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    Annual 2010 Report


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    On June 16, 2011, IBM marks its centennial. As we reflect on our first century, it has sparked new thinking about the possibilities for our second. Join us at IBM100.com


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    A Letter from the Chairman 1 Dear IBM Investor: I am pleased to report that IBM had another strong year in 2010. Your company continued to outperform our industry and the market at large. We once again achieved record pre-tax earnings, record earnings per share, record free cash flow and improved profit margins, with increased revenues. At the same time, we continued to deliver superior returns to you, our owners. Most importantly, we are well positioned to grow as the global economy recovers. These results were made possible by decisions and actions that we undertook a decade ago, based on where we believed the world was shifting. But even more, they are a reflection of the mindset, ambitions and values that have guided IBM since its inception, 100 years ago. As such, our performance in 2010 marks a fitting conclusion to our first century as a corporation, and a promising start to our second. In this letter, I will explain why the long-term thinking and management that IBM has practiced over the past decade have positioned your company advantageously for the next five years and beyond.


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    2 Cash flow: IBM has consistently generated strong IBM today cash flow, a key indicator of real business performance. IBM’s performance in 2010 is indicative both of our In 2010 our free cash flow, excluding the year-to- high-value market position and of the discipline we year change in Global Financing receivables, was apply to our strategy and operations. Since 2002, $16.3 billion, an increase of $1.2 billion from 2009. we have added $14 billion to IBM’s pre-tax profit base, IBM ended 2010 with $11.7 billion of cash and increased our pre-tax income 3.4 times, our earnings marketable securities. per share 4.7 times and our free cash flow 2.8 times. Investment and return to shareholders: Our superior Cumulatively, we have generated about $96 billion of cash flow has enabled us to invest in the business and free cash flow. to generate substantial returns to investors. Our 2010 Our strong 2010 continued this record of superior cash investment was $6 billion for 17 acquisitions— performance: 13 of them in key areas of software. After investing Revenue and income: Our revenue was $99.9 billion, $6 billion in R&D and $4 billion in net capital expendi- up 4 percent. In 2010 we grew pre-tax income by tures, we were able to return more than $18 billion 9 percent, to $19.7 billion, our highest ever. to you—$15.4 billion through share repurchases and $3.2 billion through dividends. Last year’s dividend Margins: IBM’s gross profit margin rose for the increase was 18 percent, marking the 15th year in a row seventh consecutive year—to 46.1 percent, up in which we have raised our dividend. Over the past 9.4 points since 2002. Our pre-tax income margin rose decade, we have returned $107 billion to you in the form to 19.7 percent. Both margins are at their highest of dividends and share repurchases, while investing in more than a decade. We achieved this by driving $70 billion in capital expenditures and acquisitions, productivity and continuing to shift our business and almost $60 billion in R&D. mix to more profitable segments. Once again, more than 90 percent of our segment profit in 2010 was from software, services and financing. Leading our industry Earnings per share: We have continued to achieve and the market strong EPS growth. Last year was another record, We have been able to achieve these results because with diluted earnings per share of $11.52, up of the transformation of our company that we began 15 percent. This marked eight straight years of several years ago. At the time, we saw an undercurrent double-digit EPS growth. of fundamental change.


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    A Letter from the Chairman 3 Samuel J. Palmisano Chairman, President and Chief Executive Officer


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    4 1. Changes in the world: The lowering of trade barriers, the rise of the developing world and the emergence of the World Wide Web were unleashing the flow of work Now that we have shown on a global scale. We believed these changes were we can deliver results powerful and irreversible, and that they would lead to new high-growth market opportunities and a new with consistency, we are form of the corporation itself—what we came to call doing it again through the globally integrated enterprise. the introduction last year 2. Changes in technology: At the same time, a new model of computing was replacing the PC-based, of our 2015 Road Map. client/server approach. Computational capability was being put into things no one would recognize as Because we believed that these shifts would change computers: phones, cameras, cars, appliances, road- our industry, creating winners and losers, we trans- ways, power lines, clothes—and even natural systems, formed IBM’s mix of products, services, skills and such as agriculture and rivers. All of these were being technologies—exiting commoditizing businesses connected. And we had developed the computing like PCs and hard disk drives, and making 116 strategic power and advanced analytics to turn mountains acquisitions over the course of the decade, largely of data into insight. As a result, the economic, societal in software and services. We amassed substantial and physical systems of the world were becoming cross-industry expertise, and reinvented the way instrumented, interconnected and intelligent. we deploy it, shifting skills and decision making Our planet was becoming smarter. closer to the marketplace and the client. We invested 3. Changes in client demand: Driven by the new significantly more in our teams and capabilities in opportunities and competitive demands of these first the developing world, and we accelerated the global two shifts, enterprises and institutions were no longer integration of IBM’s operations. content with off-the-shelf technology. They now sought We also worked to rebalance our internal R&D. to innovate—not just in their products and services, Of the 5,896 U.S. patents IBM received in 2010 (once but also their business processes, management systems, again a record for any company, and our 18th straight policies and core business models. To accomplish year of patent leadership), more than 70 percent were that, they needed to focus on the business outcomes for software and services. that resulted from technological innovation.


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    A Letter from the Chairman 5 of productivity improvement over the next five years. A road map to the future Part of that will go to our bottom line, and part will IBM today is a fundamentally different company. go to investments that improve our competitiveness In order to make that clear to our investors and to the in the marketplace. financial markets, we decided four years ago to Secondly, we will continue returning value to you. introduce our 2010 Road Map. We wanted to explain Our road map calls for $50 billion in anticipated share where we were going and to provide benchmarks repurchases and $20 billion in dividends. for you to evaluate us along the way. We believed— When it comes to the third component of our and still believe—that this longer-term framework road map, we will focus on four growth priorities: is the most helpful way to understand our company. 1. Growth Markets. To some, it seemed foolhardy. To my knowledge A historic economic expansion is underway in the no company in our industry had done this before. emerging markets of the world—as their populations But we felt IBM should take a long-term view, in public join the middle class and their economies join the as well as in private. And we felt confident about the global marketplace. These markets are expected future, because of the transformational steps we had to achieve average GDP growth of 5 percent through taken to reposition the company. 2015, more than double the projected growth Clearly, this worked. As you know, we surpassed rate of the developed world. In the largest of these our 2010 goal of $10 to $11 in earnings per share. emerging markets, such as China, India and Brazil, And now that we have shown we can deliver results IBM is broadening its well-established base of skills with consistency, we are doing it again through the and capabilities, nearly doubling our number of branch introduction last year of our 2015 Road Map. locations. In less developed markets, such as Africa, As before, our new road map isn’t just a list we are leveraging anchor clients in sectors like of targets; it’s a management model, organized communications and banking. Our recent partnership around the major drivers of IBM’s earnings per with Bharti Airtel to provide 21st century wireless share performance. Those are: operating leverage, telecommunications across 16 countries of Sub- share repurchase and growth strategies. Saharan Africa is one example. Our Growth Markets Operating leverage will come from our continuing Unit accounted for 21 percent of IBM’s geographic shift to higher-margin businesses and our improving revenue in 2010. We are aiming to approach enterprise productivity. We are aiming for $8 billion 30 percent by 2015.


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    6 2. Business Analytics and Optimization. 4. Smarter Planet. The research firm IDC predicts that global data Put it all together, and you have what we mean volumes will increase by 29 times over the next by “building a smarter planet.” In 2008 and 2009, 10 years—to 35 zettabytes. (A zettabyte is a 1 followed we articulated a point of view on ways the world by 21 zeros.) Enterprises need a way to manage can become smarter, and in 2010, we deployed and mine this deluge of potentially valuable significant resources to capture the opportunity information, and the key is advanced data analytics. in key, high-growth industries—such as healthcare, IBM spotted this emerging need early, building the retail, banking and telecommunications—where world’s leading analytics practice, with 7,800 expert our experience and solution delivery is strongest. consultants, the world’s premier nonacademic We also expanded our Smarter Cities initiative. mathematics function, leading-edge software and Our road map calls for Smarter Planet solutions offerings integrated by industry. We have received to grow to $10 billion in revenue by 2015. more than 500 analytics patents and have made acquisitions to deepen our capabilities. Under our 2015 Road Map, analytics is expected to grow to $16 billion in revenue by 2015. By becoming a very different 3. Cloud and Smarter Computing. company from what we As the world becomes more instrumented and inter- were just a few years ago, connected, businesses and institutions need smarter IT infrastructures to handle dramatic increases in we have become much more data volumes, and to improve data center efficiency. like the company IBM has We are creating new ways to design computer systems—optimized for specific workloads—and been for most of its history. new ways to deliver IT-infused services. IBM has helped thousands of clients adopt aspects of cloud In sum, our superior strategic positioning, strong delivery, where IT resources are virtualized, highly balance sheet, solid recurring revenue, robust automated and accessed by self-service. We profit streams and unmatched global reach give are assisting clients in areas as diverse as banking, us confidence that we will be able to continue healthcare and government to build their own clouds achieving the same kinds of results in the next five or to tap securely into IBM cloud-based business years that we have achieved during the past decade. and infrastructure services. Our road map calls for $7 billion in revenue from cloud by 2015.


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    A Letter from the Chairman 7 Over the last 10 years, we have nearly tripled scale systems such as U.S. Social Security; and our EPS, added $109 billion in free cash flow, returned the farther reaches of scientific progress, from the $107 billion to you, tripled our software profits and exploration of space to the frontiers of genomics, increased the share of our revenue from growth bioinformatics and nanotechnology. Today, it markets from 11 to 21 percent, excluding divested encompasses the even broader range of work we PCs and printers. Over the next five years, we expect describe as building a smarter planet—optimizing to grow our operating (non-GAAP) earnings to at the enormously complex systems that enable services least $20 per share, to generate another $100 billion to be delivered; physical goods to be developed, in free cash flow, to return an additional $70 billion manufactured, bought and sold; everything from to you, to grow our software profit to about half of people and money to oil, water and electrons total segment profit and to increase growth markets’ to move; and billions of people to work and live. contribution to our revenue to nearly 30 percent. Second, we have created the tools to do that The information on pages 9 to 15—“Generating ambitious work and to capture its economic Higher Value at IBM”—summarizes our road opportunity. maps, places them in the context of IBM’s 100 years of growth, and describes our opportunities in the In the early decades of IBM’s life, this involved clocks, coming era. scales and punched card tabulators. It changed fundamentally with the dawn of the computer age, as IBM created many of its technological break- A new century of progress throughs, from the relational database to the disk Let me close with a few words on reaching the drive, DRAM, FORTRAN, the mainframe, the PC extraordinary milestone of 100 years, which we will and much more. We built the world’s most productive mark on June 16 of this year. industrial laboratory—home to five Nobel Prize Throughout this time, spanning many eras of winners and generator of more U.S. patents than technology, markets, global economics, politics and any other company in the world. And it continues culture—and across multiple managements, strategies, today, with breakthroughs such as Watson, the innovations, products and services within IBM itself— computer that recently defeated the two all-time our company has consistently done three things: champions on the television quiz show, Jeopardy! Watson’s vast analytic capacity represents a new First, we have foreseen the opportunities stage in computing’s ability to tackle the world’s of our times, and made markets in them. most pressing needs where and when they really These have included the automation of modern retail, emerge—in the natural language of healthcare, banking and air travel; the creation of population- banking, government, retail and more.


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    8 Finally, we have consistently built an organization In a fundamental sense, by becoming a very different that can sustainably deliver that kind of value. company from what we were just a few years ago, we have become much more like the company IBM This is nontrivial. Over the past century, many has been for most of its history. As we start our second enterprises, institutions and governments have century, that’s a good place to be. come and gone. IBM’s longevity rests on our founders’ Let me close by expressing my pride in the world- success in shaping a particular kind of organization. wide IBM team for bringing us to this point, and my It was a company that mastered the creation of gratitude to you, our shareholders, for your unwavering economic value from knowledge and information; support. I hope that you are pleased with how your that was truly global—whatever that meant for each company is performing and evolving. And I trust that era; and that pioneered a new kind of relationship you share our excitement about the future of an with society. Most importantly, IBM’s leaders believed enterprise whose storied past is propelling us into that a great company could only survive decades an enormously promising future. of change through the intentional creation of a vibrant culture, one grounded in shared beliefs and values. And they and subsequent generations of IBMers actually built it. That is the legacy of IBM’s first century, and it continues to shape our company today. It is no accident that Samuel J. Palmisano our growth strategies like Smarter Planet and Growth Chairman, President and Chief Executive Officer Markets are aimed at the most promising business and societal opportunities of our era. Nor is it surprising that we are pushing the frontiers of science and technology to achieve those ambitious goals—from analytics, to cloud, to new workload-specific computing models. It is also consistent with our DNA that we have paid equal attention to the continual reinvention of IBM itself—most importantly, reexamining and applying our core values to how we run the company. This letter includes selected references to certain non-GAAP financial measures that are made to facilitate a comparative view of the company’s ongoing operational performance. For information about the company’s financial results related to (i) free cash flow excluding Global Financing receivables and (ii) operating (non-GAAP) earnings, which are in each case non-GAAP measures, see the company’s Form 8-K submitted to the SEC on January 18, 2011 (Attachment II — Non-GAAP Supplementary Materials).


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    Generating Higher Value at IBM 9 Generating Higher Value at IBM Over the past decade, IBM has built a record of leadership by pursuing the most transformational opportunities, inventing the breakthrough technologies to capture them and building an organization able to deliver superior results over the long term. This wasn’t new. It’s what we have been doing for 100 years.


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    10 As the new century dawned, we saw change coming. The IT industry and the broader economy were being transformed by the rising tide of global integration, by a new computing model and by new client needs for integration and innovation. And that meant we needed to transform ourselves. 1. We changed our business mix toward 2. We became a globally integrated enterprise, higher-value, more profitable technologies improving productivity and capturing new growth. and market opportunities. Since 2005, global integration has enabled IBM to gain $6 billion in productivity savings while improving service quality. We have shifted Segment Pre-Tax Income* ($ in billions) resources toward building client relationships and employee skills, 2.7 1.2 4.5 2.8 while positioning IBM for new market opportunities, such as business analytics, Smarter Cities and infrastructure build-outs underway in 2000** 24% 11% 40% 25% emerging markets. 1.6 2.0 8.1 9.1 Growth Markets Share of Geographic Revenue 2010 8% 9% 39% 44% (excluding divested businesses of PCs and printers) 21 % 0 4 8 12 16 $20 Hardware Financing Services Software * Sum of external segment pre-tax income not equal to IBM pre-tax income. 11% ** Excludes Enterprise Investments and not restated for stock-based compensation. 00 06 07 08 09 10 Financial Performance History 3. By aligning our business model with our clients’ (% of total revenue, $ in billions) needs we generated superior financial results. 50% $16 46.1% We achieved record earnings per share. Diluted earnings per share in 2010 were $11.52, having nearly 12 37% tripled since the end of 2000, and marking eight consecutive years of double-digit growth. Our focus on productivity and a continuing shift in our business mix to more profitable 25 8 segments has helped drive our performance. 19.7% And record cash performance. 4 12% In 2010 our free cash flow, excluding the year-to-year change in Global Financing receivables, was $16.3 billion—an increase of $1.2 billion from 2009. Since the end of 2000 we have generated 0 0 00 10 00 10 $109 billion in free cash flow. Pre-Tax Income Margin Gross Profit Margin Free Cash Flow Primary Uses of Cash Since the End of 2000 4. We invested in future sources of growth and provided record returns to shareholders … Since the end of 2000, we invested $43 billion in capital expenditures and $27 billion net on acquisitions (116 companies) targeted toward high-value areas. $ 70billion Reinvested Capital Expenditures & Acquisitions We returned $89 billion to our shareholders as share repurchases and increased our dividend each year over the last decade. $ 177 billion At the end of 2010 our quarterly dividend per share was five times higher than in 2000. $ 107billion Returned to Shareholders … while continuing to invest in R&D — nearly Share Repurchases & Dividends $60 billion since the end of 2000.


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    Generating Higher Value at IBM 11 5. Today, we run a business model that delivers long-term value and high performance. At Least $20 Early in 2007, we established our earnings per share road map Operating EPS* to 2010. It provided clarity about our business model, objectives and key factors driving performance. The road map also aligned all IBMers against a set of long-term objectives. We achieved $11.52 of EPS in 2010, well above the high end of the range of $10 to $11 during one of the toughest economic environments in decades. This resulted in superior returns to investors over the road map period. Now, our 2015 Road Map continues the drive to higher value—with the expectation of at least $20 operating EPS in five years (non-GAAP).* Key objectives over the next five years: • $100 billion in free cash flow • Software becomes about half of segment profit • $70 billion of capital returned to shareholders • Growth markets approach 30 percent of • $20 billion in spending geographic revenue on acquisitions Operating EPS* Segment Operating Pre-Tax Income*, ** Software Services Hardware/Financing 2000 2006 2007 2008 2009 2010 2015 Key Drivers for 2015 EPS Road Map *Excludes acquisition-related and nonoperating retirement-related charges. Revenue Growth Operating Leverage Share Repurchase A combination of base A shift to higher-margin businesses Leveraging our strong cash **2000 and 2001 exclude Enterprise Investments revenue growth, a shift to and enterprise productivity generation to return value and not restated for stock-based compensation. Sum of external segment pre-tax income not equal faster growing businesses derived from global integration to shareholders by reducing to IBM pre-tax income. and strategic acquisitions. and process efficiencies. shares outstanding.


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    12 Today our investments are fueling growth initiatives that are expected to drive $20 billion in incremental revenue by 2015. Growth Markets A historic economic expansion is underway in the Approaches emerging markets of the world—as their populations 30% of IBM’s geographic revenue by 2015 join the middle class and their economies join the global marketplace. In the largest of these emerging markets, such as China, India and Brazil, IBM is broadening Opportunity: its well-established base of skills and capabilities, nearly The emerging market GDP growth doubling our number of branch locations. In less rate—expected to be 5 percent developed markets, such as Africa, we are leveraging through 2015—is more than double that of major markets. anchor clients in sectors like communications and banking. Our recent partnership with Bharti Airtel Africa to 2015 Road Map Objective: Growth Markets revenue provide 21st century wireless telecommunications across approaches 30 percent of IBM’s 16 countries of Sub-Saharan Africa is one example. geographic revenue by 2015. Cloud IBM has helped thousands of clients in areas as diverse $ 7billion in revenue by 2015 as banking, healthcare and government build their own clouds or securely tap into IBM cloud-based business and infrastructure services. IBM manages millions of cloud- based transactions every day and provides cloud analytics Opportunity: Cloud is a new, highly efficient model services to clients like Seton Hall University, Petco, Speedo for consuming and delivering IT-based and Crocs. services. It is made possible by virtualizing resources, automating processes ING, a major player in the financial services industry, and standardizing tasks so they can be engaged IBM to design and build a cloud platform that will offered as easy-to-use services. speed the delivery of new services to millions of clients and 2015 Road Map Objective: employees. Danone is working with IBM to provide a secure Cloud revenue is expected to be cloud trading network for its customers and business $7 billion by 2015, of which $3 billion is incremental. partners, while ADP is using IBM’s cloud integration software to expand its tax filing offerings to new markets serving employers of all sizes.


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    Generating Higher Value at IBM 13 Business Analytics Enterprises need a way to manage and mine the deluge $ 16 billion in revenue by 2015 of potentially valuable information, and the key is advanced data analytics. IBM spotted this emerging need early, building the world’s leading analytics practice—with 7,800 expert consultants, the world’s premier nonacademic Opportunity: Global data volumes are predicted mathematics function and the acquisition of 25 companies, to increase by 29 times over the next for $14 billion in gross spending, to deepen our capabilities. 10 years to 35 zettabytes.* (A zettabyte is a 1 followed by 21 zeros.) Our scientists have received more than 500 analytics 2015 Road Map Objective: patents. They are expanding technology frontiers through Business analytics revenue is breakthroughs like the powerful new computer named expected to be $16 billion by 2015. Watson, which competed and won on the television quiz show Jeopardy! Applying Watson’s use of advanced analytics to decipher natural language, IBM is working to identify better healthcare diagnoses, potential drug interactions and “what if” scenarios in finance and compliance. Smarter Planet In 2008 and 2009, we articulated a point of view on ways $ 10 billion in revenue by 2015 the world can become smarter, and in 2010, we deployed significant resources to capture the opportunity in key, high-growth industries where our experience and solution delivery is strongest. We also expanded our Smarter Cities Opportunity: The infusion of digital intelligence into initiative, targeting local leaders who influence trillions in industries, infrastructures, processes spending worldwide. In Rio de Janeiro, IBM is developing and cities can make them more a system to integrate real-time information and processes productive, efficient and responsive. across many city departments, including civil defense, 2015 Road Map Objective: transportation and meteorology, for a sustainable opera- Smarter Planet revenue is expected to be $10 billion by 2015. tions infrastructure in the face of unprecedented growth. Similar city infrastructure projects are underway in cities across the world such as Ho Chi Minh City, Shanghai, Seoul, Sydney, Helsinki, Amsterdam, Rotterdam, San Francisco and Washington, D.C. *David Reinsel, vice president, Storage Group, IDC Research


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    14 In our second century, as in our first, IBM’s business model is based on continuous forward motion. Through 100 years of a commitment to innovation and progress … Inventing core technologies … A commitment to research … Through breakthroughs like the FORTRAN programming IBM has invested more than $150 billion in R&D, and has received language in 1957, computer memory in the 1960s, the relational more than 75,000 U.S. patents. Five IBMers were Nobel Laureates. database in the 1970s, reduced instruction set computing (RISC) Today we have 10 global research labs pioneering breakthroughs, in the early 1980s, and materials science advances in the 1990s advancing technologies and helping define open standards. IBM (now in millions of mobile devices), IBM built the foundations for a Research is engaged in long-term collaborations with universities, world of instrumented, interconnected and intelligent systems. government agencies and businesses, in fields as varied as nanotechnology, deep analytics and the evolution of the Internet. Defining computing architectures … From punched card tabulators in the 1920s, to the compatible mainframe System/360 in the 1960s, to the PC in the 1980s, to parallel computing in the 1990s, IBM has shaped the modern IT industry. Today IBM is leading shifts to enterprise cloud computing and building highly optimized systems like Watson able to understand and analyze natural language. • 1911 • 1943 1957 • Net income: Net income: Net income: $800,000 $9 million $110 million Revenue: Revenue: exceeds $100 million exceeds $1 billion 1910 1920 1930 1940 1950 1960 For 100 years, IBM has transformed industries and advanced the world’s most critical systems. Automating Rail Systems Modernizing Government Automating Aviation Raising Healthcare 1915 Nearly all major U.S. 1922 Tabulating technology Industry Operations Standards railroads used tabulating used to conduct Brazil’s first 1962 Created the Sabre 1965 Physicians detected technology to automate mechanized census. airline reservation system for changes in temperature, blood scheduling and accounting American Airlines—a precursor pressure and heartbeat with 2010 Helped New York of everything from the ATM data collected and visualized operations, starting State save nearly $1 billion to e-commerce. by an IBM monitoring system. with New York Central and preventing tax fraud with Hudson River Railroad. advanced analytics. 2010 Helping New Delhi’s 2010 Stream computing 2010 Helped Russian Railways international airport manage technology and advanced move 1.3 billion passengers growth in air travel from analytics research at the and freight more efficiently. 28 million passengers today University of Ontario Institute to an expected 150 million of Technology are used to passengers in 2020. monitor the health of premature babies at the Hospital for Sick Children, Toronto.


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    Generating Higher Value at IBM 15 IBM Share Price* $160 (Adjusted for stock splits) … IBM has changed global business and society, in the $140 process generating strong financial results and superior returns to our owners. $120 Since 1915, IBM stock has Over that same period the appreciated more than Dow Jones Industrial Average has appreciated about 40,000 $100 times its original value. 125 times. $80 One hundred years of driving progress gives us confidence that we can continue to do so—and to deliver superior returns—in our second century. $60 $40 • 1985 • 2000 2010 • Net income: Net income: Net income: $6.6 billion $7 billion $14.8 billion $20 Revenue: Revenue: Revenue: exceeds $85.1 billion $99.9 billion $50 billion 1970 1980 1990 2000 2010 Building Smarter Energy Reinventing Transportation Upgrading the Developing Banking and Water Systems 1930 IBM receives patent Retail Experience Infrastructure 1965 Analyzed ways to increase for traffic signal timing system. 1974 Supermarkets start 1997 Created first global power output of hydroelectric scanning UPC barcodes, settlement system for currency dams in France. 2010 Helped speed invented by IBM. exchange, averaging $4 trillion development of GM’s a day, with the CLS Group, an 2009 Helped implement Chevrolet Volt electric vehicle 2010 Collaborated with industry consortium. the world’s first nationwide with sophisticated design Thailand’s Ministry of smart grid for Malta’s and simulation software. Agriculture and Cooperatives 2008 Introduced world’s first energy and water systems. to implement food traceability real-time securities settlement technologies with farmers, system for Mexico. exporters and retailers. *Reflects IBM share price from November 1915 through January 19, 2011, the day after IBM’s 2010 earnings announcement. IBM share price from December 1925 to December 2010 was calculated (or derived) based on data from CRSP US Stock Database © 2010. Center for Research in Security Prices (CRSP), The University of Chicago Booth School of Business. “Generating Higher Value at IBM” includes selected references to certain non-GAAP financial measures that are made to facilitate a comparative view of the company’s ongoing operational performance. For information about the company’s financial results related to (i) free cash flow excluding Global Financing receivables and (ii) operating (non-GAAP) earnings, which are in each case non-GAAP measures, see the company’s Form 8-K submitted to the SEC on January 18, 2011 (Attachment II — Non-GAAP Supplementary Materials).


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    Financial Highlights 16 International Business Machines Corporation and Subsidiary Companies ($ in millions except per share amounts) For the year ended December 31: 2010 2009 Revenue $ 99,870 $ 95,758 Net income $ 14,833 $ 13,425 Earnings per share of common stock: Assuming dilution $ 11.52 $ 10.01 Basic $ 11.69 $ 10.12 Net cash provided by operating activities $ 19,549 $ 20,773 Capital expenditures, net 3,984 3,747 Share repurchases 15,375 7,429 Cash dividends paid on common stock 3,177 2,860 Per share of common stock 2.50 2.15 At December 31: 2010 2009 Cash, cash equivalents and marketable securities $ 11,651 $ 13,973 Total assets 113,452 109,022 Working capital 7,554 12,933 Total debt 28,624 26,099 Total equity 23,172 22,755 Common shares outstanding (in millions) 1,228 1,305 Market capitalization $180,220 $170,869 Stock price per common share $ 146.76 $ 130.90 Number of employees in IBM/wholly owned subsidiaries 426,751 399,409


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    Report of Financials International Business Machines Corporation and Subsidiary Companies 17 Management Discussion Notes to Consolidated Overview 18 Financial Statements Forward-Looking and Cautionary Statements 18 A Significant Accounting Policies 68 Management Discussion Snapshot 18 B Accounting Changes 79 Description of Business 20 C Acquisitions/Divestitures 81 Year in Review 25 D Fair Value 86 Prior Year in Review 39 E Financial Instruments (Excluding Derivatives) 88 Other Information 46 F Inventories 90 Looking Forward 46 G Financing Receivables 90 Liquidity and Capital Resources 47 H Plant, Rental Machines and Other Property 92 Critical Accounting Estimates 50 I Investments and Sundry Assets 92 Currency Rate Fluctuations 53 J Intangible Assets Including Goodwill 93 Market Risk 53 K Borrowings 94 Financing Risks 54 L Derivative Financial Instruments 96 Employees and Related Workforce 54 M Other Liabilities 102 Global Financing 55 N Equity Activity 103 O Contingencies and Commitments 103 Report of Management 60 P Taxes 106 Report of Independent Registered Q Research, Development and Engineering 108 Public Accounting Firm 61 R Earnings Per Share of Common Stock 108 S Rental Expense and Lease Commitments 109 Consolidated Financial Statements T Stock-Based Compensation 109 Earnings 62 U Retirement-Related Benefits 112 Financial Position 63 V Segment Information 126 Cash Flows 64 W Subsequent Event 130 Changes in Equity 65 Five-Year Comparison of Selected Financial Data 131 Selected Quarterly Data 132 Performance Graphs 133 Board of Directors and Senior Leadership 135 Stockholder Information 136


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    Management Discussion 18 International Business Machines Corporation and Subsidiary Companies Overview • Within the financial statements and tables in this Annual Report, certain columns and rows may not add due to the use of rounded The financial section of the International Business Machines Cor- numbers for disclosure purposes. Percentages reported are poration (IBM or the company) 2010 Annual Report includes the calculated from the underlying whole-dollar numbers. Management Discussion, the Consolidated Financial Statements and the Notes to the Consolidated Financial State ments. This Over view is designed to provide the reader with some perspective Forward-Looking regarding the information contained in the financial section. and Cautionary Statements Certain statements contained in this Annual Report may constitute Organization of Information forward-looking statements within the meaning of the Private Secur- • The Management Discussion is designed to provide readers ities Litigation Reform Act of 1995. Any forward-looking statement with an overview of the business and a narrative on the com- in this Annual Report speaks only as of the date on which it is made; pany’s financial results and certain factors that may affect the company assumes no obligation to update or revise any such its future prospects from the perspective of the company’s statements. Forward-looking statements are based on the com- management. The “Management Discussion Snapshot” on pany’s current assumptions regarding future business and financial pages 18 to 20 presents an overview of the key performance performance; these statements by their nature address matters that drivers in 2010. are uncertain to different degrees. Forward-looking statements • Beginning with the “Year in Review” on page 25, the Management involve a number of risks, uncertainties and other factors that could Discussion contains the results of operations for each reportable cause actual results to be materially different, as discussed more segment of the business and a discussion of the company’s fully elsewhere in this Annual Report and in the company’s filings financial position and cash flows. Other key sections within the with the Securities and Exchange Commission (SEC), including the Management Discussion include: “Looking Forward” on pages company’s 2010 Form 10-K filed on February 22, 2011. 46 and 47 and “Liquidity and Capital Resources” on pages 47 to 50. It is useful to read the Management Discussion in conjunc- tion with note V, “Segment Information,” on pages 126 to 130. Management Discussion Snapshot • Global Financing is a reportable segment that is measured as ($ and shares in millions except per share amounts) a standalone entity. A separate “Global Financing” section is Yr.-to-Yr. Percent/ included beginning on page 55. Margin • The Consolidated Financial Statements are presented on pages For the year ended December 31: 2010 2009 Change 62 through 67. These statements provide an overview of the Revenue $ 99,870 $ 95,758 4.3%* company’s income and cash flow performance and its financial Gross profit margin 46.1% 45.7% 0.3 pts. position. Total expense and other income $ 26,291 $ 25,647 2.5% • The Notes follow the Consolidated Financial Statements. Total expense and other Among other items, the Notes contain the company’s accounting income-to-revenue ratio 26.3% 26.8% (0.5) pts. policies (pages 68 to 79), acquisitions and divestitures (pages Income before income taxes $ 19,723 $ 18,138 8.7% 81 to 86), detailed information on specific items within the finan- Provision for income taxes 4,890 4,713 3.8% cial statements, certain contingencies and commitments (pages Net income $ 14,833 $ 13,425 10.5% 103 through 105), and retirement-related benefits information Net income margin 14.9% 14.0% 0.8 pts. (pages 112 through 126). Earnings per share of • The Consolidated Financial Statements and the Notes have been common stock: prepared in accordance with accounting principles generally Assuming dilution $ 11.52 $ 10.01 15.1% accepted in the United States (GAAP). Weighted-average shares • The references to “adjusted for currency” or “at constant cur- outstanding: rency” in the Management Discussion are made so that certain Assuming dilution 1,287.4 1,341.4 (4.0)% financial results can be viewed without the impact of fluctuations Assets** $113,452 $109,022 4.1% in foreign currency exchange rates, thereby facilitating period- Liabilities** $ 90,279 $ 86,267 4.7% to-period comparisons of business performance. Financial results adjusted for currency are calculated by translating Equity** $ 23,172 $ 22,755 1.8% current period activity in local currency using the comparable * 3.3 percent adjusted for currency. prior year period’s currency conversion rate. This approach is ** At December 31. used for countries where the functional currency is the local country currency. See “Currency Rate Fluctuations” on page In 2010, the company delivered strong financial results highlighted 53 for additional information. by improved revenue performance, continued margin expansion, solid cash generation and record levels of net income and earnings per share. The financial performance continues to be driven by the


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    Management Discussion International Business Machines Corporation and Subsidiary Companies 19 strength of the company’s global model and the results of the Russia, India and China which increased 18 percent, adjusted for strategic transformation of the business. currency. Within the growth markets, 40 countries grew revenue The company’s transformation, which started at the beginning at a double-digit rate at constant currency in 2010 compared to of the decade, has been focused on shifting the business to higher the prior year. Segment performance was driven by Systems and value areas of the market, improving operating leverage through Technology which increased 11.0 percent year to year (11 percent productivity and investing in opportunities to drive future growth. adjusted for currency) and Software which increased 5.1 percent The overall changes to the business have been dramatic. Several (5 percent adjusted for currency). Software revenue, excluding examples demonstrate the success of this transformation. PLM, grew 8.1 percent (8 percent adjusted for currency). Within To capture the opportunity that exists in the emerging markets, Software, performance was led by key branded middleware the company created a dedicated management system and which increased 10.8 percent (11 percent adjusted for currency) invested to drive market expansion and infrastructure development. compared to the prior year. Systems and Technology revenue Since 2000, the company has added $10 billion in annual revenue growth was driven by new product introductions and very strong from its growth markets, and with a revenue growth rate that has performance in the growth markets which increased 20 percent consistently exceeded the major markets, the revenue contribution (19 percent adjusted for currency). from the growth markets has increased significantly to 21 percent The consolidated gross profit margin increased 0.3 points of total geographic revenue in 2010. versus 2009 to 46.1 percent, reflecting the improved business mix, Across the company’s portfolio, there has been a shift to higher operating leverage and the continued success of the company’s value areas while divesting commoditizing businesses. These productivity initiatives. This was the seventh consecutive year actions have contributed to a significant change in the mix of the of improvement in the gross profit margin. Gross profit margin business. In 2000, Global Services segment pre-tax income was performance by segment and the impact to the consolidated gross $4.5 billion; in 2010, it was over $8 billion. The Software growth is margin was as follows: even more dramatic. In 2000, Software segment pre-tax income was $2.8 billion; in 2010, it was over $9 billion, tripling since 2000 Gross Yr.-to-Yr. Consolidated Margin Change Impact and now representing 44 percent of total segment pre-tax income. At the consolidated level, since 2000, the company has added Global Technology Services 34.7% (0.3) pts. (0.0) pts. $10 billion of pre-tax income, nearly tripled earnings per share and Global Business Services 28.3% 0.0 pts. 0.0 pts. generated over $162 billion in cash flow from operating activities. Software 86.9% 0.9 pts. 0.3 pts. The strong profit and cash generation has enabled the company Systems and Technology 38.5% 0.7 pts. 0.0 pts. to invest in the business, while delivering significant shareholder Global Financing 51.3% 3.8 pts. 0.1 pts. returns. In the past 10 years, the company has invested almost $60 billion in research and development and approximately $32 In 2010, the company continued to invest for innovation and billion in acquiring 116 companies, adding to its capabilities in high- growth. These investments supported the introduction of the new value areas like business analytics and smarter planet. From 2001- System z mainframe and POWER7 products and the success in 2010, the company returned $107 billion to shareholders through the performance of the growth markets. The company also invested share repurchases and dividends, with almost $19 billion in 2010. $6 billion to acquire 17 companies, adding significant new capa- The company’s performance in 2010 marked the end of a very bilities to support its growth initiatives. successful decade. The changes that the company has made over Total expense and other income increased 2.5 percent in 2010 the last 10 years have strengthened the business and position it versus 2009. The year-to-year drivers were approximately: well going forward. For the year, the company delivered $11.52 in diluted earnings • Operational expense, (2) points per share, an increase of 15.1 percent year to year. This was the • Currency,* 1 point eighth consecutive year of double-digit earnings per share growth. • Acquisitions,** 3 points In 2007, the company developed a Road Map for growth with an * Reflects impacts of translation and hedging programs. earnings per share objective for 2010 of $10 to $11 per share. With ** Includes acquisitions completed in prior 12-month period. its performance in 2010, the company exceeded the low end of its objective by $1.52 per share and the high end by $0.52 per Pre-tax income grew 8.7 percent and the pre-tax margin was 19.7 share. The resilience of the business model enabled the company percent, an increase of 0.8 points versus 2009. Net income to exceed its objective even while managing through the severe increased 10.5 percent reflecting an improvement in the tax rate. global recession. The effective tax rate was 24.8 percent, compared with 26.0 Total revenue for 2010 increased 4.3 percent (3 percent adjusted percent in the prior year. Net income margin improved 0.8 points for currency) compared to 2009; excluding the divested Product to 14.9 percent. Lifecycle Management (PLM) operations, total revenue increased Diluted earnings per share improved 15.1 percent reflecting the 4.9 percent (4 percent adjusted for currency). Revenue from the strong growth in net income and the benefits of the common stock growth markets increased 16.0 percent (11 percent adjusted for repurchase program. In 2010, the company repurchased approxi- currency) with performance led by the BRIC countries of Brazil, mately 118 million shares of its common stock. Diluted earnings per


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    Management Discussion 20 International Business Machines Corporation and Subsidiary Companies share of $11.52 increased $1.51 from the prior year driven by the Net cash used in financing activities of $12,429 million was following factors: $2,271 million lower versus 2009, primarily due to the net benefit from debt ($9,812 million) and an increase in cash from other • Revenue increase at actual rates, $0.43 common stock transactions ($722 million), partially offset by higher • Operating leverage, $0.62 common stock repurchases ($7,946 million). • Common stock repurchases, $0.46 The estimated Global Services backlog was $142 billion at December 31, 2010, up $5 billion ($4 billion adjusted for currency) At December 31, 2010, the company’s balance sheet and liquidity versus the prior year-end balance. positions remained strong. Cash and marketable securities at year In January 2011, the company disclosed that it is expecting GAAP end were $11,651 million. Total debt of $28,624 million increased earnings of at least $12.56 and operating (non-GAAP) earnings of $2,525 million year to year, and the company generated $19,549 at least $13.00 per diluted share for the full year 2011. For additional million in operating cash flow in 2010. The company has consistently information on the company’s use of operating (non-GAAP) earnings, generated strong cash flow from operations and also continues to see the “Looking Forward” section on pages 46 and 47. have access to additional sources of liquidity through the capital For additional information and details, see the “Year in Review” markets and its global credit facility. section on pages 25 to 39. Key drivers in the company’s balance sheet and total cash flows are highlighted below. Total assets increased $4,430 million ($3,609 million adjusted Description of Business for currency) from December 31, 2009, driven by: Please refer to IBM’s Annual Report on Form 10-K filed with the SEC • Increased goodwill ($4,946 million) and intangible assets ($975 on February 22, 2011 for a more detailed version of this Description million) driven by 2010 acquisitions; of Business, especially Item 1A. entitled “Risk Factors.” • Higher level of total receivables ($1,337 million) and increased The company creates business value for clients and solves total other assets ($679 million), partially offset by; business problems through integrated solutions that leverage • Decreases in cash and cash equivalents ($1,522 million) and information technology and deep knowledge of business processes. marketable securities ($800 million); and IBM solutions typically create value by reducing a client’s operational • Lower total deferred taxes ($1,140 million). costs or by enabling new capabilities that generate revenue. These solutions draw from an industry-leading portfolio of consulting, Total liabilities increased $4,012 million ($3,673 million adjusted for delivery and implementation services, enterprise software, systems currency) from December 31, 2009 driven by: and financing. • Higher total debt ($2,525 million); • Increase in deferred income ($839 million); and an Strategy • Increase in compensation and benefits ($523 million). Despite the volatility of the information technology (IT) industry over the past decade, IBM has consistently delivered superior Total equity of $23,172 million increased $418 million from the prior performance, with a steady track record of sustained earnings per year-end balance as a result of: share growth. The company has shifted its business mix, exiting commoditized segments while increasing its presence in higher- • Higher retained earnings ($11,632 million); value areas such as services, software and integrated solutions. • Increase in common stock ($3,608 million); As part of this shift, the company has acquired 116 companies • Increase in foreign currency translation adjustments ($643 this past decade, complementing and scaling its portfolio of million); and an products and offerings. • Increase in net unrealized gains on hedge of cash flow derivatives IBM’s clear strategy has enabled steady results in core business ($385 million), partially offset by an; areas, while expanding its offerings and addressable markets. The • Increase in treasury stock ($14,918 million); and a key tenets of this strategy are: • Decrease in retirement-related items ($992 million). • Deliver value to enterprise clients through integrated business The company generated $19,549 million in cash flow provided by and IT innovation; operating activities, a decrease of $1,224 million, compared to 2009, • Shift the business mix to higher-value areas; and primarily driven by a decrease in cash from total receivables ($2,620 • Become the premier globally integrated enterprise million), partially offset by the increase in net income ($1,408 million). Net cash used in investing activities of $8,507 million was $1,778 These priorities reflect a broad shift in client spending away from million higher than 2009, primarily due to increased acquisitions “point products’’ and toward integrated solutions, as companies ($4,728 million), decreased cash from divestitures ($345 million) seek higher levels of business value from their IT investments. IBM and increased net capital spending ($299 million), partially offset has been able to deliver this enhanced client value thanks to its by the year-to-year net impacts related to marketable securities industry expertise, understanding of clients’ businesses and the and other investments ($3,753 million). breadth and depth of the company’s capabilities.


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    Management Discussion International Business Machines Corporation and Subsidiary Companies 21 Consistent with this strategy IBM is leveraging its capabilities IBM’s approach is end-to-end, providing cross-enterprise as to build and expand strong positions in targeted growth areas. well as industry-based analytics solutions. IBM has established IBM’s growth initiatives include Smarter Planet, Growth Markets, the Business Analytics and Optimization practice, leveraging IBM Business Analytics and Optimization, and Cloud Computing. Each consulting capabilities and software products, along with systems initiative represents a significant growth opportunity with attractive and research assets. IBM’s breadth of expertise uniquely positions profit margins for IBM. the company for revenue and profit growth. Smarter Planet Cloud Computing Smarter Planet is an overarching strategy that highlights IBM’s Cloud is a new model for consuming and delivering IT and business differentiated capabilities and generates broad-based demand services. It can deliver significant economies of scale, higher qual- for the company’s products and services. Smarter Planet encap- ities of service and a new platform for business model innovation. sulates IBM’s view of enterprise IT’s next major revolution: the The power of the model comes from harnessing vast stores of instrumentation and integration of the world’s processes and under-utilized technology with highly efficient virtualization and infrastructures—from energy grids and pipelines to supply chains management, consumer-style user interfaces and the ubiquitous and traffic systems. The amount of data these systems can generate broadband. can now be captured and analyzed. This infusion of intelligence IBM has helped thousands of clients adopt aspects of cloud enables more efficiency, productivity and responsiveness. computing. IBM is helping them build their own cloud-based infra- Clients seeking these “smart’’ solutions value IBM’s deep structures, provide security and integration services or offering industry and process expertise, powerful back-end systems and infrastructure and business services from the IBM Cloud, including data analytics, complex systems integration capability and unique advanced analytics, collaboration, and IT infrastructure including research capacity. IBM has built a series of horizontal solutions virtual servers and storage or access to tools for testing software. through organic development and strategic acquisitions including IBM brings expert consulting, breakthrough technologies and a smarter commerce and smarter physical infrastructure. IBM’s portfolio of cloud services squarely focused on the requirements of Industry Frameworks provide a flexible software foundation for the enterprise. IBM has also implemented the cloud model within developing, acquiring and deploying these smart industry solutions. IBM in areas as diverse as sales analytics and research collaboration. Each framework supports multiple solutions, enabling fast, efficient and tailored capabilities in support of clients’ business needs. Business Model These frameworks represent a proven technique for the company The company’s business model is built to support two principal to engage with its clients, driving sustained growth and high goals: helping clients succeed in delivering business value by business value in support of our Smarter Planet strategy. becoming more innovative, efficient and competitive through the use of business insight and IT solutions; and providing long-term Growth Markets value to shareholders. The business model has been developed The company has benefited from its investments over the past over time through strategic investments in capabilities and tech- several years in growth markets. The focus now is on geographic nologies that have the best long-term growth and profitability expansion of IBM’s presence; on specific industry verticals of prospects based on the value they deliver to clients. the highest impact and opportunity; on countries’ build-out of The company’s global capabilities include services, software, infrastructure aligned with their national agendas; and on creating systems, fundamental research and related financing. The broad mix markets and new business models to serve the different require- of businesses and capabilities are combined to provide business ments that exist in these emerging countries. insight and solutions for the company’s clients. In order to support this growth, IBM is continuing to invest sig- The business model is resilient, adapting to the continuously nificantly in these markets to expand capacity and develop talent. changing market and economic environment. The company con- At the same time, IBM is expanding and benefiting from large teams tinues to divest commoditizing businesses and strengthen its of talent with global missions of delivery. The company continues position through strategic organic investments and acquisitions in to deepen its research and development (R&D) teams to design higher-value segments like business analytics, smarter planet and for the unique challenges and rapid growth facing these markets. cloud computing. In addition, the company has transformed itself into a globally integrated enterprise which has improved overall Business Analytics and Optimization productivity and is driving investment and expanding participation Business optimization through the application of analytics across in the world’s fastest growing markets. As a result, the company is the business has emerged as another major category of business a higher performing enterprise today than it was several years ago. value. It succeeds earlier generations of back-office automation, This business model, supported by the company’s long-term basic enterprise resource planning and traditional business intel- financial model, has enabled the company to deliver consistently ligence. Business analytics allows clients to see patterns in data strong earnings, cash flows and returns to shareholders in changing they could not see before, understand their exposure to risk, and economic environments. predict the outcomes of business decisions with greater certainty.


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    Management Discussion 22 International Business Machines Corporation and Subsidiary Companies Business Segments and Capabilities and centers. Each competency provides industry-leading, stan- The company’s major operations consists of five business seg- dardized, integrated tools and processes. By leveraging insights ments: Global Technology Services, Global Business Services, and experience drawn from IBM’s global scale, skills and technology, Software, Systems and Technology and Global Financing. with applied innovation from IBM Research, clients gain access to leading-edge, high-quality services with improved productivity, Global Services is a critical component of the company’s strategy flexibility and cost. of providing IT infrastructure and business insight and solutions GTS Services Delivery also provides efficient, world-class delivery to clients. While solutions often include industry-leading IBM capabilities in support of IBM’s process-based services, which software and systems, other suppliers’ products are also used if include Business Transformation Outsourcing, Business Process a client solution requires it. Approximately 60 percent of external Outsourcing and Business Process Services. These delivery capa- Global Services segment revenue is annuity-based, coming bilities are available to clients through highly skilled employees and primarily from outsourcing, maintenance and application manage- delivery centers in over 40 countries worldwide. ment services arrangements. The Global Services backlog provides a solid revenue base entering each year. Within Global Services, Global Business Services (GBS) primarily provides professional there are two reportable segments: Global Technology Services services and application management services, delivering business and Global Business Services. value and innovation to clients through solutions which leverage industry and business-process expertise while integrating the Global Technology Services (GTS) primarily provides IT infra- industry-leading portfolio of IBM and strategic partners, to define structure services and business process services, delivering the upper end of client-valued services. business value through the company’s global scale, standardiza- tion and automation. GBS Capabilities Consulting and Systems Integration. Delivery of value to clients GTS Capabilities through consulting services for Strategy and Transformation; Strategic Outsourcing Services. Comprehensive IT outsourcing Application Innovation Services; Enterprise Applications (SAP and services dedicated to transforming clients’ existing infrastructures Oracle) and Business Analytics and Optimization. to ensure better quality, flexibility, risk management and financial value. IBM integrates long-standing experience in service manage- Application Management Services. Application development, ment, technology and industry applications with new technologies, management, maintenance and support services for packaged such as cloud computing and virtualization, to help clients maximize software, as well as custom and legacy applications. Value is deliv- the application of technology to achieve their business objectives. ered through advanced capabilities in areas such as applications testing and modernization, cloud application security, the company’s Global Process Services. A range of offerings from standardized highly differentiated globally integrated capability model, industry processing platforms and business process outsourcing through knowledge and the standardization and automation of application transformational offerings that deliver improved business results development. to clients through the strategic change and/or operation of the client’s business processes, applications and infrastructure Software consists primarily of middleware and operating systems (previously known as Business Transformation Outsourcing). software. Middleware software enables clients to integrate sys- tems, processes and applications across a standard software Integrated Technology Services. Project-based portfolio of services platform. IBM middleware is designed on open standards, making that enable clients to optimize their IT environments by driving it easier to integrate disparate business applications, developed efficiency, flexibility and productivity, while reducing costs. The stan- by different methods and implemented at different times. Operating dardized portfolio is built around key assets and patented software, systems are the software engines that run computers. Approximately and incorporates best practices and proven methodologies that two-thirds of external software segment revenue is annuity-based, ensure predictive quality of delivery, security and compliance. coming from recurring license charges and ongoing subscription Maintenance. A complete line of support services from product and support. The remaining one-third relates to one-time charge maintenance through solution support to maintain and improve (OTC) arrangements in which clients pay one, up-front payment the availability of clients’ IT infrastructures. for a perpetual license. Typically, the sale of OTC software includes one year of subscription and support. Clients can also purchase GTS Services Delivery. Responsible for the worldwide delivery of ongoing subscription and support after the first year, which includes IBM’s technology- and process-based services. In support of product upgrades and technical support. technology-based services, GTS Services Delivery manages the world’s largest privately owned IT infrastructure with employees Software Capabilities in over 40 countries, supporting approximately 430 data centers. WebSphere Software. Delivers capabilities that enable clients to Operating in a globally integrated delivery model enables regional integrate and manage business processes across their organiza- client-facing teams to utilize a global network of competencies tions with the flexibility and agility they need to respond to changing


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    Management Discussion International Business Machines Corporation and Subsidiary Companies 23 conditions quickly. With a services-oriented architecture (SOA), these systems form the foundation for IBM’s integrated offerings, businesses can more easily link together their fragmented data and such as IBM Smart Business Storage Cloud, IBM Smart Analytics business processes to extract value from their existing technology. Cloud, IBM Smart Analytics System and IBM CloudBurst. IBM servers use both IBM and non-IBM microprocessor technology Information Management Software. Enables clients to integrate, and operating systems. All IBM servers run Linux, a key open- manage and use their information to gain business value and source operating system. improve their outcomes. Solutions include advanced database management, enterprise content management, information integra- Storage. Data storage products and solutions that allow clients to tion, data warehousing, business analytics and intelligence, retain and manage rapidly growing, complex volumes of digital performance management and predictive analytics. information. These solutions address critical client requirements for information retention and archiving, data deduplication, avail- Tivoli Software. Helps clients manage their technology and busi- ability and virtualization, and security and compliance. The port- ness assets by providing visibility, control and automation across folio consists of a broad range of disk and tape storage systems their organizations. With solutions for identity management, and software, including the ultra-scalable disk storage system XIV. data security, storage management and the ability to provide auto- mation and provisioning of the datacenter, Tivoli helps build the Retail Store Solutions. Point-of-sale retail systems (network infrastructure needed to make the world’s systems—from trans- connected cash registers) as well as solutions which connect them portation to water, energy and telecommunications—run smarter. to other store systems. Lotus Software. Enables businesses to connect people and Microelectronics. Semiconductor design and manufacturing pri- processes for more effective communication and increased pro- marily for use in IBM systems and storage products as well as ductivity through collaboration, messaging and social networking delivering semiconductors and related services to external clients. software. By remaining at the forefront of collaboration tools, Lotus helps organizations reap the benefits of social networking and Global Financing facilitates clients’ acquisition of IBM systems, other Web 2.0 modalities. software and services. Global Financing invests in financing assets, leverages with debt and manages the associated risks with the Rational Software. Supports software development for both IT objective of generating consistently strong returns on equity. The and embedded system solutions with a suite of Application Lifecycle primary focus on the company’s offerings and clients mitigates Management products. Jazz, Rational’s technology platform, many of the risks normally associated with a financing company. transforms the way people work together to build software, making Global Financing has the benefit of both a deep knowledge of its software delivery more collaborative, productive and transparent. client base and a clear insight into the products and services that Business Analytics. Enables clients to better analyze their data are being financed. This combination allows Global Financing to and predict outcomes in order to make better business decisions. effectively manage two of the major risks (credit and residual value) Solutions include Cognos’ business intelligence software, which that are normally associated with financing. provides comprehensive tools that range from querying to fore- casting; as well as SPSS predictive analytics software that helps Global Financing Capabilities clients predict outcomes and act on that insight. Client Financing. Lease and loan financing to end users and internal clients for terms generally between two and seven years. Internal Operating Systems. Software that manages the fundamental financing is predominantly in support of Global Services’ long-term processes that make computers run. client service contracts. Global Financing also factors a selected portion of the company’s accounts receivable, primarily for cash Systems and Technology provides clients with business solutions management purposes. All internal financing arrangements are at requiring advanced computing power and storage capabilities. arm’s-length rates and are based upon market conditions. Approximately half of Systems and Technology’s server and storage sales transactions are through the company’s business Commercial Financing. Short-term inventory and accounts receiv- partners; with the balance direct to end-user clients. In addition, able financing to dealers and remarketers of IT products. Systems and Technology provides leading semiconductor tech- nology, products and packaging solutions to clients and for IBM’s Remanufacturing and Remarketing. As equipment is returned at own advanced technology needs. the conclusion of a lease transaction, these assets are refurbished and sold or leased to new or existing clients both externally and Systems and Technology Capabilities internally. Externally remarketed equipment revenue represents sales Systems. A range of general purpose and integrated systems or leases to clients and resellers. Internally remarketed equipment designed and optimized for specific business, public and scientific revenue primarily represents used equipment that is sold or leased computing needs. These systems—System z, Power Systems and internally to Systems and Technology and Global Services. Systems System x—are typically the core technology in data centers that and Technology may also sell the equipment that it purchases provide required infrastructure for business and institutions. Also, from Global Financing to external clients.


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    Management Discussion 24 International Business Machines Corporation and Subsidiary Companies IBM Worldwide Organizations Research, Development and Intellectual Property The following worldwide organizations play key roles in IBM’s IBM’s R&D operations differentiate the company from its com- delivery of value to its clients: petitors. IBM annually invests approximately $6 billion for R&D, focusing on high-growth, high-value opportunities. The company • Sales and Distribution has rebalanced its internal R&D. Today, IBM’s portfolio is built • Research, Development and Intellectual Property around networked, modularized and embedded technologies, as • Enterprise Transformation well as business intelligence and analytics. In 2010, the company • Integrated Supply Chain was once again awarded more U.S. patents than any other company, the 18th consecutive year IBM has been the patent leader. IBM’s Sales and Distribution 5,896 patents in 2010 were the most U.S. patents ever awarded to IBM has a significant global presence, operating in more than 170 one company in a single year. Over 70 percent of the patents issued countries, with an increasingly broad-based geographic distribution in 2010 were for software and services. The company’s R&D efforts of revenue. The company’s Sales and Distribution organization continue to push the frontiers of science and technology—from manages a strong global footprint, with dedicated country-based analytics to cloud, to a computer named Watson that applied operating units focused on delivering client value. Within these advanced analytics to defeat the all-time champions on the units, client relationship professionals work with integrated teams television quiz show, Jeopardy! Watson represents a tremendous of consultants, product specialists and delivery fulfillment teams breakthrough in the ability of computers to understand natural to improve clients’ business performance. These teams deliver language and analyze massive amounts of data. It signals a new value by understanding the clients’ businesses and needs, and era in computing, where computers will increasingly be built and then bring together capabilities from across IBM and an extensive optimized for specific tasks and be able to learn. network of Business Partners to develop and implement solutions. In addition to producing world-class systems, software and By combining global expertise with local experience, IBM’s technology products, IBM innovations are also a major differen- geographic structure enables dedicated management focus for tiator in providing solutions for the company’s clients through local clients, speed in addressing new market opportunities and its services businesses. As an example, the math department at timely investments in emerging opportunities. The geographic IBM Research—the largest math department in the world housed units align industry-skilled resources to serve clients’ agendas. in one institution—helps enterprises more effectively capture IBM extends capabilities to mid-market client segments by leverag- and analyze massive amounts of data to improve their business ing industry skills with marketing, ibm.com and local Business performance. Partner resources. The company will continue to actively seek intellectual property Through its growth markets organization, the company contin- protection for its innovations, while increasing emphasis on other ues to increase its focus on the emerging markets around the world initiatives designed to leverage its intellectual property leadership. that have market growth rates greater than the global average— The company’s investments in R&D also result in intellectual property countries within Southeast Asia, Eastern Europe, the Middle East (IP) income of approximately $1 billion annually. Some of IBM’s tech- and Latin America. The company’s major markets include the nological breakthroughs are used exclusively in IBM products, while United States (U.S.), Canada, the United Kingdom (U.K.), France, others are licensed and may be used in either/both IBM products Germany, Italy, Japan, Denmark, Sweden, Switzerland, Austria, and/or the products of the licensee. While the company’s various Belgium, Finland, Greece, Iceland, Ireland, Malta, the Netherlands, proprietary intellectual property rights are important to its success, Portugal, Cyprus, Norway, Israel, Spain, the Bahamas and the IBM believes its business as a whole is not materially dependent on Caribbean region. any particular patent or license, or any particular group of patents The majority of IBM’s revenue, excluding the company’s original or licenses. IBM owns or is licensed under a number of patents, equipment manufacturer (OEM) technology business, occurs in which vary in duration, relating to its products. Licenses under pat- industries that are broadly grouped into six sectors: ents owned by IBM have been and are being granted to others under reasonable terms and conditions. • Financial Services: Banking, Financial Markets, Insurance • Public: Education, Government, Healthcare, Life Sciences Enterprise Transformation • Industrial: Aerospace and Defense, Automotive, Chemical and A key element of the company’s strategy has been focused on Petroleum, Electronics becoming the premier globally integrated enterprise. In the early part • Distribution: Consumer Products, Retail, Travel and Trans- of the decade, the company drove implementation of a consistent portation set of processes and standards worldwide to reduce inefficiencies • Communications: Telecommunications, Media and Entertain- and improve collaboration. With its processes fully integrated, the ment, Energy and Utilities company implemented a new operating model with work shared in • General Business: Mainly companies with fewer than 1,000 employees


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    Management Discussion International Business Machines Corporation and Subsidiary Companies 25 global resource centers of excellence located where it made the Integrated Supply Chain most business sense. Since 2005, global integration has enabled Consistent with the company’s work with clients to transform their the company to reduce spending by over $5 billion and improve supply chains for greater efficiency and responsiveness to global service quality, speed and risk management. The company has market conditions, the company continues to derive business value shifted resources toward building client relationships and employees from its own globally integrated supply chain, thereby providing a skills, while positioning the company for new market opportunities. strategic advantage for the company to create value for clients. During this period, IBM has pioneered this new operating model, IBM leverages its supply-chain expertise for clients through its changing from a classic “multinational”, with smaller versions of supply-chain business transformation outsourcing service to opti- the parent company replicated in countries around the world, to mize and help operate clients’ end-to-end supply-chain processes, a global model with one set of processes, shared services and from procurement to logistics. broadly distributed decision making. IBM spends approximately $35 billion annually through its The company is now embarking on the next generation of supply chain, procuring materials and services globally. The supply, its transformation in which new capabilities and technologies manufacturing, and logistics and customer fulfillment operations like business analytics and cloud computing will drive performance. are integrated in one operating unit that has optimized inventories The proven principles of the globally integrated enterprise will over time, improved response to marketplace opportunities and be applied to all of the company’s spending to continue to drive external risks, and converted fixed costs to variable costs. Simplifying additional productivity benefits in shared services, integrated and streamlining internal processes has improved operations, operations and end-to-end process transformation. sales force productivity and processes. Year in Review Segment Details The following is an analysis of the 2010 versus 2009 reportable segment results. The table below presents each reportable segment’s external revenue and gross margin results. ($ in millions) Yr.-to-Yr. Yr.-to-Yr. Percent/ Change Margin Adjusted For the year ended December 31: 2010 2009 Change for Currency Revenue: Global Technology Services $38,201 $37,347 2.3% 0.7% Gross margin 34.7% 35.0% (0.3) pts. Global Business Services 18,223 17,653 3.2% 1.6% Gross margin 28.3% 28.2% 0.0 pts. Software 22,485 21,396 5.1% 4.8% Gross margin 86.9% 86.0% 0.9 pts. Systems and Technology 17,973 16,190 11.0% 11.1% Gross margin 38.5% 37.8% 0.7 pts. Global Financing 2,238 2,302 (2.8)% (4.3)% Gross margin 51.3% 47.5% 3.8 pts. Other 750 869 (13.7)% (13.8)% Gross margin (0.9)% 11.6% (12.5) pts. Total revenue $99,870 $95,758 4.3% 3.3% Gross profit $46,014 $43,785 5.1% Gross margin 46.1% 45.7% 0.3 pts.


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    Management Discussion 26 International Business Machines Corporation and Subsidiary Companies The following table presents each reportable segment’s external revenue as a percentage of total segment external 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: 2010 2009 2010 2009 Global Technology Services 38.5% 39.4% 26.8% 28.6% Global Business Services 18.4 18.6 12.4 13.2 Total Global Services 56.9 58.0 39.2 41.9 Software 22.7 22.5 43.8 41.9 Systems and Technology 18.1 17.1 7.6 7.3 Global Financing 2.3 2.4 9.4 8.9 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 and excludes certain unallocated corporate items; see note V, “Segment Information” for additional information. Workforce rebalancing charges were recorded in the first quarter Global Services of 2009 and 2010. The PLM and Geodis divestiture transactions The Global Services segments, GTS and GBS, delivered combined were recorded in the first quarter of 2010 and the first quarter of revenue of $56,424 million, an increase of 2.6 percent (1 percent 2009, respectively. These transactions impacted the year-to- adjusted for currency) in 2010 when compared to 2009. Services year segment results for 2010 compared to 2009. Workforce revenue performance at constant currency improved over the rebalancing charges were incurred in every segment while the course of 2010 led by the transaction businesses. In the first and PLM transaction gain was recorded in Software and the Geodis second quarter, revenue, adjusted for currency, decreased 2 percent transaction gain was recorded in the following segments: Global and increased 1 percent, respectively, versus the prior year periods. Technology Services ($81 million), Global Business Services In the third and fourth quarters, revenue increased 2 percent, at ($46 million), Software ($106 million) and Systems and Technology constant currency, in each period. The estimated Global Services ($64 million). In the following segment analysis and in the Global backlog at actual currency rates was $142 billion at December 31, Financing analysis on page 55, each segment’s pre-tax income 2010, an increase of $5 billion ($4 billion adjusted for currency) and pre-tax margin for 2010 is presented on an as reported basis compared to the December 31, 2009 level. Backlog for the out- and on a basis normalized for these transactions in both years sourcing businesses at actual currency rates was estimated to to provide a better perspective of the underlying operational be $97 billion at December 31, 2010, an increase of $3 billion performance of the segments. ($1 billion adjusted for currency) from December 31, 2009. The The segment results reflect the company’s continuing shift to Global Services segments delivered a combined pre-tax profit of higher value areas, while divesting commoditizing businesses. Total $8,136 million in 2010, a growth of 0.5 percent versus 2009 with Global Services pre-tax income has increased to over $8 billion a pre-tax margin of 13.9 percent, down 0.2 points year to year. in 2010 compared to $4.5 billion in 2000. Software pre-tax income of $9 billion in 2010 has more than tripled since 2000 and now contributes 44 percent of total segment profit compared to 25 percent in 2000. ( $ in millions) Yr.-to-Yr. Yr.-to-Yr. Change Adjusted For the year ended December 31: 2010 2009 Change for Currency Global Services external revenue: $56,424 $55,000 2.6% 1.0% Global Technology Services $38,201 $37,347 2.3% 0.7% Outsourcing 22,241 21,620 2.9 1.1 Integrated Technology Services 8,714 8,771 (0.6) (1.8) Maintenance 7,250 6,956 4.2 2.6 Global Business Services $18,223 $17,653 3.2% 1.6%


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    Management Discussion International Business Machines Corporation and Subsidiary Companies 27 Global Technology Services revenue of $38,201 million ($ in millions) increased 2.3 percent (1 percent adjusted for currency) in 2010 Yr.-to-Yr. For the year ended December 31: 2010 2009 Change versus 2009. The rate of year-to-year revenue growth, adjusted Global Services: for currency, demonstrated an improving trend over the second Global Technology Services: half of 2010. In the first half, revenue, adjusted for currency, was flat versus the prior year, and in the second half, revenue increased External gross profit $13,267 $13,081 1.4% 1 percent, at constant currency, compared to the prior year period. External gross profit margin 34.7% 35.0% (0.3) pts. GTS Outsourcing revenue increased 2.9 percent (1 percent Pre-tax income $ 5,568 $ 5,537 0.6% adjusted for currency) in 2010 with fairly consistent year-to-year Pre-tax margin 14.1% 14.3% (0.2) pts. growth, adjusted for currency, throughout the year. Revenue growth Pre-tax income—normalized* $ 5,840 $ 5,571 4.8% was led by performance in the growth markets, up 18.4 percent Pre-tax margin—normalized 14.8% 14.4% 0.4 pts. (8 percent adjusted for currency), as the company’s outsourcing Global Business Services: offerings help clients build out their IT infrastructures. Integrated External gross profit $ 5,148 $ 4,979 3.4% Technology Services (ITS) revenue decreased 0.6 percent (2 percent External gross profit margin 28.3% 28.2% 0.0 pts. adjusted for currency) in 2010 versus 2009. Revenue performance, Pre-tax income $ 2,569 $ 2,555 0.5% adjusted for currency, in ITS improved over the course of 2010 and Pre-tax margin 13.5% 13.8% (0.3) pts. the growth markets had good year-to-year growth, up 8 percent at constant currency, throughout 2010. Maintenance revenue Pre-tax income—normalized** $ 2,697 $ 2,632 2.5% increased 4.2 percent (3 percent adjusted for currency) compared Pre-tax margin—normalized 14.2% 14.2% 0.0 pts. to 2009 with consistent performance, at constant currency, * Excludes $273 million and $115 million of workforce rebalancing charges in the first quarter of 2010 and 2009, respectively, and ($81) million related to the Geodis gain throughout the year. in the first quarter of 2009. Global Business Services revenue increased 3.2 percent ** Excludes $128 million and $123 million of workforce rebalancing charges in the first (2 percent adjusted for currency) in 2010 and delivered growth in quarter of 2010 and 2009, respectively, and ($46) million related to the Geodis gain in the first quarter of 2009. outsourcing and the transactional businesses: consulting and systems integration. Revenue growth was strongest in North GTS gross profit margin declined 0.3 points to 34.7 percent in 2010. America, up 8.5 percent (7 percent adjusted for currency) and was Segment pre-tax profit increased to $5,568 million with a pre-tax broad based across the industry sectors with Financial Services, margin of 14.1 percent. On a normalized basis, segment pre-tax Distribution, Industrial, Public and General Business each delivering income in 2010 increased 4.8 percent and margin expanded growth on a constant currency basis. GBS had good performance 0.4 points to 14.8 percent reflecting the benefits from workforce in its growth initiatives in 2010, with revenue and transactional rebalancing and an improved revenue growth trend. signings growth in the growth markets and revenue growth of GBS gross profit increased 3.4 percent in 2010, in line with over 35 percent in business analytics. GBS added over 4,000 revenue growth. Gross profit margin of 28.3 percent was flat year- consultants in 2010 and now has over 7,800 dedicated consultants to-year. Segment pre-tax profit improved 0.5 percent to $2,569 in its business analytics practice. million with a pre-tax margin decline of 0.3 points year over year. On a normalized basis, segment pre-tax income in 2010 increased 2.5 percent with a pre-tax margin of 14.2 percent, flat compared to 2009. Throughout 2010, GBS improved utilization and delivery excellence, while continuing to invest in globally integrated capa- bilities and skills to support growth initiatives. Global Services Signings Total Global Services signings of $57,696 million increased 1.1 percent (flat adjusted for currency) compared to 2009. Outsourcing signings for the year of $33,064 million increased 0.2 percent (decreased 1 percent adjusted for currency). In the fourth quarter, outsourcing signings increased 24.2 percent, after declining by 14.9 percent in the third quarter when compared to the prior year periods. On a dollar basis, fourth quarter outsourcing signings exceeded the third quarter by $8,458 million ($14,138 million versus $5,680 million). These quarterly dynamics are a good example of the volatility that can occur with outsourcing signings. Due to this volatility, outsourcing signings are not a good predictor of revenue. This is due to the many factors that impact how signings translate to revenue, such as duration, start date of the contract, and


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    Management Discussion 28 International Business Machines Corporation and Subsidiary Companies whether it is a new contract or an extension of an existing contract. performance is predominantly determined by the dynamics within The company’s outsourcing business revenue is more determined a quarter with signings providing little additional insight into period by backlog, and period signings are just one of several inputs to performance. backlog. Transactional signings increased 2.3 percent (1 percent The following table presents Global Services signings. adjusted for currency) to $24,633 million, with growth in Integrated Outsourcing signings include GTS Outsourcing and Application Technology Services and Consulting signings. In the transactional Management Services Outsourcing. Transactional signings include services businesses, revenue growth and signings growth Integrated Technology Services, Consulting and AMS Systems have historically been similar within a quarterly period. Revenue Integration. ($ in millions) Yr.-to-Yr. Yr.-to-Yr. Change Adjusted For the year ended December 31: 2010 2009 Change for Currency Outsourcing signings $33,064 $33,014 0.2% (1.0)% Transactional signings 24,633 24,081 2.3 1.4 Total signings $57,696 $57,094 1.1% 0.0% Global Services signings are management’s initial estimate of the Total Global Services backlog includes GTS Outsourcing, ITS, revenue value of a client’s commitment under a Global Services GBS and Maintenance. Outsourcing backlog includes GTS Outsourc- contract. There are no third-party standards or requirements ing and Application Management Services Outsourcing. Backlog governing the calculation of signings. The calculation used by is intended to be a statement of overall work under contract and management involves estimates and judgments to gauge the therefore does include Maintenance. Backlog estimates are subject extent of a client’s commitment, including the type and duration of to change and are affected by several factors, including terminations, the agreement, and the presence of termination charges or wind- changes in the scope of contracts, periodic revalidations, adjust- down costs. ments for revenue not materialized and adjustments for currency. Signings include GTS Outsourcing, ITS and GBS contracts. Contract portfolios purchased in an acquisition are treated as Contract extensions and increases in scope are treated as signings positive backlog adjustments provided those contracts meet the only to the extent of the incremental new revenue value. Maintenance company’s requirements for initial signings. A new signing will be is not included in signings as maintenance contracts tend to be recognized if a new services agreement is signed incidental or more steady state, where revenues equal renewals. coincidental to an acquisition or divestiture. Software ($ in millions) Yr.-to-Yr. Yr.-to-Yr. Change Adjusted For the year ended December 31: 2010 2009* Change for Currency Software external revenue: $22,485 $21,396 5.1% 4.8% Middleware $18,444 $17,125 7.7% 7.5% Key Branded Middleware 13,876 12,524 10.8 10.7 WebSphere 20.8 20.6 Information Management 8.6 8.3 Lotus (2.3) (2.1) Tivoli 15.0 15.1 Rational 4.8 4.8 Other middleware 4,568 4,602 (0.7) (1.2) Operating systems 2,282 2,163 5.5 4.9 Other 1,759 2,108 (16.6) (17.0) * Reclassified to conform with 2010 presentation.


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    Management Discussion International Business Machines Corporation and Subsidiary Companies 29 Software revenue of $22,485 million increased 5.1 percent (5 percent Tivoli revenue increased 15.0 percent (15 percent adjusted adjusted for currency) in 2010 compared to 2009. Adjusting for the for currency) in 2010 when compared to 2009, with revenue divested PLM operations, revenue grew at 8.1 percent (8 percent growth in each element of the Integrated Service management adjusted for currency) in 2010. Software revenue growth continued strategy—Systems management, Security and Storage manage- to be led by the Key Branded Middleware products with strong ment. Tivoli provides clients an integrated approach to service performance in the areas of business commerce, business analytics, management. storage management and business integration. Overall, the Rational revenue increased 4.8 percent (5 percent adjusted for Software business performed well in 2010, delivering over $9 billion currency) in 2010 versus 2009. in segment pre-tax profit, an increase of 12 percent as reported Operating systems revenue increased 5.5 percent (5 percent versus 2009. In addition, the company continues to invest in addi- adjusted for currency) in 2010 compared to 2009, driven by Power tional capabilities for the software business through both organic Systems and System x related products. investments and the completion of 13 acquisitions in 2010. Other software revenue decreased 16.6 percent (17 percent Key Branded Middleware revenue increased 10.8 percent adjusted for currency) due primarily to the divestiture of the PLM (11 percent adjusted for currency) and gained market share again operations in the first quarter of 2010. in 2010 as the Software business extended its lead in the middle- ware market. Software revenue continued to mix to the faster ($ in millions) growing branded middleware which accounted for 62 percent of Yr.-to-Yr. For the year ended December 31: 2010 2009 Change total software revenue in 2010, an increase of 3 points from 2009. Software: Adjusted for currency, growth in 2010 was led by growth in External gross profit $19,537 $18,405 6.2% WebSphere and Tivoli. The Software business continues to benefit External gross profit margin 86.9% 86.0% 0.9 pts. from the company’s growth initiatives, with business analytics revenue up year over year. Pre-tax income $ 9,097 $ 8,095 12.4% WebSphere revenue increased 20.8 percent (21 percent Pre-tax margin 35.8% 33.6% 2.1 pts. adjusted for currency) in 2010 with strong performance throughout Pre-tax income—normalized* $ 8,603 $ 8,005 7.5% the year. Application Servers software had revenue growth of 12.0 Pre-tax margin—normalized 33.8% 33.3% 0.6 pts. percent (11.7 percent adjusted for currency) year to year. Business * Excludes $98 million and $17 million of workforce rebalancing charges in the first Integration software, which includes the ILOG, Sterling Commerce quarter of 2010 and 2009, respectively, and $(591) million related to the PLM gain in the first quarter of 2010 and $(106) million related to the Geodis gain in the first and Lombardi acquisitions, delivered strong revenue growth in quarter of 2009. 2010, up 33.6 percent (33 percent adjusted for currency). With the 2010 acquisitions of Sterling Commerce, Coremetrics and Unica Software gross profit of $19,537 million in 2010 increased 6.2 Corporation, the company expects continued market momentum percent versus 2009, driven primarily by the year-to-year growth in its WebSphere commerce area. in software revenue. The improvement in the gross profit margin Information Management revenue increased 8.6 percent was primarily driven by the divestiture of the lower gross margin (8 percent adjusted for currency) in 2010 versus the prior year with PLM revenue. The Software segment delivered $9,097 million of revenue growth in both Information Management solutions and pre-tax profit in 2010, an increase of $1,002 million, or 12.4 percent, infrastructure offerings. The software business continued to expand versus 2009. The segment pre-tax profit margin expanded 2.1 its Information Management capabilities through strategic acqui- points to 35.8 percent. On a normalized basis, segment pre-tax sitions, as the company completed the acquisitions of Netezza, income increased 7.5 percent and segment pre-tax margin OpenPages, PSS Systems, Clarity Systems and Initiate Systems. expanded 0.6 points to 33.8 percent. Systems and Technology ($ in millions) Yr.-to-Yr. Yr.-to-Yr. Change Adjusted For the year ended December 31: 2010 2009 Change for Currency Systems and Technology external revenue: $17,973 $16,190 11.0% 11.1% System z 16.4% 17.7% Power Systems (8.4) (8.5) System x 27.5 26.8 Storage 7.6 8.1 Retail Store Solutions 22.4 23.2 Total Systems 9.5 9.6 Microelectronics OEM 24.8 24.7


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    Management Discussion 30 International Business Machines Corporation and Subsidiary Companies Systems and Technology revenue increased 11.0 percent (11 percent Microelectronics OEM revenue increased 24.8 percent (25 adjusted for currency) in 2010 versus 2009. Revenue performance percent adjusted for currency) in 2010 versus 2009. The company was driven by double-digit growth in System z, System x, Micro- had strong revenue growth from its OEM customers in networking, electronics OEM, Storage disk products and Retail Store Solutions. game consoles and wireless communications. Systems and Technology had very strong performance in the Retail Stores Solutions revenue increased 22.4 percent (23 growth markets, which grew 20 percent (19 percent adjusted for percent adjusted for currency) in 2010 versus 2009 as the company currency), driven by the BRIC countries which increased 29 percent extended its leadership position as a point of sale provider. (28 percent adjusted for currency). The company gained share in high-end servers, while total servers and storage held share. ($ in millions) System z revenue increased 16.4 percent (18 percent adjusted Yr.-to-Yr. For the year ended December 31: 2010 2009 Change for currency) in 2010 versus 2009. The increase in revenue was driven by the new mainframe product introduced in the third quarter Systems and Technology: External gross profit $6,920 $6,127 12.9% and strong performance in both the growth markets and major markets. MIPS (millions of instructions per second) shipments External gross profit margin 38.5% 37.8% 0.7 pts. increased 22 percent in 2010 versus 2009. This performance Pre-tax income $1,586 $1,419 11.8% reflects the value and innovation System z delivers to the company’s Pre-tax margin 8.4% 8.3% 0.2 pts. clients. The new z Enterprise 196 server delivers 40 percent more Pre-tax income—normalized* $1,643 $1,359 20.9% performance than the prior generation mainframe, driven by the Pre-tax margin—normalized 8.8% 7.9% 0.8 pts. world’s fastest processor which operates at more than 5 gigahertz. * Excludes $57 million and $4 million of workforce rebalancing charges in the first Power Systems revenue decreased 8.4 percent (9 percent quarter of 2010 and 2009, respectively, and $(64) million related to the Geodis gain in the first quarter of 2009. adjusted for currency) in 2010 versus 2009. Revenue increased in the fourth quarter 1.8 percent (3 percent adjusted for currency) The increase in external gross profit for 2010 versus 2009 was as the company benefited from new POWER7 products which due to improved operating leverage driven by higher revenue. were introduced late in the third quarter. Although revenue declined Overall gross margin increased 0.7 points in 2010 versus the in 2010, Power Systems gained share and continued to be the prior year. The increase was primarily driven by improved margins market share leader. The decrease in revenue was primarily driven in Microelectronics (1.6 points), System x (0.7 points) and Storage by high-end servers which declined 26 percent (27 percent (0.4 points), partially offset by a decline due to revenue mix (1.4 adjusted for currency), partially offset by increases in midrange points) and lower margins in Power Systems (0.6 points) and systems of 7 percent (7 percent adjusted for currency) and blades System z (0.5 points). of 7 percent (7 percent adjusted for currency). The company had Systems and Technology’s pre-tax income increased 20.9 over 1,000 competitive unit displacements in 2010, which drove percent in 2010 on a normalized basis when compared to the prior approximately $1 billion of business. Approximately 60 percent of year. Pre-tax margin increased 0.8 points in 2010 on a normalized these wins came from Oracle UNIX installed accounts and 30 basis versus 2009. percent from Hewlett-Packard installed accounts. In addition, the company also drove x86 consolidations to Power Systems, with Global Financing over 100 competitive wins. See pages 55 through 59 for an analysis of Global Financing’s System x revenue increased 27.5 percent (27 percent adjusted segment results. for currency) in 2010 versus 2009. In the growth markets, revenue increased 30 percent versus the prior year. High-end System x revenue increased 22 percent (21 percent adjusted for currency) in 2010 versus 2009, while total server revenue increased 27 percent (27 percent adjusted for currency) in 2010 versus 2009. System x blades revenue increased 20 percent (20 percent adjusted for currency) versus the prior year. Storage revenue increased 7.6 percent (8 percent adjusted for currency) in 2010 versus the prior year. In the growth markets, storage revenue grew 21 percent year over year (21 percent adjusted for currency). Total disk revenue increased 13 percent (14 percent adjusted for currency) in 2010 versus 2009. The increase was driven by strength in enterprise disk products which increased 16.4 percent (17 percent adjusted for currency) led by XIV and DS8000. XIV has added over 975 new customers since the acquisition in the fourth quarter of 2007. Tape revenue declined 6 percent in 2010 versus 2009.


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    Management Discussion International Business Machines Corporation and Subsidiary Companies 31 Geographic Revenue In addition to the revenue presentation by reportable segment, the company also measures revenue performance on a geographic basis. The following geographic, regional and country-specific revenue performance excludes OEM revenue, which is discussed separately below. ($ in millions) Yr.-to-Yr. Yr.-to-Yr. Change Adjusted For the year ended December 31: 2010 2009 Change for Currency Total revenue: $99,870 $95,758 4.3% 3.3% Geographies: $97,060 $93,477 3.8% 2.8% Americas 42,044 40,184 4.6 3.5 Europe/Middle East/Africa 31,866 32,583 (2.2) 0.8 Asia Pacific 23,150 20,710 11.8 4.7 Major markets 1.1% 1.0% Growth markets 16.0% 10.9% BRIC countries 22.8% 18.4% Total geographic revenue increased 3.8 percent (3 percent adjusted declined in Spain 5.6 percent (1 percent adjusted for currency), for currency) to $97,060 million in 2010 when compared to 2009, Germany 7.7 percent (3 percent adjusted for currency) and Italy with constant currency growth in each of the geographic areas and 8.7 percent (4 percent adjusted for currency). In France, revenue markets. Overall performance was driven by the growth markets. declined 1.8 percent as reported, but increased 4 percent at constant Revenue from the major markets increased 1.1 percent (1 percent currency. Russia revenue increased 49.0 percent (48 percent adjusted for currency) and was led by growth in the U.S., the U.K. adjusted for currency). and France. Performance in the major markets improved in the Asia Pacific revenue increased 11.8 percent (5 percent adjusted second half of 2010. The major markets grew 0.3 percent (declined for currency) year over year. Asia Pacific growth market countries 1 percent adjusted for currency) in the first half and increased 1.7 increased 18.3 percent (11 percent adjusted for currency), led by percent (3 percent adjusted for currency) in the second half. growth in China and India. China revenue increased 23.4 percent Revenue from the growth markets increased 16.0 percent (11 percent (23 percent adjusted for currency) and India revenue increased adjusted for currency). The growth markets performance, adjusted 19.2 percent (13 percent adjusted for currency). Japan revenue for currency, outpaced the more established major markets by 10 increased 5.0 percent as reported but declined 2 percent adjusted points in 2010 and geographic revenue contribution increased to for currency in 2010 compared to the prior year. 21 percent, 2 points higher versus 2009. The combined revenue OEM revenue of $2,811 million in 2010 increased 23.3 percent in the BRIC countries, which represented approximately 40 percent (23 percent adjusted for currency) compared to 2009 driven by of the growth markets in 2010, increased 22.8 percent (18 percent growth in the Microelectronics OEM business. adjusted for currency) with growth in each of the four countries and strong growth in China and Russia. The company has Total Expense and Other Income continued to make investments in these markets to drive market ($ in millions) expansion and infrastructure development. The growth markets Yr.-to-Yr. performance overall was broad based with double-digit growth For the year ended December 31: 2010 2009 Change at constant currency in a total of 40 growth market countries. Total expense and other income $26,291 $25,647 2.5% Americas revenue increased 4.6 percent (3 percent adjusted for Expense-to-revenue ratio 26.3% 26.8% (0.5) pts. currency) in 2010. Within the major market countries, the U.S. increased 2.7 percent and Canada increased 10.4 percent (flat The key drivers year to year in total expense and other income adjusted for currency). Revenue in the Latin America growth markets were approximately: increased 15.4 percent (14 percent adjusted for currency) led by Brazil with growth of 20.4 percent (12 percent adjusted for currency). • Operational expense, (2) points Europe/Middle East/Africa (EMEA) revenue decreased 2.2 • Currency,* 1 point percent (increased 1 percent adjusted for currency) in 2010 compared • Acquisitions,** 3 points to 2009. In the major market countries, revenue increased in the * Reflects impacts of translation and hedging programs. U.K. 4.5 percent (6 percent adjusted for currency), while revenue ** Includes acquisitions completed in prior 12-month period.


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    Management Discussion 32 International Business Machines Corporation and Subsidiary Companies The company’s expense-to-revenue ratio improved in 2010 versus Other (Income) and Expense 2009. The increase in total expense and other income was primarily ($ in millions) driven by the company’s acquisitions and the effects of currency. Yr.-to-Yr. Operational expense improved 2 points in 2010 when com- For the year ended December 31: 2010 2009* Change pared to the prior year. The company has had an ongoing focus Foreign currency transaction on increasing efficiency and driving productivity across the (gains)/losses $ 303 $ (1) NM business. Savings from productivity initiatives result in improved Gains on derivative instruments (239) (12) NM profitability and enables continued investments in innovation and Interest income (92) (94) (2.3)% key growth initiatives. Net losses/(gains) from securities Examples of the company’s investments include: and investment assets 31 112 (72.1) Other (790) (357) 121.2 • Industry sales skills to support Smarter Planet Total $(787) $(351) 124.5% • Sales capabilities for business analytics, including the establish- * Reclassified to conform with 2010 presentation. ment of eight analytics solution centers NM—Not meaningful • Development, sales and marketing to support new high-end technology solutions in mainframes and POWER7 Other (income) and expense was income of $787 million in 2010, • Sales resources and sales enablement to drive growth market an increase in income of $436 million year to year. The increase in performance income was primarily driven by several key factors reflected in Other • Acquisition of 17 companies adding significant capabilities in the table above: the net gain from the PLM transaction in the first quarter of 2010 ($591 million); a net gain associated with the dispo- For additional information regarding total expense and other income, sition of a joint venture in third quarter of 2010 ($57 million) versus see the following analyses by category. a gain from the divestiture of the core logistics operations to Geodis in the first quarter of 2009 ($298 million); and a provision for losses Selling, General and Administrative related to a joint venture investment ($119 million) recorded in the ($ in millions) second quarter 2009. In addition, foreign currency rate volatility Yr.-to-Yr. drove higher foreign currency transaction losses ($304 million) and For the year ended December 31: 2010 2009* Change increased gains on derivative instruments ($227 million). Selling, general and administrative — base $18,585 $17,872 4.0% Research, Development and Engineering Advertising and promotional expense 1,337 1,255 6.6 ($ in millions) Workforce reductions 641 474 35.3 Yr.-to-Yr. Amortization expense — For the year ended December 31: 2010 2009 Change acquired intangibles 253 285 (11.3) Research, development and engineering Retirement-related expense 494 503 (1.7) Total $6,026 $5,820 3.5% Stock-based compensation 488 417 16.9 Bad debt expense 40 147 (72.5) The company continues to invest in research and development, Total $21,837 $20,952 4.2% focusing its investments on high-value, high-growth opportunities * Reclassified to conform with 2010 presentation. and to extend its technology leadership. Total research, development and engineering (RD&E) expense increased 3.5 percent in 2010 Total selling, general and administrative (SG&A) expense increased versus 2009, primarily driven by acquisitions (up 2 points) and 4.2 percent (3 percent adjusted for currency) in 2010 versus 2009. currency impacts (up 1 point). RD&E investments represented 6.0 Overall, the increase was driven by acquisition-related spending percent of total revenue in 2010, compared to 6.1 percent in 2009. (3 points) and currency impacts (1 point), while operational expense was essentially flat. Workforce reductions expense increased $167 Intellectual Property and Custom Development Income million due primarily to actions taken in the first quarter of 2010, ($ in millions) with the majority of the spending in Europe and Asia Pacific. Bad Yr.-to-Yr. debt expense decreased $107 million reflecting the improving For the year ended December 31: 2010 2009 Change credit environment. The allowance for credit losses coverage rate Sales and other transfers at December 31, 2010 was 1.8 percent, a decrease of 20 basis of intellectual property $ 203 $ 228 (10.8)% points from year-end 2009. Licensing/royalty-based fees 312 370 (15.6) Custom development income 638 579 10.3 Total $1,154 $1,177 (1.9)%


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    Management Discussion International Business Machines Corporation and Subsidiary Companies 33 The timing and amount of sales and other transfers of IP may retirement-related costs as operating and others as non-operating. vary significantly from period to period depending upon timing of Utilizing this characterization, operating retirement-related costs divestitures, industry consolidation, economic conditions and the for 2010 were $1,796 million, a decrease of $128 million compared timing of new patents and know-how development. There were to 2009. This decrease was driven by a $108 million reduction in no significant individual IP transactions in 2010 or 2009. total service cost and a $20 million reduction in the cost of defined contribution plans. Non-operating costs/(income) of ($414 million) Interest Expense decreased $95 million in 2010 compared to the prior year driven ($ in millions) primarily by an increase in recognized actuarial losses of $148 Yr.-to-Yr. million, a $153 million increase in curtailment settlement charges For the year ended December 31: 2010 2009 Change and a $63 million reduction in the expected return on plan assets, Interest expense partially offset by lower interest cost of $158 million and lower Total $368 $402 (8.5)% pension insolvency insurance premiums of $118 million. See note U, “Retirement-Related Benefits,” on pages 112 to 126 The decrease in interest expense was primarily due to lower for additional information on these plans and the factors driving average interest rates in 2010 versus 2009, partially offset by higher the year-to-year change in total cost. average debt balances in 2010 versus 2009. Total debt at December 31, 2010 was $28.6 billion; an increase of $2.5 billion Business Acquisition from the prior year-end position. Interest expense is presented in Intangible Asset Amortization cost of financing in the Consolidated Statement of Earnings if the The company has been investing in targeted acquisitions to related external borrowings are to support the Global Financing increase its capabilities in higher value businesses. The following external business. Overall interest expense for 2010 was $923 table presents the total amortization from intangible assets acquired million, a decrease of $185 million versus 2009. through business acquisitions included in the Consolidated Statement of Earnings. See note J, “Intangible Assets Including Stock-Based Compensation Goodwill,” on pages 93 and 94 for additional information. Total pre-tax stock-based compensation cost of $629 million ($ in millions) increased $71 million compared to 2009. The increase was principally Yr.-to-Yr. the result of an increase related to restricted and performance-based For the year ended December 31: 2010 2009 Change stock compensation costs ($87 million), partially offset by a reduction Cost: in stock option compensation costs ($16 million). The year-to-year Software (Sales) $239 $160 49.0% change was reflected in the following categories: reductions in cost Global Technology Services (Services) 6 33 (81.7) ($1 million) and Other (income) and expense ($1 million) and increases Systems and Technology (Sales) 15 11 39.8 in RD&E expense ($2 million) and SG&A expense ($71 million). Selling, general and See note T, “Stock-Based Compensation,” on pages 109 to administrative expense 253 285 (11.3) 112 for additional information on stock-based incentive awards. Total $513 $489 4.9% Retirement-Related Benefits The following table presents the total pre-tax cost for all retirement- Other acquisition-related charges were $45 million in 2010 and $9 related plans. These amounts are included in the Consolidated million in 2009. These charges include deal costs, severance costs Statement of Earnings within the category (e.g., cost, SG&A, RD&E) related to acquired resources and costs related to vacant space for relating to the job function of the plan participants. acquired companies. ($ in millions) Income Taxes Yr.-to-Yr. The effective tax rate for 2010 was 24.8 percent, compared with For the year ended December 31: 2010 2009 Change 26.0 percent in 2009. The 1.2 point decrease was primarily driven Defined benefit and contribution by a more favorable geographic mix of pre-tax income and incentives pension plans cost $1,035 $1,065 (2.8)% (2.5 points), the increased utilization of foreign tax credits (4.1 points) Nonpension postretirement plans costs 347 350 (0.9) and the completion in 2010 of the U.S. federal income tax examina- Total $1,382 $1,415 (2.3)% tion for the years 2006 and 2007 including the associated reserve redeterminations (6.4 points). These benefits were partially offset by Overall retirement-related benefit costs decreased $33 million tax charges related to certain intercompany payments made by versus 2009, driven by lower defined contribution plans cost of foreign subsidiaries (6.6 points), the tax impact of certain business $20 million and lower defined benefit plans cost of $10 million restructuring transactions (2.7 points) and the tax costs associated compared to 2009. As discussed in the “Looking Forward” section with the intercompany licensing of certain intellectual property (2.9 on page 46, the company has begun to characterize certain points). The remaining items were individually insignificant.


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    Management Discussion 34 International Business Machines Corporation and Subsidiary Companies Earnings Per Share Consistent with accounting standards, the company remea- Basic earnings per share is computed on the basis of the weighted- sures the funded status of its retirement and postretirement plans average number of shares of common stock outstanding during at December 31. The funded status is measured as the difference the period. Diluted earnings per share is computed on the basis of between the fair value of the plan assets and the benefit obligation the weighted-average number of shares of common stock outstand- and is recognized in the Consolidated Statement of Financial Position. ing plus the effect of dilutive potential common shares outstanding At December 31, 2010, the overall net underfunded position of during the period using the treasury stock method. Dilutive potential $13,735 million was essentially unchanged from December 31, common shares include outstanding stock options, share awards 2009, as improved returns on plan assets were offset by an and convertible notes. increase in the benefit obligation as a result of a reduction in dis- count rates. Due to the improvement in the financial markets in 2010, the return on the U.S. Personal Pension Plan assets was Yr.-to-Yr. For the year ended December 31: 2010 2009 Change approximately 14 percent. The company’s asset return in the non- U.S. plans was approximately 9 percent. Overall, global asset Earnings per share of common stock: returns were approximately 12 percent in 2010. At December 31, Assuming dilution $11.52 $10.01 15.1% 2010, the company’s qualified defined benefit plans worldwide were Basic $11.69 $10.12 15.5% 99 percent funded with the U.S. qualified Personal Pension Plan Weighted-average shares 101 percent funded. outstanding (in millions): In addition, total equity increased $418 million, net of tax, Assuming dilution 1,287.4 1,341.4 (4.0)% primarily as a result of an improvement in retained earnings of Basic 1,268.8 1,327.2 (4.4)% $11,632 million driven by current year net income, substantially offset by net stock transactions which declined $11,310 million Actual shares outstanding at December 31, 2010 and 2009 were primarily due to common stock repurchases. 1,228.0 million and 1,305.3 million, respectively. The average The assets and debt associated with the Global Financing number of common shares outstanding assuming dilution was business are a significant part of the company’s financial position. 54.0 million shares lower in 2010 versus 2009. The decrease was The financial position amounts appearing on page 63 are the primarily the result of the common stock repurchase program. See consolidated amounts including Global Financing. The amounts note N, “Equity Activity,” on page 103 for additional information appearing in the separate Global Financing section, beginning regarding common stock activities. Also see note R, “Earnings on page 55, are supplementary data presented to facilitate an Per Share of Common Stock,” on page 108. understanding of the Global Financing business. Financial Position Working Capital Dynamics ($ in millions) At December 31, 2010, the company’s balance sheet and liquidity At December 31: 2010 2009 positions remain strong and are positioned to support the business Current assets $48,116 $48,935 over the long term. Cash and marketable securities at year end Current liabilities 40,562 36,002 were $11,651 million. Total debt of $28,624 million increased $2,525 Working capital $ 7,554 $12,933 million from prior year-end levels, after declining by $7,826 million Current ratio 1.19:1 1.36:1 in 2009. The commercial paper balance at December 31, 2010 was $1,144 million, up from $235 million at December 31, 2009. Working capital decreased $5,379 million from the year-end 2009 The company continues to have substantial flexibility in the market. position. The key changes are described below: In the fourth quarter, the company completed two bond issuances Current assets decreased $819 million ($1,000 million adjusted raising $1 billion in five-year bonds priced at 2 percent, and an for currency), driven by: additional $1 billion in 18-month floating rate notes. In late November 2010, the company’s long-term debt rating was upgraded by • A decline of $2,322 million in cash and cash equivalents and Moody’s Investors Services from A1 to Aa3. During 2010, the marketable securities (see cash flow analysis on page 35); company generated $19,549 million in cash from operations. The partially offset by company has consistently generated strong cash flow from opera- • An increase of $1,343 million in short-term financing receivables tions and continues to have access to additional sources of liquidity ($1,122 million adjusted for currency) due to higher volumes. through the capital markets and its $10 billion global credit facility. The strong cash flow and substantial cash position permits the company to invest and deploy capital to areas with the most attractive long-term opportunities.


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    Management Discussion International Business Machines Corporation and Subsidiary Companies 35 Current liabilities increased $4,560 million ($4,101 million adjusted Net cash used in investing activities increased $1,7 78 million for currency) as a result of: driven by: • An increase in short-term debt of $2,610 million ($2,441 million • An increase of $4,728 million in cash used for acquisitions adjusted for currency) primarily driven by: primarily as a result of the Netezza and Sterling Commerce – a net increase of $909 million in commercial paper and transactions; $4,238 million in new debt issuances; and • Increased net capital spending of $299 million primarily for – reclassification of $3,941 million from long-term to short-term new hardware products and semiconductor technology; debt to reflect maturity dates; partially offset by • A decrease in cash from divestitures of $345 million as a result – $6,712 million in debt repayments. of the Geodis transaction in 2009; and • An increase in deferred income of $735 million ($672 million • A decrease in cash provided by Global Financing non-operating adjusted for currency) driven by the software business, includ- receivables of $221 million as a result of improved originations ing acquisitions; in 2010; partially offset by • An increase of $523 million in accrued compensation and • The net impact of purchases and sales of short-term market- benefits; and able securities and other investments that resulted in a source • An increase of $368 million in accounts payable, driven by of cash in the current year of $1,773 million in comparison to higher year-end activity. a use of cash of $1,895 million in 2009. Cash Flow Net cash used in financing activities decreased $2,271 million as The company’s cash flow from operating, investing and financing a result of: activities, as reflected in the Consolidated Statement of Cash Flows • Net increase in cash of $9,812 million from debt that resulted on page 64, is summarized in the table below. These amounts from net cash proceeds from debt in the current year of $2,349 include the cash flows associated with the Global Financing business. million in comparison to net cash payments to settle debt of $7,463 million in 2009; and ($ in millions) • An increase of $722 million in cash generated from other common For the year ended December 31: 2010 2009 stock transactions primarily due to higher stock option exercises; Net cash provided by/(used in): partially offset by Operating activities $ 19,549 $ 20,773 • Higher common stock repurchases of $7,946 million. Investing activities (8,507) (6,729) Financing activities (12,429) (14,700) Noncurrent Assets and Liabilities Effect of exchange rate changes ($ in millions) on cash and cash equivalents (135) 98 At December 31: 2010 2009 Net change in cash and cash equivalents $ (1,522) $ (558) Noncurrent assets $65,335 $60,087 Long-term debt $21,846 $21,932 Net cash from operating activities decreased $1,224 million as Noncurrent liabilities (excluding debt) $27,871 $28,334 compared to 2009 driven by the following key factors: • A decrease in cash provided by Global Financing receivables The increase in noncurrent assets of $5,249 million (an increase of $2,634 million as a result of improved originations in 2010; of $4,609 million adjusted for currency) was a result of: • Higher income tax payments of approximately $1,000 million driven by foreign tax payments; and • An increase of $4,946 million ($4,698 million adjusted for cur- • A decrease in cash of approximately $600 million as a result rency) in goodwill and an increase of $975 million in intangible of lower tax refunds in 2010 versus the previous year; partially assets driven by the company’s 2010 acquisitions; and offset by • An increase of $399 million in investments and sundry assets • Improved net income of $1,408 million; and primarily driven by increased prepaid income taxes; partially • Increased cash provided by other assets/liabilities of $1,125 offset by million mainly due to higher compensation and benefit accruals • A decrease of $974 million in noncurrent deferred taxes ($1,137 in 2010. million adjusted for currency) primarily driven by current year activity, including compensation and benefits, hedging and research and development. Noncurrent liabilities, excluding debt, decreased $463 million ($414 million adjusted for currency) primarily driven by a decrease in other noncurrent liabilities of $592 million due to a change in the fair value of derivatives related to foreign exchange contracts.


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    Management Discussion 36 International Business Machines Corporation and Subsidiary Companies Debt Consolidated Fourth-Quarter Results The company’s funding requirements are continually monitored ($ and shares in millions except per share amounts) and strategies are executed to manage the overall asset and liability Yr.-to-Yr. profile. Additionally, the company maintains sufficient flexibility to Percent/ Margin access global funding sources as needed. For the fourth quarter: 2010 2009 Change Revenue $29,019 $27,230 6.6%* ($ in millions) Gross profit margin 49.0% 48.3% 0.8 pts. At December 31: 2010 2009 Total expense and other income $ 7,271 $ 6,765 7.5% Total company debt $28,624 $26,099 Total expense and other Total Global Financing segment debt: $22,823 $22,383 income-to-revenue ratio 25.1% 24.8% 0.2 pts. Debt to support external clients 19,583 19,091 Income before income taxes $ 6,956 $ 6,381 9.0% Debt to support internal clients 3,240 3,292 Provision for income taxes 1,698 1,568 8.3% Net income $ 5,257 $ 4,813 9.2% Global Financing provides financing predominantly for the company’s Net income margin 18.1% 17.7% 0.4 pts. external client assets, as well as for assets under contract by other Earnings per share of common stock: IBM units. These assets, primarily for Global Services, generate Assuming dilution $ 4.18 $ 3.59 16.4% long-term, stable revenue streams similar to the Global Financing Weighted-average shares outstanding: asset portfolio. Based on their attributes, these Global Services Assuming dilution 1,258.4 1,340.7 (6.1)% assets are leveraged with the balance of the Global Financing * 7.1 percent adjusted for currency. asset base. The debt analysis above is further detailed in the Global Financing section on page 58. Given the significant leverage, the company presents a debt- Snapshot to-capitalization ratio which excludes Global Financing debt and The fourth quarter of 2010 capped off a very good year as the equity as management believes this is more representative of the company continued the trend of improving business performance, company’s core business operations. This ratio can vary from increasing constant currency revenue growth, expanding margins period to period as the company manages its global cash and and again delivering double-digit earnings per share growth. Diluted debt positions. earnings per share of $4.18 increased 16.4 percent versus the fourth “Core” debt-to-capitalization ratio (excluding Global Financing quarter of 2009 and represented the 32nd consecutive quarter of debt and equity) was 22.6 percent at December 31, 2010 compared earnings per share growth for the company. The company delivered to 16.0 percent at December 31, 2009. The increase was primarily solid financial results while continuing a high level of investment to driven by an increase in non-Global Financing debt of $2,084 million. drive future growth and delivering strong shareholder returns. With this amount of leverage, the company continues to have a high Total revenue increased 6.6 percent as reported (7 percent degree of financial flexibility. adjusted for currency) versus the fourth quarter of 2009 driven by Consolidated debt-to-capitalization ratio at December 31, 2010 hardware and software. This was the highest quarterly constant was 55.3 percent versus 53.4 percent at December 31, 2009. currency revenue growth rate in nearly a decade. Systems and Technology revenue increased 21.0 percent (22 percent adjusted for currency) with growth in every platform and strong performance Equity in the System z mainframe product. Software revenue increased Total equity increased $418 million primarily as a result of an 7.0 percent (8 percent adjusted for currency) as reported, and was increase in retained earnings of $11,632 million and an increase of up 10.5 percent (12 percent adjusted for currency) without the $3,608 million in common stock, substantially offset by an increase divested PLM operations. Software’s 12 percent growth at constant in treasury stock of $14,918 million driven by common stock currency was double the growth rate of its strong performance in repurchases during 2010. the first three quarters of the year. Total Global Services revenue growth of 2.0 percent (2 percent adjusted for currency) was con- sistent with third-quarter 2010 performance. The estimated Global Services backlog at actual currency rates was $142 billion, an increase of $5 billion ($4 billion adjusted for currency) compared to the December 31, 2009 level and an increase of $8 billion ($7 billion adjusted for currency) from September 30, 2010. From a geographic perspective, major markets revenue increased 3.9 percent (5 percent adjusted for currency) led by constant currency growth in the U.S., France and Italy. Total revenue in the growth markets increased 15.4 percent (13 percent adjusted for currency)


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    Management Discussion International Business Machines Corporation and Subsidiary Companies 37 led by the BRIC countries which increased 18.7 percent (17 percent GTS revenue of $10,165 million increased 1.1 percent (1 percent adjusted for currency). Business analytics, another of the company’s adjusted for currency) versus the fourth quarter of 2009. Out- key growth initiatives, had revenue growth of 19 percent in the sourcing revenue increased 1.3 percent (1 percent adjusted fourth quarter. for currency). The estimated outsourcing backlog, which is the The consolidated gross profit margin increased 0.8 points primary driver of outsourcing revenue, was $97 billion at December versus the fourth quarter of 2009 to 49.0 percent with improved 31, 2010, an increase of $3 billion ($1 billion adjusted for currency) margins in Systems and Technology and Software. Gross profit compared to the December 31, 2009 level and an increase of $6 margin performance by segment and the impact to the consolidated billion ($5 billion adjusted for currency) from September 30, 2010. gross margin was as follows: Fourth-quarter revenue was driven primarily from existing backlog while revenue from base accounts also increased for the first time Gross Yr.-to-Yr. Consolidated Margin Change Impact since the fourth quarter of 2008. The increase in the outsourcing backlog was due to significant demand for the company’s offerings Global Technology Services 34.7% (1.1) pts. (0.1) pts. in the growth markets as clients build out their infrastructures. ITS Global Business Services 28.3% (2.0) pts. (0.2) pts. revenue decreased 0.6 percent (flat adjusted for currency) versus Software 88.5% 0.9 pts. 0.3 pts. the prior year. Revenue performance in the fourth quarter improved Systems and Technology 43.9% 1.4 pts. 0.2 pts. from previous quarters with the growth markets continuing to have Global Financing 51.8% (0.1) pts. (0.0) pts. good performance. GTS gross profit margin of 34.7 percent declined 1.1 points Total expense and other income increased 7.5 percent in the fourth compared to the fourth quarter of 2009. The GTS segment pre-tax quarter compared to the prior year, in line with the revenue growth profit of $1,657 million was up 6.5 percent and the margin expanded in the quarter. The year-to-year drivers were approximately: 0.9 points to 15.8 percent from the fourth quarter of 2009. GBS revenue of $4,758 million increased 3.9 percent (4 percent • Operational expense, 5 points adjusted for currency) compared to the fourth quarter of 2009 • Currency,* (2) points with growth both in outsourcing and the transactional businesses: • Acquisitions,** 4 points consulting and systems integration. In the quarter, GBS gained * Reflects impacts of translation and hedging programs. share overall with gains in Consulting and sustained share in ** Includes acquisitions completed in prior 12-month period. Application Management Services. From a geographic perspective, revenue performance was led by North America with growth of 11 Pre-tax income increased 9.0 percent and pre-tax margin improved percent, adjusted for currency. From an industry sector perspective, 0.5 points to 24.0 percent versus the fourth quarter of 2009. Net revenue growth was led by Distribution, Financial Services, Industrial income increased 9.2 percent and the net income margin improved and General Business. The growth initiatives continued to have 0.4 points to 18.1 percent. good performance with GBS business analytics revenue up over Diluted earnings per share improved 16.4 percent reflecting 40 percent in the fourth quarter. the growth in net income and the benefits of the common stock GBS gross profit margin of 28.3 percent declined 2.0 points repurchase program. In the fourth quarter, the company repur- year to year. The GBS segment pre-tax profit of $746 million chased 25.1 million shares of its common stock. Diluted earnings declined 2.7 percent in the fourth quarter and pre-tax margin per share of $4.18 increased $0.59 from the prior year driven by declined 0.9 points to 15.0 percent. GBS has improved utilization the following factors: and delivery excellence, while continuing to invest in globally integrated capabilities and skills to support growth initiatives. • Revenue increase at actual rates, $0.24 Software revenue of $7,039 million increased 7.0 percent (8 • Operating leverage, $0.09 percent adjusted for currency). Adjusting for the divested PLM • Common stock repurchases, $0.26 operations, revenue grew at 12 percent adjusted for currency in the fourth quarter. Revenue from Key Branded Middleware Segments increased 13.4 percent (15 percent adjusted for currency) and The Global Services segments had combined revenue of $14,923 gained share for the 13th straight quarter as the software business million in the fourth quarter, an increase of 2.0 percent (2 percent continued to extend its lead in the middleware market. Software adjusted for currency) and delivered pre-tax profit of $2,403 million, revenue continues to mix to the faster growing branded middleware an increase of 3.5 percent year to year. Total signings for Global and, in the fourth quarter, it accounted for 66 percent of total Services in the fourth quarter were $22,094 million, an increase software revenue, an increase of 3 points year to year. Revenue of 17.8 percent (18 percent adjusted for currency) versus 2009. performance in the fourth quarter of 2010 was led by WebSphere Outsourcing signings of $14,138 million increased 24.2 percent (23 which increased 32.2 percent (34 percent adjusted for currency), percent adjusted for currency). Transactional signings increased Tivoli up 12.1 percent (14 percent adjusted for currency), Rational 7.8 percent (9 percent adjusted for currency) to $7,956 million up 10.2 percent (12 percent adjusted for currency) and Information with growth in both GBS and GTS. Signings in the quarter included Management up 10.4 percent (12 percent adjusted for currency). 19 deals greater than $100 million. The company continues to add to its software capabilities. With


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    Management Discussion 38 International Business Machines Corporation and Subsidiary Companies the acquisition of Netezza, the value of business analytics can be Systems and Technology gross margin of 43.9 percent extended to both large enterprises and smaller clients with a system increased 1.4 points versus the fourth quarter of 2009 primarily that is simple, economical and offers quick time-to-value. Netezza reflecting a richer revenue mix to System z. The Systems and got off to a strong start in the quarter and complements the Technology segment pre-tax profit increased 45.1 percent to company’s business analytics and optimization capabilities. $1,208 million. Pre-tax margin increased 3.2 points to 18.6 percent The fourth quarter concluded a strong year for the software compared to the fourth quarter of 2009. segment. Software gross profit increased 0.9 points to 88.5 percent. Global Financing revenue of $628 million increased 1.2 percent The Software segment delivered pre-tax profit of $3,172 million, (1 percent adjusted for currency), driven primarily by an increase an increase of 3.7 percent with a pre-tax margin of 40.6 percent. in used equipment sales revenue. The Global Financing segment Systems and Technology revenue of $6,277 million increased fourth-quarter pre-tax profit increased 14.0 percent to $567 million 21.0 percent (22 percent adjusted for currency), the best quarterly and the pre-tax margin expanded 3.4 points to 47.1 percent from revenue performance in over a decade. Revenue was driven by the fourth quarter of 2009. The company’s financing business growth in all brands with strong double-digit growth in System z, delivered good results as the global economy continued to emerge Power Systems entry systems, System x, Storage disk products, from a challenging credit environment. Retail Store Solutions and Microelectronics OEM. Both the major markets and growth markets had revenue growth in excess of 20 Geographic Revenue percent in the quarter. Total servers gained 3 points of market Total geographic revenue of $28,234 million increased 6.2 percent share with each of the server brands gaining share while Storage (7 percent adjusted for currency) year to year in the fourth quarter held share. System z revenue increased 69.2 percent (72 percent with constant currency growth in all geographies. Revenue from adjusted for currency). This performance reflects the value and the major markets increased 3.9 percent (5 percent adjusted innovation System z delivers to clients. System z MIPS shipments for currency) and improved 5 points from the constant currency increased 58 percent year to year. The fourth-quarter MIPS per- performance in the third quarter. The fourth-quarter revenue formance was the highest quarterly growth in six years. Power growth was driven by the U.S., France and Italy. The U.S.—the Systems revenue increased 1.8 percent (3 percent adjusted for company’s largest market—grew 10 percent, representing the currency) and gained share for the 11th consecutive quarter. This strongest year-to-year growth in 11 years. Revenue from the growth was the first quarter with the complete POWER7 product line avail- markets increased 15.4 percent (13 percent adjusted for currency); able. The newly introduced entry systems had strong customer adjusted for currency, revenue growth outpaced the major markets acceptance with revenue growth of 29.9 percent (31 percent by 8 points in the quarter. In the BRIC countries, which represented adjusted for currency) year to year. Mid-range Power Systems approximately 41 percent of the growth markets revenue in the revenue grew 6.7 percent (8 percent adjusted for currency), the quarter, revenue increased 18.7 percent (17 percent adjusted for third consecutive quarter of revenue growth. The high-end prod- currency) with growth in each of the four countries led by strong uct set has strong momentum entering 2011 as it shipped nearly growth in China (up 27.0 percent, 25 percent adjusted for currency) 200 high-end 795 servers in the fourth quarter of 2010, three times and Russia (up 45.2 percent, 46 percent adjusted for currency). as many as the third quarter of 2010. The company’s competitive Revenue growth in the growth markets continues to be broad take outs continued in the fourth quarter, with over 280 displace- based with double-digit growth in 50 countries, adjusted for ments driving approximately $325 million of business. Storage currency, up from 32 countries in the third quarter of 2010. In the revenue increased 8.3 percent (10 percent adjusted for currency) fourth quarter, the company gained share overall in the growth led by the growth markets which increased 23 percent adjusted markets as well as in hardware and software. Total Americas for currency, the third consecutive quarter of growth above 20 revenue of $12,151 million increased 9.4 percent (9 percent adjusted percent. Total disk revenue increased 10.9 percent (13 percent for currency). EMEA revenue decreased 1.8 percent (increased adjusted for currency) driven by the continued strength in high-end 4 percent adjusted for currency) to $9,516 million. Adjusted for storage, XIV and the DS8000 product. XIV added more than 200 currency, revenue performance was led by France with strong new customers to its platform in the fourth quarter. Storage had double-digit growth (7.3 percent, 17 percent adjusted for currency) a successful launch of its new V7000 mid-range product which and solid performance in Italy (declined 3.9 percent, increased was sold out in the fourth quarter. System x revenue increased 5 percent adjusted for currency). Revenue performance was mixed 18.3 percent (18 percent adjusted for currency), the fifth consecu- across the other major market countries with the U.K. down tive quarter of double-digit revenue growth. High-end System x 1.5 percent (up 2 percent adjusted for currency), Germany down revenue increased 31.0 percent (31 percent adjusted for currency) 10.7 percent (3 percent adjusted for currency) and Spain down 6.2 and System x blades revenue grew 14.1 percent (14 percent percent (up 2 percent adjusted for currency). Asia Pacific revenue adjusted for currency). Retail Stores Solutions revenue increased increased 13.6 percent (7 percent adjusted for currency) to $6,567 25.6 percent (27 percent adjusted for currency) and extended the million, with the growth markets up 19.7 percent (14 percent company’s leadership position as a point of sale provider. adjusted for currency) and Japan up 6.5 percent (decreased Microelectronics OEM revenue increased 29.6 percent (30 percent 2 percent adjusted for currency). adjusted for currency) in the fourth quarter with strong growth from networking and game console products.


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    Management Discussion International Business Machines Corporation and Subsidiary Companies 39 Expense Prior Year in Review Total expense and other income increased 7.5 percent year to year with an expense-to-revenue ratio of 25.1 percent compared The “Prior Year in Review” section provides a summary of the to 24.8 percent in the fourth quarter of 2009. The increase in total company’s financial performance in 2009 as compared to 2008. expense and other income was primarily driven by the company’s For a detailed discussion of 2009 performance, see the 2009 acquisitions over the past 12 months, a higher level of expense in Annual Report. support of fourth-quarter revenue performance and investment in capacity to support future growth. Within SG&A expense, work- ($ and shares in millions except per share amounts) force rebalancing charges decreased approximately $60 million Yr.-to-Yr. Percent/ compared to a relatively high level of activity in the fourth quarter Margin of 2009. With the year-to-year change in currencies, the hedge For the year ended December 31: 2009 2008 Change of cash flow program generated a loss of approximately $40 million Revenue $ 95,758 $103,630 (7.6)%* in the fourth quarter of 2010 compared with a loss of over $250 Gross profit margin 45.7% 44.1% 1.7 pts. million in the fourth quarter of 2009. Total expense and other income $ 25,647 $ 28,945 (11.4)% The company’s effective tax rate in the fourth quarter of 2010 Total expense and other was 24.4 percent compared with 24.6 percent in the fourth quarter income-to-revenue ratio 26.8% 27.9% (1.1) pts. of 2009. Income before income taxes $ 18,138 $ 16,715 8.5% Share repurchases totaled $3,592 million in the fourth quarter. Provision for income taxes 4,713 4,381 7.6% The weighted-average number of diluted common shares out- Net income $ 13,425 $ 12,334 8.8% standing in the fourth quarter of 2010 was 1,258.4 million compared Net income margin 14.0% 11.9% 2.1 pts. with 1,340.7 million in the fourth quarter of 2009. Earnings per share of common stock: Cash Flow Assuming dilution $ 10.01 $ 8.89 12.6% The company ended the fourth quarter of 2010 with $10,661 million Weighted-average shares in cash and cash equivalents, an increase of $801 million from outstanding: September 30, 2010. The company generated $6,795 million in Assuming dilution 1,341.4 1,387.8 (3.3)% cash flow provided by operating activities, an increase of $347 Assets** $109,022 $109,524 (0.5)% million compared to the fourth quarter of 2009, driven primarily by Liabilities** $ 86,267 $ 95,939 (10.1)% working capital/other ($978 million) and an increase in net income Equity** $ 22,755 $ 13,584 67.5% ($445 million), partially offset by Global Financing receivables * (5.3) percent adjusted for currency. ($1,060 million). Net cash used in investing activities of $4,082 ** At December 31. million increased $1,587 million primarily due to increased acquisi- tions of $1,859 million. Net cash used in financing activities of In 2009, in a difficult global economic environment, the company $1,859 million increased $653 million due to higher payments to continued to deliver value to its clients and strong financial results repurchase common stock ($538 million), lower cash from other to its investors—with profit growth driven by continued margin common stock transactions ($401 million) and increased dividend expansion, expense productivity, market share gains in software payments ($81 million), partially offset by an increased net benefit and systems and a continuing strong cash position. The company associated with debt ($367 million). again achieved record levels of pre-tax profit, earnings per share and cash flow from operations—despite a decline in revenue. The financial performance reflected the strength of the company’s global model and the results of the strategic transformation of the business.


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    Management Discussion 40 International Business Machines Corporation and Subsidiary Companies For the year, the company delivered $10.01 in diluted earnings Total expense and other income decreased 11.4 percent in 2009 per share, an increase of 12.6 percent year to year. This was the versus 2008. The year-to-year drivers were approximately: seventh consecutive year of double-digit earnings per share growth. In 2007, the company developed a Road Map for growth • Operational expense, (9) points with an earnings per share objective for 2010 of $10 to $11 per • Currency,* (4) points share. With its performance in 2009, the company achieved this • Acquisitions,** 1 point * Reflects impacts of translation and hedging programs. objective one year early. ** Includes acquisitions completed in prior 12-month period. Total revenue decreased 7.6 percent (5 percent adjusted for currency) compared to 2008. Revenue from the growth markets Pre-tax income grew 8.5 percent and the pre-tax margin was 18.9 declined 3.5 percent, but increased 1 percent at constant currency. percent, the highest level in more than a decade. Net income Performance was led by the BRIC countries of Brazil, Russia, India increased 8.8 percent reflecting a slight improvement in the tax and China which increased 4 percent, adjusted for currency. rate. The effective tax rate for 2009 was 26.0 percent, compared Segment performance was driven by Software which decreased with 26.2 percent in 2008. 3.1 percent year to year (1 percent adjusted for currency) and Global Diluted earnings per share improved 12.6 percent reflecting Technology Services which declined 4.9 percent (2 percent the strong growth in net income and the benefits of the common adjusted for currency). Within Software, performance was led by key stock repurchase program. In 2009, the company repurchased branded middleware which increased revenue 1.1 percent (3 per- approximately 69 million shares of its common stock. Diluted cent adjusted for currency) compared to the prior year. earnings per share of $10.01 increased $1.12 from the prior year Gross profit margins improved reflecting the shift to higher driven by the following factors: value businesses and the continued focus on productivity and cost management. The consolidated gross profit margin increased • Revenue decrease at actual rates, $(0.68) 1.7 points versus 2008 to 45.7 percent. This was the sixth • Operating leverage, $ 1.46 consecutive year of improvement in the gross profit margin. Gross • Common stock repurchases, $ 0.34 profit margin performance by segment and the impact to the consolidated gross margin was as follows: At December 31, 2009, the company’s balance sheet and liquidity positions remained strong. Cash on hand was $12,183 million. Total debt decreased $7,826 million year to year, and the company Gross Yr.-to-Yr. Consolidated Margin Change Impact generated $20,773 million in operating cash flow in 2009. The Global Technology Services 35.0% 2.4 pts. 0.8 pts. company has consistently generated strong cash flow from oper- ations and also continues to have access to additional sources of Global Business Services 28.2% 1.5 pts. 0.4 pts. liquidity through the capital markets and its global credit facility. Software 86.0% 0.6 pts. 0.6 pts. Systems and Technology 37.8% (0.2) pts. 0.1 pts. Global Financing 47.5% (3.8) pts. (0.1) pts. The following is an analysis of the 2009 versus 2008 reportable segment results for Global Services, Systems and Technology and Software. The Global Financing segment analysis is included in the Global Financing section on pages 55 through 59. Global Services ($ in millions) Yr.-to-Yr. Yr.-to-Yr. Change Adjusted For the year ended December 31: 2009* 2008* Change for Currency Global Services external revenue: $55,000 $58,891 (6.6)% (4.0)% Global Technology Services: $37,347 $39,264 (4.9)% (2.0)% Outsourcing 21,620 22,734 (4.9) (2.0) Integrated Technology Services 8,771 9,283 (5.5) (2.9) Maintenance 6,956 7,250 (4.1) (1.1) Global Business Services $17,653 $19,628 (10.1)% (8.1)% * Reclassified to conform with 2010 presentation.


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    Management Discussion International Business Machines Corporation and Subsidiary Companies 41 The Global Services segments, GTS and GBS, had combined Global Business Services revenue decreased 10.1 percent revenue of $55,000 million, a decrease of 6.6 percent (4 percent (8 percent adjusted for currency) in 2009 driven primarily by a adjusted for currency) in 2009 when compared to 2008. Services double-digit decline in Consulting and Systems Integration revenue. revenue performance was supported by its annuity revenue base, Application Outsourcing signings increased 27.1 percent (25 per- but also reflected the challenges in the more economically sensitive cent adjusted for currency), illustrating the strong value proposition consulting business. Application Outsourcing can provide to clients with compelling Total Global Services signings of $57,094 million decreased 0.2 cost savings. Consulting and Systems Integration signings decreased percent (increased 2 percent adjusted for currency). Outsourcing 10.2 percent (8 percent adjusted for currency). signings of $33,014 million increased 8.8 percent (11 percent adjusted for currency). Outsourcing signings growth was broad ($ in millions) based across all the major geographies. Transactional signings were Yr.-to-Yr. For the year ended December 31: 2009 2008 Change $24,081 million, a decrease of 10.2 percent (8 percent adjusted for currency). The estimated Global Services backlog at actual currency Global Services: Global Technology Services: rates was $137 billion at December 31, 2009, an increase of $7 billion ($1 billion adjusted for currency) from December 31, 2008 External gross profit $13,081 $12,802 2.2% and an increase of $2 billion ($3 billion adjusted for currency) from External gross profit margin 35.0% 32.6% 2.4 pts. September 30, 2009. Pre-tax income $ 5,537 $ 4,607 20.2% The Global Services segments delivered a combined pre-tax Pre-tax margin 14.3% 11.3% 3.0 pts. profit of $8,092 million in 2009, a growth of 11.0 percent versus Global Business Services: 2008, and expanded pre-tax margin 2.3 points to 14.1 percent. External gross profit $ 4,979 $ 5,238 (4.9)% The improved margin was a result of the structural changes made External gross profit margin 28.2% 26.7% 1.5 pts. to services delivery over the past several years. The services global Pre-tax income $ 2,555 $ 2,681 (4.7)% delivery capabilities have proven to be dynamic and flexible enough Pre-tax margin 13.8% 13.0% 0.8 pts. to deal with very tough market conditions. Overall, the Global Services business delivered strong margin and signings perfor- mance in a difficult economic climate. GTS gross profit margin improved 2.4 points to 35.0 percent in Global Technology Services revenue of $37,347 million decreased 2009 and expanded in all lines of business when compared to 4.9 percent (2 percent adjusted for currency) in 2009 versus 2008. 2008. Outsourcing gross margin improved for the fifth consecutive Outsourcing signings of $25,507 million increased 4.3 percent year, while also improving overall service delivery quality. This has (8 percent adjusted for currency) with growth of 7 percent in the been accomplished through a disciplined and innovative approach major markets and 14 percent in the growth markets, adjusted for to delivery focused on both labor and non-labor productivity actions. currency. Integrated Technology Services signings of $9,196 million GTS has been executing a strategy to deliver services out of key decreased 10.3 percent (8 percent adjusted for currency). global delivery centers using consistent global delivery methods Outsourcing revenue decreased 4.9 percent (2 percent adjusted and processes. The delivery centers are also improving labor for currency). Outsourcing revenue performance, adjusted for utilization with analytics and by applying supply chain tools and currency, was consistent throughout the year, although impacted techniques to the labor base. Integrated Technology Services gross by reduced volumes in the existing client base. Revenue trends in margin improved as the result of mixing the portfolio to more prof- Outsourcing should improve in 2010 as a result of the 2009 signings itable labor-based services. Segment pre-tax profit increased 20.2 performance. percent to $5,537 million with a pre-tax margin of 14.3 percent, an Integrated Technology Services (ITS) revenue decreased 5.5 increase of 3.0 points versus 2008. percent (3 percent adjusted for currency) in 2009 versus 2008. GBS gross profit margin improved 1.5 points to 28.2 percent in Revenue performance largely reflects recent signings performance 2009 with an improving margin trend throughout the year. Segment which continued to be impacted by declines in OEM offerings, as pre-tax profit was down 4.7 percent to $2,555 million, however, the the ITS portfolio shifts to higher value, higher margin offerings. margin improved 0.8 points year over year. Throughout the year, the dynamic GBS delivery model enabled solid profit performance in a tough economic climate. The pre-tax margin expansion also included improving trends throughout the year and was driven primarily by improved delivery center utilization, reduced subcon- tractor spending and improved cost and expense management.


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    Management Discussion 42 International Business Machines Corporation and Subsidiary Companies Software ($ in millions) Yr.-to-Yr. Yr.-to-Yr. Change Adjusted For the year ended December 31: 2009* 2008* Change for Currency Software external revenue: $21,396 $22,089 (3.1)% (0.8)% Middleware $17,125 $17,305 (1.0)% 1.4% Key Branded Middleware 12,524 12,392 1.1 3.4 WebSphere 10.5 12.7 Information Management (0.5) 1.9 Lotus (10.0) (7.9) Tivoli 2.9 5.1 Rational 0.2 2.7 Other middleware 4,602 4,912 (6.3) (3.5) Operating systems 2,163 2,337 (7.4) (4.9) Other 2,108 2,448 (13.9) (12.0) * Reclassified to conform with 2010 presentation. Software revenue of $21,396 million decreased 3.1 percent (1 percent Information Management revenue decreased 0.5 percent adjusted for currency) in 2009 compared to 2008. Adjusted for (increased 2 percent adjusted for currency) in 2009 versus the prior currency, growth in the Key Branded Middleware products was year, with revenue growth, adjusted for currency, in both Information offset by decreased revenue in other components of the software Management solutions and infrastructure offerings. Cognos and portfolio. Overall, the software business continued to perform well InfoSphere software, two key components of the business analytics in the uncertain environment. The company’s acquisitions increased area, both had double-digit revenue growth adjusted for currency. revenue and the company is continuing to invest in capabilities The acquisition of SPSS, which was completed in early October that accelerate the development of new market opportunities like 2009, further expands the company’s business analytics capabilities. business analytics and smarter planet. Lotus revenue decreased 10.0 percent (8 percent adjusted for Key Branded Middleware revenue increased 1.1 percent currency) in 2009. Demand for Lotus software was impacted by (3 percent adjusted for currency) and represented 59 percent of customer consolidations and downsizing throughout 2009. total Software revenue, an increase of 2 points from 2008. The Tivoli revenue increased 2.9 percent (5 percent adjusted for company continued to solidify its lead in the middleware market, currency) in 2009 when compared to 2008, driven by growth in gaining share for nine consecutive quarters. Organic investments storage software. Tivoli storage revenue grew consistently and acquisitions in middleware capabilities continue to result in it throughout the year as customers managed their rapidly growing becoming a larger portion of the software portfolio and improving storage data. the overall software revenue growth rate. Growth in 2009, adjusted Rational revenue increased 0.2 percent in 2009 as reported and for currency, was led by WebSphere and Tivoli. increased 3 percent adjusted for currency versus 2008. Rational’s WebSphere revenue increased 10.5 percent (13 percent integrated software tools improve the speed, quality and efficiency adjusted for currency) in 2009 with strong performance through- for customers with software development projects. Telelogic con- out the year. Application Servers, which provide customers with tributed strong revenue growth in 2009 and extended the brand’s a secure and resilient infrastructure for mission-critical business reach into the systems development market opportunity. applications, grew 5 percent adjusted for currency. Business Revenue from Other middleware products decreased 6.3 Integration software had double-digit revenue growth in 2009, percent (3 percent adjusted for currency) in 2009 versus the prior including strong contribution from ILOG, a company acquired year. This software product set includes more mature products in the fourth quarter of 2008. which provide a more stable flow of revenue. Operating systems product revenue decreased 7.4 percent (5 percent adjusted for currency) in 2009 compared to 2008, reflecting declining sales in all system brands. Other revenue declined 13.9 percent (12 percent adjusted for currency) versus 2008 primarily driven by a decrease in PLM software.


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    Management Discussion International Business Machines Corporation and Subsidiary Companies 43 ($ in millions) Software gross profit of $18,405 million in 2009 decreased 2.4 Yr.-to-Yr. percent versus 2008, driven primarily by declining revenue. Gross For the year ended December 31: 2009 2008 Change profit margin expanded 0.6 points to 86.0 percent in 2009. The Software: Software segment delivered $8,095 million of pre-tax profit in External gross profit $18,405 $18,859 (2.4)% 2009, an increase of 14.4 percent versus 2008. The segment pre- External gross profit margin 86.0% 85.4% 0.6 pts. tax profit margin expanded 5.2 points to 33.6 percent. The breadth Pre-tax income $ 8,095 $ 7,075 14.4% of the software portfolio, the strong recurring revenue stream and Pre-tax margin 33.6% 28.5% 5.2 pts. the actions taken to improve efficiency and productivity combined to deliver strong profit results. Systems and Technology ($ in millions) Yr.-to-Yr. Yr.-to-Yr. Change Adjusted For the year ended December 31: 2009 2008 Change for Currency Systems and Technology external revenue: $16,190 $19,287 (16.1)% (14.9)% System z (28.7)% (27.5)% Power Systems (10.7) (9.2) System x (4.6) (3.3) Storage (12.0) (11.0) Retail Store Solutions (25.6) (23.6) Total Systems (15.9) (14.6) Microelectronics OEM (15.1) (15.2) Systems and Technology revenue decreased 16.1 percent (15 System x revenue decreased 4.6 percent (3 percent adjusted percent adjusted for currency) in 2009 versus 2008 reflecting the for currency) in 2009 versus 2008. Revenue performance in the challenges that transactional-based businesses faced in the second half of the year was strong with third-quarter revenue difficult economic environment. While revenue performance increasing 0.6 percent (2 percent adjusted for currency) and fourth- declined in 2009, the rate of decline improved sequentially in the quarter revenue increasing 36.8 percent (30 percent adjusted for third and fourth quarters. The company gained share in Power currency) compared to the prior-year periods. System x server Systems, System x, blades and Storage external disk and tape revenue declined 4 percent, primarily driven by decreased low-end storage during 2009. server revenue (10 percent) in 2009 versus 2008. Blades revenue System z revenue decreased 28.7 percent (28 percent adjusted increased 11 percent in 2009 versus 2008. System x server gained for currency) in 2009 versus 2008. MIPS (millions of instructions share in four consecutive quarters. The company’s improved sales per second) shipments decreased 13 percent in 2009 versus model and enhanced product offerings were the key contributors the prior year. MIPS increased 4 percent in 2009 on a two year to this performance. compounded growth rate and this performance was consistent Storage revenue decreased 12.0 percent (11 percent adjusted with what the company expected at this point in the product cycle. for currency) in 2009 versus 2008. Total disk revenue decreased In the third quarter, the company introduced System z Solution 9 percent versus 2008. These decreases were driven by declines Editions, which expanded the platform’s value proposition to both in mid-range disk revenue of 18 percent and decreased Enterprise new and existing clients. Disk revenue of 6 percent. In the fourth quarter, the company intro- Power Systems revenue decreased 10.7 percent (9 percent duced the DS8700 product, the latest addition to the DS8000 line adjusted for currency) in 2009 versus 2008. Low-end server of high-end disk systems. The company’s storage acquisitions, XIV revenue declined 43 percent, mid-range server revenue decreased and Diligent, had strong performance. XIV has added over 400 new 2 percent and high-end server revenue decreased 10 percent customers since the acquisition. Tape revenue declined 20 percent versus 2008. Although revenue declined, the company continued in 2009 versus 2008. to gain market share in the mid range and high end by helping Retail Stores Solutions revenue decreased 25.6 percent (24 clients increase efficiency in their data centers by leveraging con- percent adjusted for currency) in 2009 versus 2008, reflecting solidation and virtualization results. This has led to seven con- continued weakness in the retail sector. secutive quarters of share gains. In addition, in 2009, the company Microelectronics OEM revenue decreased 15.1 percent (15 increased sales generated by UNIX competitive displacements to percent adjusted for currency), in 2009 versus 2008. Although over $600 million. 2009 revenue declined, second-half revenue improved significantly over first-half performance with performance essentially flat compared to the prior year.


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    Management Discussion 44 International Business Machines Corporation and Subsidiary Companies ($ in millions) Systems and Technology’s pre-tax income decreased Yr.-to-Yr. 8.5 percent in 2009 when compared to 2008 driven by lower For the year ended December 31: 2009 2008 Change revenue. Pre-tax margin increased 0.6 points in 2009 versus the Systems and Technology: prior year, reflecting the focus on cost and expense management External gross profit $6,127 $7,341 (16.5)% and improving productivity. External gross profit margin 37.8% 38.1% (0.2) pts. Pre-tax income $1,419 $1,550 (8.5)% Global Financing Pre-tax margin 8.3% 7.7% 0.6 pts. See pages 55 through 59 for an analysis of Global Financing’s segment results. The decrease in external gross profit for 2009 versus 2008 was primarily driven by lower revenue. Geographic Revenue Overall, gross margin decreased 0.2 points versus the prior In addition to the revenue presentation by reportable segment, the year. Margin improvements in System x, Power Systems and company also measures revenue performance on a geographic System z were offset by impacts due to product mix and a margin basis. The following geographic, regional and country-specific decline in Microelectronics. revenue performance excludes OEM revenue, which is discussed separately below. ($ in millions) Yr.-to-Yr. Yr.-to-Yr. Change Adjusted For the year ended December 31: 2009 2008 Change for Currency Total revenue: $95,758 $103,630 (7.6)% (5.3)% Geographies: $93,477 $100,939 (7.4)% (5.1)% Americas 40,184 42,807 (6.1) (5.1) Europe/Middle East/Africa 32,583 37,020 (12.0) (5.7) Asia Pacific 20,710 21,111 (1.9) (3.7) Major markets (8.2)% (6.4)% Growth markets (3.5)% 1.2% BRIC countries 0.7% 4.3% Geographic revenue decreased 7.4 percent (5 percent adjusted Europe/Middle East/Africa (EMEA) revenue decreased 12.0 for currency) to $93,477 million in 2009 when compared to 2008, percent (6 percent adjusted for currency) in 2009 when compared with relatively consistent performance, adjusted for currency, to 2008. Revenue decreased in the major market countries with across the geographies. Revenue from the growth markets year-to-year declines in the U.K. of 13.6 percent (increased 1 percent decreased 3.5 percent (increased 1 percent adjusted for currency) adjusted for currency), Germany 10.3 percent (6 percent adjusted and revenue from the major markets decreased 8.2 percent for currency), France 11.6 percent (7 percent adjusted for currency), (6 percent adjusted for currency). While the economic environment Italy 11.3 percent (7 percent adjusted for currency) and Spain 12.6 slowed globally in 2009, revenue growth, adjusted for currency, in percent (8 percent adjusted for currency). the growth markets remained approximately 8 points higher than Asia Pacific revenue decreased 1.9 percent (4 percent adjusted the major markets. The company has been investing to capture for currency) year over year. Revenue in the Asia Pacific growth the opportunity in the emerging markets as these countries build markets decreased 2.4 percent (increased 3 percent adjusted for out their public and private infrastructures. The growth markets currency), led by growth in China and India. China revenue increased contributed 19 percent of the geographic revenue in 2009, 1 point 10 percent, adjusted for currency, as the company leveraged its higher versus 2008. Within the BRIC countries, revenue increased broad portfolio to provide comprehensive solutions to clients. India 0.7 percent (4 percent adjusted for currency) led by growth in revenue increased 6 percent, adjusted for currency. Japan revenue China, India and Brazil, adjusted for currency. decreased 1.4 percent (10 percent adjusted for currency). Americas revenue decreased 6.1 percent (5 percent adjusted The company continues to see growing opportunity globally— for currency) in 2009. Within the major market countries, the U.S. much of which is outside the traditional IT opportunity—to help declined 6.5 percent and Canada decreased 7.1 percent (1 percent its clients drive efficiency in their physical infrastructures. adjusted for currency). Revenue in the Latin America growth markets decreased 3.4 percent (increased 1 percent adjusted for currency) led by growth in Brazil (increased 3 percent adjusted for currency).


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    Management Discussion International Business Machines Corporation and Subsidiary Companies 45 OEM revenue of $2,281 million in 2009 declined 15.2 percent Other (income) and expense was income of $351 million in (15 percent adjusted for currency) compared to 2008 driven by 2009, an increase in income of $53 million year to year. The reduced demand year over year in the technology OEM business. increase was driven by several key factors: the $298 million gain Year-to-year revenue performance improved in this business from the core logistics operations divestiture; increased foreign across the second half of 2009. currency transaction gains of $329 million; offset by less interest income of $249 million due to lower rates; less gains from securities Total Expense and Other Income transactions of $162 million due to Lenovo equity sales in 2008; and a 2009 loss provision related to a joint venture investment of ($ in millions) Yr.-to-Yr. $119 million. For the year ended December 31: 2009 2008 Change The company continues to invest in research and development, Total expense and other income $25,647 $28,945 (11.4)% focusing its investments on high-value, high-growth opportunities. Expense-to-revenue ratio 26.8% 27.9% (1.1) pts. Total RD&E expense decreased 8.2 percent in 2009 versus 2008; adjusted for currency, expense decreased 6 percent in 2009. The decrease in spending, adjusted for currency, was driven by The key drivers year to year in total expense and other income were continued process efficiencies and reductions in discretionary approximately: spending, partially offset by the impact of acquisitions. RD&E • Operational expense, (9) points investments represented 6.1 percent of total revenue in 2009, flat • Currency,* (4) points compared to 2008. • Acquisitions,** 1 point The timing and amount of sales and other transfers of IP may * Reflects impacts of translation and hedging programs. vary significantly from period to period depending upon timing of ** Includes acquisitions completed in prior 12-month period. divestitures, industry consolidation, economic conditions and the timing of new patents and know-how development. There were In 2009, the company continued to execute its operational plan no significant individual IP transactions in 2009 or 2008. to increase process efficiency and productivity; leveraging the The decrease in interest expense was primarily due to lower company’s scale and global presence. The company’s efforts have debt balances in 2009 versus 2008. Total debt at December 31, been focused on all areas of the business—from sales efficiency, 2009 was $26.1 billion; a decline year to year of $7.8 billion of supply chain management and service delivery to the global primarily non-Global Financing debt. Overall interest expense for support functions. The company’s cost and expense base 2009 was $1,109 million, a decrease of $353 million versus 2008. (approximately $80 billion) provides ample opportunity for savings and the company yielded approximately $3.7 billion in Income Taxes cost and expense savings in 2009. The company’s initiatives have The effective tax rate for 2009 was 26.0 percent, compared with contributed to an improved operational balance point and the 26.2 percent in 2008. The 0.2 point decrease was primarily driven improvements in margins and profit. As a result, the company is by a more favorable geographic mix of pre-tax income, the absence able to continue to invest in capabilities that will differentiate the of the 2008 tax cost impacts associated with the intercompany company in the future and accelerate the development of new transfer of certain intellectual property and the agreements reached market opportunities. regarding the completion of the U.S. federal income tax examina- Total SG&A expense decreased 10.4 percent (8 percent adjusted tion for the years 2004 and 2005, including the associated income for currency) in 2009 versus 2008. Overall, the decrease was tax reserve redeterminations. These benefits were offset by a driven by reductions in operational expense (down 9 points) as decrease in 2009 in the utilization of foreign tax credits. the company continued to focus on disciplined expense manage- ment, while investing for future growth. Currency impacts also Financial Position drove a year-to-year decline (down 3 points), partially offset by Total assets decreased $502 million (decreased $3,885 million acquisition-related spending (up 1 point). Workforce reductions adjusted for currency) from December 31, 2008, driven by: expense decreased $264 million, primarily due to actions taken in the fourth quarter of 2008, reflecting workforce actions in Japan • Decreases in cash and cash equivalents ($558 million) and ($120 million) and other ongoing skills rebalancing that is a regular total receivables ($1,301 million); and element of the company’s business model. Bad debt expense • Lower deferred taxes ($2,888 million) and intangible assets decreased $159 million primarily driven by reductions in specific ($365 million); partially offset by reserve requirements and lower accounts receivable balances in • Increased goodwill ($1,964 million) and prepaid pension assets 2009 versus 2008. The company’s accounts receivable provision ($1,401 million); and coverage was 2.0 percent, flat compared to the prior year. • Higher level of marketable securities ($1,625 million).


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    Management Discussion 46 International Business Machines Corporation and Subsidiary Companies The company had $13,973 million in cash and marketable securities In an effort to provide better transparency into the operational at December 31, 2009. results of the business, the company will separate business results Total liabilities decreased $9,672 million (decreased $11,213 into operating and non-operating categories. Operating earnings million adjusted for currency) from December 31, 2008 driven by: is a non-GAAP measure that excludes the effects of certain acqui- sition-related charges and retirement-related costs, and their • Lower total debt ($7,826 million); related tax impacts. For acquisitions, operating earnings will • Decrease in retirement-related benefit obligations ($3,500 exclude the amortization of purchased intangible assets and million); partially offset by acquisition-related charges such as in-process research • Higher tax liabilities ($1,083 million); and and development, transaction costs, applicable restructuring • Increased deferred income ($997 million). and related expenses and tax charges related to acquisition integration. In the technology sector, it is common practice to Total equity of $22,755 million increased $9,170 million from the provide earnings information on a non-GAAP basis that excludes prior year-end balance as a result of: acquisition-related items. Within retirement-related costs, given the significant impact that the debt and equity markets can have • Higher retained earnings ($10,546 million); on the company’s retirement-related costs and the fact that these • Increase in foreign currency translation adjustments ($1,732 market forces are not under direct management control and are million); non-operational, the company has characterized certain items as • Increase in retirement-related items ($1,727 million) and common operating and others as non-operating. The company will include stock ($2,682 million); partially offset by defined benefit plan and nonpension postretirement benefit plan • Increased treasury stock ($7,072 million); and service cost, amortization of prior service cost and the cost of • Increased net unrealized losses on cash flow derivatives defined contribution plans in operating earnings. Non-operating ($556 million). retirement-related cost will include defined benefit plan and non- The company generated $20,773 million in cash flow provided by pension postretirement benefit plan interest cost, expected return operating activities, an increase of $1,961 million, compared to on plan assets, amortized actuarial gains/losses, the impacts of 2008, primarily driven by a decrease in receivables ($1,857 million). any plan curtailments/settlements and multi-employer/pension Net cash used in investing activities of $6,729 million was $2,556 insolvency/other costs. These costs are primarily those related to million lower than 2008, primarily due to the prior year Cognos changes in pension plan assets and liabilities which are tied to acquisition and the core logistics operations divestiture in 2009, financial market performance and the company considers these partially offset by the year-to-year impacts related to marketable costs to be outside the operational performance of the business. securities and other investments. Overall, the company believes that providing investors with a Net cash used in financing activities of $14,700 million was view of operating earnings will provide better transparency and $2,866 million higher, primarily due to debt repayments ($5,019 clarity into both the operational results of the business and the million), partially offset by lower common stock repurchases impact of the performance of the company’s pension plans; ($3,150 million) in 2009 versus 2008. improve visibility to management decisions and their impacts on operational performance; enable better comparison to peer com- panies; and, allow the company to provide a long-term strategic Other Information view of the business going forward. There will be no changes to the balance sheet or cash flow presentation. The company Looking Forward will provide this view of its performance in addition to its GAAP The company enters 2011 in an excellent position with a strong reporting. The company’s calculation of operating earnings may portfolio of offerings, momentum in its key growth initiatives, a differ from similarly titled measures reported by other companies. solid operating model and a strong financial position. The company The objective of the company’s new Road Map for growth is will continue to transform the business by executing its strategy to achieve at least $20 of operating (non-GAAP) earnings per to shift to higher-value areas, improving operating leverage and diluted share in 2015. Consistent with the prior Road Map, the com- investing where management sees the best long-term opportunities. pany has identified the major drivers of financial performance: This transformation delivered solid performance in the past decade, revenue growth, operating leverage and common stock share an overachievement of the 2010 earnings per share Road Map and repurchase. The revenue growth will come from a combination of continues to position the company for growth going forward. base revenue growth, a mix to faster growing businesses and from In May 2010, the company met with investors and introduced acquisitions closed between 2010 and 2015. The contribution from a new Road Map for earnings per share in 2015, and also dis- operating leverage will be driven by the shift to higher-margin busi- cussed its transition to operating earnings beginning in 2011. nesses and enterprise productivity. The company is driving for $8 billion of productivity over the next five years—part which will result in improved profitability and part which will drive competitiveness in the marketplace. The company will also continue to return value


  • Page 49

    Management Discussion International Business Machines Corporation and Subsidiary Companies 47 to its shareholders, with approximately $50 billion of share repur- In addition, in January 2011, the company disclosed that it chase and $20 billion of dividends during the Road Map period. expected to recognize a gain on an asset sale in the first quarter of Overall, the company expects fairly balanced contribution from 2011. The company indicated that this gain would be primarily offset revenue growth, operating leverage and share repurchase. Similar in the first quarter by workforce rebalancing actions, predominately to its performance in the 2010 Road Map, the company is relying in Europe, although the company expects workforce rebalancing on the resilience of its business model to drive the overall objective charges to decline in total in 2011 versus 2010. In February 2011, the of at least $20 of operating (non-GAAP) earnings per diluted share company completed the majority of the asset sale and will record a in 2015. The company measures the success of its business model pre-tax gain of approximately $175 million in the first quarter of 2011. over the long term, not any individual quarter or year. The com- The company expects 2011 pre-tax retirement-related plan cost pany’s strategies, investments and actions are all taken with an to be approximately $1.9 billion, an increase of approximately $500 objective of optimizing long-term performance. million compared to 2010. This estimate reflects current pension plan For 2010, the company’s non-GAAP operating earnings per assumptions at December 31, 2010. Within total retirement-related diluted share was $11.67. From its reported earnings per diluted plan cost, operating retirement-related plan cost is expected to be share of $11.52, operating earnings excludes acquisition-related approximately $1.9 billion, an increase of approximately $100 million charges of $0.34 per share and non-operating retirement-related versus 2010. Non-operating retirement-related plan cost is expected costs which was income of $0.20 per share. The 2010 operating to be approximately zero versus income of $0.4 billion in 2010. earnings per diluted share of $11.67 is the company’s starting point Effective January 1, 2011, the company will implement new for its 2015 Road Map. The company will focus on operating earn- accounting standards that have been issued by the Financial ings going forward with management decisions, performance- Accounting Standards Board. These standards include: amended based compensation and business segment performance sup- guidance regarding pro-forma financial information related to busi- porting and tied to operating performance. ness combinations, amended guidance related to goodwill impair- In January 2011, the company disclosed that it is expecting ment testing, additional disclosures related to financing receivables GAAP earnings of at least $12.56 and operating (non-GAAP) and additional disclosures related to fair value measurements. The earnings of at least $13.00 per diluted share for the full year 2011. company has evaluated the new guidance and does not expect The operating (non-GAAP) earnings per share expectations an impact in the Consolidated Financial Statements. excludes acquisition-related charges of $0.41 per share and non- operating retirement-related costs of $0.03 per share. This expec- Liquidity and Capital Resources tation results in an increase year to year of 9 percent in GAAP The company has consistently generated strong cash flow from earnings per share and an increase of 11 percent year to year operations, providing a source of funds ranging between $15.0 in operating earnings per share. The company believes the billion and $20.8 billion per year over the past five years. The com- 11 percent growth in operating earnings puts the company on pany provides for additional liquidity through several sources: track to achieve its objective of at least $20 of operating earnings maintaining an adequate cash balance, access to global funding per share in 2015. sources, a committed global credit facility and other committed From a segment perspective, the company enters 2011 and uncommitted lines of credit worldwide. At December 31, 2010, with an excellent product lineup in the Systems and Technology the company had total unused lines of credit of $21,388 million. business, strong momentum in the Software business and good The following table provides a summary of the major sources of growth in the Global Services backlog. Within Systems and liquidity for the years ended December 31, 2006 through 2010. Technology, the new System z mainframe product had a great launch in the second half of 2010 and the company anticipates Cash Flow and Liquidity Trends continued opportunity and momentum for its hardware brands in the first quarter of 2011, resulting in an expected double-digit ($ in billions) 2010 2009 2008 2007 2006 revenue growth rate at constant currency compared to the first quarter of 2010. The Software business also had strong perfor- Net cash from operating activities $19.5 $20.8 $18.8 $16.1 $15.0 mance in the fourth quarter. The Software business is benefiting from the company’s strategic initiatives—business analytics, Cash and short-term marketable securities $11.7 $14.0 $12.9 $16.1 $10.7 smarter planet, growth markets and cloud—and the company Committed global credit expects this to continue in the first quarter with the Software facilities $10.0 $10.0 $10.0 $10.0 $10.0 business again delivering double-digit revenue growth at constant currency, excluding the divested PLM operations. The Global Services backlog, adjusted for currency, increased $4 billion from The major rating agencies’ ratings on the company’s debt securities year-end 2009 and $7 billion from the third quarter of 2010. As a at December 31, 2010 appear in the table on page 48. On November result, the company expects the Global Services revenue growth 23, 2010, Moody’s Investors Services raised its rating on the com- rate in the first quarter of 2011 to improve when compared to the pany’s senior long-term debt one level from A1 to Aa3. Standard fourth quarter of 2010. and Poor’s and Fitch Ratings debt ratings remained unchanged


  • Page 50

    Management Discussion 48 International Business Machines Corporation and Subsidiary Companies from December 31, 2009. The company’s debt securities do not term under GAAP and it should not be inferred that the entire free contain any acceleration clauses which could change the sched- cash flow amount is available for discretionary expenditures. The uled maturities of the obligation. In addition, the company does company defines free cash flow as net cash from operating not have “ratings trigger” provisions in its debt covenants or activities less the change in Global Financing receivables and net documentation, which would allow the holders to declare an event capital expenditures, including the investment in software. As of default and seek to accelerate payments thereunder in the event discussed on page 23, a key objective of the Global Financing of a change in credit rating. The company’s contractual agree- business is to generate strong returns on equity. Increasing receiv- ments governing derivative instruments contain standard market ables is the basis for growth in a financing business. Accordingly, clauses which can trigger the termination of the agreement if the management considers Global Financing receivables as a profit- company’s credit rating were to fall below investment grade. generating investment, not as working capital that should be At December 31, 2010, the fair value of those instruments that minimized for efficiency. After considering Global Financing receiv- were in a liability position was $1,006 million, before any applicable ables as an investment, the remaining net operational cash flow netting, and this position is subject to fluctuations in fair value less net capital expenditures is viewed by the company as free period to period based on the level of the company’s outstanding cash flow. instruments and market conditions. The company has no other From the perspective of how management views cash flow, in contractual arrangements that, in the event of a change in credit 2010, free cash flow was $16.3 billion, an increase of $1.2 billion rating, would result in a material adverse effect on its financial compared to 2009. This cash performance was driven primarily by position or liquidity. the growth in net income of $1.4 billion and increased cash provided by other assets/liabilities of $1.1 billion. These increases were Moody’s partially offset by higher income tax payments of approximately Standard Investors Fitch $1.0 billion and a decrease in cash of approximately $0.6 billion, & Poor’s Service Ratings as a result of lower tax refunds in 2010 versus the prior year. Senior long-term debt A+ Aa3 A+ Over the past five years, the company generated over $68 Commercial paper A-1 Prime-1 F1 billion in free cash flow. During that period, the company invested $18 billion in strategic acquisitions and returned over $72 billion to The company prepares its Consolidated Statement of Cash Flows shareholders through dividends and share repurchases. The in accordance with applicable accounting standards for cash flow amount of prospective returns to shareholders in the form of presentation on page 64 and highlights causes and events under- dividends and share repurchases will vary based upon several lying sources and uses of cash in that format on page 35. For factors including each year’s operating results, capital expenditure purposes of running its business, the company manages, monitors requirements, research and development investments and acqui- and analyzes cash flows in a different format. sitions, as well as the factors discussed on page 49. Management uses a free cash flow measure to evaluate the The company’s Board of Directors meets quarterly to consider company’s operating results, plan share repurchase levels, eval- the dividend payment. In the second quarter of 2010, the Board uate strategic investments and assess the company’s ability and of Directors increased the company’s quarterly common stock need to incur and service debt. Free cash flow is not a defined dividend from $0.55 to $0.65 per share. The table below represents the way in which management reviews cash flow as described above. ($ in billions) For the year ended December 31: 2010 2009 2008 2007 2006 Net cash from operating activities per GAAP (Continuing Operations) $ 19.5 $20.8 $ 18.8 $ 16.1 $15.0 Less: the change in Global Financing receivables (0.7) 1.9 (0.0) (1.3) (0.3) Net cash from operating activities (Continuing Operations), excluding Global Financing receivables 20.3 18.9 18.8 17.4 15.3 Capital expenditures, net (4.0) (3.7) (4.5) (5.0) (4.7) Free cash flow (excluding Global Financing receivables) 16.3 15.1 14.3 12.4 10.5 Acquisitions (5.9) (1.2) (6.3) (1.0) (3.8) Divestitures 0.1 0.4 0.1 0.3 — Share repurchase (15.4) (7.4) (10.6) (18.8) (8.1) Dividends (3.2) (2.9) (2.6) (2.1) (1.7) Non-Global Financing debt 2.3 (4.7) (3.2) 10.9 (1.1) Other (includes Global Financing receivables and Global Financing debt) 3.5 1.7 5.0 3.8 1.1 Change in cash, cash equivalents and short-term marketable securities $ (2.3) $ 1.1 $ (3.2) $ 5.5 $ (3.0)

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