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    2008 ANNUAL REPORT


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    A LETTER FROM THE CHAIRMAN Dear IBM Investor: As I write to you, the global economy is experiencing profound disruption. There is a great deal of understandable and appropriate anxiety about where we are headed in the near and medium term. Many approaches are being offered to stimulate economic recovery and growth. And it is clear that IBM’s industry, as well as many others, will look very different a few years from now. You need to know, in this time of turmoil, that your company is well positioned to continue delivering strong results, as we have been doing and did again in 2008— achieving record revenue, record pre-tax earnings, record earnings per share and record free cash flow. Even more importantly, we are also positioned to lead in the new era that lies on the other side of the present crisis. In this letter, I will explain why. I will describe how this moment of historic change presents an opportunity for IBM, not only to assert leadership in our industry, but to play a central role in changing how the world literally works. Our confidence is grounded in the strategic transformation of IBM over the past several years and the focused execution of nearly 400,000 dedicated and innovative women and men 1 around the world. IBM is now a very different company than it was just a few years ago. As a result, we entered this turbulent period strong, and we expect to exit it stronger.


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    A LETTER FROM THE CHAIRMAN A New Era—and a New IBM systems alone. Increasingly, the digital infrastructure of the world was merging with What explains our strong performance, when the physical infrastructure of the world. so many of our competitors and other companies And that was creating a new platform for the across business are struggling during a deep global economy and society. We are now living economic slowdown? The answer lies at the in a world that is: beginning of this decade, when the IT industry and businesses everywhere were confronted by – instrumented: Computational power is three fundamental shifts in the world: being put into things no one would recognize as computers: phones, cameras, cars, appliances, 1. the reality of global integration. roadways, power lines, clothes—and even I don’t mean simply the widely shared recogni- natural systems, such as livestock and rivers. tion that the world was becoming “flat,” but – interconnected: All of this is being the way in which that was happening, and what connected through the Internet, which has it meant for the goals and the very forms of come of age. organizations. The lowering of trade barriers, – intelligent: We now have the computing the rise of the developing world and the emer- power, advanced analytics and new computing gence of the World Wide Web combined to models (such as “cloud”) to make sense of the unleash the flow of work on a truly global scale. world’s digital knowledge and pulse, and to turn Therefore, the key questions facing leaders of mountains of data into intelligence. all kinds became: How will we get that work to flow to us? How will we differentiate ourselves 3. innovation and integration. Because in a global economy? And how will we capture of this new global arena and new technology the new growth opportunities that are emerging model, business leaders expanded their around the world? Increasingly, new business horizons—driven both by competitive pressures models—in fact, a new model of the corporation and the remarkable array of new capabilities. itself—began to take shape. At IBM, we called No longer content with cost savings from it the Globally Integrated Enterprise. off-the-shelf technologies and solutions, they were seeking to innovate—and not just in their 2. the emergence of a new computing products and services, but also their business model. This new model, which was replacing processes, management systems, policies and the PC-based, client/server approach, core business models. To accomplish that, was networked, modular and open. Just as they sought to integrate advanced technology important, it was no longer confined to IT far deeper into their operations. 2


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    Samuel J. Palmisano CHAIRMAN, PRESIDENT AND CHIEF EXECUTIVE OFFICER


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    A LETTER FROM THE CHAIRMAN At IBM, we saw that these shifts would analytics. As a result, we are well positioned reshape the economic, technological and to build the kinds of IT infrastructures and competitive landscape, and open up enormous solutions that will be of the highest value to business opportunity. So we made some our clients. important decisions, and we got to work. business: The kind of value our clients sought global integration: We made major invest­ required a partner with intimate knowledge ments in our teams and capabilities in emerging of their industry, and with the ability to turn that markets around the world. This is helping us knowledge into company­specific operational achieve superior growth in emerging markets— and management systems. You can’t do that on not only in the so­called BRIC countries of a global scale from corporate headquarters. Brazil, Russia, India and China, but in dozens of So we not only amassed considerable industry countries across the developing world. At the expertise, but also made major changes in how same time, we accelerated the global integration we deploy it. We shifted skills and decision­ of IBM’s operations. As a result, our supply making closer to the marketplace and the client. chain, research labs, software development and At the same time, we transformed our vast service delivery today are truly global in scope. services delivery capability. We applied We have made substantial progress toward automation, standardization and the kinds of remaking IBM into a Globally Integrated engineering and management principles that Enterprise, with more still to do. were long ago adopted in manufacturing and supply chains. The results are showing up in technology: We transformed IBM’s mix our margins and in our best­in­class levels of of products, services, skills and technologies— service delivery client satisfaction. exiting commoditizing businesses like PCs and hard disk drives, and making more than 100 strategic acquisitions this decade. We also We Enter this Period Strong shifted our internal R&D. Of the more than Put it all together, IBM today is a very different 4,000 U.S. patents IBM received in 2008 (our company, which is evident in our results. 16th straight year of patent leadership), more Since the dot­com crash in 2002, we have more than 70 percent were for software and services. than doubled our pre­tax income and free cash IBM’s portfolio today is built around networked, flow, and more than tripled our earnings per modularized and embedded technologies, share. Our standout 2008 continued this record such as service­oriented architecture (SOA), of superior performance. virtualization, business intelligence and 4


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    revenue and income: Our revenue was Global Financing receivables, was $14.3 billion, a record $103.6 billion, up 5 percent. In 2008 an increase of $1.9 billion from 2007. Our we grew pre-tax income from continuing business model has allowed us to generate more operations by 15 percent, to $16.7 billion, than $84 billion in free cash flow over the past the highest ever. nine years. IBM ended 2008 with $12.9 billion of cash and marketable securities. margins: IBM’s gross profit margin rose for the fifth consecutive year—to 44.1 percent, investment and return to up 7.6 points since 2003. Our pre-tax income shareholders: Our superior cash flow margin rose to 16.1 percent. Both margins are has enabled us to invest in the business and to at their highest in more than a decade. We generate substantial returns to investors. achieved this by driving productivity and Our 2008 cash investment was $6.3 billion for 15 acquisitions —10 of them in key areas of software. And after investing $6.3 billion Since the dot-com crash in 2002, in R&D and $4.5 billion in net capital we have more than doubled expenditures, we were able to return more our pre-tax income and free cash than $13 billion to you—$10.6 billion through flow, and more than tripled our share repurchase and $2.6 billion through earnings per share. dividends. Last year’s dividend increase was 25 percent, marking the 13th year in a row in which we have raised our dividend. continuing to shift our business mix to more In this environment, clients’ immediate profitable segments. More than 90 percent of needs are very clear: to save money, preserve our segment profit in 2008 was from software, capital and reduce costs. We help them do that, services and financing. and our ability to deliver that kind of value is why they are continuing to choose IBM. earnings per share: We have continued to It’s why our services business achieved its achieve strong EPS growth. Last year was highest margin in the past five years. It’s why another record, with diluted earnings per share our software business continues to grow so from continuing operations of $8.93, up robustly—with pre-tax profit doubling over the 24 percent. This marked six straight years of past five years, to $7 billion in 2008. And it’s double-digit EPS growth. why we continue to enjoy strength in high- cash flow: IBM has consistently generated utilization, high-performance infrastructure. strong cash flow. In 2008 our free cash 5 flow, excluding the year-to-year change in


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    A LETTER FROM THE CHAIRMAN In sum, with our excellent financial position, Through pervasive instrumentation and strong balance sheet, solid recurring revenue, interconnection, almost anything—any person, strong profit streams and unmatched global any object, any process or any service, for any reach, we are confident about 2009 and are ahead organization, large or small—can become of pace to achieve our 2010 objective of $10 digitally aware, networked and intelligent. This to $11 in earnings per share. The information means that industries, infrastructures, processes on pages 10–15—“Generating Higher Value and entire societies can be more productive, at IBM”— will help explain why. efficient and responsive. And problems that have heretofore been insoluble can now be tackled. A Smarter Planet Problems like wasting too much energy. Like spending too much time in traffic. Like produc- The coming era will not be kind to enterprises ing food too expensively, and wasting too much or institutions that have failed to step up to of what we produce. Like missing too many unresolved issues in their core models, strategies sales opportunities and disappointing too many or operations. In our view, this is not simply a customers because of inefficient supply chains. cyclical downturn, but a major shift in the Like making too many medical errors, and global economy and society— one that is simple spending too much to deliver healthcare to too to state, but profound in its implications. few. And most obviously of late, like failing to In the last two decades, we have seen our manage financial risk. planet become smaller and “flatter.” In the next two, we will see it become smarter. This isn’t a metaphor, and I’m not talking about the Knowledge Economy— or even the In the last two decades, we have fact that hundreds of millions of people from developing nations are gaining the education seen our planet become smaller and skills to enter the global workforce. I mean and “flatter.” In the next two, we will the infusion of intelligence into the way the see it become smarter. world actually works: the systems and processes that enable physical goods to be developed, These and other systems by which the world manufactured, bought and sold; services to be works are increasingly unsustainable. They may delivered; everything from people and money be networked, but it turns out that being to oil, water and electrons to move; and billions connected isn’t enough. It doesn’t make them of people to work and live. smart. But the good news is, they can be. 6


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    We know this because IBM is building these 38 states. And, partnering with Google and the systems today, in collaboration with forward­ Continua Health Alliance, we have introduced thinking clients around the world. In them, we software that will enable data from personal can see a foreshadowing of how banking will medical devices to feed a patient’s electronic work, how telecommunications will work, how health record. energy, healthcare, transportation and retail will smarter food systems: IBM built a system work. We can see a world that is becoming for Norway’s largest food supplier that uses smarter before our eyes. RFID technology to trace meat and poultry from smarter traffic: Stockholm’s intelligent the farm, through the supply chain, all the way traffic system, created by IBM, has resulted in to supermarket shelves. 20 percent less gridlock, a 12-percent drop smarter money: Foreign currency exchange is in emissions and a reported 40,000 additional the world’s largest single market. Thanks to a daily users of public transport. IBM is building smart financial system IBM developed, intraday smart traffic systems in cities from London settlement risk for more than $2 trillion in daily to Brisbane to Singapore — with many more volume — more than 60 percent of the world’s being planned. foreign exchange transactions—has been smarter power grids: IBM today is leading effectively eliminated. And through technology- seven of the world’s top ten automated meter enabled microfinance, organizations like management projects. Our intelligent utility Grameen Foundation and Financial Information network with CenterPoint Energy enables Network and Operations Ltd. (FINO) are remote sensing and operation of the electric grid, providing poor people around the world with connection and disconnection of service, fewer collateral-free loans and financial services to and shorter outages, improved customer service support income-generating businesses. and the integration of new, environmentally smarter telecommunications: IBM is friendly power sources such as wind and solar— helping traditional telecom service providers, as well as the charging of plug-in electric mobile and broadband operators and broad- vehicles. In Malta, we will build the world’s first casters transform their networks and services. national smart grid, which will also instrument IBM’s solutions are being used in India to deliver and monitor the country’s water systems. new services dynamically to support 185 million smarter healthcare: The cost of therapy mobile phone subscribers—more than half of the is being lowered by as much as 90 percent. total Indian market for mobile services. For example, IBM technology is being used to 7 monitor the proper delivery of injections and vaccines to more than 2 million patients in


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    A LETTER FROM THE CHAIRMAN smarter water: We can even use computer We will be aggressive in our pursuit of this modeling to simulate, monitor—and potentially opportunity. Indeed, you will be hearing and manage—the behavior of river basins around seeing much more about our smarter planet the world, as Water for Tomorrow, a collaboration vision in the weeks and months ahead, as between IBM and The Nature Conservancy, we establish our point of view, build the right is now doing in Brazil, China and the U.S. relationships and offer smart solutions in the marketplace. In every one of these examples—and there are many more —we see improved productivity, efficiency, responsiveness, profitability and We Will Emerge Stronger societal benefit. In closing, I think it’s worthwhile to step back With so much technology and networking and consider this moment, and our response abundantly available at such low cost, what to it, in a broader context. Many companies are service wouldn’t you provide a customer, citizen, reacting to the current global downturn by student or patient? What wouldn’t you connect? drastically curtailing spending and investment, What information wouldn’t you mine for insight? even in areas that are important to their future. The answer is, you—or your competitor — We are taking a different approach. will do all of that. You will do it because you Of course, we must continue to improve can, because the technology is both available our competitiveness. But while we maintain and affordable. discipline and prudence in the near term, we And governments and societies around the also maintain the discipline to plan for the world will do it because they must. As I talk to future. We’re not looking back, we’re looking leaders everywhere from business, government ahead. We’re continuing to invest in R&D, and across civil society, I am hearing the same in strategic acquisitions, in growth initiatives— urgency for action, the same need for significant and most importantly, during these difficult investment, and the same focus on not simply times, in our people. repairing what’s broken, but preparing for In other words, we will not simply ride a new economy in a new century. In particular, out the storm. Rather, we will take a long-term there is widespread and growing recognition view, and go on offense. Throughout our of the importance of smart infrastructure. history, during periods of disruption and global Our conversations around the world are giving change, this is what IBM has done. Again and us confidence that IBM is well positioned again, we have played a leadership role. to address society’s and businesses’ most We have imagined what the world might be, 8 urgent needs. and actually built it.


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    We find ourselves at such a moment now. for your unwavering support. I hope that This is an inflection point—both in the course you are pleased with how your company is of modern technology and economic history, performing and evolving. And I trust that you and in the nearly 100-year journey of IBM. share our excitement about the role we can As someone who has been here for more than play in what promises to be a new era for our a third of that journey, I can tell you that it industry, for business and for our planet. presents the best opportunity I have seen in my IBM career to align those two trajectories in very powerful ways. From cabinet rooms, to board rooms, to kitchen tables around the world, people are eager for change. Such a mandate doesn’t come around very often—perhaps once in a genera- tion, or once in a century. It’s not something to squander. I and my fellow IBMers have no Samuel J. Palmisano intention of doing so. CHAIRMAN, PRESIDENT AND CHIEF EXECUTIVE OFFICER Let me close by expressing my pride in the worldwide IBM team for bringing us to this point, and my gratitude to you, our shareholders, The selected references in this letter to the company’s financial results (i) excluding Enterprise Investments and stock-based compensation, (ii) at local (constant) currency, and (iii) excluding Global Financing receivables are, in each case, non-GAAP financial measures. These references are made to facilitate a comparative view of the company’s ongoing operational performance. Information about references to the company’s financial results excluding Enterprise Investments, stock-based compensation and Global Financing receivables is provided in the company’s Form 8-K submitted to the SEC on January 20, 2009 (Attachment II— Non-GAAP Supplementary Materials). Information about references to local currency is provided in the company’s 2008 Annual Report to Stockholders (Management Discussion—Year in Review) and in the company’s Form 10-K for 2008 (Part II, Item 7). 9


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    Generating Higher Value at IBM 1. Several years ago, we saw change coming. Value was shifting in the IT industry, driven by the rising tide of global integration, a new computing paradigm and new client needs. These shifts meant the world was becoming not just smaller and “flatter,” but also smarter. Economies of developing A new computing architecture Companies were seeking to nations were growing rapidly, enabled pervasive instrumentation, integrate advanced technology driven by historic investments in unprecedented computing power with their business processes fundamental business infrastructure. and advanced analytics to transform and operations, not only to reduce Enterprises were looking to tap oceans of data into insight and costs, but to enable innovation skills and capabilities available intelligence. and growth. all over the world and to integrate their operations globally. 2. We remixed our businesses in order to move to the emerging higher-value spaces. IBM has divested commoditizing businesses like From 2000 to 2008 we acquired more than personal computers and hard disk drives, and 100 companies to complement and scale our portfolio strengthened its position through strategic investments of products and offerings. This has changed our and acquisitions in higher-value segments like business mix toward higher-value, more profitable business intelligence and analytics, virtualization segments of the industry. and green solutions. SEGMENT PRE-TAX INCOME MIX 2000 2000 2008 2008 Pre-tax Margin Pre-tax Income Pre-tax Margin Pre-tax Income 12.0% $10.2B 16.1% $16.7B 100% 25 28 42 34 35 42 40 40 40 Software 80 40 46 60 41 35 30 37 37 42 Services 44 40 10 13 14 20 24 10 12 11 9 10 16 18 9 Financing 14 13 15 13 14 9 Hardware 0 00* 01* 02 03 04 05 06 07 08 * Segment mix excludes enterprise investments and stock-based compensation.


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    3. We became a globally integrated enterprise in order to capture the best growth opportunities and improve IBM’s profitability. IBM operates in more than 170 countries and enjoys grew 10 percent last year, and made up 18 percent an increasingly broad-based geographic reach. of our revenues. Revenue increased 18 percent Our non-U.S. operations generated approximately (15 percent in local currency) in Brazil, Russia, India 65 percent of IBM’s revenue in 2008. IBM’s Growth and China. Markets unit, which was established in 2008, 2008 PERFORMANCE Major Markets Growth Markets Percent of IBM 82% 18% Geographic Revenue 5% 10% Revenue Growth Revenue Growth 2% 10% in Local Currency Major Markets Growth Markets We are rebalancing our spending 2008 GROWTH In local currency (excludes OEM) to areas of greatest opportunity. As we continue to drive significant 15% productivity in Major Markets, 13 we are increasing investment in Growth Markets, expanding our 12 go-to-market capabilities and skills 10 to capture the infrastructure 9 build-out in these regions. We are 9 leveraging our global reach and 7 integrated model to drive higher 6 profitability across the company. 3 2 1 0 0 11 Revenue Gross Sales and General and Profit Marketing Administrative Expense Expense Major Markets Growth Markets Total IBM


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    GENER ATING HIGHER VALUE AT IBM 4. As a result, IBM is a higher-performing enterprise today than it was a decade ago. Our business model is more aligned with our clients’ needs and generates better financial results. We have achieved record earnings per share … … and record cash performance. Diluted earnings per share in 2008 were $8.93, In 2008 our free cash flow, excluding the year-to-year marking six consecutive years of double-digit change in Global Financing receivables, was growth. Pre-tax earnings from continuing operations $14.3 billion—an increase of $1.9 billion from 2007. were $16.7 billion, an increase of 15 percent. EARNINGS PER SHARE FINANCIAL PERFORMANCE HISTORY ( $ in billions) $10 $20 8.93 18 $104 99 $16.7 96 8 16 91 91 89 7.18 85 83 81 $14.3 * 14 6.06 6 12 4.91 10 4.39 3.88 3.94 3.76 4 8 6 2.43 2 4 2 0 0 00 01 02 03 04 05 06 07 08 00 01 02 03 04 05 06 07 08 Revenue Free Pre-tax Cash Flow Income * Excluding Global Financing receivables 12


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    5. We have therefore been able to invest in future sources of growth and provide record return to investors … PRIMARY USES OF CASH FROM 2000 TO 2008 $146 $ 60 billion billion $ 86 billion Reinvested: Returned to Shareholders: Acquisitions and Capital Expenditures Share Repurchases and Dividends … while continuing to invest in R&D—more than $ 50 billion from 2000 to 2008. 6. This gives us confidence that we are entering the current economic environment from a position of strength … In 2008 we made progress toward our 2010 objectives by growing earnings per share 24 percent. And with this strong 2008 performance, we are clearly ahead of pace on our road map to $10–$11 of earnings per share. EARNINGS PER SHARE ROAD MAP $12 $11 $10 KEY DRIVERS 10 $8.93 Historical revenue growth: We maintain historical revenue growth through annuity businesses, global 6%-11% Compound presence and a balanced business mix. 8 Annual Growth $7.18 Rate Margin expansion: We focus on delivering higher 24% value to clients and on increasing productivity, to $6.06 improve profitability. 6 18% Share repurchases: Our strong cash generation lets us return value to shareholders by reducing shares outstanding while reinvesting for future growth. 4 Growth initiatives and future acquisitions: We 13 invest in key growth initiatives and strategic acquisitions to complement and scale our product portfolio. 2 Retirement-related costs: Retirement-related costs vary based on market performance and plan redesigns. 0 06 07 08 09 10


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    GENER ATING HIGHER VALUE AT IBM 7. … and that we will emerge from it even stronger, thanks to our long-term fundamentals and our agenda for a smarter planet. All around the world, businesses, governments Many of their key priorities are in areas where and institutions are investing to reduce costs, IBM has leading solutions—such as smarter utility drive innovation and transform their infrastructure. grids, traffic, healthcare, financial systems, The economic downturn has intensified this trend, telecommunications and cities. We are aggressively as leaders seek not simply to repair what is pursuing this transformational, global opportunity. broken, but to prepare for a 21st Century economy. Smarter Traffic Cities are struggling with traffic today—and it’s about to get much worse, as the planet urbanizes. By 2010, 59 metropolitan areas will have populations above 5 million. Smart traffic systems encompass tolling, embedded sensors and large-scale simulations to predict traffic flows. Stockholm has seen 20 percent less traffic, 12 percent lower emissions and 40,000 additional users of public transport a day. Smarter Grids With businesses and societies facing often-volatile energy supplies and costs, as well as growing environmental concerns, a smart grid can save electricity and money and protect the planet, by linking smart meters in the home with instrumented power lines and plants. And it even paves the way to integrate renewable sources like wind and solar. IBM today is leading seven of the world’s top ten automated meter management projects. Smarter Healthcare Our healthcare system isn’t a “system” at all. It can’t link from diagnosis, to drug discovery, to providers, insurers, employers and patients. But smart healthcare can lower costs, reduce errors and empower patients. One hospital is applying analytics to speed childhood 14 cancer research and improve patient outcomes— while lowering the cost of data acquisition by 75 percent.


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    Smarter Food In a world where 820 million people are undernour- ished, it is a tragedy that grocers and consumers throw away $48 billion worth of food each year in the U.S. alone. Inefficiencies and quality issues plague the global food supply chain. But with new technologies to trace food from the farm to the market shelf, and more intelligent solutions to track supply and demand, a healthier future is in store. Smarter Money The world’s financial institutions could spread risk. But the world’s financial infrastructure couldn’t manage risk, in a world where money moves with the speed of ones and zeroes. However, smart money systems are at hand. Intraday settlement risk for more than $2 trillion in daily currency exchange has been effectively eliminated. Smart systems can enable a safer and more transparent global economy. Smarter Telecommunications Two billion people will soon be online—along with a trillion intelligent phones, cameras, cars, appliances, packages, power lines, roadways and more. By 2012, video will account for nearly 90 percent of consumer IP traffic. To handle this vast data stream, we’ll need a smart global network. Fortunately, next-generation digital platforms are already enabling telecom providers to deliver new services, and helping billions of people join the global economy. Smarter Oil As we move toward a renewable energy future, we need smarter oil and gas fields today. We can only extract a third of the oil in an existing reserve —but that’s changing, thanks to 3-D models of reservoirs, to help decide where to drill; and sensors embedded across an entire field, to optimize well performance and protect 15 the environment.


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    Financial Highlights ( $ in millions except per share amounts) For the year: 2008 2007 Revenue $103,630 $ 98,786 Income from continuing operations $ 12,334 $ 10,418 Income/(loss) from discontinued operations — (00) Net income $ 12,334 $ 10,418 Earnings/(loss) per share of common stock: Assuming dilution: Continuing operations $ 8.93 $ 7.18 Discontinued operations — (0.00) Total $ 8.93 $ 7.18 Basic: Continuing operations $ 9.07 $ 7.32 Discontinued operations — (0.00) Total $ 9.07 $ 7.32 Net cash provided by operating activities from continuing operations $ 18,812 $ 16,094 Capital expenditures, net 4,536 4,968 Share repurchase 10,578 18,828 Cash dividends paid on common stock 2,585 2,147 Per share of common stock 1.90 1.50 At year end: 2008 2007 Cash, cash equivalents and marketable securities $ 12,907 $ 16,146 Total assets 109,524 120,431 Working capital 6,568 8,867 Total debt 33,926 35,274 Stockholders’ equity 13,465 28,470 Common shares outstanding (in millions) 1,339 1,385 Market capitalization $112,698 $149,744 Stock price per common share $ 84.16 $ 108.10 Number of employees in IBM/wholly owned subsidiaries 398,455 386,558 16


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    Report of Financials INTERNATIONAL BUSINESS MACHINES CORPOR ATION and Subsidiary Companies management discussion notes to consolidated financial Road Map 18 statements forward-Looking and Cautionary Statements 18 A Significant Accounting Policies 66 Management Discussion Snapshot 19 B Accounting Changes 76 Description of Business 20 C Acquisitions/Divestitures 78 Year in Review 25 D fair Value 84 Prior Year in Review 39 E financial Instruments (Excluding Derivatives) 85 Discontinued Operations 44 F Inventories 86 Other Information 44 G financing Receivables 86 Looking forward 44 H Plant, Rental Machines and Other Property 86 Liquidity and Capital Resources 45 I Investments and Sundry Assets 87 Critical Accounting Estimates 48 J Intangible Assets Including Goodwill 87 Currency Rate fluctuations 51 K Borrowings 88 Market Risk 51 L Derivatives and Hedging Transactions 90 financing Risks 52 M Other Liabilities 94 Employees and Related Workforce 52 N Stockholders’ Equity Activity 95 Global financing 53 O Contingencies and Commitments 97 P Taxes 99 REPORT OF MANAGEMENT 58 Q Research, Development and Engineering 101 REPORT OF INDEPENDENT REGISTERED R Earnings Per Share of Common Stock 102 PUBLIC ACCOUNTING FIRM 59 S Rental Expense and Lease Commitments 103 consolidated financial statements T Stock-Based Compensation 103 U Retirement-Related Benefits 106 Earnings 60 V Segment Information 116 financial Position 61 W Subsequent Event 119 Cash flows 62 Stockholders’ Equity 63 FIVE-YEAR COMPARISON OF SELECTED FINANCIAL DATA 120 SELECTED QUARTERLY DATA 121 PERFORMANCE GRAPHS 122 BOARD OF DIRECTORS AND SENIOR LEADERSHIP 124 STOCKHOLDER INFORMATION 125 17


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    Management Discussion international buSineSS machineS corpor ation and Subsidiary companies Road Map • The reference to “adjusted for currency” in the Management Discussion is made so that certain financial results can be viewed The financial section of the International Business Machines Corpor- without the impacts of fluctuating foreign currency exchange ation (IBM or the company) 2008 Annual Report consists of this rates and therefore facilitates a comparative view of business Management Discussion, the Consolidated financial Statements and performance. See “Currency Rate fluctuations” on page 51 for the Notes to the Consolidated financial Statements. This Road Map additional information. is designed to provide the reader with some perspective regarding the • Within the financial tables in this Annual Report, certain columns information contained in the financial section. and rows may not add due to the use of rounded numbers for disclosure purposes. Percentages reported in the financial tables organization of information throughout this Annual Report are calculated from the underly- • The Management Discussion is designed to provide readers with ing whole-dollar numbers. a narrative on the company’s financial results and certain factors that may affect future prospects from the perspective of the discontinued operations company’s management. The “Management Discussion Snapshot” On December 31, 2002, the company sold its hard disk drive (HDD) on pages 19 and 20 presents an overview of the key performance business to Hitachi, Ltd. (Hitachi). The HDD business was accounted drivers in 2008. for as a discontinued operation under generally accepted accounting • Beginning with the “Year in Review” on page 25, the Management principles (GAAP) and therefore, the HDD results of operations and Discussion contains the results of operations for each segment of cash flows have been removed from the company’s results of con- the business, a discussion of the company’s financial position and tinuing operations and cash flows for all periods presented in this cash flows, in addition to other key information and data. It is document except 2008, in which there was no activity. See page 44 for useful to read the Management Discussion in conjunction with additional information. note V, “Segment Information,” on pages 116 to 119. • Global financing is a reportable segment that is measured as if it were a standalone entity. A separate “Global financing” section is Forward-Looking included beginning on page 53. The information presented in this and Cautionary Statements section is consistent with this separate company view. Certain statements contained in this Annual Report may constitute • The Consolidated financial Statements are presented on pages 60 forward-looking statements within the meaning of the Private Secur- through 65. These statements provide an overview of the compa- ities Litigation Reform Act of 1995. These statements involve a number ny’s income and cash flow performance and its financial position. of risks, uncertainties and other factors that could cause actual results • The notes follow the Consolidated financial Statements. Among to be materially different, as discussed more fully elsewhere in this other items, the notes contain the company’s accounting policies Annual Report and in the company’s filings with the Securities and (pages 66 to 76), acquisitions and divestitures (pages 78 through 83), Exchange Commission (SEC), including the company’s 2008 form detailed information on specific items within the financial state- 10-K filed on february 24, 2009. ments, certain contingencies and commitments (pages 97 to 99), and retirement-related benefits information (pages 106 to 116). 18 Management Discussion ................................................................................................18 DISCONTINUED OPERATIONS .............................................................................. 44 ROAD MAP ............................................................................................................ 18 OTHER INFORMATION .......................................................................................... 44 FORWARD-LOOKING AND CAUTIONARY STATEMENTS ..................................... 18 GLOBAL FINANCING ............................................................................................. 53 MANAGEMENT DISCUSSION SNAPSHOT ........................................................... 19 Report Of Management ............................................................................................... 58 DESCRIPTION OF BUSINESS................................................................................ 20 Report Of Independent Registered Public Accounting Firm ................................. 59 YEAR IN REVIEW ................................................................................................... 25 Consolidated Statements ............................................................................................ 60 PRIOR YEAR IN REVIEW ....................................................................................... 39 Notes ............................................................................................................................... 66


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    Management Discussion international buSineSS machineS corpor ation and Subsidiary companies Management Discussion Snapshot Overall, the company capitalized on the opportunities in the global ( $ and shares in millions except per share amounts) economies, generating approximately 65 percent of its revenue outside Yr.-to-Yr. the United States (U.S.), in delivering full year growth of 4.9 percent Percent/ Margin (2 percent adjusted for currency). Revenue increased in all geogra- for the year ended December 31: 2008 2007 Change phies, both on an as reported basis and adjusted for currency — the Revenue $103,630 $ 98,786 4.9%* revenue performance, adjusted for currency, was stable throughout Gross profit margin 44.1% 42.2% 1.8 pts. the year as the company focused on solutions that meet clients’ needs. Total expense and other income $ 28,945 $ 27,240 6.3% Revenue from the company’s growth markets organization increased Total expense and other 9.8 percent (10 percent adjusted for currency). In these markets, income-to-revenue ratio 27.9% 27.6% 0.4 pts. where the growth is driven by the infrastructure build-out, the com- Income from continuing operations before income taxes $ 16,715 $ 14,489 15.4% pany invested aggressively to capture these opportunities. For the full Provision for income taxes 4,381 4,071 7.6% year and in the fourth quarter, growth in these markets, adjusted for Income from continuing currency, was 8 points greater than the major markets. operations $ 12,334 $ 10,418 18.4% Gross profit margins improved, reflecting the shift to higher Net income $ 12,334 $ 10,418 18.4% value businesses, pricing for value and the continued focus on pro- Net income margin 11.9% 10.5% 1.4 pts. ductivity and cost management. Pre-tax income from continuing Earnings per share of operations grew 15.4 percent and net income from continuing common stock: operations increased 18.4 percent reflecting an improvement in the Assuming dilution: company’s tax rate. Diluted earnings per share improved 24.4 percent Continuing operations $ 8.93 $ 7.18 24.4% reflecting the strong growth in net income and the benefits of the Discontinued operations — (0.00) NM common stock repurchase program. In 2008, the company repur- Total $ 8.93 $ 7.18 24.4% chased approximately 90 million shares of its common stock. Weighted-average shares The increase in 2008 revenue was primarily due to: outstanding: Assuming dilution 1,381.8 1,450.6 (4.7)% • Continued strong performance from Global Technology Services Assets** $109,524 $120,431 (9.1)% and Global Business Services with growth in all business lines and Liabilities** $ 96,058 $ 91,962 4.5% geographic units; Equity** $ 13,465 $ 28,470 (52.7)% • Continued strong demand in the Software business, driven by Key * 2.3 percent adjusted for currency. Branded Middleware products, with strong contributions from ** At December 31. strategic acquisitions; and NM—Not meaningful • Continued strength in the growth markets. The increase in income from continuing operations before income continuing operations taxes in 2008 was primarily due to the revenue growth and gross profit In 2008, the company performed extremely well in a difficult econ- margin improvements in the Global Services and Software segments. omic environment, delivering record levels of revenue, pre-tax profit, The consolidated gross profit margin increased 1.8 points versus earnings per share and cash flow from operations. The financial per- 2007 to 44.1 percent. Gross margin performance by segment and the formance reflected the continuing strength of the company’s global impact to the consolidated gross margin was as follows: model and the results of the ongoing transformation of the business. Gross Yr.-to-Yr. Consolidated The key elements of the company’s transformation include: Margin Change Impact Global Technology Services 32.6% 2.7 pts. 0.8 pts. • A continuing shift to higher value businesses; Global Business Services 26.7% 3.2 pts. 0.5 pts. • Investing for growth in the emerging markets; Software 85.4% 0.2 pts. 0.5 pts. • Global integration; Systems & Technology 38.1% (1.7) pts. (0.2) pts. • Investing in innovation; and Global Financing 51.3% 4.6 pts. 0.1 pts. • Ongoing productivity resulting in higher profit margins. 19


  • Page 22

    Management Discussion international buSineSS machineS corpor ation and Subsidiary companies Total expense and other income increased 6.3 percent in 2008 versus Total Global Services signings increased 2 percent to $57,182 2007. The year-to-year drivers were approximately: million ($49,738 million adjusted for currency, flat versus 2007). Short-term signings were $26,831 million, an increase of 8 percent • Operational expense, -1 point year to year (5 percent adjusted for currency), while long-term sign- • Acquisitions, +5 points ings were $30,351 million, a decrease of 3 percent (5 percent adjusted • Currency, +2 points for currency). The estimated Global Services backlog, adjusted for currency, was $117 billion at December 31, 2008, down $2 billion ver- The effective tax rate for 2008 was 26.2 percent, compared with 28.1 sus the December 31, 2007 balance. percent in 2007. The decrease in the tax rate was primarily due to for additional information and details, see the “Year in Review” increased utilization of tax credits. section on pages 25 to 39. At December 31, 2008, the company’s balance sheet and liquidity positions remained strong. Cash on hand was $12,741 million. Total debt decreased $1,349 million year to year, and the company gener- Description of Business ated $18,812 million in operating cash flow in 2008. The company please refer to ibm’s annual report on form 10-K filed with the Sec has consistently generated strong cash flow from operations and also on february 24, 2009 for a more detailed version of this Description of continues to have access to additional sources of liquidity through business, especially item 1a. entitled “risk factors.” the capital markets and its global credit facility. The company creates business value for clients and solves business Key drivers in the company’s balance sheet and total cash flows problems through integrated solutions that leverage information are highlighted below. technology and deep knowledge of business processes. IBM solutions Total assets decreased $10,907 million ($5,854 million adjusted typically create value by reducing a client’s operational costs or by for currency) primarily due to decreases in cash and cash equivalents enabling new capabilities that generate revenue. These solutions draw ($2,250 million), prepaid pension assets ($15,816 million), short-term from an industry leading portfolio of consulting, delivery and imple- marketable securities ($989 million) and total financing receivables mentation services, enterprise software, systems and financing. ($1,233 million). These decreases were partially offset by increases in long-term deferred taxes ($5,757 million), goodwill ($3,941 million) strategy and intangible assets ($771 million). In IBM’s view, today’s networked economy has created a global busi- Total liabilities increased $4,097 million ($5,275 million adjusted ness landscape and a mandate for business change. It also opens the for currency) driven primarily by increases in retirement and non- opportunity to upgrade the efficiency and effectiveness of the global pension postretirement benefit obligations ($5,871 million) and total infrastructure through embedded information technology — what deferred income ($547 million), partially offset by decreases in total IBM calls a “smarter planet.” Smart airports, smart highways, smart debt ($1,349 million) and accounts payable ($1,041 million). supply chains are all possible. IBM is working with clients and Stockholders’ equity of $13,465 million decreased $15,004 million governments around the world to explore these opportunities and versus 2007. Net income of $12,334 million was offset by the effects of implement new ideas. pension remeasurements and other retirement-related items ($14,856 Integrated global economies have opened markets of new million), common/treasury stock activity ($6,322 million), dividends opportunity and new sources of skills. The Internet has enabled com- ($2,585 million) and equity translation adjustments ($3,552 million). munication and collaboration across the world and brought with it a The company generated $18,812 million in cash flow provided by new computing model premised on continuous global connection. In operating activities, an increase of $2,718 million, compared to 2007, that landscape, companies can distribute work and technology any- primarily driven by increased net income ($1,916 million). Net cash where in the world. IBM continues to adjust its footprint toward used in investing activities of $9,285 million was $4,611 million higher emerging geographies, tapping their higher growth, providing the than 2007, primarily due to increased spending for acquisitions technology infrastructure they need and taking advantage of the tal- ($5,304 million). Net cash used in financing activities of $11,834 ent pools they provide to better service the company’s clients. million increased $7,095 million primarily due to debt transactions ($14,556 million), partially offset by lower common stock repur- chases ($8,249 million) in 2008 versus 2007. 20 Management Discussion ................................................................................................18 DISCONTINUED OPERATIONS .............................................................................. 44 ROAD MAP ............................................................................................................ 18 OTHER INFORMATION .......................................................................................... 44 FORWARD-LOOKING AND CAUTIONARY STATEMENTS ...................................... 18 GLOBAL FINANCING ............................................................................................. 53 MANAGEMENT DISCUSSION SNAPSHOT ........................................................... 19 Report Of Management ............................................................................................... 58 DESCRIPTION OF BUSINESS ............................................................................... 20 Report Of Independent Registered Public Accounting Firm ................................. 59 YEAR IN REVIEW ................................................................................................... 25 Consolidated Statements ............................................................................................ 60 PRIOR YEAR IN REVIEW ....................................................................................... 39 Notes ............................................................................................................................... 66


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    Management Discussion INTERNATIONAL BUSINESS MACHINES CORPOR ATION and Subsidiary Companies At the same time, the current economic crisis increases the pressure • To reshape its business for the global economy, IBM has replaced on both businesses and governments around the world to adapt. The vertical hierarchies with horizontally integrated teams. needs for additional transparency, security and efficiencies are clear. • Across the business, the company has made significant invest- Given these opportunities and economic challenges, IBM is work- ments in emerging markets, taking core processes and functions ing with its clients to develop new business designs and technical that were once managed regionally and shifting them to a globally architectures that allow their businesses the flexibility required to integrated model. compete in this new landscape. IBM’s strategy addresses this new era and delivers value to its clients through three strategic priorities: Looking forward, IBM is confident it understands the economic shift of globalization, the evolution of the new computing model and the Focus on Open Technologies and High-Value Solutions powerful role of innovation in this new landscape. Its unique capa- A new computing model has emerged, replacing the PC-based, cli- bilities are well adapted to help the company’s clients innovate and ent/server approach. This new model is networked, modular, open compete effectively in this new environment. and represents a fundamental shift in the technology requirements of the company’s clients. IBM is well positioned to provide its enterprise business model clients the open technologies and high-value solutions they will need The company’s business model is built to support two principal goals: to compete. helping clients succeed in delivering business value by becoming more innovative, efficient and competitive through the use of business • IBM is leveraging its leadership position in the convergence of insight and IT solutions; and, providing long-term value to share- software and services, in service oriented architecture (SOA), in holders. The business model has been developed over time through virtualization, in business intelligence and analytics, in open and strategic investments in capabilities and technologies that have the modular information technology (IT) — continuing its shift best long-term growth and profitability prospects based on the value from commoditizing segments to higher value segments with they deliver to clients. better profit opportunity. The company’s global capabilities include services, software, • The company continues to be a leading force in open source solu- hardware, fundamental research and related financing. The broad tions to enable its clients to achieve higher levels of interoperability, mix of businesses and capabilities are combined to provide business cost efficiency and quality. insight and solutions for the company’s clients. The business model is flexible, adapting to the continuously Deliver Integration and Innovation to Clients changing market and economic environment. The company has Changes in the market have caused IBM’s clients to seek flexibility divested commoditizing businesses like personal computers and and innovation in everything from technical architecture to their hard disk drives, and strengthened its position through strategic business model. In response, IBM is focused on delivering integra- investments and acquisitions in higher value segments like business tion and innovation to its clients — offering them technologies and intelligence and analytics, virtualization and green solutions. In addi- services that support real value creation. tion, the company has transformed itself into a globally integrated enterprise which has improved overall productivity and is driving • IBM has a long heritage of transforming the business operations investment and participation in the world’s fastest growing markets. of large enterprises and has earned the trust to be their innovation As a result, the company is a higher performing enterprise today partner and global integrator. than it was several years ago. • The company has an extensive set of global assets and capabilities The business model, supported by the company’s long-term it is applying to improve services profitability, both for its clients financial model, has enabled the company to deliver consistently and for itself. strong earnings, cash flows and returns on invested capital in chang- ing economic environments. Become the Premier Globally Integrated Enterprise As global networks and technology capabilities change business eco- nomics, legacy business designs can quickly become noncompetitive. IBM believes a globally integrated enterprise, designed for this new landscape, can compete effectively and will benefit from the oppor- tunities offered. 21


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    Management Discussion INTERNATIONAL BUSINESS MACHINES CORPOR ATION and Subsidiary Companies business segments and capabilities GBS CAPABILITIES The company’s major operations are comprised of: a Global Tech­ Consulting and Systems Integration. Delivery of value to clients through nology Services segment; a Global Business Services segment; a consulting services for client­relationship management, financial man­ Software segment; a Systems and Technology segment; and a Global agement, human­capital management, business strategy and change, Financing segment. and supply­chain management. Global Services is a critical component of the company’s strategy of providing IT infrastructure and business insight and solutions to Application Management Services. Application development, manage­ clients. While solutions often include industry­leading IBM software ment, maintenance and support services for packaged software, as well and hardware, other suppliers’ products are also used if a client solu­ as custom and legacy applications. Value is delivered through the tion requires it. Within Global Services there are two reportable company’s global resource capabilities, industry knowledge and the segments: Global Technology Services and Global Business Services. standardization and automation of application development. Global Technology Services (GTS) primarily provides IT Software consists primarily of middleware and operating systems infrastructure services and business process services, delivering busi­ software. Middleware software enables clients to integrate systems, ness value through the company’s global scale, standardization and processes and applications across a standard software platform. IBM automation. middleware is designed to open standards which allows the efficient integration of disparate client applications that may have been built GTS CAPABILITIES internally, or provided by packaged software vendors or system Strategic Outsourcing Services. Comprehensive IT services integrated integrators. Operating systems are the software engines that run com­ with business insight working with clients to reduce costs and improve puters. Approximately two­thirds of external software segment revenue productivity through the outsourcing of processes and operations. is annuity­based, coming from recurring license charges and ongoing subscription and support from one­time charge (OTC) arrange­ Integrated Technology Services. Services offerings that help clients ments. The remaining one­third of external revenue relates to OTC access, manage and support their technology infrastructures through arrangements, in which the client pays one up­front payment for a a combination of skilled resources, software and IBM’s knowledge of perpetual license. Typically, arrangements for the sale of OTC soft­ business processes. The portfolio includes Service Product Lines which ware include one year of maintenance. The client can also purchase complement hardware from Systems and Technology and software ongoing maintenance after the first year, which includes product offerings from the Software business. upgrades and technical support. Business Transformation Outsourcing. A range of offerings from stan­ SOFTWARE CAPABILITIES dardized processing platforms and Business Process Outsourcing WebSphere Software. Management of a wide variety of business processes through transformational offerings that deliver improved business using open standards to interconnect applications, data and operating results to clients through the strategic change and/or operation of the systems. Provides the foundation for Web­enabled applications and client’s business processes, applications and infrastructure. is a key product set in deploying an SOA. Maintenance. A number of support services from product maintenance Information Management Software. Advanced database, content man­ through solution support to maintain and improve the availability of agement, information integration and business intelligence software clients’ IT infrastructure. that helps companies integrate, manage and gain value from their business information. Global Business Services (GBS) primarily provides professional services and application outsourcing services, delivering business Tivoli Software. Software for infrastructure management, including value and innovation to clients through solutions which leverage security and storage management that will help organizations better industry­ and business­process expertise. manage their IT infrastructure to more effectively deliver IT services. Lotus Software. Collaboration, messaging and social networking soft­ ware that enables businesses to communicate, collaborate and increase productivity. 22 Management Discussion ................................................................................................18 DISCONTINUED OPERATIONS .............................................................................. 44 ROAD MAP ............................................................................................................ 18 OTHER INFORMATION .......................................................................................... 44 FORWARD-LOOKING AND CAUTIONARY STATEMENTS ...................................... 18 GLOBAL FINANCING ............................................................................................. 53 MANAGEMENT DISCUSSION SNAPSHOT ............................................................ 19 Report Of Management ............................................................................................... 58 DESCRIPTION OF BUSINESS ............................................................................... 20 Report Of Independent Registered Public Accounting Firm ................................. 59 YEAR IN REVIEW ................................................................................................... 25 Consolidated Statements ............................................................................................ 60 PRIOR YEAR IN REVIEW ....................................................................................... 39 Notes ............................................................................................................................... 66


  • Page 25

    Management Discussion INTERNATIONAL BUSINESS MACHINES CORPOR ATION and Subsidiary Companies Rational Software. Software tools that help clients manage their soft- ibm worldwide organizations ware development processes and capabilities. With the acquisition of The following worldwide organizations play key roles in IBM’s deliv- Telelogic in 2008, Rational software supports software development ery of value to its clients: for both IT solutions and embedded system solutions. • Sales and Distribution Operating Systems. Software that manages the fundamental processes • Research, Development and Intellectual Property that make computers run. • Integrated Supply Chain • Integrated Technology Delivery Systems and Technology provides clients with business solu- • Business Process Delivery tions requiring advanced computing power and storage capabilities. Approximately 55 percent of Systems and Technology’s server and Sales and Distribution storage sales transactions are through the company’s business partners; IBM has a significant global presence, operating in over 170 coun- approximately 45 percent are direct to end-user clients. In addition, tries, with an increasingly broad-based geographic distribution of Systems and Technology provides leading semiconductor technol- revenue. The company’s Sales and Distribution organization manages ogy and products, packaging solutions and engineering technology a strong global footprint, with dedicated country-based operating services to clients and for IBM’s own advanced technology needs. units focused on delivering client value. Within these units, client relationship professionals work with integrated teams of consultants, SYSTEMS AND TECHNOLOGY CAPABILITIES product specialists and delivery fulfillment teams to improve clients’ Servers. IBM systems, which are typically connected to a network and business performance. These teams deliver value by understanding provide the required infrastructure for business. These systems use the clients’ business and needs, and then bring together capabilities both IBM and non-IBM operating systems, and all IBM servers can from across IBM and an extensive network of Business Partners to also run Linux, a key open source operating system. (System z, legacy develop and implement solutions. System i, converged System p and System x). By combining global expertise with local experience, IBM’s geo- graphic structure enables dedicated management focus for local Storage. Information infrastructure products and solutions, which clients, speed in addressing new market opportunities and timely address critical client requirements for information retention and investments in emerging opportunities. The geographic units align archiving, availability and virtualization, and security and compli- industry-skilled resources to serve clients’ agendas. IBM extends ance. The portfolio consists of a broad range of disk and tape storage capabilities to mid-market client segments by leveraging industry systems and software. skills with marketing, ibm.com and local Business Partner resources. In 2008, the company implemented a new growth markets orga- Microelectronics. Semiconductor design and manufacturing primarily nization to increase its focus on the emerging markets of Brazil, for use in IBM systems and for sale to external clients (OEM). Russia, India and China and the additional opportunities around the Retail Store Solutions. Point-of-sale retail systems (network connected world that have market growth rates greater than the global average cash registers) as well as solutions which connect them to other store — countries within Southeast Asia, Eastern Europe, the Middle East systems. and Latin America. The company’s major markets include the United States, Canada, the U.K., France, Germany, Italy, Japan, Denmark, Global Financing is described on pages 53 through 57. Sweden, Switzerland, Austria, Belgium, Finland, Greece, Ireland, the Netherlands, Portugal, Cyprus, Norway, Israel, Spain, the Bahamas GLOBAL FINANCING CAPABILITIES and the Caribbean region. Client Financing. Lease and loan financing to end users and internal The majority of IBM’s revenue, excluding the company’s origi- clients for terms generally between two and seven years. nal equipment manufacturer (OEM) technology business, occurs in industries that are broadly grouped into six sectors: Commercial Financing. Short-term inventory and accounts receivable financing to dealers and remarketers of IT products. • Financial Services: Banking, Financial Markets, Insurance • Public: Education, Government, Healthcare, Life Sciences Remarketing. The sale and lease of used equipment (primarily sourced • Industrial: Aerospace and Defense, Automotive, Chemical and from the conclusion of lease transactions) to new or existing clients. Petroleum, Electronics 23


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    Management Discussion INTERNATIONAL BUSINESS MACHINES CORPOR ATION and Subsidiary Companies • Distribution: Consumer Products, Retail, Travel and Transportation Integrated Supply Chain • Communications: Telecommunications, Media and Entertainment, Consistent with the company’s work with clients to transform their Energy and Utilities supply chains for greater efficiency and responsiveness to global • Small and Medium Business: Mainly companies with less than market conditions, the company continues to derive business value 1,000 employees from its own globally integrated supply chain, which provides a strategic advantage for the company to create value for clients. IBM Research, Development and Intellectual Property leverages its supply-chain expertise for clients through its supply-chain IBM’s research and development (R&D) operations differentiate the business transformation outsourcing service to optimize and help company from its competitors. IBM annually spends approximately operate clients’ end-to-end supply-chain processes, from procure- $6 billion for R&D, focusing its investments on high-growth, high- ment to logistics. value opportunities. As a result of innovations in these and other IBM spends approximately $38 billion annually through its sup- areas, IBM was once again awarded more U.S. patents in 2008 than ply chain, procuring materials and services globally. The supply, any other company, the first company to achieve over 4,000 patents manufacturing and logistics, and customer fulfillment operations are in a year. The company will continue to actively seek intellectual integrated in one operating unit that has optimized inventories property protection for its innovations, while increasing emphasis on over time, improved response to marketplace opportunities and other initiatives designed to leverage its intellectual property leader- external risks, and converted fixed costs to variable costs. Simplifying ship and promote innovation. and streamlining internal processes has improved operations, sales In addition to producing world-class hardware and software prod- force productivity and processes, and these actions have improved ucts, IBM innovations are also a major differentiator in providing client satisfaction. solutions for the company’s clients through its services businesses. The company’s investments in R&D also result in intellectual prop- Integrated Technology Delivery erty (IP) income of approximately $1 billion annually. Some of IBM’s Integrated Technology Delivery (ITD) combines all of the worldwide technological breakthroughs are used exclusively in IBM products, service delivery capabilities for Strategic Outsourcing with strong while others are licensed and may be used in either/both IBM prod- local and regional management teams supported by a set of global ucts and/or the products of the licensee. While the company’s various competencies. ITD leverages the company’s global scale and advanced proprietary intellectual property rights are important to its success, technology to deliver standardized solutions that are automated, IBM believes its business as a whole is not materially dependent on repeatable and globally integrated. Clients gain cost advantages, access any particular patent or license, or any particular group of patents or to industry-leading skills and IBM’s scale and overall flexibility. ITD licenses. IBM owns or is licensed under a number of patents, which manages the world’s largest privately-owned IT infrastructure with vary in duration, relating to its products. Licenses under patents employees in over 40 countries supporting over 450 data centers. owned by IBM have been and are being granted to others under reasonable terms and conditions. Business Process Delivery Business Process Delivery (BPD) provides highly efficient, world-class delivery capabilities in IBM’s business process delivery operations, which include Business Transformation Outsourcing, Business Pro- cess Outsourcing and Business Process Services. BPD has employees and delivery centers in over 40 countries worldwide. 24 Management Discussion ................................................................................................18 DISCONTINUED OPERATIONS .............................................................................. 44 ROAD MAP ............................................................................................................ 18 OTHER INFORMATION .......................................................................................... 44 FORWARD-LOOKING AND CAUTIONARY STATEMENTS ...................................... 18 GLOBAL FINANCING ............................................................................................. 53 MANAGEMENT DISCUSSION SNAPSHOT ............................................................ 19 Report Of Management ............................................................................................... 58 DESCRIPTION OF BUSINESS ............................................................................... 20 Report Of Independent Registered Public Accounting Firm ................................. 59 YEAR IN REVIEW .................................................................................................. 25 Consolidated Statements ............................................................................................ 60 PRIOR YEAR IN REVIEW ....................................................................................... 39 Notes ............................................................................................................................... 66


  • Page 27

    Management Discussion international buSineSS machineS corpor ation and Subsidiary companies Year in Review results of continuing operations Segment Details The following is an analysis of the 2008 versus 2007 reportable segment results. The analysis of 2007 versus 2006 reportable segment results is on pages 39 to 42. The following table presents each reportable segment’s external revenue and gross margin results. ( $ in millions) Yr.-to-Yr. Yr.-to-Yr. Percent/ Percent Change Margin Adjusted for the year ended December 31: 2008 2007 Change for Currency Revenue: Global Technology Services $ 39,264 $36,103 8.8% 5.8% Gross margin 32.6% 29.9% 2.7 pts. Global Business Services 19,628 18,041 8.8% 5.1% Gross margin 26.7% 23.5% 3.2 pts. Software 22,089 19,982 10.5% 8.2% Gross margin 85.4% 85.2% 0.2 pts. Systems and Technology 19,287 21,317 (9.5)% (10.8)% Gross margin 38.1% 39.7% (1.7) pts. Global Financing 2,559 2,502 2.3% 0.3% Gross margin 51.3% 46.7% 4.6 pts. Other 803 842 (4.6)% (5.9)% Gross margin 13.4% 4.4% 9.1 pts. TOTAL REVENUE $103,630 $98,786 4.9% 2.3% Gross profit $ 45,661 $41,729 9.4% Gross margin 44.1% 42.2% 1.8 pts. The following table presents each reportable segment’s external revenue as a percentage of total segment revenue and each reportable segment’s pre-tax income as a percentage of total segment pre-tax income. Revenue Pre-tax Income* for the year ended December 31: 2008 2007 2008 2007 Global Technology Services 38.2% 36.9% 26.3% 23.5% Global Business Services 19.1 18.4 15.3 13.6 Total Global Services 57.3 55.3 41.6 37.1 Software 21.5 20.4 40.4 39.6 Systems and Technology 18.8 21.8 8.8 14.2 Global Financing 2.5 2.6 9.2 9.1 TOTAL 100.0% 100.0% 100.0% 100.0% * Segment pre-tax income includes transactions between segments that are intended to reflect an arm’s-length transfer price. 25


  • Page 28

    Management Discussion international buSineSS machineS corpor ation and Subsidiary companies In 2008, Global Services and Software increased as a percentage of total Global Technology Services revenue increased 8.8 percent (6 percent segment revenue and total segment pre-tax income. Global Services adjusted for currency) in 2008 versus 2007 with strong performance increased its revenue and profit contribution by 2.0 points and 4.5 across all lines of business. Total signings in GTS increased 1 percent points, respectively, while the Software business increased by 1.1 points (flat adjusted for currency) led by short-term signings growth of and 0.8 points, respectively. These improvements reflect the compa- 5 percent (4 percent adjusted for currency). Long-term signings ny’s portfolio actions and targeted investment strategies — both aimed decreased 1 percent (2 percent adjusted for currency). at market segments that present the best long-term opportunities. Strategic Outsourcing (SO) revenue was up 7.9 percent (5 percent adjusted for currency) with growth in all geographies, driven by prior GLOBAL SERVICES year’s signings and continued growth in the base accounts. SO sign- The Global Services segments, Global Technology Services (GTS) ings in 2008 increased 3 percent (1 percent adjusted for currency) and Global Business Services (GBS), had combined revenue of when compared to 2007. Signings were very strong in the fourth $58,891 million, an increase of 8.8 percent (6 percent adjusted for quarter (up 20 percent), as clients focused on the value of the SO currency) in 2008 when compared to 2007. Revenue performance was offerings in the current environment. The initiatives around stan- broad based across the segments, lines of business and geographic dardization, global integration and improved efficiency are driving units, driven primarily by a strong annuity base and growth in short- improvements in quality and customer satisfaction which are reflected term signings. in the signings performance and in improved profitability. In 2008, total Global Services signings increased 2 percent year to Information Technology Services (ITS) revenue increased 10.0 year to $57,182 million ($49,738 million adjusted for currency, flat percent (7 percent adjusted for currency) in 2008 versus 2007 led year to year). Short-term signings were $26,831 million, an increase of by growth in key infrastructure offerings such as Green Data Cen- 8 percent (5 percent adjusted for currency) versus 2007. Short-term ter and Converged Communications. ITS infrastructure offerings signings increased in both the growth markets and the major markets. deliver high-value, standardized, asset-based services that leverage Long-term signings were $30,351 million, a decrease of 3 percent the company’s services, hardware and software capabilities, providing (5 percent adjusted for currency) compared to 2007. Long-term sign- clients end-to-end solutions and processes that transform their busi- ings declined in both the major and growth markets. The total nesses. ITS signings increased 5 percent (4 percent adjusted for Global Services backlog decreased $2 billion from the prior year to currency) in 2008. an estimated $117 billion at December 31, 2008. Business Transformation Outsourcing (BTO) revenue increased The Global Services segments leveraged very strong margin 11.2 percent (12 percent adjusted for currency) with growth in all performance and delivered combined pre-tax profit of $7,288 million geographies, led by Asia Pacific. The Daksh business, which is focused in 2008, an improvement of 29.6 percent versus 2007. The services on business process outsourcing, delivered strong growth. BTO sign- business contributed approximately 42 percent of the company’s seg- ings decreased 18 percent (14 percent adjusted for currency) in 2008 ment pre-tax profit in 2008. Through its transformation initiatives, compared to 2007. the Global Services business has focused on higher value offerings Maintenance revenue increased 8.7 percent (5 percent adjusted with a more flexible labor model that can adapt to changing market for currency) with growth in availability services on both IBM and environments. non-IBM IT equipment. Global Business Services revenue increased 8.8 percent (5 percent ( $ in millions) adjusted for currency) in 2008, with balanced growth across all three Yr.-to-Yr. for the year ended December 31: 2008 2007 Change geographies. Revenue performance was led by growth in Application GLOBAL SERVICES REVENUE: $58,891 $54,144 8.8% Management Services (12.5 percent) and Core Consulting (6.1 per- cent). Total signings in GBS increased 2 percent (decreased 1 percent Global Technology Services $39,264 $36,103 8.8% adjusted for currency), led by a 10 percent (6 percent adjusted for Strategic Outsourcing 20,183 18,701 7.9 Integrated Technology Services 9,283 8,438 10.0 currency) growth in short-term signings. Short-term signings growth Business Transformation Outsourcing 2,550 2,294 11.2 was driven by offerings that enable clients to reduce cost and conserve Maintenance 7,250 6,670 8.7 capital. In the second half of the year, signings for transformational Global Business Services $19,628 $18,041 8.8% and compliance offerings also increased. Long-term signings decreased 14 percent (16 percent adjusted for currency) year over year. 26 Management Discussion ................................................................................................18 DISCONTINUED OPERATIONS ................................................................................ 44 ROAD MAP ............................................................................................................ 18 OTHER INFORMATION .......................................................................................... 44 FORWARD-LOOKING AND CAUTIONARY STATEMENTS ...................................... 18 GLOBAL FINANCING ............................................................................................. 53 MANAGEMENT DISCUSSION SNAPSHOT ............................................................ 19 Report Of Management ............................................................................................... 58 DESCRIPTION OF BUSINESS................................................................................ 20 Report Of Independent Registered Public Accounting Firm ................................. 59 YEAR IN REVIEW .................................................................................................. 25 Consolidated Statements ............................................................................................ 60 PRIOR YEAR IN REVIEW .......................................................................................39 Notes ............................................................................................................................... 66


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    Management Discussion international buSineSS machineS corpor ation and Subsidiary companies ( $ in millions) Adjusted for Currency Yr.-to-Yr. ( $ in millions) for the year ended December 31: 2008 2007 Change Yr.-to-Yr. for the year ended December 31: 2008 2007 Change GLOBAL SERVICES GROSS PROFIT: Global Technology Services: GLOBAL TECHNOLOGY Gross profit $12,802 $10,800 18.5% SERVICES SIGNINGS: Gross profit margin 32.6% 29.9% 2.7 pts. Long term $21,220 $21,550 (1.5)% Global Business Services: Short term 8,920 8,604 3.7 Gross profit $ 5,238 $ 4,240 23.5% TOTAL $30,141 $30,154 0.0% Gross profit margin 26.7% 23.5% 3.2 pts. GLOBAL BUSINESS SERVICES SIGNINGS: GTS gross profit increased 18.5 percent compared to 2007, with Long term $ 5,333 $ 6,330 (15.8)% gross profit margin improving 2.7 points. All lines of business deliv- Short term 14,264 13,411 6.4 ered gross margin expansion year over year driven by a combination TOTAL $19,597 $19,741 (0.7)% of a mix to higher value offerings and an improved cost structure. Segment pre-tax profit increased 29.5 percent to $4,607 million with Global Services signings are management’s initial estimate of the a pre-tax margin of 11.3 percent, an increase of 1.9 points versus revenue value of a client’s commitment under a Global Services con- 2007. GTS has delivered six consecutive quarters of double-digit tract. Signings are used by management to assess period performance pre-tax profit growth. The margin improvement was driven primar- of Global Services management. There are no third-party standards ily by a delivery structure that maximizes utilization and flexibility, or requirements governing the calculation of signings. The calcula- a mix to higher value offerings, lower retirement-related costs and tion used by management includes an approximation of currency and improved productivity. involves estimates and judgments to gauge the extent of a client’s GBS gross profit increased 23.5 percent to $5,238 million in 2008 commitment, including the type and duration of the agreement, when compared to 2007, and the gross profit margin improved 3.2 and the presence of termination charges or wind-down costs. For points. Segment pre-tax profit increased 29.9 percent to $2,681 million example, for long-term contracts that require significant up-front with a pre-tax margin of 13.0 percent, an improvement of 2.2 points investment by the company, the portions of these contracts that year over year. This was the third straight year of profit growth constitute a signing are those periods in which there is a significant greater than 20 percent in GBS and demonstrates the results of a economic impact on the client if the commitment is not achieved, strong operating discipline and the benefits of a globally integrated usually through a termination charge or the client incurring signifi- operating model. The margin expansion was driven by improved cant wind-down costs as a result of the termination. For short-term utilization, cost and expense management, stable pricing and lower contracts that do not require significant up-front investments, a retirement-related costs. signing is usually equal to the full contract revenue value. Long-term contracts represent SO and BTO contracts as well as GBS contracts Global Services Signings with the U.S. Federal government and its agencies and Application The tables below present Global Services signings as reported and Management Services (AMS) for custom and legacy applications. adjusted for currency. Signings at actual currency rates provide inves- Short-term contracts represent the remaining GBS offerings of tors a better view of how these signings will convert to services revenue Consulting and Systems Integration, AMS for packaged applications and provide better comparability to other companies in the industry and ITS contracts. who report signings using actual rates. Signings include SO, BTO, ITS and GBS contracts. Contract At Actual Currency Rates extensions and increases in scope are treated as signings only to the ( $ in millions) extent of the incremental new revenue value. Maintenance is not Yr.-to-Yr. included in signings as maintenance contracts tend to be more steady for the year ended December 31: 2008 2007 Change state, where revenues equal renewals. GLOBAL TECHNOLOGY Backlog includes SO, BTO, ITS, GBS and Maintenance. Backlog SERVICES SIGNINGS: is intended to be a statement of overall work under contract and Long term $24,446 $24,576 (0.5)% Short term 10,247 9,776 4.8 therefore does include Maintenance. Backlog estimates are subject to change and are affected by several factors, including terminations, TOTAL $34,693 $34,352 1.0% 27 changes in the scope of contracts, periodic revalidations, adjustments GLOBAL BUSINESS SERVICES for revenue not materialized and currency assumptions used to approx- SIGNINGS: imate constant currency. Long term $ 5,905 $ 6,847 (13.8)% Short term 16,584 15,094 9.9 TOTAL $22,488 $21,941 2.5%


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    Management Discussion international buSineSS machineS corpor ation and Subsidiary companies Contract portfolios purchased in an acquisition are treated as posi- Lotus revenue increased 10.4 percent (8 percent adjusted for tive backlog adjustments provided those contracts meet the company’s currency) in 2008 led by growth in Lotus Notes products as customers requirements for initial signings. A new signing will be recognized if continue to invest to improve their workforce efficiency. Lotus soft- a new services agreement is signed incidental or coincidental to an ware is well established as a tool for providing improved workplace acquisition or divestiture. collaboration and productivity. Tivoli revenue increased 2.9 percent (2 percent adjusted for cur- SOFTWARE rency) in 2008 when compared to 2007. Revenue performance was ( $ in millions) led by growth in Tivoli Security and Storage Management products. Yr.-to-Yr. for the year ended December 31: 2008 2007 Change Tivoli software provides the advanced capabilities required to run large mission-critical environments. This includes security and storage SOFTWARE REVENUE: $22,089 $19,982 10.5% software which helps customers improve utilization and reduce costs. Middleware $17,305 $15,505 11.6% Rational revenue increased 13.2 percent (12 percent adjusted for Key Branded Middleware 12,383 10,827 14.4 currency) in 2008 driven primarily by Telelogic contributions. WebSphere Family 6.2 Telelogic’s suite of system programming tools complements Rational’s Information Management 24.5 IT tool set, providing a common framework for software and systems Lotus 10.4 Tivoli 2.9 delivery across a client’s enterprise. Rational 13.2 Revenue from Other middleware products increased 5.2 percent Other middleware 4,922 4,678 5.2 (3 percent adjusted for currency) in 2008 versus the prior year. This Operating systems 2,337 2,319 0.8 software product set includes more mature products which provide a Product Lifecycle more stable flow of revenue. Management 960 1,051 (8.6) Other software segment revenue increased 34.4 percent (31 per- Other 1,488 1,107 34.4 cent adjusted for currency) versus 2007 reflecting continued growth in software-related services. Software segment revenue of $22,089 million increased 10.5 percent ( $ in millions) (8 percent adjusted for currency) in 2008 led by growth in the Key Yr.-to-Yr. Branded Middleware products and strong contributions from the for the year ended December 31: 2008 2007 Change annuity base and acquisitions. Clients continue to embed the compa- SOFTWARE GROSS PROFIT: ny’s software in the fabric of their IT infrastructures. Gross profit $18,859 $17,015 10.8% Key Branded Middleware revenue increased 14.4 percent (12 per- Gross profit margin 85.4% 85.2% 0.2 pts. cent adjusted for currency) and represented 56 percent of total Software segment revenue, an increase of 2 points from 2007. When adjusted Software segment gross profit increased 10.8 percent to $18,859 mil- for currency, growth in 2008 was led by Information Management, lion in 2008, driven primarily by the strong revenue growth. The Rational and Lotus. Strategic acquisitions, including Cognos and large annuity base of this business continues to provide a predictable Telelogic, have extended the segment’s middleware capabilities. and growing profit stream. Gross profit margin was 85.4 percent in WebSphere Family revenue increased 6.2 percent (5 percent 2008, an increase of 0.2 points versus 2007. The company has been adjusted for currency) in 2008 and was led by growth in WebSphere investing significantly in the software business with good results. The Application Servers and WebSphere Business Integration software. Software segment contributed $7,075 million of pre-tax profit in 2008, In December 2008, the company completed the acquisition of ILOG, an increase of 17.9 percent versus 2007 while successfully integrating whose products help customers improve business decisions with opti- Cognos and Telelogic. Software contributed approximately 40 percent mization, visualization and business rules software. The WebSphere of the company’s segment pre-tax profit in 2008. The segment pre-tax products provide the foundation for Web-enabled applications and profit margin increased 1.7 points to 28.5 percent. The pre-tax income are a key product set in deploying a client’s SOA. Information and margin improvements have been driven primarily by revenue Management revenue increased 24.5 percent (22 percent adjusted growth and increasing operational efficiencies. for currency) in 2008 versus the prior year, reflecting the contribu- tion from Cognos and strong demand for the distributed relational database products. Cognos’ performance management solution helps 28 customers improve decision-making across the enterprise to opti- mize business performance. Management Discussion ................................................................................................18 DISCONTINUED OPERATIONS .............................................................................. 44 ROAD MAP ............................................................................................................ 18 OTHER INFORMATION .......................................................................................... 44 FORWARD-LOOKING AND CAUTIONARY STATEMENTS ...................................... 18 GLOBAL FINANCING ............................................................................................. 53 MANAGEMENT DISCUSSION SNAPSHOT ............................................................ 19 Report Of Management ............................................................................................... 58 DESCRIPTION OF BUSINESS................................................................................ 20 Report Of Independent Registered Public Accounting Firm ................................. 59 YEAR IN REVIEW .................................................................................................. 25 Consolidated Statements ............................................................................................ 60 PRIOR YEAR IN REVIEW ....................................................................................... 39 Notes ............................................................................................................................... 66


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    Management Discussion international buSineSS machineS corpor ation and Subsidiary companies SYSTEMS AND TECHNOLOGY Converged System p revenue increased 11.2 percent (11 percent ( $ in millions) adjusted for currency) in 2008 versus 2007, reflecting solid demand Yr.-to-Yr. for the year ended December 31: 2008 2007 Change for the energy efficiencies and multi-operating system capabilities of POWER6 technology. Clients are concluding that POWER6 SYSTEMS AND TECHNOLOGY REVENUE: $19,287 $21,317 (9.5)% technology is the right solution for a multitude of workloads. The revenue growth was primarily driven by midrange servers which System z 12.5% increased 32 percent and high-end servers which increased 3 per- Legacy System i (66.1) cent in 2008 versus 2007. Converged System p 11.2 System x (16.9) Legacy System i revenue decreased 66.1 percent (67 percent System Storage (3.4) adjusted for currency) in 2008 versus 2007, as the company continues Retail Store Solutions (15.0) to transition the System i customer base to the converged POWER Total Systems (4.9) platform within System p. Microelectronics OEM (25.1) System x revenue decreased 16.9 percent (19 percent adjusted for Printing Systems NM currency) in 2008 versus 2007. System x server revenue declined 15 NM—Not meaningful percent and blades revenue decreased 3 percent, in 2008 versus 2007, respectively. The decline in server revenue reflects a significant Systems and Technology segment revenue decreased 9.5 percent slowdown in the x86 market, especially in the second half of 2008, as (down 11 percent adjusted for currency) in 2008 versus 2007. In June clients are virtualizing and consolidating workloads onto more effi- 2007, the company divested its printing business. Systems and Tech- cient platforms such as POWER and mainframe. nology revenue, excluding the divested printing business, decreased System Storage revenue decreased 3.4 percent (5 percent adjusted 7.8 percent (9 percent adjusted for currency) in 2008 versus 2007. for currency) in 2008 versus 2007. Total disk revenue was essentially Total Systems revenue decreased 4.9 percent (6 percent adjusted for flat in 2008 versus 2007. Enterprise Disk revenue increased 2 percent currency) in 2008 versus 2007. primarily due to increased demand for the DS8000 product, while In the current economic environment, clients are focused on midrange disk revenue declined 15 percent. Tape revenue declined reducing the cost of running their IT infrastructure. Virtualization, 10 percent in 2008 primarily due to reduced demand and clients which provides the capability to run multiple workloads on a single deciding to purchase additional media to expand the utilization of server, is a key enabler of efficiency. System z is the leading platform their existing devices. for virtualization as it is able to support thousands of images and Microelectronics OEM revenue decreased 25.1 percent (25 per- operate fully utilized. The company’s POWER architecture supports cent adjusted for currency) in 2008 versus 2007. The primary mission hundreds of partitions, often driving utilization rates of over 60 per- of this business is to provide leadership technology for the systems cent. Both of these platforms leverage the entire system, from the business, as demonstrated during 2008 in the new System z10 main- company’s custom semiconductors through the software stack, to frame and POWER6 systems. achieve these high levels of efficiency and lower cost of ownership. Retail Stores Solutions revenue decreased 15.0 percent (16 percent The distributed computing model, which utilizes many small servers, adjusted for currency) in 2008 versus 2007, reflecting weakness in the cannot offer the same level of efficiency and value. retail sector and a compare to a strong 2007, when a new program- System z revenue increased 12.5 percent (11 percent adjusted for mable point-of-sale solution was being delivered to large clients. currency) in 2008 versus 2007. System z revenue growth was particu- ( $ in millions) larly strong in the Americas (up 19 percent), as well as in the financial Yr.-to-Yr. Services and Industrial sectors globally. Clients in emerging markets for the year ended December 31: 2008 2007 Change also leveraged this platform’s stability and efficiency during 2008. SYSTEMS AND TECHNOLOGY MIPS (millions of instructions per second) shipments increased 25 GROSS PROFIT: percent in 2008 versus 2007, posting double-digit growth in each Gross profit $7,341 $8,468 (13.3)% quarter, reflecting strength in both traditional and specialty work- Gross profit margin 38.1% 39.7% (1.7) pts. loads. Specialty MIPS increased 68 percent in 2008, as clients exploit the capabilities of System z to bring new Linux and Java applications to this highly efficient and cost effective platform. 29


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    Management Discussion international buSineSS machineS corpor ation and Subsidiary companies Overall, gross margin decreased by 1.7 points versus the prior year. increased 9.0 percent (2 percent adjusted for currency). Italy increased This decrease was primarily driven by margin declines in System z, 5.8 percent (decreased 1 percent adjusted for currency) while the U.K. System x and Microelectronics OEM which impacted the overall decreased 4.9 percent (increased 4 percent adjusted for currency). margin by 1.6 points, 1.3 points and 1.2 points, respectively. Partially Asia Pacific revenue increased 8.3 percent (2 percent adjusted for offsetting these margin declines was a revenue mix benefit of 2.7 points currency) year over year. Revenue increased in the India, South Korea, due to the increased revenue in System z and converged System p. ASEAN, Australia/New Zealand and China regions with combined Systems and Technology segment pre-tax margin declined 2.0 growth of 8.1 percent (9 percent adjusted for currency). Japan reve- points to 7.7 percent in 2008 reflecting the lower revenue and gross nue, which represented 49 percent of the Asia Pacific revenue base, profit margin in 2008 versus 2007. increased 8.5 percent as reported, but decreased 5 percent adjusted for currency in 2008 when compared to 2007. GLOBAL FINANCING Across the geographies, aggregate revenue from the countries See pages 53 and 54 for an analysis of Global Financing’s segment comprising the company’s growth markets organization increased results. 9.8 percent (10 percent adjusted for currency) in 2008 and represented approximately 18 percent of the company’s total geographic revenue. GEOGRAPHIC REVENUE The company has continued to invest to capture new infrastructure spending in the growth markets. Adjusted for currency, growth in In addition to the revenue presentation by reportable segment, the these markets was 8 points higher than in the major markets. The company also measures revenue performance on a geographic basis. BRIC countries, a subset of the growth markets, together grew The following geographic, regional and country-specific revenue 17.6 percent (15 percent adjusted for currency), with growth in India performance discussion excludes OEM revenue, which is presented of 25.8 percent (33 percent adjusted for currency), Brazil 18.3 percent separately. (13 percent adjusted for currency), China 14.7 percent (8 percent ( $ in millions) adjusted for currency) and Russia 11.0 percent (11 percent adjusted Yr.-to-Yr. for the year ended December 31: 2008 2007 Change for currency). OEM revenue decreased 22.4 percent (23 percent adjusted for TOTAL REVENUE: $103,630 $98,786 4.9% currency) in 2008 when compared to 2007, driven by reduced demand Geographies: $100,939 $95,320 5.9% in the Microelectronics OEM business. Americas 42,807 41,122 4.1 Europe/Middle East/Africa 37,020 34,699 6.7 TOTAL EXPENSE AND OTHER INCOME Asia Pacific 21,111 19,501 8.3 ( $ in millions) OEM $ 2,691 $ 3,465 (22.4)% Yr.-to-Yr. for the year ended December 31: 2008 2007 Change Geographic revenue increased 5.9 percent (3 percent adjusted for cur- Total expense and other income $28,945 $27,240 6.3% rency) to $100,939 million in 2008 when compared to 2007. Revenue Expense to Revenue 27.9% 27.6% 0.4 pts. increased in all geographies in 2008, and adjusted for currency, revenue growth was strongest in the Americas followed by Europe and Asia The key drivers year to year in total expense and other income were Pacific. Revenue from the company’s growth markets organization approximately: increased 9.8 percent (10 percent adjusted for currency) while growth in the more established major markets was 5.1 percent (2 percent • Operational expense, -1 point adjusted for currency). • Acquisitions, +5 points Americas revenue increased 4.1 percent (4 percent adjusted for • Currency, +2 points currency) in 2008. Revenue increased in all regions with the U.S. up In 2008, the company continued to focus on productivity improve- 2.9 percent, Canada 5.6 percent (6 percent adjusted for currency) and ments in its more established markets and increased its investments Latin America 13.9 percent (11 percent adjusted for currency). in the growth markets. Within selling, general and administrative Europe/Middle East/Africa (EMEA) revenue increased 6.7 per- expense (SG&A), total sales and marketing expense increased 4 cent (3 percent adjusted for currency) in 2008 when compared to 2007. percent year to year (2 percent adjusted for currency). Sales and mar- The majority of major market countries performed well led by Spain keting expense in the growth markets increased 13 percent (13 percent 30 which grew 12.0 percent (5 percent adjusted for currency), Germany increased 10.8 percent (4 percent adjusted for currency) and France Management Discussion ................................................................................................18 DISCONTINUED OPERATIONS .............................................................................. 44 ROAD MAP ............................................................................................................ 18 OTHER INFORMATION .......................................................................................... 44 FORWARD-LOOKING AND CAUTIONARY STATEMENTS ...................................... 18 GLOBAL FINANCING ............................................................................................. 53 MANAGEMENT DISCUSSION SNAPSHOT ............................................................ 19 Report Of Management ............................................................................................... 58 DESCRIPTION OF BUSINESS................................................................................ 20 Report Of Independent Registered Public Accounting Firm ................................. 59 YEAR IN REVIEW .................................................................................................. 25 Consolidated Statements ............................................................................................ 60 PRIOR YEAR IN REVIEW ....................................................................................... 39 Notes ............................................................................................................................... 66


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    Management Discussion international buSineSS machineS corpor ation and Subsidiary companies adjusted for currency), as compared to major markets where sales and Other (income) and expense was income of $298 million and $626 mil- marketing expense increased 3 percent (1 percent adjusted for cur- lion in 2008 and 2007, respectively. The decrease in income was rency) year to year. On a consolidated basis, general and administrative primarily driven by higher foreign currency transaction losses ($285 expenses, which are indirect expenses incurred in the business, million) and lower interest income reflecting lower cash balances and increased 2 percent (flat at constant currency) year to year. the current interest rate environment ($222 million). These decreases were partially offset by a gain on derivative instruments which pri- Selling, General and administrative marily hedge foreign currency risks ($221 million). Included within ( $ in millions) the foreign currency hedging activity, the company hedges its major Yr.-to-Yr. cross-border cash flows to mitigate the effect of currency volatility in for the year ended December 31: 2008 2007 Change its global cash planning, which also reduces volatility in the year- Selling, general and over-year results. The impact of these hedging programs is primar- administrative — base $20,006 $19,078 4.9% ily reflected in other (income) and expense, as well as cost of goods Advertising and promotional expense 1,259 1,242 1.4 sold. The impact of losses from these cash flow hedges reflected in Workforce reductions — ongoing 706 318 121.8 other (income) and expense was $186 million, a decrease of $24 mil- Amortization expense —acquired lion year to year. intangibles 306 234 30.5 Retirement-related expense 319 607 (47.3) research, Development and engineering Stock-based compensation 484 480 0.8 Bad debt expense 306 100 205.1 ( $ in millions) TOTAL $23,386 $22,060 6.0% Yr.-to-Yr. for the year ended December 31: 2008 2007 Change Research, development Total SG&A expense increased 6.0 percent (4 percent adjusted for and engineering currency) in 2008 versus 2007. The increase in SG&A was primarily TOTAL $6,337 $6,153 3.0% due to acquisition-related spending, predominantly for Cognos and Telelogic, which accounted for 5 points of the increase, while the The increase in research, development and engineering (RD&E) effects of currency accounted for 2 points. Workforce reductions — expense was primarily driven by acquisitions and investments to ongoing expense increased $387 million primarily due to charges maintain technology leadership across the company’s offerings. recorded in the fourth quarter reflecting workforce actions in Japan Software spending increased $262 million, partially offset by lower ($120 million) and other ongoing skills rebalancing that is a regular spending in Systems and Technology ($54 million) and other unit element of the company’s business model. In addition, bad debt spending ($74 million), while stock-based compensation expense expense increased $206 million primarily driven by additional spe- decreased $9 million versus 2007. cific accounts receivable reserves reflecting the current economic environment in many industries. The company’s accounts receivable intellectual property and custom Development income provision coverage at year end is 2.0 percent, an increase of 50 basis ( $ in millions) points from year-end 2007. These increases were partially offset by Yr.-to-Yr. lower retirement-related expense of $287 million. for the year ended December 31: 2008 2007 Change Sales and other transfers other (income) and expense of intellectual property $ 138 $138 (00.0)% ( $ in millions) Licensing/royalty-based fees 514 368 39.7 Yr.-to-Yr. Custom development income 501 452 10.9 for the year ended December 31: 2008 2007 Change TOTAL $958 $1,153 20.4% Foreign currency transaction losses* $ 330 $ 45 NM (Gains)/losses on derivative instruments* (27) 194 (114.1)% Interest income (343) (565) (39.3) The timing and amount of sales and other transfers of IP may vary Net gains from securities and significantly from period to period depending upon timing of divesti- investment assets (52) (68) (22.6) tures, industry consolidation, economic conditions and the timing of Net realized gains from certain new patents and know-how development. While IP income increased real estate activities (26) (18) 45.0 20.4 percent in 2008, there were no significant individual IP transac- 31 Other (179) (214) (16.5) tions in 2008 or 2007. The improvement year to year was primarily TOTAL $(298) $(626) (52.4)% driven by the Systems and Technology business. * Reclassified to conform with 2008 presentation. NM—Not meaningful


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    Management Discussion international buSineSS machineS corpor ation and Subsidiary companies interest expense Overall, retirement-related plan costs decreased $1,181 million ver- sus 2007 primarily as a result of pension plan redesign efforts and a ( $ in millions) Yr.-to-Yr. lower level of recognized actuarial losses. for the year ended December 31: 2008 2007 Change Effective January 1, 2008, benefit accruals ceased in the IBM Per- Interest expense sonal Pension Plan, a U.S. defined benefit plan. This decrease was TOTAL $673 $611 10.3% partially offset by an increase in defined contribution plans, primarily in the U.S. See note U, “Retirement-Related Benefits,” on pages 106 The increase in interest expense was primarily due to the increase in to 116 for additional information on these plan changes and all the debt in 2007 associated with the financing of the accelerated share factors driving the year-to-year change in total cost. repurchase agreements, partially offset by lower interest rates in 2008. Retirement-related plan costs decreased approximately $771 mil- See note N, “Stockholders’ Equity,” on pages 95 and 96 for additional lion in cost, $287 million in SG&A expense, $117 million in RD&E information regarding the accelerated share repurchase. Interest expense and $5 million in other (income) and expense year to year. expense is presented in cost of financing in the Consolidated State- ACQUIRED INTANGIBLE ASSET AMORTIZATION ment of Earnings if the related external borrowings are to support the Global financing external business. See page 56 for additional The company has been investing in targeted acquisitions to increase information regarding Global financing debt and interest expense. its capabilities in higher value businesses. The following table pres- Overall interest expense for 2008 was $1,477 million, an increase of ents the total acquired intangible asset amortization included in the $46 million versus 2007. Consolidated Statement of Earnings. See note J, “Intangible Assets Including Goodwill,” on pages 87 and 88 for additional information. STOCK-BASED COMPENSATION ( $ in millions) Total pre-tax stock-based compensation cost of $659 million Yr.-to-Yr. for the year ended December 31: 2008 2007* Change decreased $54 million compared to 2007. The decrease was princi- pally the result of a reduction in the level of stock option grants ($203 Cost: Software (Sales) $173 $ 91 89.2% million), offset by an increase related to restricted and performance- Global Technology Services (Services) 32 41 (21.0) based share units ($149 million). The year-to-year change was Global Business Services (Services) 0 1 (67.0) reflected in the following categories: reductions in cost ($50 million) Systems and Technology (Sales) 8 0 NM and RD&E expense ($9 million), and increases in SG&A expense ($4 Selling, general and million) and other (income) and expense ($1 million). administrative expense 306 234 30.5 See note T, “Stock-Based Compensation,” on pages 103 to 106 for TOTAL $520 $367 41.5% additional information on the company’s stock-based incentive awards. * Reclassified to conform with 2008 presentation disclosing the two services segments separately. RETIREMENT-RELATED BENEFITS NM—Not meaningful The following table provides the total pre-tax cost for all retirement- related plans. These amounts are included in the Consolidated INCOME TAXES Statement of Earnings within the caption (e.g., cost, SG&A, RD&E) The effective tax rate for 2008 was 26.2 percent, compared with relating to the job function of the plan participants. 28.1 percent in 2007. The 1.9 point decrease was primarily driven by ( $ in millions) the 2008 net increase in the utilization of foreign and state tax credits Yr.-to-Yr. (2.9 points), the benefit associated with the second quarter 2008 for the year ended December 31: 2008 2007 Change agreement reached with the U.S. Internal Revenue Service (IRS) Defined benefit and contribution regarding claims for certain tax incentives (1.7 points) and the benefit pension plans cost $1,053 $2,198 (52.1)% related to certain issues associated with newly published U.S. tax Nonpension postretirement plans costs 363 399 (9.0) regulations (1.2 points). These benefits were partially offset by several TOTAL $1,416 $2,597 (45.5)% 32 Management Discussion ................................................................................................18 DISCONTINUED OPERATIONS .............................................................................. 44 ROAD MAP ............................................................................................................ 18 OTHER INFORMATION .......................................................................................... 44 FORWARD-LOOKING AND CAUTIONARY STATEMENTS ...................................... 18 GLOBAL FINANCING ............................................................................................. 53 MANAGEMENT DISCUSSION SNAPSHOT ............................................................ 19 Report Of Management ............................................................................................... 58 DESCRIPTION OF BUSINESS................................................................................ 20 Report Of Independent Registered Public Accounting Firm ................................. 59 YEAR IN REVIEW .................................................................................................. 25 Consolidated Statements ............................................................................................ 60 PRIOR YEAR IN REVIEW ....................................................................................... 39 Notes ............................................................................................................................... 66


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    Management Discussion international buSineSS machineS corpor ation and Subsidiary companies items including the net impact related to the completion of the U.S. Financial Position federal income tax examination for the years 2004 and 2005 including DYNAMICS the associated income tax reserve redeterminations (0.5 points), the At December 31, 2008, the company’s balance sheet and liquidity second quarter 2008 tax cost associated with the intercompany transfer position remain strong. Cash on hand at year-end was $12,741 mil- of certain intellectual property (2.8 points) and lower capital loss lion. Total debt of $33,926 million decreased $1,349 million from utilization in 2008 (0.7 points). The remaining items were individu- prior year-end levels. The commercial paper balance at December 31 ally insignificant. was $468 million, down $5,363 million from December 31, 2007. In 2008, the company generated $18,812 million in cash from operations, EARNINGS PER SHARE an increase of $2,718 million compared to 2007. The company has Basic earnings per share is computed on the basis of the weighted- consistently generated strong cash flow from operations and contin- average number of shares of common stock outstanding during the ues to have access to additional sources of liquidity through the period. Diluted earnings per share is computed on the basis of the capital markets and its $10 billion global credit facility. weighted-average number of shares of common stock plus the effect Consistent with retirement and postretirement plan accounting of dilutive potential common shares outstanding during the period standards, the company remeasures the funded status of its plans at using the treasury stock method. Dilutive potential common shares December 31. The funded status is measured as the difference include outstanding stock options, share awards, convertible notes between the fair value of the plan assets and the benefit obligation and shares which may be required to settle accelerated share repur- and is recognized in the Consolidated Statement of Financial chase (ASR) agreements. Position. At December 31, 2008, primarily as a result of the returns Yr.-to-Yr. on plan assets, coupled with changes in certain plan assumptions and for the year ended December 31: 2008 2007 Change plan contributions, the overall net funded position decreased $21,793 Earnings per share of common stock: million from December 31, 2007 to a net under-funded position of Assuming dilution: $18,485 million. This change is primarily reflected in prepaid pen- Continuing operations $8.93 $ 7.18 24.4% sion assets and retirement and nonpension postretirement benefit Discontinued operations — (0.00) NM obligations which decreased $15,816 million and increased $5,871 Total $8.93 $ 7.18 24.4% million respectively from year-end 2007 levels. Due to the extreme Basic: volatility in the equity markets in 2008, the return on IBM Personal Continuing operations $9.07 $ 7.32 23.9% Pension Plan assets declined 15 percent, compared to a 14 percent Discontinued operations — (0.00) NM increase in 2007. The company’s asset return in the non-U.S. plans Total $9.07 $ 7.32 23.9% declined approximately 21 percent. Within the company’s defined Weighted-average shares benefit plans, the net funded status declined in 2008 due to the vola- outstanding (in millions): tility in the financial markets. At December 31, 2008, the company’s Assuming dilution 1,381.8 1,450.6 (4.7)% qualified defined benefit plans worldwide were 93 percent funded, Basic 1,359.8 1,423.0 (4.4)% with the U.S. qualified Personal Pension Plan 97 percent funded. NM—Not meaningful In addition, stockholders’ equity decreased $15,004 million, net of tax, primarily as a result of changes from pension remeasurements Actual shares outstanding at December 31, 2008 and December 31, and current year activity within accumulated gains and (losses) not 2007 were 1,339.1 million and 1,385.2 million, respectively. The aver- affecting retained earnings. This is a non-cash impact to equity and age number of common shares outstanding assuming dilution was does not affect the company’s access to capital markets or its ability 68.8 million shares lower in 2008 versus 2007. The decrease was to meet its obligations. primarily the result of the company’s common stock repurchase pro- The assets and debt associated with the Global Financing business gram. See note N, “Stockholders’ Equity Activity,” on pages 95 and are a significant part of the company’s financial position. The financial 96 for additional information regarding common stock activities. Also position amounts appearing on pages 34 to 36 are the consolidated see note R, “Earnings Per Share of Common Stock,” on page 102. amounts including Global Financing. The amounts appearing in the separate Global Financing section on pages 53 through 57 are supple- mentary data presented to facilitate an understanding of the Global Financing business. 33


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    Management Discussion international buSineSS machineS corpor ation and Subsidiary companies WORKING CAPITAL • An increase of $436 million (net of a $288 million negative ( $ in millions) currency impact) in deferred income mainly driven by Software at December 31: 2008 2007 ($285 million) and Global Services ($139 million). Current assets $49,004 $53,177 Current liabilities 42,435 44,310 CASH FLOW WORKING CAPITAL $ 6,568 $ 8,867 The company’s cash flow from operating, investing and financing Current ratio 1.15 1.20 activities, as reflected in the Consolidated Statement of Cash Flows on page 62, is summarized in the following table. These amounts include Working capital decreased $2,299 million compared to the prior year the cash flows associated with the Global Financing business. primarily as a result of a net decrease in current assets. The key drivers ( $ in millions) are described below: for the year ended December 31: 2008 2007 Current assets decreased $4,174 million due to: Net cash provided by/(used in) continuing operations: • A decrease of $3,239 million in cash and cash equivalents and Operating activities $ 18,812 $16,094 marketable securities (see Cash Flow analysis below and on Investing activities (9,285) (4,675) page 35); Financing activities (11,834) (4,740) • A decrease of $1,235 million in short-term receivables driven by Effect of exchange rate changes on cash currency impacts of $1,202 million; and cash equivalents 58 294 Net cash used in discontinued Partially offset by: operations — operating activities — (5) NET CHANGE IN CASH AND CASH EQUIVALENTS $ (2,250) $ 6,969 • An increase of $409 million in prepaid expenses and other current assets primarily resulting from: – an increase of $353 million in prepaid taxes; Net cash from operating activities for 2008 increased $2,718 million – an increase of $238 million in derivative assets primarily due as compared to 2007 driven by the following key factors: to changes in foreign currency rates for certain economic • An increase in net income of $1,916 million; hedges; and • Decreases in accounts receivable drove an increase in cash of – approximately $189 million negative currency impact. $1,682 million, driven by Global Financing receivables ($1,280 Current liabilities decreased $1,875 million as a result of: million) and non-Global Financing receivables ($402 million) primarily resulting from reduced fourth-quarter 2008 revenue • A decrease of $1,041 million (including $260 million of negative and improved collections; and impact due to currency) in accounts payable primarily due to lower • A decrease year to year in retirement-related plan funding of purchasing volumes; $426 million; • A decrease of $999 million in short-term debt primarily driven by the reduction in commercial paper balances; and Partially offset by: • A decrease of $930 million (including $222 million negative cur- • Accounts payable drove a use of cash of $718 million; and rency impact) in taxes payable; • A decrease in cash of $284 million driven by growth in inventory. Partially offset by: Net cash used in investing activities increased $4,611 million on a • An increase of $679 million in other accrued liabilities primarily year-to-year basis driven by: due to: • An increase of $5,304 million utilized for acquisitions (see note C, – an increase of $502 million in derivative liabilities as a result of “Acquisitions/Divestitures,” on pages 78 through 83 for additional changes in foreign currency rates; information); and – an increase of $329 million in workforce reduction accruals; and • A decrease of $239 million received from divestitures; – approximately $172 million negative currency impact. 34 Management Discussion ................................................................................................18 DISCONTINUED OPERATIONS .............................................................................. 44 ROAD MAP ............................................................................................................ 18 OTHER INFORMATION .......................................................................................... 44 FORWARD-LOOKING AND CAUTIONARY STATEMENTS ...................................... 18 GLOBAL FINANCING ............................................................................................. 53 MANAGEMENT DISCUSSION SNAPSHOT ............................................................ 19 Report Of Management ............................................................................................... 58 DESCRIPTION OF BUSINESS................................................................................ 20 Report Of Independent Registered Public Accounting Firm ................................. 59 YEAR IN REVIEW .................................................................................................. 25 Consolidated Statements ............................................................................................ 60 PRIOR YEAR IN REVIEW ....................................................................................... 39 Notes ............................................................................................................................... 66


  • Page 37

    Management Discussion international buSineSS machineS corpor ation and Subsidiary companies Partially offset by: • A decrease of $777 million in plant, rental machines and other property mainly due to currency impact ($576 million) and lower • The net impact of the purchases and sales of marketable securi- capital spending primarily in Global Technology Services; and ties and other investments resulted in an increase in cash of • A decrease of $420 million in long-term financing receivables $642 million; and mainly due to currency impact; • A decrease in net capital spending of $431 million resulting from: – a decrease of $272 million primarily driven by lower spending by Partially offset by: Global Technology Services and Systems and Technology; and – a decrease of $159 million in capitalized software development • An increase in deferred tax assets of $5,757 million primarily due expenditures. to pension remeasurements; and • An increase in goodwill of $3,941 million (net of a $1,529 million Net cash used in financing activities increased $7,095 million com- negative currency impact) and an increase of $771 million (net of pared to 2007 as a result of: a $160 million negative currency impact) in intangible assets-net primarily driven by the Cognos and Telelogic acquisitions. • An increase of $14,556 million in cash used to retire debt, net of cash proceeds, primarily driven by higher proceeds in 2007 due to Long-term debt decreased $350 million primarily due to reclasses to the issuance of debt for the ASR and a decline in commercial short-term debt as certain instruments approached maturity; offset paper in 2008; by new debt issuances. • Higher dividend payments of $438 million; and • A decrease of $350 million in cash received due to lower other com- Other noncurrent liabilities, excluding debt, increased $6,322 million mon stock transactions primarily due to stock option exercises; primarily driven by: Partially offset by: • An increase of $5,871 million in retirement and nonpension postretirement benefit obligations primarily driven by pension • Lower common stock repurchases of $8,249 million. remeasurement; and • An increase in noncurrent tax reserves of $1,450 million related Within total debt, on a net basis, the company utilized $2,444 million to unrecognized tax benefits; in net cash to retire debt versus $12,112 million in net cash proceeds in 2007. The net cash used to retire debt in 2008 was comprised of: Partially offset by: $10,248 million in cash payments to settle debt and net payments of $6,025 million in short-term borrowings, partially offset by $13,829 • A decrease of $794 million in noncurrent deferred tax liabilities million of new debt issuances. See note K, “Borrowings,” on pages 88 primarily due to pension remeasurement; and to 90 for a listing of the company’s debt securities. • A decrease of $154 million in restructuring liabilities mainly driven by the reclass to current liabilities. NONCURRENT ASSETS AND LIABILITIES ( $ in millions) DEBT at December 31: 2008 2007 The company’s funding requirements are continually monitored and Noncurrent assets $60,520 $67,254 strategies are executed to manage the overall asset and liability profile. Long-term debt $22,689 $23,039 ( $ in millions) Noncurrent liabilities (excluding debt) $30,934 $24,612 at December 31: 2008 2007 Total company debt $33,926 $35,274 The decrease in noncurrent assets of $6,733 million compared to the Total Global Financing segment debt: $24,360 $24,532 prior year-end balance was primarily driven by: Debt to support external clients 20,892 21,072 Debt to support internal clients 3,468 3,460 • A decrease of $15,816 million in prepaid pension assets primarily resulting from pension remeasurements; 35


  • Page 38

    Management Discussion international buSineSS machineS corpor ation and Subsidiary companies The Global financing business provides funding predominantly for consolidated fourth-quarter results the company’s external client assets as well as for assets under con- ( $ and shares in millions except per share amounts) tract by other IBM units. These assets, primarily for Global Services, Yr.-to-Yr. Percent/ generate long-term, stable revenue streams similar to the Global Margin for the fourth quarter: 2008 2007 Change financing asset portfolio. Based on their nature, these Global Services Revenue $27,006 $28,866 (6.4)%* assets are leveraged with the balance of the Global financing asset Gross profit margin 47.9% 44.9% 3.0 pts. base. The debt analysis on page 35 is further detailed in the Global Total expense and other income $ 7,127 $ 7,481 (4.7)% financing section on page 57. Total expense and other Total debt decreased $1,177 million in 2008 versus 2007, primarily income-to-revenue ratio 26.4% 25.9% 0.5 pts. due to reductions in commercial paper. The debt-to-capital ratio at Income from continuing December 31, 2008 was 49.0 percent, an increase of 19.0 points from operations before income taxes $ 5,808 $ 5,489 5.8% December 31, 2007, primarily due to the reduction in equity driven Provision for income taxes 1,382 1,537 (10.1)% by the pension remeasurements. Income from continuing operations 4,427 3,951 12.0% Income from discontinued operations — 1 NM EQUITY Net income $ 4,427 $ 3,952 12.0% ( $ in millions) Net income margin 16.4% 13.7% 2.7 pts. at December 31: 2008 2007 Earnings per share of common stock: Stockholders’ equity Assuming dilution: TOTAL $13,465 $28,470 Continuing operations $ 3.28 $ 2.80 17.1% Discontinued operations — 0.00 NM Total $ 3.28 $ 2.80 17.1% The company’s consolidated stockholders’ equity decreased $15,004 million in 2008 as a result of several key factors: Weighted-average shares outstanding: • A decrease of $18,431 million in accumulated gains and (losses) Assuming dilution 1,347.9 1,412.9 (4.6)% not affecting retained earnings resulted from non-cash equity * (1.0) percent adjusted for currency. impacts, primarily from pension remeasurement and other retire- NM—Not meaningful ment-related activities ($14,856 million), and a decrease in foreign currency translation adjustments ($3,552 million); and Continuing Operations • A decrease related to net stock transactions of $6,286 million, In the fourth quarter, in an increasingly challenging economic driven by common stock repurchases; environment, the company delivered solid financial results. Total revenue decreased 6.4 percent as reported, 1.0 percent adjusted for Partially offset by: currency, versus the fourth quarter of 2007. Gross margin improved • An increase of $9,713 million in retained earnings primarily driven 3.0 points driven by margin expansion in Global Services and by net income of $12,334 million, partially offset by dividends Software. This improvement in gross margin coupled with focused ($2,585 million). expense management drove an improvement year to year in pre-tax income of 5.8 percent. A lower tax rate versus the prior year, primar- ily driven by the utilization of tax credits , resulted in a 12.0 percent increase in net income. Diluted earning per share of $3.28 increased 17.1 percent year to year. 36 Management Discussion ................................................................................................18 DISCONTINUED OPERATIONS .............................................................................. 44 ROAD MAP ............................................................................................................ 18 OTHER INFORMATION .......................................................................................... 44 FORWARD-LOOKING AND CAUTIONARY STATEMENTS ...................................... 18 GLOBAL FINANCING ............................................................................................. 53 MANAGEMENT DISCUSSION SNAPSHOT ............................................................ 19 Report Of Management ............................................................................................... 58 DESCRIPTION OF BUSINESS................................................................................ 20 Report Of Independent Registered Public Accounting Firm ................................. 59 YEAR IN REVIEW .................................................................................................. 25 Consolidated Statements ............................................................................................ 60 PRIOR YEAR IN REVIEW ....................................................................................... 39 Notes ............................................................................................................................... 66


  • Page 39

    Management Discussion INTERNATIONAL BUSINESS MACHINES CORPOR ATION and Subsidiary Companies fourth quarter revenue performance was impacted by currency GBS revenue of $4,709 million decreased 4.5 percent (flat and the changing economic environment, but the modest decline of adjusted for currency) compared to fourth-quarter 2007. In the cur- 1.0 percent adjusted for currency reflects the company’s broad busi- rent economy, offerings that deliver cost savings continued to drive ness capabilities and contribution from the annuity content of the the majority of business, although demand for transformational and business model. Adjusted for currency, revenue performance was led compliance offerings also increased. GBS signings of $6,162 mil- by growth in the Software and Global Services segments offset by a lion, decreased 9 percent (3 percent adjusted for currency), driven by decline in Systems and Technology. a 25 percent decline (16 percent adjusted for currency) in long-term The Global Services segments combined had $14,333 million of signings. Short-term signings of $4,483 million decreased 1 percent revenue in the fourth quarter, a decrease of 4.0 percent (increase of (increased 4 percent adjusted for currency) in the quarter. Cost savings 2 percent adjusted for currency) and delivered pre-tax profit of offerings accounted for the majority of the new signings. GBS gross $2,177 million, an increase of 32.1 percent year to year. The services profit increased 18.5 percent in the quarter with the gross margin business performed exceptionally well in the current economic envi- improving 5.6 points. The GBS segment pre-tax profit increased ronment through disciplined execution on resource optimization and 26.0 percent in the quarter and the margin expanded 3.6 points to improved operating efficiencies, while at the same time delivering 14.9 percent. The margin performance reflects a strong operating services with a high level of quality and customer satisfaction. Total discipline and the benefits of a globally integrated operating model. signings for Global Services in the fourth quarter were $17,207 million, Despite slower revenue growth, utilization improved year to year a decrease of 5 percent (increase of 2 percent adjusted for currency) resulting from resource optimization throughout the globally inte- versus the fourth quarter of 2007. Signings in the quarter included 24 grated capacity model as well as effective balancing of domestic, global deals larger than $100 million. Long-term signings of $9,900 million and subcontracted resources. GBS also benefited from continued deal decreased 3 percent (increased 3 percent adjusted for currency) with selectivity, stable pricing, lower managed labor costs and ongoing a 20 percent growth in Strategic Outsourcing signings. Short-term operational efficiencies. signings decreased 7 percent (1 percent adjusted for currency) to Software segment revenue of $6,420 million, increased 2.6 percent $7,307 million, compared to a very strong fourth quarter of 2007. (9 percent adjusted for currency), driven by solid sales execution and GTS revenue of $9,623 million decreased 3.7 percent (increased growth in mission critical production software. Customers continue 3 percent adjusted for currency) versus the fourth quarter of 2007. to utilize infrastructure software in their production environments to GTS signings of $11,045 million decreased 2 percent (increased optimize their data centers. Many large customers signed multi-year 4 percent adjusted for currency) with long-term signings increasing deals in the fourth quarter demonstrating continued commitment to 4 percent (9 percent adjusted for currency) to $8,221 million, offset the company’s technology. Revenue growth was led by Americas with by a 15 percent decrease (7 percent adjusted for currency) in short- an increase of 13 percent, adjusted for currency. Revenue from Key term signings. SO revenue decreased 3.2 percent (increased 3 percent Branded Middleware increased 6.2 percent (13 percent adjusted for adjusted for currency). SO signings increased 20 percent (23 percent currency) and represented 61 percent of total software revenue. adjusted for currency) led by strong signings in the U.S. and Europe Revenue from the WebSphere family of products declined 0.9 per- as clients turn to outsourcing’s value proposition as an effective way cent (increased 5 percent adjusted for currency) in the quarter. to attain their financial objectives in this economic climate. ITS Information Management revenue increased 17.9 percent (25 percent revenue increased 0.2 percent (6 percent adjusted for currency). ITS adjusted for currency) driven by contribution from Cognos as well as signings decreased 15 percent (7 percent adjusted for currency), organic growth. Revenue from Distributed Relational Database prod- although signings in the key infrastructure offerings continued to be ucts increased over 30 percent, adjusted for currency. Lotus revenue good. BTO revenue decreased 19.0 percent (11 percent adjusted for decreased 0.5 percent (increased 6 percent adjusted for currency) currency) and signings decreased 53 percent (44 percent adjusted for capitalizing on the strong performance of collaboration software. currency). GTS gross profit increased 11.8 percent in the quarter and Tivoli software revenue decreased 3.8 percent (increased 4 percent the gross margin improved 4.8 points with margin expansion in all adjusted for currency). Rational revenue decreased 1.3 percent lines of business. The GTS segment fourth-quarter pre-tax profit was (increased 5 percent adjusted for currency) compared to a strong up 35.5 percent and the margin improved 4.1 points to 14.4 percent fourth-quarter 2007 with revenue performance led by Telelogic. from fourth-quarter 2007. This was the sixth consecutive quarter of Software gross profit increased 3.3 percent with margin improve- double-digit pre-tax profit growth in GTS. The margin improve- ment of 0.6 points. The Software segment delivered pre-tax profit of ment was driven primarily by a delivery structure that maximizes $2,789 million, an increase of 14.6 percent. The pre-tax margin of utilization and flexibility, a mix to higher value offerings, lower total 39.1 percent increased 4.2 points compared to fourth-quarter 2007. 37 managed labor costs and a global skills mix that efficiently moves The large annuity base in the software business continues to provide resources to opportunities. a predictable and growing stream of profit and cash.


  • Page 40

    Management Discussion INTERNATIONAL BUSINESS MACHINES CORPOR ATION and Subsidiary Companies Systems and Technology segment revenue was $5,425 million, a from the company’s growth markets organization decreased 7.1 per- decrease of 20.2 percent (16 percent adjusted for currency), reflecting cent (increased 6 percent adjusted for currency). Americas revenue growth in high-end servers offset by a decline in x86 and storage was $11,454 million, a decrease of 1.9 percent (increase of 2 percent products. System z revenue decreased 5.9 percent (increased 1 percent adjusted for currency). Adjusted for currency, Latin America was up adjusted for currency). Adjusted for currency, revenue performance 12 percent, Canada was up 6 percent and the U.S. was flat. EMEA was led by double-digit growth in the Americas and strong growth in revenue decreased 12.2 percent (1 percent adjusted for currency) to the Financial Services and Industrial sectors globally. System z contin- $9,468 million. Revenue performance in the major countries was ues to perform well due to its ability to consolidate multiple workloads mixed when adjusted for currency, with Germany up 7 percent, the onto a single, virtualized platform. System z MIPS shipments increased U.K. up 4 percent, France grew 2 percent while Italy declined 8 per- 12 percent year to year. This was the fourth consecutive quarter of cent. Asia Pacific revenue decreased 0.7 percent (1 percent adjusted for double-digit MIPS growth. Converged System p revenue grew 8.0 currency) to $5,469 million, with growth in the India, Australia/New percent (14 percent adjusted for currency), driven by strong growth Zealand, and South Korea regions, being more than offset by declin- in both high-end and midrange servers. This was the tenth consecu- ing revenue in Japan. The company has been investing heavily in the tive quarter of revenue growth for converged System p. System x emerging markets to capture opportunities to build out public and revenue decreased 33.0 percent (29 percent adjusted for currency) private infrastructures. Additionally, these markets benefited in the reflecting a significant slowdown in the industry-standard x86 market quarter from customer demand for cost saving offerings during the as customers are virtualizing and consolidating workloads onto more current economic environment. Revenue from these markets repre- efficient platforms such as POWER and mainframe. System x server sented 18 percent of the company’s geographic revenue in the quarter revenue declined 32 percent (28 percent adjusted for currency) with and increased 6 percent, adjusted for currency. The BRIC countries, blades down 27 percent (23 percent adjusted for currency). Legacy a subset of the growth markets, together grew 1.6 percent (13 percent System i revenue decreased 91.6 percent (91 percent adjusted for adjusted for currency) led by double-digit growth in Brazil and India, currency) as the company continues to transition the System i cus- adjusted for currency. Russia revenue was significantly impacted by tomer base to the converged POWER platform within System p. credit limitations and declined 22 percent in the fourth quarter. Systems Storage revenue decreased 19.9 percent (16 percent adjusted Revenue from the company’s industry sales units decreased for currency) driven by revenue declines in total disk and total tape 5.7 percent (flat adjusted for currency) in the fourth quarter of 2008. products. Retail Store Solutions revenue decreased 27.8 percent (22 Public sector revenue decreased 0.8 percent (increased 5 percent percent adjusted for currency) and Microelectronics OEM revenue adjusted for currency) with strength in government and with educa- declined 34.3 percent. tion returning to growth, when adjusted for currency. In the growth Systems and Technology gross margin of 39.9 percent, declined markets, clients are investing in education as a way to develop national 5.8 points versus the fourth quarter of 2007 driven by margin declines skill sets. Industrial sector revenue decreased 8.0 percent (5 percent in all system brands and Microelectronics OEM; partially offsetting adjusted for currency) as concerns with the credit markets and mar- these margin declines was a revenue mix benefit due to a shift in gin pressures continued. Financial Services sector revenue declined revenue toward System z and converged System p. Systems and 5.8 percent (1 percent adjusted for currency) and was in line with the Technology segment pre-tax profit decreased 47.1 percent to $722 company’s overall performance for the fifth consecutive quarter. The million. Pre-tax margin declined 6.7 points to 12.7 percent compared U.S. financial services sector revenue was up 4 percent and improved to the fourth quarter of 2007. significantly from the third quarter. Growth was driven by banking Global Financing revenue of $660 million decreased 1.3 percent and financial markets reflecting strong performance in software, (increased 5 percent adjusted for currency). Increased financing rev- System z and POWER products. Partially offsetting the U.S. growth enue was more than offset by a decline in sales of used equipment. was weakness in Japan and Europe as the economic climate worsened. Geographic revenue decreased 5.6 percent (flat adjusted for cur- Revenue from small and medium business clients declined 8.6 percent rency) with mixed performance by geography. Adjusted for currency, (3 percent adjusted for currency) although services signings in this Americas had the strongest performance with Europe and Asia customer set increased 10 percent versus the fourth quarter of 2007. both declining year to year. Globally, revenue in the major markets decreased 5.3 percent (1 percent adjusted for currency) while revenue 38 Management Discussion ................................................................................................18 DISCONTINUED OPERATIONS .............................................................................. 44 ROAD MAP ............................................................................................................ 18 OTHER INFORMATION .......................................................................................... 44 FORWARD-LOOKING AND CAUTIONARY STATEMENTS ...................................... 18 GLOBAL FINANCING ............................................................................................. 53 MANAGEMENT DISCUSSION SNAPSHOT ............................................................ 19 Report Of Management ............................................................................................... 58 DESCRIPTION OF BUSINESS................................................................................ 20 Report Of Independent Registered Public Accounting Firm ................................. 59 YEAR IN REVIEW .................................................................................................. 25 Consolidated Statements ............................................................................................ 60 PRIOR YEAR IN REVIEW ...................................................................................... 39 Notes ............................................................................................................................... 66


  • Page 41

    Management Discussion international buSineSS machineS corpor ation and Subsidiary companies Total expense and other income decreased 4.7 percent compared to ( $ and shares in millions except per share amounts) Yr.-to-Yr. the fourth quarter of 2007. The decrease was driven by approximately Percent/ 8 points due to the effects of currency, partially offset by 6 points due Margin for the year ended December 31: 2007 2006 Change to the impact of acquisitions with the remainder attributed to lower Revenue $ 98,786 $ 91,424 8.1%* operational expenses. The company continues to focus on structural Gross profit margin 42.2% 41.9% 0.4 pts. changes that reduce spending and improve productivity. Within sell- Total expense and other income $ 27,240 $ 24,978 9.1% ing, general and administrative expense, workforce reduction charges Total expense and other increased approximately $380 million in the fourth quarter, reflecting income-to-revenue ratio 27.6% 27.3% 0.3 pts. workforce actions in Japan and other ongoing skills rebalancing. Income from continuing Other (income) and expense was $97 million of income, a decrease of operations before income taxes $ 14,489 $ 13,317 8.8% 1.5 percent compared to fourth-quarter 2007. Interest income was Provision for income taxes 4,071 3,901 4.4% down approximately $120 million reflecting the current interest rate Income from continuing operations 10,418 9,416 10.6% environment. While the effects of foreign currency transaction losses Income/(loss) from also negatively impacted other (income) and expense in the fourth discontinued operations — 76 NM quarter, they were partially offset by a benefit from the impact of the Net income $ 10,418 $ 9,492 9.7% company’s hedging programs, which was a gain in the fourth quarter Net income margin 10.5% 10.4% 0.2 pts. of 2008 compared to a loss in the prior year. Earnings per share of common stock: The company’s effective tax rate in the fourth-quarter 2008 was Assuming dilution: 23.8 percent compared with 28.0 percent in the fourth quarter of Continuing operations $ 7.18 $ 6.06 18.5% 2007. The 4.2 point decrease in the fourth-quarter 2008 tax rate was Discontinued operations (0.00) 0.05 NM primarily attributable to the net effect of several items in the quarter. Total $ 7.18 $ 6.11 17.5% In 2008, the fourth-quarter tax rate was favorably impacted by the net increase in the utilization of foreign and state tax credits as well as the Weighted-average shares outstanding: retroactive reinstatement of the U.S. research tax credit in the fourth Assuming dilution 1,450.6 1,553.5 (6.6)% quarter of 2008. These benefits were partially offset by the net tax Assets** $120,431 $103,234 16.7% cost related to the completion of the U.S. federal income tax exami- Liabilities** $ 91,962 $ 74,728 23.1% nation for the years 2004 and 2005 including the associated income Equity** $ 28,470 $ 28,506 (0.1)% tax reserve redeterminations. * 4.2 percent adjusted for currency. Share repurchases totaled $604 million in the fourth quarter. The ** At December 31. weighted-average number of diluted common shares outstanding in NM—Not meaningful the fourth quarter of 2008 was 1,347.9 million compared with 1,412.9 million in the fourth quarter of 2007. The company ended the quarter with $12,741 million of cash and continuing operations cash equivalents and generated $6,621 million in cash flow provided The company’s performance in 2007 reflected the strength of its global by operating activities driven primarily by net income. Net cash from model. Revenue increased in all geographies, with strong growth in investing activities was a use of cash of $880 million in fourth quarter emerging markets worldwide. The company capitalized on the oppor- of 2008 versus a source of cash of $1,098 million in the fourth quarter tunities in the global economies, generating 63 percent of its revenue of 2007, resulting primarily from the disposition of higher levels of outside the United States, in delivering full-year growth of 8.1 percent short-term marketable securities in 2007. (4 percent adjusted for currency). Gross profit margins improved reflecting a shift to higher value offerings, continued benefits from productivity initiatives and the Prior Year in Review transformation to a globally integrated enterprise. Pre-tax income The Prior Year in Review section provides a summary of the company’s from continuing operations grew 8.8 percent and net income from financial performance in 2007 as compared to 2006. for a detailed dis- continuing operations increased 10.6 percent versus 2006. Diluted cussion of 2007 performance, see the company’s 2007 Annual Report. earnings per share improved 18.5 percent, reflecting the strong growth in net income and the benefits of the common stock repur- chase program. In 2007, the company repurchased approximately 39 $18.8 billion of its common stock, including a $12.5 billion accelerated share repurchase in the second quarter.


  • Page 42

    Management Discussion international buSineSS machineS corpor ation and Subsidiary companies The increase in 2007 revenue was primarily due to: GTS revenue increased 11.7 percent (7 percent adjusted for cur­ rency) in 2007 versus 2006. The strong performance reflected the • Strong performance from Global Technology Services and Global extensive transformation which occurred in this business over the past Business Services with growth in all business lines; few years. This transformation included revamping the entire ITS • Continued strong demand in the Software business, driven by Key portfolio, continued improvement in SO delivery and a disciplined Branded Middleware products, with strong contributions from approach to driving new business in existing accounts. Total signings strategic acquisitions; and in GTS increased 7 percent (2 percent adjusted for currency). SO • Continued growth in emerging countries (Brazil, Russia, India revenue was up 9.7 percent (5 percent adjusted for currency) with and China: up 26 percent) and solid performance in all geogra­ growth in all geographies, led by EMEA and Asia Pacific. Revenue phies, led by Asia Pacific. growth benefited from prior­year signings, sales of new business in existing accounts, lower base contract erosion and good yield from The increase in income from continuing operations before income 2007 signings. ITS revenue increased 13.3 percent (9 percent adjusted taxes in 2007 was primarily due to the revenue growth and gross profit for currency). Revenue growth was driven primarily by increased margin improvements in the Global Services and Systems and Tech­ signings and reflected the strength of the ITS portfolio worldwide. nology segments. The revamped ITS portfolio includes ten Service Product Lines The following is an analysis of the 2007 versus 2006 reportable which complement hardware offerings from Systems and Technology segment results for Global Services, Systems and Technology and and software offerings from the Software business. The acquisition Software. The Global Financing segment analysis is included in the of Internet Security Systems (ISS), in the fourth quarter of 2006, Global Financing section on pages 53 through 57. also contributed to the revenue growth. BTO revenue increased 24.4 percent (20 percent adjusted for currency), with double­digit Global Services growth in all geographies. Maintenance revenue increased 11.4 per­ ( $ in millions) Yr.-to-Yr. cent (7 percent adjusted for currency) driven primarily by increased for the year ended December 31: 2007 2006 Change availability services on non­IBM IT equipment. Services provided to GLOBAL SERVICES REVENUE: $54,144 $48,291 12.1% InfoPrint Solutions, following the divestiture of the printer business Global Technology Services: $36,103 $32,322 11.7% in the second quarter of 2007, contributed 4 points of growth. Strategic Outsourcing 18,701 17,044 9.7 GBS revenue increased 13.0 percent (9 percent adjusted for Integrated Technology Services 8,438 7,448 13.3 currency) with balanced growth across all three geographies. Revenue Maintenance 6,670 5,986 11.4 performance was led by double­digit growth in application manage­ Business Transformation ment services offerings and growth in all consulting service lines. Total Outsourcing 2,294 1,845 24.4 signings in GBS increased 3 percent (1 percent adjusted for currency), Global Business Services $18,041 $15,969 13.0% led by growth in shorter term signings. ( $ in millions) The Global Services segments, GTS and GBS had combined revenue Yr.-to-Yr. of $54,144 million, an increase of 12.1 percent (8 percent adjusted for for the year ended December 31: 2007 2006 Change currency) in 2007 when compared to 2006. Global Services signings GLOBAL SERVICES GROSS PROFIT: at actual rates were $56.3 billion in 2007 as compared to $53.4 billion Global Technology Services: in 2006. The Global Services backlog was estimated to be $118 bil­ Gross profit $10,800 $9,623 12.2% lion at December 31, 2007, versus $116 billion at December 31, 2006. Gross profit margin 29.9% 29.8% 0.1 pts. The Global Services segments delivered combined pre­tax profit of Global Business Services: $5,622 million, an increase of 12.6 percent. Gross profit $ 4,240 $3,694 14.8% Gross profit margin 23.5% 23.1% 0.4 pts. 40 Management Discussion ................................................................................................18 DISCONTINUED OPERATIONS .............................................................................. 44 ROAD MAP ............................................................................................................ 18 OTHER INFORMATION .......................................................................................... 44 FORWARD-LOOKING AND CAUTIONARY STATEMENTS ...................................... 18 GLOBAL FINANCING ............................................................................................. 53 MANAGEMENT DISCUSSION SNAPSHOT ............................................................ 19 Report Of Management ............................................................................................... 58 DESCRIPTION OF BUSINESS................................................................................ 20 Report Of Independent Registered Public Accounting Firm ................................. 59 YEAR IN REVIEW ................................................................................................... 25 Consolidated Statements ............................................................................................ 60 PRIOR YEAR IN REVIEW ...................................................................................... 39 Notes ............................................................................................................................... 66


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    Management Discussion international buSineSS machineS corpor ation and Subsidiary companies GTS gross profit increased 12.2 percent with gross profit margin by the Notes/Domino family of products. Lotus Connections, released improving 0.1 points, driven primarily by margin expansion in SO, in the second quarter of 2007, was rapidly adopted by customers. The due to an improved cost structure, and ITS, which benefited from latest version of Lotus Notes, Lotus Notes 8.0, was delivered in the a mix to higher value offerings. Segment pre-tax profit increased third quarter of 2007. Revenue from Tivoli software increased 18.0 8.2 percent to $3,557 million with a pre-tax margin of 9.4 percent, a percent (13 percent adjusted for currency) with double-digit growth decline of 0.2 points. Increased investments in sales and delivery, in each segment of the portfolio: Systems Management, Security and acquisitions and workforce reduction charges were essentially offset Storage. The acquisitions of MRO, in the fourth quarter of 2006, and by productivity improvements and effective expense management. Vallent and Consul, in the first quarter of 2007, also contributed to GBS gross profit increased 14.8 percent to $4,240 million and the the brand’s revenue growth. Rational revenue increased 13.7 percent gross profit margin improved 0.4 points. Segment pre-tax profit (9 percent adjusted for currency) in 2007 which reflected strong cus- increased 21.0 percent to $2,064 million with a pre-tax margin of tomer acceptance of its integrated product set. 10.7 percent, an improvement of 0.9 points. The margin expansion Revenue from Other middleware products increased 3.5 percent was driven primarily by revenue growth, ongoing productivity and (flat adjusted for currency) in 2007 versus the prior year. This soft- utilization initiatives, and expense management. ware product set includes mature products which provide a more stable flow of revenue. Software Operating systems revenue increased 2.0 percent (decreased 2 ( $ in millions) percent adjusted for currency) in 2007 versus 2006. Product Lifecycle Yr.-to-Yr. for the year ended December 31: 2007 2006* Change Management (PLM) revenue decreased 6.4 percent (11 percent adjusted for currency) driven by declines in the Small and Medium SOFTWARE REVENUE: $19,982 $18,161 10.0% Business sector. Other software segment revenue increased 26.7 Middleware: $15,505 $13,891 11.6% percent (22 percent adjusted for currency) reflecting growth in soft- Key Branded Middleware 10,827 9,373 15.5 ware-related services, such as consulting and education. WebSphere Family 19.1 Information Management 14.7 ( $ in millions) Lotus 8.7 Yr.-to-Yr. for the year ended December 31: 2007 2006 Change Tivoli 18.0 Rational 13.7 SOFTWARE GROSS PROFIT: Other middleware 4,678 4,518 3.5 Gross profit $17,015 $15,471 10.0% Operating systems 2,319 2,273 2.0 Gross profit margin 85.2% 85.2% 0.0 pts. Product Lifecycle Management 1,051 1,123 (6.4) Other 1,107 874 26.7 Software segment gross profit increased 10.0 percent to $17,015 mil- * Reclassified to conform with 2007 presentation. lion in 2007, driven primarily by strong revenue growth. Gross profit margin was 85.2 percent in 2007, flat versus the prior year. Software segment revenue of $19,982 million increased 10.0 percent The Software segment contributed $6,002 million of pre-tax profit (6 percent adjusted for currency) in 2007 reflecting strong demand in 2007, an increase of 9.3 percent versus 2006. The segment pre-tax for the Key Branded Middleware products. Revenue performance profit margin of 26.8 percent was essentially flat (declined 0.1 points) was led by double-digit growth in the Financial Services, Public and versus the prior year, reflecting the integration of acquired businesses. Small and Medium Business sectors. Key Branded Middleware revenue was $10,827 million, up 15.5 Systems and Technology percent (11 percent adjusted for currency) and increased 3 points to ( $ in millions) Yr.-to-Yr. 54 percent of total software segment revenue. for the year ended December 31: 2007 2006 Change WebSphere Family revenue increased 19.1 percent (14 percent SYSTEMS AND TECHNOLOGY adjusted for currency) and was led by double-digit growth in REVENUE: $21,317 $21,970 (3.0)% WebSphere Application Servers and WebSphere Business Integration System z (11.2)% software. The strong revenue performance reflected the industry’s Legacy System i (10.6) adoption of SOA. Information Management revenue increased Converged System p 8.8 14.7 percent (10 percent adjusted for currency) in 2007 versus the prior System x 7.0 year. The acquisition of FileNet, in the fourth quarter of 2006, con- 41 System Storage 5.1 tributed strong revenue growth throughout the year. Lotus revenue Retail Store Solutions 14.5 increased 8.7 percent (4 percent adjusted for currency) in 2007 driven Total Systems 2.8 Microelectronics OEM (11.8) Printing Systems (63.1)


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    Management Discussion international buSineSS machineS corpor ation and Subsidiary companies Systems and Technology segment revenue decreased 3.0 percent The increase in Systems and Technology gross profit dollars was (6 percent adjusted for currency). On June 1, 2007, the company primarily due to higher gross profit margins in System z, converged completed the divestiture of its printing business to Ricoh. This System p and System x servers. The Systems and Technology gross resulted in the loss of approximately $600 million of Systems and profit margin increased 2.0 points to 39.7 percent. Converged Technology revenue in 2007 when compared to 2006. Systems and System p performance contributed 1.3 points to the overall margin Technology revenue, excluding the printing business, was flat improvement, while System z and System x contributed 0.7 points (declined 3 percent adjusted for currency) in 2007 versus 2006. and 0.4 points, respectively. These increases were partially offset by System z revenue decreased 11.2 percent (15 percent adjusted for lower gross margins in legacy System i of 0.2 points and System currency). System z MIPS shipments increased 3 percent. System z Storage of 0.2 points. revenue declined in the second half of 2007 following a long and suc- Systems and Technology segment pre-tax margin expanded cessful technology cycle of over two-and-a-half years. Converged 2.1 points to 9.6 percent driven primarily by a strong combination of System p revenue increased 8.8 percent (5 percent adjusted for cur- operational cost management and the value that virtualization has rency). The increase was primarily driven by strength in midrange driven in the enterprise space. POWER5+ and POWER6 servers, which increased 23 percent. Legacy System i revenue decreased 10.6 percent (14 percent adjusted Global Financing for currency). Although legacy System i revenue declined year over See pages 53 and 54 for a discussion of the Global Financing segment. year, fourth-quarter 2007 revenue increased 2 percent with growth in POWER6 servers which were introduced late in the third quarter of Geographic Revenue 2007. System x revenue increased 7.0 percent (3 percent adjusted for ( $ in millions) Yr.-to-Yr. currency). Revenue performance was driven by System x server for the year ended December 31: 2007 2006 Change products which grew 8 percent and System x blades which increased TOTAL REVENUE: $98,786 $91,424 8.1% 16 percent in 2007 versus 2006. System Storage revenue increased 5.1 percent (2 percent adjusted for currency). The increase was pri- Geographies: $95,320 $87,564 8.9% marily driven by 13 percent growth in tape products, while external Americas 41,122 39,511 4.1 Europe/Middle East/Africa 34,699 30,491 13.8 disk products increased 1 percent. Enterprise tape products had Asia Pacific 19,501 17,566 11.0 strong double-digit revenue growth, while midrange tape products OEM $ 3,465 $ 3,856 (10.1)% had mid single-digit revenue growth. Retail Store Solutions revenue increased 14.5 percent (11 percent adjusted for currency) primarily From a geographic perspective, revenue increased in all geographies due to the continued roll out of new programmable point-of-sale in 2007 when compared to 2006. Adjusted for currency, revenue solutions to large retail clients. growth was led by Asia Pacific and steady performance throughout Microelectronics OEM revenue decreased 11.8 percent driven the year in EMEA. by reduced demand for game processors. Printing Systems revenue Americas revenue increased 4.1 percent (3 percent adjusted for decreased as a result of the divestiture of the business. The 2007 currency) in 2007. Revenue increased in all regions with the U.S. up results included five months of revenue while the 2006 results 2.9 percent, Canada 8.4 percent (2 percent adjusted for currency) and included 12 months of revenue. Latin America 8.6 percent (2 percent adjusted for currency). ( $ in millions) EMEA revenue increased 13.8 percent (5 percent adjusted for Yr.-to-Yr. for the year ended December 31: 2007 2006 Change currency) in 2007 when compared to 2006. Within the European market, IT spending grew at a moderate rate, and the company’s SYSTEMS AND TECHNOLOGY GROSS PROFIT: mid single-digit revenue growth rates throughout 2007 reflected Gross profit $8,468 $8,284 2.2% that environment. Revenue increased in all major countries with Gross profit margin 39.7% 37.7% 2.0 pts. Spain up 21.7 percent (11 percent adjusted for currency), Germany 14.6 percent (5 percent adjusted for currency), the U.K. 11.3 percent (3 percent adjusted for currency), France 10.2 percent (1 percent adjusted for currency) and Italy 8.7 percent (decreased 1 percent adjusted for currency). 42 Management Discussion ................................................................................................18 DISCONTINUED OPERATIONS .............................................................................. 44 ROAD MAP ............................................................................................................ 18 OTHER INFORMATION .......................................................................................... 44 FORWARD-LOOKING AND CAUTIONARY STATEMENTS ...................................... 18 GLOBAL FINANCING ............................................................................................. 53 MANAGEMENT DISCUSSION SNAPSHOT ............................................................ 19 Report Of Management ............................................................................................... 58 DESCRIPTION OF BUSINESS................................................................................ 20 Report Of Independent Registered Public Accounting Firm ................................. 59 YEAR IN REVIEW ................................................................................................... 25 Consolidated Statements ............................................................................................ 60 PRIOR YEAR IN REVIEW ...................................................................................... 39 Notes ............................................................................................................................... 66


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    Management Discussion INTERNATIONAL BUSINESS MACHINES CORPOR ATION and Subsidiary Companies Asia Pacific revenue increased 11.0 percent (8 percent adjusted was essentially flat versus year-end 2006. Ongoing workforce reduc- for currency) year over year. Growth was led by strong performance tions increased as a result of actions taken to address cost issues in in the India, Greater China, Australia/New Zealand, ASEAN and GTS, primarily in SO, during the second quarter of 2007. Korea regions, where the economies remain strong, with combined Other (income) and expense was income of $626 million and revenue growth of 23.8 percent (17 percent adjusted for currency). $766 million in 2007 and 2006, respectively. The decrease in income Japan revenue, which represented 49 percent of the Asia Pacific rev- was primarily due to higher losses on derivative instruments. The enue base, was flat (increased 1 percent adjusted for currency) in 2007 company hedges its major cross-border cash flows to mitigate the when compared to 2006, reflecting a slower economy. effect of currency volatility in the year-over-year results. The impact Across the geographies, the emerging BRIC countries of Brazil, of these hedging programs is primarily reflected in other (income) and Russia, India, and China together grew 26.3 percent (18 percent expense, as well as cost of goods sold. Losses from derivatives, as a adjusted for currency), reflecting the investments made to build result of currency movements, resulted in $247 million of year-to-year capabilities and capture opportunities in these countries. Brazil rev- impact to other (income) and expense. This decrease in income was enue increased 14.3 percent (1 percent adjusted for currency), Russia partially offset by a gain from the divestiture of the printing business grew 30.3 percent (30 percent adjusted for currency), India increased in the second quarter and sales of Lenovo stock in the first and sec- 37.9 percent (26 percent adjusted for currency) and China increased ond quarters of 2007. 32.5 percent (29 percent adjusted for currency). In addition to the RD&E expense of $6,153 million increased 0.8 percent primarily BRIC markets, the company also had strong revenue growth in other driven by acquisitions and investments to maintain technology leader- nations where there was strong demand for business and IT infra- ship across the product offerings. Software spending increased $339 structure solutions. million partially offset by lower Systems and Technology spending of Revenue growth rates, as reported, were impacted in 2007 as a $204 million. result of the divestiture of the printing business on June 1, 2007. Intellectual property and custom development income of $958 mil- Revenue, excluding the printing business in both years, increased as lion increased $58 million or 6.4 percent versus 2006. There were no follows compared to 2006: significant IP transactions in 2007 and 2006. Interest expense of $611 million increased $333 million, or 119.6 • Americas — 5.2% percent in 2007 primarily due to the higher debt associated with the • EMEA — 14.5% financing of the ASR agreements. • Asia Pacific — 11.8% • IBM Consolidated — 8.9% Income Taxes The provision for income taxes resulted in an effective tax rate of OEM revenue decreased 10.1 percent (10 percent adjusted for cur- 28.1 percent for 2007, compared with the 2006 effective tax rate of rency) in 2007 when compared to 2006, driven by a slowdown in 29.3 percent. The 1.2 point decrease was primarily driven by the demand for game processors. absence of the one-time tax cost associated with the intercompany transfer of certain intellectual property in the fourth quarter of 2006 Total Expense and Other Income (4.3 points) and the absence of the benefit from the settlement of the Total expense and other income increased 9.1 percent (5 percent U.S. federal income tax audit for the years 2001 through 2003, also in adjusted for currency) in 2007 versus 2006. The increase was primarily the fourth quarter of 2006 (3.0 points). The company also benefited due to increased SG&A expense and interest expense. SG&A expense in 2007 from a more favorable mix of income in lower tax rate juris- increased primarily due to acquisition-related spending, as well as dictions and increased capital loss and state credit benefits, offset by increased investments in emerging countries and the software and a reduction in certain tax incentives. services businesses. Interest expense increased primarily due to higher debt levels associated with the financing of the ASR agreements. The Financial Position expense-to-revenue ratio increased 0.3 points to 27.6 percent in 2007, Assets of $120,431 million increased $17,197 million ($12,957 million as revenue increased 8.1 percent and expense increased 9.1 percent in adjusted for currency) primarily due to increases in cash and cash 2007 versus 2006. equivalents ($6,969 million), prepaid pension assets ($6,788 mil- Total SG&A expense of $22,060 million increased 8.9 percent lion), total financing receivables ($2,729 million) and goodwill (6 percent adjusted for currency) versus 2006. The increase was pri- ($1,431 million). These increases were partially offset by decreases in marily driven by acquisition-related spending (3 points), the effects 43 long-term deferred tax assets ($2,367 million) and short-term mar- of currency (3 points) and investments in the software and services ketable securities ($1,479 million). businesses, as well as emerging markets. In addition, bad debt expense Liabilities of $91,962 million increased $17,234 million ($13,642 increased $113 million primarily due to an increase in the provision for million adjusted for currency) driven primarily by increases in total doubtful accounts. The reserve coverage for receivables of 1.5 percent debt ($12,592 million), tax liabilities ($1,492 million) and total deferred income ($1,773 million).


  • Page 46

    Management Discussion INTERNATIONAL BUSINESS MACHINES CORPOR ATION and Subsidiary Companies Stockholders’ equity of $28,470 million was essentially flat versus The company has a significant global presence, operating in over 2006. Increased treasury stock ($17,649 million) from share repur- 170 countries, with approximately 65 percent of its revenue generated chases, which included the ASR, was largely offset by increased retained outside the U.S. This global reach gives the company access to mar- earnings ($8,208 million) driven by net income, increased common kets, with well-established organizations and management systems stock ($3,917 million) related to stock options and a decline in accu- who understand the clients and their challenges and who can respond mulated gains and (losses) not affecting retained earnings ($5,487 to these opportunities with value-add solutions. The company’s trans- million) primarily due to the effects of pension remeasurements. formation to a globally integrated enterprise provides the capabilities The company generated $16,094 million in cash flow provided by to service clients globally and deliver the best skills and cost from operating activities, an increase of $1,075 million compared to 2006, anywhere in the world. primarily driven by increased net income. Net cash used in investing In emerging markets, the company will continue to invest for activities of $4,675 million was $6,874 million lower than 2006 driven revenue growth by capturing new infrastructure spending in these primarily by proceeds from disposition of short-term marketable markets. While some of these economies have slowed, these markets securities and a reduction in cash used for acquisitions. Net cash still offer good growth opportunities relative to the rest of the world. used in financing activities of $4,740 million decreased $3,464 mil- The company has developed a strong value proposition for the lion versus 2006 driven by increased net proceeds from total debt established markets based on cost reduction, capital conservation and ($12,233 million), partially offset by increased share repurchases risk management. The high value, integrated offerings, including green ($10,744 million). data centers, outsourcing and virtualization on high-end systems, have performed well in these markets in the current environment. Looking forward, the company’s “Smarter Planet” agenda will Discontinued Operations provide an important new opportunity to deliver value to clients. On December 31, 2002, the company sold its HDD business to Hitachi The company anticipates a significant opportunity in “smart infra- for approximately $2 billion. The final cash payment of $399 million structure” projects as governments around the world implement was received on December 30, 2005. economic stimulus programs focused on next generation smart In 2006, the company reported net income of $76 million, net of grids, healthcare-related information technology and broadband. tax, primarily related to tax benefits from tax audit settlements. Projects of these types require technology integration and industry insight which should uniquely position the company to participate Other Information in these opportunities. The company remains committed to technology leadership and looking forward will continue to focus internal investments, complemented with Looking forward, the company enters 2009 in an excellent operational strategic acquisitions, on high-value, high-growth opportunities. The and financial position. The company has shifted its business to higher company invested over $6 billion in RD&E in 2008 and approxi- value services and software, with less dependence on commoditizing mately $30 billion over the past five years. and cyclical businesses. The Global Services business in 2008 con- In addition, the company’s financial position is strong. Through its tributed 42 percent of total segment pre-tax income and managed efficient cash generation business model based on disciplined balance over 60 percent of the company’s resources. The company’s software sheet management, in 2008, the company generated $18.8 billion in capabilities have grown through internal investment and acquisitions operating cash flow and ended the year with $12.9 billion in cash and with Software segment pre-tax profit more than doubling in the marketable securities. This provides the company with the financial past five years to over $7 billion in 2008. In 2008, over 80 percent flexibility for investments in changing business environments. The of segment pre-tax profit came from Global Services and Software, company will also continue to focus on cost and expense reduction and over 90 percent from Global Services, Software and Global and improved efficiency. In 2008, those efforts translated to margin Financing. The company has changed the profile of the business to expansion and the company expects this to continue into 2009. make it more adaptable to different business environments. In May 2007, the company met with investors and analysts and The company enters 2009 and the current market from a position discussed a road map to deliver earnings per share in 2010 in the of strength. The company will take advantage of the environment to range of $10 to $11 per share, or 14 to 16 percent compound growth continue to execute its strategies. rate from 2006. The company’s 2010 road map is to generate earn- ings per share in the range of $9 to $10 per share, or 10 to 14 percent 44 Management Discussion ................................................................................................18 DISCONTINUED OPERATIONS ............................................................................. 44 ROAD MAP ............................................................................................................ 18 OTHER INFORMATION .......................................................................................... 44 FORWARD-LOOKING AND CAUTIONARY STATEMENTS ...................................... 18 GLOBAL FINANCING ............................................................................................. 53 MANAGEMENT DISCUSSION SNAPSHOT ............................................................ 19 Report Of Management ............................................................................................... 58 DESCRIPTION OF BUSINESS................................................................................ 20 Report Of Independent Registered Public Accounting Firm ................................. 59 YEAR IN REVIEW ................................................................................................... 25 Consolidated Statements ............................................................................................ 60 PRIOR YEAR IN REVIEW ...................................................................................... 39 Notes ............................................................................................................................... 66


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    Management Discussion INTERNATIONAL BUSINESS MACHINES CORPOR ATION and Subsidiary Companies growth from 2006 through a combination of revenue growth, margin In the Systems and Technology business, the company will continue improvement, growth initiatives, acquisitions and effective capital to focus its investments on differentiating technologies with leader- deployment to fund growth and provide returns to shareholders ship and high-growth potential including POWER, high-performance through dividends and common stock repurchases. computing, virtualization, nanotechnology and energy efficiency. In In addition to these elements, the company’s roadmap to the $10 this market, the value has shifted to the high end to address clients’ to $11 per share range includes the projected benefit of retirement- needs to consolidate and virtualize their environments. The company related costs based on December 31, 2006 assumptions. Actual will focus on providing clients with a clear path to a fully dynamic infra- retirement-related costs will depend on several factors including structure that not only reduces cost, but is both intelligent and secure. financial market performance, the interest rate environment and In 2009, Global financing will seek to expand its core business by actuarial assumptions. In March 2008, the company met again with accelerating growth in the participation rates for IBM products and investors and analysts and discussed the progress the company is services transactions. In addition, the business will be focused on making on its 2010 roadmap. optimizing its global infrastructure, resources and processes through The company’s performance in 2008 highlighted the benefits of the deployment of its single operating model initiative. its global reach and the strength of its business model. The financial The company expects 2009 pre-tax retirement-related plan cost results reflected solid progress on major elements of the long-term to be approximately $1.5 billion, an increase of approximately $100 goals, however, the company measures the success of its business million compared to 2008. This estimate reflects current pension plan model over the long term, not any individual quarter or year. Earnings assumptions and the impacts of recent pension plan redesign efforts. per share growth is dependent on a number of factors and may not See note U, “Retirement-Related Benefits,” on pages 106 to 116 for be consistent throughout the periods. The company’s strategies, additional information. investments and actions are all taken with an objective of optimizing The company expects in the normal course of business that its long-term performance. effective tax rate in 2009 will be approximately 26.5 percent. The rate The continued investments in Software have led to this segment’s will change year to year based on non-recurring events, such as the emergence as a strong source of revenue growth and the largest con- settlement of income tax audits, as well as recurring factors including tributor to the company’s profit in 2008 and 2007. The Software the geographic mix of income before taxes, the timing and amount of business is differentiated in the industry by both the strength of its foreign dividend repatriation, state and local taxes and the effects of individual products and the breadth of the software offerings. Clients various global income tax strategies. continue to rely on the extensive middleware portfolio to help them transform their business, streamline costs and seek new business liquidity and capital resources opportunities. The key to continued Software growth stems from the The company has consistently generated strong cash flow from ability to maintain and grow this industry-leading software business, operations, providing a source of funds ranging between $14.9 billion and by continuing to capitalize on industry trends. Investments will and $18.8 billion per year over the past five years. The company be aligned to advance the company’s growth strategy through new provides for additional liquidity through several sources: maintaining client acquisition, with specific focus on key industries and local busi- a sizable cash balance, access to global funding sources, a committed nesses. The company will also continue to focus on expanding its global credit facility and other committed and uncommitted lines software capabilities through a combination of internal development of credit worldwide. At December 31, 2008, the company had total and strategic acquisitions. unused lines of credit of $18,264 million. The following table pro- Within the Global Services business, revenue and profit growth vides a summary of these major sources of liquidity for the years improved and the company saw significant results from the targeted ended December 31, 2004 through 2008. actions and investments it has made in the last few years. The busi- ness has been transformed into one that is more flexible and more Cash Flow and Liquidity Trends focused on higher value segments of the market. The Global Services ( $ in billions) 2008 2007 2006 2005 2004 business enters 2009 with a revenue backlog of $117 billion. The port- Net cash from folio is strong with a complement of offerings and capabilities that operating activities $18.8 $16.1 $15.0 $14.9 $15.3 deliver both high value and productivity to clients. Going forward Cash and short-term the Global Services business will look to build upon its momentum marketable securities $12.9 $16.1 $10.7 $13.7 $10.6 from the strong 2008 performance by continuing its “clients first Committed global credit approach” and by focusing on further enhancements to its offerings/ facilities $10.0 $10.0 $10.0 $10.0 $10.0 45 integrated solutions portfolio, continuing to improve both the skills Trade receivables and structure of the business and accelerating the deployment of the securitization facility $ — $ — $ — $ 0.5 $ 0.5 Global Delivery framework, a set of delivery practices that will enable consistent global delivery excellence.


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    Management Discussion international buSineSS machineS corpor ation and Subsidiary companies The major rating agencies’ ratings on the company’s debt securities at for efficiency. After classifying Global financing accounts receivables December 31, 2008 appear in the following table. All ratings remain as an investment, the remaining net operational cash flow less capital unchanged from December 31, 2007. The company has no contractual expenditures is viewed by the company as the free cash flow available arrangements that, in the event of a change in credit rating, would for investment and distribution to shareholders. result in a material adverse effect on its financial position or liquidity. from the perspective of how management views cash flow, in The company believes its earnings and cash flow growth provide 2008, free cash flow was $14.3 billion, an increase of $1.9 billion com- sufficient flexibility within the existing credit ratings to continue to pared to 2007. This cash performance was driven primarily by the execute its current investment, dividend and acquisition strategies, as growth in net income from continuing operations, controls on capital well as refinance maturing debt when required. spending and lower retirement-related funding year over year. Moody’s Over the past five years, the company generated over $55 billion Standard Investors in free cash flow available for investment and distribution to share- & Poor’s Service Fitch holders. During that period, the company invested $14.3 billion in Senior long-term debt A+ A1 A+ strategic acquisitions and returned over $61 billion to shareholders Commercial paper A-1 Prime-1 F1 through dividends and share repurchases. The amount of prospective returns to shareholders in the form of dividends and share repurchases The company prepares its Consolidated Statement of Cash flows in will vary based upon several factors including each year’s operating accordance with Statement of financial Accounting Standards (SfAS) results, capital expenditure requirements, research and development No. 95, “Statement of Cash flows,” on page 62 and highlights causes and acquisitions, as well as the factors discussed on page 47. and events underlying sources and uses of cash in that format on The company’s Board of Directors meets quarterly to consider pages 34 and 35. for purposes of running its business, the company the dividend payment. The company expects to fund dividend pay- manages, monitors and analyzes cash flows in a different format. ments through cash from operations. In the second quarter of 2008, As discussed on page 53, a key objective of the company’s Global the Board of Directors increased the company’s quarterly common financing business is to generate strong return on equity. Increasing stock dividend from $0.40 to $0.50 per share. receivables is the basis for growth in a financing business. Accordingly, management considers Global financing receivables as a profit-gen- erating investment, not as working capital that should be minimized The table below represents the way in which management reviews cash flow as described above. ( $ in billions) for the year ended December 31: 2008 2007 2006 2005 2004 Net cash from operating activities (Continuing Operations) $ 18.8 $ 16.1 $15.0 $14.9 $15.3 Less: Global Financing accounts receivable (0.0) (1.3) (0.3) 1.8 2.5 Net cash from operating activities (Continuing Operations), excluding Global Financing receivables 18.8 17.4 15.3 13.1 12.9 Capital expenditures, net (4.5) (5.0) (4.7) (3.5) (3.7) Free cash flow (excluding Global Financing accounts receivable) 14.3 12.4 10.5 9.6 9.1 Acquisitions (6.3) (1.0) (3.8) (1.5) (1.7) Divestitures 0.1 0.3 — 0.9 — Share repurchase (10.6) (18.8) (8.1) (7.7) (7.1) Dividends (2.6) (2.1) (1.7) (1.2) (1.2) Non-Global Financing debt (3.2) 10.9 (1.1) 1.2 0.7 Other (includes Global Financing accounts receivable and Global Financing debt) 5.0 3.8 1.1 1.9 3.1 CHANGE IN CASH, CASH EQUIVALENTS AND SHORT-TERM MARKETABLE SECURITIES $ (3.2) $ 5.5 $ (3.0) $ 3.1 $ 2.9 46 Management Discussion ................................................................................................18 DISCONTINUED OPERATIONS .............................................................................. 44 ROAD MAP ............................................................................................................ 18 OTHER INFORMATION .......................................................................................... 44 FORWARD-LOOKING AND CAUTIONARY STATEMENTS ...................................... 18 GLOBAL FINANCING ............................................................................................. 53 MANAGEMENT DISCUSSION SNAPSHOT ............................................................ 19 Report Of Management ............................................................................................... 58 DESCRIPTION OF BUSINESS................................................................................ 20 Report Of Independent Registered Public Accounting Firm ................................. 59 YEAR IN REVIEW ................................................................................................... 25 Consolidated Statements ............................................................................................ 60 PRIOR YEAR IN REVIEW ....................................................................................... 39 Notes ............................................................................................................................... 66


  • Page 49

    Management Discussion INTERNATIONAL BUSINESS MACHINES CORPOR ATION and Subsidiary Companies Events that could temporarily change the historical cash flow dynam- to certain non-U.S. plans of approximately $5.6 billion in the next ics discussed on page 46 include significant changes in operating five years. The 2009 contributions are expected to be approximately results, material changes in geographic sources of cash, unexpected $1 billion. financial market performance in 2009 could increase the adverse impacts from litigation or future pension funding require- legally mandated minimum contributions in certain non-U.S. coun- ments during periods of severe downturn in the capital markets. tries that require more frequent remeasurement of the funded status. Whether any litigation has such an adverse impact will depend on a The company is not quantifying any further impact from pension number of variables, which are more completely described on pages funding because it is not possible to predict future movements in the 97 to 99. With respect to pension funding, in 2008, the company capital markets or pension plan funding regulations. contributed $917 million to its non-U.S. defined benefit plans, versus The Pension Protection Act of 2006 (the Act) was enacted into $503 million in 2007. Also, in 2007, the company made a $500 million law in 2006, and, among other things, increases the funding require- voluntary cash contribution to the U.S. nonpension postretirement ments for certain U.S. defined benefit plans beginning after December plan. As highlighted in the Contractual Obligations table below, the 31, 2007. No mandatory contribution is required for the U.S. defined company expects to make legally mandated pension plan contributions benefit plan in 2009 or 2010 as of December 31, 2008. Contractual Obligations Total Payments due in Contractual ( $ in millions) Payment Stream 2009 2010-11 2012-13 After 2013 Long-term debt obligations $30,289 $ 8,874 $ 5,190 $ 5,595 $10,630 Interest on long-term debt obligations 16,437 1,382 2,264 1,821 10,969 Capital (finance) lease obligations 213 57 78 40 38 Operating lease obligations 5,969 1,481 2,312 1,362 814 Purchase obligations 1,280 568 512 133 67 Other long-term liabilities: Minimum pension funding (mandated)* 5,582 974 2,467 2,141 — Executive compensation 894 60 136 157 541 Long-term termination benefits 2,230 571 285 229 1,145 Tax reserves** 3,485 163 — — — Other 788 81 126 79 502 TOTAL $67,167 $14,212 $13,370 $11,557 $24,706 * Represents future pension contributions that are mandated by local regulations or statute, all associated with non-U.S. pension plans. The projected payments beyond 2013 are not currently determinable. See note U, “Retirement-Related Benefits,” on pages 106 to 116 for additional information on the non-U.S. plans’ investment strategies and expected contributions and for information regarding the company’s unfunded pension plans of $20,086 million at December 31, 2008. ** These amounts represent the liability for unrecognized tax benefits under FIN 48. The company estimates that approximately $163 million of the liability is expected to be settled within the next 12 months. The settlement period for the noncurrent portion of the income tax liability cannot be reasonably estimated as the timing of the payments will depend on the progress of tax examinations with the various tax authorities; however, it is not expected to be due within the next 12 months. 47


  • Page 50

    Management Discussion INTERNATIONAL BUSINESS MACHINES CORPOR ATION and Subsidiary Companies Total contractual obligations are reported in the table on page 47 critical accounting estimates excluding the effects of time value and therefore, may not equal the The application of GAAP requires the company to make estimates amounts reported in the Consolidated Statement of financial Posi- and assumptions about future events that directly affect its reported tion. Total contractual obligations increased $23.8 billion from the financial condition and operating performance. The accounting esti- amount reported in the 2007 Annual Report primarily due to the mates and assumptions discussed in this section are those that the addition of interest on long-term debt obligations ($16.4 billion), company considers to be the most critical to its financial statements. which was not previously reported, and an increase in long-term debt An accounting estimate is considered critical if both (a) the nature of obligations ($4.2 billion), including current (2009) maturities. the estimate or assumption is material due to the levels of subjectivity Purchase obligations include all commitments to purchase goods and judgment involved, and (b) the impact within a reasonable range of or services of either a fixed or minimum quantity that meet any of the outcomes of the estimate and assumption is material to the company’s following criteria: (1) they are noncancelable, (2) the company would financial condition or operating performance. Senior management incur a penalty if the agreement was canceled, or (3) the company has discussed the development, selection and disclosure of these esti- must make specified minimum payments even if it does not take mates with the Audit Committee of the company’s Board of Directors. delivery of the contracted products or services (take-or-pay). If the The company’s significant accounting policies are described in note A, obligation to purchase goods or services is noncancelable, the entire “Significant Accounting Policies,” on pages 66 to 76. value of the contract is included in the table above. If the obligation A quantitative sensitivity analysis is provided where that informa- is cancelable, but the company would incur a penalty if canceled, the tion is reasonably available, can be reliably estimated and provides dollar amount of the penalty is included as a purchase obligation. material information to investors. The amounts used to assess sensi- Contracted minimum amounts specified in take-or-pay contracts are tivity (e.g., 1 percent, 10 percent, etc.) are included to allow users of also included in the table as they represent the portion of each contract the Annual Report to understand a general direction cause and effect that is a firm commitment. of changes in the estimates and do not represent management’s In the ordinary course of business, the company enters into con- predictions of variability. for all of these estimates, it should be noted tracts that specify that the company will purchase all or a portion of that future events rarely develop exactly as forecast, and estimates its requirements of a specific product, commodity or service from a require regular review and adjustment. supplier or vendor. These contracts are generally entered into in order to secure pricing or other negotiated terms. They do not Pension Assumptions specify fixed or minimum quantities to be purchased and, therefore, for defined benefit pension plans, the measurement of the company’s the company does not consider them to be purchase obligations. benefit obligation and net periodic pension cost/(income) requires the use of certain assumptions, including, among others, estimates Off-Balance Sheet Arrangements of discount rates and expected return on plan assets. See note U, In the ordinary course of business, the company enters into off- “Retirement-Related Benefits,” on pages 106 to 116 for a description balance sheet arrangements as defined by the SEC financial Reporting of the company’s defined benefit pension plans. Release 67 (fRR-67), “Disclosure in Management’s Discussion and Changes in the discount rate assumptions will impact the service Analysis about Off-Balance Sheet Arrangements and Aggregate Con- cost, (gain)/loss amortization and interest cost components of the net tractual Obligations.” periodic pension cost/(income) calculation (see page 112 for informa- The company has no off-balance sheet arrangements that have, or tion regarding the discount rate assumptions) and the projected are reasonably likely to have, a material current or future effect on benefit obligation (PBO). As presented on page 112, the company financial condition, changes in financial condition, revenues or expen- decreased the discount rate assumption for the IBM Personal Pension ses, results of operations, liquidity, capital expenditures or capital Plan (PPP), a U.S.-based defined benefit plan, by 25 basis points to resources. See the table on page 47 for the company’s contractual 5.75 percent on December 31, 2008. This change will increase pre-tax obligations and note O, “Contingencies and Commitments,” on cost and expense recognized in 2009 by approximately $71 million. If pages 97 to 99, for detailed information about the company’s guar- the discount rate assumption for the PPP increased by 25 basis points antees, financial commitments and indemnification arrangements. on December 31, 2008, pre-tax cost and expense recognized in 2009 The company does not have retained interests in assets transferred would have decreased by approximately $67 million. Changes in the to unconsolidated entities or other material off-balance sheet inter- discount rate assumptions will impact the PBO which, in turn, may ests or instruments. impact the company’s funding decisions if the PBO exceeds plan 48 assets. Each 25 basis point increase or decrease in the discount rate Management Discussion ................................................................................................18 DISCONTINUED OPERATIONS .............................................................................. 44 ROAD MAP ............................................................................................................ 18 OTHER INFORMATION .......................................................................................... 44 FORWARD-LOOKING AND CAUTIONARY STATEMENTS ...................................... 18 GLOBAL FINANCING ............................................................................................. 53 MANAGEMENT DISCUSSION SNAPSHOT ............................................................ 19 Report Of Management ............................................................................................... 58 DESCRIPTION OF BUSINESS................................................................................ 20 Report Of Independent Registered Public Accounting Firm ................................. 59 YEAR IN REVIEW ................................................................................................... 25 Consolidated Statements ............................................................................................ 60 PRIOR YEAR IN REVIEW ....................................................................................... 39 Notes ............................................................................................................................... 66

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