023 and December 31, 2022; a year-to-year increase of 4 points as compared to March 31, 2022. This investment grade percentage is based on the credit ratings of the companies in the portfolio and reflects certain mitigating actions taken to reduce the risk to IBM.

We have a long-standing practice of taking mitigation actions, in certain circumstances, to transfer credit risk to third parties. These actions may include credit insurance, financial guarantees, nonrecourse borrowings, transfers of receivables recorded as true sales in accordance with accounting guidance or sales of equipment under operating lease. Sale of receivables arrangements are also utilized in the normal course of business as part of our cash and liquidity management. For additional information relating to financing receivables refer to note 9, “Financing Receivables.” Refer to pages 57 through 58 for additional information related to Financing segment receivables, allowance for credit losses and debt.

Management Discussion – (continued)

Return on Equity Calculation

​	​	​	​	​	​	​	​
(Dollars in millions)	​	​	​	​	​	​	​
For the three months ended March 31:		2023			2022		​
Numerator	​	​	​	​	​	​
Financing after-tax income*	​	$	82	​	$	69	​
Annualized after-tax income (1)	​	$	329	​	$	275	​
Denominator	​	​	​	​	​	​	​
Average Financing equity (2)**	​	$	1,301	​	$	1,450	​
Financing return on equity (1)/(2)	​	​	25.3	%	​	19.0	%

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

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

​

Return on equity was 25.3 percent compared to 19.0 percent for the three months ended March 31, 2023 and 2022, respectively. The increase was primarily driven by an increase in net income, and a lower average equity balance.

Residual Value

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

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

The following table presents the recorded amount of unguaranteed residual value for sales-type and direct financing leases at March 31, 2023 and December 31, 2022. In addition, the table presents the run out of when the unguaranteed residual value assigned to equipment on leases at March 31, 2023 is expected to be returned to the company. The unguaranteed residual value for operating leases at March 31, 2023 and December 31, 2022 was not material.

Unguaranteed Residual Value

​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
​	​	At		​	At		​	Estimated Run Out of March 31, 2023 Balance
​	​	December 31,		​	March 31,		​	​	​	​	​	​	​	​	​	​	2026 and
(Dollars in millions)		2022			2023			2023			2024			2025			Beyond
Sales-type and direct financing leases	​	$	422	​	$	400	​	$	46	​	$	60	​	$	141	​	$	153

​

​

​

​

Management Discussion – (continued)

GAAP Reconciliation

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

​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	Acquisition-		​	Retirement-		​	U.S.		​	Kyndryl-		​	​	​
(Dollars in millions except per share amounts)	​	​	​	​	Related		​	Related		​	Tax Reform		​	Related		​	Operating
For the three months ended March 31, 2023:		GAAP			Adjustments			Adjustments		​	Impacts			Impacts		​	(non-GAAP)
Gross profit	​	$	7,509	​	$	148	​	$	—	​	$	—	​	$	—	​	$	7,658	​
Gross profit margin	​		52.7	%		1.0	pts.		—	pts.		—	pts.	​	—	pts.		53.7	%
SG&A	​	$	4,853	​	$	(246)	​	$	—	​	$	—	​	$	—	​	$	4,607	​
Other (income) and expense	​	$	(245)	​	$	(2)	​	$	5	​	$	—	​	$	—	​	$	(242)	​
Total expense and other (income)	​	$	6,451	​	$	(247)	​	$	5	​	$	—	​	$	—	​	$	6,209	​
Pre-tax income from continuing operations	​	$	1,058	​	$	396	​	$	(5)	​	$	—	​	$	—	​	$	1,449	​
Pre-tax margin from continuing operations	​		7.4	%		2.8	pts.		0.0	pts.		—	pts.	​	—	pts.		10.2	%
Provision for income taxes*	​	$	124	​	$	91	​	$	(10)	​	$	(5)	​	$	—	​	$	200	​
Effective tax rate	​		11.7	%		3.1	pts.		(0.7)	pts.		(0.3)	pts.	​	—	pts.		13.8	%
Income from continuing operations	​	$	934	​	$	305	​	$	5	​	$	5	​	$	—	​	$	1,249	​
Income margin from continuing operations	​		6.6	%		2.1	pts.		0.0	pts.		0.0	pts.	​	—	pts.		8.8	%
Diluted earnings per share from continuing operations	​	$	1.02	​	$	0.33	​	$	0.01	​	$	0.01	​	$	—	​	$	1.36	​

​

​

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

• 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.

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Management Discussion – (continued)

Forward-Looking and Cautionary Statements

Except for the historical information and discussions contained herein, statements contained in this Form 10-Q may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based on the company’s current assumptions regarding future business and financial performance. These statements involve a number of risks, uncertainties and other factors that could cause actual results to differ materially, including, but not limited to, the following: a downturn in economic environment and client spending budgets; a failure of the company’s innovation initiatives; damage to the company’s reputation; risks from investing in growth opportunities; failure of the company’s intellectual property portfolio to prevent competitive offerings and the failure of the company to obtain necessary licenses; the company’s ability to successfully manage acquisitions, alliances and dispositions, including integration challenges, failure to achieve objectives, the assumption of liabilities, and higher debt levels; fluctuations in financial results; impact of local legal, economic, political, health and other conditions; the company’s failure to meet growth and productivity objectives; ineffective internal controls; the company’s use of accounting estimates; impairment of the company’s goodwill or amortizable intangible assets; the company’s ability to attract and retain key employees and its reliance on critical skills; impacts of relationships with critical suppliers; product quality issues; impacts of business with government clients; reliance on third party distribution channels and ecosystems; cybersecurity and data privacy considerations; adverse effects related to climate change and environmental matters, tax matters; legal proceedings and investigatory risks; the company’s pension plans; currency fluctuations and customer financing risks; impact of changes in market liquidity conditions and customer credit risk on receivables; potential failure of the separation of Kyndryl to qualify for tax-free treatment; risk factors related to IBM securities; and other risks, uncertainties and factors discussed in the company’s Form 10-Qs, Form 10-K and in the company’s other filings with the U.S. Securities and Exchange Commission or in materials incorporated therein by reference. Any forward-looking statement in this Form 10-Q speaks only as of the date on which it is made. Except as required by law, the company assumes no obligation to update or revise any forward-looking statements.